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<h1 id="bitcoin-astronomy-part-ii"><a href="https://unchained-capital.com/blog/bitcoin-astronomy-part-ii/">Bitcoin Astronomy: Part II</a></h1>
<h3 id="by-dhruv-bansal">By <a href="https://twitter.com/dhruvbansal">Dhruv Bansal</a></h3>
<h3 id="posted-december-9-2020">Posted December 9, 2020</h3>
<p>This is Part II in a series of speculations about the hyperbitcoinized future. In <a href="https://unchained-capital.com/blog/law-of-hash-horizons/">Part I</a>, we defined the First Law of Bitcoin Astronomy and described how it incentivizes searching for energy to power our growing civilization.</p>
<p>In this part, we continue to <em>follow the energy</em> and speculate about how money and society coevolve as humanity expands through space. We begin with a brief review of Part I.</p>
<hr />
<h3 id="first-law-101">First Law 101</h3>
<p>In Part I, we speculated about a hyperbitcoinized humanity where bitcoin has become much more than just a currency or even a global financial system. In the future, bitcoin is deeply integrated into energy, telecommunications, logistics, and other sectors of Earthâs economy. Secondary and tertiary layers of networks settling into bitcoin are how markets, supply chains, and political systems organize themselves.</p>
<p><img src="/assets/images/2020/m12/db1.png" alt="" /></p>
<p><em>The âCenter of Hashâ was defined in <a href="https://unchained-capital.com/blog/law-of-hash-horizons/">Part I</a> of this series.</em></p>
<p>Humanity is also beginning to settle other planets such as Mars. This led us to explore how bitcoin works when great distances separate users and miners. We introduced the idea of a <em>center of hash</em> (above) and explained how it leads to the First Law of Bitcoin Astronomy: proof-of-work mining is not feasible far from the center of hash of a blockchain. All of a blockchainâs miners must be co-located within the same <em>hash horizon</em> â a spatial sphere with a diameter comparable to the the distance light can travel within that blockchainâs block time. Bitcoinâs choice of a 10 minute block time places Mars (at an average distance of 12 light minutes) outside of Earthâs hash horizon. Martians will be able to use bitcoin, but never mine it!</p>
<p>Mining is one of the most important industries of the hyperbitcoinized future. Itâs not just about capturing transaction settlement fees â the ability for anyone to turn energy directly into money incentivizes broader collection of energy and optimizes its distribution. Eager to kickstart this virtuous cycle (and a wave of financial speculation), distant colonies will launch their own bitcoin-like blockchains.</p>
<p>We followed the launch of Muskcoin, the first of these blockchains, on the planet Mars. The launch of Muskcoin is a kind of economic and political revolution. Terran miners will not support it, preferring to keep Martian transaction fees accumulating on Earth. The First Law of Bitcoin Astronomy is the reason Martians launch Muskcoin, but it will also be why Muskcoin survives; Terran miners are too far away from Muskcoinâs center of hash to prevent it from becoming the new currency of the Red Planet.</p>
<p>This pattern of expansion and revolution will repeat throughout the future. As great distances divide our civilization, the First Law ensures that those on the fringes will have both the incentive and the capability to launch their own blockchains. These pioneers will settle the outer planets, and eventually nearby stars, simply <em>because they are far away</em>.</p>
<h3 id="kardashev-civilizations">Kardashev Civilizations</h3>
<p>Before we continue our speculations, it will be useful to introduce some terminology for describing civilizations by their energy usage. Nikolai Kardashevâs <a href="https://www.centauri-dreams.org/2014/03/21/what-kardashev-really-said/">famous scale</a> categorizes civilizations as follows:</p>
<ul>
<li>A<strong>Â Type I</strong> civilization uses energy on a <em>planetary</em> scale (~1017 Watts)</li>
<li>A<strong>Type II</strong> civilization uses energy on a <em>stellar</em> scale (~1026 Watts)</li>
<li>A<strong>Type III</strong> civilization uses energy on a <em>galactic</em> scale (~1037 Watts)</li>
</ul>
<p><img src="/assets/images/2020/m12/db2.png" alt="" /></p>
<p>This scale is not precise and is more than a little arbitrary, but it does capture the vast gulf in energy usage between civilizations of different types: a Type II stellar civilization, for example, uses billions of times more energy than a Type I planetary civilization. The three original categories have since been extended (Type IV, Type V, &c.) and interpolated. A Type 2.1 civilization, for example, would use more energy than a Type II stellar civilization but less than a Type III galactic civilization.</p>
<p>Science fiction frequently describes fantastic megaprojects of advanced civilizations, such as space elevators and Dyson spheres, but it seldom articulates <em>how they pay for it all</em>. How can money develop the reach to coordinate society across solar systems and galaxies? What size market is required to settle the sale of a star system? Which reserve currency would an immortal future investor choose to hold? These questions are ignored by most science fiction writers who view money as either uninteresting because itâs just like todayâs or irrelevant because the future is post-scarcity.</p>
<blockquote>
<p>âŠif your theory is found to be against the second law of thermodynamics I can give you no hope; there is nothing for it but to collapse in deepest humiliation.</p>
</blockquote>
<p>â Sir Arthur Eddington</p>
<p>We believe that the laws of thermodynamics are inviolable. Energy will always be scarce, and using it will always create entropy through waste heat. The only quantity in the universe with infinite supply is human ambition. No future society will therefore ever be post-scarcity. For humanity, this means money and markets â and therefore blockchains â will always be useful for optimizing resource collection, distribution, and allocation.</p>
<h3 id="kardashev-blockchains">Kardashev Blockchains</h3>
<p>We believe money will scale with societyâs energy usage.</p>
<p>Today, at the dawn of bitcoin we are (by <a href="https://en.wikipedia.org/wiki/Kardashev_scale#cite_note-books.google.com-4">some measures</a>) a Type 0.7 âsub-planetaryâ civilization. By the time of the Muskcoin revolution, our burgeoning interplanetary civilization will have risen to somewhere between Type I and II on the Kardashev scale, though much closer to Type I.</p>
<p>As we continue towards becoming a Type II civilization, we will outgrow Type I âplanetary blockchains,â such as bitcoin or Muskcoin. We will still value these currencies, but will forge a new, <em>stellar blockchain</em> to span our entire solar system. We will call this Type II blockchain <strong>Solcoin</strong>, as it will come to be used for most trade occurring in orbit of the star Sol, our sun.</p>
<p>But money doesnât just scale in response to societyâs energy usage, it <em>causes it</em>: blockchains of higher type bootstrap civilizations of lower type up the Kardashev scale. Bitcoin was a Type I blockchain built by a Type 0.7 civilization. It incentivized energy collection near the Earth, propelling us up into orbit and out into the solar system towards becoming a Type I civilization. Solcoin is a Type II blockchain built by a Type 1.x civilization. It will incentivize energy collection across the entire solar system, powering megastructures and interstellar missions, enabling our species to expand through our galactic neighborhood.</p>
<p>When humanity eventually reaches other stars, we will launch blockchains there, too â first planetary, then stellar. Our eventual Type 2.x interstellar society will launch Type III <em>galactic blockchains</em>. This positive feedback between expanding societies and new blockchains will repeat at ever larger scales determined by the distribution of matter in the universe.</p>
<p>Weâll begin our story with the origin of Solcoin on the once great planet of Earth, sometime after the Muskcoin revolution.</p>
<h2 id="type-i-civilizations-launch-type-ii-blockchains">Type I Civilizations Launch Type II Blockchains</h2>
<p>The Muskcoin Revolution was a shock to many Terrans. Earth was the oldest, most populated, and most developed world, and the hashrate of Terran miners was tremendous. Yet Mars, a small colony that would have failed without continued investment and nourishment of Earth, successfully revolted against bitcoin.</p>
<p>The crucial factor in the success of this revolution was the Martiansâ choice of a block time short enough to place Earth outside of Muskcoinâs hash horizon, preventing Terran miners from mining Muskcoin. Had Martians chosen to endow Muskcoin with a block time of several hours, Earth would have been within Muskcoinâs hash horizon. The massively larger Terran hashrate would have out-competed Martian miners, allowing them to hash bomb Muskcoin, destroying it and the revolution without any shots fired.</p>
<blockquote>
<p>Short block times are a form of economic protectionism enabled by the finite speed of light.</p>
</blockquote>
<p>Martians and other potential revolutionaries intuitively understand this relationship: short block times allow fledgling blockchains to defend themselves against the predations of powerful incumbents. Long block times not only make secondary and tertiary layers of a blockchain-based economy more challenging to engineer, they also cede power to faraway interests. No revolution would be so foolish as to start a blockchain with a long block time.</p>
<h3 id="the-decline-and-fall-of-the-terran-empire">The Decline and Fall of the Terran Empire</h3>
<p>But what about an empire?</p>
<p>Like the American Revolution centuries prior, the Muskcoin revolution became a model for other colonies seeking independence from Terran economic and political control. Powerful interests on Earth, like the British Empire before them, are faced with the prospect of continually diminishing influence, as faraway colonies grow and, inspired by the example of Mars, demand their independence.</p>
<p>Clever Terrans will realize that a blockchain with a long block time may be exactly what is needed to curtail future revolutions. Martians used bitcoin on Mars for many years before they launched Muskcoin; it was the inability to <em>mine</em> bitcoin and the absence of the virtuous cycle of mining that prompted the revolution.</p>
<p>Most of the solar systemâs mass is within a light day of Earth. If Terrans were to launch a blockchain with a block time of several <em>days,</em> its hash horizon would encompass all miners in the entire solar system. This will lead them to suggest Solcoin, the first Type II stellar blockchain.</p>
<p>Terrans hope Solcoin will transform potential colonial revolutionaries into productive miners, all hashing together within a single, solar-system wide market. A single money, theyâll argue, is more efficient than many separate monies. Theyâll advocate for citizens of faraway colonies to use Type I planetary blockchains such as bitcoin for their daily transactions but mine Solcoin for the health of their economies.</p>
<p>Such an arrangement would be of great benefit to Terran miners. Large distances and short block times cut off their tremendous hashrate, largest in the solar system, from the fee markets of blockchains such as Muskcoin. Solcoin is an interplanetary fee market that all miners in the solar system can compete in. Since Terrans have the highest hashrate, they would dominate this market, capturing settlement fees that currently go to miners of other blockchains.</p>
<p><img src="/assets/images/2020/m12/db3.png" alt="" /></p>
<blockquote>
<p>Solcoiners are selling their hashrate to interplanetary society. And, you know, thereâs no such thing as interplanetary society. There are individual planets and moons and there are asteroids.â</p>
</blockquote>
<p>â Stargaret Hasher, 2187</p>
<p>This point will not be lost on the governments, businesses, and people living far from Earth, already using or contemplating their own planetary blockchains. Local mining industries solar-system wide will balk at opening themselves up to competition with Terran miners, in the same way that domestic manufacturers balk at lowering tariffs on foreign imports. Detractors will argue that Solcoin is merely a ploy by perfidious Terran miners to interfere in the money and politics of the other worlds, a sign of an empire in decline, unwilling to gracefully cede interplanetary space to those who dwell there.</p>
<h3 id="a-million-tiny-worlds">A Million Tiny Worlds</h3>
<p>But Terran miners wonât be the only Solcoin supporters. To find others, we must turn our attention to the literal fringes of interplanetary society.</p>
<p>Not all humans will choose to live on or near planetary bodies. Many will prefer to take up residence in engineered space habitats that offer the most Earth-like living conditions away from the hustle and grime of Earth itself. Spinning cylinders can provide Earth-equivalent gravity, which is much more difficult to produce on the surface of Mars or the Moon. Fusion lamps, powered by water, can provide Earth-natural sunlight. Space habitats can thrive anywhere. Some may even migrate.</p>
<p><img src="/assets/images/2020/m12/db4.png" alt="" /></p>
<p>Artificial space colonies can house millions of people and orbit anywhere in the solar system. How will the builders of these bauble worlds participate in the mining industry? [<a href="https://commons.wikimedia.org/wiki/File:Spacecolony3edit.jpeg">Source</a>]</p>
<p>These habitats will first be built in orbit near the Earth, Moon, and Mars, and then at nearby <a href="https://en.wikipedia.org/wiki/Lagrange_point">Lagrange points</a>. But hauling large amounts of material up from a planetâs surface is inefficient and expensive. Later habitats will be built where the materials to make them are abundant and where there is no gravity well to fight: the asteroid belt between Mars and Jupiter, and the belt of comets beyond the orbit of Neptune known as the Kuiper belt (of which Pluto is the most prominent member). Asteroids and comets are made of carbon, silicon, metals, ammonia, methane and water: all raw ingredients of the space industry. They are the perfect substrate for building colonies. The belts will become full with them.</p>
<p>It is possible that belters on opposite sides of the solar system feel no mutual relation, but itâs also possible that the belters have their own cultural identity and economic network full of people with a shared history and similar problems. Belters will want to unite behind a blockchain they can all mine, pulling the virtuous cycle of mining into their orbit.</p>
<p>But a settled belt is very different than a planet. A single space colony may house a few million people, about the scale of a large city. The billions of humans eventually settling the asteroid and Kuiper belts will be spread across hundreds and then thousands of such colonies. At first the colonies may be near each other, but over time they will distribute around the full circumference of the belts. If belters were to start a blockchain, what block time should they choose?</p>
<p><img src="/assets/images/2020/m12/db5.png" alt="" /></p>
<p>Belts are extended objects which span significant distances in space. The asteroid belt (left), between Mars and Jupiter, is about a light-hour in diameter. The Kuiper belt (right), beyond the orbit of Neptune, is a full light-day in diameter. Type I blockchains with block times of minutes can be used by belters but will never be mined by them. The huge amounts of energy available in the belts will only be harnessed by a Type II blockchain with a block time comparable to (or, more likely, many times) their diameter.</p>
<p>Planetary blockchains such as bitcoin and Muskcoin have short block times of ~10 minutes and correspondingly small hash horizons. This is sufficient for civilizations such as Earthâs or Marsâ, which are located near planets and span just a few light-seconds. If, like these planetary blockchains, belters choose a convenient time near 10 minutes, then their hash horizons will be similarly small. Asteroids in the asteroid belt arenât a dangerous mine-field of obstacles, as often depicted in movies. In reality, asteroids are about <a href="https://physics.stackexchange.com/questions/26712/what-is-the-average-distance-between-objects-in-our-asteroid-belt">3 light-seconds apart on average</a>, more than twice as far apart as the Earth and Moon. Comets in the Kuiper belt are even further apart. A blockchain with a small hash horizon will therefore only be able to connect miners on a few nearby colonies. A small number of nearby colonies is like a small number of nearby cities. They will not have the population, industry, or hashrate to support an entire blockchain, let alone one that could defend itself against aggression from nearby planetary blockchains. But the population of the full belt, hashing together, could hold against the center.</p>
<p>The geography, or perhaps the <em>topology</em>, of their society presents some immediate challenges. A belt is not localized near any single point. It is an annulus of material surrounding the Sun. The diameter of the asteroid belt is larger than the orbit of Mars â signals take almost a full hour to cross it. The Kuiper belt is even larger in diameterâ a full light-day. A blockchain that could connect all these far-flung miners would need an extremely long block time.</p>
<p>This is exactly the problem a stellar blockchain such as Solcoin solves. Without Solcoin, belters could transact using any number of local planetary blockchains, but they would never be able start the virtuous cycle of mining. With Solcoin, belters can spin up mining rigs anywhere they can find energy to harvest and hope to earn transaction fees from solar-system wide trade.</p>
<p>Perhaps one of the great ironies of the future will be the Solcoin alliance between urbane Terrans and hillbilly belters.</p>
<h2 id="type-i--ii-blockchains-are-different">Type I & II Blockchains Are Different</h2>
<p>Though they work on the same principles, the vast difference in scale between stellar Type II and planetary Type I blockchains doesnât just make Solcoin bigger, it makes it <em>different</em>.</p>
<h3 id="confirmation-times-are-long">Confirmation times are long</h3>
<p>To allow mining across the solar system, Solcoin must have a hash horizon that is 1-2 light days wide, but this does not necessarily mean the block time should be equal to 1-2 days. It only takes a few seconds for a signal to traverse the entire Earthâs network infrastructure, yet the bitcoin block time is ten minutes, which is hundreds of times longer.</p>
<p>The unpredictability of proof-of-work means that block times have irreducible statistical variance â a blockchain targeting a block time of ten minutes will occasionally have blocks just a few minutes or even seconds apart. The block time needs to be long enough that the network has enough time to integrate over the current fee market in the mempool, as well as source enough hashrate to defend against adversarial attempts to reorg the chain. Block times should be at least several times the signal traversal time between the most distant miners.</p>
<p>If we naively scaled up the numbers, a signal traversal time of 1-2 days across the settled solar system suggests a block time of <em>several hundred days</em>. Linear scaling may be too conservative; itâs possible that as signal traversal times increase, the ideal multiple for block time may decrease. We might be less conservative and suggest a block time as short as 7-30 days â between a Terran standard week and month â but even in this optimistic case, a single Solcoin transaction could take_months_ to confirm!</p>
<h3 id="issuance-is-slow">Issuance is slow</h3>
<p>If Solcoinâs monetary policy is comparable to bitcoinâs (fixed cap, block subsidy, halvings), then the long block time implies a correspondingly slow issuance schedule. Assuming the halving period is kept at 210,000 blocks, instead of every four years, 7-30 day blocks would imply that halvings occur <em>every ~4,000 â 17,000 years</em>. Bitcoin is scheduled to produce its predetermined supply of 21M BTC within ~140 years of launch. With 7-30 day blocks, Solcoin would take <em>~140,000 â 600,000</em> <em>years</em> to do the same . These are longer timescales than humanity has ever considered â longer, perhaps, than the history of our species itself.</p>
<p>Solcoinâs issuance could be accelerated by restricting its scale in space. If the poor denizens of the Kuiper belt can be excluded, then the required hash horizon of Solcoin can be reduced to, say, the diameter of Neptuneâs orbit: a mere 8 light-hours. This would enable a correspondingly shorter block time, which leads to more frequent halvings. Alternatively, Solcoin could retain its desired scale in space and the corresponding 7-30 day block time but simply reduce the number of blocks between each halvings from 210,000 to perhaps as low as 10,000. This still yields ~180 â 800 years between halvings and ~6,600 â 29,000 years to produce the Solcoin supply.</p>
<p>It seems that regardless of what numbers we use, if we want Solcoin mining to be possible over an appreciable fraction of our solar system, then we are forced to think at very long time scales.</p>
<h3 id="difficulty--hashrate-are-high">Difficulty & hashrate are high</h3>
<p>As a stellar blockchain, Solcoinâs miners should not be concentrated too densely near any particular planet or colony. This means the difficulty of Solcoin blocks has to be extremely high.</p>
<p>During the early days of Solcoinâs launch, when hashrate is low, if minimum difficulty were also low, then it would be possible for miners who command significant hashrate in one location (a single planet) to mine blocks faster than they can be transmitted through the network (1-2 days). If more than one miner (or pool) did this, it would destabilize consensus. Difficulty should therefore be high enough that even if a significant percentage of some planetâs hashrate chooses to mine Solcoin, it would be insufficient to consistently win them blocks.</p>
<p>One strategy Solcoin might use to rebuff attacks from miners of planetary blockchains during its infancy is to use a unique mining algorithm. While this may initially work, itâs also possible that future advances make printing custom ASICs trivial. The surer defense is to simply set a high difficulty and not launch Solcoin until sufficient hashrate exists to operate it. Using the same mining algorithm as planetary blockchains may also be a way to encourage adoption.</p>
<p>To stabilize payouts in the face of such high difficulties (and long block times), Solcoin miners would be forced to create and join mining pools distributed across the solar system. (Note: Even if Solcoin hashrate grows to exceed that of planetary blockchains, by the First Law, distributed Solcoin mining pools cannot coordinate to attack planetary blockchains as most of their members would be outside a planetary blockchainâs hash horizon.)</p>
<h3 id="energy-usage--price-are-astronomical">Energy usage & price are astronomical</h3>
<p>Because of its high difficulty, the proof-of-work in a single Solcoin block will eventually represent <em>more energy than that used by whole planets</em>. Solcoin isnât just a stellar blockchain in physical diameter, itâs also a stellar blockchain in energy scale (weâll return to this point below).</p>
<p>For mining to make economic sense, Solcoins must therefore become extremely valuable (in planetary currency). This hypothesis will fuel much early speculation in the Solcoin price. But speculators alone arenât sufficient to sustain a gargantuan project such as Solcoin. If Solcoin is to succeed, it must be broadly accepted by interplanetary society. Given that Solcoinâs price and pace rule out many kinds of economic activity, what exactly would people use it for? Why would people, outside of greedy Terrans and poor belters, want to hold Solcoin?</p>
<h2 id="type-i--ii-civilizations-are-different">Type I & II Civilizations are Different</h2>
<p>Type II civilizations are as different from Type I civilizations as Type II blockchains are from Type I blockchains. As a Type I civilization evolves into a Type II, it experiences structural changes paralleled by its money. Both become lower time-preference, have longer investment horizons, and increased energy requirements. Civilizations and blockchains coevolve together.</p>
<p>Letâs explore some of the ways Type I & II civilizations differ, and in so doing, understand why a Type II civilization will find a Type II blockchain such as Solcoin valuable.</p>
<h3 id="culture-is-low-time-preference">Culture is low time-preference</h3>
<p>Like todayâs time zone differences, the myriad day and night cycles across the solar system will make coordinating simultaneous interplanetary activities more difficult. But unlike communicating across time zones, interplanetary communication is asynchronous. When you call someone on the opposite side of the world, it may be an inconvenient time for them, but your conversation starts instantly and occurs in real-time. You donât call someone on a different planet at all; you send them recorded messages which they receive hours later. This is an unavoidable limitation of communication imposed upon on all future civilizations by the finite speed of light.</p>
<p>Asynchronous communication is already commonplace in our world today â everyone emails, texts, and messages on social platforms, but live connections are important to us. Remote work and relationships are maintained through the ease of getting âonlineâ (witness the massive increase video chat applications during the 2020 pandemic). When major parts of our civilization are incapable of live communication, the future begins to resemble the past â a slower-paced society of letters and telegrams.</p>
<p>But the future will also resemble no time before it. Technology, whether through medicine, computing, or both, will significantly extend human lifespans. A life expectancy of hundreds or even thousands of years may become commonplace. Long-lived, asynchronously communicating people will have a different relationship to time than humans of today. The cumulative effect of these changing temporal relationships across society, even if life extension is somewhat rare, could be profound. Patience, planning, and low time-preference â at least compared with todayâs business cycles â may become the norm.</p>
<p>For a person who expects to live for 10,000 years and is accustomed to casual conversations bridging hours and days of light lag, the slowness of Solcoin may be unremarkable. Waiting three months for a Solcoin transaction to confirm may feel normal, just like waiting an hour for a bitcoin transaction to confirm feels normal today. Waiting a century for a time-locked Solcoin contract to activate would be like waiting just a year today for long-term capital gains to kick in. Solcoinâs pace increasingly matches the time-preference of its era.</p>
<h3 id="transportation-is-slow">Transportation is slow</h3>
<p>Modern transportation networks make our world feel small. Voyages between distant worlds will take months and be expensive. This will cause interplanetary travel to become highly stratified by time-preference.</p>
<p><img src="/assets/images/2020/m12/db6.png" alt="" />
<em>Isochrone map of distances from London, circa 1843. Anywhere in Europe could be reached within a week but it could take months to reach the more far-flung parts of the British Empire. The vast distances of space will similarly require many months to cross. In this way the future will be like the past. (<a href="https://www.1843magazine.com/places/cartophilia/time-travel">source</a>)</em></p>
<p>Transporting people or vital supplies will be done along direct, extremely expensive minimum-time routes, which will still take weeks to months, depending on the distance. But most goods will be shipped along slower, cheaper minimum-energy routes, which like the seasonal oceanic shipping routes of the past, are only sporadically available, varying with the positions of the planets in their orbits. The <a href="https://en.wikipedia.org/wiki/Hohmann_transfer_orbit">Hohmann transfer</a> from Earth to Mars, for example, is one of the most energy-efficient routes between those planets but takes 9 months to complete and only presents a launch window every 24 months. Martian businesses may become accustomed to waiting up to 3 years for the next cheap delivery window from Earth.</p>
<p>There are even more energy efficient trajectories between worlds (utilizing the <a href="https://en.wikipedia.org/wiki/Interplanetary_Transport_Network">Interplanetary Transport Network</a>) that take decades or centuries. These routes are usually ignored as too long to be practical, but they may be appropriate for transporting huge amounts of mass such as whole asteroids and comets. A significant source of revenue for belters may be the export of such objects from their home orbit to the rest of the solar system. The cheapest way to ship a 5-mile diameter water-rich comet to your Jovian orbital factory might be to pay up-front in Solcoin and wait 75 years.</p>
<h3 id="investment-horizons-are-long">Investment horizons are long</h3>
<p><img src="/assets/images/2020/m12/db7.png" alt="" /></p>
<p>âMethsâ in Netflixâs <em>Altered Carbon</em> series are immortal oligarchs commanding vast power and wealth. They can afford unlimited backups of their own bodies and can spend decades traveling between star systems. How would such a person store their wealth?</p>
<p>Longer lives donât just mean that we can be more patient with Solcoin transactions, they change the way we invest and our risk/return tolerance. If you plan to live for 10,000 years, <em>how would you store and preserve your wealth</em>?</p>
<p>Wealth preservation is all about risk management, and the future, on a long enough time scale, is a dangerous place. You might not worry today about a catastrophic âblack swanâ event with a 1% chance of occurring per century, but if you lived for 10,000 years, the probability of that same event occurring at least once approaches 2-in-3. Given enough time, natural accidents like extraterrestrial impacts, solar flares, or super-volcanoes will manifest somewhere, sometime.</p>
<p>And given our bellicose history, itâs unlikely that future societies expanding and competing for the solar systemâs resources will always remain at peace; total war in a high-energy future society could mean the destruction of an entire planet and its blockchain along with it. Even if the conflict doesnât escalate to such a destructive level, if Earth and Mars were to go to war, could either bitcoin or Muskcoin be considered neutral money? Would bitcoin miners, united by their common location on Earth to view Mars as an enemy, choose (or be politically compelled) to censor the transactions of known Martian entities? This possibility was one of the instigating causes of the Muskcoin revolution, after all. If you are a rich Martian pondering going into cryo-stasis for 1,000 years as you await the development of your investments, you may worry about these kinds of unforeseen political conflicts.</p>
<p>Long time horizon investors today use real estate or commodities such as gold, oil, precious metals and â increasingly â bitcoin to hedge exposure to geopolitical risk. What assets would long time horizon investors of the future use to hedge their exposure to <em>heliopolitical</em> risk?</p>
<p>Planetary blockchains are, by definition, localized to a given planet and are therefore inseparable from the heliopolitical risks of that planet. Investors of the future can attempt to hedge this risk by holding a portfolio of planetary blockchains and rebalancing it over the centuries, or they may invest in commodities, though their choices would be different (e.g. hydrogen instead of petroleum).</p>
<p>By distributing consensus throughout the whole solar system, a stellar blockchain such as Solcoin provides exactly the asset that long time horizon investors are looking for. They view Solcoinâs long block times and tremendous hashrates as features, not bugs. Solcoin is a heliopolitically neutral, low-risk money for long-term capital preservation.</p>
<p>This will not be apparent to elites when Solcoin first launches. âSeriousâ money managers will not initially consider Solcoin a real asset class, but significant appreciation over some decades (or centuries) may convince them that Solcoin has superior properties as a store of wealth compared to any planetary blockchain, due to its greater robustness against local threats â natural or political. Eventually, Solcoin will be held by everyone, whether directly or through some future equivalent of an index fund.</p>
<h3 id="energy-scales-are-increasing">Energy scales are increasing</h3>
<p>Science fiction often depicts interplanetary societies launching interstellar missions or constructing megastructures, such as <a href="https://en.wikipedia.org/wiki/Ringworld">ringworlds</a>, <a href="https://en.wikipedia.org/wiki/Dyson_sphere">Dyson spheres/swarms</a>, <a href="https://en.wikipedia.org/wiki/Stellar_engine">Shkadov thrusters</a>, &c., but seldom describes how such projects are funded. Megaprojects will be the most expensive and largest collaborations in the history of our species, consuming more energy than entire planetary societies. They will take thousands of years to complete, which means thousands of years of paying designers, suppliers, & builders from Mercury to the Kuiper belt. What currency will these people and companies demand? Solcoin, of course!</p>
<p><img src="/assets/images/2020/m12/db8.png" alt="" /></p>
<p>A âDyson Sphereâ is a swarm of spacecraft & colonies harvesting the full energy output of a star. Which markets are hungry enough to consume a starâs worth of energy? [<a href="https://commons.wikimedia.org/wiki/File:A_Dyson_Swarm_Superstructure_(21983905140).png">Source</a>]</p>
<p>Solcoinâs heliopolitical neutrality makes it a natural fit for funding megaprojects. Â Contractors and investors across the solar system feel more comfortable relying on a neutral Solcoin rather than a possibly partisan planetary blockchain such as bitcoin. Â Solcoinâs timescale also matches that of megaprojects themselves, allowing their supporters to manage the risk of such a large investment over such a long time period. Â But there is an even deeper connection between Type II blockchains and megaprojects: they both operate at the same tremendously high energy scales.</p>
<p>Consider the classic example of a Dyson sphere (above). The amount of energy required to reconfigure enough matter to blot out a star, by definition, puts such a project in the Type II category. Why would humanity choose to build such a megastructure or use so much energy? A Dyson sphere can support not trillions of people but <em>trillions of Earthâs worth of people</em>. Simple population expansion and uninhibited consumerism alone may not be enough to generate demand for so much energy.</p>
<p>But there are other drivers for energy consumption. Fundamental research and interstellar missions will also require energy scales beyond a single planet. If humanity is to ever experiment on black holes or settle another star, we will require the energy budget of a Type II civilization, even if we never build a Dyson sphere. This requires creating an economic incentive to collect energy across the whole solar system.</p>
<p>Type I blockchains donât provide this incentive. Itâs true that concentrations of energy far from existing centers of hash will attract settlers, grow civilizations, and start their own blockchains, incentivizing energy collection in the vicinity of that planet, moon, or colony. But these Type I blockchains will not be able to incentivize the collection of energy outside their limited hash horizons. Gathering the vast energy in the comets of the Kuiper belt or from the light our sun streams out into every direction in space requires incentivizing energy collection at every point in our solar system.</p>
<p>This is exactly what a Type II blockchain such as Solcoin does. Solcoinâs broad hash horizon means that a miner can reliably turn harvestable energy anywhere in the solar system into profit without having to first transport it close to a planetary blockchainâs center of hash. Like bitcoin before it on Earth, Solcoinâs hashrate market is a ratchet, which cranks society into ever-higher tiers of energy production.</p>
<p>Turning this relationship around, we also see why itâs vital for a Type II civilization to use a Type II blockchain.  Type II civilizations use billions of times more energy than Type I civilizations and, consequently, than Type I blockchains. If even a small fraction of this energy were concentrated in one spatial location and turned into hashrate, it could destabilize a local Type I blockchain â just like a hash bomb during the Muskcoin revolution. Only a Type II blockchain operates at energy scales high enough to defend against such attacks.</p>
<h2 id="type-ii-blockchains-wont-displace-type-i">Type II Blockchains Wonât Displace Type I</h2>
<p>One of the earliest lessons of hyperbitcoinization was that only <em>one</em> blockchain â one sound money â can exist. All other monies fail or are subsumed by bitcoin denominated trade. The successful launches of Muskcoin and other planetary blockchains was another lesson: multiple blockchains â multiple sound monies â can coexist, but only if theyâre <em>far enough away from each other in space</em>. Solcoin claims to be a blockchain that is <em>close to everyone</em> (its hash horizon spans the solar system). If there can only be one sound money in one place at one time, doesnât the success of Solcoin require it to displace all planetary blockchains?</p>
<h3 id="demand-exists-across-time-preferences">Demand exists across time preferences</h3>
<p>Some Solcoin-maximalists will believe this, and will therefore view all planetary blockchains as competitive and their supporters as enemies of Solcoin. But the truth is more nuanced. As weâve seen, Type II blockchains such as Solcoin are extremely different from Type I blockchains. Theyâre not just larger; theyâre also slower, use more energy, and are much more valuable. This difference in scale segregates economic activity by time preference.</p>
<p>Solcoin is designed for long-timescale, high-energy, cross-solar-system trade and projects. Planetary blockchains cannot support these use cases, which is the source of the low time preference demand for Solcoin in the first place.</p>
<p>But economic activity at the scale of planets will mostly continue to use planetary blockchains. In a hyperbitcoinized economy, only the largest transactions are directly put on the blockchain anyway. Planetary economies are already organized in layers, which settle to their local blockchain. Solcoin may come to be used for a small percentage of the most valuable planetary transactions, but most will continue to use planetary currency. Purchasing the quintessential space coffee will still be done using some higher layer payment network settling through the local planetary blockchain.</p>
<p>Higher layer networks settling to Solcoin will also arise. These layers will allow for faster Solcoin transactions, just as they do for planetary blockchains. But these layers wonât be able to bridge the gap between the Solcoin block time and the pace of daily life (opening & closing channels still requires waiting for blocks to confirm, which could take months in Solcoin). Solcoin is just too slow for most kinds of local trade. This means there will always be some demand for the tokens and hashrate of planetary blockchains. Even if you or your company prefers to operate at the ethereal scale of Solcoin, the vendors you buy from or the workers you hire may have different time preferences than you.</p>
<p>Over time, an increasing fraction of economic value and system-wide hashrate may gravitate to Solcoin â but planetary blockchains will survive where they can. Type II civilizations donât displace Type I civilizations, they contain them. Similarly, Type II blockchains donât displace Type I blockchains, they contain them.</p>
<h3 id="portfolio-management-at-the-kardashev-scale">Portfolio Management at the Kardashev Scale</h3>
<p>One of the important roles of any blockchain is to provide a long-term store of value. Solcoin is designed to be a better store-of-value than any planetary blockchain, so some amount of savings will transfer from planetary blockchains to Solcoin. Investors will decide how much of their portfolio to store in planetary blockchains (they may decide to hold more than one) and how much to store in Solcoin based on their time preference and their heliopolitical concerns. The longer the time horizon of an investor, the more likely they are to hold their wealth in Solcoin, but the need to make investments or purchases on a planetary scale will always ensure some demand for holding planetary blockchains.</p>
<p>As a result, miners will have to decide how much hashrate to invest into their local planetary blockchain (bitcoin, Muskcoin, &c.) vs. how much to invest in Solcoin. The ratio each miner chooses between these two hashrates balances their beliefs about the current hashrate markets, future price movement between Solcoin and their local currency, as well as their own time preference. Miners who value immediate returns will put more hashrate towards their planetary blockchain, those who can afford to be lower time-preference will put more hashrate towards Solcoin. If too many miners in one location are hashing Solcoin, it should create an incentive for others to begin hashing on their local planetary blockchain â and vice versa. To a first approximation, the ratio of hashrate a miner dedicates to their own planetary blockchain vs. to Solcoin should equal the overall hashrate ratio between that planetary blockchain and Solcoin.</p>
<h2 id="towards-a-second-law">Towards a Second Law</h2>
<p>Type I & II blockchains can âoverlapâ in space because the market segregates their usage by time. A physical analogy may help visualize this situation as well as provide some useful terminology.</p>
<h3 id="interference">Interference</h3>
<p><a href="https://en.wikipedia.org/wiki/Wave">Waves</a> are self-sustaining oscillations that contain or transport energy. Waves are characterized by several parameters such as frequency, wavelength, amplitude, &c. These parameters are constrained: lower the frequency and the wavelength increases while the energy decreases. Interactions between waves can be very rich. When waves have different frequencies/wavelengths, they can overlap in space â one wave will âpass throughâ another without either being disturbed. When waves have similar frequencies/wavelengths, they can interact strongly, exhibiting constructive or deconstructive interference.</p>
<p>Blockchains arenât waves, but they are self-sustaining. They contain energy, and theyâre characterized by constrained parameters. Instead of a frequency, a blockchain has a block time. Instead of a wavelength, it has a hash horizon. Lower the frequency (block time) and the wavelength (hash horizon) increases (due to the First Law). Interestingly, as we saw above, lowering the frequency <em>increases</em> the energy â Solcoin uses much more energy than a planetary blockchain.</p>
<p><img src="/assets/images/2020/m12/db9.png" alt="" /></p>
<p>We can use this analogy to talk about blockchains in a new way. Two blockchains with very different frequencies/wavelengths (block times/hash horizons) such as Solcoin and bitcoin can overlap. They donât âeconomically interfereâ with each other because they operate at such different timescales. The market can support both blockchains for their different use cases.</p>
<p>Two blockchains of similar frequency/wavelength (block time/hash horizon) cannot overlap. They economically interfere with each other: miners and users will inevitably pick one of them. This is why altcoins died out while bitcoin survived. Blockchains of a similar frequency/wavelength must be widely separated, such as bitcoin and Muskcoin, decoupling their mining markets through the First Law.</p>
<p>Summarizing, blockchains can coexist if they are widely separated in <em>physical space</em> OR in <em>frequency space</em> â block time. Type I blockchains have similar block times but are far apart in space. Type I and Type II blockchains overlap in space but are far apart in frequency space â block time.</p>
<h3 id="resonance">Resonance</h3>
<p>But exactly how widely separated must blockchains be? This is another way waves provide a good analogy.</p>
<p>Waves in free-space (called âtraveling wavesâ) can have any wavelength â this is why you can see light in all colors, but waves interacting with matter will react to it. Most waves will bounce off or decay. Some waves, called âstanding wavesâ or ânormal modes,â are special â they can persist for long times, storing or absorbing energy. Normal modes have âcharacteristic wavelengthsâ and ânatural frequencies,â which are determined by the geometry of the matter they interact with. Normal modes can also âresonate,â quickly absorbing energy input at their characteristic frequencies. This is why no matter how you ring a bell, bang a gong, or pluck a guitar string (within reason), the same tone emerges.</p>
<p>Consider a blockchain with a block time of several hours designed to connect the inner planets â a Type 1.3 blockchain, say. Its block time would be long enough to make Type I transactions expensive and inefficient, yet not long enough to provide Type II risk-management capabilities. Its hash horizon would be smaller than a Type II blockchain, insufficient to include the outer planets and the belts, leaving them without a chain to mine on, dis-incentivizing the collection of energy from their orbits. Such an intermediate, Type 1.x blockchain is an awkward, partial solution.</p>
<p>If blockchains are like waves, then Type I & II blockchains are normal modes. Their characteristic wavelengths and natural frequencies are determined by the distributions of matter they draw energy from and the cultural timescales of the civilizations they power. Type I and II blockchains are Schelling points, resonating with the market, allowing a small group of initial supporters and low hashrate to excite a self-sustaining money that absorbs energy and value.</p>
<p>A Type I blockchain resonates with a 10-minute frequency around a planet or colony and is used for daily transactions and global trade.</p>
<p>A Type II blockchain resonates with a month-long frequency throughout a star system and is used for long-timescale capital preservation and high-energy investments such as megaprojects.</p>
<p>This is why we did not speculate about any blockchains intermediate in scale between Type I and Type II. We hypothesize that intermediate blockchains, should they be launched, would not be Schelling points. Far from resonance, they would decay away, surrendering their hashrate to either Type I or Type II neighbors.</p>
<h3 id="exclusion">Exclusion</h3>
<p>The two analogies of interference and resonance imply a third.</p>
<p>Classical physics is usually continuous. Distinct energy or position states of matter can be arbitrarily close together. Quantum physics is usually discrete. Matter particles must occupy distinct states with different energies and or positions. States are usually âfilled upâ by matter particles in order of increasing energy, outward from some source. This is known as the <a href="https://en.wikipedia.org/wiki/Pauli_exclusion_principle">Pauli exclusion principle</a>.</p>
<p>Blockchains must resonate around matter distributions (planet or solar systems) and a cultural timescale (real-time or long-term), which means the set of allowable states for blockchains is discrete, not continuous. Blockchains in the same state (location and block time) economically interfere. Like matter particles, only a single blockchain can occupy a given state, and states are populated in order of increasing energy scale and distance from Earth: Type I before Type II, bitcoin before Muskcoin.</p>
<p>We hypothesize blockchains, like matter, obey some economic version of an exclusion principle which we promote as a Second Law:</p>
<blockquote>
<p><strong>The Second Law of Bitcoin Astronomy</strong> (The Hash Exclusion Principle): Discrete physical and temporal scales provide hierarchical states for blockchains to occupy in order of increasing energy and distance from Earth.</p>
</blockquote>
<p>As humanity ascends the Kardashev scale, the Second Law describes how blockchains populate the matter our society has colonized and the timescales our culture can experience.</p>
<p>Blockchains are a kind of economic dark matter, shadowing normal matter wherever civilization settles, invisible but detectable through the constant pressure they exert on energy markets and supply chains.</p>
<h2 id="type-ii-civilizations-launch-type-iii-blockchains">Type II Civilizations Launch Type III Blockchains</h2>
<p>Following the implications of the Second Law, humanity â should we survive long enough â will eventually launch a Type III galactic blockchain.</p>
<p>Such a heady notion requires us to first become a Type 2.x civilization which in turn requires expanding to other stars.</p>
<h3 id="interstellar-missions-are-type-ii-megaprojects">Interstellar missions are Type II megaprojects</h3>
<p>Stars are extremely far apart; todayâs fastest space probes will take hundreds of thousands of years to reach neighboring stars. Â Reducing the timeframe of such voyages to centuries or decades will require ships to travel at substantial fractions of the speed of light. Â Our current generation of spacecraft are also uncrewed and no bigger than cars or small buses; an interstellar mission would require a massive ship capable of supporting a human crew and some complement of (perhaps hibernating) colonists and their supplies.</p>
<p>More mass moving faster means the ship has more <em>kinetic energy</em>. The total amount of kinetic energy can be used to estimate the total cost of the mission (this estimate is an order-of-magnitude lower-bound: construction costs, inefficiencies, and many other considerations make an interstellar mission even more costly in reality). As a concrete example, consider a spaceship the size of a modern aircraft carrier moving at 10% the speed of light (such a ship would still take a century to reach even the closest stars and would barely be big enough to keep its passengers alive en route, but no matter). The kinetic energy of this ship would be <em>orders of magnitude larger</em> than the <em>current annual energy usage</em> of <strong>our entire civilization!</strong></p>
<p>And that is just <em>one ship!</em> Launching many interstellar missions will use orders of magnitude more energy than even this. Interstellar settlement is the domain of Type II civilizations. Developing energy infrastructure on such a scale will require markets like Solcoin. If you believe humanityâs destiny is to settle other star systems then you would be a Solcoin supporter.</p>
<h3 id="the-cycle-repeats-anew">The cycle repeats anew</h3>
<p>Given the years it will take to send transactions, colonists of a remote star system will barely be able to <em>use</em>, much less mine, any Type I blockchains such as bitcoin from our solar system. These colonists will therefore launch their own Type I blockchain to support the first colony at the new star. They may wait to start this blockchain until they arrive in the new system, but they may also start it en route, on the colony ship, or perhaps even prior to launch. As long as all the miners stay with the ship, travel together to the new star system, while continuously hashing, the blockchain â like an ember in a fire bundle â will survive the long, cold journey through interstellar space.</p>
<p>Over thousands of years, the colony will grow, settling other planets of the remote star system, launching additional planetary blockchains. One day there will be sufficient demand at the remote colony to launch its own Type II blockchain. Receiving genesis blocks from human colonies around other stars will make humans here in orbit around Sol feel the fierce pride of parents watching their children grown up.</p>
<h3 id="the-cycle-grows-larger">The cycle grows larger</h3>
<p>As humanity grows from a Type II to a Type III civilization, the virtuous cycle will repeat itself on an even larger and more dizzying scale.</p>
<p><a href="https://en.wikipedia.org/wiki/File:Observable_universe_logarithmic_illustration.png"><img src="/assets/images/2020/m12/db10.png" alt="" /></a></p>
<p><a href="https://en.wikipedia.org/wiki/File:Observable_universe_logarithmic_illustration.png"><img src="/assets/images/2020/m12/db11.png" alt="" /></a></p>
<p><a href="https://en.wikipedia.org/wiki/File:Observable_universe_logarithmic_illustration.png"><img src="/assets/images/2020/m12/db12.png" alt="" /></a></p>
<blockquote>
<p>Great chains have little chains within their hash horizons,<br />
And little chains have lesser chains, and so ad infinitum.</p>
</blockquote>
<p>â <em>Hymenoptera,</em> from MICHAELUS de Saylorâs <em>A Blockchain of Paradoxes</em> (2194)</p>
<p>Our stellar neighborhood will eventually host many Type II blockchains from Solcoin to Centauricoin, Siriuscoin and others. The humans â though they may increasingly not resemble the humans of today â living in orbit of these faraway stars will eventually seek to create the next blockchain on the Kardashev scale, a Type III galactic blockchain with a block time of thousands of years, designed to span our stellar diaspora the way Solcoin spans our solar system and bitcoin or Muskcoin span Earth or Mars.</p>
<p>This galactic blockchain would harvest the energy of unsettled star systems, rogue planets, and interstellar gas clouds. It would have a hashrate larger than the total energy usage of entire Type II civilizations. Over millions of years, it would slowly mint its fixed supply of coins, blithely robust to the occasional nova or rogue black hole.</p>
<p>HODL on.</p>
<h2 id="part-iii-beyond-humanity">Part III: Beyond Humanity</h2>
<p>So far we have confined our speculations to the human species. But, having come this far, there is no reason we should stop. Should other intelligent civilizations exist in our galaxy, will they also discover blockchains? Will their future societies resemble ours, organized into planetary, stellar, and galactic blockchains? Will blockchains of different species ever interact?</p>
<p>If so, what will happen to our hyperbitcoinized future humans when they detect an indisputably intelligent extraterrestrial transmission which consists of ⊠block headers?</p>
<p>If you enjoyed this article, <a href="https://unchained-capital.com/blog/bitcoin-astronomy-part-iii/">read Part III here</a>!</p>
<h3 id="thank-you">THANK YOU</h3>
<p>Thank you so much to my wonderful colleagues at Unchained Capital for having the patience to tolerate my speculations and for providing me a platform through which to publish them. Also to be thanked are my friends <a href="https://twitter.com/bhudgeons">Brandon Hudgeons</a>, <a href="https://twitter.com/Bquittem">Brandon Quittem</a>, <a href="https://twitter.com/DestrySaul">Destry Saul</a>, <a href="https://twitter.com/josephkelly">Joe Kelly</a>, and <a href="https://twitter.com/TaylorPearsonMe">Taylor Pearson</a>, all of whom provided extended and valuable feedback on early drafts. Particular thanks are due to Martin Grogono who makes everything he touches pretty and <a href="https://twitter.com/phil_geiger">Phil Geiger</a>, whose enthusiasm is the second infinite resource in the universe.</p>
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<!--End mc_embed_signup-->Dhruv BansalIn this part, we continue to _follow the energy_ and speculate about how money and society coevolve as humanity expands through space.Why does Bitcoin have value?2020-12-02T00:00:00+00:002020-12-02T00:00:00+00:00https://bitcoinwords.github.io/why-does-bitcoin-have-value<table class="notice--info">
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<h1 id="why-does-bitcoin-have-value--aier"><a href="https://www.aier.org/article/why-does-bitcoin-have-value/">Why Does Bitcoin Have Value? â AIER</a></h1>
<h3 id="by-jeffrey-a-tucker">By <a href="https://www.aier.org/staffs/jeffrey-tucker/">Jeffrey A. Tucker</a></h3>
<h3 id="posted-december-2-2020">Posted December 2, 2020</h3>
<blockquote>
<p>âThink of a world without essential third parties, including the most dangerous third party ever conceived of by man: the state and the central bank. Imagine that future and you begin to grasp the fullness of the implications of our future. Ludwig von Mises would be amazed and surprised atâŠâ - Jeffrey Tucker</p>
</blockquote>
<hr />
<p>Even after eleven years experience, and a per Bitcoin price of nearly $20,000, the incredulous are still with us. I understand why. Bitcoin is not like other traditional financial assets. Even describing it as an asset is misleading. It is not the same as a stock, as a payment system, or a money. It has features of all these but it is not identical to them. What Bitcoin is depends on its use as a means of storing and porting value, which in turn rests of secure titles to ownership of a scarce good. Those without experience in the sector look at all of this and get frustrated that understanding why it is valuable is not so easy to grasp. </p>
<p>In this article, Iâm updating an <a href="https://fee.org/articles/what-gave-bitcoin-its-value/">analysis</a> I wrote six years ago. It still holds up. For those who donât want to slog through the entire article, my thesis is that Bitcoinâs value obtains from its underlying technology, which is an open-source ledger that keeps track of ownership rights and permits the transfer of these rights. Bitcoin managed to bundle its unit of account with a payment system that lives on the ledger. Thatâs its innovation and why it obtained a value and that value continues to rise. </p>
<p>Consider the criticism offered by traditional gold advocates, who have, for decades, pushed the idea that sound money must be backed by something real, hard, and independently valuable. Bitcoin doesnât qualify, right? Maybe it does. </p>
<p>Bitcoin first emerged as a possible competitor to national, government-managed money in 2009. Satoshi Nakamotoâs <a href="http://nakamotoinstitute.org/bitcoin/">white paper</a> was released October 31, 2008. The structure and language of this paper sent the message: This currency is for computer technicians, not economists nor political pundits. The paperâs circulation was limited; novices who read it were mystified. </p>
<p>But the lack of interest didnât stop history from moving forward. Two months later, those who were paying attention saw the emergence of the âGenesis Block,â the first group of bitcoins generated through Nakamotoâs concept of a distributed ledger that lived on any computer node in the world that wanted to host it.</p>
<p>Here we are all these years later and a single bitcoin trades at $18,500. The currency is held and accepted by many thousands of institutions, both online and offline. Its payment system is very popular in poor countries without vast banking infrastructures but also in developed countries. And major institutionsâincluding the Federal Reserve, the OECD, the World Bank, and major investment housesâare paying respectful attention and weaving blockchain technology into their operations.. </p>
<p>Enthusiasts, who are found in every country, say that its exchange value will soar even more in the future because its supply is strictly limited and it provides a system vastly superior to government money. Bitcoin is transferred between individuals without a third party. It is relatively low-cost to exchange. It has a predictable supply. It is durable, fungible, and divisible: all crucial features of money. It creates a monetary system that doesnât depend on trust and identity, much less on central banks and government. It is a new system for the digital age.</p>
<h3 id="hard-lessons-for-hard-money">Hard lessons for hard money</h3>
<p>To those educated in the âhard moneyâ tradition, the whole idea has been a serious challenge. Speaking for myself, I had been reading about bitcoin for two years before I came anywhere close to understanding it. There was just something about the whole idea that bugged me. You canât make money out of nothing, much less out of computer code. Why does it have value then? There must be something amiss. This is not how we expected money to be reformed.</p>
<p>Thereâs the problem: our expectations. We should have been paying closer attention to Ludwig von Misesâ theory of moneyâs originsânot to what we think he wrote, but to what he actually did write. </p>
<p>In 1912, Mises released <a href="http://www.econlib.org/library/Mises/msT.html"><em>The Theory of Money and Credit</em></a>. It was a huge hit in Europe when it came out in German, and it was translated into English. While covering every aspect of money, his core contribution was in tracing the <em>value and price</em> of moneyâand not just money itselfâto its origins. That is, he explained how money gets its price in terms of the goods and services it obtains. He later called this process the âregression theorem,â and as it turns out, bitcoin satisfies the conditions of the theorem.</p>
<p>Misesâ teacher, Carl Menger, demonstrated that money itself originates from the marketânot from the State and not from social contract. It emerges gradually as monetary entrepreneurs seek out an ideal form of commodity for indirect exchange. Instead of merely bartering with each other, people acquire a good not to consume, but to trade. That good becomes money, the most marketable commodity.</p>
<p>But Mises added that the value of money traces backward in time to its value as a bartered commodity. Mises said that this is the only way money can have value.</p>
<blockquote>
<p>The theory of the value of money as such can trace back the objective exchange value of money only to that point where it ceases to be the value of money and becomes merely the value of a commodityâŠ. If in this way we continually go farther and farther back we must eventually arrive at a point where we no longer find any component in the objective exchange value of money that arises from valuations based on the function of money as a common medium of exchange; where the value of money is nothing other than the value of an object that is useful in some other way than as moneyâŠ. Before it was usual to acquire goods in the market, not for personal consumption, but simply in order to exchange them again for the goods that were really wanted, each individual commodity was only accredited with that value given by the subjective valuations based on its direct utility.</p>
</blockquote>
<p>Misesâ explanation solved a major problem that had long mystified economists. It is a narrative of conjectural history, and yet it makes perfect sense. Would salt have become money had it otherwise been completely useless? Would beaver pelts have obtained monetary value had they not been useful for clothing? Would silver or gold have had money value if they had no value as commodities first? The answer in all cases of monetary history is clearly no. The initial value of money, before it becomes widely traded as money, originates in its direct utility. Itâs an explanation that is demonstrated through historical reconstruction. Thatâs Misesâ regression theorem.</p>
<h3 id="bitcoins-use-value">Bitcoinâs use value</h3>
<p>At first glance, bitcoin would seem to be an exception. You canât use a bitcoin for anything other than money. It canât be worn as jewelry. You canât make a machine out of it. You canât eat it or even decorate with it. Its value is only realized as a unit that facilitates indirect exchange. And yet, bitcoin already is money. Itâs used every day. You can see the exchanges in real time. Itâs not a myth. Itâs the real deal.</p>
<p>It might seem like we have to choose. Is Mises wrong? Maybe we have to toss out his whole theory. Or maybe his point was purely historical and doesnât apply in the future of a digital age. Or maybe his regression theorem is proof that bitcoin is just an empty mania with no staying power, because it canât be reduced to its value as a useful commodity.</p>
<p>And yet, you donât have to resort to complicated monetary theory in order to understand the sense of alarm surrounding bitcoin. Many people, as I did, just have a feeling of uneasiness about a money that has no basis in anything physical. Sure, you can print out a bitcoin on a piece of paper, but having a paper with a QR code or a public key is not enough to relieve that sense of unease.</p>
<p>How can we resolve this problem? In my own mind, I toyed with the issue for more than a year. It puzzled me. I wondered if Misesâ insight applied only in a pre-digital age. I followed the speculations online that the value of bitcoin would be zero but for the national currencies into which it is converted. Perhaps the demand for bitcoin overcame the demands of Misesâ scenario because of a desperate need for something other than the dollar.</p>
<p>As time passedâand I read the work of <a href="http://konradsgraf.com/blog1/2013/2/27/in-depth-bitcoins-the-regression-theorem-and-that-curious-bu.html">Konrad Graf</a>, <a href="http://www.economicsofbitcoin.com/">Peter Surda</a>, and <a href="http://nakamotoinstitute.org/mempool/the-original-value-of-bitcoins/">Daniel Krawisz</a>âfinally the resolution came. Bitcoin is both a payment system and a money. The payment system is the source of value, while the accounting unit merely expresses that value in terms of price. The unity of money and payment is its most unusual feature, and the one that most commentators have had trouble wrapping their heads around.</p>
<p>We are all used to thinking of currency as separate from payment systems. This thinking is a reflection of the technological limitations of history. There is the dollar and there are credit cards. There is the euro and there is PayPal. There is the yen and there are wire services. In each case, money transfer relies on third-party service providers. In order to use them, you need to establish what is called a âtrust relationshipâ with them, which is to say that the institution arranging the deal has to believe that you are going to pay.</p>
<p>This wedge between money and payment has always been with us, except for the case of physical proximity.</p>
<p>If I give you a dollar for your pizza slice, there is no third party. But payment systems, third parties, and trust relationships become necessary once you leave geographic proximity. Thatâs when companies like Visa and institutions like banks become indispensable. They are the application that makes the monetary software do what you want it to do.</p>
<p>The hitch is that the payment systems we have today are not available to just anyone. In fact, a vast majority of humanity does not have access to such tools, which is a major reason for poverty in the world. The financially disenfranchised are confined to only local trade and cannot extend their trading relationships with the world.</p>
<p>A major, if not a primary, purpose of developing Bitcoin was to solve this problem. The protocol set out to weave together the currency feature with a payment system. The two are interlinked in the structure of the code itself. This connection is what makes bitcoin different from any existing national currency, and, really, any currency in history.</p>
<p>Let Nakamoto speak from the introductory abstract to his white paper. Observe how central the payment system is to the monetary system he created:</p>
<blockquote>
<p>A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution. Digital signatures provide part of the solution, but the main benefits are lost if a trusted third party is still required to prevent double-spending. We propose a solution to the double-spending problem using a peer-to-peer network. The network timestamps transactions by hashing them into an ongoing chain of hash-based proof-of-work, forming a record that cannot be changed without redoing the proof-of-work. The longest chain not only serves as proof of the sequence of events witnessed, but proof that it came from the largest pool of CPU power. As long as a majority of CPU power is controlled by nodes that are not cooperating to attack the network, theyâll generate the longest chain and outpace attackers. The network itself requires minimal structure. Messages are broadcast on a best effort basis, and nodes can leave and rejoin the network at will, accepting the longest proof-of-work chain as proof of what happened while they were gone.</p>
</blockquote>
<p>Whatâs very striking about this paragraph is that there is <strong>not even one mention of the currency unit itself</strong>. There is only the mention of the problem of double-spending (which is to say, the problem of inflationary money creation beyond which the protocol would otherwise permit). The innovation here, even according to the words of its inventor, is the payment network, not the coin. The coin or digital unit only expresses the value of the network. It is an accounting tool that absorbs and carries the value of the network through time and space.</p>
<p>This network is the blockchain. Itâs a ledger that lives in the digital cloud, a distributed network, and it can be observed in operation by anyone at any time. It is carefully monitored by all users. It allows the transference of secure and non-repeatable bits of information from one person to any other person anywhere in the world, and these information bits are secured by a digital form of property title. This is what Nakamoto called âdigital signatures.â His invention of the cloud-based ledger allows property rights to be verified without having to depend on some third-party trust agency.</p>
<p>The blockchain solved what has come to be known as the <a href="https://en.wikipedia.org/wiki/Byzantine_fault_tolerance">Byzantine generalsâ problem</a>. This is the problem of coordinating action over a large geographic range in the presence of potentially malicious actors. Because generals separated by space have to rely on messengers and this reliance takes time and trust, no general can be absolutely sure that the other general has received and confirmed the message, much less its accuracy.</p>
<p>Putting a ledger, to which everyone has access, on the Internet overcomes this problem. The ledger records the amounts, the times, and the public addresses of every transaction. The information is shared across the globe and always gets updated. The ledger guarantees the integrity of the system and allows the currency unit to become a digital form of property with a title.</p>
<p>Once you understand this, you can see that the value proposition of bitcoin is bound up with its attached payment network. Here is where you find the use value to which Mises refers. It is not embedded in the currency unit but rather in the brilliant and innovative payment system on which bitcoin lives. If it were possible for the blockchain to be somehow separated from bitcoin (and, really, this is not possible), the value of the currency would instantly fall to zero.</p>
<h3 id="proof-of-concept">Proof of concept</h3>
<p>Now, to further understand how Misesâ theory fits with bitcoin, you have to understand one other point concerning the history of the cryptocurrency. On the day of its release (January 9, 2009), the value of bitcoin was exactly zero. And so it remained for 10 months after its release. All the while, transactions were taking place, but it had no posted value above zero for this entire time.</p>
<p>The first posted price of bitcoin appeared on October 5, 2009. On this exchange, $1 equaled 1,309.03 Bitcoin (which many considered overpriced at the time). In other words, the first valuation of bitcoin was little more than one-tenth of a penny. Yes, if you had bought $100 worth of bitcoin in those days, and not sold them in some panic, you would be a half-billionaire today.</p>
<p>So here is the question: What happened between January 9 and October 5, 2009, to cause bitcoin to obtain a market value? The answer is that traders, enthusiasts, entrepreneurs, and others were trying out the blockchain. They wanted to know if it worked. Did it transfer the units without double-spending? Did a system that depended on voluntary CPU power actually suffice to verify and confirm transactions? Do the rewarded bitcoins land in the right spot as payment for verification services? Most of all, did this new system actually work to do the seemingly impossibleâthat is, to move secure bits of title-based information through geographic space, not by using some third party but rather peer-to-peer?</p>
<p>It took 10 months to build confidence. It took another 18 months before bitcoin reached parity with the U.S. dollar. This history is essential to understand, especially if you are relying on a theory of moneyâs origins that speculates about the pre-history of money, as Misesâ regression theorem does. Bitcoin was not always a money with value. It was once a pure accounting unit attached to a ledger. This ledger obtained what Mises called âuse value.â All conditions of the theorem are thereby satisfied.</p>
<h3 id="final-accounting">Final accounting</h3>
<p>To review, if anyone says that bitcoin is based on nothing but thin air, that it cannot be a money because it has no real history as a genuine commodity, and whether the person saying this is a novice or a highly trained economist, you need to bring up two central points. One, bitcoin is not a stand-alone currency but a unit of accounting attached to an innovative payment network. Two, this network and therefore bitcoin only obtained its market value through real-time testing in a market environment.</p>
<p>In other words, once you account for the razzle-dazzle technical features, bitcoin emerged exactly like every other currency, from salt to gold, did. People found the payment system useful, and the attached accounting was portable, divisible, fungible, durable, and scarce.</p>
<p>A new form of money was born. This money has all the best features of money from history but adds a weightless and spaceless payment network, one that is reliable and verified in real time, that enables the entire world to trade without having to rely on third parties. </p>
<p>But notice something extremely important here. The blockchain is not only about money. It is about any information transfers that require security, confirmations, and total assurance of authenticity. This pertains to contracts and transactions of all sorts, all performed peer-to-peer. </p>
<p>To be sure, the sector has come to be dominated by third parties that operate mainly as custodians. The crucial point is that this is a market development driven by consumer desire but it is not necessary for the functioning of the system. In addition, thousands of additional tokens have appeared that operate and compete in the crypto sector which is now worth, at the time of this writing, $560 billion in market capitalization. </p>
<p>Think of a world without essential third parties, including the most dangerous third party ever conceived of by man: the state and the central bank. Imagine that future and you begin to grasp the fullness of the implications of our future.</p>
<p>Ludwig von Mises would be amazed and surprised at bitcoin. But he might also feel a sense of pride that his monetary theory of more than a century ago has been confirmed and given new life in the 21st century.</p>
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<h1 id="7-misconceptions-about-bitcoin-and-where-to-buy"><a href="https://www.lynalden.com/misconceptions-about-bitcoin/">7 Misconceptions about Bitcoin, and Where to Buy</a></h1>
<h3 id="by-lyn-alden">By <a href="https://twitter.com/LynAldenContact">Lyn Alden</a></h3>
<h3 id="posted-november-11-2020">Posted November 11, 2020</h3>
<p><em>Published: November 11, 2020</em></p>
<p>I initially covered Bitcoin in an article in autumn 2017, and was neutral-to-mildly-bearish for the intermediate term, and took no position.</p>
<p>The technology was well-conceived, but I had concerns about euphoric sentiment and market dilution. I neither claimed that it had to go lower, nor viewed it bullishly, and merely stepped aside to keep watching.</p>
<p>However, I turned bullish on Bitcoin in April 2020 in my research service at about $6,900/BTC and went long. It had indeed underperformed many other asset classes from autumn 2017 into spring 2020, but from that point, a variety of factors turned strongly in its favor. I then wrote a <a href="https://www.lynalden.com/invest-in-bitcoin/">public article</a> about it in July when it was at $9,200/BTC, further elaborating on why I am bullish on Bitcoin.</p>
<p>That July article received a lot of press, and the CEO of MicroStrategy (MSTR), the first publicly-traded company on a major stock exchange to put part of its cash position into Bitcoin, stated that he sent that article among other key resources to his board of directors as part of his team education process. Itâs written with institutional readers in mind, in other words, in addition to retail investors.</p>
<p>With a price tag of over $15,000/BTC today, Bitcoin is up over 120% from the initial price at my April pivot point, and is up over 60% from July, but I continue to be bullish through 2021. From there, I would expect a period of correction and consolidation, and Iâll re-assess its forward prospects from that point.</p>
<p>Naturally, Iâve received many emails about Bitcoin over this summer and autumn. Iâve answered several of them via email, but figured I would summarize the most popular ones into a quick article on the subject. These are common misconceptions, risks, or questions. All of which make sense to ask, so I do my best here to address them as I see it.</p>
<p>If you havenât read it, Iâd recommend reading my <a href="https://www.lynalden.com/invest-in-bitcoin/">July Bitcoin article</a> first.</p>
<h2 id="1-bitcoin-is-a-bubble">1) âBitcoin is a Bubbleâ</h2>
<p>Many people view Bitcoin as a bubble, which is understandable. Especially for folks who were looking at the linear chart in 2018 or 2019, Bitcoin looked like it hit a silly peak in late 2017 after a parabolic rise that would never be touched again.</p>
<p>This linear price chart goes from the beginning of 2016 to the beginning of 2019, and shows how it looked like a classic bubble:</p>
<p><img src="/assets/images/2020/m12/la1.png" alt="Bitcoin Bubble" /></p>
<p><em>Chart: StockCharts.com</em></p>
<p>Maybe it is a bubble. Weâll see. However, it looks a lot more rational when you look at the long-term logarithmic chart, especially as it relates to Bitcoinâs 4-year halving cycle.</p>
<p><img src="/assets/images/2020/m12/la2.png" alt="Bitcoin Halving Cycle" /></p>
<p><em>Chart Source: Chart Source: <a href="https://twitter.com/100trillionUSD">PlanB @100trillionUSD</a>, with annotations added by Lyn Alden</em></p>
<p>Each dot in that chart represents the monthly bitcoin price, with the color based on how many months it has been since the prior halving. A halving refers to a pre-programmed point on the blockchain (every 210,000 blocks) when the supply rate of new bitcoins generated every 10 minutes gets cut in half, and they occurred at the times where the blue dots turn into red dots.</p>
<p>The first cycle (the launch cycle) had a massive gain in percent terms from zero to over $20 per bitcoin at its peak. The second cycle, from the peak price in cycle 1 to the peak price in cycle 2, had an increase of over 50x, where Bitcoin first reached over $1,000. The third cycle from peak-to-peak had an increase of about 20x, where Bitcoin briefly touched about $20,000.</p>
<p>Since May 2020, weâve been in the fourth cycle, and weâll see what happens over the next year. This is historically a very bullish phase for Bitcoin, as demand remains strong but new supply is very limited, with a big chunk of the existing supply held in strong hands.</p>
<p>The monthly chart is looking solid, with positive MACD, and a higher current price than any monthly close in history. Only on an intra-month basis, within December 2017, has it been higher than it is now:</p>
<p><img src="/assets/images/2020/m12/la3.png" alt="Bitcoin Monthly Chart" /></p>
<p><em>Chart Source: StockCharts.com</em></p>
<p>The weekly chart shows how many times it became near-term overbought, and how many corrections it had, on its previous post-halving bullish run where it went up by 20x:</p>
<p><img src="/assets/images/2020/m12/la4.png" alt="Bitcoin Weekly Chart" /></p>
<p><em>Chart Source: StockCharts.com</em></p>
<p>My job here is simply to find assets that are likely to do well over a lengthy period of time. For many of the questions/misconceptions discussed in this article, there are digital asset specialists that can answer them with more detail than I can. A downside of specialists, however, is that many of them (not all) tend to be perma-bulls on their chosen asset class.</p>
<p>This is true with many specialist gold investors, specialist stock investors, specialist Bitcoin investors, and so forth. How many gold newsletters suggested that you might want to take profits in gold around its multi-year peak in 2011? How many Bitcoin personalities suggested that Bitcoin was probably overbought in late 2017 and due for a multi-year correction?</p>
<p>Iâve had the pleasure of having conversations with some of the most knowledgeable Bitcoin specialists in the world; the ones that keep their outlooks measured and fact-based, with risks clearly indicated, rather than being constant promoters of their industry at any cost. Bitcoinâs power comes in part from how enthusiastic its supporters are, but there is room for independent analysis on bullish potential and risk analysis as well.</p>
<p>And as someone who isnât in the digital asset industry myself, but who has a background that blends engineering and finance that lends itself reasonably well to analyzing it, I approach Bitcoin like I approach any other asset class; with an acknowledgement of risks, rewards, bullish cycles, and bearish cycles. I continue to be bullish here.</p>
<p>If this fourth cycle plays out anywhere remotely close to the past three cycles since inception (which isnât guaranteed), Bitcoinâs relative strength index could become quite extreme again in 2021. Hereâs a chart from PlanB about Bitcoinâs historical monthly RSI during the bullish and bearish phases of its 4-year halving cycle:</p>
<p><img src="/assets/images/2020/m12/la5.png" alt="Bitcoin RSI Misconceptions" /></p>
<p><em>Chart Source: <a href="https://twitter.com/100trillionUSD">PlanB @100trillionUSD</a></em></p>
<p>For that reason, Bitcoin going from $6,900 to $15,000+ in seven months doesnât lead me to take profits yet. In other words, a monthly RSI of 70 doesnât cut it as âoverboughtâ in Bitcoin terms, particularly this early after a halving event. Iâll likely look into some rebalancing later in 2021, though.</p>
<p>Each investor has their own risk tolerance, conviction, knowledge, and financial goals. A key way to manage Bitcoinâs volatility is to manage your position size, rather than try to trade it too frequently. If Bitcoinâs price volatility keeps you up at night, your position is probably too big. If you have an appropriately-sized position, itâs the type of asset to let run for a while, rather than to take profits as soon as itâs slightly popular and doing well.</p>
<p>When itâs at *extreme* sentiment, and/or its position has grown to a disproportionately large portion of your portfolio, itâs likely time to consider rebalancing.</p>
<h2 id="2-bitcoins-intrinsic-value-is-zero">2) âBitcoinâs Intrinsic Value is Zeroâ</h2>
<p>I approached this topic heavily in my autumn 2017 article, and again in <a href="https://www.lynalden.com/invest-in-bitcoin/">my summer 2020 article</a>.</p>
<p>To start with, digital assets can certainly have value. In simplistic terms, imagine a hypothetical online massive multiplayer game played by millions of people around the world. If there was a magical sword item introduced by the developer that was the strongest weapon in the game, and there were only a dozen of them released, and accounts that somehow got one could sell them to another account, you can bet that the price for that digital sword would be outrageous.</p>
<p>Bitcoinâs utility is that it allows people to store value outside of any currency system in something with provably scarce units, and to transport that value around the world. Its founder, Satoshi Nakamoto, solved the double-spending problem and crafted a well-designed protocol that has scarce units that are tradeable in a stateless and decentralized way.</p>
<p>In terms of utility, try bringing $250,000 worth of gold through an international airport vs bringing $250,000 worth of bitcoins with you instead, via a small digital wallet, or via an app on your phone, or even just by remembering a 12-word seed phrase. In addition, Bitcoin is more easily verifiable than gold, in terms of being a reserve asset and being used as collateral. Itâs more frictionless to transfer than gold, and has a hard-capped supply. And I like gold too; Iâve been long it since 2018, and still am.</p>
<p>Bitcoin is a digital commodity, as Satoshi envisioned it:</p>
<blockquote>
<p>As a thought experiment, imagine there was a base metal as scarce as gold but with the following properties:<br />
â boring grey in colour<br />
â not a good conductor of electricity<br />
â not particularly strong, but not ductile or easily malleable either<br />
â not useful for any practical or ornamental purpose</p>
<p>and one special, magical property:<br />
â can be transported over a communications channel</p>
<p>If it somehow acquired any value at all for whatever reason, then anyone wanting to transfer wealth over a long distance could buy some, transmit it, and have the recipient sell it.</p>
<p>-Satoshi Nakamoto, August 2010</p>
</blockquote>
<p>Compared to every other cryptocurrency, Bitcoin has by far the strongest network effect by an order of magnitude, and thus is the most secure in terms of decentralization and the amount of computing power and expense that it would take to try to attack the network. There are thousands of cryptocurrencies, but none of them have been able to rival Bitcoin in terms of market capitalization, decentralization, ubiquity, firm monetary policy, and network security combined.</p>
<p>Some other tokens present novel privacy advancements, or smart contracts that can allow for all sorts of technological disruption on other industries, but none of them are a major challenge to Bitcoin in terms of being an emergent store of value. Some of them can work well alongside Bitcoin, but not in place of Bitcoin.</p>
<p>Bitcoin is the best at what it does. And in a world of negative real rates within developed markets, and a host of currency failures in emerging markets, what it does has utility. The important question, therefore, is how much utility.</p>
<p>The pricing of that utility is best thought of in terms of the whole protocol, which is divided into 21 million bitcoins (each of which is divisible into 100 million sats), and combines the asset itself with the means of transmitting it and verifying it. The value of the protocol grows as more individuals and institutions use it to store and transmit and verify value, and can shrink if fewer folks use it.</p>
<p>The total market capitalization of gold is estimated to be over $10 trillion. Could Bitcoin reach 10% of that? 25%? Half? Parity? I donât know.</p>
<p>Iâm focusing on one Bitcoin halving cycle at a time. A four-year outlook is enough for me, and Iâll calibrate my analysis to what is happening as we go along.</p>
<h2 id="3-bitcoin-isnt-scalable">3) âBitcoin Isnât Scalableâ</h2>
<p>A common criticism of Bitcoin is that the number of transactions that the network can handle per 10 minutes is very low compared to, say, Visa (V) datacenters. This limits Bitcoinâs ability to be used for everyday transactions, such as to buy coffee.</p>
<p>In fact, this played a key role in the 2017 hard fork between Bitcoin and Bitcoin Cash. Proponents of Bitcoin Cash wanted to increase the block size, which would allow the network to process more transactions per unit of time.</p>
<p>However, with any payment protocol, there is a trade-off between security, decentralization, and speed. Which variables to maximize is a design choice; itâs currently impossible to maximize all three.</p>
<p>Visa, for example, maximizes speed to handle countless transactions per minute, and has moderate security depending on how you measure it. To do this, it completely gives up on decentralization; itâs a centralized payment system, run by Visa. And it of course relies on the underlying currency, which itself is centralized government fiat currency.</p>
<p>Bitcoin, on the other hand, maximizes security and decentralization, at the cost of speed. By keeping the block size small, it makes it possible for people all over the world to run their own full nodes, which can be used to verify the entire blockchain. Widespread node distribution (over 10,000 nodes) helps ensure decentralization and continual verification of the blockchain.</p>
<p>Bitcoin Cash potentially increases transaction throughput with bigger block sizes, but at the cost of lower security and less decentralization. In addition, it still doesnât come anywhere close to Visa in terms of transaction throughput, so it doesnât really maximize any variable.</p>
<p>Basically, the dispute between Bitcoin and Bitcoin Cash is whether Bitcoin should be both a settlement layer and a transaction layer (and thus not be perfect at either of those roles), or whether it should maximize itself as a settlement layer, and allow other networks to build on top of it to optimize for transaction speed and throughput.</p>
<p>The way to think about Bitcoin is that it is an ideal settlement layer. It combines a scarce currency/commodity with transmission and verification features, and has a huge amount of security backing it up from its high global hash rate. In fact, thatâs what makes Bitcoin vs Visa an inappropriate comparison; Visa is just a layer on top of deeper settlement layers, with merchant banks and other systems involved under the surface, whereas Bitcoin is foundational.</p>
<p>The global banking system has extremely bad scaling when you go down to the foundation. Wire transfers, for example, generally take days to settle. You donât pay for everyday things with wire transfers for that reason; theyâre mainly for big or important transactions.</p>
<p>However, the banking system builds additional layers of scalability onto those types of settlement layers, so we have things like paper checks, electronic checks, credit cards, PayPal, and so forth. Consumers can use these systems to perform a large number of smaller transactions, and the underlying banks settle with each other with more foundational, larger transactions less frequently. Each form of payment is a trade-off between speed and security; banks and institutions settle with each other with the most secure layers, while consumers use the speedier layers for everyday commerce.</p>
<p>Similarly, there are protocols like the Lightning Network and other smart contract concepts that are built on top of Bitcoin, which increase Bitcoinâs scalability. Lightning can perform tons of quick transactions between counterparties, and reconcile them with Bitcoinâs blockchain in one batch transaction. This reduces the fees and bandwidth limitations per small transaction.</p>
<p><img src="/assets/images/2020/m12/la6.png" alt="Lightning Network Diagram" /></p>
<p><em>Source: <a href="http://lightning.network/docs/">Lightning.Network</a></em></p>
<p>I donât know, looking back years from now, which scaling systems will have won out. Thereâs still a lot of development being done. The key thing to realize is that although Bitcoin is limited in terms of how many transactions it can do per unit of time, it is not limited by the total <em>value</em> of those transactions. The amount of value that Bitcoin can settle per unit of time is limitless, depending on its market cap and additional layers.</p>
<p>In other words, suppose that the Bitcoin network is limited to 250 transactions per minute, which is low. Those transactions could average $100 or $1 million, or any number. If they average $100 each, it means only $25,000 in transaction value is performed per minute. If they average $1 million each, it means $250 million in transaction value is performed per minute. If Bitcoin grows in use as a store of value, the transaction fees and inherent limitations prioritize the largest and most important transactions: the major settlement transactions.</p>
<p>Additional layers built on top of Bitcoin can do an arbitrary number of transactions per minute, and settle them with batches on the actual Bitcoin blockchain. This is similar to how consumer layers like Visa or PayPal can process an arbitrary number of transactions per minute, while the banks behind the scenes settle with larger transactions less frequently.</p>
<p>The market has already spoken about which technology it thinks is best, between Bitcoin and others like Bitcoin Cash. Ever since the 2017 hard fork, Bitcoinâs market capitalization and hash rate and number of nodes have greatly outperformed Bitcoin Cashâs. Watching this play out in 2017 was one of my initial risk assessments for the protocol, but three years later, that concern no longer exists.</p>
<h2 id="4-bitcoin-wastes-energy">4) âBitcoin Wastes Energyâ</h2>
<p>The Bitcoin network currently uses as much energy as a small country. This naturally brings up environmental concerns, especially as it grows.</p>
<p>Similarly, gold mining uses a ton of energy. For each gold coin, a ton of money, energy, and time went into exploration for deposits, developing a mine, and then processing countless tons of rock with heavy equipment to get a few grams of gold per ton. Then, it has to be purified and minted into bars and coins, and transported.</p>
<p>It takes several tons of processed rock to get each 1-ounce gold coin, and thousands of tons of processed rock for each good delivery gold bar. The amount of energy that goes into a small unit of gold is immense.</p>
<p>In fact, that energy is what gives gold value, and what made it internationally recognized as money for thousands of years. Gold is basically concentrated energy, concentrated work, as a dense store of value that does not erode with time.</p>
<p>Thereâs no limit to how many dollars, euros, or yen we can print, however. Banks multiply them all the time with a stroke of a keyboard. Likewise, industrial metals like iron are very common as well; we have no shortage of them. Gold, however, is very rare, and when found, it takes a ton of energy and time to get into pure form. And then we have to spend more energy transporting, securing, and verifying it from time to time.</p>
<p>However, the world does that anyway, because it derives value from it compared to the value that it had to put in to get it. Gold mining and refining requires energy, but in turn, central banks, institutions, investors, and consumers obtain a scarce store of value, or jewelry, or industrial applications from the rare metal.</p>
<p>Similarly, Bitcoin takes a lot of energy, but thatâs because it has so much computing power constantly securing its protocol, compared to countless other cryptocurrencies that are easy to attack or insufficiently decentralized.</p>
<p>Visa uses much less energy than Bitcoin, but it requires complete centralization and is built on top of an abundant fiat currency. Litecoin uses much less energy than Bitcoin as well, but itâs easier for a well-capitalized group to attack.</p>
<p>The question then becomes whether that energy associated with Bitcoin is put to good use. Does Bitcoin justify its energy usage? Does it add enough value?</p>
<p>So far, the market says it does and I agree. A decentralized digital monetary system, separate from any sovereign entity, with a rules-based monetary policy and inherent scarcity, gives people around the world a choice, which some of them use to store value in, and/or use to transmit that value to others.</p>
<p>Those of us in developed markets that havenât experienced rapid inflation for decades may not see the need for it, but countless people in emerging markets have experienced many instances of severe inflation in their lifetimes, and tend to get the concept more quickly.</p>
<p><img src="/assets/images/2020/m12/la7.png" alt="Cryptocurrency Adoption" /></p>
<p><em>Chart Source: <a href="https://www.statista.com/chart/18345/crypto-currency-adoption/">Statista</a></em></p>
<p>Furthermore, a significant portion of the energy that Bitcoin uses could otherwise be wasted. Bitcoin miners seek out the absolute cheapest sources of electricity in the world, which usually means energy that was developed for one reason or another, but that doesnât currently have sufficient demand, and would therefore be wasted.</p>
<p>Examples of this include over-built hydroelectric dams in certain regions of China, or stranded oil and gas wells in North America. Bitcoin mining equipment is mobile, and thus can be put near wherever the cheapest source of energy is, to arbitrage it and give a purpose to that stranded energy production.</p>
<p>Bitcoin mining converts the output from those cheap stranded sources of energy into something that currently has monetary value.</p>
<h2 id="5-bitcoin-is-too-volatile">5) âBitcoin is Too Volatileâ</h2>
<p>Bitcoin is promoted as a store of value and medium of exchange, but it has a very volatile price history. This leads, again somewhat understandably, for investors to say itâs not a good store of value or medium of exchange, and thus fails at the one thing that itâs designed to do.</p>
<p>And theyâre kind of right. Bitcoin isnât the asset that you put money into for an emergency fund, or for a down payment on a house that youâre saving up for 6 months from now. When you definitely need a certain amount of currency in a near-term time horizon, Bitcoin is not the asset of choice.</p>
<p>This is because itâs an <em>emerging</em> store of value, roughly 12 years old now, and thus carries with it a significant degree of growth and speculation. Its market capitalization is growing over time, taking some market share from other stores of value, and growing into a meaningful asset class. Weâll see if it continues to do so, or if it levels off somewhere and starts to stagnate.</p>
<p><img src="/assets/images/2020/m12/la8.png" alt="Bitcoin Market Capitalization" /></p>
<p>For Bitcoinâs market cap to grow from a $25 million to $250 million to $2.5 billion to $25 billion to todayâs value of over $250 billion, it requires volatility, especially upward volatility (which, of course, comes with associated downside volatility).</p>
<p>As it grows larger, its volatility reduces over time. If Bitcoin becomes a $2.5 trillion asset class one day, with more widespread holding, its volatility would likely be lower than it is now.</p>
<p>Therefore, having a nonzero exposure to Bitcoin is basically a bet that Bitcoinâs network effect and use case will continue to grow until it reaches some equilibrium where it has lower volatility and is more stable. For now, it has plenty of volatility, and it needs that volatility if it is to keep growing. Bitcoinâs technological foundation as a decentralized store of value is well-designed and maintained; it has all of the parts it needs. It just needs to grow into what it can be, and weâll see if it does.</p>
<p>Itâs like if someone identifies a new element, and people begin discovering uses for that element, and it experiences a period of rapid growth and high price volatility, until it has been around for sufficient time that it eventually settles in to a normal volatility band.</p>
<p>While Bitcoin remains as volatile as it is, investors can mitigate the risk by having an appropriate position size.</p>
<h2 id="6-governments-will-ban-bitcoin">6) âGovernments Will Ban Bitcoinâ</h2>
<p>Another legitimate concern that folks have is that even if Bitcoin is successful, that will make governments ban it. Some governments already have. So, this falls more in the âriskâ category than a âmisconceptionâ.</p>
<p>There is precedent for this. The United States made it illegal for Americans to own gold from 1933 to 1975, other than in small amounts for jewelry and collectibles. In the land of the free, there was a benign yellow metal that we could be sent to prison for owning coins and bars of, simply because it was seen as a threat to the monetary system.</p>
<p>This chart shows the interest rate of 10-year Treasury yields in blue. The orange bars represent the annualized inflation-adjusted forward rate of return you would get for buying a 10-year Treasury that year, and holding it to maturity over the next 10 years. The green square shows the period of time where owning gold was illegal.</p>
<p><img src="/assets/images/2020/m12/la9.png" alt="Gold Illegal from 1933-1975" /></p>
<p><em>Data Sources: <a href="http://www.econ.yale.edu/~shiller/data.htm">Robert Shiller</a>, <a href="http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/histretSP.html">Aswath Damodaran</a></em></p>
<p>There was a four-decade period from the 1930âs to the 1970âs where keeping money in the bank or in sovereign bonds didnât keep up with inflation, i.e. the orange bars were net negative. Saversâ purchasing power went down if they held these paper assets.</p>
<p>This was due to two inflationary decades: one in the 1940âs, and one in the 1970âs. There were some periods in the middle, like the 1950âs, where cash and bonds did okay, but over this whole four-decade period, they were a net loss in inflation-adjusted terms.</p>
<p>Itâs not too shocking, therefore, that one of the release valves for investors was banned during that specific period. Gold did great over that time, and held its purchasing power against currency debasement. The government considered it a matter of national security to âprevent hoardingâ and basically force people into the paper assets that lost value, or into more economic assets like stocks and real estate.</p>
<p>This was back when the dollar was backed by gold, so the United States government wanted to own most of the gold, and limit citizensâ abilities to acquire gold. No such backing exists today for gold or Bitcoin, and thus there is less incentive to try to ban it.</p>
<p>And, the gold ban was hard to enforce. There were rather few prosecutions over gold ownership, even though the penalties on paper were severe.</p>
<p>Bitcoin uses encryption, and thus is not really able to be confiscated other than through legal demand. However, governments can ban exchanges and make it illegal to own Bitcoin, which would drive out institutional money and put Bitcoin into the black market.</p>
<p>Hereâs the problem. Bitcoin has over $250 billion in market capitalization. Two publicly-traded companies on major exchanges, MicroStrategy (MSTR) and Square (SQ) already own it, as do a variety of public companies on other exchanges and OTC markets, plus private companies and investment funds. Big investors like Cathie Woods, Paul Tudor Jones, and Stanley Druckenmiller own it, as does <a href="https://fortune.com/2020/11/04/wyoming-bitcoin-cynthia-lummis-u-s-senate/">at least one U.S. senator-elect</a>. Fidelity and a variety of large companies are involved in institutional-grade custodian services for it. PayPal (PYPL) is getting involved. Federally regulated U.S. banks <a href="https://www.occ.gov/news-issuances/news-releases/2020/nr-occ-2020-98.html">can now officially custody crypto assets</a>. The IRS treats it like a commodity for tax purposes. Thatâs a lot of mainstream momentum.</p>
<p>It would be extremely difficult for major capital markets like the United States or Europe or Japan to ban it at this point. If, in the years ahead, Bitcoinâs market capitalization reaches over $1 trillion, with more and more institutions holding exposure to it, it becomes harder and harder to ban.</p>
<p>Bitcoin was already an unusual asset that grew into the semi-mainstream from the bottom up, through retail adoption. Once the political donor class owns it as well, which they increasingly do, the game is basically over for banning it. Trying to ban it would be an attack on the balance sheets of corporations, funds, banks, and investors that own it, and would not be popular among millions of voters that own it.</p>
<p>I think regulatory hostility is still a risk to watch out for while the market capitalization is subâ$1 trillion. And the risk can be managed with an appropriate position size for your unique financial situation and goals.</p>
<h2 id="7-where-to-buy-bitcoin">7) âWhere to Buy Bitcoinâ</h2>
<p>The most frequent question I get about Bitcoin is simply where to buy bitcoins. Some people donât know how to start, and other people are familiar with the popular places to buy, but donât know which ones are ideal.</p>
<p>Thereâs no one answer; it depends on your goals with it, and where you live in the world.</p>
<p>The first question to ask is whether youâre a trader or a saver. Do you want to establish a long-term Bitcoin position, or buy some with a plan to sell it in a few months? Or maybe some of both?</p>
<p>The second question to ask yourself is whether you want to self-custody it with private keys and a hardware wallet or multi-signature solution, which has an upfront learning curve but is ultimately more secure, or if you want to have someone else custody it for you, which is simpler but involves counterparty risk.</p>
<p>Bitcoin is accessible through some publicly traded funds, like the Grayscale Bitcoin Trust (GBTC), of which I am long. However, funds like these trade at a premium to NAV, and rely on counterparties. A fund like that can be useful as part of a diversified portfolio in an IRA, due to tax advantages, but outside of that isnât the best way to establish a core position.</p>
<p>Bitcoin is also available on <a href="https://coinmarketcap.com/rankings/exchanges/">major exchanges</a>, where it can then be sent to a private hardware wallet or elsewhere. I donât have a strong view on which exchanges are the best. However, be careful about platforms that donât let you withdraw your Bitcoin, like Robinhood. I personally bought my core position through an exchange in April when I turned bullish, and transferred a lot of it to personal custody.</p>
<p>From there, I began dollar-cost averaging through <a href="https://www.swanbitcoin.com/alden/">Swan Bitcoin</a>, where it can be kept in their cold storage or transferred out to personal custody as well. Swan specializes in Bitcoin (rather than multiple types of digital assets), and has very low fees for folks who like to dollar-cost average. Itâs a saverâs platform, in other words, rather than a traderâs platform. Iâm an advisor to Swan Bitcoin and know several of their staff including their CEO, so itâs my preferred way to accumulate Bitcoin.</p>
<p>Overall, having access to a crypto exchange, and having access to a dollar-cost averaging platform like Swan, along with a personal custody solution like a hardware wallet or a multi-signature solution, is a good combo.</p>
<p>For folks who are early in the learning curve, keeping it on an exchange or in custody storage is also fine, and as you learn more, you can choose to self-custody if itâs right for your situation.</p>
<p><em>Acknowledgments to Michael Hartl for editing assistance.</em></p>
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<!--End mc_embed_signup-->Lyn AldenThis article answers some popular misconceptions and questions about Bitcoin, and then shows the best place for where to buy Bitcoin.November 2020 Journal2020-11-30T00:00:00+00:002020-11-30T00:00:00+00:00https://bitcoinwords.github.io/cy20m11<p><a href="https://paywall.link/to/2020M11" class="align-left"><img src="/assets/images/covers/CY20M11-cover-150.png" alt="November 2020 Journal Cover" title="November 2020 Journal Cover" /></a> <em>WORDS</em> is a monthly journal of Bitcoin commentary. For the uninitiated, getting up to speed on Bitcoin can seem daunting. Content is scattered across the internet, in some cases behind paywalls, and content has been lost forever. Thatâs why we made this journal, to preserve and further the understanding of Bitcoin.</p>
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<h1 id="bitcoin-is-the-most-sustainable-money-the-world-has-ever-seen"><a href="https://gaelgss.medium.com/bitcoin-is-the-most-sustainable-money-the-world-has-ever-seen-8c187b71cdd1">Bitcoin is the Most Sustainable Money The World Has Ever Seen</a></h1>
<h3 id="by-gael-sĂĄnchez-smith">By <a href="https://twitter.com/gaelsansmith">Gael SĂĄnchez Smith</a></h3>
<h3 id="posted-september-15-2020">Posted September 15, 2020</h3>
<p><img src="/assets/images/2020/m11/gss1.png" alt="" />
<em>Planetary boundaries: Guiding human development on a changing planet (2015)</em></p>
<p>One of the greatest challenges facing the world is ensuring economic progress is undertaken in a way that doesnât impose an insurmountable cost to the planet.</p>
<p>Scientists have been warning for decades that the current rate of environmental degradation puts humanity on the brink of disaster and yet the economic machine continues unfettered, eating away at the planetâs life support systems.</p>
<p>In a recent report, researchers point out that four of the nine worldwide processes that underpin life on earth have exceeded the âsafe zoneâ, including anthropogenic climate change, loss of biodiversity, soil and freshwater depletion & ocean acidification.</p>
<p>Many argue that the environmental damage should be tackled through government taxes and regulations, others go as far as calling for the end of capitalism and a return to socialist economic planning. History teaches us that the latter would lead to a disaster that would not only fail in its alleged goal of creating a more sustainable world, it would also impoverish society like every other centrally planned economy of the past.</p>
<p>The radical proposals coming from the extremes of the environmentalist movement make it all the more pressing for lovers of capitalism, free markets and liberty to take ecological challenges seriously and to propose solutions. In this regard, there is one central area of every economy that remains largely unscrutinized but could contain part of the solution, namely the monetary system.</p>
<p>Bitcoin is widely criticized for its high carbon footprint, which, according to the most recent researchers, is estimated around 17 megatonnes of CO2 per year, about the same as the country of Croatia. This increase in carbon emissions couldnât have come at a worse time, with the world rapidly approaching the 2 degree warming level, which would prove catastrophic for many parts of the world. However, CO2 emissions arenât an inherent feature of the Bitcoin network and they most certainly wonât be a problem in the long run; let me explain:</p>
<p><img src="/assets/images/2020/m11/gss2.png" alt="" />
<em>Bloomberg New Energy Finance (2019)</em></p>
<p>Bitcoinâs carbon footprint is caused by its high electricity consumption, which is needed to secure the decentralization of the network. However, at present more than 35% of the worldâs electricity is produced from renewables+nuclear and in the U.S. the figure is even higher, with 38% of electricity being carbon-free. Furthermore, the exponential cost declines of solar and wind over the past 10 years means they are already the cheapest electricity sources across two thirds of the world.</p>
<p>As efficiency improvements continue reducing the cost of generating and storing renewable energy, solar and wind will become the cheapest sources of energy across the globe. Once the availability and intermittency of renewables is solved, fossil fuels will be removed from the worldâs energy grid and the Bitcoin network will be 100% carbon-free.</p>
<p><strong>Monetary Policy & Environmentalism</strong></p>
<p>Many of the environmental challenges highlighted at the start of this article can be partially attributed to the <em>fiat</em> monetary system, which has been imposed upon the world:</p>
<ol>
<li>The Keynesian obsession with maintaining an <strong>ever-expanding rate of aggregate demand,</strong> rising government spending to prop up GDP or monetary expansions to punish hoarding, results in high rates of environmental degradation for short-term gains in consumption and investment.</li>
<li><strong>The overconsumption of natural resources</strong> <strong>during the malinvestment phase of the business cycle</strong> is caused by fractional reserve credit expansion. The relationship between credit expansion and environmental degradation has been pointed out by Jesus Huerta de Soto, who notes how âcredit expansion hinders sustainable economic development and needlessly damages the natural environment.â</li>
<li><strong>Inflationary currency depreciation</strong> lowers the incentive to hold cash balances and incentivizes individuals to consume in the present. Consumerism contributes to environmental degradation associated to the manufacturing and distribution of consumer goods.</li>
<li><strong>Inflationary currency depreciation</strong> incentivizes individuals to invest in projects that offer negative real returns, simply to minimize the loss in purchasing power of their savings. These investments are not only destructive of societyâs capital stock, many of them also have negative consequences on the environment.</li>
</ol>
<p>Under a Bitcoin standard, the above-mentioned forms of social engineering would be impossible and consequently, the environment would be given a very much needed breath of fresh air:</p>
<ol>
<li>Manipulations of aggregate demand through monetary expansion would be impossible since the monetary supply is capped and stimulus programs would be limited by the governmentâs fiscal position.</li>
<li>Business cycles and their resulting malinvestments wouldnât occur since fractional reserve banking is unfeasible without a central bank. Under a Bitcoin standard, market interest rates would do what they are supposed to do; communicate the time, risk and liquidity preferences of market participants.</li>
<li>Bitcoinâs fixed money supply introduces incentives for individuals not to spend in the present, since money appreciates over time reflecting gains in productivity. Additionally, only investments that offer a return above the rate of deflation would be undertaken.</li>
</ol>
<p>A Bitcoin economy would likely be one with more sustainable levels of consumption and investment; in a sense it might resemble the degrowth economy advocated by many environmentalists. The availability of a store of wealth that offers a risk free return would give people the peace of mind and the time required to engage in non-economic activities. Spending less time in the mall and in the factory wouldnât make society poorer, on the contrary, it would allow individuals to focus on family, friendships, charity, spirituality, religion or whatever they believe will bring them closer to âthe good lifeâ.</p>
<p>In his magnum opus, The Bitcoin Standard, Saifedean Ammous explains how the fetishization of growth has been massively destructive of economic progress. In this article, I contend that it has also led us on a path of utter destruction of the environment, putting in danger the very prospect of life on the only home weâve ever known, a pale blue dot within a boundless, dark night.</p>
<p><img src="/assets/images/2020/m11/gss3.png" alt="" />
<em>The phrase âPale Blue Dotâ was coined in 1990 by Carl Sagan during his reflections on the importance of preserving life in the universe.</em></p>
<p><strong>References</strong></p>
<ul>
<li>https://about.bnef.com/new-energy-outlook/</li>
<li>https://www.theguardian.com/environment/2015/jan/15/rate-of-environmental-degradation-puts-life-on-earth-at-risk-say-scientists</li>
<li>https://www.newscientist.com/article/2224037-bitcoins-climate-change-impact-may-be-much-smaller-than-we-thought/</li>
<li>https://en.wikipedia.org/wiki/List_of_countries_by_carbon_dioxide_emissions</li>
<li>https://mises.org/library/some-additional-reflections-economic-crisis-and-theory-cycle</li>
<li>https://nakamotoinstitute.org/mempool/fractional-reserve-banking-is-obsolete/</li>
</ul>
<hr />
<h1 id="our-most-brilliant-idea"><a href="https://breedlove22.medium.com/our-most-brilliant-idea-aced329f8941">Our Most Brilliant Idea</a></h1>
<h3 id="by-robert-breedlove">By <a href="https://twitter.com/Breedlove22">Robert Breedlove</a></h3>
<h3 id="posted-november-1-2020">Posted November 1, 2020</h3>
<p>Ideas ambulate humanity across history. A new and useful idea is an innovation, which can benefit everyone for the rest of time. Therefore, it is critical we construct socioeconomic structures conducive to the creation of new ideas: civilization can only advance amid an everlasting flow of fresh knowledge. Free trade is the means by which we maximize ideation and its physical manifestation: wealth creation. Anything that impedes tradeâlike central bankingâis (by definition) a terrible idea. Contrarily, all accelerants to free tradeâlike moneyâare among the most brilliant ideas weâve ever had.</p>
<p><img src="/assets/images/2020/m11/rb1.jpg" alt="Image for post" /></p>
<h2 id="ideas-drive-economics">Ideas Drive Economics</h2>
<blockquote>
<p>âA pile of rocks ceases to be so when somebody contemplates it with the idea of a cathedral in mind.â â Antoine De St-Exupery</p>
</blockquote>
<p>Ideas are the origins of everything we say, do, or make. The purpose of any economy is to generate and share useful ideas through free trade (to achieve what economists call the division of labor or knowledge specialization). Civilization emerges not by an aimless concourse of variation, but rather it is molded in the image of our ideas, which we express through action to remake the face of the Earth. Better ideas, or sharper knowledge, equip mankind to more intelligently harness the gifts of the Earth to satisfy his wants to ever-higher degrees in ever-less time. In ideological space, competition is free and fierce: only the most useful ideas survive the test of time. Resultant knowledge encodes the patterns of action we use to etch our imaginations into the world around us. Winning ideas are chosen by the market, only to be widely distributed as material riches, finer manners and morals, and more profound art. Our lives are lived enacting our ideas. As HG Wells said:</p>
<blockquote>
<p>âHuman history is, in essence, a history of ideas.â</p>
</blockquote>
<p>Or as William Durant elaborates:</p>
<blockquote>
<p>âHistory as a laboratory rich in a hundred thousand experiments in economics, religion, literature, science, and governmentâhistory as our roots and our illumination, as the road by which we came and the only light that can clarify the present and guide us into the future.â</p>
</blockquote>
<p>Pouring forth from our forebears is this civilizing heritage of ideas sharpened through free trade and expressed in the tools, techniques, and cultures we make for ourselves. As we trade, our ideas become better, giving everything we say, do, or make more want-satisfying qualities. Consider how our language has evolved from grunts to enunciations, or how our behaviors have been shaped by culture, or how our transportation technologies have progressed from wagons to airplanes. Substantive ingredients for all modern miracles surrounding us today have always been available, but prior to their invention, we simply lacked the ideas necessary to manifest them. As the living generation responsible for ideation, our aim must be to forge our ideas into finer form for posterity: an aim we accomplish through innovation.</p>
<p><img src="/assets/images/2020/m11/rb2.jpg" alt="Image for post" /></p>
<p>Ideally, our civilization is the manifestation of our most useful ideas.</p>
<p>Innovation is simply a reconfiguration of the âraw materialsâ of nature by indexing them to our most useful idea structures. Said differently: creativity is taking known elements and reassembling them in accordance with new knowledge. Sharpening knowledge to better satisfy ourselves requires fires from the ideological collisions and frictions innate to trade. Trade, then, is mankindâs âmeta-ideaâ â the generative idea of all our best ideas. Meta (from the Greek ΌΔÏÎŹ, meaning âafterâ or âbeyondâ) is a prefix meaning more comprehensive or transcending: trade is an idea about improving ideas. It presupposes that anyone may know something everyone else does not, incentivizes them to teach the rest of us, and lets us all capitalize on any such learning opportunities. Trade indicates to us whether we are ill-informed in the pursuit of a goal, which can save us from harm, or help us achieve it more easily. Wealth generation is inseparable from ideation: the more we know, the more effortlessly we satisfy our (present and potential future) wants through innovation, and the more wealth we gain. Author Matt Ridley captures the spirit of this relationship between free trade and innovation in these words:</p>
<blockquote>
<p>âInnovation is the child of freedom and the parent of prosperity.â</p>
</blockquote>
<p>Free market capitalism is an idea unequaled in its generation of innovation. It proved itself as the most successful economic model for expanding trade, ideation, and wealth creation in the 20th century ideological contention between American capitalism and Soviet communism. Misguided by utopian promises, Soviet Russia attempted to replace the profit motive intrinsic to American capitalism with appeals to nationalistic faith and devotion, thereby poisoning the wellspring of learning engendered by trade. Under the moralistic camouflage of communism (âfrom each according to their ability, to each according to their needsâ was the Marxist slogan) some of the most gruesome atrocities in history were perpetrated. Soon into the Soviet experiment, productivity collapsed, and millions starved or were slaughtered by the state. When governments play God, civilizations burn in hell. Soviet Russia rediscovered what wise Aristotle had warned centuries earlier:</p>
<blockquote>
<p>âWhen everybody owns everything nobody takes care of anything.â</p>
</blockquote>
<p>American capitalism outcompeted Soviet communism. Capitalism is a socioeconomic system premised on the three pillars of private property rights, rule of law, and honest money. Private property rights represent an exclusive relationship between individuals and any portion of nature they invest their time in reshaping; rights they can then exchange with similarly self-sovereign people. Rule of law is a mechanism for nonviolently resolving private property disputes. Honest money is the private property unimpeded market processes naturally select as most tradable. Since capitalism optimizes for trade, it supports this generative source of new ideas by incentivizing economic cooperation and (peaceful) competition. Indeed, the stability of rules is the bedrock of peace: with fixed and simple laws, market participants are forced to play the game well to make an honest living. As Bastiat said:</p>
<blockquote>
<p>âWhen goods donât cross borders, soldiers will.â</p>
</blockquote>
<p>In an elemental sense, trade is the water that sustains innovation, and its steadfast flow a source of peace. Capitalism is the socioeconomic âwater wellâ built to protect this everlasting ideological wellspring of civilizationâtrade.</p>
<p><img src="/assets/images/2020/m11/rb3.png" alt="Image for post" /></p>
<p>Capitalism is a socioeconomic âwater wellâ which protects our wellspring of ideas: trade.</p>
<h2 id="the-idea-supercomputer">The Idea Supercomputer</h2>
<blockquote>
<p><em>âGreat minds discuss ideas. Average minds discuss events. Small minds discuss people.ââEleanor Roosevelt</em></p>
</blockquote>
<p>As the ultimate token of trade, money is an indispensable tool for ideation. In trade, everything is valued at some ratio of everything else. For instance, a car might be worth 132 chairs, or a house worth 11 cars. Money is the medium through which we more easily calculate these exchange ratios: a tool that simplifies trade by standardizing its intermediation. Like all tools, money lets us achieve greater results with less efforts, and the time-savings tools impart <em>is</em> wealth. Specifically, money lets us calculate, negotiate, and execute trades more quickly. Without money, a constant recalculation of countless exchange ratios among different economic goods would be necessary. With money, all exchange ratios are compressed into a single number â the money-expressed market price. In this way, money is an accelerant to trade and (its invisible twin) ideation. Standardization to one money creates economies of scale in trade. Such economization is what drives the market to coalesce around a single money â as we saw with gold and (its former currency abstraction, and now apparition) the US dollar:</p>
<p><img src="/assets/images/2020/m11/rb4.jpg" alt="Image for post" /></p>
<p>Americaâs founding fathers knew the dangers of falsifying money.</p>
<p>Money is the medium through which market participants express their ideas, preferences, and values. Pricing systems are economic telecommunication networks endlessly echoing and coordinating market action by dynamically informing everyone of everyone elseâs trades. For instance, when you buy a car and sell a house, the economy responds adaptively by producing more cars and less houses. Even when you buy a public equity, you are expressing the idea its expected future cash flows are worth more than its current price, and the marketplace absorbs this thesis when you execute the trade. Price signals perpetually prime incentives to ensure resources are allocated in accordance with the current aggregate composition of market participant preferences. Entrepreneurs engaging in trade give rise to truthful pricing as they strive to buy low, sell high, and profitably serve one another. A true free market is a forum of unhampered and voluntary exchange where ideas compete, combine, and transform. Seen this way, the free market may be considered the ultimate distributed computing system â a nexus of consciousnesses driven by human action and interconnected by prices.</p>
<p><img src="/assets/images/2020/m11/rb5.png" alt="" />
The distributed computing power of the free market is the most intelligent system in the world.</p>
<p>Money improves the extensibility of our minds. Thinking is an expression of rationality: the act of comparing all relevant factors to any course of action. By cognitively generating different aspects and avatars relevant to any given situation, humans create mental staging areas for future action. As with the root word of rationality â <em>ratio</em> â thinking involves contrasting one thing against another. When we extend our thinking into money, we gain insight into the collective mind of other market participants through price signals, which themselves are expressions of rationality: ratios of exchange denominated in monetary terms. By consolidating the rationality of all market actors into the market price, ideation explodes. In this way, free markets are idea-generating supercomputers. This is why American innovation is unrivaled. Mankind makes the world his own by channeling energy across the ideological field lines fashioned in his extended mindâthe free market.</p>
<h2 id="free-markets-are-free-thinking">Free Markets are Free Thinking</h2>
<blockquote>
<p>âManâs mind, once stretched by a new idea, never regains its original dimensions.ââOliver Wendell Holmes</p>
</blockquote>
<p>Contrary to popular misconception, money is <strong>not</strong> a government creation. Money is emergentâit is simply the most tradable good in any given market. As people seek to satisfy their wants through trade, they steadily seek to trade their goods for more tradable goods to get closer to obtaining the object(s) they desire. As this process unfolds, a certain asset gains the highest liquidityâwhether it is salt, cattle, or goldâthis most exchangeable good is (by definition) money. Money, then, is an inexorable outcome of free trade.</p>
<p>As global markets converged, they coalesced around precious metals as money due to their superior monetary properties of durability, divisibility, portability, recognizability, and scarcity. Goldâwhich excelled all other metals in scarcityâbecame the dominant money of the world precisely because its supply was the least changeable. Central banks eventually coopted gold and built a <a href="https://medium.com/@breedlove22/masters-and-slaves-of-money-255ecc93404f">pyramid scheme</a> on it called <em>fiat currency</em>. When central banks monopolized the market for money, it became <em>unfree</em>. Violating free market capitalism, as Soviet Russia learned the hard way, is a really bad ideaâit runs countervailing to the natural human proclivity for trade, ideation, and wealth generation. As Marcus Aurelius poeticizes our capacity for collaboration:</p>
<blockquote>
<p>âWe were born to work together like feet, hands, and eyes, like the two rows of teeth, upper and lower. To obstruct each other is unnatural.â</p>
</blockquote>
<p>Clearly, obstructing the ability of market participants to express their ideas through trade is a breakdown in the ârulesâ of capitalism. All frictions on free trade are dissipative to both innovation and wealth creation. A true capitalist society necessitates unbreakable rules of trade such as equitable rule of law, inviolable private property rights, and unstoppable honest money. In such a pure capitalistic system, individuals would have no way to create value for themselves other than giving society what it wants (even if its wants are as yet unarticulated). But our over-regulated world today is a far cry from this ideal.</p>
<p>All regulations are limitations on free market forces that constrict ideation and its physical manifestation: wealth creation. The ultimate expression of legal regulation is monopolization, in which all peaceful competition is suppressed through coercion or violence. In the world today, the market for money is not a free market, as it is forcibly dominated by cartels of central banks â legal monopolies that distort prices, reduce trade, and interrupt ideation. Tellingly, central banking was also a key component of Soviet communismâan exclusive state-owned banking monopoly was the <a href="https://mises.org/wire/why-marx-loved-central-banks">5th measure</a> in Marxâs 1848 <em>Manifesto to the Communist Party</em>. True capitalism has never existed, precisely because the rules of money have always become twisted by interventionists pursuing their own pecuniary gain in every market known to history. Legal impediments erected by governments to insulate central bank monopolies on money from free market capitalism are manifold. Such artifice destroys accountability, ingenuity, and virtue.</p>
<p><img src="/assets/images/2020/m11/rb6.jpg" alt="Image for post" /></p>
<p>With unbreakable capitalistic rules, the âgameâ of macroeconomics would impose an organizing principle onto humanity, encouraging us to find better ways of saying, doing, or making things by betting against each other in the marketplace as opposed to lying, stealing, or taxing. When rules cannot break, play is fair, and want-satisfactions escalate. As âplayersâ prove one another wrong in the marketplaceâby discovering and selling better means of satisfying wantsâthe resultant productivity gains diffuse into society through trade. An environment conducive to continuous learning at scale is cultivated through capitalism. Said differently: when ideas compete freely, more wealth is createdâmost often in the form of better tools, services, or knowledge. Mises describes this inextricable relationship between ideation and market competition in his masterwork <a href="https://cdn.mises.org/Human%20Action_3.pdf">Human Action</a>:</p>
<blockquote>
<p>âBut competition does not mean that anybody can prosper by simply imitating what other people do. It means the opportunity to serve the consumers in a better or cheaper way without being restrained by privileges granted to those whose vested interests the innovation hurts. What a newcomer who wants to defy the vested interest of the old established firms needs most is brains and ideas. If his project is fit to fill the most urgent of the unsatisfied needs of the consumers or to purvey them at a cheaper price than their olde purveyors, he will succeed in spite of the much talked of bigness and power of old firms.â</p>
</blockquote>
<p>To use <a href="https://medium.com/@breedlove22/an-open-letter-to-ray-dalio-re-bitcoin-4b07c52a1a98">Ray Dalioâs</a> term: free markets are <em>idea meritocracies</em>: unhampered trade networks that incentivize the cultivation and infusion of the best ideas into civilization. Implicit in the meta-idea is the presupposition innovation can only be nurtured, not legislated. Here, the ignorance of <a href="https://mises.org/power-market/mmt-not-modern-not-monetary-not-theory">MMT</a> advocates clamoring for âthe activation of idle capital through inflationâ rears its head: proceeds from theft via inflation can mobilize people and capital, but only in an unintelligent way since bureaucrats lack both the accountability and distributed computing power endogenous to the free market, and only until this parasitization of value from the productive economy kills it. In simple economic terms: free markets make mankind more productive; monopolies, or unfree markets, make mankind less productive. Further, the condition of our collective mind closely mirrors the state of our money. We only think in dollars today because they were once redeemable for gold. Central banks have hijacked the monetary extensibility of our minds (the old âbait and switchâ tactic), and corrupted our capacity to perceive the world clearly:</p>
<p><img src="/assets/images/2020/m11/rb7.png" alt="" /></p>
<p>Central banking distorts market pricing by counterfeiting currency.</p>
<p>Free minds need freely selected money. By embracing a free market paradigm in the totality of our actions we become more free thinking, intelligent, and wealthy. Another way to think about the free market is as a system of error detection and correction: through prices, it incentivizes the discovery and resolution of unsatisfied wants (socioeconomic errors). Central bank induced inflation distorts this error correction system, and causes dissatisfactions to swell. This market manipulation is (ostensibly) justified by the self-deceptive intentionality of central bankers to âmanage the economy,â as if any human had ever successfully managed any complex system without triggering a cascade of unintended consequences. Conviction in the utility of their necessarily limited knowledge, as opposed to the free market processes which continually revivify knowledge, is the black core of central bank malevolence. As John Milton, author of <a href="https://en.wikipedia.org/wiki/Paradise_Lost"><em>Paradise Lost</em></a>, brilliantly observed:</p>
<blockquote>
<p>âEvil is the force that believes its knowledge is complete.â</p>
</blockquote>
<p>Central banks could repent merely by admitting this gargantuan error in ideology, and letting the free market clear its 100+ years of errors. This would be painful at first, but undoubtedly in the long-term best interests of civilizationâlike a drug addict finally entering rehabilitation. But hubris and greed will almost certainly prevent such an ideal outcome. To summarize the argument: free market pricing is an error-clearing system, and central banking ameliorates its capacity for error detection and correction; acting as if its knowledge of markets is complete, central banking is evil incarnateâan institution of economic tyranny as misguided as Soviet Russia. In the ideological sphere, freedom is as creative as tyranny is destructive.</p>
<h2 id="the-greatest-idea-of-history">The Greatest Idea of History</h2>
<blockquote>
<p>âAn Idea Is Salvation By Imagination.â â Frank Lloyd Wright</p>
</blockquote>
<p>Quintessential to the idea of any money is that both present and future market participants will freely accept it in trade. The likelihood of a money to be accepted by the broadest possible set of trading partners is largely based on how reliably it maintains its scarcity across time. To maximize this store of value function, a money must be resistant to misappropriationâwhether by inflation, counterfeit, or confiscation (all of which are theft). The money most resistant to involuntary exchange (aka theft) tends to become the most widely adopted voluntary medium of exchange. Put another way: in free market competition the most theft-proof money wins. Those who erroneously choose a less theft-proof money are disfavored by market processes when their wealth is compromised by thieves through inflation, counterfeiting, or confiscation. Another way to say it: market participants adopt the money which minimizes the need to trust one another. Central banks continue to hoard gold because it is trust-minimized money. Bitcoin exhibits even greater trust-minimization qualities, and is therefore <a href="https://medium.com/the-bitcoin-times/bitcoin-and-the-tyranny-of-time-scarcity-1d1550dfd8b0">disruptive to gold</a>.</p>
<p><img src="/assets/images/2020/m11/rb8.png" alt="" /></p>
<p>Bitcoin is a renaissance of free market forces.</p>
<p>Money is the best idea weâve ever had, for without it, all the other marvelous ideas generated by markets would not exist. As the most tradable thing, money is the highest instantiation of our meta-idea, offering us unbridled optionality in market exchange. As a technology, free-market-selected money maximizes both human freedom and cooperation. Historically, gold reduced the incentives to violence, because it was a more securable form of wealth than food, land, and most other assets. In this way, gold greatly constricted the scope of assets worth fighting over, thereby inducing unparalleled social cooperation, trade, and wealth generation. This has profound moral implications too: when money is hard to steal, society becomes hard working; when it is easy to steal, society drifts toward kleptocracy. Let me state the argument in a single sentence: gold was the greatest tool we ever had to incentivize ourselves to civilize ourselves.</p>
<p><strong><em>If the aim of humanity is to build civilizations, then our most brilliant idea was the use of gold as money.</em></strong></p>
<p>The global gold standard improved trade (our meta-idea) in a trust-minimized way and standardized the world to a single monetary protocolâthereby maximizing time-savings in trade and its associated wealth creation (two sides of the <a href="https://medium.com/@breedlove22/money-bitcoin-and-time-part-1-of-3-b4f6bb036c04">same coin</a>). Again, wealth creation is absolutely dependent on ideation: using gold as money led the world into an unequaled effulgence of novel ideas and innovations, ushering in an era known colloquially as both The Gilded Age and La Belle Ăpoque:</p>
<p><img src="/assets/images/2020/m11/rb9.jpg" alt="" /></p>
<p>La Belle Ăpoqueâan era of significant innovation and wealth creationâwas also considered the âbeautiful ageâ of painting. This epoch of civilization was built on the idea of gold being used as money.</p>
<p>A brilliant idea indeed, but far from perfect: because gold is physical, it is still vulnerable to theft; and because gold is heavy, economies of scale related to its use as money led to the centralization of its custody in bank vaults (since it is cheaper to transact in paper abstractions of gold than physical gold). An anticapitalist institutionâthe central bankâfestered around these centralized gold hoards. These deceptive and evil institutions operate with flagrant disregard for the tenets of capitalism: central banks are above the law, practice perpetual private property confiscation via inflation, and peddle the most dishonest money in history. All central bank business models are critically dependent on the divisibility, portability, and recognizability shortcomings of gold:</p>
<ul>
<li>If gold were perfectly divisible, there would be no reason to abstract it into paper currency</li>
<li>If gold were perfectly portable, it would be encoded as information and there would be no need to place trust in banking custodians as final settlement could be conducted at the speed of light</li>
<li>If gold were perfectly recognizable, there would be no economic gain from the âpublic stampâ of national currencies as anyone could verify the veracity of money themselves instantaneously</li>
</ul>
<p>Indeed, these technological failings of gold formed the attack surface repeatedly exploited by central banks. Fortunately for citizens of the 21st century, free tradeâwhich has been exponentially enhanced by the internet and digital technologiesâhas generated an even more brilliant idea that promises a permanent ending to the thieving schemes of central banks.</p>
<h2 id="the-greatest-idea-of-modernity">The Greatest Idea of Modernity</h2>
<blockquote>
<p>âThere Is One Thing Stronger Than All The Armies In The World, And That Is An Idea Whose Time Has Come.ââ Victor Hugo</p>
</blockquote>
<p>America was founded on the three pillars of free market capitalism: private property rights, rule of law, and honest money. The American Constitution authorized states to issue gold or silver currency, outlawed income tax, and prohibited national central banking. Unfortunately, upon successful implementation of the American central bank (after two failed attempts), the private property rights foundational to free market capitalism became vulnerable to limitless violation via inflation. An example of this failure came with the â<a href="https://mises.org/library/great-gold-robbery-1933">Great Gold Robbery of 1933</a>â (aka Executive Order 6102): an unconstitutional decree and blatant violation of private property rights. All government decrees by fiat are lies (including fiat currency), for truth need never be forced. Free market forces always <a href="https://medium.com/@breedlove22/the-number-zero-and-bitcoin-4c193336db5b">zero-in</a> on truth.</p>
<p><img src="/assets/images/2020/m11/rb10.png" alt="" /></p>
<p>Bitcoin perfectly exemplifies the ideas America was founded uponâit is American AF.</p>
<p>Bitcoin is the ideological synthesis of gold and the internet; it perfectly exemplifies the three pillars of free market capitalism undergirding the idea of America in a form that cannot be perverted by fiat decree. As its money supply cannot be changed, its holders are immune to confiscation via inflation, thus perfecting their private property rights (Pillar 1). Disputes within the Bitcoin network are settled consensually, and it is impractical to employ violence in an attempt to sway this process, thus perfecting the process of nonviolent dispute resolution embodied by the rule of law (Pillar 2). By perfecting these first two pillars of free market capitalism, Bitcoin is a self-fulfilling prophecy predestined to perfect its final pillar by becoming the final evolution in free-market-selected honest money (Pillar 3). As the only sacrosanct money in existence, Bitcoin is purified capitalism: a permanent implementation of the soundest socioeconomic âwater wellâ in history:</p>
<p><img src="/assets/images/2020/m11/rb11.png" alt="Image for post" /></p>
<p>Bitcoin is purified capitalism: an elegant mathematical solution to the past problems of money.</p>
<p>Competition and collaboration are the trades of life. Conservatism of energy is truthâorganizations, methods, and tools that accomplish the greatest results with the least effort tend toward dominance as they are willingly embraced by market participants whose âskin is in the game.â Strict adherence to thermodynamic principles is the way all natural systems grow (there is no other way). Monies, moralities, and strategies which best amplify productivity outcompete on the free market for ideasâsubmission to this truth is freedom. Bitcoin is a system that minimizes competitive asymmetries by maximizing accountability, and thereby incentivizes fair play and error-clearing in the market. Modeled on the unbreakable rules of the universeâthermodynamicsâBitcoin is best known for its meteoric growth pattern:</p>
<p><img src="/assets/images/2020/m11/rb12.jpg" alt="" /></p>
<p>Adherence to thermodynamic principles has made Bitcoin the most explosive money in history.</p>
<p>We are what we build, and we build what we are. Ideation and wealth creation are mere expressions of lifeâs central impulse: growth. Without adequate levels of exchange, growth of organisms and economies deteriorate. On this point, nature is ruthlessly clear: when youâre finished changing, youâre finished. As we age, we experience a slowing of blood flow, which presages a breakdown of body and mind. Physical exercise can provide some protection by increasing our metabolic exchange of oxygen, water, and nutrients thereby keeping us smarter, healthier, and more energetic as we grow old. As William Durant eloquently describes this decline into senescence:</p>
<blockquote>
<p>âIt is a physiological and psychological involution. It is a hardening of the arteries and categories, an arresting of thought and blood; a man is as old as his arteries, and as young as his ideas.â</p>
</blockquote>
<p>What is true for the individual market participant microcosm is true for the global market macrocosm: impeding free trade constricts ideological âblood flowâ and makes the âsocioeconomic superorganismâ (aka humanity) more vulnerable to disease and death. Close-minded constituents conjure a build up of misfitness to reality for the collective. Creating blockages to trade via regulation and confiscationâthe implicit purpose of central bankingâis cancerous to the free market paradigm that invigorates our economic vitality, social morality, and the advancement of civilization.</p>
<p>All individuals seek to attain freedom, goods, and power for themselves. Governments are simply a multiplication of ourselves and our desires, without external governance, and armed with weapons of mass destruction. No amount of tears can wash away the blood war sheds, only practicality, properly implemented, can prevail. Absent a battle to fight â whether moral or physical â people become weaker. Arraying armies against an enemy gives people cause for unity. Perhaps Bitcoin will serve as a moral alternative to war â a peaceful yet disciplinary force on humanity. American Pragmatist William James believed a âmoral equivalentâ of war was necessary to end its horrors:</p>
<blockquote>
<p>âSo far war has been the only force that can discipline a whole community, and until an equivalent discipline is organized, I believe that war must have its way.â</p>
</blockquote>
<p>If this proves true, Bitcoin would become a new organizing mode for civilization: like a religion born from economic and computer science; a wisdom tradition that defunds and destroys central bank war machines and ideologies. Warfare is Darwinism writ geopolitical, and its atrocities will be endless until all nations agree, or are forced, to yield their self-arrogated sovereignty to a higher authority â a âsuperstateâ hodling individual sovereignty as its axiomatic mantra. Bitcoin â a public utility that facilitates trade flows of private property â is the bridge between communistic utopianism and capitalistic pragmatism, and could grow to become the superstate to which all nations bend the knee. Perhaps this ultimate usurpation of the nation began with the Genesis Block on day one, or perhaps it is still yet to transpire one day. For now, we can only say: Bitcoin is money.</p>
<p>Money is the ultimate token of trade, and trade is mankindâs meta-idea. Whatever wins as money on the free market is a brilliantly formulated, civilizing idea. Capitalism is the socioeconomic system which optimizes for the expansion of tradeâs scope by respecting free market principles, foremost of which is individual sovereignty. Bitcoinâan honest money offering its holders inviolable private property rights and perfected rule of lawâis the capstone innovation of capitalism. It is as if all trade throughout history led us to the emergence of this idea: an unstoppable, incorruptible, and highly accessible money. Like ideas, Bitcoin exhibits non-corporeality, virality, and antifragilityâit can be moved at the speed of light and stored in the mind. By virtue of its resistance to theft and rootedness in the thermodynamics of work, Bitcoin portals us into a world of untold liberty, elevated morality, and enhanced productivity. Bitcoin gives us the freedom to: trade without central bank interference, store our wealth in a place resistant to seizure, and to embrace truth in a world drowning in deception.</p>
<p><strong><em>Considered in combination, these ideas make Bitcoin mankindâs most brilliant idea yetâa salvific foundation on which we can build a future civilization characterized by more ingenuity, morality, and prosperity.</em></strong></p>
<blockquote>
<p>âSalvation: to see each thing for what it is â its nature and its purpose. To do only what is right, say only what is true, without holding back. What else could it be but to live life fully â to pay out goodness like the rings of a chain, without the slightest gap.â <em>â Marcus Aurelius</em></p>
</blockquote>
<p><strong>Thank you for reading <em>Our Most Brilliant Idea</em>.</strong></p>
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<p><strong>Translations:</strong></p>
<ul>
<li><a href="https://bitcoin-translate.it/blog/20201114.php">Italian</a></li>
</ul>
<p>Thank you for feedback during the writing process: <a href="https://medium.com/u/4acb12744ff8?source=post_page-----aced329f8941--------------------------------">Jimmy Song</a> <a href="https://medium.com/u/4f4c6b04c659?source=post_page-----aced329f8941--------------------------------">Brandon Quittem</a> @Greg Z <a href="https://medium.com/u/e36e0e52f842?source=post_page-----aced329f8941--------------------------------">Zach_of_Earth</a></p>
<p><strong>My sincerest gratitude to these amazing minds:</strong></p>
<p>@real_vijay, <a href="https://medium.com/u/becf6824fd89?source=post_page-----4b07c52a1a98----------------------">Saifedean Ammous</a>, <a href="https://medium.com/u/c74d75cd8d58?source=post_page-----4b07c52a1a98----------------------">Brandon Quittem</a>, <a href="https://medium.com/u/ca481e1bf815?source=post_page-----4b07c52a1a98----------------------">Dan Held</a>, <a href="https://medium.com/u/67f5049293c7?source=post_page-----4b07c52a1a98----------------------">Naval Ravikant</a>, @NickSzabo4, <a href="https://medium.com/u/a063100e6515?source=post_page-----4b07c52a1a98----------------------">Nic Carter</a>, @MartyBent, <a href="https://medium.com/u/1206face71fc?source=post_page-----4b07c52a1a98----------------------">Pierre Rochard</a>, <a href="https://medium.com/u/1d0168ffead9?source=post_page-----4b07c52a1a98----------------------">Anthony Pompliano</a>, <a href="https://medium.com/u/2a8f9285c9aa?source=post_page-----4b07c52a1a98----------------------">Chris Burniske</a>, @MarkYusko, @CaitlinLong_, <a href="https://medium.com/u/dc7ae094ae3a?source=post_page-----4b07c52a1a98----------------------">Nik Bhatia</a>, <a href="https://medium.com/u/f138bf5466fe?source=post_page-----4b07c52a1a98----------------------">Nassim Nicholas Taleb</a>, <a href="https://medium.com/u/b0082959a759?source=post_page-----4b07c52a1a98----------------------">Stephan Livera</a>, <a href="https://medium.com/u/79b96a130697?source=post_page-----4b07c52a1a98----------------------">Peter McCormack</a>, <a href="https://medium.com/u/29f663fdaf68?source=post_page-----4b07c52a1a98----------------------">Gigi</a>, <a href="https://medium.com/u/90326a938400?source=post_page-----4b07c52a1a98----------------------">Hasu</a>, @MustStopMurad, <a href="https://medium.com/u/2c121d83fdee?source=post_page-----4b07c52a1a98----------------------">Misir Mahmudov</a>, <a href="https://medium.com/u/11fe656b8466?source=post_page-----4b07c52a1a98----------------------">Mises Institute</a>, <a href="https://medium.com/u/e179e924df32?source=post_page-----4b07c52a1a98----------------------">John Vallis</a>, @FriarHass, <a href="https://medium.com/u/7e2af4996eb3?source=post_page-----4b07c52a1a98----------------------">Conner Brown</a>, <a href="https://medium.com/u/41b995bfb220?source=post_page-----4b07c52a1a98----------------------">Ben Prentice</a>, <a href="https://medium.com/u/c3dfe7e1392a?source=post_page-----4b07c52a1a98----------------------">Aleksandar Svetski</a>, <a href="https://medium.com/u/f1620960c83?source=post_page-----4b07c52a1a98----------------------">Cryptoconomy</a>, <a href="https://medium.com/u/8dbb1acf1534?source=post_page-----4b07c52a1a98----------------------">Citizen Bitcoin</a>, <a href="https://medium.com/u/b35b793f54bf?source=post_page-----4b07c52a1a98----------------------">Keyvan Davani</a>, @RaoulGMI, @DTAPCAP, <a href="https://medium.com/u/4860f822b31a?source=post_page-----4b07c52a1a98----------------------">Parker Lewis</a>, @Rhythmtrader, <a href="https://medium.com/u/ffa1d9486b31?source=post_page-----4b07c52a1a98----------------------">Russell Okung</a>, @sthenc, <a href="https://medium.com/u/1b4838316374?source=post_page-----4b07c52a1a98----------------------">Nathaniel Whittemore</a>, @ck_SNARKs, <a href="https://medium.com/u/37121823cc91?source=post_page-----4b07c52a1a98----------------------">Trevor Noren</a>, <a href="https://medium.com/u/1fed44f3e556?source=post_page-----4b07c52a1a98----------------------">Cory Klippsten</a>, <a href="https://medium.com/u/f12c589770d1?source=post_page-----4b07c52a1a98----------------------">Knut Svanholm</a> @relevantpeterschiff, <a href="https://medium.com/u/db32871ef5f3?source=post_page-----255ecc93404f--------------------------------">Preston Pysh</a>, @bezantdenier</p>
<p>And anyone else I forgot :)</p>
<p><strong>Sources:</strong></p>
<p>a. <a href="https://www.grunge.com/91938/ideas-changed-course-humanity/">https://www.grunge.com/91938/ideas-changed-course-humanity/</a></p>
<p>b. Rational Optimist by Matt Ridley</p>
<p>c. Meditations by Marcus Aurelius</p>
<p>d. Fallen Leaves: Last Words on Life, Love, War, and God by Will Durant</p>
<p>e. Manifesto to the Communist Party by Karl Marx</p>
<p>f. <a href="https://oll.libertyfund.org/pages/did-bastiat-say-when-goods-don-t-cross-borders-soldiers-will">https://oll.libertyfund.org/pages/did-bastiat-say-when-goods-don-t-cross-borders-soldiers-will</a></p>
<h4 id="thanks-to-brandon-quittem-jimmy-song-and-zach_of_earth">Thanks to Brandon Quittem, Jimmy Song, and Zach_of_Earth.</h4>
<hr />
<h1 id="the-costs-that-haunt-your-dreams-of-hyperbitcoinization"><a href="https://medium.com/@bdratings/the-costs-that-haunt-your-dreams-of-hyperbitcoinization-c45d2b28b6d2">The Costs that Haunt Your Dreams of Hyperbitcoinization</a></h1>
<h3 id="by-emil-sandstedt">By <a href="https://twitter.com/bezantdenier">Emil Sandstedt</a></h3>
<h3 id="posted-september-3-2020">Posted September 3, 2020</h3>
<h2 id="capitalism-division-of-labor-and-money">Capitalism, Division of Labor and Money</h2>
<p>Capitalism incentivizes profit seeking, meaning profit margins are eyed vigilantly. Any sector or niche is vulnerable to attracting entrepreneurs that set to work on making themselves richer, unintentionally shrinking said margins in the process. <strong>This profit seeking is conducted by utilizing money</strong>, as money leaves the entrepreneur through costs and reaches the entrepreneur through revenues. The entrepreneur, as a way to maximize profits, has chosen to specialize and is thus part of the massive, decentralized collaboration we call Division of Labor. As a participant, he must make use of money â the fragile glue that binds the whole construction together. Therefore, with ever increasing profit seeking and specialization in the world, and therefore ever increasing trade between participants, the transaction costs of money see a continuous increase in economic importance. It follows that transaction costs is an important factor in determining the money of a highly specialized future.</p>
<p>In Misesâs <a href="https://mises.org/library/human-action-0/html/pp/740">Evenly Rotating Economy</a> abstraction, every day is the same; yesterday is no different from today, and today is no different from tomorrow. In such an economy, all the factors of production are employed in such a way that they provide the highest valued service possible. There are no more entrepreneurs as all profit margins have already been fully exploited. Since every day is the same, there is also no more uncertainty, and so instead of holding money that for instance would put the holder first in line to react to future economic surprises, individuals have simply exchanged their money for debt or equity. The lending- and investment periods in the thought experiment are of course fully flexible, meaning any period could be stipulated in contracts. <strong>Since everyone knows the future, they have lent out or invested their money, and the value of money has fallen to zero</strong>. Phrased perhaps more coherently, due to no more surprises ever occurring in the economy, producers have set up perpetual barter contracts defined in the final prices of goods and services, and no actual money is used. In this way, the same trade outcomes are iterated day after day without incurring unnecessary transaction costs through the use of an intermediary good. The main takeaway from all this is that, only if the future is uncertain will individuals demand to hold money. <strong>Money is for uncertainty.</strong></p>
<p>Money then, to summarize, must facilitate profit seeking or entrepreneurs will use a money better suited for the purpose. It must also facilitate a possibility to respond to unexpected changes such as stock market crashes or unexpected new production (both for which sellers ask for money in return);money is for the proverbial rainy day â an idiom from a time when the weather could not be well predicted. <strong>From these prerequisites â two sides of the same coin â it follows that money can only stay money and stay valuable as money if transaction costs are low.</strong> If such costs get too high, trade and division of labor are simultaneously eroded until a better money is adopted. The higher the transaction costs, the closer the world economy resembles one-man Robinson Crusoe economies, where holding money obviously is as worthless as in the Evenly Rotating Economy; in this hypothetical case there is certainty not about the future, but that there is no-one to profitably trade with.</p>
<h2 id="costs-of-bitcoin">Costs of Bitcoin</h2>
<p>A severely limited block space, though prudently defending against fraud, monetary over issuance and fatal tinkering by leaving users in control of both economic rules and validation, also means on-chain fees rise astronomically should <a href="https://nakamotoinstitute.org/mempool/hyperbitcoinization/">hyperbitcoinization</a> proceed. Bitcoin is monetarily rather unique in this regard, that it becomes more expensive to use the more people that are using it â a point previously made by <a href="https://breakingsatoshi.com/2020/01/18/more-on-digital-gold/">Deryk Makgill</a> among others, and I have to say, an obvious hurdle standing between genesis and hyperbitcoinization. When gold was money, certain gold transactions were crowded out in not the same but a similar fashion, as the physical amount of gold for small-value transactions became too impracticable and costly for the buyer and seller to handle â hence the use of silver and copper as money. But in any case, no Bitcoin profit seeking can be expected to take place on-chain, but rather on higher, more complicated layers on top of Bitcoin, such as through Lightning channels and various centralized database solutions offered by third-parties. Only if total costs through such scaling attempts decrease enough to make Bitcoin the generally cheapest medium of exchange can it attempt to monetize fully and become money. By viewing potential Bitcoin hyperbitcoinization through the lens of its ability to be used in universal profit seeking or in reaction to general economic uncertainty, we are simply reiterating a more pragmatic version of the now rather well understood <a href="https://mises.org/library/origins-money-0">Mengerean theory</a> of money and saleableness. In this theory of money, the winner-takes-it-all effect leaves little room for insufficiencies. <strong>This is why Bitcoin transaction costs become incredibly important when speculating about hyperbitcoinization</strong>. Somewhere around here, in this mess we call money and economics, is where some people get confused.</p>
<p>Managing Lightning channels are, and likely will be, both tricky and expensive in the foreseeable future. Inescapable costs are for example channel settlement, larger attack surfaces with regards to theft, and larger incident surfaces with regards to simply losing control of Bitcoins due to software bugs or interface deficiencies. Although less tricky and less expensive in some regards, using centralized Bitcoin schemes supplied by trusted third-parties of course introduces other costs. While escaping direct on-chain transaction costs, including costs of settling channels, as well as costs related to bugs in the scaling software, new costs related to custody make themselves felt; legal looting by governments, conventional theft by the custodians themselves, and fraud. <strong>So, in an attempt to make up for the sub-optimal prospects of a subset of Bitcoinâs congestion related costs, it is tempting to point to the solution of <em>hodling</em></strong>. To be clear, holding on to a good is of course prudent if expecting monetization to continue. Only a fool would want to get rid of a good he expects to increase in value, as he can just spend bad, inflationary fiat money instead. No, the confusion is not about the rational (non)act of holding on to a medium of exchange currently surfing a Mengerean monetization feedback loop, but about why a specific medium of exchange would qualify for such a loop in the first place; <strong>by <em>hodling</em> Bitcoins, and because producing new Bitcoins is a task that seldom becomes any easier, enough costs are thought to be escaped to have total costs stand in competition with established monies</strong>. In other words, through <em>hodling</em>, it is said, the saleableness of Bitcoin is high enough to have it start dethrone less saleable monies and impose itself on a shocked world economy through blitzkrieging hyperbitcoinization. There is just one problem: the superior saleableness (which by the way decreases with <em>hodling</em>) may be artificial and therefore shatter in real economic situations.</p>
<p>At a glance, the logic behind lowering costs through <em>hodling</em> seems to check out. By not spending Bitcoins, saleableness-eating transaction costs of course do not accumulate. Saleableness-eating supply dilution costs have already been conquered with the supply cap and the difficulty adjustment algorithm. <strong>But anyone decreasing costs by <em>hodling</em> his Bitcoins over a longer period of time is put in the awkward situation where his Bitcoins are now in competition with conventional debt and equity rather than with conventional monies</strong>. The reason a person canât escape monetary costs by making his money artificially illiquid is because the opportunity cost of not lending and not investing then would make itself felt. <strong>Another opportunity cost â the inability to act during future economic uncertainty â will take its toll as well for those finding themselves <em>hodling</em> Bitcoins for the sole purpose of lowering costs.</strong> To be first in line to spend during a sudden crisis is only an opportunity if the money is not already artificially promised not to be spent. In other words, there are costs for prohibiting your money from being used as money. It is binding yourself to the mast of a ship when you may have to steer it later to escape the storms.</p>
<p>In short, certain costs that people are trying to escape, are very, very hard to run away from because they haunt the attempted money in various forms. There is no running away from what money is meant to be. <strong>This means that <em>hodl</em>, by the very nature of how money is successfully used, canât help make Bitcoin money in and of itself. Only functional scaling can, and that road is full of uncertainty and danger.</strong> Hyperbitcoinization then stands or falls with, among other things, the attempted technical solutionsâ ability to drastically lower total costs, and not with any collective <em>hodl</em> incantations. The cost situation is serious enough as to having prompted some intelligent Bitcoiners to capitulate with regards to off-chain scaling. They now embrace low on-chain transaction fees and, in my opinion, therefore may stumble into other scary and hidden costs related to the inability of choosing economic rules and validating transactions. For some of these people, it seems to simply be a disagreement about the promises of off-chain scaling as they are seen wandering the foggy transaction- and validation cost trade-off frontier in war-afflicted Bitcoin land.</p>
<p>On a slightly different, albeit more ridiculous note, some Bitcoiners have pursued <em>hodling</em> as part of <strong>their sacrifice to the collective</strong>. Such self-inflicted economic flagellation is not the same cost as the ones described above, but it goes without saying that if the Bitcoin you own is so bad that it demands sacrifices from you, it is not going to survive very long.</p>
<h2 id="money-or-not--how-much-does-it-matter">Money or not â how much does it matter?</h2>
<p>Whether Bitcoin can become money or not is a question time will answer; the factors involved are complicated enough to throw certainty aside. Still, it is worth thinking about what Bitcoin is if it fails in becoming money. Although what individuals choose to use as money arguably is a manner of subjectivity, Austrian monetary theory has, as earlier indicated, a more objective view of this and states that only the most liquid good is money. In other words, according to this viewpoint, Bitcoin is not money unless it is globally used as a highly liquid medium of exchange. <strong>The exclusivity born out of this definition takes us to an interesting focal point.</strong> A focal point is something that facilitates an above average probability that the same decision may be made by various parties, absent communication. Absent communication, but knowing the exact day they are supposed to attack, most Byzantine generals likely unsheathe their swords at noon.</p>
<p><strong>Being money then, in a digital world where code bases can be copied and blockchains forked without costs, is thus a focal point worth thinking about.</strong> Unlike gold, as an example, Bitcoin can be copied and forked to oblivion over the coming decades, but the position as being money cannot, under Austrian definition. It is because of this that Bitcoiners such as Daniel Krawisz argue that becoming money is the moat Bitcoin needs if it wants to succeed in the long run. A Bitcoin which fails to become money (for example by not facilitating profit seeking), according to Krawisz, would find itself worthless in the end precisely because the neccesary focal point is lacking. I am much more optimistic.</p>
<p>Gold is not used as money today, yet is worth an incredible amount. The reason some refuse to extrapolate that fact and apply it to a Bitcoin not used as money is what has already been touched upon, that Bitcoin is digital whereas gold is not, and so in the long run lacks the focal point needed for it to be distinguishable from digital copies. <strong>But there are other focal points involved.</strong> Admittedly, becoming global money would be an excellent additional focal point for Bitcoin, given the adversarial nature of no-cost copying. But it might be the case that Bitcoin canât be money, and so there wonât be any such hyperbitcoinization. This scenario is, it seems to me, not unlikely. Instead, being, and having been for over a decade, <strong>the first, most valuable and most liquid cryptocurrency</strong>, is a sound focal point as well, with a similar exclusivity extracted out of its definition<strong>.</strong> It is likely that, given that decentralization, a non-changing code base, and other prerequisites donât break down in the future, this focal point is enough to build the moat against future digital contenders, despite lacking the focal point discussed earlier. <strong>To summarize, a Bitcoin failing to become money is likely to still have a good chance of becoming and staying highly valuable for the same reasons gold stayed valuable after demonetization.</strong></p>
<p>Gold, although not used as money anymore, is still a hedge against coercion and violence of various sorts; escaping inflation may be attempted with equity and other assets, but escaping violence in a similar fashion can be hard as many of the assets are immovable and thus confiscatable or destructible. Owning factories or conventional real estate will do you no good if the Enemyâs war apparatus set to work, or if your fellow countrymen suddenly deem you of an inferior race, or of a heretical religion, or of an exploitative class. When fleeing a country, or fleeing certain government edicts within a country, the shape and form of owned assets decide the success of how much wealth survives. Gold has facilitated good enough resistance against such forms of violence, why it has kept its high valuation beyond the fate sadly bestowed upon it in the previous century. <strong>For similar reasons can a non-monetary Bitcoin attain a very high valuation if it facilitates even better resistance against coercion and violence, which, arguably, it does.</strong> The confiscation resistance is one of its biggest strengths and it is easy to imagine future scenarios where families escape wealth destruction by simply holding Bitcoins private keys. If Bitcoin fails as money, in other words, it still would likely facilitate more prosperity and more justice through keeping intact property rights when nothing else could.</p>
<p>Special thanks to Daniel Krawisz and Deryk Makgill from whom I silently borrowed ideas about how money works.</p>
<hr />
<h1 id="lies-deception-and-unnatural-money"><a href="https://bitcoinmagazine.com/articles/lies-deception-and-unnatural-money">Lies, Deception And Unnatural Money</a></h1>
<h3 id="by-nik-hoffman">By <a href="https://twitter.com/nikcantmine">Nik Hoffman</a></h3>
<h3 id="posted-october-13-2020-on-bitcoin-magazine">Posted October 13, 2020 on <a href="https://bitcoinmagazine.com/articles/lies-deception-and-unnatural-money">Bitcoin Magazine</a></h3>
<blockquote>
<p>âIt is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morningâ</p>
<p>â Henry Ford</p>
</blockquote>
<p>The continued functioning of the financial system you have lived under for your entire life is dependent on the average person not understanding exactly how it works, and there are many reasons for this. As you read deeper and deeper into this article, I hope that you will realize how deceiving our money really is. Governments and banks lie to you and take advantage of you every single day, most people just donât realize it. The money you use to save your value or purchase goods and services is unnatural; it is the equivalent of manmade garbage that youâd throw away in a second if you understood it better and had a viable alternative to opt into instead.</p>
<p>I was always told growing up that the financial system was broken and that it doesnât work properly, but that there were no good solutions to its problems. While most agree that the system is unfair, I wanted to find out what about it is broken exactly, and I did. But I also found that because the entire financial system is broken for the vast majority of people, that means itâs working just as intended.</p>
<h2 id="what-makes-money-valuable">What Makes Money Valuable?</h2>
<p>Money is a fundamental aspect of our daily lives that touches almost everything that we do, but the vast majority of people arenât taught everything they should know about the history of money and how it works. </p>
<p>So, what are people generally taught about money? At most, they are usually taught some basic Keynesian economic principles, which emphasize governments and central banks while deemphasizing the sovereignty of their constituents. Keynesian economics are macroeconomic philosophies that developed in the wake of the Great Depression, but have resulted in an unfair system that most people donât understand, even if they live under it. But here is some truth about what really makes money valuable.</p>
<p>Good money typically has <a href="https://www.stlouisfed.org/education/economic-lowdown-podcast-series/episode-9-functions-of-money#:~:text=The%20characteristics%20of%20money%20are,%2C%20limited%20supply%2C%20and%20acceptability.">six main characteristics</a>: durability, portability, divisibility, uniformity, scarcity (limited supply) and acceptability. Each one of these characteristics plays a key role in the value that a certain form of money can provide, with all different forms of traditional money having tradeoffs. </p>
<p>All effective monetary media throughout history have possessed some combination of these qualities, but not all. Historical forms of money include gold, silver, stones, seashells, glass beads and more. These tools were used as money because they fulfilled a certain role in a given society typically in either storing value or facilitating exchange. </p>
<p>Money is a universal tool used by everyone to exchange value for goods and/or services; itâs an asset that requires certain characteristics to be functional in exchange. If someone is using money without most of these characteristics, then it is bad money. </p>
<p>The U.S. dollar, for instance, is not durable, it has an unlimited supply, itâs not very divisible and doesnât have solid uniformity. You can use just about anything people deem as having any value as money, but there are long-term, harsh consequences to using bad money. Such as wealth evaporation.</p>
<p>Good money comes and goes and has always served a particular role in its given society. But over time, historically good money has often become bad money, as a society shifted to a better form of money. Money has evolved over time, adapting to its surroundings and technology. With enough time having passed, weâve seen good money turn to bad money and ultimately fail, time and time again. </p>
<p>So, you may be asking yourself: âIf these characteristics are what make good money, then how can good money turn to bad money and fail?â</p>
<h2 id="money-printing-is-inevitable">Money Printing Is Inevitable </h2>
<blockquote>
<p>âThe root problem with conventional currency is all the trust thatâs required to make it work. The central banks must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust.â</p>
<p>â <a href="http://p2pfoundation.ning.com/forum/topics/bitcoin-open-source">Satoshi Nakamoto, 2009</a></p>
</blockquote>
<p>History has proven that if humans are able to print money, they will. Everyone wants a shortcut and nobody can be trusted with this power, as history has demonstrated.</p>
<p>Itâs been estimated that during the time of the <a href="https://www.usmarshals.gov/history/counterfeit/counterfeit.htm">Civil War</a>, about one-third of all of the money in circulation was counterfeit. And today, counterfeiting is still rampant. <a href="https://www.zerohedge.com/markets/83-tons-fake-gold-bars-gold-market-rocked-massive-china-counterfeiting-scandal">Zero Hedge</a> reported earlier this year that a Chinese gold processor was behind a scandal involving 83 tons of fake gold bars, which would account for 4.2 percent of the countryâs total gold reserves in 2019. </p>
<p>There have been many different examples of money printing throughout time, resulting from cycles of human greed that lead to lies, deception and unnatural money. Whether it be counterfeiting banknotes, gold bars or even glass beads, people will always try to get an unfair edge over others.</p>
<p>If you were to print money for little to no cost, quickly or over long periods of time, you end up devaluing everyone elseâs hard-earned money. But since it costs you little to nothing to produce, youâre not losing any wealth, youâre just stealing it from everyone else. This same reasoning applies to âlegitimateâ money printing â not just counterfeiting, but governmental money production â and then becomes a function that is dependent on the people not realizing that their wealth is deteriorating. </p>
<p>Inflation stems from money printing, the same process that is known as âcounterfeiting.â Itâs unnatural, man-made intervention that screws up everything in an otherwise natural, free market.</p>
<h2 id="money-printing-is-unnatural">Money Printing Is Unnatural</h2>
<p>Now that we know what makes good money and that money printing is inevitable and inflationary, letâs take a look at the root cause of the failure of all previous forms of good money. If we look at the characteristics that make good money, there is one that stands out among the rest. Iâm talking, of course, about scarcity, or the enforcement of a limited supply, which is critical in making good money and simultaneously something that is constantly being undermined by greedy people who find a way to exploit the system.</p>
<p>âDeception is an act or statement which misleads, hides the truth, or promotes a belief, concept, or idea that is not true,â according to <a href="https://en.wikipedia.org/wiki/Deception">Wikipedia</a>. âIt is often done for personal gain or advantage.â</p>
<p>As noted above, money printing only âworksâ if the majority of people donât even realize that it is steadily devaluing their earnings and savings. People must be deceived into believing a false ideology about this practice, but that can only work for so long; as weâve seen throughout history, bad money doesnât last forever. The people who were deceived also pay for the consequences that bad money causes.</p>
<p>One of the most impactful stories of how money printing ruined a society involves the Rai Stones on the Island of Yap. These giant limestones were used as money there and stored familiesâ value for generations. These stones were very difficult to produce so, the bigger the stone, the more value it had, with some stones larger than a fully-grown human. </p>
<p>As <a href="https://twitter.com/saifedean?s=20">Saifedean Ammous</a> described in âThe Bitcoin Standard,â the <a href="https://saifedean.com/book/">Island of Yap thrived until Irishman David OâKeefe</a> immigrated there and saw the immense opportunity to mass produce these stones using iron tools. The key here was that OâKeefe was able to make these stones at a quicker rate and to make them smaller, making them more transportable. Over time, the Rai Stone market was so flooded that the stones became worthless, and the value held by the islanders was wiped out.</p>
<h2 id="effects-of-government-money-printing">Effects Of Government Money Printing</h2>
<p>One of the most recent examples of the devastating effects of money printing happened in 2019 when the Venezualan bolĂvar experienced hyperinflation of some 2,000,000 percent, destroying the wealth of the country. Venezuela was once South Americaâs richest country, until it started going down a slippery slope via corrupt leaders with deceiving, flawed and socialist ideologies. The countryâs death knell was put into motion when President NicolĂĄs Maduro was voted into office. </p>
<p>Maduro appealed to many voters because of his socialist policies, knowingly deceiving his target audience. Once Maduro was elected, the money printing press ran hot while deficit spending rose astronomically. The wealth of the country vanished as the once-richest country in Latin America became the poorest. The public was taken advantage of for Maduroâs ideological gain, and was ultimately punished, with many no longer being able to afford to eat. </p>
<p>The destruction of Venezuelaâs national currency transformed the country into a totally failed state. Since the government has full control over the bolĂvar, they are able to force people to get paid at the official exchange rate, which is significantly less than it is on the unmanipulated black market, stopping the citizens from having any hope of saving their wealth or getting ahead, while benefiting the government by keeping hold over its citizens. </p>
<p>This horrible aftermath of money printing is not unique to this specific case. As you study the after effects of other hyperinflated currencies, it becomes apparent that the results are always the same.</p>
<h2 id="youre-being-blatantly-lied-to">Youâre Being Blatantly Lied To</h2>
<blockquote>
<p>âThe CPI is deliberately designed to understate and mask the inflation that the Federal Reserve is creatingâ</p>
<p>â <a href="https://youtu.be/xjwEpj2yduM">Peter Schiff</a></p>
</blockquote>
<p>Inflation silently steals our wealth from right under us and yet, governments and central banks canât even be truthful to us about that. But how do we calculate and know what the inflation rate is? We find out through something called the Consumer Price Index (CPI). According to the <a href="https://www.bls.gov/cpi/">U.S. Bureau of Labor Statistics</a>, CPI is a measure of the average change over time in the price paid by urban consumers for a market basket of consumer goods and services (food, housing, clothes, transport, medical care, recreation and education). </p>
<p>This bureau implies that CPI is calculated simply, but itâs actually extremely complicated. On the bureauâs website, you can download a <a href="https://www.bls.gov/opub/hom/pdf/cpi-20180214.pdf">PDF file</a> with its methods of calculation. The only problem is that itâs a whopping 107 pages long! And to think it calculates just one simple and fundamental problem: the degree to which the money that you have today will be devalued by tomorrow. The main goal for the Bureau of Labor Statistics seems not to be solving this problem, but to be jumping through loopholes and twisting and turning things until it gets a low enough number to report to the public.</p>
<p>Even as real inflation goes up due to money printing, the government may say that there was 0 percent inflation for that year, because the government calculates inflation via CPI, which allows it to jump through loopholes to get a certain number most appealing to the public. A huge consequence of actual inflation means that your dollar is purchasing less and less every year while you end up getting taxed more because of CPI. Then, the government bumps you up into a new tax bracket in which you are now taxed at a higher percentage of your income and end up taking home less value than before. </p>
<p>It lies about the inflation rate for political gain and it saves the government money while stealing from the citizens.</p>
<h3 id="bitcoin-fixes-this">Bitcoin Fixes This</h3>
<p>Humanity cannot advance forward unless we solve the problem of money printing, and Bitcoin actually fixes this. </p>
<p>Bitcoin has all of the qualities of money as mentioned in âWhat Makes Money Valuable?â above, unlike all previous forms of money before, which have either lacked these qualities or failed to retain them.</p>
<p>Durability isnât a problem for bitcoin, as itâs completely digital money that canât be destroyed or withered like paper money or gold. Bitcoin is extremely portable and can be stored or transferred anywhere in the world with ease, as it is not bound to border restrictions â you can send money to anyone in the world no matter where you are, with it arriving safely and quickly. </p>
<p>Bitcoin is the most divisible form of money humanity has ever experienced. Whereas the U.S. dollar is divisible into 100 pennies at most, 1 bitcoin is divisible into 100 million units called satoshis (or âsatsâ for short). Bitcoin has strong uniformity as each unit is essentially the same as all others. </p>
<p>BTC is accepted by more and more people all over the world every day. Weâve seen a large increase in people, small businesses and large institutions that have come to accept bitcoin as money since it was introduced.</p>
<p>Lastly, the bitcoin supply is capped at 21 million, as mentioned above, and, as a result, it has a finitely limited supply. Historically, money printing was inevitable, but not anymore. Everyone abides by the rules of the network enforced by the nodes and miners, which keep everyone else honest and prevent anyone from ever increasing the supply cap, ever. </p>
<p>You can look at historical forms of good money as having a set of ârulesâ that the system is based on, until someone comes in and âcheatsâ the system for selfish gain. That money created by the cheater is unnatural and ruins the âgame.â Bitcoin fixes this, because everyone and anyone is capable of running a full node to maintain their own exact copy of the Bitcoin ledger, which keeps everyone honest and prevents bad actors â especially when the nodes and miners are financially incentivized to do so!</p>
<p>Bitcoin is superior money compared to hyper-inflatable currency. It doesnât bear the same problems that have come with forms of money in the past, and it prevents the issues mentioned above from happening again. History has shown that humanity has thrived when society had hard money, and the impacts of a currency that can never be hyperinflated look very promising. It has the potential to usher in a new Renaissance or Industrial Revolution. </p>
<p>And, last but not least, the Bitcoin network will never lie to you. It is open-source, meaning you can look at the code yourself, for free, right down to every last detail. BTC has an open ledger that lets you become your own bank, and the master of your money. With Bitcoin, you take back the power from the corrupted people you were blindly trusting.</p>
<hr />
<h1 id="tweet-thread---the-four-valuation-frameworks-for-bitcoin"><a href="https://twitter.com/real_vijay/status/1325961588633841664">Tweet Thread - The Four Valuation Frameworks for Bitcoin</a></h1>
<h3 id="by-vijay-boyapati">By <a href="https://twitter.com/real_vijay">Vijay Boyapati</a></h3>
<h3 id="posted-november-9-2020">Posted November 9, 2020</h3>
<p>There are four main valuation frameworks for Bitcoin and I wanted to summarize them with a target valuation that one would assign if one subscribed to that framework.</p>
<p>Thread đ</p>
<p>1) Bitcoinâs rise is equivalent to the Tulip Mania. It has no real comparative advantage to any existing monetary good or to the current fiat monetary system and is a bubble that will eventually pop.</p>
<p><strong>Long term target price: $0.</strong></p>
<p>2) Bitcoin is a new monetary technology whose appeal is largely limited to technologically savvy and libertarian minded people who can tolerate its volatility, which will be a permanent feature of its existence going forward.</p>
<p><strong>Long term target price: $10,000 - $100,000</strong></p>
<p>3) Bitcoin is a new monetary good that will primarily disrupt its closest monetary cousin, gold. It is significantly superior to gold along all the attributes that make gold a good store of value.</p>
<p><strong>Long term target: $300,000 - $1,000,000</strong></p>
<p>4) Bitcoin will ultimately become the worldâs reserve currency. It is superior as a collateral asset to anything ever created and will eventually drain store of value premiums out of government bonds, real-estate, precious metals and rare art.</p>
<p><strong>Long term target: $10,000,000+</strong></p>
<p>After existing for a decade the first valuation framework, which was dominant in the early years, is now only subscribed to by ideologues and luddites (e.g., @PeterSchiff, @paulkrugman and @nouriel). No intelligent thinker who understands Bitcoin subscribes to this framework.</p>
<p>The primary valuation frameworks that investors subscribe to today are 2) and 3) with the market slowly transitioning from 2) to 3). Once framework 3 is widely accepted by the market, it will lay a foundation for framework 4 to be viewed as possible and even inevitable.</p>
<hr />
<h1 id="exploring-bitcoins-core-values-and-why-we-defend-them"><a href="https://insights.deribit.com/market-research/exploring-bitcoins-core-values-and-why-we-defend-them/">Exploring Bitcoinâs core values and why we defend them</a></h1>
<h3 id="by-hasu">By <a href="https://twitter.com/hasufl">Hasu</a></h3>
<h3 id="posted-november-10-2020-on-deribit-insights">Posted November 10, 2020 on <a href="https://insights.deribit.com/">Deribit Insights</a></h3>
<p><img src="https://insights.deribit.com/wp-content/uploads/2020/11/Exploring-Bitcoins-core-values-and-why-we-defend-them.jpg" alt="" /></p>
<p>In his essay â<a href="https://medium.com/s/story/what-is-it-like-to-be-a-bitcoin-56109f3e6753">Bitcoinâs Existential Crisis</a>â, Nic Carter describes the identity problem that is inherent to Bitcoin. Because no one has the authority to give decentralized systems an identity, they rely on intersubjective consensus around a set of practical core values.</p>
<p>You can think of these core values as the lowest common denominator between all people in Bitcoin, and I tried to formalize them in <a href="https://uncommoncore.co/unpacking-bitcoins-social-contract/">Unpacking Bitcoinâs Social Contract</a> â with the caveat that any such attempt is necessarily both highly subjective and chasing a moving target.</p>
<p>When people disagree about what Bitcoin is or should be, that can impact the real world in two different ways. For one, there is an unspoken rule that the protocol wonât be updated unless virtually all important stakeholders are satisfied with the proposal. When people disagree over basic principles, no major proposal can ever get the buy-in of all necessary parties. We call this âprotocol ossificationâ and most people seem fine with it today because (1) Bitcoin doesnât really need to change much from here, and (2) that resistance to change is seen as a valuable property that sets it apart from centralized systems of the past.</p>
<p>But thereâs also the risk that some external event occurs that requires Bitcoin to change, whether in response to an attack or bug or more generally due to a lack of success in the market. In that case, the same governance gridlock can quickly become an existential issue as the community fractures into opposing sides.</p>
<p>Mutually exclusive narratives can coexist with each other for some time, but eventually they reach their boiling point. That was the case in Bitcoin with the collision of âBitcoin is for cheap paymentsâ vs. âstore of valueâ and in Ethereum with âcode is lawâ vs âsocial consensus is lawâ. Both sides had just as much a credible claim to being right, because there is no central party to âtie-breakâ their disagreement. The only way these conflicts resolve is via messy social consensus formation, market signals, and in some cases, permanent community splits.</p>
<p>The biggest questions today are probably how to address possible incentive problems due to the declining block subsidy, and how private Bitcoin should be in the wake of increasing blockchain surveillance. Nic and I tried to account for these and other possible narrative collisions back in our article <a href="https://uncommoncore.co/visions-of-bitcoin-how-major-bitcoin-narratives-changed-over-time/">Visions of Bitcoin</a>.</p>
<p>As Nic puts it, âsystems with more internal consistency and more universally agreed upon value sets are better equipped to last.â That suggest the optimal social contract<br />
(1) has a very small number of rules (to include as many people as possible)<br />
(2) that users are highly committed to if something ever goes wrong with the software.</p>
<p>In todayâs article, I want to build on this existing body of work by exploring where real bitcoiners actually draw the line in terms of their core values, where their logic might reveal potential narrative collisions, and what all this means for Bitcoinâs future.</p>
<h3 id="introducing-the-questionnaire">Introducing the questionnaire</h3>
<p>In order to explore this topic, I employed a basic questionnaire to ask my Twitter followers what they see the core values of Bitcoin. The way I framed the questions was to ask for the negative â what changes or events would make Bitcoin no longer Bitcoin to them? The implication here is that users would be bothered enough to sell their coins and leave the project.</p>
<p>All questions can be grouped into these five high level topics:</p>
<ol>
<li>Censorship-resistance;</li>
<li>Intermediation;</li>
<li>Monetary inflation;</li>
<li>Settlement guarantees; and</li>
<li>Means vs. ends (more on that later.)</li>
</ol>
<h3 id="censorship-resistance">Censorship-resistance</h3>
<p><img src="/assets/images/2020/m11/h1.png" alt="" /></p>
<p>The first topic I asked about was censorship resistance, which has always been one of the core tenants of the Bitcoin social contract. And indeed the results came in like expected: People really value censorship resistance, both for themselves and others, to the degree where it can seem irrational to bystanders. After all, people donât stop using Paypal because it has deplatformed legal arms dealers or political dissidents, or leave Twitter after it has censored many a conservative media organization or politician.</p>
<p>This only goes to show that Bitcoin actually *has* a social contract, and people feel disproportionately more violated if censorship happens in Bitcoin than in other systems where they might have come to expect it, even when they are not personally affected.</p>
<p>Indeed, Bitcoinâs design makes censorship very unattractive because if one miner doesnât include your transaction, the next miner might, and as a result they will make more money in the long run. This holds true unless one miner (or coalition) controls over half of the hashpower and can safely ignore any non-compliant blocks from other miners. It also works with less than half of hashpower if the attacker can credibly scare other miners out of including transactions or addresses that are on a public blacklist (see â<a href="https://ieeexplore.ieee.org/abstract/document/7163021">feather forking</a>â).</p>
<p>The fact that users aggressively signal that they wonât accept others being censored actually matters to that, if the counter-threat can make it unprofitable for miners to follow the feather-forker. It is also a counter-argument to the popular thesis that only transaction fees and not the block subsidy protect Bitcoin from censorship, as the attacker stands to lose business from uncensored parties as well.</p>
<h3 id="intermediation">Intermediation</h3>
<p>If people are censored from using Bitcoin, this could only really happen in two ways: 1) on the consensus layer by miners, or 2) on the application layer by trusted intermediaries.</p>
<p>Bitcoin is often said to eliminate said <a href="https://nakamotoinstitute.org/trusted-third-parties/">trusted third parties</a>, but that applies only when users interact with Bitcoin directly. If most activity happens through trusted third parties, we could see the same encapsulation of a trustless base asset in a trusted wrapper by that eventually led to the failure of the gold standard. For a thought experiment of why intermediation is a big risk to bitcoin, see <a href="https://insights.deribit.com/market-research/why-bitcoin-might-not-survive-a-bitcoin-standard/">Why Bitcoin might not survive a Bitcoin Standard</a>.</p>
<p><img src="/assets/images/2020/m11/h2.png" alt="" /></p>
<p>Given the aptness of bitcoiners for pointing out goldâs weaknesses, I expected tolerance for a fully intermediated Bitcoin to be very low. But alas, I was surprised by how many people would be a-okay with it. Maybe they are simply pragmatic because Bitcoin indeed can only support so many base layer and LN transactions before fees would price out most smaller users and transactions, and most people might not think of themselves as ârich enoughâ.</p>
<p>That said, there are good reasons why the worries about an intermediated Bitcoin could be overblown and Bitcoin could fare better than gold has, due to its unique advantages. Because Bitcoin is a digital bearer asset, anyone from anywhere in the world can create a new Bitcoin bank that doesnât necessarily have to comply with local regulations. And why intermediaries would still be trusted, there would be more competition between them, putting the customers in a better position than if regulation protected incumbents from disruption. Because Bitcoin can be transferred so easily, this would also make it easier for customers to switch between different intermediaries, further lowering the exit cost.</p>
<p>In spite of being generally skeptical of other non-Bitcoin blockchains, it also seems that Bitcoin users appreciate the benefits a blockchain provides in terms of transparency and validity over the black box that is traditional banking.</p>
<p><img src="/assets/images/2020/m11/h3.png" alt="" /></p>
<p>I think that this trend is likely to continue, as weâll see different trust models, from <em>fully trustless</em> (TBTC) to <em>secured by majority of hashpower</em> (Drivechain) to <em>secured by a consortium</em> (Liquid) to <em>secured by single custodian</em> (BitGo) for users to choose from.</p>
<h3 id="monetary-inflation">Monetary inflation</h3>
<p>The easiest way to trigger my fellow Bitcoin friends on twitter is to entertain â even with many caveats â the idea of adding some kind of monetary inflation. Hence I thought that this dislike of inflation would be reflected in the responses, but came out quite surprised.</p>
<p>I went ahead and first asked about âaccidental inflationââŠ</p>
<p><img src="/assets/images/2020/m11/h4.png" alt="" /></p>
<p>âŠfollowed by the kind of deliberate inflation that is often proposed as a solution to paying miners if L1 fee revenue turns out to be insufficient.</p>
<p><img src="/assets/images/2020/m11/h5.png" alt="" /></p>
<p>It seems that many people are willing to accept inflation if it is accidental â even if it is substantial (+1m total supply!) â but are far less tolerant for deliberate inflation.</p>
<p>This requires some discussion, as it could seem irrational at first. At 0.1% monetary inflation, it takes 48 years to create the same 1m BTC and yet more people would rather reject a version of Bitcoin with a tiny bit of tail inflation than one that has the same 1m BTC immediately. Even though the tail inflation makes Bitcoin more secure, while the accidental inflation would not!</p>
<p>We know there are many people in Bitcoin who value scarcity and Bitcoinâs 21m cap a lot, but it seems they are also pragmatic about it. If a bug has inflated the supply, then the damage is already done, and â assuming the bug is fixed â that does not necessarily make another inflation bug any more likely. Whereas if we deliberately agreed to inflation, it might feel more like a betrayal to the core values rather than a mistake at implementing them.</p>
<p>One thing that often annoys me is peopleâs fixation on monetary inflation over price inflation. The first is the increase of Bitcoinâs supply, the second is a decline of bitcoinâs purchasing power. The reason it seems so short-sighted is because supply inflation ignores half the market â the demand side for Bitcoin!</p>
<p>To give a very simple thought experiment, if supply inflation was the only thing to optimize, we could change the protocol to stop issuing more coins starting tomorrow. But the purpose of Satoshiâs distribution schedule was not simply to limit supply inflation but 1) to give more people the chance to buy or mine Bitcoin, and 2) to pay for miner security until the blockspace market has come of age.</p>
<p>A bitcoin without the block subsidy would not be secure today and its price would likely falter as a result of this insecurity. This alone proves that supply inflation can be positive for the price and hence the purchasing power of holders. It simply depends how much the market values sustainability and long-term predictability.</p>
<p>As a counterargument to my own thesis, I would like to once again offer Nicâs thesis that a social contract should be as simple and consistent as possible. âWe should optimize Bitcoinâs priceâ is how most people actually behave, but itâs much more abstract and subjective than âWe should keep Bitcoin free of supply inflationâ. So maybe in practice, the best thing is to converge on the less accurate and useful more objective and verifiable choice of limiting supply inflation, not price inflation.</p>
<h3 id="settlement-guarantees">Settlement guarantees</h3>
<p>Moving on to Bitcoinâs settlement guarantees, I was quite interested in the responses we would get. Both because Iâve locked horns significantly with the Bitcoin community over this topic but also also because unlike inflation or censorship, the settlement guarantees are something that is experienced very directly by everyone who transacts with Bitcoin.</p>
<p><img src="/assets/images/2020/m11/h6.png" alt="" /></p>
<p>More than half of respondents find a Bitcoin that takes days to settle no longer useful. I do see that as a blow to the popular argument that miner rewards can never be too low in the future as users will simply wait many blocks for settlement (advanced by <a href="https://twitter.com/NickSzabo4/status/1097037769455501313?s=20">Nick Szabo</a> and others). This argument ignores that Bitcoin competes with other solutions in a competitive market place for money, and while it can afford to have worse efficiency in return for better scarcity and censorship resistance, there is a limit to how much worse it can be.</p>
<p>That said, more people than in any other question chose âshow resultâ, indicating a high degree of uncertainty.</p>
<p><img src="/assets/images/2020/m11/h7.png" alt="" /></p>
<p>Around half of respondents draw the line at double-spends, which makes sense in a system that values property rights above else. But if we think about this, double-spending is basically like bouncing a check or reversing a credit card transaction. Does the fact that some people bounce their credit card transactions make it useless as a system, especially considering that users themselves would basically never be victims of this, only exchanges and large merchants?</p>
<p>Maybe the same logic applies here that we discussed in the context of censorship resistance, where â unlike a credit card â Bitcoin transactions are intended to be âeventually finalâ, and hence any violation feels more like an attack on the system as a whole.</p>
<p>That said, the other half of respondents would keep using Bitcoin even when there are occasional double-spends, and I think that is a much healthier attitude. if Bitcoin users wanted absolute safety from this attack, then it would mean that</p>
<ol>
<li>they would have to spend more on security than a Bitcoin where occasional double-spends are accepted. Depending on the development of the blockspace market, this view could eventually collide with the âno inflationâ view, in which case one of them would have to lose and there might be a community split. If we want to prevent that, loosening your standards in favor of a âlesser evilâ can sometimes go a long way.</li>
<li>Users would have to be prepared to reject more reorgs with social coordination. Doing that in an efficient way requires procedures and hierarchies (think: leaders) to be put in place that make the system less socially scalable.</li>
</ol>
<p>In summary, I think that usersâ preference for fast and reliable settlement and their preference for no monetary inflation are the most likely (but still not likely in absolute terms) to collide.</p>
<h3 id="means-vs-ends">Means vs. ends</h3>
<p>To conclude the questionnaire, I wanted to ask about a few deliberately random aspects of Bitcoin that are *not* tied to its core values. The goal here was to see if people can identify the difference between the ends â our goals for Bitcoin as a system â and the mechanisms (means) that implement them.</p>
<p><img src="/assets/images/2020/m11/h8.png" alt="" /></p>
<p>As maybe the biggest surprise of the entire questionnaire, almost more people draw the line at âBitcoin has proof-of-workâ than âBitcoin has a fixed supplyâ. As Iâve argued many times before, I see Bitcoin as a set of goals and shared rules, a social contract, and that we build software to automate this social contract. In 2008, Satoshi identified proof-of-work as a key part of solving this puzzle. But it doesnât mean that PoW is itself one of these goals or core values of Bitcoin.</p>
<p><img src="/assets/images/2020/m11/h9.png" alt="" /></p>
<p>Source: <a href="https://uncommoncore.co/unpacking-bitcoins-social-contract/">Unpacking Bitcoinâs Social Contract</a></p>
<p>Instead, proof-of-work is a mechanism to implement two specific goals:</p>
<ol>
<li>The trustless distributed time-stamping of transaction â <a href="https://grisha.org/blog/2018/01/23/explaining-proof-of-work/">a decentralized clock</a></li>
<li>Distributing coins initially in a fair and trustless manner</li>
</ol>
<p>If any other mechanism ever succeeds at implementing these goals better, and is as battle-hardened as PoW, or if a major vulnerability is detected in PoW, then I would not be opposed to replacing it. But maybe itâs not surprising that the community takes a much stronger stand on the mechanism of PoW than any other, as â with more and more proof-of-stake networks coming online â people âwant to give no ground to the enemy hereâ.</p>
<p>To clarify, I do not think that Bitcoin has anything to fear from PoS coins on a purely fundamental basis, but the arguments given in the favor of PoS (more green, no risk from China, attackers can be identified and slashed) have powerful narrative-value, and I think most bitcoiners are at least subconsciously concerned about that.</p>
<p><img src="/assets/images/2020/m11/h10.png" alt="" /></p>
<p>As for the other two questions, the answers are much more in line with what I expected, with people identifying that the current block size limit or the current core development team are not âmeansâ in itself but âendsâ to the âmeansâ of implementing Bitcoinâs core values into a technical protocol.</p>
<p>For example, the block size limit is needed to ensure that Bitcoin remains affordable to use for full nodes, who have to validate the entire history of the blockchain and then stay in sync with all incoming blocks as well. It is also important to ensure the scarcity of block space as the block subsidy expires, so transactional demand from users leads to sufficient fee revenue for miners.</p>
<h3 id="bitcoins-veto-based-governance">Bitcoinâs veto-based governance</h3>
<p>Something I really want to point out is how every question had many people âdraw the lineâ and say âthis is not Bitcoin for meâ. One the one hand, this confirms that we indeed correctly identified Bitcoinâs core values. On the other, it nicely explains why</p>
<ol>
<li>there is so little progress in Bitcoinâs protocol development (itâs so hard to get consensus on anything)</li>
<li>itâs very hard to introduce potentially dangerous changes into Bitcoin. The latter makes Bitcoin very reliable for businesses and developers to build on.</li>
</ol>
<p><img src="/assets/images/2020/m11/h11.png" alt="" /></p>
<p>Source: <a href="https://twitter.com/bitstein/status/901500957862899712?s=20">Twitter</a></p>
<p>Of course the answers here are not necessarily indicative of how someone would vote with their wallet at the end of the day and I suspect that â more than everything else â bitcoiners who stuck with BTC during the scaling wars care about being in consensus with as many other people as possible to protect Bitcoinâs network effect.</p>
<p>If youâre like me, you might think that we should protect Bitcoinâs long-term sustainability by discussing such options as a security tax or supply inflation today â of course without activating them before it provably becomes a problem. But even though this isnât communicated anywhere, I think most peopleâs initial reaction to such discussions is that they see them as <em>slippery slopes</em>.</p>
<p>The idea of a slippery slope is that a chain of itself innocuous events could lead to some eventually very bad change, such as the slow erosion of Bitcoinâs anti-inflation values. In order to prevent a slippery slope from happening, bitcoiners create <em>Schelling fences</em> â a concept which actually explains quite well what we are seeing today.</p>
<h3 id="on-schelling-fences-and-social-signaling">On schelling fences and social signaling</h3>
<p>A <a href="https://www.lesswrong.com/posts/Kbm6QnJv9dgWsPHQP/schelling-fences-on-slippery-slopes">Schelling fence</a> (first introduced by Scott Alexander) is a Schelling point that people make a credible precommitments to defend â almost like a binding contract with themselves. Maybe the best example most of us would be familiar with is to never even smoke the first cigarette, because you donât know what it will do to you.</p>
<p>To return with to the example of inflation, the slippery slope argument would be that if we normalized the idea of 0.01% tail inflation today, we might also eventually accept the idea of 0.02% tail inflation, and so on, until Bitcoin has become indistinguishable from fiat money. Because we canât trust our future selves, we commit to never even entertaining the idea of inflation, even if that means going down with the ship.</p>
<p>Creating these precommitments serves as the first line of defense to negative changes to Bitcoin, but it also serves more functions beyond that:</p>
<ol>
<li>Users constantly signal their precommitment to other bitcoiners, both to verify that they are still on the right track as well as to strengthen the shared commitment with the rest of the tribe.</li>
<li>During attacks or other bad events, itâs important that everyone already âknows the drillâ because they have a precommitment to the values they want to defend and how.</li>
<li>There is tremendous value in making that intangible precommitment tangible to newcomers. The more people who are less familiar with Bitcoinâs lore and history can rely that the existing community is hell-bent on defending Bitcoinâs core protocol values, the more safely they can hold and use and build on Bitcoin at the end of the day.</li>
</ol>
<p><img src="/assets/images/2020/m11/h12.png" alt="" /></p>
<h3 id="caveats-to-this-analysis">Caveats to this analysis</h3>
<p>Iâd be remiss if I didnât mention several caveats that are inherent to any such âsocial scienceâ experiment.</p>
<ol>
<li>An analysis like the one I did today is incredibly subjective and shouldnât be seen as something that represents the diverse views of the Bitcoin community, most of whom are not my Twitter followers.</li>
<li>The problem with polling current holders is that theyâre a minority of future users <em>if</em> usage actually picks up, who might hold very different views of what Bitcoin should do and where the Schelling fences should be put. This is akin to the argument that all strongly libertarian leaning people in the world are already in Bitcoin, so the marginal person who joins Bitcoin tomorrow is bound to be increasingly less ideological about its values and more focused on its every-day use value.</li>
<li>While people can be allergic to intentionalism, Satoshi left us a lot of âoriginalistâ literature of what he intended Bitcoinâs social contract to be. Whether bitcoiners stick by what Satoshi had planned is a different matter, but the intentions of its creator are at least a strong natural Schelling point.</li>
<li>Bitcoin is not a democracy, and most peoplesâ votes donât matter. At the end of the day, most of us are here because we believe that the free market can produce a better money than governments can. Most of us are not smarter than the market, and ultimately listen to what the markets want. So if we do end up getting a clash between two mutually exclusive core values in Bitcoin, I could imagine that most people will continue to ride with what the market sees as most valuable (e.g. in the form of fork futures or prediction markets) and use that to inform their own views.</li>
</ol>
<p>(1) The logic is that a censor always earns the block subsidy, but only the fees of uncensored transactions. I want to link to Ericâs Voskuilâs post on the matter, but Libbitcoin.org seems to be down right now</p>
<hr />
<h1 id="how-bitcoins-power-consumption-is-good-for-the-planet"><a href="https://www.voice.com/post/@jasonadeane/how-bitcoins-power-consumption-is-good-for-the-planet-1605113957-1">How Bitcoinâs Power Consumption Is Good for the Planet</a></h1>
<h3 id="by-jason-deane-for-cryptowriter-in-association-with-voice">By <a href="https://twitter.com/JasonADeane">Jason Deane</a> for <a href="https://www.voice.com/post/@jasonadeane/how-bitcoins-power-consumption-is-good-for-the-planet-1605113957-1">Cryptowriter in association with Voice</a></h3>
<h3 id="posted-november-11-2020">Posted November 11, 2020</h3>
<h2 id="a-controversial-proposition-that-might-just-holdwater">A controversial proposition that might just hold water</h2>
<p>In early 2018, an analyst called Alex De Vries at Pricewaterhouse Coopers (PwC for short, thank goodness) produced a report entitled â<a href="https://www.sciencedirect.com/science/article/pii/S2542435118301776">Bitcoinâs Growing Energy Problem</a>â which seemed to provide a plausible calculation of the power consumption of the Bitcoin network.</p>
<p>It seemed viable, was generally well supported and, rightly on wrongly, went on to become the basis on which many lasting assumptions about Bitcoinâs power consumption were made. It was timely enough that I even included a detailed reference to it in one of the chapters of the book I was writing at the time called â<a href="https://www.amazon.co.uk/How-EXPLAIN-BITCOIN-your-mum-ebook/dp/B07KCDM38F/ref=tmm_kin_swatch_0?_encoding=UTF8&qid=1605105835&sr=8-1">How to Explain Bitcoin to Your Mum</a>â.</p>
<p>The chapter was called âWhy Bitcoin WONâT workâ which was a counterpoint to the preceding chapter entitled, surprisingly enough, âWhy Bitcoin WILL workâ.</p>
<p>Some, however, questioned the validity of the underlying assumptions about the type of equipment used a reference point to calculate power consumption and some considered whether renewable energy had been given enough consideration overall. </p>
<p>While both points are far from resolved, the latter was revisited by the same analyst a year later when he produced another report entitled â<a href="https://www.sciencedirect.com/science/article/pii/S254243511930087X">Renewable Energy Will Not Solve Bitcoinâs Sustainability Problem</a>â, the main conclusion of which is probably self explanatory.</p>
<h2 id="the-size-of-theproblem">The size of the problem</h2>
<p>De Vries had done the best he could with the data available, as had many others when trying to answer the question of just how much power Bitcoin consumes, but the actual number varies considerably depending on who you ask and at what point in Bitcoinâs history you need an answer forâââand with good reason.</p>
<p>The <a href="https://digiconomist.net/bitcoin-energy-consumption">Bitcoin Energy Consumption Index</a> has long since estimated total power consumption and, as of today, estimates a figure of 74 TWh (Terrawatt Hour), which is roughly equivalent to the entire power consumption of Venezuela, at least according to their latest official estimate which, oddly, was way back in 2015. </p>
<p>Even getting accurate energy consumption data by country is surprisingly hard and often the range of official estimates varies according to which source you refer to. No single source, in fact, appears to have a consistently up to date list of energy consumption levels, a point I find interesting in itself but is beyond the scope of this article.</p>
<p>Nevertheless, it is certainly <em>possible</em> that Bitcoinâs current power consumption is more than Denmark, Hungary, Hong Kong, Portugal, Singapore, Bangladesh, Israel, Greece, Kuwait, Switzerland, Chile and Austria to mention just a few.</p>
<p>In fact, assuming this data <em>is</em> correct and Bitcoin was classed a country it would be ranked 39th in the world according to the <a href="https://www.cia.gov/library/publications/the-world-factbook/rankorder/2233rank.html">official list of countries by power consumption</a> provided, interestingly, by the CIA. Yes, <em>that</em> CIA. (Note: there are other lists, but they are not dissimilar)</p>
<p>Just the mere possibility of that is astonishing, but the reality is that it could be even higher. Recently, a note appeared on the official Bitcoin Energy Consumption Index that simply read:</p>
<blockquote>
<p>Study reveals Bitcoinâs electricity consumption is underestimated ⊠(August 2020).</p>
</blockquote>
<p>Following the link provided leads to a <a href="https://www.sciencedirect.com/science/article/abs/pii/S2214629620302966?via%3Dihub">new report</a> that concludes that, as of the end of 2019, the conservative estimate was actually 87.1 TWh of power, not 42 TWh as shown on the chart. By that reasoning and using the same formula, does it mean consumption is actually closer to 150 TWh today? </p>
<p>If so, that puts the Bitcoin network as the fourth biggest consumer of power on the planet. Bitcoin would therefore consume more power than every other country except the entire European Union combined, the United States and, of course, China.</p>
<p>Could this really be the case, and if so, what does it mean for sustainability and Bitcoinâs future?</p>
<h2 id="whoa-there">Whoa, there</h2>
<p>Before we get all carried way with this revelation, it should already be clear that there is significant doubt over just how accurate this data is. </p>
<p>After all, if countries themselves are unable to provide good, solid data for their own consumption figures, how can we possibly say with any accuracy what the true consumption of a disparate bunch of machines spread across the planet really is, especially when we donât really know quantities or specifications?</p>
<p>However, even as a proponent of the ideology and practicality of Bitcoin, I will absolutely concede that it is a) âa lotâ and b) set to consume more power as time goes onâââat least for now, a point we will revisit shortly. We need to examine what happens next, but since we have no universally agreed data as a starting point it is perhaps more useful to look at trends and take a broader view.</p>
<p>In fact, it may be the only way.</p>
<h2 id="theres-power-and-therespower">Thereâs power ⊠and thereâs power</h2>
<p>When breaking down the âa lotâ figure, there are a few caveats that we need to mention, specifically different types of energy classed as renewable, stranded or unsold energy.</p>
<p>While itâs usually claimed that âmostâ Bitcoin mining is carried out via renewable energy (hydro, wind, solar etc), the <a href="https://www.jbs.cam.ac.uk/faculty-research/centres/alternative-finance/publications/3rd-global-cryptoasset-benchmarking-study">University of Cambridgeâs September 2020 report challenges this</a>âââat least partially.</p>
<p>It certainly agrees that some 76% of miners use renewable energy as âpart of their energy mixâ but states that, overall, only 39% of total energy is genuinely from renewables, most commonly hydroelectric power. </p>
<p>This is to do with the allocation of hash powerâââwhile the Asia-Pacific (APAC) region still produces most of it, their percentage of renewable energy is only 29%, whereas itâs as high as 70% and 66% in Europe and North America respectively where hash output is lower.</p>
<p>However, since the world is, generally, moving towards renewable energy at an ever increasing rate, it is clear that this percentage will increase over time, but itâs hard to say what timescale is needed to make the difference.</p>
<p>In addition, there are some circumstances where there are some directly positive outcomes of Bitcoin mining.</p>
<p>âStrandedâ energy, for example, refers to energy that would otherwise be wasted or unused, most commonly gas that has to be deliberately flared due to lack of pipeline capacity or is simply located where it is not cost efficient to transport.</p>
<p>In those cases, such as the mining farms created in Texas and North Dakota for exactly that reason, there is an unquantifiable benefit of avoiding that action.</p>
<p>Finally, there are areas in the world where too much power is produced and thereâs no efficient way of transporting it anywhere or to reduce the power output in a way that makes economic sense. This is common, for example, around hydroelectric dams. </p>
<p>Here, power is sold very cheaply to mining operations on condition they locate themselves in these areas. This creates a win-win for the provider, consumer AND environmentalists since no extra power is technically produced. Mining farms are one of the few industries that can operate pretty much anywhere as long as an internet connection is available.</p>
<p>However, in truth there is currently no way of quantifying the beneficial aspects against the obvious negative ones of coal or oil fired power generation, but we can safely assume that the former is much smaller than the latter and the net effective is still a negative one.</p>
<p>The bigger question would have to be this: if ALL Bitcoin mining was done on a renewable energy basis, would that ultimately be considered a satisfactory outcome for all concerned? For some, yes, but for others, no.</p>
<p>Even without the power issue, there are still environmental concerns. ASICs (the machines used by Bitcoin miners) can only do one task and when they reach of life, they are not easy to recycle, if at all. Almost certainly, hundreds of thousands of these machines have found their way into landfill with the promise of more to come.</p>
<p>Not only that, but mining rigs produce a lot of heat and either need more power to cool them (this is, in fact, a significant part of the quoted power consumption figures) OR they need to be located where it is cold.</p>
<p>In the latter case, could there be a long term environmental issue caused by dumping a giant heater in a cold place? Logic would dictate that there certainly could be.</p>
<p>It seems the problems for Bitcoin keep mounting up.</p>
<p>But, of course, weâve been here before.</p>
<h2 id="deja-vu">Deja Vu</h2>
<p>Any âgold rushâ for new tech leaves a path of destruction behind it. It has always been the case and probably always will be.</p>
<p>Whilst trying to think of a solid analogy, I decided (after rejecting many other possibilities) the most appropriate one was probably the PC itself.</p>
<p>After all, the explosive growth in PC use is still within living memory, the global tech development race was similar and these items were all designed to be used as tools to support and use the main non-sovereign, non-physical product that was initially hard for people to get their heads aroundâââi.e. the internet.</p>
<p>According to historical data collated by Gartner and presented on <a href="https://en.wikipedia.org/wiki/Market_share_of_personal_computer_vendors">Wikipedia</a>, between 1996 and 2003 some 922 million PC units were sold globally. I chose these dates because this was the era of proper âfirst genâ home computing, where connectivity to the net, such as it was, was possible, but difficult. After 2004, ADSL lines and other solutions started to become widely available and the tech began to change accordingly.</p>
<p>Thatâs a huge amount of boxes, but how many of those do we still use today? The answer, almost certainly, is none. Well, apart from the one my mum keeps in her spare room to play solitaire on occasionally.</p>
<p>Almost a billion units have been thrown away and, since these were the days before recycling, they also probably made it to the landfills too. And what about the billion or so modems we produced in the days before ADSL? Now all gone too. It was expensive both in terms of environment and dollars, but things have settled down considerably since then.</p>
<p>Last year just 261 million units were shipped compared to the peak in 2011 of 353 million, a drop of 102 million units in a trend that is still falling. We use other devices these days instead of just computers and we tend to upgrade far less frequently anyway as the gap between hardware and software capability has narrowed.</p>
<p>The PCs we do still use are far more energy efficient than their ancestors, especially in terms of monitors, so as the amount of connections to the internet have increased over the years, itâs likely that power consumption hasnât increased proportionately.</p>
<p>My view is that, over time, we will see the same with Bitcoin.</p>
<p>Right now, weâre in an arms race where even a slightly better machine is sought after at almost any price in the same way a 66Mhz processor was favored over a 33Mhz processor in the early, frantic days of computing.</p>
<p>But like PCs, over time this will settle down and many of the issues will be resolved, something I may seem overly confident about.</p>
<p>Hereâs why:</p>
<h2 id="the-future-and-context-of-proof-ofwork">The Future and Context of Proof of Work</h2>
<p>Although I am a self-confessed optimist on, well, pretty much everything really, I am also quite cynical about certain aspects of human nature. The bottom line is that, collectively, we just wonât care enough about things like the environment unless a) it affects us directly and b) it makes us money.</p>
<p>The trick, therefore, is to align global needs with selfish needs, or, to put it another way, to ensure that making money happens to coincide with things that are beneficial to the planet. </p>
<p>And although Bitcoin seems to be the opposite at first, from a long term perspective thereâs a natural alliance that could actually turn out to be very beneficial for all parties concerned.</p>
<p>Making money as a Bitcoin miner is all about efficiency and, as time goes on for technical reasons, this becomes more and more important. </p>
<p>Right now, weâre using the mining equivalent of the huge, extremely inefficient engines that were prevalent in American cars in the 70âs and got 8â10 miles to the gallon. After all why not? Fuel was cheap, plentiful and the environment (whatever that was) was fine with it, right?</p>
<p>But youâd never buy a new car like that now, partly due to a change in social awareness, but also because it would be too expensive to run. As soon as it becomes more about money, we pay attention.</p>
<p>Right now, new, sleeker tech is being developed. Each generation will produce more hash power for less energy and as these lines convergeâââas they always doâââit simply wonât be cost effective to run older, hotter, juicier equipment that needs to be frequently upgraded.</p>
<p>As time goes by, and even as Bitcoinâs hashrate and influence increases, I bet you any money (<em>in bitcoin please, not dollars</em>) that its carbon footprint doesnât increase in proportion to that growth. </p>
<p>This will be partly because of the equipment itself, but also due to the fact that earlier this year a whole swathe of reports, <a href="https://www.carbonbrief.org/solar-is-now-cheapest-electricity-in-history-confirms-iea">such as this one</a>, came out confirming that solar and wind are now the cheapest forms of energy production on the planet. Renewables, like Bitcoin, are here to stay and will now grow faster than any other sector as a result.</p>
<p>About time too.</p>
<h2 id="a-net-reduction">A net reduction?</h2>
<p>I further bet you based on what weâve seen historically, applications of Mooreâs Law (the concept rather than the technical absolute) and the fact that we humans, collectively, are predictable when it comes to money, that <strong>this power consumption will plateau and</strong> <em><strong>even fall</strong></em> <strong>eventually.</strong></p>
<p>Itâs a bold statement and itâs definitely not something that will happen next yearâââalthough certainly could within the next decadeâââand Iâm happy to go on record with that forecast.</p>
<p>Thereâs always a counter position of course, and the most relevant one in this case is the LED light argument, covered in <a href="https://advances.sciencemag.org/content/3/11/e1701528">this article</a>. The crux of this report is that overall power consumption in lighting has increased, even though much less power is now required to produce the same amount of light.</p>
<p>Iâm sure thatâs true as population and applications have grown on a global level, but when I switched all my lights at home to the latest-gen LED lighting, I noticed an immediate and significant reduction in both power consumption and energy bills as well as a far superior light. I have also never had to replace any bulbs as yet, something I definitely would have done several times over by now using the old, hot, inefficient tech.</p>
<p>I think we can safely assume Bitcoin miners, on an individual level, will consistently seek to do the same. After all, their livelihoods depend on it.</p>
<p>And thereâs also one more consideration worth noting.</p>
<p>Itâs easy to overlook that the traditional banking and global payment processing sectors also require enormous amounts of power to run, although itâs even harder to calculate what these numbers might actually be. Thereâs no single network to base assumptions on and thereâs literally thousands of independent companies and organizations who are often not exactly forthcoming about their carbon footprints.</p>
<p>However, we can safely assume that this power consumption, globally, must be <em>at least</em> what Bitcoinâs requirement is.</p>
<p>Bitcoin, in my view, will never replace that existing banking system, nor should it, but there is at least the <em>possibility</em> of reducing it in the long term. For example, every transaction that takes places over the Bitcoin network is, mathematically speaking, a transaction that does not take place on the traditional network.</p>
<p>Itâs a very simplified view, but on a big enough and prolonged enough scale, this could make a difference, especially when it comes to decisions about power hungry physical premises and data centers by incumbent financial institutions.</p>
<p>The size of that impact may ultimately be tiny or it may be significant, and my guess is that it will be somewhere between the two. On a global scale, this is therefore a redirect of power resource rather than a requirement for more, and that can be considered a benefit of the Bitcoin network.</p>
<h2 id="the-bottomline">The bottom line</h2>
<p>I think Alex De Vries work is actually very good as he embarked on a difficult task with little hard information. It has limitations, but these are clearly explained through caveats. </p>
<p>However, I disagree entirely with his prognosis as it assumes that what is happening right now will be the same going forward. I propose that this will not be the case because the parameters will change, the tech will change and as for the rule bookâââwell, we havenât even got round to writing that yet.</p>
<p>Although I have no doubt that De Vries work is right in the short term while we power through this crazy growth-spurt-cum-gold-rush phase of Bitcoinâs lifecycle, the adoption and management phases will see a different, more measured approach where power efficiency will become ever more important.</p>
<p>This means there will be an even more absolute and direct link between the power consumption of the miners and their standard of living. You can bet, therefore, they will continually seek out the lowest cost energy sources (already proven to be renewables), and the most efficient, lowest heat producing machines that have the best longevity. Yâknow, a bit like my LED lights.</p>
<p>They will also do this with a level of motivation that would outweigh anything in the traditional banking sector because they would be directly incentivized to do so.</p>
<p>And when individual needs align with things that are good for the planet, you know they will get done, even if itâs not for the reasons weâd prefer.</p>
<p>Still, weâll take it.</p>
<p>And so will Mother Nature.</p>
<hr />
<p><em>This post is published for Cryptowriter in association with Voice.</em></p>
<p><strong>Disclosure</strong>:Â <em>The author of this opinion piece has been heavily involved with bitcoin for several years and holds a substantial cryptocurrency portfolio, including bitcoin. He also has a mining operation running the SHA-256 algorithm based in Siberia and is a published author on the subject of promoting the understanding of cryptocurrency.</em></p>
<p>Jason is an analyst at <a href="https://quantumeconomics.io/"><em>Quantum Economics</em></a><em>, specializing in Bitcoin and macro economics.</em>ï»ż</p>
<p><strong>Disclaimer:</strong>Â <em>Investing in any asset class is risky. The above should not be taken as financial advice, nor construed as so. Always do your own research before investing or consult with a professional financial planner.</em></p>
<hr />
<h1 id="banks-qe-and-money-printing"><a href="https://www.lynalden.com/money-printing/">Banks, QE, and Money-Printing</a></h1>
<h3 id="by-lyn-alden">By <a href="https://twitter.com/LynAldenContact">Lyn Alden</a></h3>
<h3 id="posted-november-22-2020">Posted November 22, 2020</h3>
<p><img src="/assets/images/2020/m11/la1.png" alt="Banks, QE, and Money-Printing" /></p>
<p>Lately, it has become fashionable to debate what is, or is not, âmoney-printingâ by central banks.</p>
<p>This debate is natural, due to the extreme policy nature of 2020, with massive fiscal expenditures, huge increases in central bank balance sheets, and changes in central bank inflation targets. Itâs important to know what is inflationary, and what isnât, and to what extent.</p>
<p>Because people have very different understandings of how central bank policy and fiscal policy work, there have been analyst calls this year ranging from hyperinflation to deep deflation, and everything in between.</p>
<p>The outcome has of course been somewhere in the middle as measured by CPI or PCE, with inflation that rebounded from March lows in response to policy, but neither much of an overshoot or undershoot, and still generally below long-term central bank inflation targets.</p>
<p>Many inflation categories for the most essential and non-outsourced goods and services, however, have risen faster than the overall basket this year, and in recent years.</p>
<p>The crux of this article is that quantitative easing on its own, and quantitative easing combined with massive fiscal deficits, are two very different situations to consider when it comes to analyzing the possibilities between inflation and deflation, and what constitutes âmoney printingâ.</p>
<h2 id="the-deflationary-backdrop">The Deflationary Backdrop</h2>
<p>Before diving into the mechanisms of money-printing, it helps to set the stage. Context is key.</p>
<p>Historically speaking, weâre coming down from the apex of, and currently within the lengthy resolution process of, a <a href="https://www.lynalden.com/fiscal-and-monetary-policy/">long-term debt cycle</a>, which refers to a multi-decade peak in public and private debts relative to the size of the economy and money supply. This occurs in the aftermath of when interest rates hit zero.</p>
<p>Weâve been in this resolution process for the past 12 years, and the previous time before that was the two-decade period of the 1930âs and 1940âs where we hit the previous apex of a long-term debt cycle.</p>
<p>Here is total debt as a % of GDP in the United States over the past century in blue on the left axis (all debts, public and private), along with short-term interest rates in orange on the right axis:</p>
<p><img src="/assets/images/2020/m11/la2.png" alt="Long Term Debt Cycle Policy" /></p>
<p><em>Data Sources: U.S. Treasury Department, U.S. Federal Reserve</em></p>
<p>And here is total debt as a % of the broad money supply, which shows the structural peaks of each cycle even more clearly (since policymakers have more influence over broad money supply than GDP, due to shifting monetary velocity):</p>
<p><img src="/assets/images/2020/m11/la3.png" alt="Debt vs M2 vs Rates Policy" /></p>
<p><em>Data Sources: U.S. Treasury Department, U.S. Federal Reserve</em></p>
<p>If we break out federal debt from non-federal debt (households, businesses, states, financial leverage, etc), we see two distinct peaks in each long-term cycle. Non-federal debt (orange line) peaks first in a commercial banking crisis (early 1930âs and late 2000âs), and then federal debt (blue line) peaks many years later in a sovereign debt crisis (mid-1940âs and ???-2020âs):</p>
<p><img src="/assets/images/2020/m11/la4.png" alt="Debt Devaluation Policy" /></p>
<p><em>Data Sources: U.S. Treasury Department, U.S. Federal Reserve</em></p>
<p>There are a lot of deflationary forces on consumer prices in the economy:</p>
<ul>
<li>High private debt levels are deflationary, since it makes consumers and businesses financially restrained and risk-adverse.</li>
<li>Slowing population growth and aging demographics are deflationary, since resource demand slows.</li>
<li>Technology is deflationary, since it makes some things cheaper and better.</li>
<li>Wealth concentration into fewer hands is deflationary, since money coalesces rather than circulates.</li>
<li>Commodity oversupply is deflationary, since it cheapens the building blocks we use for everything else.</li>
<li>Outsourcing is deflationary, since it lowers labor costs of goods and puts downward pressure on domestic wages.</li>
</ul>
<p>In a low-debt system, structural deflation for some of the positive reasons, such as technological improvement, would be a good thing. It means your moneyâs purchasing power grows over time, as higher productivity from technological enhancements lowers the cost of goods or improves their quality, so you get more value for your dollar.</p>
<p>However, in an extraordinarily high-debt system (which requires a lot of central policy intervention in the first place to be able to get up that high), deflation breaks things and results in widespread defaults, because the cost of servicing debts goes up relative to cash flows.</p>
<p>So, fiscal and monetary policymakers deliberately push back on deflationary forces with inflationary policy, especially when it gets to those extremes. And there are a few definitions or types of inflation that we can identify.</p>
<p>Monetary inflation refers to the growth of the broad money supply, which can be calculated in a few ways but is pretty straightforward.</p>
<p>Asset price inflation refers to bubble-like increases in the prices of financial assets, like stocks, bonds, gold, private equity, fine art, and so forth. This is a bit more subjective because valuations on assets can vary, but there are various ratios to keep track of it in a broad sense.</p>
<p>Consumer price inflation refers to a broad rise in the prices of everyday goods and services, and people debate about how it should be measured. The government uses CPI and PCE calculations on a basket of goods, but those use various substitutions. There are alternative calculations that donât use substitutes, which generally lead to higher figures.</p>
<p>Each household has their own unique basket of consumer goods and services that they buy. For research purposes, I calculated that my personal household consumer price inflation rate averaged about 3% per year over the past two years, taking into account our total purchases of non-investment goods and services.</p>
<h2 id="qe-alone--bank-recapitalization">QE Alone = Bank Recapitalization</h2>
<p>Going into the 2008 crisis, U.S. banks were extremely leveraged, with very low bank reserves.</p>
<p>Large bank cash levels equaled just 3% of their assets (blue line below; cash as a percentage of total assets), and large bank holdings of Treasuries as a percentage of assets were pretty low historically as well (red line; treasury securities as a percentage of total assets):</p>
<p><img src="/assets/images/2020/m11/la5.png" alt="Bank Cash and Treasury Levels" /></p>
<p><em>Chart Source: St. Louis Fed</em></p>
<p>So, leading into the financial crisis, only about 13% of their assets consisted of cash (3%) and Treasury securities (10%). The rest of their assets were invested in loans and riskier securities. This was also at a time when household debt to GDP reached a record high, as consumers were caught up in the housing bubble.</p>
<p>That over-leveraged bank situation hit a climax into the 2008/2009 crisis, coinciding with record high debt-to-GDP among households, and was the apex of the long-term private (non-federal) debt cycle. When banks are that leveraged with very little cash reserves, even a 3% loss in assets results in insolvency. And thatâs what happened; the banking system as a whole hit a peak total loan charge-off rate of over 3%, and it resulted in a widespread banking crisis.</p>
<p>However, banks were bailed out via QE and the Troubled Asset Relief Program. It was a top-down, anti-deflationary bank industry bailout, but not a bottom-up, pro-inflationary real economy bailout. TARP boosted bank solvency, and QE boosted bank liquidity.</p>
<p>As the crisis played out and some banks failed and others were bailed out, regulators wanted to increase bank reserve requirements and capital requirements, requiring banks to hold a greater percent of their assets in cash reserves and other safe assets. The problem with that, however, is that banks canât just magically boost up their reserves; they would have to sell other assets to get cash, but if every bank in the system sells assets to get cash, who do they sell to, and where would so much cash come from to buy what they sell?</p>
<p>In other words, while itâs possible for an individual bank to boost its reserves by selling assets to raise capital, itâs mechanically impossible for the entire banking industry to collectively raise its reserves industry-wide.</p>
<p>So, in the role of lender/buyer of last resort, the Federal Reserve created new cash reserves out of thin air, gave them to the banks, and took some of their Treasuries and mortgage-backed securities in return, aka quantitative easing or QE. Along with TARP, this recapitalized banks, bringing them from 3% cash as a percentage of assets at the start of 2008, to 8% by the end of 2008. The Fed did further rounds of QE through 2014 that brought banks collectively up to 15% cash levels, which brought them up to frothy levels of excess reserves.</p>
<p>This, however, didnât result in more money chasing fewer goods and services, and therefore wasnât particularly inflationary for every prices. The money remained mostly internal to the banking system, at higher reserve levels. Broad money supply didnât increase rapidly.</p>
<p>Many analysts that were worried about inflation missed the fact that the transmission mechanism from QE to the real economy was small, so this was mostly just a bank-recapitalization process. Banks and their executives got a nice assist from the Fed and Treasury, but the broad public did not. Banks didnât lend much of the money out (nor was there a ton of creditworthy demand for them to do so), and fiscal spending didnât go around the banking channel very much either.</p>
<p>A similar version of this played out in the 1930âs, which was the previous time that interest rates hit the zero bound at the apex of a long-term private debt cycle. The banking system collapsed back then too, so policymakers devalued the dollar vs the gold peg, expanded the monetary base, and recapitalized banks during a banking holiday. This was enough to offset the deep deflation that was happening in the early 1930âs, and turn it back into a reflationary trend in the mid-1930âs, but not enough to cause rapid broad consumer price inflation. It was anti-deflationary, in other words, but not outright inflationary.</p>
<h3 id="the-inflation-fake-out">The Inflation Fake-Out</h3>
<p>All told, the Fed expanded their balance sheet by about $3.5 trillion from mid-2008 to the end of 2014. They created new bank reserves to buy Treasuries and mortgage-backed securities.</p>
<p>Many folks thought this would be hyperinflationary, Weimar Republic style. So, they bid up the price of gold rather high. Iâm glad they felt that way, because I sold my gold to them in 2011, during a period of very high sentiment. Itâs the only time I sold physical bullion. I wanted to load up on historically cheap stocks instead.</p>
<p>Here was the gold price relative to my model (i.e. orange area way above blue line):</p>
<p><img src="/assets/images/2020/m11/la6.png" alt="Gold Valuation Model" /></p>
<p><em>Data Source: St. Louis Fed</em></p>
<p>And here were stock valuations relative to fundamentals:</p>
<p><img src="/assets/images/2020/m11/la7.png" alt="Stock Valuations" /></p>
<p>Of course, this QE ended up not being outright inflationary for consumer prices, for reasons described before. It was anti-deflationary, rather than outright inflationary. Along with low rates, it was somewhat inflationary for asset prices, but not most consumer prices. Thatâs how it worked in the 1930âs, too.</p>
<p>We can put some broad numbers on it. From 2007 to 2009, there was a $11 trillion decline in U.S. household net worth, as it fell from $71 trillion to $60 trillion, due to a decline in stock and house prices. It then took about five years for U.S. household net worth to recover to previous highs. This was $11 trillion in deflationary wealth destruction (plus technology improvements, and commodity oversupply, tightened credit for home equity loans, and other deflationary forces), up against the response of $3.5 trillion in Fed bank reserve creation or QE. Of course it wouldnât be hyperinflationary.</p>
<p>Morally hazardous? Sure. Hyperinflationary? No.</p>
<p>Moreover, as previously-described, most of the $3.5 trillion never entered the broad money supply because there was no major fiscal transfer mechanism, so it mostly just stayed in bank reserves. It offset a deflationary shock and bank collapse by recapitalizing the banking system with higher levels of solvency and liquidity (and thus was anti-deflationary), but it was not outright inflationary.</p>
<h3 id="bank-reserve-example">Bank Reserve Example</h3>
<p>Banks, in practice, are limited in how much leverage and risk they can take by their regulatory capital requirements. In this model, there are some very low-risk assets (like bank reserves, Treasury securities, and gold) that donât count against the bankâs risk level, and there are higher-risk assets (like personal loans, or corporate bonds) that do count against a bankâs overall risk level. Banks need to maintain an appropriate balance of assets to avoid being considered too risk-heavy.</p>
<p>In some regulation regimes, banks can also be constrained by reserve requirements, meaning that banks are required to have a certain percentage of deposits stored as cash reserves.</p>
<p>Suppose that there is a regulatory rule which says that all banks must have an amount of cash equal to 5% of their customer bank deposits (which are liabilities for banks; owed to their customers) held in reserve at the Federal Reserve. So, if a bank has $100 billion in customer bank deposits held with them (which are liabilities for the bank), and $110 billion in assets (and so they have $10 billion more assets than liabilities), they can put up to $105 billion of their assets into various forms (making loans, buying securities, etc), but must hold at least $5 billion in cash reserves at their account with the Fed.</p>
<p>Here is a reserve-constrained bank example. A bank has $100 billion in deposits (liabilities), and $110 billion in assets. Of their assets, $5 billion is in cash reserves, $20 billion is in Treasuries, $10 billion is in mortgage-backed securities, and $75 billion is in other assets (personal loans, mortgage loans, corporate loans, and/or whatever else). This bank canât lend anymore, until either it collects more deposits which would also boost reserves, or sells some existing assets. It is therefore reserve-constrained. It might want to lend, and has good client demand to lend money to, but it simply canât leverage itself anymore. If the Fed were to create $5 billion in brand new reserves (aka QE) and buy $5 billion of their Treasuries or mortgage-backed securities, it would alleviate their reserve-constrained status, and the bank could use that $5 billion to lend more, or buy more securities. This would be economically stimulative if the bank wants to lend money, because now the bank can go ahead and lend that money, and thus create deposits somewhere in the system and increase the broad money supply.</p>
<p>Here is a non-reserve-constrained example. A bank has $100 billion in deposits (liabilities) and $110 billion in total assets. Of their assets, $15 billion is in cash reserves, $20 billion is in Treasuries, $10 billion is in mortgage-backed securities, and $65 billion is in other assets. This bank has $10 billion in excess reserves above the $5 billion requirement; extra money it can lend. Maybe it doesnât want to lend right now; it doesnât see any good risk-adjusted loans to make. Or maybe there isnât a lot of demand from its clients to borrow money. So, itâs just holding that extra $10 billion as excess reserves, in addition to their $5 billion required reserves. If the Fed were to do QE and buy $5 billion of their Treasuries, and bring the bank up to $20 billion in reserves, it wonât affect how much they lend, because they werenât reserve-constrained to begin with. This would not be stimulative and would not increase the broad money supply, since it doesnât coerce the bank to make any more loans.</p>
<p>That is why QE alone isnât inflationary. Increasing bank reserves does not necessarily increase the broad money supply. A rapidly increasing broad money supply along with constraints on the supply of goods and services, is what can lead to inflation.</p>
<p>There are two ways to increase broad money supply. Either banks need to lend, or the federal government can go around them and run big fiscal deficits. At the apex of a long-term debt cycle, the latter tends to happen.</p>
<h2 id="qe--fiscal-stimulus--money-printing">QE + Fiscal Stimulus = Money Printing</h2>
<p>Now in 2020, in the next recession twelve years after the 2008 banking crisis, weâre back at it and bigger than before, but with a twist.</p>
<p>This time, going into the crisis, the banking system was already well-capitalized. The percent of bank assets that consist of cash and Treasuries was already historically high. So, unlike 2008, banks werenât over-leveraged. However, the broader economy was over-leveraged, and the pandemic hit the broader economy.</p>
<p>Millions of people became unemployed, and countless businesses faced insolvency risk as their cash flows collapsed. For the Fed to simply buy Treasuries and MBS from banks wouldnât do almost anything for this, because itâs not a bank recapitalization issue, and there would be no transmission mechanism to the public. Banks were already well-capitalized, and so the banks werenât reserve-constrained.</p>
<p>Instead, this time, fiscal authorities (Congress and the President) spent trillions of dollars into the real non-bank economy, sending folks stimulus checks, boosting unemployment benefits by an extra $600/week (which is $2,400/month for several months for folks who received it), financing banks to give small businesses PPP loans that mostly turn into grants, and partially bailing out some of the hardest-hit corporate industries with fresh capital injections. It was a much larger stimulus than anything from 2008/2009.</p>
<p>The way that the governmentâs accounting works in the current legal structure, is that they have to issue a lot of Treasury securities to fund that expenditure. However, the foreign sector was not really buying Treasuries, and in fact were selling some Treasuries early this year. So, who would be available to buy $3 trillion in extra Treasury securities this year?</p>
<p>Enter the Fed again. When the Treasury market became illiquid in March from foreigners and hedge funds selling Treasuries against a backdrop of insufficient buyers, the Fed stepped in, and created $1 trillion in brand new bank reserves out of thin air to buy $1 trillion in Treasuries over a 3-week period. This was the most rapid asset-purchase program the Fed has ever done. And then they tapered that rate but kept buying Treasuries for months to soak up the massive 2020 Treasury issuance that funded all the stimulus, and are still buying tens of billions of dollars of Treasuries monthly with newly-created bank reserves to this day.</p>
<p>So, the Fed once again increased its balance sheet (this time by nearly $3 trillion in just three months) to buy a large chunk of Treasuries, plus some other assets like mortgage-backed securities and a handful of corporate bonds. About $2 trillion, or 2/3rds of this 2020 balance sheet expansion so far, consisted of buying Treasuries. But what made this one different, was that it didnât just stay in the banking system to recapitalize banks. It flowed through banks to the U.S. Treasury Department, which injected that money directly into the economy as authorized by Congressâ CARES Act.</p>
<p>This following chart shows the year-over-year change (in billions of dollars) of total U.S. commercial bank deposits in blue, government transfer payments in green, and the Fedâs balance sheet in red:</p>
<p><img src="/assets/images/2020/m11/la8.png" alt="QE and Fiscal Money Printing" /></p>
<p><em>Chart Source: St. Louis Fed</em></p>
<p>That chart is critical to see why 2020 and 2008 were quite different, and why the policy response acted so much quicker and more powerfully on financial markets and personal income this time. Personal income and net worth on a nationwide scale went up, rather than down, in 2020 so far.</p>
<p>In 2008-2014, there was a lot of QE (red line going up), but those dollars didnât get out into public bank deposits (which is what mostly makes up the broad money supply). This was because there was little or no fiscal transmission mechanism; the government wasnât sending huge checks to people. So, the green line (year-over-year change in government transfer payments) and blue line (year-over-year change in bank deposits) remained low. The QE process in 2008 mostly just recapitalized banks.</p>
<p>However, 2020 was a very different story. The government sent out tons of money directly into the economy, and financed it by issuing Treasury bonds that the Federal Reserve created new bank reserves to buy. For legal reasons, the Fed buys those securities on the secondary market, but that doesnât make much of a difference in practice; itâs where they end up and remain that matters. The banks that buy them from the Treasury and sell them to the Fed just act as pass-through entities in this case.</p>
<p>So, the blue, green, and red lines all went vertical in 2020, unlike the 2008-2014 period. The government sent money to people and businesses (green line), that money showed up in their bank deposits (blue line) and thus in the broad money supply, and the Fed created new bank reserves to buy a lot of the Treasury securities issued to fund that program (red line).</p>
<p>Or, put simply, the broad money supply went up a lot in 2020, but didnât budge nearly as much in 2008/2009 (in either absolute or percent terms), because QE alone to recapitalize banks, and QE-financed fiscal stimulus into the real economy, are two very different situations:</p>
<p><img src="/assets/images/2020/m11/la9.png" alt="M2 Growth 2008 vs 2020" /></p>
<p><em>Chart Source: St. Louis Fed</em></p>
<p>Many people who saw the inflationary non-event from 2008-2014, are suggesting that QE is inherently deflationary, and that it wonât cause inflation this time either.</p>
<p>Iâm glad many people feel that way, because Iâm happy to buy their gold from them on dips. I bought plenty of precious metals back in 2018 and have cooled my purchases since then due to the notable uptick in price, but am still happy to dollar-cost average into them at these prices, or buy on dips. I also like cheap natural resources more broadly, as well as high-quality equities, real estate, Bitcoin, and other scarce assets for a diverse mix, with a long-term view.</p>
<p>In my view, the âQE is deflationary; it only increases bank reserves!â position is from not taking into account the fiscal element; the transmission mechanism that gets QE into the hands of the public rather than stuck in the banking system. QE alone is not inflationary and mostly stays in bank reserves, but QE combined with massive fiscal deficits, is inflationary, and gets the funds out into the broad money supply, out into commercial bank deposits of the public.</p>
<p>Basically, massive fiscal spending combined with the central bank buying lots of sovereign bonds to fund it, is a modern monetary theory âMMTâ program in practice, for the first time since the 1940âs when the equivalent of âwartime MMTâ was used.</p>
<p>Now, bear in mind that this is still up against large deflationary forces: technology, demographics, debt, and shifting consumer behavior around the pandemic. So, even a one-time pro-inflationary $3 trillion injection into the real economy is merely enough to cause a quick rebound in inflation and a sharp recovery in asset prices, as we saw in 2020 from the March lows. Combined with certain supply limitations, it also helped cause non-discretionary prices to rise: grocery price inflation in particular was rather significant this year.</p>
<p>However, a one-time $3 trillion injection is not enough to cause a persistent trend change in inflation. Those deflationary forces outweigh it. There is not yet a situation of too much money chasing too few goods and services, except in niche areas. The stimulus delayed an insolvency crisis for several months and got consumers through the worst 3-4 month period of the economic shutdowns.</p>
<p>If we look over the past century, we can see that the two inflationary decades (the 1940âs and 1970âs) occurred when broad money rose rapidly. This chart shows the 5-year rolling cumulative percent increase in the consumer price index and in broad money supply per capita:</p>
<p><img src="/assets/images/2020/m11/la10.png" alt="M2 vs CPI Rolling 5-Year Growth" /></p>
<p><em>Data Source: U.S. Federal Reserve</em></p>
<p>Therefore, the big question for investors in multiple asset classes, is whether the fiscal authorities will keep repeating that on a notable scale, or whether they will cool off. Without the massive fiscal+QE âMMTâ combo, the economy remains in the grip of structural disinflation, and a renewed cyclical disinflationary trend. However, with another round of massive fiscal+QE âMMTâ combo, the outcome would likely be more of what we saw in spring/summer of 2020: rebounding inflation and asset prices, and likely eventually pushing too far.</p>
<p>Ultimately, with so much debt in the system and the weight of private debt, policymakers are likely to be forced to do more rounds of fiscal stimulus (either from civil unrest or political donors), but the timing for that is something that investors need to work around when it comes to assessing the inflationary or disinflationary outlook for the next couple quarters ahead.</p>
<p>Right now, with money velocity so low and the pandemic still raging, and plenty of commodity oversupply particularly in regards to oil, it may seem like there is a limitless sink for broad money creation without leading to sustained consumer price inflation. However, that can change a couple years down the line, as the world fully emerges from pandemic effects, after years of not putting much capital into resource development.</p>
<p>Itâs also worth noting that âfiscal stimulusâ in this sense refers to both spending and taxation. In other words, federal deficits. A fiscal stimulus could include giving everyone a $1,200 check, or could include giving everyone a $1,200 payroll tax cut, for example. The differences between those two mechanisms matter around the margins (particularly for the unemployed, who wouldnât benefit from a payroll tax cut), but for large chunks of the 150 million working population, a stimulus check and a payroll tax cut are functionally similar throughout the course of a year, and result in more cash in the hands of most people. These policies increase the amount of broad money, not just bank reserves.</p>
<p>When it comes to fiscal stimulus, regardless of whether it takes the form of taxation or spending changes, its stimulatory impact and inflation outcomes are mostly a question of magnitude, as well as who it primarily targets (unemployed, working class, middle class, wealthy, or rich). Itâs inflationary, against the deflationary backdrop, and so whether the outcome shifts to inflation or remains disinflationary becomes a question of scale and persistence, and whether it increases productive capacity or not.</p>
<h2 id="rules-are-meant-to-be-broken-bent">Rules Are Meant to Be⊠Broken? Bent?</h2>
<p>In my view, focusing on some of the mechanics of the Fedâs QE combined with fiscal injections is like focusing on the trees and missing the forest.</p>
<p>This is because at the end of a long-term debt cycle, policymakers do whatever they need to in order to avoid a deflationary collapse and get towards some degree of reflation and devalued debt levels.</p>
<p>The Federal Reserve Act doesnât allow the Fed to buy corporate bonds. And yet, the Fed bought corporate bonds this year.</p>
<p>How did the Fed do that? They worked with the Treasury and Congress, set up a Special Purpose Vehicle, and bought corporate bonds through that vehicle, with any defaults on those bonds funded by the Treasury so the Fed doesnât face the risk of nominal losses.</p>
<p>People saying this violates the Federal Reserve Act are, unfortunately, falling on deaf ears.</p>
<p><img src="/assets/images/2020/m11/la11.png" alt="Nobody Cares Meme" /></p>
<p>Policymakers went around the spirit of the Federal Reserve Act, but perhaps not the letter of the law due to the structure involved. Itâs perhaps not surprising that the heads of the worldâs two biggest central banks, the Fed and the ECB, are both lawyers rather than economists.</p>
<p>I personally think that the Fed buying corporate bonds was not a good part of the overall policy response, and sets a bad precedent and moral hazard. But, it happened nonetheless, and it is during the apexes of long-term debt cycles that these sorts of âexceptionsâ tend to happen.</p>
<p>The Fed has legal limitations on its own, which is good. However, when the Fed works closely with the Treasury Department and Congress to combine fiscal and monetary policy, all bets are off. They worked together closely in 1940âs decade to fund World War II in the second half of the previous long-term debt cycle apex, and they did so again here in the new 2020âs decade.</p>
<p>Love it or hate it, that Treasury+Fed combo is extremely powerful and bypasses just about any limitation that the Fed alone has. The Fed can lend but canât spend. The Treasury can spend, but if it spends a ton and issues more sovereign debt than there is demand for, it needs the Fed to buy some of its sovereign debt issuance (using primary dealer banks as pass-through entities). The Fed canât buy certain securities, particularly those that could lead to nominal losses, but with a special purpose vehicle and a financial backstop by the Treasury, they can. Together, they can create new money, and inject it to whoever they want.</p>
<p>Many people think that the broad money supply is only able to increase when banks lend money and create deposits. However, ironically, the biggest increases in the broad money supply historically happen when things are terrible and so banks *arenât* lending much, and thus when the money multiplier (broad money divided by base money) is low.</p>
<p>At those times, the federal government runs massive fiscal deficits, and goes around the bank lending channel to either tax less from the economy or inject more money into the economy (historically they choose the latter), and finances its massive deficits by having the Federal Reserve create new bank reserves to buy a large chunk of its Treasury debt issuance.</p>
<p>This chart highlights that, by showing the money multiplier on the left axis, with federal deficits as a percent of GDP, and year-over-year percent increase in the broad money supply, on the right axis:</p>
<p><img src="/assets/images/2020/m11/la12.png" alt="Bank Lending Channel" /></p>
<p><em>Data Sources: U.S. Treasury Department, U.S. Federal Reserve</em></p>
<p>However, when it comes to investment timing, sometimes focusing on the mechanics is helpful. So, letâs dive into some of those mechanics.</p>
<h2 id="bank-reserve-accounting">Bank Reserve Accounting</h2>
<p>Bank reserves, referring to the accounts that commercial banks have with the Federal Reserve, are strange beasts because of how unintuitive they are.</p>
<p>In fact, even the very definition of âmoneyâ is subject to debate. There are multiple ways to define âmoneyâ in the modern banking system.</p>
<p>The monetary base, and the broad money supply, are the two most important definitions, so letâs quantify them for context.</p>
<h3 id="base-money">Base Money</h3>
<p>The monetary base is the foundation, and consists of physical currency in circulation (currently around $2 trillion) and cash reserve deposits that the commercial banking system has with the Fed (currently around $2.8 trillion).</p>
<p>Although not part of the original definition, because the Treasuryâs general account âTGAâ with the Fed has grown in size and importance in recent years (currently $1.7 trillion), we functionally should include that as well, since itâs another cash deposit with the Fed. Those three buckets combined are $6.5 trillion in âbase moneyâ.</p>
<p>All three of these buckets of base money (currency in circulation, bank reserves with the Fed, and the Treasuryâs general account with the Fed) are the Fedâs biggest liabilities. On the other side of the Fedâs ledger, Treasuries and mortgage-backed securities represent most of the Fedâs assets.</p>
<p>If we look at these major Fed liabilities separately, with the TGA in blue, bank reserves in red, and currency in circulation in green, it looks pretty random:</p>
<p><img src="/assets/images/2020/m11/la14.png" alt="Federal Reserve Liabilities" /></p>
<p><em>Chart Source: St. Louis Fed</em></p>
<p>However, thereâs a method to the madness, and the Fed controls the total sum.</p>
<p>This next chart shows the sum of those three lines, meaning currency in circulation, commercial bank reserves with the Fed, and the Treasuryâs general account with the Fed (which are collectively the main liabilities of the Fed) in blue, and shows the Fedâs total assets in red (which mostly consists of Treasuries and mortgage-backed securities):</p>
<p><img src="/assets/images/2020/m11/la13.png" alt="Federal Reserve Assets and Liabilities" /></p>
<p><em>Chart Source: St. Louis Fed</em></p>
<p>Bank cash reserves at the Fed are fungible with each other. As folks like you and I use various payment systems to transact with each other, our banks use reserves to settle with each other behind the scenes.</p>
<p>Bank reserves are also fungible to some extent with currency in circulation. In fact, thatâs one of the initial reasons for banks to have reserves in the first place: in case tons of people want to withdraw money at once. In theory, if we all wanted to go and take out some of our bank cash at once, it would come from bank reserves. However, in practice, the amount of minted physical currency is limited (mostly on purpose), so if there was a bank run, consumers would quickly find themselves limited in how much cash they would physically be allowed to withdraw, as the bank runs out of vault cash. But basically, physical currency and bank reserves are fungible.</p>
<p>Bank reserves are fungible with the Treasury general account as well. When the Treasury issues a lot of bonds and pulls capital into its account, it sucks it out of bank reserves. When it eventually spends down its account, those funds wind up back in bank reserves.</p>
<h3 id="broad-money">Broad money</h3>
<p>The broad money supply, on the other hand, is currently $18.8 trillion, which is far larger than the base money amount. This broad money calculation consists of currency in circulation, but then also includes the massive amounts of checking deposits, savings deposits, and various functional cash-equivalents that consumers and businesses hold at commercial banks. This is the broader set of money that we consumers actually use to transact with each other and store our capital and define as our âmoneyâ.</p>
<p>The blue line below shows the broad money supply. The red line shows commercial bank deposits, and the green line shows physical currency in circulation. The red line and green line added together roughly equal the blue line.</p>
<p><img src="/assets/images/2020/m11/la15.png" alt="M2 Broad Money Supply" /></p>
<p><em>Chart Source: St. Louis Fed</em></p>
<p>When the Fed does QE alone, it increases bank reserves in the system, but doesnât necessarily increase the broad money supply. The broad money supply only increases when either a) banks create more money by making loans or b) the federal government runs big fiscal deficits to inject money to people and businesses in the system. Many people miss that second one; they assume that money supply can only increase if banks lend, which isnât correct.</p>
<h3 id="conservation-of-reserves--currency--tga-base-money">Conservation of Reserves + Currency + TGA (Base Money)</h3>
<p>For the most part, only the Fed can determine the sum of commercial bank reserves + currency in circulation + the Treasuryâs general account, hereby referred to as âbase moneyâ.</p>
<p>Think of these three forms of base money as buckets of water. The total amount of water can move around between the three buckets if we pour one into another, but is conserved within the total three-bucket system. Only the Fed can increase or decrease the total amount of water in the total three-bucket system.</p>
<p><img src="/assets/images/2020/m11/la16.png" alt="Base Money 3 Bucket Analogy" /></p>
<p>The purpose of modern banks is to âmultiplyâ base money into broad money, and make a profit along the way. We can call this the âmoney multiplierâ, defined as the broad money supply divided by the base money supply.</p>
<p>When a bank makes a loan to someone, it becomes another bankâs deposit, and the loaning bank sends the reserve amount to the depositing bank, and increases the total amount of commercial bank deposits and broad money in the system. So, when they âloan reservesâ, banks collectively donât actually reduce total bank reserves in the banking system; they just lever those reserves up with a higher money multiplier, and change the location/ownership of those reserves.</p>
<p>Any individual bank can leverage itself (up to a limiting point where it still meets capital and reserve requirements) by lending money or buying securities, and thus reducing its excess cash reserves at the Fed. However, when they make these loans or buy those assets, they create deposits somewhere else in the financial system, and those deposits become reserves of other banks. Similarly, a bank could sell assets and increases its cash reserves, but in doing so, some other bank deposits would be drained to buy those assets, which would reduce reserves somewhere else in the system.</p>
<p>Therefore, the banking system as a whole canât decide to collectively increase or decrease the system-wide amount of bank reserves, even though any individual bank can alter its own level of reserves. They can collectively increase the money multiplier (the broad money supply divided by base money) by making more loans or buying more securities, but they canât change the total system-wide bank reserves. They can just move them around, and leverage them up, or deleverage them.</p>
<p>Similarly, the U.S. Treasury can determine the size of its general account at the Fed. To increase it, they can issue Treasuries, bring in a lot of cash, and then hold the cash in that account at the Fed for a while before spending it. This sucks bank reserves out of the system, on a 1:1 basis with the general account increase. When they eventually reduce the general account by spending more than they take in, that money goes into peoplesâ and companiesâ bank accounts and thus winds up back in bank reserves.</p>
<p>The public can theoretically pull money out of excess bank reserves into physical currency, or deposit physical currency into banks which would wind up as more reserves, like water flowing back and forth between those two buckets of base money. In practice, however, physical currency is limited on purpose, so if the public collectively tries to pull bank reserves out into physical currency, they get told by the bank teller that they canât, because thereâs a nationwide shortage of physical currency.</p>
<p>The Fed, however, can create new base money, and thus add more total water to the three-bucket system analogy, by performing quantitative easing or âQEâ. To do this, they create new bank reserves out of thin air, and then buy existing assets, like Treasuries or mortgage-backed securities with those new reserves. After this asset swap, the reserves become owned by a commercial bank (and thus become the Fedâs liabilities), and the securities become owned by the Fed (and thus become the Fedâs assets). In this process, the Fed increases their total assets (the securities they are buying) and increases their liabilities (the new reserves they are creating) by the same amount.</p>
<p>The Fed can also decrease base money, or destroy water in the three-bucket system analogy, by performing quantitative tightening âQTâ. To do this, they sell or let some of their Treasuries or mortgage-backed securities mature and get their principle back. They then retire that cash. In this process, both the Fedâs assets and liabilities decrease.</p>
<p>In a vacuum, neither QE nor QT alone directly affects the broad money supply; it just affects the base money amount.</p>
<p>However, if the federal government is running very large fiscal deficits and the Fed is creating new bank reserves to buy the Treasury issuance to fund those deficits, it directly creates new broad money (and thus goes around the bank lending channel).</p>
<p>On the other hand, if the federal government were to run big fiscal surpluses on a sustained basis (i.e. tax more than they spend by a lot), at a time when banks arenât lending much either, they can theoretically decrease the total amount of broad money. This would be very rare, if ever, to occur. Additionally, widespread bank collapses without any bailout or FDIC insurance can also theoretically reduce broad money, which happened in the early 1930âs.</p>
<h2 id="bank-reserve-accounting-examples">Bank Reserve Accounting Examples</h2>
<p>This section gets gritty. Iâll work through six examples of bank lending, QE, and fiscal deficits, to help show which types of actions by banks, the Fed, and the government, can influence the amount and location of bank reserves and broad money supply in the system.</p>
<table>
<tbody>
<tr>
<td>For each example, I have two people, Mary and Sara, the two banks they do business with, the Fed, and the U.S. Treasury. Each of these six entities has a column that represent each of their assets and liabilities âA</td>
<td>Lâ.</td>
</tr>
</tbody>
</table>
<p>Each example is a small closed-loop financial system. Each block in an entityâs asset or liability column represents $1,000 of value.</p>
<ul>
<li>âDâ represents a $1,000 customer bank deposit.</li>
<li>âRâ represents a $1,000 cash reserve allocation that a bank has at the Fed.</li>
<li>âTâ represents a $1,000 U.S. Treasury note; U.S. federal government debt.</li>
<li>Other assets, like a $1,000 used car âCâ or a $1,000 car loan âLâ are sometimes used as well.</li>
</ul>
<p>A deposit block âDâ is an asset for a consumer, and is simultaneously a liability for their commercial bank, since the bank holds it on behalf of the consumer and owes it to them on demand.</p>
<p>Similarly, a reserve block âRâ is an asset for a commercial bank, and they keep it at the Fed. The Fed lists it as a liability, owed to the bank who deposited it with them.</p>
<p>Likewise, a Treasury note âTâ is an asset for whoever holds it, whether a consumer, or a commercial bank, or the Fed, and is a liability of the U.S. Treasury.</p>
<p>A bank loan block âLâ or mortgage block âMâ is an asset for the bank that lent it, and is a liability for the consumer who borrowed it from their bank.</p>
<h3 id="example-1-a-bank-loans-money">Example 1) A Bank Loans Money</h3>
<p>This is the simplest example to show how banks create deposits and broad money without reducing the amount of reserves in the system. It involves Mary buying a used car from Sara.</p>
<p>Here is the visual, with a beginning, intermediate, and ending state, and a description afterward, so you can go back and forth between the visual and the description:</p>
<p><img src="/assets/images/2020/m11/la17.png" alt="Loan Example" /></p>
<h4 id="beginning-state"><em>Beginning State</em></h4>
<p>Mary begins with âDâ in assets, meaning a $1,000 deposit in her bank, and no liabilities. Her bank (which is very unlevered) starts with her deposit âDâ as a $1,000 liability, and then has two reserve block assets âRâ, representing $2,000 held at the Fed.</p>
<p>Sara begins with âDDDCâ in assets, meaning $3,000 in bank deposits at her bank âDDDâ, and a $1,000 used car âCâ, and no liabilities. Her bank starts with her deposit âDDDâ as liabilities, and has its assets primarily invested in Treasuries âTTTâ and one reserve block at the Fed âRâ.</p>
<p>The Federal Reserve holds the three blocks of reserves from the two banks as its liabilities, and has three blocks of Treasuries as its assets. The banks use the Federal Reserve as their bank, in a similar way that Mary and Sara use their banks. In other words, the two banks store their extra cash reserve assets in their accounts at the Fed, which are the Fedâs liabilities.</p>
<p>The U.S. Treasury Department, representing the financial arm of the overall U.S. Federal Government, has 6 blocks of Treasuries outstanding as its liabilities. For the sake of simplicity it doesnât have any assets listed, but in reality, its assets would consist of working capital, various federal buildings and lands and military assets, and its ability to tax citizens. Its 6 Treasury liabilities are owned by the Fed and Saraâs bank.</p>
<p>Between Mary and Saraâs cash, there are 4 deposit âDâ blocks in the total system, which are assets for them and liabilities for their banks. Likewise, there are 3 reserve âRâ blocks in the system, which are assets for their banks and liabilities for the Fed.</p>
<h4 id="intermediate-state"><em>Intermediate State</em></h4>
<p>Now, for the intermediate state, Mary and Sara enter into negotiations, and Sara agrees to sell her car to Mary for $1,000. Mary, however, only has $1,000 in deposits, and although she needs the car, she doesnât want to be completely cash-less. So, she goes to her bank, and takes out a $1,000 car loan âLâ. Maryâs bank creates a $1,000 deposit âDâ for Mary, and creates a $1,000 loan liability âLâ for her as well. For the bank itself, Maryâs new deposit asset is its new liability, and Maryâs new loan liability is its new asset. No reserves moved, but a new deposit was created.</p>
<p>Maryâs net worth is unchanged at $1,000 in total, but she now has $2,000 in deposits and $1,000 in loan liabilities ,and thus is a bit more leveraged. Maryâs bankâs net worth is unchanged as well, but it also leveraged itself up a bit, by creating a new asset and a new liability, since it expects that Mary will be able to pay the loan back with interest.</p>
<p>Neither the Fed nor the U.S. Treasury are involved yet.</p>
<p>There are now 5 deposit âDâ blocks in the system rather than 4, because Maryâs bank is more levered with an additional asset and liability. It created new broad money by loaning a new deposit into existence. However, there are still 3 reserve âRâ blocks in the system.</p>
<h4 id="ending-state"><em>Ending State</em></h4>
<p>For the ending state, Mary writes Sara a $1,000 check for the car, and therefore gives her the new deposit âDâ that she just received from her bank loan. Sara receives the check and deposits it in her bank account, and her bank credits this by giving her an extra $1,000 deposit asset âDâ, which becomes a new liability for her bank. Behind the scenes, Maryâs bank sends a $1,000 reserve block âRâ to Saraâs bank to honor the check. So, Saraâs bank now has a new liability âDâ in the form of Saraâs new deposit, but also has a new reserve block âRâ as its new asset. Saraâs bank doesnât have any creditworthy clients asking for loans at the moment, so it keeps its new reserve block at its Fed account for now.</p>
<p>The Fedâs ending state is unchanged on net, except that it updated its book-keeping for its two client banks when Maryâs bank sent Saraâs bank a $1,000 reserve block âRâ. The Fed used to attribute âRRâ to Maryâs bank and âRâ to Saraâs bank, but now it attributes âRâ to Maryâs bank and âRRâ to Saraâs bank. These reserve blocks are liabilities for the Fed, but assets for its client banks.</p>
<p>The U.S. Treasuryâs ending state is also unchanged, and unlike the Fed, it wasnât even aware of the transaction at all.</p>
<p>In the final ending state, just like the intermediate state, there are still three reserve blocks âRâ in the system, and there are 5 deposit blocks âDâ, which is one extra deposit block compared to the beginning state, created by Maryâs bank loan.</p>
<p>The point of this example is to show how, when a bank uses its reserves to lend money, the reserves arenât destroyed. The money shows up in another bank, and the reserve amount is sent there. The overall amount of reserves or base money in the system is unchanged, but the system becomes slightly more levered, and has more consumer deposits and therefore more broad money. In other words, the money multiplier ratio (D-to-R, broad money to base money) increased from 4-to-3 to 5-to-3.</p>
<p>Any bank can increase or decrease its own amount of reserves by buying or selling assets, or making loans. However, those reserves get moved around to or from other banks rather than created or destroyed. Banks can, however, create or reduce the amount of deposits leveraged on those reserves, depending on how much risk it wants to take on and how many creditworthy opportunities it has to lend money for.</p>
<h3 id="example-2-the-fed-performs-qe-from-banks">Example 2) The Fed Performs QE from Banks</h3>
<p>This next example is a bit more realistic, with a more levered banking system. It involves the Fed performing quantitative easing on the banking system, meaning it creates new reserves to buy existing assets from the banks.</p>
<p>Iâll just show the beginning and end state here, and skip over the intermediate state:</p>
<p><img src="/assets/images/2020/m11/la18.png" alt="QE Example" /></p>
<h4 id="beginning-state-1"><em>Beginning State</em></h4>
<p>Sara and Mary are identical to each other in this example. For assets, they each have a House âHâ, a car âCâ, and $4,000 in cash deposits âDDDDâ at their banks. For liabilities, they also have a car loan âLâ and a mortgage loan âMâ owed to their respective banks.</p>
<p>The banks are also identical to each other in this example. They each have their $4,000 customer deposits âDDDDâ as liabilities owed to Mary and Sara respectively. For assets, they each have âRTTMLâ, meaning one reserve block, two Treasury blocks, one mortgage loan block, and one car loan block. The banks are rather highly levered, with lots of assets and liabilities relative to their sole reserve block.</p>
<p>The Fed is small, with just âRRâ in liabilities for their member bank reserve accounts, one for each, and âTTâ in assets.</p>
<p>The U.S. Treasury has âTTTTTTâ in liabilities, which are owned by the banks and the Fed.</p>
<p>There are 8 deposit blocks âDâ in the system, and 2 reserve blocks âRâ. So, the system money multiplier is levered 8-to-2, aka 4-to-1.</p>
<h4 id="ending-state-1"><em>Ending State</em></h4>
<p>In this example, the Federal Reserve realizes that both Maryâs bank and Saraâs bank have just one reserve block each. Assuming the banks are each required by regulations to have at least one reserve block, this means they canât really lend any more, and canât create more broad money. The Fed wants banks to be able to lend. So, the Fed decides to recapitalize the banking system by giving them plenty of excess reserve blocks. It canât, however, legally just give free money to banks; it has to take something in return.</p>
<p>The Fed creates four new reserve blocks out of thin air, and gives two to Maryâs bank and two to Saraâs bank. These new reserve blocks become liabilities of the Fed, and become assets for the banks. In return, the Fed takes one mortgage block and one Treasury block from each bank. The Fed therefore adds âTTMMâ to its assets and âRRRRâ to its liabilities.</p>
<p>The banks are now much-better capitalized, with plenty of excess reserves as assets, and fewer Treasuries and mortgages. If they want to loan money or buy more securities, they now have plenty of excess reserves to do so with. However, they havenât lent any more money yet, so the amount of deposits or broad money in the system remains unchanged. Underneath the surface, the banks are just less-leveraged, with plenty of reserves relative to deposit liabilities and overall assets.</p>
<p>Mary and Sara didnât notice anything from beginning to end in this example. They have the same assets and liabilities that they started with. They werenât even aware this happened.</p>
<p>The Fed is more leveraged now, with more assets and liabilities than it started with.</p>
<p>The U.S. Treasury didnât change on net, except that it now attributes ownership of 2 of its Treasury note liabilities to the Fed instead of to the private banks, since the banks each sold a Treasury note âTâ to the Fed.</p>
<p>There are still 8 deposit blocks âDâ in the system, but the number of reserve blocks âRâ increased from 2 to 6. So, the money multiplier in the system is now 8-to-6, aka 1.33-to-1. The amount of broad money hasnât changed, but the amount of base money grew, due to the Fedâs decision to buy bank assets with new reserves. The banking system has been recapitalized, and has a lot more lending power now.</p>
<p>This is why, although many people think QE by itself is inflationary on consumer prices, it generally isnât. The money isnât getting out to consumers like Mary and Sara yet; itâs just internal to the banking system. This QE process sets the long-term stage for inflation as an early foundation, by recapitalizing banks and therefore being âanti-deflationaryâ by preventing a bank collapse and ensuring they have plenty of lending capacity, but itâs not inflationary yet.</p>
<p>Inflation would come if Mary and Sara have a lot more deposit money chasing the same amount of goods and services, but neither Mary nor Sara have more deposit money than they started with, and thereâs no reason for anything to be inflationary. The amount of consumer deposits in the system hasnât changed.</p>
<h3 id="example-3-the-fed-performs-qe-from-non-banks"><strong>Example 3) The Fed Performs QE from Non-Banks</strong></h3>
<p>This third example starts with a simpler system again, very similar to Example 1. However, instead of having a car as an extra asset that she had in the first example, Sara has a Treasury note.</p>
<p>Sara decides to sell her Treasury note, but there arenât many buyers for it at the moment. So, the Federal Reserve steps in and performs QE to buy it from her. The result ends up slightly differently compared to the Fed buying a Treasury note from the banking system.</p>
<p><img src="/assets/images/2020/m11/la19.png" alt="Nonbank QE Example" /></p>
<h4 id="beginning-state-2"><em>Beginning State</em></h4>
<p>Everything begins similarly to Example 1, except Sara has a Treasury note instead of a car. There are 4 âDâ deposits in the total system, and 3 âRâ reserves to start.</p>
<p>Sara decides to sell her Treasury note, but neither Mary nor either bank particularly want to buy it.</p>
<p>So, the Fed decides to buy it. The Fed creates a new bank reserve âRâ out of thin air and gives it to Saraâs bank, and tells the bank to buy Saraâs Treasury note with a new deposit, and then to give the Fed the Treasury âTâ.</p>
<p>The Fed, therefore, bought Saraâs Treasury note with a brand new reserve block, using the bank as the intermediary (so Sara and the Fed never talked to each other; Sara sold the Treasury note to her bank for a deposit block âDâ, and her bank sold that Treasury note to the Fed, who bought it with a new reserve block âRâ).</p>
<h4 id="ending-state-2"><em>Ending State</em></h4>
<p>After the bank completes this task, Sara has the same net worth as she started the example with, but replaced her Treasury âTâ with an extra deposit âDâ. Her bank also has the same net worth as it started the example with, but grew a bit bigger, with an extra reserve block asset âRâ and an extra deposit block liability to Sara âDâ.</p>
<p>The Fed grew a bit more leveraged as well, with an additional Treasury asset âTâ and an additional reserve liability âRâ, which it lists as an asset of Saraâs bank.</p>
<p>The U.S. Treasury didnât change on net, except that it now recognizes Saraâs initial Treasury âTâ as owned by the Fed instead of Sara now, since the Fed bought it.</p>
<p>Whether this is stimulatory for the economy or not depends on what Sara wants to do with her extra cash. She had âDDDTâ and now she has âDDDDâ as her assets. Itâs still $4,000 but itâs a bit more liquid now. If the reason for her selling the Treasury was to raise more cash to do something big, like start a business or lend money to her friend to start a business, then it might be simulative. However, if she merely holds the money in an extra âDâ deposit rather than the Treasury âTâ, then sheâs not using the money any differently. It then becomes a question of what her bank does.</p>
<p>Saraâs bank now has an extra reserve asset block and an extra deposit block liability compared to the beginning state, meaning itâs a bit bigger and has more lending power. It could finance a corporate loan, or a consumer loan, which would be stimulative. Or, if it thinks the economy is too risky, or if none of its creditworthy corporate or consumer clients are asking for a loan, it might just sit on its safe âRRTTTâ assets and do nothing. In that case, this example wouldnât be stimulative.</p>
<p>There are now 5 âDâ deposits in the system compared to the beginning state that only had 4. In addition, there are 4 âRâ reserve blocks in the system compared to the beginning state that only had 3.</p>
<p>So, thereâs more liquidity in the system, with an increase in both base money and broad money. However, none of that broad money moved yet, and is just sitting there with Sara and her bank. Broad money velocity is low, in other words. There is more inflationary potential in the system, due to there being more broad money and reserves, but no consumer price inflation yet. Sara isnât any richer; just slightly more liquid.</p>
<p>In this example, the Fed directly increased the amount of broad money in the system without banks doing any private lending, and without the federal government doing any spending, but it remains unclear if it will be impactful or not (subject to what Sara and/or her bank do with their extra liquidity). And even if it was impactful, the Fed wouldnât be able to repeat it a second time, because neither Mary nor Sara (the two private non-bank entities) have any more Treasury notes to sell to the Fed.</p>
<p>If anything, itâs likely to be somewhat inflationary on asset prices, because Sara is flush with cash, and perhaps more willing to buy stocks, or buy more Treasuries, etc. Sheâs a saver and this might not make her spend more, but it might shift how she invests, with her extra liquidity.</p>
<h3 id="example-4-nonbank-financed-helicopter-money"><strong>Example 4) Nonbank-Financed Helicopter Money</strong></h3>
<p>The first three example were separate cases, each meant to illustrate a different scenario.</p>
<p>These final three examples, Example 4, Example 5, and Example 6, however, build on top of it each other to show what happens when the U.S. Treasury gets involved with deficit spending, with differences depending on who finances that spending by buying the Treasury debt.</p>
<p>Example 4 begins with a relatively unlevered system. However, the economy is in a recession, and Mary just lost her job and only has a little bit of money in her bank account and is making her frustration known, so Congress authorizes the U.S. Treasury to send everyone $1,000 in stimulus checks, right to their bank accounts. This is known in economics as âhelicopter moneyâ, referring to a thought experiment of dropping money out of helicopters on consumers. The Treasury finances this by issuing Treasury bonds, which Sara, who has plenty of money and hasnât lost her job, buys.</p>
<p><img src="/assets/images/2020/m11/la20.png" alt="Helicopter Money Example" /></p>
<h4 id="beginning-state-3"><em>Beginning State</em></h4>
<p>Mary has a car âCâ and a deposit âDâ as assets, and a car loan âLâ as a liability. Maryâs bank has a reserve block âRâ and Maryâs car loan âLâ as assets, and has Maryâs deposit âDâ as its liability.</p>
<p>Sara has three blocks of deposits âDDDâ as her assets, and no liabilities. Saraâs bank has a blend of excess reserves and some Treasuries as assets âRRTTâ, and has Saraâs three deposit blocks âDDDâ as its liabilities.</p>
<p>The Fed holds the banksâ 3 total system reserve blocks as its liabilities, and holds 3 Treasuries as its assets.</p>
<p>The U.S. Treasury has 5 Treasury notes outstanding as liabilities, which are owned by the Fed and Saraâs bank.</p>
<p>Total system deposits are 4D = $4,000, and total system reserves are 3R = $3,000.</p>
<h4 id="intermediate-state-not-shown"><em>Intermediate State (not shown)</em></h4>
<p>Although it is the originator of currency, the U.S. Federal Government legally has to finance its spending by receiving taxes or issuing Treasury debt to settle its account.</p>
<p>So, the U.S. Treasury sends a $1,000 deposit âDâ block each to both Mary and Sara, deposited in their bank accounts. Both Mary and Sara are happy, because their net worth goes up by $1,000 each. Their banks get money deposited into them, and havenât loaned any out yet, so they just keep this new cash at their Fed account as new reserves.</p>
<p>However, this is just a brief intermediate state. The Treasury now issues new Treasury note liabilities âTTâ to pay for the expenditures it just made. Sara then decides to use two of her deposit blocks âDDâ to buy those two Treasury securities âTTâ, since they are yielding slightly higher rates than her bank deposit account yields.</p>
<p>If we imagine it happening simultaneously, what happened is that the U.S. Treasury extracted two deposit blocks from Sara (and therefore extracted two reserve blocks from Saraâs bank, as Saraâs bank settled the transfer with the U.S. Treasury), and the U.S. Treasury gave Sara two Treasury note blocks as assets in return. At the same time, the U.S. Treasury gave both Mary and Sara one deposit block each, and therefore gives one reserve block to Maryâs bank, and one reserve block to Saraâs bank, to settle the transfers.</p>
<h4 id="ending-state-3"><em>Ending State</em></h4>
<p>By the end of the transfers, both Mary and Sara are $1,000 richer than they started. Maryâs assets simply went from âCDâ to âCDDâ as she gained a deposit block. Saraâs assets went from âDDDâ to âDDTTâ, because she gained a deposit block but used two deposit blocks to buy two Treasury notes.</p>
<p>Maryâs bank is slightly bigger than it began, because Mary received a deposit block âDâ and her bank was credited with a reserve block âRâ to settle it (but also owes an extra liability âDâ owed to Mary), and Mary hasnât spent it yet. So, Maryâs bank has the same net worth (both its assets and liabilities increased by the same amount), but itâs overall combined assets and liabilities are bigger, and it has more lending power now because of that.</p>
<p>Saraâs bank is slightly smaller than it began, because although Sara and her bank received a deposit and reserve block respectively, Sara sent two deposit blocks to the Treasury to receive the Treasury notes, and therefore Saraâs bank sent two reserve blocks to the Treasury, which were then given back out, one to Maryâs bank and one back to Saraâs bank. Saraâs bank has the same net worth, but is simply smaller, as both assets and liabilities decreased, and its lending power is decreased.</p>
<p>The Fed is unchanged, except that it updated its book-keeping to attribute one of the reserve blocks âRâ originally attributed to Saraâs bank, to being attributed to Maryâs bank instead. Its overall amount of Treasury note assets and reserve liabilities remains unchanged.</p>
<p>The U.S. Treasury is more leveraged, with an extra âTTâ in debt liabilities outstanding, owed to Sara.</p>
<p>Total system deposits are 4D = $4,000, and total system reserves are 3R = $3,000, meaning that neither the total amount of deposits or reserves changed in the system from the beginning state to the end state. Deposits and reserves were just moved around a bit within the system.</p>
<h3 id="example-5-fed-financed-helicopter-money"><strong>Example 5) Fed-Financed Helicopter Money</strong></h3>
<p>Example 5 starts exactly where Example 4 left off, and builds from there.</p>
<p>Both Mary and Sara are happy because they got some extra money in the previous example. However, Sara is just prudently saving her money due to uncertainty about the economy, and Mary still doesnât have a job so she is also just saving her money, and their favorite restaurants and vacation spots are closed due a virus pandemic anyway.</p>
<p>Some politicians want to give $1,000 to everyone every month for the next year, due to so many displaced workers like Mary having so little money and with no jobs. Other politicians say, âno, thatâs too much federal debt, let the economy try to heal itself.â The politicians argue for a couple months and then eventually compromise and decide to send everyone $1,000 one more time, to see if that helps. So, Congress authorizes the U.S. Treasury to send out another $1,000 to everyone.</p>
<p>This time, instead of Sara buying the new Treasury liabilities with her existing deposits, the Fed buys the new Treasury liabilities with new reserves.</p>
<p><img src="/assets/images/2020/m11/la21.png" alt="Helicopter Money + QE" /></p>
<h4 id="beginning-state-4"><em>Beginning State</em></h4>
<p>Sara already owns a lot of Treasury notes and sees that the U.S. Treasury will become even more indebted after it sends out all this money without raising taxes, so she doesnât want to buy any more Treasury notes. So, how will the U.S. Treasury finance this second round of helicopter money?</p>
<p>Well, because there is a lot of new Treasury note issuance but nobody desiring to buy it at current prices, the Treasury note market suddenly becomes illiquid, and prices start to fall (meaning yields start to rise). Sara and her bank both get nervous, because they own a lot of Treasury notes.</p>
<p>The Treasury note market briefly looks like it did in March 2020: totally illiquid, with yields extremely volatile.</p>
<p>However, this problem doesnât last long, because the Fed says, âItâs fine everyone! Weâll buy the extra Treasury note issuance. Relax.â</p>
<p>So, the Fed creates two new bank reserve blocks âRRâ, and gives them to the Treasury in exchange for the new Treasury debt liabilities, âTTâ, which become the Fedâs assets. Technically, the Fed canât legally buy directly from the Treasury, so they agree to transfer the securities through one of the banks as a brief pass-through entity.</p>
<p>The U.S. Treasury then sends a $1,000 deposit âDâ each to Mary and Sara, and settles this by sending a reserve block âRâ to each of Maryâs and Saraâs banks.</p>
<h4 id="ending-state-4"><em>Ending State</em></h4>
<p>Mary and Sara are both $1,000 richer, again. They each have a new $1,000 deposit âDâ.</p>
<p>Mary and Saraâs banks are both bigger, although their net worth didnât change. They each have an extra $1,000 reserve block âRâ, but also each have a new $1,000 liability block to their customer deposits âDâ.</p>
<p>The Fed is bigger and more levered, with $2,000 more assets in the form of Treasuries âTTâ, and $2,000 more liabilities in the form of reserves âRRâ that they hold for the banks.</p>
<p>The U.S. Treasury is bigger and more levered, with $2,000 âTTâ in more debt liabilities outstanding.</p>
<p>System-wide deposits (broad money) increased over the beginning state, from 4D = $4,000 to 6D = $6,000. System-wide reserves (base money) also increased over the beginning state, from 3R = $3,000 to 5R = $5,000.</p>
<p>This was outright money-printing. The amount of broad money and base money in the system went up by a lot. Mary and Sara are richer, and their banks are bigger. Money was injected into the system, without being extracted anywhere from the system, because the deficit spending was financed by the Fed creating new bank reserves to buy the Treasury notes.</p>
<p>The Treasury and Fed can perform this repeatedly if they want, any number of times, although they both know that if they do it too much, it could cause consumer price inflation.</p>
<p>Whether it is inflationary for consumer prices or not, however, depends on whether Mary and Sara still have confidence in the value of their deposits, and whether they go and spend them or not. Itâs also potentially inflationary for asset prices; Sara in particular is flush with assets and more likely to put some money to work in stocks other gold or other assets than she was before.</p>
<h3 id="example-6-bank-financed-helicopter-money"><strong>Example 6) Bank-Financed Helicopter Money</strong></h3>
<p>Example 6 starts exactly where Example 5 left off. Both Mary and Sara are happy because they got some extra money in the previous example, again.</p>
<p>The pandemic eased a bit, and Mary got a new job, but realizes she needs to keep more cash on hand in case she loses her job again in the future. She learned a lesson about saving, in other words.</p>
<p>Sara was already a saver, and hasnât been spending extra money yet either. Sara, however, is considering going on a vacation or buying a car, now that sheâs feeling a bit more confident with so much cash. Sheâs also not sure about the value of her money, as she watches the broad money supply expanding so rapidly due to these helicopter checks that everyone is receiving. Car prices are starting to go up, probably due to so many people receiving stimulus checks, so there seems little reason to wait.</p>
<p>However, because the economy is still sluggish, with many people saving more than they used to, Congress decides to do yet another round of $1,000 helicopter checks to everyone, and issue $2,000 in new Treasury note liabilities âTTâ to pay for it. This is it, the final stimulus round!</p>
<p>Fortunately for the U.S. Treasury, the banking system has tons of excess reserves due to their previous round of helicopter spending that the Fed bought with new reserves, and so this time, the banks each agree to buy one Treasury note âTâ with one of their excess reserve blocks. (In fact, the banks donât have much of a choice, because as primary dealers they âhaveâ to buy Treasury notes at auction if they have enough liquidity to do so, and if neither Mary nor Sara nor the Fed agree to buy the Treasury notes from them, they get stuck holding the Treasury notes.)</p>
<p><img src="/assets/images/2020/m11/la22.png" alt="Helicopter Money with Bank Financing" /></p>
<h4 id="beginning-state-5"><em>Beginning State</em></h4>
<p>System-wide deposits are 6D = $6,000. System-wide reserves are 5R = $5,000.</p>
<p>Hereâs what happens if we imagine the process happening simultaneously. The U.S. Treasury sends Mary and Sara each a $1,000 deposit âDâ block, and sends their banks each a $1,000 reserve âRâ block to settle it. The U.S. Treasury then issues two new Treasury note liabilities âTTâ to pay for it. The banks each send a reserve block âRâ to the U.S. Treasury in exchange for one of those Treasury notes âTâ.</p>
<h4 id="ending-state-5"><em>Ending State</em></h4>
<p>Mary and Sara are, yet again, $1,000 richer. They each have yet another deposit block âDâ added to their assets.</p>
<p>Their banks have the same amount of reserves they started with, because they each received a reserve block âRâ from the U.S. Treasuryâs helicopter deposits to their customers, but since each bank also sent a reserve block âRâ back to the U.S. Treasury to pay for the stimulus, they each ultimately received a Treasury note âTâ as an asset instead. They still have the same amount of reserve blocks that they started with, but they each have an extra asset âTâ, and they each have an extra deposit liability âDâ for their customers. So, they are a bit more levered overall.</p>
<p>The Fed didnât change at all from the beginning of this example, although it did some book-keeping for the reserves moving around and ending back in the same place.</p>
<p>The U.S. Treasury is $2,000 or âTTâ more in debt than it started the example with.</p>
<p>System-wide deposits increased by $2,000 or âDDâ from 6D = $6,000 to 8D = $8,000. System-wide reserves are still 5R = $5,000. So, the money multiplier increased a bit, from 6-to-5 to 8-to-5. Broad money increased, but base money remained the same.</p>
<p>Will it be inflationary? It depends on what Mary and Sara do from here, but most likely at this point, yes. Sara now has tons of cash and is concerned about the value of that cash, so she decides to spend money on a vacation and buy that new car, or buy stocks or gold or real estate, or something. Even Mary decides to eat out at restaurants more, now that she has more cash than usual. Other people seem to be doing the same; prices of things are inching up each month.</p>
<p>There is now $8,000 in total deposits (broad money) in the system, compared to the start of Example 4 where there was only $4,000 in deposits. However, the amount of goods and service in the economy have not doubled. So, if Mary and Sara and others decide to start spending their money, it could indeed result in a lot of money chasing a limited supply of goods and services, and therefore could push up consumer prices and be inflationary.</p>
<p>In response to high inflation, the Fedâs normal tool would be to raise interest rates. However, with U.S. Treasury debt so high at that point, the Fedâs ability to raise interest rates would be limited, since it would result in an acute fiscal crisis as rising Treasury debt interest eats up a large part of the fiscal budget. So, either the Fed would have to let inflation run hot and inflate away part of the debt and keep creating Reserve blocks to buy new Treasury notes as needed to keep Treasury security yields low (which they did back in the 1940âs), or the U.S. Treasury would have to restructure/default on the central bank portion of U.S. Treasury debt.</p>
<p>So, the Treasury+Fed combo has all the power to boost the broad money supply enough to cause a rising trend shift in inflation, but when they do with such a highly-leveraged U.S. Treasury, they face some consequences in their ability to constrain it.</p>
<h3 id="example-summaries-and-findings"><strong>Example Summaries and Findings</strong></h3>
<p>If we analyze all of the examples, we see a few observations:</p>
<p>-Banks can create new deposits and increase the the amount of deposits (broad money) in the system by lending. Lending creates deposits. This lending doesnât change the amount of base money (reserves) in the system, but it moves those reserves around from one bank to another, and levers those reserves up. This is the money multiplier ratio, the ratio of broad money to reserves in these simplified examples. Although the banks can create new deposits and increase broad money by lending, it is not âmoney printingâ because the banks are simply making decisions regarding how much to lever themselves up relative to their cash reserve assets, and they are constrained by various regulatory standards for how much leverage they can have.</p>
<p>-The Fed alone has the power to create new bank reserves, and to therefore increase the amount of bank reserves in the system (base money) or more broadly, the total amount of water in the three-bucket system analogy. However, if it buys assets from banks, it doesnât directly lead to more deposits (broad money) being in the system. It de-levers banks and gives them more capacity to lend and create new deposits (broad money), but whether they will or not is up to them. On the other hand, if it buys assets from non-bank entities like Sara (using the banking system as its intermediary), it can slightly increase deposits (broad money) in the system, but only to a limited extent, based on limited amounts of non-bank entities holdingsâ of Treasuries that they can sell. It is, in this sense, very limited âmoney printingâ.</p>
<p>-On behalf of Congress, the U.S. Treasury can give more deposits to somewhere in the system, but deposits also get extracted back out of the system when non-bank entities like Sara buy the Treasuries that are used to fund this expenditure. So, it doesnât necessarily create new deposits or new reserves. This is what deflationists often refer to as the âcrowding out effectâ, meaning that the U.S. Treasury can extract capital from somewhere in the economy and inject it somewhere else in the economy, if it runs large deficits and builds up federal debt, and it displaces nonbank capital that could have been used for something else. This is not âmoney printingâ since it just moves things around and levers up the Treasury.</p>
<p>-However, if the Treasury and Fed work together, they can rapidly increase both the deposits (broad money), and bank reserves in the system (base money), without extracting deposits from anywhere in the system. In this process, the Treasury injects money into the economy by spending, which creates new deposits, but instead of that money being extracted from deposits somewhere else in the economy, the Fed finances those new Treasuries with newly-created bank reserves out of thin air, and thus levers itself with additional assets (the new Treasuries) and additional liabilities (the new reserves attributed to the banking system). It doesnât matter if banks lend or not; the Treasury+Fed combo goes around the bank lending channel by just giving people and businesses more deposits (broad money). This outright increases the net worth of Mary and Sara in the examples, and increases the size of their banks including broad money supply and bank reserves (but the banksâ net worth remains unchanged), and levers up both the Fed and the U.S. Treasury. There is no limit to the amount they can do this, other than the fact that it would eventually be inflationary if done too much and too rapidly relative to the amount of goods and services and productive capacity in the economy. This is outright âmoney printingâ, although there are some checks and balances since fiscal changes have to be passed by Congress and signed into law, rather than done unilaterally by the Fed.</p>
<p>-Additionally, if the U.S. Treasury injects money into the economy with large deficits and the Treasuries to finance it are bought by a well-capitalized banking system (usually as a result of the Fed already having capitalized banks by creating excess reserves in the recent past), it also increases the deposits (broad money) and levers up the money multiplier. This can be done quite a bit if banks start with excess reserves, because every time the federal government injects more money into the system, it creates more bank deposits, which replenishes the reserves that the bank spent buying Treasuries, and thus gives the banks more ability to buy additional Treasuries. This is mostly âmoney printingâ, although to maintain leverage ratios, the banks need to start with plenty of excess reserves.</p>
<p>-If there is a lot of broad money added to the system, with both Mary and Sara confident to spend, it could very well be inflationary. Plus, now that Mary and Sara are richer than they started, they might feel more confident to take out a mortgage loan or business loan from their bank to buy a house or start a business, and their banks are more willing to lend it now because Mary and Sara both have plenty of net worth and creditworthiness. This could very well be inflationary.</p>
<p>-There are proposals for central bank digital currencies, which if enacted may allow the Fed to inject money to consumer deposits without going through Congress. This would likely require an overhaul of the Federal Reserve Act, and would substantially change the nature of the system. Some folks argue that this would be necessary for inflation to happen, but inflation can already happen within the existing framework through the combination of fiscal deficits and QE monetization of those deficits. The current framework requires Congress to go along with it rather than performed unilaterally by the Fed, and thus has checks and balances in the system.</p>
<h2 id="implications-focus-on-broad-money">Implications: Focus on Broad Money</h2>
<p>Itâs fashionable to debate lately whether QE is inflationary or not, and whether central banks have run amok.</p>
<p>However, for more fruitful results as it relates to analyzing inflation vs deflation and the associated impacts on various asset classes, investors should focus on <strong>fiscal spending</strong>, especially when it is combined with monetary financing to pay for it. Are major fiscal deficits happening or no? How big are the deficits, relative to the deflationary backdrop? Who are the deficits targeting? Who is financing the deficits by accumulating the Treasury securities?</p>
<p>And then specifically, look at what the <strong>broad money</strong> supply is doing. Is it going up, or no? At what rate?</p>
<p>Banks are already well-capitalized. The big non-fiscal QE for bank recapitalization was done back in 2008-2014. Now, with massive Treasury debt in the system and interest rates at zero, fiscal authorities find themselves spending more, and running larger deficits, with the Fed and banking system buying the majority of their Treasury note issuance.</p>
<p>We have division of fiscal and monetary powers, and only when the powers combine (like in the 1940âs and again in 2020, where the Treasury runs massive deficits and those Treasury notes are accumulated by the Fed and banking system), does it become outright money-printing. It doesnât require any change to existing laws for them to do that; they use banks as pass-through entities and other structures as needed to do what they do.</p>
<p>QE alone, where the Fed buys existing assets mostly from banks, is simply anti-deflationary, to recapitalize a banking system and fill it up with excess reserves. Itâs not outright inflationary because it doesnât directly increase the broad money supply. If the Fed buys existing assets from non-banks, it only increases broad money a bit, around the margins.</p>
<p>Meanwhile, large fiscal deficits funded by QE (the central banks monetizing deficit spending by buying any of the excess Treasuries over the real demand for them), actually is pro-inflationary, because it gets money directly into the economy, into the broad money supply, and can be done with no limit except for inflation that it would eventually cause when done to excess.</p>
<p>Whether it takes the role of unfunded tax cuts or unfunded fiscal spending, if fiscal spending combined with monetary financing results in higher personal income for consumers like Mary and Sara, and more broad money in the system, itâs an inflationary force. It then becomes a question of how big it is, how persistent it is, and what portion of the income spectrum it is targeting.</p>
<p>Given how highly-leveraged the system still is, and how reluctant banks are to lend, for the next several years as we head deeper into the 2020âs and eventually move past the pandemic, navigating the âinflation vs deflationâ debate is going to mostly be a matter of watching how large or small the federal deficits are, and observing who funds those deficits (i.e. the Fed and banking system), and to see if the broad money supply goes up more quickly than the deflationary forces that exist.</p>
<hr />
<h1 id="the-intelligent-bitcoin-miner-part-i"><a href="https://www.aniccaresearch.tech/blog/the-intelligent-bitcoin-miner-part-i">The Intelligent Bitcoin Miner, Part I.</a></h1>
<h3 id="by-leo-zhang-jack-koehler-and-david-cai---general-mining-research">By <a href="https://twitter.com/leorzhang">Leo Zhang</a>, <a href="https://www.linkedin.com/in/jack-koehler-5933bb44/">Jack Koehler</a>, and <a href="https://twitter.com/David_3Chez">David Cai - general mining Research</a></h3>
<h3 id="posted-november-22-2020-1">Posted November 22, 2020</h3>
<p><em>This article is a collaboration with</em> <a href="https://www.gmr.xyz"><em>General Mining Research</em></a><em>, a Singapore based hashpower-focused company, who invests and trades hashpower of cryptocurrency networks, as well as derivatives. GMR supports our work by providing proprietary machine market data, as well as hashrate growth predictions over the next few months based on sales projections aggregated from manufacturers.</em></p>
<blockquote>
<p><em>âYou will be much more in control, if you realize how much you are not in control.â</em></p>
<p><em>â Benjamin Graham,</em><a href="https://www.goodreads.com/work/quotes/102974"><em>The Intelligent Investor</em></a></p>
</blockquote>
<p>The valuation of hashpower is one of the oldest and most arcane topics in the mining world. Several prior academic papers and industry research have explored the economic and game theoretic aspects of proof-of-work, but most of them oversimplify or make unrealistic assumptions about how the hashpower market works in practice. </p>
<p>In this paper, we illustrate that operating hashpower is akin to managing a portfolio, and the difficulties of reflecting the aspects of portfolio in the pricing of hashpower. We walk through how the popular pricing mechanism works, and the flaws of the current valuation heuristics. We parametrize a hashpower portfolio, and show how the outcome changes as we test a broad range of assumptions. As a coda, we argue that the importance of valuation framework is more than just a theoretical exercise, but a foundational step in developing a proper risk management practice for the hashpower industry.</p>
<p><strong>The Fair Value of Hashpower</strong></p>
<p>Why run a mining operation when you can purchase coins on the open market?</p>
<p>This is the most common reaction when someone first hears about mining. Itâs no secret that it was the outsize financial return that spurred the initial interest in mining and accelerated its growth into a billion-dollar behemoth. A successful miner is able to produce Bitcoin at a cost lower than the spot price, and can accordingly build a position at a steep discount compared to purchasing on the open market. </p>
<p>However, the low cost-of-production is by no means permanent. Over the years, competition has been heating up, and the market cycle is becoming too obscure to predict. The âdiscountâ that the miners have gotten so spoiled with can deteriorate into painful loss any moment. In todayâs market, is mining still more profitable than purchasing on the open market? Given the number of variables involved, itâs futile to attempt at a timeless generalization. However, we can break down the market cycle into several archetypal phases, and observe how the profitability of common mining and trading strategies evolve in each phase. </p>
<p>Weâll begin with 2018, a miserable year for most miners. In the <a href="https://www.aniccaresearch.tech/blog/the-alchemy-of-hashpower-part-ii">previous article</a>, we describe the first three quarters as the <a href="https://www.aniccaresearch.tech/blog/the-alchemy-of-hashpower-part-ii"><strong>Inventory Flush</strong></a> phase of a mining cycle, where coin price drops while network hashpower continues to increase. </p>
<p>Hypothetically, a miner that purchased 10 Ph/s of Antminer S9 at the beginning of the year would have spent a total of $1.85MM spent on 690 units given the unit price at the time of $2,675 per machine. Assuming the machines linearly depreciated over 24 months, and the minerâs all-in electricity cost was $0.0507 per KwH (industry-wide average rate in China, courtesy of GMR) , we can backtest the performances of three common strategies:Â </p>
<ol>
<li><strong>Moderate</strong>: the miner sells enough coins to cover the daily power bill ($941.38) as well as the daily depreciation ($2,563.54). If the mining revenue of the day is less than the total expense ($3,709.01), then only sell enough to cover the power bill. Everything else remains in BTC position. </li>
<li><strong>Long BTC</strong>: the miner sells just enough to cover the daily power bill ($941.38), leaving all remaining coins in a long position. </li>
<li><strong>Sell Daily</strong>: the miner immediately sells all coins into USD. The only goal is to arbitrage the difference between spot price and cost-of-production. Worth noting that this strategy is not tax efficient and incurs constant market slippage. For modeling simplicity we do not take these factors into consideration. </li>
</ol>
<p>Next, we compare the performances of the mining strategies against open market purchases. We consider two simple strategies:</p>
<ol>
<li><strong>Upfront Purchase</strong>: On the same day as the mining valuation period starts (1/1/2018), buy coins whose notional is equivalent to the total capex + yearly opex ($1,845,750 + $941.38*365) at the spot of that day ($13,465), and <em>hodl</em> till the end of the valuation period. For the sake of simplicity, we will not factor in the significant amount of slippage incurred by purchasing this quantity of bitcoin. </li>
<li><strong>Dollar Cost Averaging</strong>: Spend the same notional as mining capex + yearly opex, but purchase a uniform notional ($2.26MM / 365) of coins everyday throughout the valuation period.</li>
</ol>
<p><img src="/assets/images/2020/m11/lz1.png" alt="Screen Shot 2020-11-22 at 8.02.01 PM.png" /></p>
<p>Over the course of the year, daily cost-of-production per coin ($3,709.01 expense divided by the number of coins mined on that day) surpassed market price around July, and kept climbing in the second half of the year, rendering the miner unprofitable for an extended period of time. As we can see from the result, after a year of bear market, the <strong>Sell Daily</strong> strategy lost the least amount, and the <strong>Long BTC</strong> strategy took the biggest hit. </p>
<p>This is because <strong>Sell Daily</strong> is the only strategy that has no unrealized <em>PnL</em>. Every other strategy has long positions to various extent. During the <a href="https://www.aniccaresearch.tech/blog/the-alchemy-of-hashpower-part-ii"><strong>Inventory Flush</strong></a>phase where mining revenue continuously decreases, the unrealized position is very likely to result in a loss at the end of the valuation period. </p>
<p>In practice, sensible miners would have turned off the machines after mining at loss for such a long period of time. If the miner had shut down the operation at the end of June, their loss would have been a lot smaller. If the miner were using the <strong>Sell Daily</strong> strategy, the miner would even have made a profit:</p>
<p><img src="/assets/images/2020/m11/lz2.png" alt="Screen Shot 2020-11-22 at 8.07.57 PM.png" /></p>
<p>The <strong>Moderate</strong> and <strong>Long BTC</strong> strategies would have remained unprofitable, albeit to a lesser extent than open market purchases. The loss primarily stems from capital expenditure of the machines. The miner bought them at $1.84MM, but could only resell them for $738K (not including transaction slippage, transportation, and tax). The gains from the Bitcoin mined did not make up for the hardware depreciation. </p>
<p>In both examples, <strong>Sell Daily</strong> appears to be the safest strategy. What happens in an opposite phase in the market cycle, where mining revenue continuously increases?</p>
<p>After the <a href="https://www.aniccaresearch.tech/blog/the-alchemy-of-hashpower-part-ii"><strong>Shakeout</strong></a> phase at the end of 2018, the first half of 2019 turned out to be quite festive for miners. Performing the same analysis but from 1/1/19 to 6/30/19, we can see that <strong>Sell Daily</strong> would have been the least profitable, whereas the aggressive strategies, <strong>Long BTC</strong> and <strong>Upfront Purchase</strong>, would have done more than 50% better than the defensive strategy.</p>
<p><img src="/assets/images/2020/m11/lz3.png" alt="*Life Cycle adjusted to 12 months at the beginning of 2019." /></p>
<p><em>*Life Cycle adjusted to 12 months at the beginning of 2019.</em></p>
<p>Itâs easy to identify the winning strategy with the benefit of hindsight. It takes conviction and deep understanding of the macro conditions to adopt the aggressive strategies when the overall market has been depressed for a while. This especially the case for <strong>Upfront Purchase</strong>, which requires deploying all the capital on day one. </p>
<p>Mid-2019 was also a transition period where new generation machines became available. Itâs common for miners to sell old machines to rotate into more efficient models. In this example, the miners could actually sell the machines at prices higher than their purchase price thanks to the raging price rally. </p>
<p>Hypothetically, if the miner sold all 690 units of Antminer and used the $271k proceeds to purchase new Whatsminer M20 for the second half of the year: Â </p>
<p><img src="/assets/images/2020/m11/lz4.png" alt="Screen Shot 2020-11-22 at 8.14.32 PM.png" /></p>
<p>For the entire year of 2019, the miner wouldâve made:</p>
<p><img src="/assets/images/2020/m11/lz5.png" alt="Screen Shot 2020-11-22 at 8.15.37 PM.png" /></p>
<p>Whereas if the miner hadnât rotated machines, and continued to mine with Antminer S9 for the entire year, they would have left a lot of money on the table:</p>
<p><img src="/assets/images/2020/m11/lz6.png" alt="Screen Shot 2020-11-22 at 8.16.07 PM.png" /></p>
<p>In practice, miners are not tied to a specific <em>modus operandi</em> for the entire mining period. They have the flexibility to change the strategy whenever they think the market trend is shifting. In addition, they can complement mining with trading strategies, or lend out the coins to enhance the yields on the inventory, for instance, the miner can sell and capture profits on days mining profit exceeds cost-of-production, and buy coins on open market on days mining profit is lower than cost-of-production. Using the right combination of strategies during different stages of the mining cycle has a significant impact on the outcome. <strong>The purpose of this exercise is not to come up with a generalized winning strategy, or to prove mining is strictly better than purchasing coins, but to illustrate that managing a mining operation is essentially managing a portfolio.</strong></p>
<p>These represent the simplest and most common mining strategies. A lazy miner who only uses one simple strategy throughout all market cycles will extract a different amount of value from hashpower compared to a miner who actively employs multiple strategies. There is an infinite amount of hashpower management strategies, but the manufacturer is going to charge the same price for the machine regardless of the buyerâs strategy. Though price is a realized data point, value depends on the user. <strong>Ideally, the price of the machines should represent an average of the distribution of the values of all available strategies, but that is not possible.</strong> So how does the hashpower industry price machines? What does the price of hashpower represent exactly? More importantly, how should miners value hashpower in a way that fits their own circumstances best?</p>
<p><strong>Hashpower Pricing Heuristics </strong></p>
<p>In todayâs market, the pricing of hashpower is dominated by hardware manufacturers such as Bitmain, MicroBT, and Canaan. They are the only supplier of new hardware, they have full control over the initial issuance of machines that produce hashpower. The manufacturersâ first priority is to cover their expenses, which has less to do with the cryptocurrency market and more with <a href="https://www.aniccaresearch.tech/blog/the-alchemy-of-hashpower-part-i">supply chain management</a>. The sale price of their product can be adjusted according to market demand, provided it guarantees a certain margin over its cost of production. Sometimes manufacturers artificially suppress the pricing to outsell their competitors. <strong>In short, manufacturersâ pricing does not represent the theoretical fair value of hashpower. It is mixed with business decisions that reflect the state of their own companies. </strong></p>
<p>In <a href="https://www.aniccaresearch.tech/blog/the-alchemy-of-hashpower-part-i">part 1 of Alchemy of Hashpower</a>, we discussed that the most popular metric for hashpower pricing is <em>static-days-to-breakeven (DBE)</em>. It measures how many days it takes to break even on the machine purchase given the current snapshot price, difficulty, fee, and all-in opex. Every miner has a different <em>DBE</em> on the same machine because every miner runs operations differently. Miners calculate their <em>DBE</em> based on their own all-in cost per KwH and capacity. Manufacturers cannot take all minersâ costs into consideration, so the starting point of their <em>DBE</em> is always a market-wide average all-in cost. This figure is a very rough estimate, since the necessary data is extremely challenging to collect and underlying conditions are constantly changing. Miners with different capacity and cost structure come and go. <strong>Manufacturers do this exercise with their best guess on all-in cost, and set the price of the machines based on a reasonable range of the <em>DBE</em>.</strong></p>
<p>But what is the industry-wide all-in cost that they use as the input? We can reverse engineer it with historical machine price data. </p>
<p>Using the <a href="https://www.investopedia.com/terms/d/dcf.asp">Discounted Cash Flow</a> method, we can backtest historical machine prices to find the underlying assumptions when the manufacturers priced the machines. For example, the retail price for an Antminer S9 in January 2018 was $2,675. </p>
<p>Assuming an Antminer S9 life cycle of 24 months, we can map out the historical revenue of a single machine:</p>
<p><img src="/assets/images/2020/m11/lz7.png" alt="Screen Shot 2020-11-22 at 8.19.16 PM.png" /></p>
<p>Next, we reverse-engineer an all-in cost such that the sum of all the present values of each dayâs free cash flow equals the purchase price. Assuming an annualized <a href="https://www.investopedia.com/terms/w/wacc.asp">weighted average cost-of-capital (WACC)</a> of 12.5%, we have:</p>
<p><img src="/assets/images/2020/m11/lz8.png" alt="Screen Shot 2020-11-22 at 8.19.36 PM.png" /></p>
<p>In order to achieve $1.57 daily expense, the all-in electricity cost for an S9 needs to be $1.57 / 24 / 1.365 = $0.048 per KwH. This means that unless the miner had access to $0.048 per KwH all-in cost or lower, the miner wouldâve purchased the machine at a premium. The result above is calculated using Strategy 3, <strong>Sell Daily</strong>. Replicating the analysis with other strategies, Strategy 1 <strong>Moderate</strong> requires $0.017 per KwH all-in cost, and Strategy 2 <strong>Long BTC</strong> requires a $0.01 per KwH all-in cost. This means that in practice the actual âbreakevenâ all-in rate was within the range of $0.01-$0.048 per KwH.</p>
<p>This is drastically lower than the rate available to most miners at the beginning of 2018. Intuitively that makes sense. At that time the Bitcoin price had just reached all-time-high, the network difficulty was just beginning to catch-up, and S9 was the best machine on the market at that time. The ultimate determinant of price is still the supply and demand.</p>
<p>Applying the same method to machine prices at other points in time, the table below would be the âbreakevenâ all-in cost for miners. Here the all-in cost is the mean of all three strategies:</p>
<p><img src="/assets/images/2020/m11/lz9.png" alt="Screen Shot 2020-11-22 at 8.21.31 PM.png" /></p>
<p>From a different perspective, if the industry-wide all-in cost was $0.0507 per KwH, what would be the fair value of the machines at the time? Again, the Fair Price here is the mean of all three strategies:</p>
<p><img src="/assets/images/2020/m11/lz10.png" alt="*Premium/ Discount is Machine Price over Fair Value (Data source: hashrateindex.com)" /></p>
<p><em>*Premium/ Discount is Machine Price over Fair Value__(Data source: hashrateindex.com)</em></p>
<p>Note that this analysis does not take the changes in industry-wide average rate or WACC into calculation, since the precise industry-wide rate and WACC are difficult to estimate.</p>
<p>The point of this analysis is not to find the absolute fair value. As discussed, the fair value is not the same for every miner due to the different operating expenses as well as different strategies. However, even with an assumed industry-wide average rate, we can show how wildly inefficient the machine pricing is. <strong>During the bull market the manufacturers significantly overpriced the machines, and during the down markets the manufacturers were forced to liquidate the machines at a discount.</strong> This is aligned with empirical evidence we see in the mining market. When price rallies fast, the machine prices sometimes go up faster than the coin price. This behavior diverges from fundamentals, which indicate that machine prices should rise more slowly given the expectation of a future increase in network difficulty. <strong>At the end of the day the pricing of the machines is driven by supply and demand, and the hashpower market is highly illiquid.</strong></p>
<p>By backtesting the historical machine prices we can see that pricing heuristics based on <em>Static Days-to-Breakeven</em> are insufficient in capturing the volatility of mining profitability. In order to assess the fair value of the machines today, we need to model mining profitability on a forward-looking basis, with tools or frameworks that can capture the wild fluctuations of the outcomes.</p>
<p>A more advanced approach is to treat hashpower as a form of call option. The principle of this approach starts with treating the mining revenue of a machine as the underlying asset. There are three constituents for mining revenue: price, difficulty, and fees. A call option on Bitcoin price is arcane enough, but a derivative instrument that encapsulates these three elements is far more complex. Describing the <a href="https://en.wikipedia.org/wiki/Black%E2%80%93Scholes_model">Black-Scholes</a> theory for <a href="https://arxiv.org/pdf/1704.02036.pdf">options on multiple underlying assets</a> is straightforward: the additional considerations are the <a href="https://www.jstor.org/stable/3213286?seq=1">correlated random walks</a> and the corresponding multi-factor version of <a href="https://en.wikipedia.org/wiki/It%C3%B4%27s_lemma">Itoâs Lemma</a>. However, establishing the correlation matrix between the three variables is a daunting task.</p>
<p>As discussed in the <a href="https://www.aniccaresearch.tech/">Alchemy of Hashpower series</a>, price and hashpower have a <a href="https://en.wikipedia.org/wiki/Cross-correlation">cross-correlation</a> with a varying lag. Due to the reaction delay, when examining the relation between hashpower and price in a short time window, the correlation is <em>de minimis</em>. Hence, itâs tempting to simply model hashrate paths as a process completely independent of price. However, financially hashpower is a derivative of Bitcoin, and on a long enough time scale, the two time-series are positively correlated. On the other hand, transaction fees dynamics is even harder to model. While intuitively on some level transaction fees are connected to price and (inversely) to network hashrate, it is predominantly driven by on-chain activities, which is an exogenous factor. This is why the correlation matrix is not going to have meaningful results.</p>
<p><img src="/assets/images/2020/m11/lz11.png" alt="(Source: Glassnode )" /></p>
<p><em>(Source:</em> <a href="https://studio.glassnode.com/compare?a=BTC&a=BTC&a=BTC&c=&c=&e=&e=&e=&m=fees.VolumeSum&m=market.PriceUsdClose&m=mining.HashRateMean&mAvg=0&mAvg=0&mAvg=0&mMedian=0&mMedian=0&mMedian=0&mScl=lin&mScl=lin&mScl=lin&miner=&miner=&miner=&resolution=24h&resolution=24h&resolution=24h&s=1451676449&u=1606003200&zoom="><em>Glassnode</em></a><em>)</em></p>
<p>But once the assumptions on the distribution of the underlyings have been made, pricing hashpower in a period <em>N</em> is equivalent to pricing a series of <a href="https://www.investment-and-finance.net/derivatives/z/zero-strike-call-option.html">zero-strike European call options</a> with daily expiry. In other words, as long as the machine is on, the hashpower is a contract that exercises everyday, and converts into the underlying asset, which is the mining revenue. The cost of the contract is the depreciation of the hardware, plus the operating expenses. The option premium of the entire bundle should in theory be the price of the machine plus the present value of all the operating expenses incurred during period <em>N</em>.</p>
<p><img src="/assets/images/2020/m11/lz12.png" alt="Where: V is the fair value of the machine. Ci is the call option value with mining revenue as underlying, with expiration on day i. T is the daily operating expense." /></p>
<p><em>Where:</em></p>
<ul>
<li><em>V is the fair value of the machine.</em></li>
<li><em>Ci is the call option value with mining revenue as underlying, with expiration on day i.</em></li>
<li><em>T is the daily operating expense.</em></li>
</ul>
<p><strong>There is a critical flaw with this approach.</strong> Using this formula, the contract on day <em>i</em> and on day <em>i-1</em> are valued independently. In reality, the payoff on day <em>i-1</em> should set the initial condition for the contract expiring on the next day. Any hashpower valuation approach based on options pricing and simply sums up all trials in the period will face this path-dependence issue. Every trial will be a disjoint assessment.</p>
<p><img src="/assets/images/2020/m11/lz13.png" alt="Screen Shot 2020-11-22 at 8.29.05 PM.png" /></p>
<p><strong>Valuation with Numerical Methods</strong></p>
<p>Path-dependence is not an issue with numerical methods. Rather than valuing each day with 10,000 trials we are using the same 10,000 trials across all of them. <a href="https://www.palisade.com/risk/monte_carlo_simulation.asp">Monte Carlo simulation</a> is useful in modeling complex dynamics by generating random numbers. The expected payoff in a risk-neutral world is calculated using a sampling procedure. It is then discounted at the risk-free interest rate. With Monte Carlo methods, we are able to simulate the mining profitability of the latest-generation machines in the next two years, and compare their fair value against their prices on the market today.</p>
<p>As a first step we need to make some assumptions on the trajectory of price. <a href="https://arxiv.org/pdf/2002.07117.pdf">A numerous studies</a> argue that jump-diffusion is the most suitable in describing Bitcoin price distribution. We use a <a href="https://www.lpsm.paris/pageperso/tankov/tankov_voltchkova.pdf">jump-diffusion model</a> to simulate 10,000 possible price runs over the next two years. In a stochastic simulation, every run takes a different path.</p>
<p>A jump-diffusion model has two basic parts: the diffusion (geometric Brownian motion) and the jumps (usually Poisson distribution). For modeling simplicity, we assume that there is a threshold probability for the jumps. When jumps are triggered, the magnitude follows a normal distribution. </p>
<p>Calibrating based on historical price data, we use the following as the parameters for the model:</p>
<ul>
<li><em>Constant drift: 0.10%</em></li>
<li><em>Standard deviation of drift: 2.50%</em></li>
<li><em>Jump probability: 5.00%</em></li>
<li><em>Jump mean: 0.10%</em></li>
<li><em>Jump standard deviation: 5.00%</em></li>
</ul>
<p><img src="/assets/images/2020/m11/lz14.png" alt="Screen Shot 2020-11-22 at 11.58.37 PM.png" /></p>
<p>In addition to coin price, we need to project the network hashpower as well to calculate mining revenue. Modeling hashpower is more complicated than price trajectory because not every unit of hashpower is the same. While every miner on the network is computing hashes for the same algorithm, the amount of power consumed varies by machine. The simplified model of the current network hashrate abstracts away the presence of several hardware efficiency classes, each of which behaves differently as the market evolves. Stratifying our model by efficiency class shows us the composition of machines on the market, and therefore allows us to roughly predict how they would evolve over time.</p>
<p>Unlike price data, mining information is extremely challenging to collect. The only way to approach this is to interview as many miners, distributors, and manufacturers as possible. David from <a href="https://www.gmr.xyz">General Mining Research</a> surveyed the major manufacturers and distributors in China, and came up with the following estimate of the market composition as of 11/1/2020:</p>
<p><img src="/assets/images/2020/m11/lz15.png" alt="(Source: Proprietary data provided by GMR)" /></p>
<p><em>(Source: Proprietary data provided by GMR)</em></p>
<p>The snapshot serves as the basis for the initial condition of the projection model. Using an estimated industry-wide average all-in electricity rate, we can calculate the breakeven threshold for each layer, and understand roughly how many machines will likely drop should the price fall below the breakeven. Using $0.0507 per KwH as the estimated all-in rate, we can map out four possible scenarios based on different price levels:</p>
<p><img src="/assets/images/2020/m11/lz16.png" alt="(Source: Proprietary data provided by GMR)" /></p>
<p><em>(Source: Proprietary data provided by GMR)</em></p>
<p>Note that this only provides a baseline view of the hashrate projection. Old, marginally-economical machines sourced via secondary markets may come online and manufacturers may accelerate new production if there is a drastic rally in price.</p>
<p>Based on the scenarios above, we can find a linear function <em>y=4,544x + 6e07</em> to describe the relation between price and the network hashpower. For simplicity, we assume that for the next six months, hashrate growth follows the function of a 14-day average Bitcoin price with a drift term <em>dW</em>. We set 2.5% mean, and 5% standard deviation as the parameters of the drift term. In addition, based on our estimate of machine sales from manufacturers, we assume hashrate grows by 200 Ph/s a day for the next six months. We mimic the hardware reaction delay by incorporating a constant 20-day reaction delay. This means that hashrate only reacts to price action that at least happened 20 days ago. The full function:</p>
<p><img src="/assets/images/2020/m11/lz17.png" alt="Screen Shot 2020-11-22 at 11.58.02 PM.png" /></p>
<p>Sample trajectories look like the following:</p>
<p><img src="/assets/images/2020/m11/lz18.png" alt="Screen Shot 2020-11-22 at 9.12.47 PM.png" /></p>
<p>In reality, the relationship between hashpower and price is a messy and complex entanglement. Using a linear function to describe it is like projecting a chaotic system onto a low-dimensional subspace. There are many ways that the function can break. This is the same problem that we describe about the correlation matrix in the option pricing methods. <strong>However, this construction allows us to easily incorporate the lag time, and therefore is a significant improvement over assuming hashpower and price as two completely independent distribution.</strong> This makes the projection easier to manage.</p>
<p>To further improve our estimates, we can use a <a href="https://arxiv.org/pdf/1909.12313.pdf">Markov Chain Monte Carlo model</a>. Unlike Monte Carlo draws independent samples from the distribution, Markov Chain Monte Carlo draws samples where the next sample is dependent on the existing sample. This addresses multi-dimensional problems better than a generic Monte Carlo simulation. The exact construction of the algorithm is beyond the scope of this article.</p>
<p>Once we have the projections for price and hashrate in the next two years, we can calculate the mining profitability the same way we ran the backtests on the historical hashpower prices. Compared to two years ago, where crypto-backed lending activities were sparse, the <a href="https://www.forbes.com/sites/leeorshimron/2020/05/26/exploding-past-10b-interest-income-and-lending-are-bitcoins-first-killer-apps/?sh=29df0fda3320">lending market today has grown into a massive industry</a>. Collateralize lending is one of the most common services that miners frequently rely on. Evaluating the WACC today, the rate should improve noticeably. We can lower it to 10% instead of the 12.5% in the 2018 analysis.</p>
<p>Using a $0.0507 / KwH all-in cost, and a 10% discount rate, we can generate a distribution of the fair values. The final result is the average of all 10,000 trials. Additionally, we assume that after two years, Antminer S19 Pro and Whatsminer M30s still retain 20% of residual value.</p>
<p><img src="/assets/images/2020/m11/lz19.png" alt="Screen Shot 2020-11-22 at 9.19.52 PM.png" /></p>
<p>Needless to say, this should not be a final verdict on whether the machines are overpriced or underpriced. The mean and standard deviations in the price distribution, the function between hashpower and price, lag time, all-in cost, discount rate, and residual value are all factors that can drastically affect the outcome of this evaluation. For instance, running the simulation with $0.07 per KwH and with $0.03 per KwH all-in cost:</p>
<p><img src="/assets/images/2020/m11/lz20.png" alt="Picture1.png" /></p>
<p>We can see that when the all-in cost is high (left), the prices of the more efficient machines (Antminer S19 and Whatsminer M30s) are closer to their fair value than the lower tier machines. When the all-in cost is low (right), the pricings of the less efficient machines (Antminer S17 and Whatsminer M20s) are more favorable. <strong>This shows that if the all-in expense is competitive enough, the miner can benefit from operating less efficient machines.</strong></p>
<p>In our model we built a switch that turns off the machines if the mining revenue is consistently below expenses for 14 days. In the real world, miners donât frequently turn machines on and off based on short-term profitability. Most of the time miners have agreements with the datacenter host that they need to consume a minimal amount of power every month. Even after profitability drops below zero, most miners tend to wait for a downward trend to confirm before taking actions. <strong>Due to the labor-intensive nature of datacenter operations, and the illiquidity of machine market, miners are forced to observe longer term trends instead of short term price actions.</strong> In recent years, the rise in the volume of lending service providers also strengthened minersâ ability to endure through winters. Miners can collateralize their coins or machines to borrow fiat to pay for expenses, rather than selling a great quantity of coins. Nonetheless, this is a theoretical lower bound on mining loss. Miners cannot lose more than the capital expenditure plus the cumulative operating expense.</p>
<p>Like call options, the more volatile the underlying index is, the higher the theoretical value of the instrument. We can see how the results change as the parameters of the jump-diffusion model changes. <strong>When volatility is suppressed, the theoretical value of the machines drastically decreases. When volatility is high, the theoretical value rapidly increases:</strong></p>
<p><img src="/assets/images/2020/m11/lz21.png" alt="Picture2.png" /></p>
<p><em>*Based on $0.0507 per KwH all-in cost</em></p>
<p>This analysis is based on Strategy 3 <strong>Sell Daily</strong>. Same as the backtesting analysis, the fair value that can be âunlockedâ by running hashpower is within the range of FV(Strategy 1, Strategy 2, Strategy 3). Given that the Monte Carlo simulates 10,000 paths, each with a very different path, running one strategy alone should be sufficient to cover every type of market phase.</p>
<p><strong>A Future without Block Rewards</strong></p>
<p>Another variable that has a significant impact on mining revenue is the fees. Assume fees grows linearly by 5% and 10% a year, fair value of the machines would noticeably increase:</p>
<p><img src="/assets/images/2020/m11/lz22.png" alt="*Based on $0.0507 per KwH all-in cost" /></p>
<p><em>*Based on $0.0507 per KwH all-in cost</em></p>
<p>In reality the fee trend is much more sporadic, and its connection to other endogenous variables is less obvious. Modeling fee trends requires an entirely separate distribution. In addition, there are many ways to improve the accuracy:</p>
<ol>
<li>As discussed, use Markov Chain Monte Carlo to alleviate the <a href="https://en.wikipedia.org/wiki/Curse_of_dimensionality">curse of dimensionality</a>, </li>
<li>Introduce dynamic lag based on the four archetypal market cycles, use a <a href="https://poseidon01.ssrn.com/delivery.php?EXT=pdf&ID=272102114078118028097010019126092105123053024093062045123072092065100083111000080100034017099032020059038031127127066079067069029027003086049108109007105030085079047040060104116071087027068091029094020064026006121027027028084102069077095075066106021">poisson process to model the jumps</a>.</li>
<li>Use a hashrate-weighted average all-in cost instead of industry-wide median cost. </li>
<li>Use statistical methods to calibrate the parameters</li>
<li>Use machine learning tools to describe the relationship between hashpower and price. </li>
<li>Incorporate fee projection in mining revenue calculation. </li>
<li>Adopt <a href="https://en.wikipedia.org/wiki/Agent-based_model">agent-based simulation</a> for miner behaviors. Agent-based modeling is a technique for modeling complex systems to gain a deeper understanding of system behavior. It is widely used in high-frequency trading, or smart contract risk analysis. Under this framework, every miner is a âuserâ with different strategies and different cost basis. We can then define some simple reaction types (buy more machines, sell machines, buy more machines but wait for 30 days etc.) and build a library of âuser behaviorsâ. This would allow us to simulate much more complex interactions in the hashpower market. For more background, read about <a href="https://playgameoflife.com/">Conwayâs Game of Life</a>. </li>
</ol>
<p><em>Myron Scholes said, âall models have faults - that doesnât mean you canât use them as tools for making decisions.â</em></p>
<p>Like the Black-Scholes model, the simulation model is a mechanism that, in trying to reflect the actual world in a short description, simplifies its intricacies. This reduction makes the model usable but simultaneously limits its usefulness. Itâs important to understand where its limitations are, and that the simulations only represent possibility not certainty.</p>
<p>Nevertheless, the model is a baseline for users who have already formed a view on the market. Like any forecasting model, the simulation will only be as good as the assumptions the user makes. One uses modeling tools to turn those opinions about the future into an appropriate price today for something that will be exposed to that version of the future.</p>
<p>Why is this important? Whatâs the point of developing asset pricing theory in a market that is clearly driven by supply and demand?</p>
<p>Valuation is more than just a theoretical exercise. For Bitcoin, once mining becomes completely reliant on fees, competition yields razor-thin margins, and there is not a single element in mining revenue calculation that is predictable, how do we make sure miners keep producing hashpower? The answer is to maintain stability of continuous investments into mining hardware to augment the security budget of the network. This is critical because without enough hashpower, the whole system is susceptible to attacks, rendering Bitcoinâs settlement assurance worthless. A rigorous valuation framework is the first step in testing a broad range of assumptions and market behavior and planning accordingly. Valuation is the foundation of proper risk management for mining institutions that are becoming too-big-to-fail. The purpose of this exercise is to start a dialogue that focuses on this general direction. We will continue working to further our framework for years to come.</p>
<hr />
<h1 id="tweet-storm---about-schnorr-sigs"><a href="https://twitter.com/benthecarman/status/1330638123844288513">Tweet Storm - About Schnorr Sigs</a></h1>
<h3 id="by-ben-carman">By <a href="https://twitter.com/benthecarman">Ben Carman</a></h3>
<h3 id="posted-november-22-2020-2">Posted November 22, 2020</h3>
<p>0/ For <a href="https://threadreaderapp.com/hashtag/TaprootWeek">#TaprootWeek</a> today we are going to talk about adding Schnorr signatures to <a href="https://threadreaderapp.com/hashtag/Bitcoin">#Bitcoin</a>, why they are great, what optimizations we can get with them, and weâll tease the cool applications they can enable.</p>
<p>đđđ</p>
<p>1/ First letâs start out with hopefully what you ask yourself first about a new digital signature schema: are Schnorr signatures actually secure?</p>
<p>In short, Yes.</p>
<p>Today Bitcoin uses ECDSA for signatures which we must obviously consider secure.</p>
<p>2/ It turns out Schnorr signatures can be considered slightly more secure as their security proof has less assumptions than ECDSA and no new ones! So if we consider ECDSA secure, then Schnorr must be secure as well!</p>
<p>3/ If you want to get in deep with the actual security proof I recommend checking out waxwingâs blog on the subject</p>
<p><a href="https://joinmarket.me/blog/blog/liars-cheats-scammers-and-the-schnorr-signature/">joinmarket.me/blog/blog/liarâŠ</a></p>
<p>4/ So, Schnorr is secure, but why do we want them?</p>
<p>Switching to Schnorr signatures can actually gives a lot of efficiency gains, both in block space as well as in actual computation time.</p>
<p>Letâs talk about block space first 5/ Digital signatures generally consist of two 32 byte numbers, so naturally youâd think a signature is 64 bytes. Well sadly today in Bitcoin that is not the case, they are actually around ~72 bytes. This is because bitcoin currently uses something called DER encoding.</p>
<p>6/ DER encoding requires we add a few extra bytes around our two 32 byte numbers which in general isnât necessary for Bitcoin because we donât need to support multiple types of signature encoding for each signature schema.</p>
<p>7/ DER encoding isnât anything fancy or necessary it is just a result of the design decisions Satoshi made when initially creating bitcoin likely because of the use of the OpenSSL library.</p>
<p>If you want to know more I recommend reading BIP 66:</p>
<p><a href="https://github.com/bitcoin/bips"><strong>bitcoin/bips</strong> Bitcoin Improvement Proposals. Contribute to bitcoin/bips development by creating an account on GitHub.</a></p>
<p>8/ Getting back to Schnorr, since we are adding a new signature schema to the protocol we can also define a new way to encode these signatures. So, what we are doing is just putting the two 32 byte numbers next to each other resulting in a smaller 64 byte signature.</p>
<p>9/ Another way we can save block space by using Schnorr signatures is something called key aggregation, better known as MuSig. With key aggregation we can have one public key represent an arbitrary number of signers.</p>
<p>10/ Key aggregation is a HUGE win because today any multisig contract today requires a key and signature (in total ~100 bytes) for every signer which can get very expensive. Reducing this to a single key and signature will save users on lots of block space and thus on fees!</p>
<p>11/ The last and smallest gain we get is from switching to 33 byte public keys to 32 byte public keys. This isnât a huge gain, but with us switching to a whole new signature schema we can now store the public keys in the most compact way being 32 byte keys!</p>
<p>12/ That entails the primary ways that we save on block space by using Schnorr: smaller public keys, smaller signatures, and key aggregation.</p>
<p>Now, letâs move on to the computation efficiency gains.</p>
<p>13/ With Schnorr Signatures we can batch verify signatures.</p>
<p>Today with ECDSA we need to take each signature and verifying them individually that they are correct. This is generally fine for something like checking a new transaction in your mempool but not ideal for an IBD.</p>
<p>14/ Today Bitcoin has had ~589 million transactions all with at least one signature. This is a lot to verifying and optimizing this verification can help a lot with bootstrapping new nodes doing an initial block download.</p>
<p>15/ With Schnorr we can take batches of signatures and verifying them together saving a lot on computation time. In BIP 340 <a href="https://twitter.com/pwuille">@pwuille</a> has a graph showing the actual improvements.</p>
<p><img src="/assets/images/2020/m11/bc1.png" alt="" /></p>
<p>16/ To further quantify this improvement, letâs say it takes 1 unit of time to verifying a signature.</p>
<p>Today without batch verification it takes n units of time to verifying n signatures.</p>
<p>With Schnorr and batch verification, to verifying n signatures will instead be n/log n</p>
<p>17/ Those are the majority of the base improvements of adding Schnorr signatures to Bitcoin. There are a lot of cool things weâll talk about tomorrow on different applications they enable and youâll see later how Taproot itself benefits from using Schnorr as well!</p>
<hr />
<h1 id="an-open-letter-to-friends-and-family"><a href="https://pastebin.com/raw/aXfVpm81">An Open Letter to Friends and Family</a></h1>
<h3 id="by-james-obeirne">By <a href="https://twitter.com/jamesob">James OâBeirne</a></h3>
<h3 id="posted-november-29-2020">Posted November 29, 2020</h3>
<p>Friends and family,</p>
<p>Dispensation of unsolicited financial advice is a tricky thing. Itâs not something Iâm prone to naturally, and itâs a good way to look foolish.</p>
<p>That said, here I am.</p>
<p>Iâve weighed the risk of seeming uncouth against a desire to see the people I care about share in a major success. The prospect of a great return on an investment is a nice thing, but to see such a return along with many of the people you care about is wholly better.</p>
<p>Iâve personally benefited from keeping an eye on Bitcoin since 2014. I wrote some of you a similar letter in 2017, back when a coin cost $3,582 (as I write now itâs $17,810). The depth of my belief led me to make Bitcoin my full-time job in 2018.</p>
<p>But whatâs more important â and the cause for this email â is that I have good reason to think that a big price movement is coming in the next year.</p>
<p>From Nasdaq. I donât think this is a hyperbole.</p>
<p>I have two takeaways:</p>
<ul>
<li>There is a high likelihood that the Bitcoin price will approach or surpass $100,000 per coin within the next year.</li>
<li>You should own some Bitcoin not just for the mid-term price appreciation, but to safeguard against the enormous economic changes that are set to unfold over the next five years.</li>
</ul>
<p>In brief, Bitcoin is poised to rise in value because we are in uncharted territory. A countermeasure against currency devaluation is becoming more important than ever as the Fed (and every other central bank around the world) creates record amounts of new money to keep the economy on life support. Historically gold has been the go-to defense for this scenario, but Bitcoin is quickly replacing it as a much more practical alternative.</p>
<p>Hedge funds and money managers are quickly realizing this.</p>
<p>It should go without saying that my conviction carries through to my portfolio. I am over 90% in Bitcoin and continue to buy regularly.</p>
<p>In this mail Iâll briefly talk about the backdrop for Bitcoinâs rise, and why weâre at a critical inflection point in our money system. Iâll talk about how I value Bitcoin, and the reason next year is going to be so crazy.</p>
<hr />
<p>As you may know, our countryâs federal debt has been steadily accumulating over the past few decades to levels that will make repayment impossible. COVID-19 has kicked this expansion of debt into hyperdrive.</p>
<p>The nationâs debt has exploded to 140% of GDP as the government has been faced with the impossible dilemma of both fighting the virus and preventing the country from suffering permanent economic harm. The governmentâs answer so far, in brief, has been to turn on the printing presses while keeping everyone at home. Iâm not here to make moral assessments of this solution, it is what it is.</p>
<p>Since untethering the US dollar from gold in 1971 (yep, production of dollars used to be limited by a physical commodity) the government has been able to produce currency at unlimited rates. Most people donât realize that this is a 50 year old experiment involving money whose supply is not limited by anything.</p>
<p>Thereâs much more to say on the macroeconomic backdrop of Bitcoinâs rise, but itâs too in-the-weeds for many and so I wonât include it here. If you want more information, you can read my article Bitcoin for Safety.</p>
<p>Nearly all of Wall St. realizes that the government has no option but to print big and keep at it indefinitely. Most have decided to shove capital into the stock market to protect their money, which explains the bizarre rise of stocks in light of the country being in a dystopic pandemic-driven lockdown.</p>
<p>Large businesses are increasingly coming to a similar conclusion. You may have heard recently about a tech company that invested the majority of its cash treasury ($500 million) into Bitcoin.</p>
<p>Michael Saylor, MIT grad and founder/CEO of MicroStrategy, realized that the purchasing power of his companyâs cash reserves was eroding at a rapid clip. In recent weeks he has spoken at length about the importance of Bitcoin and its uniqueness over any existing asset class.</p>
<p>Payments processing company Square has also adopted this rationale and has started to put some of their cash into Bitcoin.</p>
<p>This will become increasingly common among businesses concerned about the effect of rapid inflation on their cash balances. Because Bitcoinâs supply is limited and discovery of new Bitcoins is becoming less and less frequent over time, this heightened demand will do things to the price of Bitcoin that seem unthinkable now.</p>
<p>Bitcoin is the only asset ever to have a truly fixed supply. Even great works of art can be fabricated. Itâs difficult to think through the implications of a truly fixed supply since weâre used to companies issuing more shares or governments printing more dollars. This canât happen with Bitcoin, which is what causes the price to do outrageous things.</p>
<p>Money managers are beginning to realize this. Some of the biggest names in finance have come out in the past weeks expressing support or positive curiosity over Bitcoin.</p>
<p>Raoul Pal, noted investor and founder of Real Vision (âthe Netflix of financeâ), calls Bitcoin âthe only tradeâ right now. He is âirresponsibly long.â</p>
<p>Iâve linked to a video Raoul did about his thoughts on Bitcoin at the end of the email.</p>
<p>Paul Tudor Jones, one of the most successful hedge fund managers alive, has recently come out in strong support of Bitcoin. He has 2% of his assets invested.</p>
<p>Paul said</p>
<p>âBack in March and April, it became really apparent, given the monetary policy that was being pursued by the Fed, the incredible quantitative easing they were doing and other central banks were doing, that we were in an unprecedented time,â he explained. Noting additional problems brought about by the Covid-19 pandemic, he said, âone had to begin to think about how you defend yourself against inflation.â</p>
<p>âI came to the conclusion that bitcoin was going to be the best of inflation trades, the defensive trades that you would take.â</p>
<p>Examining the overall market caps and characteristics of all inflation trades, he said that bitcoin has âa very small coterie of people investing in it, it was portable, it was liquid, had a variety of characteristics that made it a great inflation hedge.â While Jones pointed out that âThe one thing it [bitcoin] didnât have is it didnât have integrity and long-term staying power,â he emphasized that âevery day that goes by, of course, it gains on that. It gains on credibility and integrity.â</p>
<p>Stan Druckenmiller, another Wall St. luminary, has revealed heâs buying Bitcoin recently. Stanâs fund, per wikipedia has âpost[ed] an average annual return of 30 percent without any money-losing yearâ for 30 years.</p>
<p>Raoul Pal remarked that âthe significance of the worldâs greatest and most respected money manager - Stan Druckenmiller - saying just now that he is long bitcoin can not be overstated. That has removed every obstacle for any hedge fund or endowment to invest.â</p>
<p>The point is, this narrative is spreading quickly through the finance community. Bitcoin is in the early days of being accepted as the successor to gold at a time when the role of gold is increasingly critical for protecting wealth.</p>
<p>If you take goldâs (conservative) market cap of $7 trillion and divide that over Bitcoinâs 21 million fixed supply, you get a price of $333,333 per coin. Even assuming Bitcoin takes just 10% of goldâs market cap, thatâs $33,333 per coin.</p>
<p>Gold is venerable but outdated - Iâve bought and sold a lot of it in the past year, and obtaining physical gold and then selling it was an absolute pain. Bitcoin is way more practical.</p>
<p>And replacing gold is just the start. Bitcoin isnât just a better gold; because of its programmability, itâs a platform that will host the future of money. It will disintermediate many core functions in finance.</p>
<p>You might have questions like âif Bitcoin is digital, how can there only ever be 21 million? Canât anyone just copy the source code and make their own Bitcoin?â</p>
<p>Iâm happy to do a follow-up on why Bitcoin is scarce, but I donât want to belabor details here that most might be uninterested in. As a relative expert in computers, I can say that Bitcoin is a genuine technological breakthrough and it is indeed scarce. There will only ever be 21 million.</p>
<p>So why is Bitcoin on the rise in the next year? Why are you sending me this email now?</p>
<p>The ânewâ narrative about Bitcoin circulating among finance professionals isnât the only thing at work here. There is an inherent property of Bitcoin that creates a recurring cycle of demand called the âhalving.â</p>
<p>Every four years, the rate at which new Bitcoin is discovered halves. Since 2009, this has created a roughly four year cycle that results in a wild price run-up about a year after the halving (which most recently happened a few months ago).</p>
<p>The effect of the halving is that there is less Bitcoin to be sold as demand is held constant or increases. That causes the price to shoot up. Which causes demand to shoot up. Which causes price to shoot up. Which âŠ</p>
<p>We are on the orange line right now. Note that this is a log-scale chart and if Bitcoin follows previous trends, weâre looking at a coin price in the $200k-$300k range.</p>
<p>We are on course for some wild price appreciation in the next year, and I wanted to make sure to send out this warning before the fireworks start in earnest. Bitcoin might reach upwards of $120k per coin during this cycle. Some speculate that because of acceptance from the traditional finance crowd, this may be the last such cycle and the price just wonât come back, as it has in previous seasons.</p>
<p>Bitcoin as diversification</p>
<p>It took me a while to understand that this moon math is credible, so I get it if you donât take it seriously. (Youâll see over the next year.) If not, you can simply think of Bitcoin as an excellent portfolio diversifier.</p>
<p>Bitcoin is one of the few financial assets you can buy that has been shown to be uncorrelated to other asset classes.</p>
<p>Easy for you to say all this - you bought Bitcoin when it was $200.</p>
<p>When I first bought Bitcoin, I bought the top. The year was 2014 and I bought Bitcoin for around $1,000 a coin. Then it âcrashedâ to $200 and stayed in that range for years. I looked like an idiot. But I kept buying, because I understood many of the mechanics I outlined above.</p>
<p>In 2016 and 2017, I piled into Bitcoin as the price broke all-time highs of $1,200 and shot up to $20,000 over the course of the year. It crashed down to $3,000 and while I did some ill-advised trading and lost some Bitcoin, I kept buying.</p>
<p>When the price was at $19,000 last week, I was buying. Iâve sold other assets to pile into Bitcoin at these prices. They may seem high, but in a year theyâll look like a bargain. People will be talking about how you could once buy $20,000 Bitcoin in the same way that I just mentioned that there was a day when I was buying $200 Bitcoin.</p>
<p>I regret every sale of Bitcoin Iâve made so far.</p>
<p>What are some other good resources?</p>
<ul>
<li>(3 minutes) Finance bro Anthony Pompliano explaining new demand for Bitcoin on CNBC https://www.youtube.com/watch?v=i5wv6i71Its</li>
<li>(8 minutes) Michael Saylor of MicroStrategy on CNBC on why the company put $500M in Bitcoin https://www.youtube.com/watch?v=CxnNoqbSLGo</li>
<li>(30 minutes) Raoul Pal on âThe Bitcoin Life Raftâ https://www.youtube.com/watch?v=qL2LfVRl3J0</li>
<li>(1 hour) a longer discussion with Michael Saylor: https://www.youtube.com/watch?v=t_nVYtoiShg</li>
<li>âMisconceptions about Bitcoinâ by investment advisor Lyn Alden, published a few days ago https://www.lynalden.com/misconceptions-about-bitcoin/</li>
<li>My article, Bitcoin for Safety: https://jameso.be/2019/08/24/bitcoin-is-for-this.html</li>
</ul>
<p>Okay, how can I buy a little?</p>
<p>I recommend allocating anywhere from 1-5% of your portfolio to Bitcoin. This is low enough that you can ride out any price swings and hang on for the long-term, but high enough that youâll be exposed to any massive upside.</p>
<p>I personally recommend River.com. If they arenât available in your state, Coinbase.com is a fine choice. Or you can use Squareâs Cash app for small-ish purchases. I havenât tried SwanBitcoin.com yet but it seems good.</p>
<p>If you are going to be buying and holding a sizable chunk of Bitcoin (say over $10,000) you should really consider custodying it yourself with whatâs called a âhardware wallet.â Iâm happy to help any of you with this, just send me an email.</p>
<p>My advice is not to wait. There were many people who thought the price was just a little too high at $200, $1,200, or $12,000 and decided to wait for a pullback that never came.</p>
<p>In closing</p>
<p>Iâm relieved to be finishing and finally distributing this email. I donât particularly like giving sales pitches, but it has weighed on me that I havenât sent out an email like this earlier. I want to encourage participation in what is not only the emergence of a new financial asset class that I think will perform tremendously, but a defense against some very strange times to come.</p>
<p>If I can answer any questions, let me know.</p>
<p>James</p>
<hr />
<h1 id="tweetstorm---bitcoin-and-the-power-of-incentives"><a href="https://twitter.com/Bquittem/status/1327732566191976452">Tweetstorm - Bitcoin and the power of incentives</a></h1>
<h3 id="by-brandon-quittem">By <a href="https://twitter.com/Bquittem">Brandon Quittem</a></h3>
<h3 id="posted-november-14-2020">Posted November 14, 2020</h3>
<p>1/ A quick thread about #Bitcoin and the power of incentives.</p>
<p>For Bitcoin to reach global dominance, it must inspire a vibrant ecosystem of allies.</p>
<p>âShow me the incentives, and Iâll show you the outcome.â</p>
<p>Letâs go đ</p>
<p>2/ Bitcoin attracts new users for many reasons</p>
<ul>
<li>Get wealthy</li>
<li>Stay Wealthy</li>
<li>Preserve Freedom</li>
<li>Minimize violence</li>
<li>Empower the poor</li>
<li>Increase prosperity in the world</li>
</ul>
<p>Users are incentivized to defend the network, improve the network, and onboard new users to the network</p>
<p>3/ Investors buy Bitcoin to generate wealth.</p>
<p>âBitcoin was designed to pump foreverâ - @matt_odell</p>
<p>Bitcoin is the best trade of the century. Will be obvious in hindsight. Massive wealth transfer coming.</p>
<p>4/ Billionaires need Bitcoin to protect their wealth.</p>
<p>They have a lot to lose & theyâre vulnerable to confiscation. Bitcoin is insurance against collapse, confiscation, or a greedy state.</p>
<p>Billionaires make powerful allies in the battles that come.</p>
<p><a href="https://twitter.com/SquawkCNBC/status/1148557011237429249"><img src="/assets/images/2020/m11/bq1.png" alt="squawk" /></a></p>
<p>5/ Bitcoiners adopt Bitcoin because itâs the right thing to do Current system is broken. Bitcoin shifts power from incumbents
Rightwards arrow an intolerant minority of cypherpunks, polymaths, freedom maximalists, and first principle thinkers. Bitcoiners will build a better world.</p>
<p>6/ Corporations need Bitcoin to protect their balance sheets.</p>
<p>While governments compete to devalue their currency, many corporations cannot generate a positive return on capital. Bitcoin protects the treasury.</p>
<p><a href="https://bitcointreasuries.org">https://bitcointreasuries.org</a></p>
<p>7/ Freedom lovers adopt Bitcoin to protect liberty.</p>
<p>Bitcoin is a 10x improvement over existing property rights. Shifts power away from the state and towards the individual. Enables the rise of the Sovereign individual.</p>
<p>cc: <a href="https://twitter.com/hasufl">@hasufl</a></p>
<p><a href="https://medium.com/@hasufly/bitcoin-and-the-promise-of-independent-property-rights-8f10e5c7efa8#"><img src="/assets/images/2020/m11/bq2.png" alt="hasu" /></a></p>
<p>8/ Pensions need Bitcoin to generate a positive yield.</p>
<p>With mounting unfunded liabilities, $17t in negative-yielding bonds, and few options for positive yieldâŠ</p>
<p>Money managers will be forced to buy Bitcoin. Itâs their only hope.</p>
<p><img src="/assets/images/2020/m11/bq3.jpg" alt="" /></p>
<p>9/ Millenials need Bitcoin or theyâll âhave fun staying poorâ</p>
<p>Millennials have been dealt a bad hand by older generations. The 2020s will make things worse. Bitcoin is their best chance to generate wealth</p>
<p>Bitcoin will eat the SoV premium on real estate, enabling home ownership.</p>
<p>10/ Tech companies leverage Bitcoin to defend their moat</p>
<p>Money is being reinvented. Companies are scrambling to acquire territory on the new frontier. Square has an early lead (<a href="https://twitter.com/CashApp">@CashApp</a>), PayPal has entered the game.</p>
<p>When Apple, Google, Microsoft, and Facebook?</p>
<p>11/ Normal people use Bitcoin as a savings technology</p>
<p>Rather than staying wave-slaves, normal people can store the fruits of their labor in an asset that preserves their time & energy.</p>
<p>12/ Ostrisziced nations need Bitcoin to trade</p>
<p>The dollar hegemony excludes enemies from participating in the global financial system. Bitcoin is an open financial system, accessible to all.</p>
<p>Example: Iran is paying for imports by monetizing energy assets through Bitcoin mining.</p>
<p>13/ Banks adopt Bitcoin to stay relevant</p>
<p>Old banking is dead, digital mobile banking (Cash app, etc) is the future. CBDCâs are coming. Low-interest rate environments squeeze commercial bank margins.</p>
<p>Jamie Dimon should have stayed humble and stacked some sats.</p>
<p>14/ Humanitarians adopt Bitcoin to empower the disenfranchised</p>
<p>Billions of individuals donât have access to basic financial services (or are opressed by their gov)</p>
<p>Entrepreneurs like <a href="https://twitter.com/raypaxful">@raypaxful</a> leverage Bitcoin (and other tools) to âbank the unbankedâ in developing countries.</p>
<p>15/ Politicians support Bitcoin because their constituents demand it</p>
<p>As more citizens own Bitcoin, theyâll elect more representatives who support Bitcoin.</p>
<p>When powerful people own Bitcoin, they ensure favorable laws.</p>
<p><img src="/assets/images/2020/m11/bq4.png" alt="" /></p>
<p>16/ Boomers need Bitcoin to protect their net egg</p>
<p>Pensions and Social Security are underfunded. Boomers need Bitcoin to retire with peace of mind.</p>
<p>17/ Governments will adopt Bitcoin as a hedge against currency failure</p>
<p>Just as governments and central banks hold Gold today, Bitcoin will serve as a hedge against state failure.</p>
<p>Small nations will adopt Bitcoin to leapfrog ahead of nocoiner nations.</p>
<p>18/ Environmentalist will adopt Bitcoin to preserve the planet</p>
<p>The fiat system produces massive negative externalities on the environment.</p>
<p>Bitcoin reduces flared methane, reduces waste, incentives R&D for low-cost energy production, and minimizes fiat externalities.</p>
<p>19/ Americans adopt Bitcoin because it preserves âAmerican Valuesâ</p>
<p>Bitcoin is a tool that empowers an individualsâ life, liberty, and the pursuit of happiness.</p>
<p>Whatâs more American than that?</p>
<p>20/ Cyber Hornets protect Bitcoin because it enables a better world.</p>
<p>Driven by curiosity, seeking truth, and fighting for freedom, the cyber hornets defend the network at all costs.</p>
<p><img src="/assets/images/2020/m11/bq5.png" alt="" /></p>
<p>21/ What else (besides Bitcoin) aligns humanitarians, billionaires, governments, environmentalists, and cyber hornets?</p>
<p>Each group offers unique advantages that strengthen the network.</p>
<p>Each marginal users improves the chance of success.</p>
<p>22/ âShow me the incentives and Iâll show you the outcome.â</p>
<p>Bitcoin is a force of nature that systematically aligns the incentives of the human race.</p>
<p>Bitcoinâs global dominance is all be guaranteed.</p>
<p>END/ Thanks for the inspiration.</p>
<p>@Breedlove22 @michael_saylor @matt_odell @hasufl @nlw @raypaxful @JeffBooth @chamath @MartyBent and many more.</p>
<hr />đȘđąđ„đđŠbitcoinwords@gmail.comRead + ShareAn Open Letter to Friends and Family2020-11-29T00:00:00+00:002020-11-29T00:00:00+00:00https://bitcoinwords.github.io/an-open-letter-to-friends-and-family<table class="notice--info">
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<h1 id="an-open-letter-to-friends-and-family"><a href="https://pastebin.com/raw/aXfVpm81">An Open Letter to Friends and Family</a></h1>
<h3 id="by-james-obeirne">By <a href="https://twitter.com/jamesob">James OâBeirne</a></h3>
<h3 id="posted-november-29-2020">Posted November 29, 2020</h3>
<p>Friends and family,</p>
<p>Dispensation of unsolicited financial advice is a tricky thing. Itâs not something Iâm prone to naturally, and itâs a good way to look foolish.</p>
<p>That said, here I am.</p>
<p>Iâve weighed the risk of seeming uncouth against a desire to see the people I care about share in a major success. The prospect of a great return on an investment is a nice thing, but to see such a return along with many of the people you care about is wholly better.</p>
<p>Iâve personally benefited from keeping an eye on Bitcoin since 2014. I wrote some of you a similar letter in 2017, back when a coin cost $3,582 (as I write now itâs $17,810). The depth of my belief led me to make Bitcoin my full-time job in 2018.</p>
<p>But whatâs more important â and the cause for this email â is that I have good reason to think that a big price movement is coming in the next year.</p>
<p>From Nasdaq. I donât think this is a hyperbole.</p>
<p>I have two takeaways:</p>
<ul>
<li>There is a high likelihood that the Bitcoin price will approach or surpass $100,000 per coin within the next year.</li>
<li>You should own some Bitcoin not just for the mid-term price appreciation, but to safeguard against the enormous economic changes that are set to unfold over the next five years.</li>
</ul>
<p>In brief, Bitcoin is poised to rise in value because we are in uncharted territory. A countermeasure against currency devaluation is becoming more important than ever as the Fed (and every other central bank around the world) creates record amounts of new money to keep the economy on life support. Historically gold has been the go-to defense for this scenario, but Bitcoin is quickly replacing it as a much more practical alternative.</p>
<p>Hedge funds and money managers are quickly realizing this.</p>
<p>It should go without saying that my conviction carries through to my portfolio. I am over 90% in Bitcoin and continue to buy regularly.</p>
<p>In this mail Iâll briefly talk about the backdrop for Bitcoinâs rise, and why weâre at a critical inflection point in our money system. Iâll talk about how I value Bitcoin, and the reason next year is going to be so crazy.</p>
<hr />
<p>As you may know, our countryâs federal debt has been steadily accumulating over the past few decades to levels that will make repayment impossible. COVID-19 has kicked this expansion of debt into hyperdrive.</p>
<p>The nationâs debt has exploded to 140% of GDP as the government has been faced with the impossible dilemma of both fighting the virus and preventing the country from suffering permanent economic harm. The governmentâs answer so far, in brief, has been to turn on the printing presses while keeping everyone at home. Iâm not here to make moral assessments of this solution, it is what it is.</p>
<p>Since untethering the US dollar from gold in 1971 (yep, production of dollars used to be limited by a physical commodity) the government has been able to produce currency at unlimited rates. Most people donât realize that this is a 50 year old experiment involving money whose supply is not limited by anything.</p>
<p>Thereâs much more to say on the macroeconomic backdrop of Bitcoinâs rise, but itâs too in-the-weeds for many and so I wonât include it here. If you want more information, you can read my article Bitcoin for Safety.</p>
<p>Nearly all of Wall St. realizes that the government has no option but to print big and keep at it indefinitely. Most have decided to shove capital into the stock market to protect their money, which explains the bizarre rise of stocks in light of the country being in a dystopic pandemic-driven lockdown.</p>
<p>Large businesses are increasingly coming to a similar conclusion. You may have heard recently about a tech company that invested the majority of its cash treasury ($500 million) into Bitcoin.</p>
<p>Michael Saylor, MIT grad and founder/CEO of MicroStrategy, realized that the purchasing power of his companyâs cash reserves was eroding at a rapid clip. In recent weeks he has spoken at length about the importance of Bitcoin and its uniqueness over any existing asset class.</p>
<p>Payments processing company Square has also adopted this rationale and has started to put some of their cash into Bitcoin.</p>
<p>This will become increasingly common among businesses concerned about the effect of rapid inflation on their cash balances. Because Bitcoinâs supply is limited and discovery of new Bitcoins is becoming less and less frequent over time, this heightened demand will do things to the price of Bitcoin that seem unthinkable now.</p>
<p>Bitcoin is the only asset ever to have a truly fixed supply. Even great works of art can be fabricated. Itâs difficult to think through the implications of a truly fixed supply since weâre used to companies issuing more shares or governments printing more dollars. This canât happen with Bitcoin, which is what causes the price to do outrageous things.</p>
<p>Money managers are beginning to realize this. Some of the biggest names in finance have come out in the past weeks expressing support or positive curiosity over Bitcoin.</p>
<p>Raoul Pal, noted investor and founder of Real Vision (âthe Netflix of financeâ), calls Bitcoin âthe only tradeâ right now. He is âirresponsibly long.â</p>
<p>Iâve linked to a video Raoul did about his thoughts on Bitcoin at the end of the email.</p>
<p>Paul Tudor Jones, one of the most successful hedge fund managers alive, has recently come out in strong support of Bitcoin. He has 2% of his assets invested.</p>
<p>Paul said</p>
<p>âBack in March and April, it became really apparent, given the monetary policy that was being pursued by the Fed, the incredible quantitative easing they were doing and other central banks were doing, that we were in an unprecedented time,â he explained. Noting additional problems brought about by the Covid-19 pandemic, he said, âone had to begin to think about how you defend yourself against inflation.â</p>
<p>âI came to the conclusion that bitcoin was going to be the best of inflation trades, the defensive trades that you would take.â</p>
<p>Examining the overall market caps and characteristics of all inflation trades, he said that bitcoin has âa very small coterie of people investing in it, it was portable, it was liquid, had a variety of characteristics that made it a great inflation hedge.â While Jones pointed out that âThe one thing it [bitcoin] didnât have is it didnât have integrity and long-term staying power,â he emphasized that âevery day that goes by, of course, it gains on that. It gains on credibility and integrity.â</p>
<p>Stan Druckenmiller, another Wall St. luminary, has revealed heâs buying Bitcoin recently. Stanâs fund, per wikipedia has âpost[ed] an average annual return of 30 percent without any money-losing yearâ for 30 years.</p>
<p>Raoul Pal remarked that âthe significance of the worldâs greatest and most respected money manager - Stan Druckenmiller - saying just now that he is long bitcoin can not be overstated. That has removed every obstacle for any hedge fund or endowment to invest.â</p>
<p>The point is, this narrative is spreading quickly through the finance community. Bitcoin is in the early days of being accepted as the successor to gold at a time when the role of gold is increasingly critical for protecting wealth.</p>
<p>If you take goldâs (conservative) market cap of $7 trillion and divide that over Bitcoinâs 21 million fixed supply, you get a price of $333,333 per coin. Even assuming Bitcoin takes just 10% of goldâs market cap, thatâs $33,333 per coin.</p>
<p>Gold is venerable but outdated - Iâve bought and sold a lot of it in the past year, and obtaining physical gold and then selling it was an absolute pain. Bitcoin is way more practical.</p>
<p>And replacing gold is just the start. Bitcoin isnât just a better gold; because of its programmability, itâs a platform that will host the future of money. It will disintermediate many core functions in finance.</p>
<p>You might have questions like âif Bitcoin is digital, how can there only ever be 21 million? Canât anyone just copy the source code and make their own Bitcoin?â</p>
<p>Iâm happy to do a follow-up on why Bitcoin is scarce, but I donât want to belabor details here that most might be uninterested in. As a relative expert in computers, I can say that Bitcoin is a genuine technological breakthrough and it is indeed scarce. There will only ever be 21 million.</p>
<p>So why is Bitcoin on the rise in the next year? Why are you sending me this email now?</p>
<p>The ânewâ narrative about Bitcoin circulating among finance professionals isnât the only thing at work here. There is an inherent property of Bitcoin that creates a recurring cycle of demand called the âhalving.â</p>
<p>Every four years, the rate at which new Bitcoin is discovered halves. Since 2009, this has created a roughly four year cycle that results in a wild price run-up about a year after the halving (which most recently happened a few months ago).</p>
<p>The effect of the halving is that there is less Bitcoin to be sold as demand is held constant or increases. That causes the price to shoot up. Which causes demand to shoot up. Which causes price to shoot up. Which âŠ</p>
<p>We are on the orange line right now. Note that this is a log-scale chart and if Bitcoin follows previous trends, weâre looking at a coin price in the $200k-$300k range.</p>
<p>We are on course for some wild price appreciation in the next year, and I wanted to make sure to send out this warning before the fireworks start in earnest. Bitcoin might reach upwards of $120k per coin during this cycle. Some speculate that because of acceptance from the traditional finance crowd, this may be the last such cycle and the price just wonât come back, as it has in previous seasons.</p>
<p>Bitcoin as diversification</p>
<p>It took me a while to understand that this moon math is credible, so I get it if you donât take it seriously. (Youâll see over the next year.) If not, you can simply think of Bitcoin as an excellent portfolio diversifier.</p>
<p>Bitcoin is one of the few financial assets you can buy that has been shown to be uncorrelated to other asset classes.</p>
<p>Easy for you to say all this - you bought Bitcoin when it was $200.</p>
<p>When I first bought Bitcoin, I bought the top. The year was 2014 and I bought Bitcoin for around $1,000 a coin. Then it âcrashedâ to $200 and stayed in that range for years. I looked like an idiot. But I kept buying, because I understood many of the mechanics I outlined above.</p>
<p>In 2016 and 2017, I piled into Bitcoin as the price broke all-time highs of $1,200 and shot up to $20,000 over the course of the year. It crashed down to $3,000 and while I did some ill-advised trading and lost some Bitcoin, I kept buying.</p>
<p>When the price was at $19,000 last week, I was buying. Iâve sold other assets to pile into Bitcoin at these prices. They may seem high, but in a year theyâll look like a bargain. People will be talking about how you could once buy $20,000 Bitcoin in the same way that I just mentioned that there was a day when I was buying $200 Bitcoin.</p>
<p>I regret every sale of Bitcoin Iâve made so far.</p>
<p>What are some other good resources?</p>
<ul>
<li>(3 minutes) Finance bro Anthony Pompliano explaining new demand for Bitcoin on CNBC https://www.youtube.com/watch?v=i5wv6i71Its</li>
<li>(8 minutes) Michael Saylor of MicroStrategy on CNBC on why the company put $500M in Bitcoin https://www.youtube.com/watch?v=CxnNoqbSLGo</li>
<li>(30 minutes) Raoul Pal on âThe Bitcoin Life Raftâ https://www.youtube.com/watch?v=qL2LfVRl3J0</li>
<li>(1 hour) a longer discussion with Michael Saylor: https://www.youtube.com/watch?v=t_nVYtoiShg</li>
<li>âMisconceptions about Bitcoinâ by investment advisor Lyn Alden, published a few days ago https://www.lynalden.com/misconceptions-about-bitcoin/</li>
<li>My article, Bitcoin for Safety: https://jameso.be/2019/08/24/bitcoin-is-for-this.html</li>
</ul>
<p>Okay, how can I buy a little?</p>
<p>I recommend allocating anywhere from 1-5% of your portfolio to Bitcoin. This is low enough that you can ride out any price swings and hang on for the long-term, but high enough that youâll be exposed to any massive upside.</p>
<p>I personally recommend River.com. If they arenât available in your state, Coinbase.com is a fine choice. Or you can use Squareâs Cash app for small-ish purchases. I havenât tried SwanBitcoin.com yet but it seems good.</p>
<p>If you are going to be buying and holding a sizable chunk of Bitcoin (say over $10,000) you should really consider custodying it yourself with whatâs called a âhardware wallet.â Iâm happy to help any of you with this, just send me an email.</p>
<p>My advice is not to wait. There were many people who thought the price was just a little too high at $200, $1,200, or $12,000 and decided to wait for a pullback that never came.</p>
<p>In closing</p>
<p>Iâm relieved to be finishing and finally distributing this email. I donât particularly like giving sales pitches, but it has weighed on me that I havenât sent out an email like this earlier. I want to encourage participation in what is not only the emergence of a new financial asset class that I think will perform tremendously, but a defense against some very strange times to come.</p>
<p>If I can answer any questions, let me know.</p>
<p>James</p>
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<!--End mc_embed_signup-->James O'BeirneJames O'Beirne pens an open letter to his loved ones about Bitcoin. Posted November 29, 2020Tweetstorm - Bitcoin and the power of incentives2020-11-29T00:00:00+00:002020-11-29T00:00:00+00:00https://bitcoinwords.github.io/tweetstorm-bitcoin-and-the-power-of-incentives<table class="notice--info">
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<td>If you find <strong>WORDS</strong> helpful, Bitcoin donations are unnecessary but appreciated. Our goal is to spread and preserve Bitcoin writings for future generations. <a href="https://bitcoinwords.github.io/about/##goals-and-scope"><strong>Read more</strong></a>.</td>
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<h1 id="tweetstorm---bitcoin-and-the-power-of-incentives"><a href="https://twitter.com/Bquittem/status/1327732566191976452">Tweetstorm - Bitcoin and the power of incentives</a></h1>
<h3 id="by-brandon-quittem">By <a href="https://twitter.com/Bquittem">Brandon Quittem</a></h3>
<h3 id="posted-november-14-2020">Posted November 14, 2020</h3>
<p>1/ A quick thread about #Bitcoin and the power of incentives.</p>
<p>For Bitcoin to reach global dominance, it must inspire a vibrant ecosystem of allies.</p>
<p>âShow me the incentives, and Iâll show you the outcome.â</p>
<p>Letâs go đ</p>
<p>2/ Bitcoin attracts new users for many reasons</p>
<ul>
<li>Get wealthy</li>
<li>Stay Wealthy</li>
<li>Preserve Freedom</li>
<li>Minimize violence</li>
<li>Empower the poor</li>
<li>Increase prosperity in the world</li>
</ul>
<p>Users are incentivized to defend the network, improve the network, and onboard new users to the network</p>
<p>3/ Investors buy Bitcoin to generate wealth.</p>
<p>âBitcoin was designed to pump foreverâ - @matt_odell</p>
<p>Bitcoin is the best trade of the century. Will be obvious in hindsight. Massive wealth transfer coming.</p>
<p>4/ Billionaires need Bitcoin to protect their wealth.</p>
<p>They have a lot to lose & theyâre vulnerable to confiscation. Bitcoin is insurance against collapse, confiscation, or a greedy state.</p>
<p>Billionaires make powerful allies in the battles that come.</p>
<p><a href="https://twitter.com/SquawkCNBC/status/1148557011237429249"><img src="/assets/images/2020/m11/bq1.png" alt="squawk" /></a></p>
<p>5/ Bitcoiners adopt Bitcoin because itâs the right thing to do Current system is broken. Bitcoin shifts power from incumbents
Rightwards arrow an intolerant minority of cypherpunks, polymaths, freedom maximalists, and first principle thinkers. Bitcoiners will build a better world.</p>
<p>6/ Corporations need Bitcoin to protect their balance sheets.</p>
<p>While governments compete to devalue their currency, many corporations cannot generate a positive return on capital. Bitcoin protects the treasury.</p>
<p><a href="https://bitcointreasuries.org">https://bitcointreasuries.org</a></p>
<p>7/ Freedom lovers adopt Bitcoin to protect liberty.</p>
<p>Bitcoin is a 10x improvement over existing property rights. Shifts power away from the state and towards the individual. Enables the rise of the Sovereign individual.</p>
<p>cc: <a href="https://twitter.com/hasufl">@hasufl</a></p>
<p><a href="https://medium.com/@hasufly/bitcoin-and-the-promise-of-independent-property-rights-8f10e5c7efa8#"><img src="/assets/images/2020/m11/bq2.png" alt="hasu" /></a></p>
<p>8/ Pensions need Bitcoin to generate a positive yield.</p>
<p>With mounting unfunded liabilities, $17t in negative-yielding bonds, and few options for positive yieldâŠ</p>
<p>Money managers will be forced to buy Bitcoin. Itâs their only hope.</p>
<p><img src="/assets/images/2020/m11/bq3.jpg" alt="" /></p>
<p>9/ Millenials need Bitcoin or theyâll âhave fun staying poorâ</p>
<p>Millennials have been dealt a bad hand by older generations. The 2020s will make things worse. Bitcoin is their best chance to generate wealth</p>
<p>Bitcoin will eat the SoV premium on real estate, enabling home ownership.</p>
<p>10/ Tech companies leverage Bitcoin to defend their moat</p>
<p>Money is being reinvented. Companies are scrambling to acquire territory on the new frontier. Square has an early lead (<a href="https://twitter.com/CashApp">@CashApp</a>), PayPal has entered the game.</p>
<p>When Apple, Google, Microsoft, and Facebook?</p>
<p>11/ Normal people use Bitcoin as a savings technology</p>
<p>Rather than staying wave-slaves, normal people can store the fruits of their labor in an asset that preserves their time & energy.</p>
<p>12/ Ostrisziced nations need Bitcoin to trade</p>
<p>The dollar hegemony excludes enemies from participating in the global financial system. Bitcoin is an open financial system, accessible to all.</p>
<p>Example: Iran is paying for imports by monetizing energy assets through Bitcoin mining.</p>
<p>13/ Banks adopt Bitcoin to stay relevant</p>
<p>Old banking is dead, digital mobile banking (Cash app, etc) is the future. CBDCâs are coming. Low-interest rate environments squeeze commercial bank margins.</p>
<p>Jamie Dimon should have stayed humble and stacked some sats.</p>
<p>14/ Humanitarians adopt Bitcoin to empower the disenfranchised</p>
<p>Billions of individuals donât have access to basic financial services (or are opressed by their gov)</p>
<p>Entrepreneurs like <a href="https://twitter.com/raypaxful">@raypaxful</a> leverage Bitcoin (and other tools) to âbank the unbankedâ in developing countries.</p>
<p>15/ Politicians support Bitcoin because their constituents demand it</p>
<p>As more citizens own Bitcoin, theyâll elect more representatives who support Bitcoin.</p>
<p>When powerful people own Bitcoin, they ensure favorable laws.</p>
<p><img src="/assets/images/2020/m11/bq4.png" alt="" /></p>
<p>16/ Boomers need Bitcoin to protect their net egg</p>
<p>Pensions and Social Security are underfunded. Boomers need Bitcoin to retire with peace of mind.</p>
<p>17/ Governments will adopt Bitcoin as a hedge against currency failure</p>
<p>Just as governments and central banks hold Gold today, Bitcoin will serve as a hedge against state failure.</p>
<p>Small nations will adopt Bitcoin to leapfrog ahead of nocoiner nations.</p>
<p>18/ Environmentalist will adopt Bitcoin to preserve the planet</p>
<p>The fiat system produces massive negative externalities on the environment.</p>
<p>Bitcoin reduces flared methane, reduces waste, incentives R&D for low-cost energy production, and minimizes fiat externalities.</p>
<p>19/ Americans adopt Bitcoin because it preserves âAmerican Valuesâ</p>
<p>Bitcoin is a tool that empowers an individualsâ life, liberty, and the pursuit of happiness.</p>
<p>Whatâs more American than that?</p>
<p>20/ Cyber Hornets protect Bitcoin because it enables a better world.</p>
<p>Driven by curiosity, seeking truth, and fighting for freedom, the cyber hornets defend the network at all costs.</p>
<p><img src="/assets/images/2020/m11/bq5.png" alt="" /></p>
<p>21/ What else (besides Bitcoin) aligns humanitarians, billionaires, governments, environmentalists, and cyber hornets?</p>
<p>Each group offers unique advantages that strengthen the network.</p>
<p>Each marginal users improves the chance of success.</p>
<p>22/ âShow me the incentives and Iâll show you the outcome.â</p>
<p>Bitcoin is a force of nature that systematically aligns the incentives of the human race.</p>
<p>Bitcoinâs global dominance is all be guaranteed.</p>
<p>END/ Thanks for the inspiration.</p>
<p>@Breedlove22 @michael_saylor @matt_odell @hasufl @nlw @raypaxful @JeffBooth @chamath @MartyBent and many more.</p>
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<!--End mc_embed_signup-->Brandon QuittemBrandon Quittem explores the incentives of Bitcoin. Posted November 14, 2020.Banks, QE, and Money-Printing2020-11-22T00:00:00+00:002020-11-22T00:00:00+00:00https://bitcoinwords.github.io/banks-qe-and-money-printing<table class="notice--info">
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<h1 id="banks-qe-and-money-printing"><a href="https://www.lynalden.com/money-printing/">Banks, QE, and Money-Printing</a></h1>
<h3 id="by-lyn-alden">By <a href="https://twitter.com/LynAldenContact">Lyn Alden</a></h3>
<h3 id="posted-november-22-2020">Posted November 22, 2020</h3>
<p><img src="/assets/images/2020/m11/la1.png" alt="Banks, QE, and Money-Printing" /></p>
<p>Lately, it has become fashionable to debate what is, or is not, âmoney-printingâ by central banks.</p>
<p>This debate is natural, due to the extreme policy nature of 2020, with massive fiscal expenditures, huge increases in central bank balance sheets, and changes in central bank inflation targets. Itâs important to know what is inflationary, and what isnât, and to what extent.</p>
<p>Because people have very different understandings of how central bank policy and fiscal policy work, there have been analyst calls this year ranging from hyperinflation to deep deflation, and everything in between.</p>
<p>The outcome has of course been somewhere in the middle as measured by CPI or PCE, with inflation that rebounded from March lows in response to policy, but neither much of an overshoot or undershoot, and still generally below long-term central bank inflation targets.</p>
<p>Many inflation categories for the most essential and non-outsourced goods and services, however, have risen faster than the overall basket this year, and in recent years.</p>
<p>The crux of this article is that quantitative easing on its own, and quantitative easing combined with massive fiscal deficits, are two very different situations to consider when it comes to analyzing the possibilities between inflation and deflation, and what constitutes âmoney printingâ.</p>
<h2 id="the-deflationary-backdrop">The Deflationary Backdrop</h2>
<p>Before diving into the mechanisms of money-printing, it helps to set the stage. Context is key.</p>
<p>Historically speaking, weâre coming down from the apex of, and currently within the lengthy resolution process of, a <a href="https://www.lynalden.com/fiscal-and-monetary-policy/">long-term debt cycle</a>, which refers to a multi-decade peak in public and private debts relative to the size of the economy and money supply. This occurs in the aftermath of when interest rates hit zero.</p>
<p>Weâve been in this resolution process for the past 12 years, and the previous time before that was the two-decade period of the 1930âs and 1940âs where we hit the previous apex of a long-term debt cycle.</p>
<p>Here is total debt as a % of GDP in the United States over the past century in blue on the left axis (all debts, public and private), along with short-term interest rates in orange on the right axis:</p>
<p><img src="/assets/images/2020/m11/la2.png" alt="Long Term Debt Cycle Policy" /></p>
<p><em>Data Sources: U.S. Treasury Department, U.S. Federal Reserve</em></p>
<p>And here is total debt as a % of the broad money supply, which shows the structural peaks of each cycle even more clearly (since policymakers have more influence over broad money supply than GDP, due to shifting monetary velocity):</p>
<p><img src="/assets/images/2020/m11/la3.png" alt="Debt vs M2 vs Rates Policy" /></p>
<p><em>Data Sources: U.S. Treasury Department, U.S. Federal Reserve</em></p>
<p>If we break out federal debt from non-federal debt (households, businesses, states, financial leverage, etc), we see two distinct peaks in each long-term cycle. Non-federal debt (orange line) peaks first in a commercial banking crisis (early 1930âs and late 2000âs), and then federal debt (blue line) peaks many years later in a sovereign debt crisis (mid-1940âs and ???-2020âs):</p>
<p><img src="/assets/images/2020/m11/la4.png" alt="Debt Devaluation Policy" /></p>
<p><em>Data Sources: U.S. Treasury Department, U.S. Federal Reserve</em></p>
<p>There are a lot of deflationary forces on consumer prices in the economy:</p>
<ul>
<li>High private debt levels are deflationary, since it makes consumers and businesses financially restrained and risk-adverse.</li>
<li>Slowing population growth and aging demographics are deflationary, since resource demand slows.</li>
<li>Technology is deflationary, since it makes some things cheaper and better.</li>
<li>Wealth concentration into fewer hands is deflationary, since money coalesces rather than circulates.</li>
<li>Commodity oversupply is deflationary, since it cheapens the building blocks we use for everything else.</li>
<li>Outsourcing is deflationary, since it lowers labor costs of goods and puts downward pressure on domestic wages.</li>
</ul>
<p>In a low-debt system, structural deflation for some of the positive reasons, such as technological improvement, would be a good thing. It means your moneyâs purchasing power grows over time, as higher productivity from technological enhancements lowers the cost of goods or improves their quality, so you get more value for your dollar.</p>
<p>However, in an extraordinarily high-debt system (which requires a lot of central policy intervention in the first place to be able to get up that high), deflation breaks things and results in widespread defaults, because the cost of servicing debts goes up relative to cash flows.</p>
<p>So, fiscal and monetary policymakers deliberately push back on deflationary forces with inflationary policy, especially when it gets to those extremes. And there are a few definitions or types of inflation that we can identify.</p>
<p>Monetary inflation refers to the growth of the broad money supply, which can be calculated in a few ways but is pretty straightforward.</p>
<p>Asset price inflation refers to bubble-like increases in the prices of financial assets, like stocks, bonds, gold, private equity, fine art, and so forth. This is a bit more subjective because valuations on assets can vary, but there are various ratios to keep track of it in a broad sense.</p>
<p>Consumer price inflation refers to a broad rise in the prices of everyday goods and services, and people debate about how it should be measured. The government uses CPI and PCE calculations on a basket of goods, but those use various substitutions. There are alternative calculations that donât use substitutes, which generally lead to higher figures.</p>
<p>Each household has their own unique basket of consumer goods and services that they buy. For research purposes, I calculated that my personal household consumer price inflation rate averaged about 3% per year over the past two years, taking into account our total purchases of non-investment goods and services.</p>
<h2 id="qe-alone--bank-recapitalization">QE Alone = Bank Recapitalization</h2>
<p>Going into the 2008 crisis, U.S. banks were extremely leveraged, with very low bank reserves.</p>
<p>Large bank cash levels equaled just 3% of their assets (blue line below; cash as a percentage of total assets), and large bank holdings of Treasuries as a percentage of assets were pretty low historically as well (red line; treasury securities as a percentage of total assets):</p>
<p><img src="/assets/images/2020/m11/la5.png" alt="Bank Cash and Treasury Levels" /></p>
<p><em>Chart Source: St. Louis Fed</em></p>
<p>So, leading into the financial crisis, only about 13% of their assets consisted of cash (3%) and Treasury securities (10%). The rest of their assets were invested in loans and riskier securities. This was also at a time when household debt to GDP reached a record high, as consumers were caught up in the housing bubble.</p>
<p>That over-leveraged bank situation hit a climax into the 2008/2009 crisis, coinciding with record high debt-to-GDP among households, and was the apex of the long-term private (non-federal) debt cycle. When banks are that leveraged with very little cash reserves, even a 3% loss in assets results in insolvency. And thatâs what happened; the banking system as a whole hit a peak total loan charge-off rate of over 3%, and it resulted in a widespread banking crisis.</p>
<p>However, banks were bailed out via QE and the Troubled Asset Relief Program. It was a top-down, anti-deflationary bank industry bailout, but not a bottom-up, pro-inflationary real economy bailout. TARP boosted bank solvency, and QE boosted bank liquidity.</p>
<p>As the crisis played out and some banks failed and others were bailed out, regulators wanted to increase bank reserve requirements and capital requirements, requiring banks to hold a greater percent of their assets in cash reserves and other safe assets. The problem with that, however, is that banks canât just magically boost up their reserves; they would have to sell other assets to get cash, but if every bank in the system sells assets to get cash, who do they sell to, and where would so much cash come from to buy what they sell?</p>
<p>In other words, while itâs possible for an individual bank to boost its reserves by selling assets to raise capital, itâs mechanically impossible for the entire banking industry to collectively raise its reserves industry-wide.</p>
<p>So, in the role of lender/buyer of last resort, the Federal Reserve created new cash reserves out of thin air, gave them to the banks, and took some of their Treasuries and mortgage-backed securities in return, aka quantitative easing or QE. Along with TARP, this recapitalized banks, bringing them from 3% cash as a percentage of assets at the start of 2008, to 8% by the end of 2008. The Fed did further rounds of QE through 2014 that brought banks collectively up to 15% cash levels, which brought them up to frothy levels of excess reserves.</p>
<p>This, however, didnât result in more money chasing fewer goods and services, and therefore wasnât particularly inflationary for every prices. The money remained mostly internal to the banking system, at higher reserve levels. Broad money supply didnât increase rapidly.</p>
<p>Many analysts that were worried about inflation missed the fact that the transmission mechanism from QE to the real economy was small, so this was mostly just a bank-recapitalization process. Banks and their executives got a nice assist from the Fed and Treasury, but the broad public did not. Banks didnât lend much of the money out (nor was there a ton of creditworthy demand for them to do so), and fiscal spending didnât go around the banking channel very much either.</p>
<p>A similar version of this played out in the 1930âs, which was the previous time that interest rates hit the zero bound at the apex of a long-term private debt cycle. The banking system collapsed back then too, so policymakers devalued the dollar vs the gold peg, expanded the monetary base, and recapitalized banks during a banking holiday. This was enough to offset the deep deflation that was happening in the early 1930âs, and turn it back into a reflationary trend in the mid-1930âs, but not enough to cause rapid broad consumer price inflation. It was anti-deflationary, in other words, but not outright inflationary.</p>
<h3 id="the-inflation-fake-out">The Inflation Fake-Out</h3>
<p>All told, the Fed expanded their balance sheet by about $3.5 trillion from mid-2008 to the end of 2014. They created new bank reserves to buy Treasuries and mortgage-backed securities.</p>
<p>Many folks thought this would be hyperinflationary, Weimar Republic style. So, they bid up the price of gold rather high. Iâm glad they felt that way, because I sold my gold to them in 2011, during a period of very high sentiment. Itâs the only time I sold physical bullion. I wanted to load up on historically cheap stocks instead.</p>
<p>Here was the gold price relative to my model (i.e. orange area way above blue line):</p>
<p><img src="/assets/images/2020/m11/la6.png" alt="Gold Valuation Model" /></p>
<p><em>Data Source: St. Louis Fed</em></p>
<p>And here were stock valuations relative to fundamentals:</p>
<p><img src="/assets/images/2020/m11/la7.png" alt="Stock Valuations" /></p>
<p>Of course, this QE ended up not being outright inflationary for consumer prices, for reasons described before. It was anti-deflationary, rather than outright inflationary. Along with low rates, it was somewhat inflationary for asset prices, but not most consumer prices. Thatâs how it worked in the 1930âs, too.</p>
<p>We can put some broad numbers on it. From 2007 to 2009, there was a $11 trillion decline in U.S. household net worth, as it fell from $71 trillion to $60 trillion, due to a decline in stock and house prices. It then took about five years for U.S. household net worth to recover to previous highs. This was $11 trillion in deflationary wealth destruction (plus technology improvements, and commodity oversupply, tightened credit for home equity loans, and other deflationary forces), up against the response of $3.5 trillion in Fed bank reserve creation or QE. Of course it wouldnât be hyperinflationary.</p>
<p>Morally hazardous? Sure. Hyperinflationary? No.</p>
<p>Moreover, as previously-described, most of the $3.5 trillion never entered the broad money supply because there was no major fiscal transfer mechanism, so it mostly just stayed in bank reserves. It offset a deflationary shock and bank collapse by recapitalizing the banking system with higher levels of solvency and liquidity (and thus was anti-deflationary), but it was not outright inflationary.</p>
<h3 id="bank-reserve-example">Bank Reserve Example</h3>
<p>Banks, in practice, are limited in how much leverage and risk they can take by their regulatory capital requirements. In this model, there are some very low-risk assets (like bank reserves, Treasury securities, and gold) that donât count against the bankâs risk level, and there are higher-risk assets (like personal loans, or corporate bonds) that do count against a bankâs overall risk level. Banks need to maintain an appropriate balance of assets to avoid being considered too risk-heavy.</p>
<p>In some regulation regimes, banks can also be constrained by reserve requirements, meaning that banks are required to have a certain percentage of deposits stored as cash reserves.</p>
<p>Suppose that there is a regulatory rule which says that all banks must have an amount of cash equal to 5% of their customer bank deposits (which are liabilities for banks; owed to their customers) held in reserve at the Federal Reserve. So, if a bank has $100 billion in customer bank deposits held with them (which are liabilities for the bank), and $110 billion in assets (and so they have $10 billion more assets than liabilities), they can put up to $105 billion of their assets into various forms (making loans, buying securities, etc), but must hold at least $5 billion in cash reserves at their account with the Fed.</p>
<p>Here is a reserve-constrained bank example. A bank has $100 billion in deposits (liabilities), and $110 billion in assets. Of their assets, $5 billion is in cash reserves, $20 billion is in Treasuries, $10 billion is in mortgage-backed securities, and $75 billion is in other assets (personal loans, mortgage loans, corporate loans, and/or whatever else). This bank canât lend anymore, until either it collects more deposits which would also boost reserves, or sells some existing assets. It is therefore reserve-constrained. It might want to lend, and has good client demand to lend money to, but it simply canât leverage itself anymore. If the Fed were to create $5 billion in brand new reserves (aka QE) and buy $5 billion of their Treasuries or mortgage-backed securities, it would alleviate their reserve-constrained status, and the bank could use that $5 billion to lend more, or buy more securities. This would be economically stimulative if the bank wants to lend money, because now the bank can go ahead and lend that money, and thus create deposits somewhere in the system and increase the broad money supply.</p>
<p>Here is a non-reserve-constrained example. A bank has $100 billion in deposits (liabilities) and $110 billion in total assets. Of their assets, $15 billion is in cash reserves, $20 billion is in Treasuries, $10 billion is in mortgage-backed securities, and $65 billion is in other assets. This bank has $10 billion in excess reserves above the $5 billion requirement; extra money it can lend. Maybe it doesnât want to lend right now; it doesnât see any good risk-adjusted loans to make. Or maybe there isnât a lot of demand from its clients to borrow money. So, itâs just holding that extra $10 billion as excess reserves, in addition to their $5 billion required reserves. If the Fed were to do QE and buy $5 billion of their Treasuries, and bring the bank up to $20 billion in reserves, it wonât affect how much they lend, because they werenât reserve-constrained to begin with. This would not be stimulative and would not increase the broad money supply, since it doesnât coerce the bank to make any more loans.</p>
<p>That is why QE alone isnât inflationary. Increasing bank reserves does not necessarily increase the broad money supply. A rapidly increasing broad money supply along with constraints on the supply of goods and services, is what can lead to inflation.</p>
<p>There are two ways to increase broad money supply. Either banks need to lend, or the federal government can go around them and run big fiscal deficits. At the apex of a long-term debt cycle, the latter tends to happen.</p>
<h2 id="qe--fiscal-stimulus--money-printing">QE + Fiscal Stimulus = Money Printing</h2>
<p>Now in 2020, in the next recession twelve years after the 2008 banking crisis, weâre back at it and bigger than before, but with a twist.</p>
<p>This time, going into the crisis, the banking system was already well-capitalized. The percent of bank assets that consist of cash and Treasuries was already historically high. So, unlike 2008, banks werenât over-leveraged. However, the broader economy was over-leveraged, and the pandemic hit the broader economy.</p>
<p>Millions of people became unemployed, and countless businesses faced insolvency risk as their cash flows collapsed. For the Fed to simply buy Treasuries and MBS from banks wouldnât do almost anything for this, because itâs not a bank recapitalization issue, and there would be no transmission mechanism to the public. Banks were already well-capitalized, and so the banks werenât reserve-constrained.</p>
<p>Instead, this time, fiscal authorities (Congress and the President) spent trillions of dollars into the real non-bank economy, sending folks stimulus checks, boosting unemployment benefits by an extra $600/week (which is $2,400/month for several months for folks who received it), financing banks to give small businesses PPP loans that mostly turn into grants, and partially bailing out some of the hardest-hit corporate industries with fresh capital injections. It was a much larger stimulus than anything from 2008/2009.</p>
<p>The way that the governmentâs accounting works in the current legal structure, is that they have to issue a lot of Treasury securities to fund that expenditure. However, the foreign sector was not really buying Treasuries, and in fact were selling some Treasuries early this year. So, who would be available to buy $3 trillion in extra Treasury securities this year?</p>
<p>Enter the Fed again. When the Treasury market became illiquid in March from foreigners and hedge funds selling Treasuries against a backdrop of insufficient buyers, the Fed stepped in, and created $1 trillion in brand new bank reserves out of thin air to buy $1 trillion in Treasuries over a 3-week period. This was the most rapid asset-purchase program the Fed has ever done. And then they tapered that rate but kept buying Treasuries for months to soak up the massive 2020 Treasury issuance that funded all the stimulus, and are still buying tens of billions of dollars of Treasuries monthly with newly-created bank reserves to this day.</p>
<p>So, the Fed once again increased its balance sheet (this time by nearly $3 trillion in just three months) to buy a large chunk of Treasuries, plus some other assets like mortgage-backed securities and a handful of corporate bonds. About $2 trillion, or 2/3rds of this 2020 balance sheet expansion so far, consisted of buying Treasuries. But what made this one different, was that it didnât just stay in the banking system to recapitalize banks. It flowed through banks to the U.S. Treasury Department, which injected that money directly into the economy as authorized by Congressâ CARES Act.</p>
<p>This following chart shows the year-over-year change (in billions of dollars) of total U.S. commercial bank deposits in blue, government transfer payments in green, and the Fedâs balance sheet in red:</p>
<p><img src="/assets/images/2020/m11/la8.png" alt="QE and Fiscal Money Printing" /></p>
<p><em>Chart Source: St. Louis Fed</em></p>
<p>That chart is critical to see why 2020 and 2008 were quite different, and why the policy response acted so much quicker and more powerfully on financial markets and personal income this time. Personal income and net worth on a nationwide scale went up, rather than down, in 2020 so far.</p>
<p>In 2008-2014, there was a lot of QE (red line going up), but those dollars didnât get out into public bank deposits (which is what mostly makes up the broad money supply). This was because there was little or no fiscal transmission mechanism; the government wasnât sending huge checks to people. So, the green line (year-over-year change in government transfer payments) and blue line (year-over-year change in bank deposits) remained low. The QE process in 2008 mostly just recapitalized banks.</p>
<p>However, 2020 was a very different story. The government sent out tons of money directly into the economy, and financed it by issuing Treasury bonds that the Federal Reserve created new bank reserves to buy. For legal reasons, the Fed buys those securities on the secondary market, but that doesnât make much of a difference in practice; itâs where they end up and remain that matters. The banks that buy them from the Treasury and sell them to the Fed just act as pass-through entities in this case.</p>
<p>So, the blue, green, and red lines all went vertical in 2020, unlike the 2008-2014 period. The government sent money to people and businesses (green line), that money showed up in their bank deposits (blue line) and thus in the broad money supply, and the Fed created new bank reserves to buy a lot of the Treasury securities issued to fund that program (red line).</p>
<p>Or, put simply, the broad money supply went up a lot in 2020, but didnât budge nearly as much in 2008/2009 (in either absolute or percent terms), because QE alone to recapitalize banks, and QE-financed fiscal stimulus into the real economy, are two very different situations:</p>
<p><img src="/assets/images/2020/m11/la9.png" alt="M2 Growth 2008 vs 2020" /></p>
<p><em>Chart Source: St. Louis Fed</em></p>
<p>Many people who saw the inflationary non-event from 2008-2014, are suggesting that QE is inherently deflationary, and that it wonât cause inflation this time either.</p>
<p>Iâm glad many people feel that way, because Iâm happy to buy their gold from them on dips. I bought plenty of precious metals back in 2018 and have cooled my purchases since then due to the notable uptick in price, but am still happy to dollar-cost average into them at these prices, or buy on dips. I also like cheap natural resources more broadly, as well as high-quality equities, real estate, Bitcoin, and other scarce assets for a diverse mix, with a long-term view.</p>
<p>In my view, the âQE is deflationary; it only increases bank reserves!â position is from not taking into account the fiscal element; the transmission mechanism that gets QE into the hands of the public rather than stuck in the banking system. QE alone is not inflationary and mostly stays in bank reserves, but QE combined with massive fiscal deficits, is inflationary, and gets the funds out into the broad money supply, out into commercial bank deposits of the public.</p>
<p>Basically, massive fiscal spending combined with the central bank buying lots of sovereign bonds to fund it, is a modern monetary theory âMMTâ program in practice, for the first time since the 1940âs when the equivalent of âwartime MMTâ was used.</p>
<p>Now, bear in mind that this is still up against large deflationary forces: technology, demographics, debt, and shifting consumer behavior around the pandemic. So, even a one-time pro-inflationary $3 trillion injection into the real economy is merely enough to cause a quick rebound in inflation and a sharp recovery in asset prices, as we saw in 2020 from the March lows. Combined with certain supply limitations, it also helped cause non-discretionary prices to rise: grocery price inflation in particular was rather significant this year.</p>
<p>However, a one-time $3 trillion injection is not enough to cause a persistent trend change in inflation. Those deflationary forces outweigh it. There is not yet a situation of too much money chasing too few goods and services, except in niche areas. The stimulus delayed an insolvency crisis for several months and got consumers through the worst 3-4 month period of the economic shutdowns.</p>
<p>If we look over the past century, we can see that the two inflationary decades (the 1940âs and 1970âs) occurred when broad money rose rapidly. This chart shows the 5-year rolling cumulative percent increase in the consumer price index and in broad money supply per capita:</p>
<p><img src="/assets/images/2020/m11/la10.png" alt="M2 vs CPI Rolling 5-Year Growth" /></p>
<p><em>Data Source: U.S. Federal Reserve</em></p>
<p>Therefore, the big question for investors in multiple asset classes, is whether the fiscal authorities will keep repeating that on a notable scale, or whether they will cool off. Without the massive fiscal+QE âMMTâ combo, the economy remains in the grip of structural disinflation, and a renewed cyclical disinflationary trend. However, with another round of massive fiscal+QE âMMTâ combo, the outcome would likely be more of what we saw in spring/summer of 2020: rebounding inflation and asset prices, and likely eventually pushing too far.</p>
<p>Ultimately, with so much debt in the system and the weight of private debt, policymakers are likely to be forced to do more rounds of fiscal stimulus (either from civil unrest or political donors), but the timing for that is something that investors need to work around when it comes to assessing the inflationary or disinflationary outlook for the next couple quarters ahead.</p>
<p>Right now, with money velocity so low and the pandemic still raging, and plenty of commodity oversupply particularly in regards to oil, it may seem like there is a limitless sink for broad money creation without leading to sustained consumer price inflation. However, that can change a couple years down the line, as the world fully emerges from pandemic effects, after years of not putting much capital into resource development.</p>
<p>Itâs also worth noting that âfiscal stimulusâ in this sense refers to both spending and taxation. In other words, federal deficits. A fiscal stimulus could include giving everyone a $1,200 check, or could include giving everyone a $1,200 payroll tax cut, for example. The differences between those two mechanisms matter around the margins (particularly for the unemployed, who wouldnât benefit from a payroll tax cut), but for large chunks of the 150 million working population, a stimulus check and a payroll tax cut are functionally similar throughout the course of a year, and result in more cash in the hands of most people. These policies increase the amount of broad money, not just bank reserves.</p>
<p>When it comes to fiscal stimulus, regardless of whether it takes the form of taxation or spending changes, its stimulatory impact and inflation outcomes are mostly a question of magnitude, as well as who it primarily targets (unemployed, working class, middle class, wealthy, or rich). Itâs inflationary, against the deflationary backdrop, and so whether the outcome shifts to inflation or remains disinflationary becomes a question of scale and persistence, and whether it increases productive capacity or not.</p>
<h2 id="rules-are-meant-to-be-broken-bent">Rules Are Meant to Be⊠Broken? Bent?</h2>
<p>In my view, focusing on some of the mechanics of the Fedâs QE combined with fiscal injections is like focusing on the trees and missing the forest.</p>
<p>This is because at the end of a long-term debt cycle, policymakers do whatever they need to in order to avoid a deflationary collapse and get towards some degree of reflation and devalued debt levels.</p>
<p>The Federal Reserve Act doesnât allow the Fed to buy corporate bonds. And yet, the Fed bought corporate bonds this year.</p>
<p>How did the Fed do that? They worked with the Treasury and Congress, set up a Special Purpose Vehicle, and bought corporate bonds through that vehicle, with any defaults on those bonds funded by the Treasury so the Fed doesnât face the risk of nominal losses.</p>
<p>People saying this violates the Federal Reserve Act are, unfortunately, falling on deaf ears.</p>
<p><img src="/assets/images/2020/m11/la11.png" alt="Nobody Cares Meme" /></p>
<p>Policymakers went around the spirit of the Federal Reserve Act, but perhaps not the letter of the law due to the structure involved. Itâs perhaps not surprising that the heads of the worldâs two biggest central banks, the Fed and the ECB, are both lawyers rather than economists.</p>
<p>I personally think that the Fed buying corporate bonds was not a good part of the overall policy response, and sets a bad precedent and moral hazard. But, it happened nonetheless, and it is during the apexes of long-term debt cycles that these sorts of âexceptionsâ tend to happen.</p>
<p>The Fed has legal limitations on its own, which is good. However, when the Fed works closely with the Treasury Department and Congress to combine fiscal and monetary policy, all bets are off. They worked together closely in 1940âs decade to fund World War II in the second half of the previous long-term debt cycle apex, and they did so again here in the new 2020âs decade.</p>
<p>Love it or hate it, that Treasury+Fed combo is extremely powerful and bypasses just about any limitation that the Fed alone has. The Fed can lend but canât spend. The Treasury can spend, but if it spends a ton and issues more sovereign debt than there is demand for, it needs the Fed to buy some of its sovereign debt issuance (using primary dealer banks as pass-through entities). The Fed canât buy certain securities, particularly those that could lead to nominal losses, but with a special purpose vehicle and a financial backstop by the Treasury, they can. Together, they can create new money, and inject it to whoever they want.</p>
<p>Many people think that the broad money supply is only able to increase when banks lend money and create deposits. However, ironically, the biggest increases in the broad money supply historically happen when things are terrible and so banks *arenât* lending much, and thus when the money multiplier (broad money divided by base money) is low.</p>
<p>At those times, the federal government runs massive fiscal deficits, and goes around the bank lending channel to either tax less from the economy or inject more money into the economy (historically they choose the latter), and finances its massive deficits by having the Federal Reserve create new bank reserves to buy a large chunk of its Treasury debt issuance.</p>
<p>This chart highlights that, by showing the money multiplier on the left axis, with federal deficits as a percent of GDP, and year-over-year percent increase in the broad money supply, on the right axis:</p>
<p><img src="/assets/images/2020/m11/la12.png" alt="Bank Lending Channel" /></p>
<p><em>Data Sources: U.S. Treasury Department, U.S. Federal Reserve</em></p>
<p>However, when it comes to investment timing, sometimes focusing on the mechanics is helpful. So, letâs dive into some of those mechanics.</p>
<h2 id="bank-reserve-accounting">Bank Reserve Accounting</h2>
<p>Bank reserves, referring to the accounts that commercial banks have with the Federal Reserve, are strange beasts because of how unintuitive they are.</p>
<p>In fact, even the very definition of âmoneyâ is subject to debate. There are multiple ways to define âmoneyâ in the modern banking system.</p>
<p>The monetary base, and the broad money supply, are the two most important definitions, so letâs quantify them for context.</p>
<h3 id="base-money">Base Money</h3>
<p>The monetary base is the foundation, and consists of physical currency in circulation (currently around $2 trillion) and cash reserve deposits that the commercial banking system has with the Fed (currently around $2.8 trillion).</p>
<p>Although not part of the original definition, because the Treasuryâs general account âTGAâ with the Fed has grown in size and importance in recent years (currently $1.7 trillion), we functionally should include that as well, since itâs another cash deposit with the Fed. Those three buckets combined are $6.5 trillion in âbase moneyâ.</p>
<p>All three of these buckets of base money (currency in circulation, bank reserves with the Fed, and the Treasuryâs general account with the Fed) are the Fedâs biggest liabilities. On the other side of the Fedâs ledger, Treasuries and mortgage-backed securities represent most of the Fedâs assets.</p>
<p>If we look at these major Fed liabilities separately, with the TGA in blue, bank reserves in red, and currency in circulation in green, it looks pretty random:</p>
<p><img src="/assets/images/2020/m11/la14.png" alt="Federal Reserve Liabilities" /></p>
<p><em>Chart Source: St. Louis Fed</em></p>
<p>However, thereâs a method to the madness, and the Fed controls the total sum.</p>
<p>This next chart shows the sum of those three lines, meaning currency in circulation, commercial bank reserves with the Fed, and the Treasuryâs general account with the Fed (which are collectively the main liabilities of the Fed) in blue, and shows the Fedâs total assets in red (which mostly consists of Treasuries and mortgage-backed securities):</p>
<p><img src="/assets/images/2020/m11/la13.png" alt="Federal Reserve Assets and Liabilities" /></p>
<p><em>Chart Source: St. Louis Fed</em></p>
<p>Bank cash reserves at the Fed are fungible with each other. As folks like you and I use various payment systems to transact with each other, our banks use reserves to settle with each other behind the scenes.</p>
<p>Bank reserves are also fungible to some extent with currency in circulation. In fact, thatâs one of the initial reasons for banks to have reserves in the first place: in case tons of people want to withdraw money at once. In theory, if we all wanted to go and take out some of our bank cash at once, it would come from bank reserves. However, in practice, the amount of minted physical currency is limited (mostly on purpose), so if there was a bank run, consumers would quickly find themselves limited in how much cash they would physically be allowed to withdraw, as the bank runs out of vault cash. But basically, physical currency and bank reserves are fungible.</p>
<p>Bank reserves are fungible with the Treasury general account as well. When the Treasury issues a lot of bonds and pulls capital into its account, it sucks it out of bank reserves. When it eventually spends down its account, those funds wind up back in bank reserves.</p>
<h3 id="broad-money">Broad money</h3>
<p>The broad money supply, on the other hand, is currently $18.8 trillion, which is far larger than the base money amount. This broad money calculation consists of currency in circulation, but then also includes the massive amounts of checking deposits, savings deposits, and various functional cash-equivalents that consumers and businesses hold at commercial banks. This is the broader set of money that we consumers actually use to transact with each other and store our capital and define as our âmoneyâ.</p>
<p>The blue line below shows the broad money supply. The red line shows commercial bank deposits, and the green line shows physical currency in circulation. The red line and green line added together roughly equal the blue line.</p>
<p><img src="/assets/images/2020/m11/la15.png" alt="M2 Broad Money Supply" /></p>
<p><em>Chart Source: St. Louis Fed</em></p>
<p>When the Fed does QE alone, it increases bank reserves in the system, but doesnât necessarily increase the broad money supply. The broad money supply only increases when either a) banks create more money by making loans or b) the federal government runs big fiscal deficits to inject money to people and businesses in the system. Many people miss that second one; they assume that money supply can only increase if banks lend, which isnât correct.</p>
<h3 id="conservation-of-reserves--currency--tga-base-money">Conservation of Reserves + Currency + TGA (Base Money)</h3>
<p>For the most part, only the Fed can determine the sum of commercial bank reserves + currency in circulation + the Treasuryâs general account, hereby referred to as âbase moneyâ.</p>
<p>Think of these three forms of base money as buckets of water. The total amount of water can move around between the three buckets if we pour one into another, but is conserved within the total three-bucket system. Only the Fed can increase or decrease the total amount of water in the total three-bucket system.</p>
<p><img src="/assets/images/2020/m11/la16.png" alt="Base Money 3 Bucket Analogy" /></p>
<p>The purpose of modern banks is to âmultiplyâ base money into broad money, and make a profit along the way. We can call this the âmoney multiplierâ, defined as the broad money supply divided by the base money supply.</p>
<p>When a bank makes a loan to someone, it becomes another bankâs deposit, and the loaning bank sends the reserve amount to the depositing bank, and increases the total amount of commercial bank deposits and broad money in the system. So, when they âloan reservesâ, banks collectively donât actually reduce total bank reserves in the banking system; they just lever those reserves up with a higher money multiplier, and change the location/ownership of those reserves.</p>
<p>Any individual bank can leverage itself (up to a limiting point where it still meets capital and reserve requirements) by lending money or buying securities, and thus reducing its excess cash reserves at the Fed. However, when they make these loans or buy those assets, they create deposits somewhere else in the financial system, and those deposits become reserves of other banks. Similarly, a bank could sell assets and increases its cash reserves, but in doing so, some other bank deposits would be drained to buy those assets, which would reduce reserves somewhere else in the system.</p>
<p>Therefore, the banking system as a whole canât decide to collectively increase or decrease the system-wide amount of bank reserves, even though any individual bank can alter its own level of reserves. They can collectively increase the money multiplier (the broad money supply divided by base money) by making more loans or buying more securities, but they canât change the total system-wide bank reserves. They can just move them around, and leverage them up, or deleverage them.</p>
<p>Similarly, the U.S. Treasury can determine the size of its general account at the Fed. To increase it, they can issue Treasuries, bring in a lot of cash, and then hold the cash in that account at the Fed for a while before spending it. This sucks bank reserves out of the system, on a 1:1 basis with the general account increase. When they eventually reduce the general account by spending more than they take in, that money goes into peoplesâ and companiesâ bank accounts and thus winds up back in bank reserves.</p>
<p>The public can theoretically pull money out of excess bank reserves into physical currency, or deposit physical currency into banks which would wind up as more reserves, like water flowing back and forth between those two buckets of base money. In practice, however, physical currency is limited on purpose, so if the public collectively tries to pull bank reserves out into physical currency, they get told by the bank teller that they canât, because thereâs a nationwide shortage of physical currency.</p>
<p>The Fed, however, can create new base money, and thus add more total water to the three-bucket system analogy, by performing quantitative easing or âQEâ. To do this, they create new bank reserves out of thin air, and then buy existing assets, like Treasuries or mortgage-backed securities with those new reserves. After this asset swap, the reserves become owned by a commercial bank (and thus become the Fedâs liabilities), and the securities become owned by the Fed (and thus become the Fedâs assets). In this process, the Fed increases their total assets (the securities they are buying) and increases their liabilities (the new reserves they are creating) by the same amount.</p>
<p>The Fed can also decrease base money, or destroy water in the three-bucket system analogy, by performing quantitative tightening âQTâ. To do this, they sell or let some of their Treasuries or mortgage-backed securities mature and get their principle back. They then retire that cash. In this process, both the Fedâs assets and liabilities decrease.</p>
<p>In a vacuum, neither QE nor QT alone directly affects the broad money supply; it just affects the base money amount.</p>
<p>However, if the federal government is running very large fiscal deficits and the Fed is creating new bank reserves to buy the Treasury issuance to fund those deficits, it directly creates new broad money (and thus goes around the bank lending channel).</p>
<p>On the other hand, if the federal government were to run big fiscal surpluses on a sustained basis (i.e. tax more than they spend by a lot), at a time when banks arenât lending much either, they can theoretically decrease the total amount of broad money. This would be very rare, if ever, to occur. Additionally, widespread bank collapses without any bailout or FDIC insurance can also theoretically reduce broad money, which happened in the early 1930âs.</p>
<h2 id="bank-reserve-accounting-examples">Bank Reserve Accounting Examples</h2>
<p>This section gets gritty. Iâll work through six examples of bank lending, QE, and fiscal deficits, to help show which types of actions by banks, the Fed, and the government, can influence the amount and location of bank reserves and broad money supply in the system.</p>
<table>
<tbody>
<tr>
<td>For each example, I have two people, Mary and Sara, the two banks they do business with, the Fed, and the U.S. Treasury. Each of these six entities has a column that represent each of their assets and liabilities âA</td>
<td>Lâ.</td>
</tr>
</tbody>
</table>
<p>Each example is a small closed-loop financial system. Each block in an entityâs asset or liability column represents $1,000 of value.</p>
<ul>
<li>âDâ represents a $1,000 customer bank deposit.</li>
<li>âRâ represents a $1,000 cash reserve allocation that a bank has at the Fed.</li>
<li>âTâ represents a $1,000 U.S. Treasury note; U.S. federal government debt.</li>
<li>Other assets, like a $1,000 used car âCâ or a $1,000 car loan âLâ are sometimes used as well.</li>
</ul>
<p>A deposit block âDâ is an asset for a consumer, and is simultaneously a liability for their commercial bank, since the bank holds it on behalf of the consumer and owes it to them on demand.</p>
<p>Similarly, a reserve block âRâ is an asset for a commercial bank, and they keep it at the Fed. The Fed lists it as a liability, owed to the bank who deposited it with them.</p>
<p>Likewise, a Treasury note âTâ is an asset for whoever holds it, whether a consumer, or a commercial bank, or the Fed, and is a liability of the U.S. Treasury.</p>
<p>A bank loan block âLâ or mortgage block âMâ is an asset for the bank that lent it, and is a liability for the consumer who borrowed it from their bank.</p>
<h3 id="example-1-a-bank-loans-money">Example 1) A Bank Loans Money</h3>
<p>This is the simplest example to show how banks create deposits and broad money without reducing the amount of reserves in the system. It involves Mary buying a used car from Sara.</p>
<p>Here is the visual, with a beginning, intermediate, and ending state, and a description afterward, so you can go back and forth between the visual and the description:</p>
<p><img src="/assets/images/2020/m11/la17.png" alt="Loan Example" /></p>
<h4 id="beginning-state"><em>Beginning State</em></h4>
<p>Mary begins with âDâ in assets, meaning a $1,000 deposit in her bank, and no liabilities. Her bank (which is very unlevered) starts with her deposit âDâ as a $1,000 liability, and then has two reserve block assets âRâ, representing $2,000 held at the Fed.</p>
<p>Sara begins with âDDDCâ in assets, meaning $3,000 in bank deposits at her bank âDDDâ, and a $1,000 used car âCâ, and no liabilities. Her bank starts with her deposit âDDDâ as liabilities, and has its assets primarily invested in Treasuries âTTTâ and one reserve block at the Fed âRâ.</p>
<p>The Federal Reserve holds the three blocks of reserves from the two banks as its liabilities, and has three blocks of Treasuries as its assets. The banks use the Federal Reserve as their bank, in a similar way that Mary and Sara use their banks. In other words, the two banks store their extra cash reserve assets in their accounts at the Fed, which are the Fedâs liabilities.</p>
<p>The U.S. Treasury Department, representing the financial arm of the overall U.S. Federal Government, has 6 blocks of Treasuries outstanding as its liabilities. For the sake of simplicity it doesnât have any assets listed, but in reality, its assets would consist of working capital, various federal buildings and lands and military assets, and its ability to tax citizens. Its 6 Treasury liabilities are owned by the Fed and Saraâs bank.</p>
<p>Between Mary and Saraâs cash, there are 4 deposit âDâ blocks in the total system, which are assets for them and liabilities for their banks. Likewise, there are 3 reserve âRâ blocks in the system, which are assets for their banks and liabilities for the Fed.</p>
<h4 id="intermediate-state"><em>Intermediate State</em></h4>
<p>Now, for the intermediate state, Mary and Sara enter into negotiations, and Sara agrees to sell her car to Mary for $1,000. Mary, however, only has $1,000 in deposits, and although she needs the car, she doesnât want to be completely cash-less. So, she goes to her bank, and takes out a $1,000 car loan âLâ. Maryâs bank creates a $1,000 deposit âDâ for Mary, and creates a $1,000 loan liability âLâ for her as well. For the bank itself, Maryâs new deposit asset is its new liability, and Maryâs new loan liability is its new asset. No reserves moved, but a new deposit was created.</p>
<p>Maryâs net worth is unchanged at $1,000 in total, but she now has $2,000 in deposits and $1,000 in loan liabilities ,and thus is a bit more leveraged. Maryâs bankâs net worth is unchanged as well, but it also leveraged itself up a bit, by creating a new asset and a new liability, since it expects that Mary will be able to pay the loan back with interest.</p>
<p>Neither the Fed nor the U.S. Treasury are involved yet.</p>
<p>There are now 5 deposit âDâ blocks in the system rather than 4, because Maryâs bank is more levered with an additional asset and liability. It created new broad money by loaning a new deposit into existence. However, there are still 3 reserve âRâ blocks in the system.</p>
<h4 id="ending-state"><em>Ending State</em></h4>
<p>For the ending state, Mary writes Sara a $1,000 check for the car, and therefore gives her the new deposit âDâ that she just received from her bank loan. Sara receives the check and deposits it in her bank account, and her bank credits this by giving her an extra $1,000 deposit asset âDâ, which becomes a new liability for her bank. Behind the scenes, Maryâs bank sends a $1,000 reserve block âRâ to Saraâs bank to honor the check. So, Saraâs bank now has a new liability âDâ in the form of Saraâs new deposit, but also has a new reserve block âRâ as its new asset. Saraâs bank doesnât have any creditworthy clients asking for loans at the moment, so it keeps its new reserve block at its Fed account for now.</p>
<p>The Fedâs ending state is unchanged on net, except that it updated its book-keeping for its two client banks when Maryâs bank sent Saraâs bank a $1,000 reserve block âRâ. The Fed used to attribute âRRâ to Maryâs bank and âRâ to Saraâs bank, but now it attributes âRâ to Maryâs bank and âRRâ to Saraâs bank. These reserve blocks are liabilities for the Fed, but assets for its client banks.</p>
<p>The U.S. Treasuryâs ending state is also unchanged, and unlike the Fed, it wasnât even aware of the transaction at all.</p>
<p>In the final ending state, just like the intermediate state, there are still three reserve blocks âRâ in the system, and there are 5 deposit blocks âDâ, which is one extra deposit block compared to the beginning state, created by Maryâs bank loan.</p>
<p>The point of this example is to show how, when a bank uses its reserves to lend money, the reserves arenât destroyed. The money shows up in another bank, and the reserve amount is sent there. The overall amount of reserves or base money in the system is unchanged, but the system becomes slightly more levered, and has more consumer deposits and therefore more broad money. In other words, the money multiplier ratio (D-to-R, broad money to base money) increased from 4-to-3 to 5-to-3.</p>
<p>Any bank can increase or decrease its own amount of reserves by buying or selling assets, or making loans. However, those reserves get moved around to or from other banks rather than created or destroyed. Banks can, however, create or reduce the amount of deposits leveraged on those reserves, depending on how much risk it wants to take on and how many creditworthy opportunities it has to lend money for.</p>
<h3 id="example-2-the-fed-performs-qe-from-banks">Example 2) The Fed Performs QE from Banks</h3>
<p>This next example is a bit more realistic, with a more levered banking system. It involves the Fed performing quantitative easing on the banking system, meaning it creates new reserves to buy existing assets from the banks.</p>
<p>Iâll just show the beginning and end state here, and skip over the intermediate state:</p>
<p><img src="/assets/images/2020/m11/la18.png" alt="QE Example" /></p>
<h4 id="beginning-state-1"><em>Beginning State</em></h4>
<p>Sara and Mary are identical to each other in this example. For assets, they each have a House âHâ, a car âCâ, and $4,000 in cash deposits âDDDDâ at their banks. For liabilities, they also have a car loan âLâ and a mortgage loan âMâ owed to their respective banks.</p>
<p>The banks are also identical to each other in this example. They each have their $4,000 customer deposits âDDDDâ as liabilities owed to Mary and Sara respectively. For assets, they each have âRTTMLâ, meaning one reserve block, two Treasury blocks, one mortgage loan block, and one car loan block. The banks are rather highly levered, with lots of assets and liabilities relative to their sole reserve block.</p>
<p>The Fed is small, with just âRRâ in liabilities for their member bank reserve accounts, one for each, and âTTâ in assets.</p>
<p>The U.S. Treasury has âTTTTTTâ in liabilities, which are owned by the banks and the Fed.</p>
<p>There are 8 deposit blocks âDâ in the system, and 2 reserve blocks âRâ. So, the system money multiplier is levered 8-to-2, aka 4-to-1.</p>
<h4 id="ending-state-1"><em>Ending State</em></h4>
<p>In this example, the Federal Reserve realizes that both Maryâs bank and Saraâs bank have just one reserve block each. Assuming the banks are each required by regulations to have at least one reserve block, this means they canât really lend any more, and canât create more broad money. The Fed wants banks to be able to lend. So, the Fed decides to recapitalize the banking system by giving them plenty of excess reserve blocks. It canât, however, legally just give free money to banks; it has to take something in return.</p>
<p>The Fed creates four new reserve blocks out of thin air, and gives two to Maryâs bank and two to Saraâs bank. These new reserve blocks become liabilities of the Fed, and become assets for the banks. In return, the Fed takes one mortgage block and one Treasury block from each bank. The Fed therefore adds âTTMMâ to its assets and âRRRRâ to its liabilities.</p>
<p>The banks are now much-better capitalized, with plenty of excess reserves as assets, and fewer Treasuries and mortgages. If they want to loan money or buy more securities, they now have plenty of excess reserves to do so with. However, they havenât lent any more money yet, so the amount of deposits or broad money in the system remains unchanged. Underneath the surface, the banks are just less-leveraged, with plenty of reserves relative to deposit liabilities and overall assets.</p>
<p>Mary and Sara didnât notice anything from beginning to end in this example. They have the same assets and liabilities that they started with. They werenât even aware this happened.</p>
<p>The Fed is more leveraged now, with more assets and liabilities than it started with.</p>
<p>The U.S. Treasury didnât change on net, except that it now attributes ownership of 2 of its Treasury note liabilities to the Fed instead of to the private banks, since the banks each sold a Treasury note âTâ to the Fed.</p>
<p>There are still 8 deposit blocks âDâ in the system, but the number of reserve blocks âRâ increased from 2 to 6. So, the money multiplier in the system is now 8-to-6, aka 1.33-to-1. The amount of broad money hasnât changed, but the amount of base money grew, due to the Fedâs decision to buy bank assets with new reserves. The banking system has been recapitalized, and has a lot more lending power now.</p>
<p>This is why, although many people think QE by itself is inflationary on consumer prices, it generally isnât. The money isnât getting out to consumers like Mary and Sara yet; itâs just internal to the banking system. This QE process sets the long-term stage for inflation as an early foundation, by recapitalizing banks and therefore being âanti-deflationaryâ by preventing a bank collapse and ensuring they have plenty of lending capacity, but itâs not inflationary yet.</p>
<p>Inflation would come if Mary and Sara have a lot more deposit money chasing the same amount of goods and services, but neither Mary nor Sara have more deposit money than they started with, and thereâs no reason for anything to be inflationary. The amount of consumer deposits in the system hasnât changed.</p>
<h3 id="example-3-the-fed-performs-qe-from-non-banks"><strong>Example 3) The Fed Performs QE from Non-Banks</strong></h3>
<p>This third example starts with a simpler system again, very similar to Example 1. However, instead of having a car as an extra asset that she had in the first example, Sara has a Treasury note.</p>
<p>Sara decides to sell her Treasury note, but there arenât many buyers for it at the moment. So, the Federal Reserve steps in and performs QE to buy it from her. The result ends up slightly differently compared to the Fed buying a Treasury note from the banking system.</p>
<p><img src="/assets/images/2020/m11/la19.png" alt="Nonbank QE Example" /></p>
<h4 id="beginning-state-2"><em>Beginning State</em></h4>
<p>Everything begins similarly to Example 1, except Sara has a Treasury note instead of a car. There are 4 âDâ deposits in the total system, and 3 âRâ reserves to start.</p>
<p>Sara decides to sell her Treasury note, but neither Mary nor either bank particularly want to buy it.</p>
<p>So, the Fed decides to buy it. The Fed creates a new bank reserve âRâ out of thin air and gives it to Saraâs bank, and tells the bank to buy Saraâs Treasury note with a new deposit, and then to give the Fed the Treasury âTâ.</p>
<p>The Fed, therefore, bought Saraâs Treasury note with a brand new reserve block, using the bank as the intermediary (so Sara and the Fed never talked to each other; Sara sold the Treasury note to her bank for a deposit block âDâ, and her bank sold that Treasury note to the Fed, who bought it with a new reserve block âRâ).</p>
<h4 id="ending-state-2"><em>Ending State</em></h4>
<p>After the bank completes this task, Sara has the same net worth as she started the example with, but replaced her Treasury âTâ with an extra deposit âDâ. Her bank also has the same net worth as it started the example with, but grew a bit bigger, with an extra reserve block asset âRâ and an extra deposit block liability to Sara âDâ.</p>
<p>The Fed grew a bit more leveraged as well, with an additional Treasury asset âTâ and an additional reserve liability âRâ, which it lists as an asset of Saraâs bank.</p>
<p>The U.S. Treasury didnât change on net, except that it now recognizes Saraâs initial Treasury âTâ as owned by the Fed instead of Sara now, since the Fed bought it.</p>
<p>Whether this is stimulatory for the economy or not depends on what Sara wants to do with her extra cash. She had âDDDTâ and now she has âDDDDâ as her assets. Itâs still $4,000 but itâs a bit more liquid now. If the reason for her selling the Treasury was to raise more cash to do something big, like start a business or lend money to her friend to start a business, then it might be simulative. However, if she merely holds the money in an extra âDâ deposit rather than the Treasury âTâ, then sheâs not using the money any differently. It then becomes a question of what her bank does.</p>
<p>Saraâs bank now has an extra reserve asset block and an extra deposit block liability compared to the beginning state, meaning itâs a bit bigger and has more lending power. It could finance a corporate loan, or a consumer loan, which would be stimulative. Or, if it thinks the economy is too risky, or if none of its creditworthy corporate or consumer clients are asking for a loan, it might just sit on its safe âRRTTTâ assets and do nothing. In that case, this example wouldnât be stimulative.</p>
<p>There are now 5 âDâ deposits in the system compared to the beginning state that only had 4. In addition, there are 4 âRâ reserve blocks in the system compared to the beginning state that only had 3.</p>
<p>So, thereâs more liquidity in the system, with an increase in both base money and broad money. However, none of that broad money moved yet, and is just sitting there with Sara and her bank. Broad money velocity is low, in other words. There is more inflationary potential in the system, due to there being more broad money and reserves, but no consumer price inflation yet. Sara isnât any richer; just slightly more liquid.</p>
<p>In this example, the Fed directly increased the amount of broad money in the system without banks doing any private lending, and without the federal government doing any spending, but it remains unclear if it will be impactful or not (subject to what Sara and/or her bank do with their extra liquidity). And even if it was impactful, the Fed wouldnât be able to repeat it a second time, because neither Mary nor Sara (the two private non-bank entities) have any more Treasury notes to sell to the Fed.</p>
<p>If anything, itâs likely to be somewhat inflationary on asset prices, because Sara is flush with cash, and perhaps more willing to buy stocks, or buy more Treasuries, etc. Sheâs a saver and this might not make her spend more, but it might shift how she invests, with her extra liquidity.</p>
<h3 id="example-4-nonbank-financed-helicopter-money"><strong>Example 4) Nonbank-Financed Helicopter Money</strong></h3>
<p>The first three example were separate cases, each meant to illustrate a different scenario.</p>
<p>These final three examples, Example 4, Example 5, and Example 6, however, build on top of it each other to show what happens when the U.S. Treasury gets involved with deficit spending, with differences depending on who finances that spending by buying the Treasury debt.</p>
<p>Example 4 begins with a relatively unlevered system. However, the economy is in a recession, and Mary just lost her job and only has a little bit of money in her bank account and is making her frustration known, so Congress authorizes the U.S. Treasury to send everyone $1,000 in stimulus checks, right to their bank accounts. This is known in economics as âhelicopter moneyâ, referring to a thought experiment of dropping money out of helicopters on consumers. The Treasury finances this by issuing Treasury bonds, which Sara, who has plenty of money and hasnât lost her job, buys.</p>
<p><img src="/assets/images/2020/m11/la20.png" alt="Helicopter Money Example" /></p>
<h4 id="beginning-state-3"><em>Beginning State</em></h4>
<p>Mary has a car âCâ and a deposit âDâ as assets, and a car loan âLâ as a liability. Maryâs bank has a reserve block âRâ and Maryâs car loan âLâ as assets, and has Maryâs deposit âDâ as its liability.</p>
<p>Sara has three blocks of deposits âDDDâ as her assets, and no liabilities. Saraâs bank has a blend of excess reserves and some Treasuries as assets âRRTTâ, and has Saraâs three deposit blocks âDDDâ as its liabilities.</p>
<p>The Fed holds the banksâ 3 total system reserve blocks as its liabilities, and holds 3 Treasuries as its assets.</p>
<p>The U.S. Treasury has 5 Treasury notes outstanding as liabilities, which are owned by the Fed and Saraâs bank.</p>
<p>Total system deposits are 4D = $4,000, and total system reserves are 3R = $3,000.</p>
<h4 id="intermediate-state-not-shown"><em>Intermediate State (not shown)</em></h4>
<p>Although it is the originator of currency, the U.S. Federal Government legally has to finance its spending by receiving taxes or issuing Treasury debt to settle its account.</p>
<p>So, the U.S. Treasury sends a $1,000 deposit âDâ block each to both Mary and Sara, deposited in their bank accounts. Both Mary and Sara are happy, because their net worth goes up by $1,000 each. Their banks get money deposited into them, and havenât loaned any out yet, so they just keep this new cash at their Fed account as new reserves.</p>
<p>However, this is just a brief intermediate state. The Treasury now issues new Treasury note liabilities âTTâ to pay for the expenditures it just made. Sara then decides to use two of her deposit blocks âDDâ to buy those two Treasury securities âTTâ, since they are yielding slightly higher rates than her bank deposit account yields.</p>
<p>If we imagine it happening simultaneously, what happened is that the U.S. Treasury extracted two deposit blocks from Sara (and therefore extracted two reserve blocks from Saraâs bank, as Saraâs bank settled the transfer with the U.S. Treasury), and the U.S. Treasury gave Sara two Treasury note blocks as assets in return. At the same time, the U.S. Treasury gave both Mary and Sara one deposit block each, and therefore gives one reserve block to Maryâs bank, and one reserve block to Saraâs bank, to settle the transfers.</p>
<h4 id="ending-state-3"><em>Ending State</em></h4>
<p>By the end of the transfers, both Mary and Sara are $1,000 richer than they started. Maryâs assets simply went from âCDâ to âCDDâ as she gained a deposit block. Saraâs assets went from âDDDâ to âDDTTâ, because she gained a deposit block but used two deposit blocks to buy two Treasury notes.</p>
<p>Maryâs bank is slightly bigger than it began, because Mary received a deposit block âDâ and her bank was credited with a reserve block âRâ to settle it (but also owes an extra liability âDâ owed to Mary), and Mary hasnât spent it yet. So, Maryâs bank has the same net worth (both its assets and liabilities increased by the same amount), but itâs overall combined assets and liabilities are bigger, and it has more lending power now because of that.</p>
<p>Saraâs bank is slightly smaller than it began, because although Sara and her bank received a deposit and reserve block respectively, Sara sent two deposit blocks to the Treasury to receive the Treasury notes, and therefore Saraâs bank sent two reserve blocks to the Treasury, which were then given back out, one to Maryâs bank and one back to Saraâs bank. Saraâs bank has the same net worth, but is simply smaller, as both assets and liabilities decreased, and its lending power is decreased.</p>
<p>The Fed is unchanged, except that it updated its book-keeping to attribute one of the reserve blocks âRâ originally attributed to Saraâs bank, to being attributed to Maryâs bank instead. Its overall amount of Treasury note assets and reserve liabilities remains unchanged.</p>
<p>The U.S. Treasury is more leveraged, with an extra âTTâ in debt liabilities outstanding, owed to Sara.</p>
<p>Total system deposits are 4D = $4,000, and total system reserves are 3R = $3,000, meaning that neither the total amount of deposits or reserves changed in the system from the beginning state to the end state. Deposits and reserves were just moved around a bit within the system.</p>
<h3 id="example-5-fed-financed-helicopter-money"><strong>Example 5) Fed-Financed Helicopter Money</strong></h3>
<p>Example 5 starts exactly where Example 4 left off, and builds from there.</p>
<p>Both Mary and Sara are happy because they got some extra money in the previous example. However, Sara is just prudently saving her money due to uncertainty about the economy, and Mary still doesnât have a job so she is also just saving her money, and their favorite restaurants and vacation spots are closed due a virus pandemic anyway.</p>
<p>Some politicians want to give $1,000 to everyone every month for the next year, due to so many displaced workers like Mary having so little money and with no jobs. Other politicians say, âno, thatâs too much federal debt, let the economy try to heal itself.â The politicians argue for a couple months and then eventually compromise and decide to send everyone $1,000 one more time, to see if that helps. So, Congress authorizes the U.S. Treasury to send out another $1,000 to everyone.</p>
<p>This time, instead of Sara buying the new Treasury liabilities with her existing deposits, the Fed buys the new Treasury liabilities with new reserves.</p>
<p><img src="/assets/images/2020/m11/la21.png" alt="Helicopter Money + QE" /></p>
<h4 id="beginning-state-4"><em>Beginning State</em></h4>
<p>Sara already owns a lot of Treasury notes and sees that the U.S. Treasury will become even more indebted after it sends out all this money without raising taxes, so she doesnât want to buy any more Treasury notes. So, how will the U.S. Treasury finance this second round of helicopter money?</p>
<p>Well, because there is a lot of new Treasury note issuance but nobody desiring to buy it at current prices, the Treasury note market suddenly becomes illiquid, and prices start to fall (meaning yields start to rise). Sara and her bank both get nervous, because they own a lot of Treasury notes.</p>
<p>The Treasury note market briefly looks like it did in March 2020: totally illiquid, with yields extremely volatile.</p>
<p>However, this problem doesnât last long, because the Fed says, âItâs fine everyone! Weâll buy the extra Treasury note issuance. Relax.â</p>
<p>So, the Fed creates two new bank reserve blocks âRRâ, and gives them to the Treasury in exchange for the new Treasury debt liabilities, âTTâ, which become the Fedâs assets. Technically, the Fed canât legally buy directly from the Treasury, so they agree to transfer the securities through one of the banks as a brief pass-through entity.</p>
<p>The U.S. Treasury then sends a $1,000 deposit âDâ each to Mary and Sara, and settles this by sending a reserve block âRâ to each of Maryâs and Saraâs banks.</p>
<h4 id="ending-state-4"><em>Ending State</em></h4>
<p>Mary and Sara are both $1,000 richer, again. They each have a new $1,000 deposit âDâ.</p>
<p>Mary and Saraâs banks are both bigger, although their net worth didnât change. They each have an extra $1,000 reserve block âRâ, but also each have a new $1,000 liability block to their customer deposits âDâ.</p>
<p>The Fed is bigger and more levered, with $2,000 more assets in the form of Treasuries âTTâ, and $2,000 more liabilities in the form of reserves âRRâ that they hold for the banks.</p>
<p>The U.S. Treasury is bigger and more levered, with $2,000 âTTâ in more debt liabilities outstanding.</p>
<p>System-wide deposits (broad money) increased over the beginning state, from 4D = $4,000 to 6D = $6,000. System-wide reserves (base money) also increased over the beginning state, from 3R = $3,000 to 5R = $5,000.</p>
<p>This was outright money-printing. The amount of broad money and base money in the system went up by a lot. Mary and Sara are richer, and their banks are bigger. Money was injected into the system, without being extracted anywhere from the system, because the deficit spending was financed by the Fed creating new bank reserves to buy the Treasury notes.</p>
<p>The Treasury and Fed can perform this repeatedly if they want, any number of times, although they both know that if they do it too much, it could cause consumer price inflation.</p>
<p>Whether it is inflationary for consumer prices or not, however, depends on whether Mary and Sara still have confidence in the value of their deposits, and whether they go and spend them or not. Itâs also potentially inflationary for asset prices; Sara in particular is flush with assets and more likely to put some money to work in stocks other gold or other assets than she was before.</p>
<h3 id="example-6-bank-financed-helicopter-money"><strong>Example 6) Bank-Financed Helicopter Money</strong></h3>
<p>Example 6 starts exactly where Example 5 left off. Both Mary and Sara are happy because they got some extra money in the previous example, again.</p>
<p>The pandemic eased a bit, and Mary got a new job, but realizes she needs to keep more cash on hand in case she loses her job again in the future. She learned a lesson about saving, in other words.</p>
<p>Sara was already a saver, and hasnât been spending extra money yet either. Sara, however, is considering going on a vacation or buying a car, now that sheâs feeling a bit more confident with so much cash. Sheâs also not sure about the value of her money, as she watches the broad money supply expanding so rapidly due to these helicopter checks that everyone is receiving. Car prices are starting to go up, probably due to so many people receiving stimulus checks, so there seems little reason to wait.</p>
<p>However, because the economy is still sluggish, with many people saving more than they used to, Congress decides to do yet another round of $1,000 helicopter checks to everyone, and issue $2,000 in new Treasury note liabilities âTTâ to pay for it. This is it, the final stimulus round!</p>
<p>Fortunately for the U.S. Treasury, the banking system has tons of excess reserves due to their previous round of helicopter spending that the Fed bought with new reserves, and so this time, the banks each agree to buy one Treasury note âTâ with one of their excess reserve blocks. (In fact, the banks donât have much of a choice, because as primary dealers they âhaveâ to buy Treasury notes at auction if they have enough liquidity to do so, and if neither Mary nor Sara nor the Fed agree to buy the Treasury notes from them, they get stuck holding the Treasury notes.)</p>
<p><img src="/assets/images/2020/m11/la22.png" alt="Helicopter Money with Bank Financing" /></p>
<h4 id="beginning-state-5"><em>Beginning State</em></h4>
<p>System-wide deposits are 6D = $6,000. System-wide reserves are 5R = $5,000.</p>
<p>Hereâs what happens if we imagine the process happening simultaneously. The U.S. Treasury sends Mary and Sara each a $1,000 deposit âDâ block, and sends their banks each a $1,000 reserve âRâ block to settle it. The U.S. Treasury then issues two new Treasury note liabilities âTTâ to pay for it. The banks each send a reserve block âRâ to the U.S. Treasury in exchange for one of those Treasury notes âTâ.</p>
<h4 id="ending-state-5"><em>Ending State</em></h4>
<p>Mary and Sara are, yet again, $1,000 richer. They each have yet another deposit block âDâ added to their assets.</p>
<p>Their banks have the same amount of reserves they started with, because they each received a reserve block âRâ from the U.S. Treasuryâs helicopter deposits to their customers, but since each bank also sent a reserve block âRâ back to the U.S. Treasury to pay for the stimulus, they each ultimately received a Treasury note âTâ as an asset instead. They still have the same amount of reserve blocks that they started with, but they each have an extra asset âTâ, and they each have an extra deposit liability âDâ for their customers. So, they are a bit more levered overall.</p>
<p>The Fed didnât change at all from the beginning of this example, although it did some book-keeping for the reserves moving around and ending back in the same place.</p>
<p>The U.S. Treasury is $2,000 or âTTâ more in debt than it started the example with.</p>
<p>System-wide deposits increased by $2,000 or âDDâ from 6D = $6,000 to 8D = $8,000. System-wide reserves are still 5R = $5,000. So, the money multiplier increased a bit, from 6-to-5 to 8-to-5. Broad money increased, but base money remained the same.</p>
<p>Will it be inflationary? It depends on what Mary and Sara do from here, but most likely at this point, yes. Sara now has tons of cash and is concerned about the value of that cash, so she decides to spend money on a vacation and buy that new car, or buy stocks or gold or real estate, or something. Even Mary decides to eat out at restaurants more, now that she has more cash than usual. Other people seem to be doing the same; prices of things are inching up each month.</p>
<p>There is now $8,000 in total deposits (broad money) in the system, compared to the start of Example 4 where there was only $4,000 in deposits. However, the amount of goods and service in the economy have not doubled. So, if Mary and Sara and others decide to start spending their money, it could indeed result in a lot of money chasing a limited supply of goods and services, and therefore could push up consumer prices and be inflationary.</p>
<p>In response to high inflation, the Fedâs normal tool would be to raise interest rates. However, with U.S. Treasury debt so high at that point, the Fedâs ability to raise interest rates would be limited, since it would result in an acute fiscal crisis as rising Treasury debt interest eats up a large part of the fiscal budget. So, either the Fed would have to let inflation run hot and inflate away part of the debt and keep creating Reserve blocks to buy new Treasury notes as needed to keep Treasury security yields low (which they did back in the 1940âs), or the U.S. Treasury would have to restructure/default on the central bank portion of U.S. Treasury debt.</p>
<p>So, the Treasury+Fed combo has all the power to boost the broad money supply enough to cause a rising trend shift in inflation, but when they do with such a highly-leveraged U.S. Treasury, they face some consequences in their ability to constrain it.</p>
<h3 id="example-summaries-and-findings"><strong>Example Summaries and Findings</strong></h3>
<p>If we analyze all of the examples, we see a few observations:</p>
<p>-Banks can create new deposits and increase the the amount of deposits (broad money) in the system by lending. Lending creates deposits. This lending doesnât change the amount of base money (reserves) in the system, but it moves those reserves around from one bank to another, and levers those reserves up. This is the money multiplier ratio, the ratio of broad money to reserves in these simplified examples. Although the banks can create new deposits and increase broad money by lending, it is not âmoney printingâ because the banks are simply making decisions regarding how much to lever themselves up relative to their cash reserve assets, and they are constrained by various regulatory standards for how much leverage they can have.</p>
<p>-The Fed alone has the power to create new bank reserves, and to therefore increase the amount of bank reserves in the system (base money) or more broadly, the total amount of water in the three-bucket system analogy. However, if it buys assets from banks, it doesnât directly lead to more deposits (broad money) being in the system. It de-levers banks and gives them more capacity to lend and create new deposits (broad money), but whether they will or not is up to them. On the other hand, if it buys assets from non-bank entities like Sara (using the banking system as its intermediary), it can slightly increase deposits (broad money) in the system, but only to a limited extent, based on limited amounts of non-bank entities holdingsâ of Treasuries that they can sell. It is, in this sense, very limited âmoney printingâ.</p>
<p>-On behalf of Congress, the U.S. Treasury can give more deposits to somewhere in the system, but deposits also get extracted back out of the system when non-bank entities like Sara buy the Treasuries that are used to fund this expenditure. So, it doesnât necessarily create new deposits or new reserves. This is what deflationists often refer to as the âcrowding out effectâ, meaning that the U.S. Treasury can extract capital from somewhere in the economy and inject it somewhere else in the economy, if it runs large deficits and builds up federal debt, and it displaces nonbank capital that could have been used for something else. This is not âmoney printingâ since it just moves things around and levers up the Treasury.</p>
<p>-However, if the Treasury and Fed work together, they can rapidly increase both the deposits (broad money), and bank reserves in the system (base money), without extracting deposits from anywhere in the system. In this process, the Treasury injects money into the economy by spending, which creates new deposits, but instead of that money being extracted from deposits somewhere else in the economy, the Fed finances those new Treasuries with newly-created bank reserves out of thin air, and thus levers itself with additional assets (the new Treasuries) and additional liabilities (the new reserves attributed to the banking system). It doesnât matter if banks lend or not; the Treasury+Fed combo goes around the bank lending channel by just giving people and businesses more deposits (broad money). This outright increases the net worth of Mary and Sara in the examples, and increases the size of their banks including broad money supply and bank reserves (but the banksâ net worth remains unchanged), and levers up both the Fed and the U.S. Treasury. There is no limit to the amount they can do this, other than the fact that it would eventually be inflationary if done too much and too rapidly relative to the amount of goods and services and productive capacity in the economy. This is outright âmoney printingâ, although there are some checks and balances since fiscal changes have to be passed by Congress and signed into law, rather than done unilaterally by the Fed.</p>
<p>-Additionally, if the U.S. Treasury injects money into the economy with large deficits and the Treasuries to finance it are bought by a well-capitalized banking system (usually as a result of the Fed already having capitalized banks by creating excess reserves in the recent past), it also increases the deposits (broad money) and levers up the money multiplier. This can be done quite a bit if banks start with excess reserves, because every time the federal government injects more money into the system, it creates more bank deposits, which replenishes the reserves that the bank spent buying Treasuries, and thus gives the banks more ability to buy additional Treasuries. This is mostly âmoney printingâ, although to maintain leverage ratios, the banks need to start with plenty of excess reserves.</p>
<p>-If there is a lot of broad money added to the system, with both Mary and Sara confident to spend, it could very well be inflationary. Plus, now that Mary and Sara are richer than they started, they might feel more confident to take out a mortgage loan or business loan from their bank to buy a house or start a business, and their banks are more willing to lend it now because Mary and Sara both have plenty of net worth and creditworthiness. This could very well be inflationary.</p>
<p>-There are proposals for central bank digital currencies, which if enacted may allow the Fed to inject money to consumer deposits without going through Congress. This would likely require an overhaul of the Federal Reserve Act, and would substantially change the nature of the system. Some folks argue that this would be necessary for inflation to happen, but inflation can already happen within the existing framework through the combination of fiscal deficits and QE monetization of those deficits. The current framework requires Congress to go along with it rather than performed unilaterally by the Fed, and thus has checks and balances in the system.</p>
<h2 id="implications-focus-on-broad-money">Implications: Focus on Broad Money</h2>
<p>Itâs fashionable to debate lately whether QE is inflationary or not, and whether central banks have run amok.</p>
<p>However, for more fruitful results as it relates to analyzing inflation vs deflation and the associated impacts on various asset classes, investors should focus on <strong>fiscal spending</strong>, especially when it is combined with monetary financing to pay for it. Are major fiscal deficits happening or no? How big are the deficits, relative to the deflationary backdrop? Who are the deficits targeting? Who is financing the deficits by accumulating the Treasury securities?</p>
<p>And then specifically, look at what the <strong>broad money</strong> supply is doing. Is it going up, or no? At what rate?</p>
<p>Banks are already well-capitalized. The big non-fiscal QE for bank recapitalization was done back in 2008-2014. Now, with massive Treasury debt in the system and interest rates at zero, fiscal authorities find themselves spending more, and running larger deficits, with the Fed and banking system buying the majority of their Treasury note issuance.</p>
<p>We have division of fiscal and monetary powers, and only when the powers combine (like in the 1940âs and again in 2020, where the Treasury runs massive deficits and those Treasury notes are accumulated by the Fed and banking system), does it become outright money-printing. It doesnât require any change to existing laws for them to do that; they use banks as pass-through entities and other structures as needed to do what they do.</p>
<p>QE alone, where the Fed buys existing assets mostly from banks, is simply anti-deflationary, to recapitalize a banking system and fill it up with excess reserves. Itâs not outright inflationary because it doesnât directly increase the broad money supply. If the Fed buys existing assets from non-banks, it only increases broad money a bit, around the margins.</p>
<p>Meanwhile, large fiscal deficits funded by QE (the central banks monetizing deficit spending by buying any of the excess Treasuries over the real demand for them), actually is pro-inflationary, because it gets money directly into the economy, into the broad money supply, and can be done with no limit except for inflation that it would eventually cause when done to excess.</p>
<p>Whether it takes the role of unfunded tax cuts or unfunded fiscal spending, if fiscal spending combined with monetary financing results in higher personal income for consumers like Mary and Sara, and more broad money in the system, itâs an inflationary force. It then becomes a question of how big it is, how persistent it is, and what portion of the income spectrum it is targeting.</p>
<p>Given how highly-leveraged the system still is, and how reluctant banks are to lend, for the next several years as we head deeper into the 2020âs and eventually move past the pandemic, navigating the âinflation vs deflationâ debate is going to mostly be a matter of watching how large or small the federal deficits are, and observing who funds those deficits (i.e. the Fed and banking system), and to see if the broad money supply goes up more quickly than the deflationary forces that exist.</p>
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<!--End mc_embed_signup-->Lyn AldenLyn lays out how and why QE is happening. Posted November 22, 2020.The Intelligent Bitcoin Miner, Part I.2020-11-22T00:00:00+00:002020-11-22T00:00:00+00:00https://bitcoinwords.github.io/the-intelligent-miner-part-1<table class="notice--info">
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<h1 id="the-intelligent-bitcoin-miner-part-i"><a href="https://www.aniccaresearch.tech/blog/the-intelligent-bitcoin-miner-part-i">The Intelligent Bitcoin Miner, Part I.</a></h1>
<h3 id="by-leo-zhang-jack-koehler-and-david-cai---general-mining-research">By <a href="https://twitter.com/leorzhang">Leo Zhang</a>, <a href="https://www.linkedin.com/in/jack-koehler-5933bb44/">Jack Koehler</a>, and <a href="https://twitter.com/David_3Chez">David Cai - general mining Research</a></h3>
<h3 id="posted-november-22-2020">Posted November 22, 2020</h3>
<p><em>This article is a collaboration with</em> <a href="https://www.gmr.xyz"><em>General Mining Research</em></a><em>, a Singapore based hashpower-focused company, who invests and trades hashpower of cryptocurrency networks, as well as derivatives. GMR supports our work by providing proprietary machine market data, as well as hashrate growth predictions over the next few months based on sales projections aggregated from manufacturers.</em></p>
<blockquote>
<p><em>âYou will be much more in control, if you realize how much you are not in control.â</em></p>
<p><em>â Benjamin Graham,</em><a href="https://www.goodreads.com/work/quotes/102974"><em>The Intelligent Investor</em></a></p>
</blockquote>
<p>The valuation of hashpower is one of the oldest and most arcane topics in the mining world. Several prior academic papers and industry research have explored the economic and game theoretic aspects of proof-of-work, but most of them oversimplify or make unrealistic assumptions about how the hashpower market works in practice. </p>
<p>In this paper, we illustrate that operating hashpower is akin to managing a portfolio, and the difficulties of reflecting the aspects of portfolio in the pricing of hashpower. We walk through how the popular pricing mechanism works, and the flaws of the current valuation heuristics. We parametrize a hashpower portfolio, and show how the outcome changes as we test a broad range of assumptions. As a coda, we argue that the importance of valuation framework is more than just a theoretical exercise, but a foundational step in developing a proper risk management practice for the hashpower industry.</p>
<p><strong>The Fair Value of Hashpower</strong></p>
<p>Why run a mining operation when you can purchase coins on the open market?</p>
<p>This is the most common reaction when someone first hears about mining. Itâs no secret that it was the outsize financial return that spurred the initial interest in mining and accelerated its growth into a billion-dollar behemoth. A successful miner is able to produce Bitcoin at a cost lower than the spot price, and can accordingly build a position at a steep discount compared to purchasing on the open market. </p>
<p>However, the low cost-of-production is by no means permanent. Over the years, competition has been heating up, and the market cycle is becoming too obscure to predict. The âdiscountâ that the miners have gotten so spoiled with can deteriorate into painful loss any moment. In todayâs market, is mining still more profitable than purchasing on the open market? Given the number of variables involved, itâs futile to attempt at a timeless generalization. However, we can break down the market cycle into several archetypal phases, and observe how the profitability of common mining and trading strategies evolve in each phase. </p>
<p>Weâll begin with 2018, a miserable year for most miners. In the <a href="https://www.aniccaresearch.tech/blog/the-alchemy-of-hashpower-part-ii">previous article</a>, we describe the first three quarters as the <a href="https://www.aniccaresearch.tech/blog/the-alchemy-of-hashpower-part-ii"><strong>Inventory Flush</strong></a> phase of a mining cycle, where coin price drops while network hashpower continues to increase. </p>
<p>Hypothetically, a miner that purchased 10 Ph/s of Antminer S9 at the beginning of the year would have spent a total of $1.85MM spent on 690 units given the unit price at the time of $2,675 per machine. Assuming the machines linearly depreciated over 24 months, and the minerâs all-in electricity cost was $0.0507 per KwH (industry-wide average rate in China, courtesy of GMR) , we can backtest the performances of three common strategies:Â </p>
<ol>
<li><strong>Moderate</strong>: the miner sells enough coins to cover the daily power bill ($941.38) as well as the daily depreciation ($2,563.54). If the mining revenue of the day is less than the total expense ($3,709.01), then only sell enough to cover the power bill. Everything else remains in BTC position. </li>
<li><strong>Long BTC</strong>: the miner sells just enough to cover the daily power bill ($941.38), leaving all remaining coins in a long position. </li>
<li><strong>Sell Daily</strong>: the miner immediately sells all coins into USD. The only goal is to arbitrage the difference between spot price and cost-of-production. Worth noting that this strategy is not tax efficient and incurs constant market slippage. For modeling simplicity we do not take these factors into consideration. </li>
</ol>
<p>Next, we compare the performances of the mining strategies against open market purchases. We consider two simple strategies:</p>
<ol>
<li><strong>Upfront Purchase</strong>: On the same day as the mining valuation period starts (1/1/2018), buy coins whose notional is equivalent to the total capex + yearly opex ($1,845,750 + $941.38*365) at the spot of that day ($13,465), and <em>hodl</em> till the end of the valuation period. For the sake of simplicity, we will not factor in the significant amount of slippage incurred by purchasing this quantity of bitcoin. </li>
<li><strong>Dollar Cost Averaging</strong>: Spend the same notional as mining capex + yearly opex, but purchase a uniform notional ($2.26MM / 365) of coins everyday throughout the valuation period.</li>
</ol>
<p><img src="/assets/images/2020/m11/lz1.png" alt="Screen Shot 2020-11-22 at 8.02.01 PM.png" /></p>
<p>Over the course of the year, daily cost-of-production per coin ($3,709.01 expense divided by the number of coins mined on that day) surpassed market price around July, and kept climbing in the second half of the year, rendering the miner unprofitable for an extended period of time. As we can see from the result, after a year of bear market, the <strong>Sell Daily</strong> strategy lost the least amount, and the <strong>Long BTC</strong> strategy took the biggest hit. </p>
<p>This is because <strong>Sell Daily</strong> is the only strategy that has no unrealized <em>PnL</em>. Every other strategy has long positions to various extent. During the <a href="https://www.aniccaresearch.tech/blog/the-alchemy-of-hashpower-part-ii"><strong>Inventory Flush</strong></a>phase where mining revenue continuously decreases, the unrealized position is very likely to result in a loss at the end of the valuation period. </p>
<p>In practice, sensible miners would have turned off the machines after mining at loss for such a long period of time. If the miner had shut down the operation at the end of June, their loss would have been a lot smaller. If the miner were using the <strong>Sell Daily</strong> strategy, the miner would even have made a profit:</p>
<p><img src="/assets/images/2020/m11/lz2.png" alt="Screen Shot 2020-11-22 at 8.07.57 PM.png" /></p>
<p>The <strong>Moderate</strong> and <strong>Long BTC</strong> strategies would have remained unprofitable, albeit to a lesser extent than open market purchases. The loss primarily stems from capital expenditure of the machines. The miner bought them at $1.84MM, but could only resell them for $738K (not including transaction slippage, transportation, and tax). The gains from the Bitcoin mined did not make up for the hardware depreciation. </p>
<p>In both examples, <strong>Sell Daily</strong> appears to be the safest strategy. What happens in an opposite phase in the market cycle, where mining revenue continuously increases?</p>
<p>After the <a href="https://www.aniccaresearch.tech/blog/the-alchemy-of-hashpower-part-ii"><strong>Shakeout</strong></a> phase at the end of 2018, the first half of 2019 turned out to be quite festive for miners. Performing the same analysis but from 1/1/19 to 6/30/19, we can see that <strong>Sell Daily</strong> would have been the least profitable, whereas the aggressive strategies, <strong>Long BTC</strong> and <strong>Upfront Purchase</strong>, would have done more than 50% better than the defensive strategy.</p>
<p><img src="/assets/images/2020/m11/lz3.png" alt="*Life Cycle adjusted to 12 months at the beginning of 2019." /></p>
<p><em>*Life Cycle adjusted to 12 months at the beginning of 2019.</em></p>
<p>Itâs easy to identify the winning strategy with the benefit of hindsight. It takes conviction and deep understanding of the macro conditions to adopt the aggressive strategies when the overall market has been depressed for a while. This especially the case for <strong>Upfront Purchase</strong>, which requires deploying all the capital on day one. </p>
<p>Mid-2019 was also a transition period where new generation machines became available. Itâs common for miners to sell old machines to rotate into more efficient models. In this example, the miners could actually sell the machines at prices higher than their purchase price thanks to the raging price rally. </p>
<p>Hypothetically, if the miner sold all 690 units of Antminer and used the $271k proceeds to purchase new Whatsminer M20 for the second half of the year: Â </p>
<p><img src="/assets/images/2020/m11/lz4.png" alt="Screen Shot 2020-11-22 at 8.14.32 PM.png" /></p>
<p>For the entire year of 2019, the miner wouldâve made:</p>
<p><img src="/assets/images/2020/m11/lz5.png" alt="Screen Shot 2020-11-22 at 8.15.37 PM.png" /></p>
<p>Whereas if the miner hadnât rotated machines, and continued to mine with Antminer S9 for the entire year, they would have left a lot of money on the table:</p>
<p><img src="/assets/images/2020/m11/lz6.png" alt="Screen Shot 2020-11-22 at 8.16.07 PM.png" /></p>
<p>In practice, miners are not tied to a specific <em>modus operandi</em> for the entire mining period. They have the flexibility to change the strategy whenever they think the market trend is shifting. In addition, they can complement mining with trading strategies, or lend out the coins to enhance the yields on the inventory, for instance, the miner can sell and capture profits on days mining profit exceeds cost-of-production, and buy coins on open market on days mining profit is lower than cost-of-production. Using the right combination of strategies during different stages of the mining cycle has a significant impact on the outcome. <strong>The purpose of this exercise is not to come up with a generalized winning strategy, or to prove mining is strictly better than purchasing coins, but to illustrate that managing a mining operation is essentially managing a portfolio.</strong></p>
<p>These represent the simplest and most common mining strategies. A lazy miner who only uses one simple strategy throughout all market cycles will extract a different amount of value from hashpower compared to a miner who actively employs multiple strategies. There is an infinite amount of hashpower management strategies, but the manufacturer is going to charge the same price for the machine regardless of the buyerâs strategy. Though price is a realized data point, value depends on the user. <strong>Ideally, the price of the machines should represent an average of the distribution of the values of all available strategies, but that is not possible.</strong> So how does the hashpower industry price machines? What does the price of hashpower represent exactly? More importantly, how should miners value hashpower in a way that fits their own circumstances best?</p>
<p><strong>Hashpower Pricing Heuristics </strong></p>
<p>In todayâs market, the pricing of hashpower is dominated by hardware manufacturers such as Bitmain, MicroBT, and Canaan. They are the only supplier of new hardware, they have full control over the initial issuance of machines that produce hashpower. The manufacturersâ first priority is to cover their expenses, which has less to do with the cryptocurrency market and more with <a href="https://www.aniccaresearch.tech/blog/the-alchemy-of-hashpower-part-i">supply chain management</a>. The sale price of their product can be adjusted according to market demand, provided it guarantees a certain margin over its cost of production. Sometimes manufacturers artificially suppress the pricing to outsell their competitors. <strong>In short, manufacturersâ pricing does not represent the theoretical fair value of hashpower. It is mixed with business decisions that reflect the state of their own companies. </strong></p>
<p>In <a href="https://www.aniccaresearch.tech/blog/the-alchemy-of-hashpower-part-i">part 1 of Alchemy of Hashpower</a>, we discussed that the most popular metric for hashpower pricing is <em>static-days-to-breakeven (DBE)</em>. It measures how many days it takes to break even on the machine purchase given the current snapshot price, difficulty, fee, and all-in opex. Every miner has a different <em>DBE</em> on the same machine because every miner runs operations differently. Miners calculate their <em>DBE</em> based on their own all-in cost per KwH and capacity. Manufacturers cannot take all minersâ costs into consideration, so the starting point of their <em>DBE</em> is always a market-wide average all-in cost. This figure is a very rough estimate, since the necessary data is extremely challenging to collect and underlying conditions are constantly changing. Miners with different capacity and cost structure come and go. <strong>Manufacturers do this exercise with their best guess on all-in cost, and set the price of the machines based on a reasonable range of the <em>DBE</em>.</strong></p>
<p>But what is the industry-wide all-in cost that they use as the input? We can reverse engineer it with historical machine price data. </p>
<p>Using the <a href="https://www.investopedia.com/terms/d/dcf.asp">Discounted Cash Flow</a> method, we can backtest historical machine prices to find the underlying assumptions when the manufacturers priced the machines. For example, the retail price for an Antminer S9 in January 2018 was $2,675. </p>
<p>Assuming an Antminer S9 life cycle of 24 months, we can map out the historical revenue of a single machine:</p>
<p><img src="/assets/images/2020/m11/lz7.png" alt="Screen Shot 2020-11-22 at 8.19.16 PM.png" /></p>
<p>Next, we reverse-engineer an all-in cost such that the sum of all the present values of each dayâs free cash flow equals the purchase price. Assuming an annualized <a href="https://www.investopedia.com/terms/w/wacc.asp">weighted average cost-of-capital (WACC)</a> of 12.5%, we have:</p>
<p><img src="/assets/images/2020/m11/lz8.png" alt="Screen Shot 2020-11-22 at 8.19.36 PM.png" /></p>
<p>In order to achieve $1.57 daily expense, the all-in electricity cost for an S9 needs to be $1.57 / 24 / 1.365 = $0.048 per KwH. This means that unless the miner had access to $0.048 per KwH all-in cost or lower, the miner wouldâve purchased the machine at a premium. The result above is calculated using Strategy 3, <strong>Sell Daily</strong>. Replicating the analysis with other strategies, Strategy 1 <strong>Moderate</strong> requires $0.017 per KwH all-in cost, and Strategy 2 <strong>Long BTC</strong> requires a $0.01 per KwH all-in cost. This means that in practice the actual âbreakevenâ all-in rate was within the range of $0.01-$0.048 per KwH.</p>
<p>This is drastically lower than the rate available to most miners at the beginning of 2018. Intuitively that makes sense. At that time the Bitcoin price had just reached all-time-high, the network difficulty was just beginning to catch-up, and S9 was the best machine on the market at that time. The ultimate determinant of price is still the supply and demand.</p>
<p>Applying the same method to machine prices at other points in time, the table below would be the âbreakevenâ all-in cost for miners. Here the all-in cost is the mean of all three strategies:</p>
<p><img src="/assets/images/2020/m11/lz9.png" alt="Screen Shot 2020-11-22 at 8.21.31 PM.png" /></p>
<p>From a different perspective, if the industry-wide all-in cost was $0.0507 per KwH, what would be the fair value of the machines at the time? Again, the Fair Price here is the mean of all three strategies:</p>
<p><img src="/assets/images/2020/m11/lz10.png" alt="*Premium/ Discount is Machine Price over Fair Value (Data source: hashrateindex.com)" /></p>
<p><em>*Premium/ Discount is Machine Price over Fair Value__(Data source: hashrateindex.com)</em></p>
<p>Note that this analysis does not take the changes in industry-wide average rate or WACC into calculation, since the precise industry-wide rate and WACC are difficult to estimate.</p>
<p>The point of this analysis is not to find the absolute fair value. As discussed, the fair value is not the same for every miner due to the different operating expenses as well as different strategies. However, even with an assumed industry-wide average rate, we can show how wildly inefficient the machine pricing is. <strong>During the bull market the manufacturers significantly overpriced the machines, and during the down markets the manufacturers were forced to liquidate the machines at a discount.</strong> This is aligned with empirical evidence we see in the mining market. When price rallies fast, the machine prices sometimes go up faster than the coin price. This behavior diverges from fundamentals, which indicate that machine prices should rise more slowly given the expectation of a future increase in network difficulty. <strong>At the end of the day the pricing of the machines is driven by supply and demand, and the hashpower market is highly illiquid.</strong></p>
<p>By backtesting the historical machine prices we can see that pricing heuristics based on <em>Static Days-to-Breakeven</em> are insufficient in capturing the volatility of mining profitability. In order to assess the fair value of the machines today, we need to model mining profitability on a forward-looking basis, with tools or frameworks that can capture the wild fluctuations of the outcomes.</p>
<p>A more advanced approach is to treat hashpower as a form of call option. The principle of this approach starts with treating the mining revenue of a machine as the underlying asset. There are three constituents for mining revenue: price, difficulty, and fees. A call option on Bitcoin price is arcane enough, but a derivative instrument that encapsulates these three elements is far more complex. Describing the <a href="https://en.wikipedia.org/wiki/Black%E2%80%93Scholes_model">Black-Scholes</a> theory for <a href="https://arxiv.org/pdf/1704.02036.pdf">options on multiple underlying assets</a> is straightforward: the additional considerations are the <a href="https://www.jstor.org/stable/3213286?seq=1">correlated random walks</a> and the corresponding multi-factor version of <a href="https://en.wikipedia.org/wiki/It%C3%B4%27s_lemma">Itoâs Lemma</a>. However, establishing the correlation matrix between the three variables is a daunting task.</p>
<p>As discussed in the <a href="https://www.aniccaresearch.tech/">Alchemy of Hashpower series</a>, price and hashpower have a <a href="https://en.wikipedia.org/wiki/Cross-correlation">cross-correlation</a> with a varying lag. Due to the reaction delay, when examining the relation between hashpower and price in a short time window, the correlation is <em>de minimis</em>. Hence, itâs tempting to simply model hashrate paths as a process completely independent of price. However, financially hashpower is a derivative of Bitcoin, and on a long enough time scale, the two time-series are positively correlated. On the other hand, transaction fees dynamics is even harder to model. While intuitively on some level transaction fees are connected to price and (inversely) to network hashrate, it is predominantly driven by on-chain activities, which is an exogenous factor. This is why the correlation matrix is not going to have meaningful results.</p>
<p><img src="/assets/images/2020/m11/lz11.png" alt="(Source: Glassnode )" /></p>
<p><em>(Source:</em> <a href="https://studio.glassnode.com/compare?a=BTC&a=BTC&a=BTC&c=&c=&e=&e=&e=&m=fees.VolumeSum&m=market.PriceUsdClose&m=mining.HashRateMean&mAvg=0&mAvg=0&mAvg=0&mMedian=0&mMedian=0&mMedian=0&mScl=lin&mScl=lin&mScl=lin&miner=&miner=&miner=&resolution=24h&resolution=24h&resolution=24h&s=1451676449&u=1606003200&zoom="><em>Glassnode</em></a><em>)</em></p>
<p>But once the assumptions on the distribution of the underlyings have been made, pricing hashpower in a period <em>N</em> is equivalent to pricing a series of <a href="https://www.investment-and-finance.net/derivatives/z/zero-strike-call-option.html">zero-strike European call options</a> with daily expiry. In other words, as long as the machine is on, the hashpower is a contract that exercises everyday, and converts into the underlying asset, which is the mining revenue. The cost of the contract is the depreciation of the hardware, plus the operating expenses. The option premium of the entire bundle should in theory be the price of the machine plus the present value of all the operating expenses incurred during period <em>N</em>.</p>
<p><img src="/assets/images/2020/m11/lz12.png" alt="Where: V is the fair value of the machine. Ci is the call option value with mining revenue as underlying, with expiration on day i. T is the daily operating expense." /></p>
<p><em>Where:</em></p>
<ul>
<li><em>V is the fair value of the machine.</em></li>
<li><em>Ci is the call option value with mining revenue as underlying, with expiration on day i.</em></li>
<li><em>T is the daily operating expense.</em></li>
</ul>
<p><strong>There is a critical flaw with this approach.</strong> Using this formula, the contract on day <em>i</em> and on day <em>i-1</em> are valued independently. In reality, the payoff on day <em>i-1</em> should set the initial condition for the contract expiring on the next day. Any hashpower valuation approach based on options pricing and simply sums up all trials in the period will face this path-dependence issue. Every trial will be a disjoint assessment.</p>
<p><img src="/assets/images/2020/m11/lz13.png" alt="Screen Shot 2020-11-22 at 8.29.05 PM.png" /></p>
<p><strong>Valuation with Numerical Methods</strong></p>
<p>Path-dependence is not an issue with numerical methods. Rather than valuing each day with 10,000 trials we are using the same 10,000 trials across all of them. <a href="https://www.palisade.com/risk/monte_carlo_simulation.asp">Monte Carlo simulation</a> is useful in modeling complex dynamics by generating random numbers. The expected payoff in a risk-neutral world is calculated using a sampling procedure. It is then discounted at the risk-free interest rate. With Monte Carlo methods, we are able to simulate the mining profitability of the latest-generation machines in the next two years, and compare their fair value against their prices on the market today.</p>
<p>As a first step we need to make some assumptions on the trajectory of price. <a href="https://arxiv.org/pdf/2002.07117.pdf">A numerous studies</a> argue that jump-diffusion is the most suitable in describing Bitcoin price distribution. We use a <a href="https://www.lpsm.paris/pageperso/tankov/tankov_voltchkova.pdf">jump-diffusion model</a> to simulate 10,000 possible price runs over the next two years. In a stochastic simulation, every run takes a different path.</p>
<p>A jump-diffusion model has two basic parts: the diffusion (geometric Brownian motion) and the jumps (usually Poisson distribution). For modeling simplicity, we assume that there is a threshold probability for the jumps. When jumps are triggered, the magnitude follows a normal distribution. </p>
<p>Calibrating based on historical price data, we use the following as the parameters for the model:</p>
<ul>
<li><em>Constant drift: 0.10%</em></li>
<li><em>Standard deviation of drift: 2.50%</em></li>
<li><em>Jump probability: 5.00%</em></li>
<li><em>Jump mean: 0.10%</em></li>
<li><em>Jump standard deviation: 5.00%</em></li>
</ul>
<p><img src="/assets/images/2020/m11/lz14.png" alt="Screen Shot 2020-11-22 at 11.58.37 PM.png" /></p>
<p>In addition to coin price, we need to project the network hashpower as well to calculate mining revenue. Modeling hashpower is more complicated than price trajectory because not every unit of hashpower is the same. While every miner on the network is computing hashes for the same algorithm, the amount of power consumed varies by machine. The simplified model of the current network hashrate abstracts away the presence of several hardware efficiency classes, each of which behaves differently as the market evolves. Stratifying our model by efficiency class shows us the composition of machines on the market, and therefore allows us to roughly predict how they would evolve over time.</p>
<p>Unlike price data, mining information is extremely challenging to collect. The only way to approach this is to interview as many miners, distributors, and manufacturers as possible. David from <a href="https://www.gmr.xyz">General Mining Research</a> surveyed the major manufacturers and distributors in China, and came up with the following estimate of the market composition as of 11/1/2020:</p>
<p><img src="/assets/images/2020/m11/lz15.png" alt="(Source: Proprietary data provided by GMR)" /></p>
<p><em>(Source: Proprietary data provided by GMR)</em></p>
<p>The snapshot serves as the basis for the initial condition of the projection model. Using an estimated industry-wide average all-in electricity rate, we can calculate the breakeven threshold for each layer, and understand roughly how many machines will likely drop should the price fall below the breakeven. Using $0.0507 per KwH as the estimated all-in rate, we can map out four possible scenarios based on different price levels:</p>
<p><img src="/assets/images/2020/m11/lz16.png" alt="(Source: Proprietary data provided by GMR)" /></p>
<p><em>(Source: Proprietary data provided by GMR)</em></p>
<p>Note that this only provides a baseline view of the hashrate projection. Old, marginally-economical machines sourced via secondary markets may come online and manufacturers may accelerate new production if there is a drastic rally in price.</p>
<p>Based on the scenarios above, we can find a linear function <em>y=4,544x + 6e07</em> to describe the relation between price and the network hashpower. For simplicity, we assume that for the next six months, hashrate growth follows the function of a 14-day average Bitcoin price with a drift term <em>dW</em>. We set 2.5% mean, and 5% standard deviation as the parameters of the drift term. In addition, based on our estimate of machine sales from manufacturers, we assume hashrate grows by 200 Ph/s a day for the next six months. We mimic the hardware reaction delay by incorporating a constant 20-day reaction delay. This means that hashrate only reacts to price action that at least happened 20 days ago. The full function:</p>
<p><img src="/assets/images/2020/m11/lz17.png" alt="Screen Shot 2020-11-22 at 11.58.02 PM.png" /></p>
<p>Sample trajectories look like the following:</p>
<p><img src="/assets/images/2020/m11/lz18.png" alt="Screen Shot 2020-11-22 at 9.12.47 PM.png" /></p>
<p>In reality, the relationship between hashpower and price is a messy and complex entanglement. Using a linear function to describe it is like projecting a chaotic system onto a low-dimensional subspace. There are many ways that the function can break. This is the same problem that we describe about the correlation matrix in the option pricing methods. <strong>However, this construction allows us to easily incorporate the lag time, and therefore is a significant improvement over assuming hashpower and price as two completely independent distribution.</strong> This makes the projection easier to manage.</p>
<p>To further improve our estimates, we can use a <a href="https://arxiv.org/pdf/1909.12313.pdf">Markov Chain Monte Carlo model</a>. Unlike Monte Carlo draws independent samples from the distribution, Markov Chain Monte Carlo draws samples where the next sample is dependent on the existing sample. This addresses multi-dimensional problems better than a generic Monte Carlo simulation. The exact construction of the algorithm is beyond the scope of this article.</p>
<p>Once we have the projections for price and hashrate in the next two years, we can calculate the mining profitability the same way we ran the backtests on the historical hashpower prices. Compared to two years ago, where crypto-backed lending activities were sparse, the <a href="https://www.forbes.com/sites/leeorshimron/2020/05/26/exploding-past-10b-interest-income-and-lending-are-bitcoins-first-killer-apps/?sh=29df0fda3320">lending market today has grown into a massive industry</a>. Collateralize lending is one of the most common services that miners frequently rely on. Evaluating the WACC today, the rate should improve noticeably. We can lower it to 10% instead of the 12.5% in the 2018 analysis.</p>
<p>Using a $0.0507 / KwH all-in cost, and a 10% discount rate, we can generate a distribution of the fair values. The final result is the average of all 10,000 trials. Additionally, we assume that after two years, Antminer S19 Pro and Whatsminer M30s still retain 20% of residual value.</p>
<p><img src="/assets/images/2020/m11/lz19.png" alt="Screen Shot 2020-11-22 at 9.19.52 PM.png" /></p>
<p>Needless to say, this should not be a final verdict on whether the machines are overpriced or underpriced. The mean and standard deviations in the price distribution, the function between hashpower and price, lag time, all-in cost, discount rate, and residual value are all factors that can drastically affect the outcome of this evaluation. For instance, running the simulation with $0.07 per KwH and with $0.03 per KwH all-in cost:</p>
<p><img src="/assets/images/2020/m11/lz20.png" alt="Picture1.png" /></p>
<p>We can see that when the all-in cost is high (left), the prices of the more efficient machines (Antminer S19 and Whatsminer M30s) are closer to their fair value than the lower tier machines. When the all-in cost is low (right), the pricings of the less efficient machines (Antminer S17 and Whatsminer M20s) are more favorable. <strong>This shows that if the all-in expense is competitive enough, the miner can benefit from operating less efficient machines.</strong></p>
<p>In our model we built a switch that turns off the machines if the mining revenue is consistently below expenses for 14 days. In the real world, miners donât frequently turn machines on and off based on short-term profitability. Most of the time miners have agreements with the datacenter host that they need to consume a minimal amount of power every month. Even after profitability drops below zero, most miners tend to wait for a downward trend to confirm before taking actions. <strong>Due to the labor-intensive nature of datacenter operations, and the illiquidity of machine market, miners are forced to observe longer term trends instead of short term price actions.</strong> In recent years, the rise in the volume of lending service providers also strengthened minersâ ability to endure through winters. Miners can collateralize their coins or machines to borrow fiat to pay for expenses, rather than selling a great quantity of coins. Nonetheless, this is a theoretical lower bound on mining loss. Miners cannot lose more than the capital expenditure plus the cumulative operating expense.</p>
<p>Like call options, the more volatile the underlying index is, the higher the theoretical value of the instrument. We can see how the results change as the parameters of the jump-diffusion model changes. <strong>When volatility is suppressed, the theoretical value of the machines drastically decreases. When volatility is high, the theoretical value rapidly increases:</strong></p>
<p><img src="/assets/images/2020/m11/lz21.png" alt="Picture2.png" /></p>
<p><em>*Based on $0.0507 per KwH all-in cost</em></p>
<p>This analysis is based on Strategy 3 <strong>Sell Daily</strong>. Same as the backtesting analysis, the fair value that can be âunlockedâ by running hashpower is within the range of FV(Strategy 1, Strategy 2, Strategy 3). Given that the Monte Carlo simulates 10,000 paths, each with a very different path, running one strategy alone should be sufficient to cover every type of market phase.</p>
<p><strong>A Future without Block Rewards</strong></p>
<p>Another variable that has a significant impact on mining revenue is the fees. Assume fees grows linearly by 5% and 10% a year, fair value of the machines would noticeably increase:</p>
<p><img src="/assets/images/2020/m11/lz22.png" alt="*Based on $0.0507 per KwH all-in cost" /></p>
<p><em>*Based on $0.0507 per KwH all-in cost</em></p>
<p>In reality the fee trend is much more sporadic, and its connection to other endogenous variables is less obvious. Modeling fee trends requires an entirely separate distribution. In addition, there are many ways to improve the accuracy:</p>
<ol>
<li>As discussed, use Markov Chain Monte Carlo to alleviate the <a href="https://en.wikipedia.org/wiki/Curse_of_dimensionality">curse of dimensionality</a>, </li>
<li>Introduce dynamic lag based on the four archetypal market cycles, use a <a href="https://poseidon01.ssrn.com/delivery.php?EXT=pdf&ID=272102114078118028097010019126092105123053024093062045123072092065100083111000080100034017099032020059038031127127066079067069029027003086049108109007105030085079047040060104116071087027068091029094020064026006121027027028084102069077095075066106021">poisson process to model the jumps</a>.</li>
<li>Use a hashrate-weighted average all-in cost instead of industry-wide median cost. </li>
<li>Use statistical methods to calibrate the parameters</li>
<li>Use machine learning tools to describe the relationship between hashpower and price. </li>
<li>Incorporate fee projection in mining revenue calculation. </li>
<li>Adopt <a href="https://en.wikipedia.org/wiki/Agent-based_model">agent-based simulation</a> for miner behaviors. Agent-based modeling is a technique for modeling complex systems to gain a deeper understanding of system behavior. It is widely used in high-frequency trading, or smart contract risk analysis. Under this framework, every miner is a âuserâ with different strategies and different cost basis. We can then define some simple reaction types (buy more machines, sell machines, buy more machines but wait for 30 days etc.) and build a library of âuser behaviorsâ. This would allow us to simulate much more complex interactions in the hashpower market. For more background, read about <a href="https://playgameoflife.com/">Conwayâs Game of Life</a>. </li>
</ol>
<p><em>Myron Scholes said, âall models have faults - that doesnât mean you canât use them as tools for making decisions.â</em></p>
<p>Like the Black-Scholes model, the simulation model is a mechanism that, in trying to reflect the actual world in a short description, simplifies its intricacies. This reduction makes the model usable but simultaneously limits its usefulness. Itâs important to understand where its limitations are, and that the simulations only represent possibility not certainty.</p>
<p>Nevertheless, the model is a baseline for users who have already formed a view on the market. Like any forecasting model, the simulation will only be as good as the assumptions the user makes. One uses modeling tools to turn those opinions about the future into an appropriate price today for something that will be exposed to that version of the future.</p>
<p>Why is this important? Whatâs the point of developing asset pricing theory in a market that is clearly driven by supply and demand?</p>
<p>Valuation is more than just a theoretical exercise. For Bitcoin, once mining becomes completely reliant on fees, competition yields razor-thin margins, and there is not a single element in mining revenue calculation that is predictable, how do we make sure miners keep producing hashpower? The answer is to maintain stability of continuous investments into mining hardware to augment the security budget of the network. This is critical because without enough hashpower, the whole system is susceptible to attacks, rendering Bitcoinâs settlement assurance worthless. A rigorous valuation framework is the first step in testing a broad range of assumptions and market behavior and planning accordingly. Valuation is the foundation of proper risk management for mining institutions that are becoming too-big-to-fail. The purpose of this exercise is to start a dialogue that focuses on this general direction. We will continue working to further our framework for years to come.</p>
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<!--End mc_embed_signup-->Leo ZhangLeo explores the operation mining hashpower is akin to portfolio management. Posted November 22, 2020.Tweet Storm - About Schnorr Sigs2020-11-22T00:00:00+00:002020-11-22T00:00:00+00:00https://bitcoinwords.github.io/tweetstorm-about-schnorr-sigs<table class="notice--info">
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<h1 id="tweet-storm---about-schnorr-sigs"><a href="https://twitter.com/benthecarman/status/1330638123844288513">Tweet Storm - About Schnorr Sigs</a></h1>
<h3 id="by-ben-carman">By <a href="https://twitter.com/benthecarman">Ben Carman</a></h3>
<h3 id="posted-november-22-2020">Posted November 22, 2020</h3>
<p>0/ For <a href="https://threadreaderapp.com/hashtag/TaprootWeek">#TaprootWeek</a> today we are going to talk about adding Schnorr signatures to <a href="https://threadreaderapp.com/hashtag/Bitcoin">#Bitcoin</a>, why they are great, what optimizations we can get with them, and weâll tease the cool applications they can enable.</p>
<p>đđđ</p>
<p>1/ First letâs start out with hopefully what you ask yourself first about a new digital signature schema: are Schnorr signatures actually secure?</p>
<p>In short, Yes.</p>
<p>Today Bitcoin uses ECDSA for signatures which we must obviously consider secure.</p>
<p>2/ It turns out Schnorr signatures can be considered slightly more secure as their security proof has less assumptions than ECDSA and no new ones! So if we consider ECDSA secure, then Schnorr must be secure as well!</p>
<p>3/ If you want to get in deep with the actual security proof I recommend checking out waxwingâs blog on the subject</p>
<p><a href="https://joinmarket.me/blog/blog/liars-cheats-scammers-and-the-schnorr-signature/">joinmarket.me/blog/blog/liarâŠ</a></p>
<p>4/ So, Schnorr is secure, but why do we want them?</p>
<p>Switching to Schnorr signatures can actually gives a lot of efficiency gains, both in block space as well as in actual computation time.</p>
<p>Letâs talk about block space first 5/ Digital signatures generally consist of two 32 byte numbers, so naturally youâd think a signature is 64 bytes. Well sadly today in Bitcoin that is not the case, they are actually around ~72 bytes. This is because bitcoin currently uses something called DER encoding.</p>
<p>6/ DER encoding requires we add a few extra bytes around our two 32 byte numbers which in general isnât necessary for Bitcoin because we donât need to support multiple types of signature encoding for each signature schema.</p>
<p>7/ DER encoding isnât anything fancy or necessary it is just a result of the design decisions Satoshi made when initially creating bitcoin likely because of the use of the OpenSSL library.</p>
<p>If you want to know more I recommend reading BIP 66:</p>
<p><a href="https://github.com/bitcoin/bips"><strong>bitcoin/bips</strong> Bitcoin Improvement Proposals. Contribute to bitcoin/bips development by creating an account on GitHub.</a></p>
<p>8/ Getting back to Schnorr, since we are adding a new signature schema to the protocol we can also define a new way to encode these signatures. So, what we are doing is just putting the two 32 byte numbers next to each other resulting in a smaller 64 byte signature.</p>
<p>9/ Another way we can save block space by using Schnorr signatures is something called key aggregation, better known as MuSig. With key aggregation we can have one public key represent an arbitrary number of signers.</p>
<p>10/ Key aggregation is a HUGE win because today any multisig contract today requires a key and signature (in total ~100 bytes) for every signer which can get very expensive. Reducing this to a single key and signature will save users on lots of block space and thus on fees!</p>
<p>11/ The last and smallest gain we get is from switching to 33 byte public keys to 32 byte public keys. This isnât a huge gain, but with us switching to a whole new signature schema we can now store the public keys in the most compact way being 32 byte keys!</p>
<p>12/ That entails the primary ways that we save on block space by using Schnorr: smaller public keys, smaller signatures, and key aggregation.</p>
<p>Now, letâs move on to the computation efficiency gains.</p>
<p>13/ With Schnorr Signatures we can batch verify signatures.</p>
<p>Today with ECDSA we need to take each signature and verifying them individually that they are correct. This is generally fine for something like checking a new transaction in your mempool but not ideal for an IBD.</p>
<p>14/ Today Bitcoin has had ~589 million transactions all with at least one signature. This is a lot to verifying and optimizing this verification can help a lot with bootstrapping new nodes doing an initial block download.</p>
<p>15/ With Schnorr we can take batches of signatures and verifying them together saving a lot on computation time. In BIP 340 <a href="https://twitter.com/pwuille">@pwuille</a> has a graph showing the actual improvements.</p>
<p><img src="/assets/images/2020/m11/bc1.png" alt="" /></p>
<p>16/ To further quantify this improvement, letâs say it takes 1 unit of time to verifying a signature.</p>
<p>Today without batch verification it takes n units of time to verifying n signatures.</p>
<p>With Schnorr and batch verification, to verifying n signatures will instead be n/log n</p>
<p>17/ Those are the majority of the base improvements of adding Schnorr signatures to Bitcoin. There are a lot of cool things weâll talk about tomorrow on different applications they enable and youâll see later how Taproot itself benefits from using Schnorr as well!</p>
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<!--End mc_embed_signup-->Ben CarmanBen Carman explains Schnorr Signatures at a high level. Posted November 22, 2020.How Bitcoinâs Power Consumption Is Good for the Planet2020-11-11T00:00:00+00:002020-11-11T00:00:00+00:00https://bitcoinwords.github.io/how-bitcoins-power-consumption-is-good-for-the-planet<table class="notice--info">
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<h1 id="how-bitcoins-power-consumption-is-good-for-the-planet"><a href="https://www.voice.com/post/@jasonadeane/how-bitcoins-power-consumption-is-good-for-the-planet-1605113957-1">How Bitcoinâs Power Consumption Is Good for the Planet</a></h1>
<h3 id="by-jason-deane-for-cryptowriter-in-association-with-voice">By <a href="https://twitter.com/JasonADeane">Jason Deane</a> for <a href="https://www.voice.com/post/@jasonadeane/how-bitcoins-power-consumption-is-good-for-the-planet-1605113957-1">Cryptowriter in association with Voice</a></h3>
<h3 id="posted-november-11-2020">Posted November 11, 2020</h3>
<h2 id="a-controversial-proposition-that-might-just-holdwater">A controversial proposition that might just hold water</h2>
<p>In early 2018, an analyst called Alex De Vries at Pricewaterhouse Coopers (PwC for short, thank goodness) produced a report entitled â<a href="https://www.sciencedirect.com/science/article/pii/S2542435118301776">Bitcoinâs Growing Energy Problem</a>â which seemed to provide a plausible calculation of the power consumption of the Bitcoin network.</p>
<p>It seemed viable, was generally well supported and, rightly on wrongly, went on to become the basis on which many lasting assumptions about Bitcoinâs power consumption were made. It was timely enough that I even included a detailed reference to it in one of the chapters of the book I was writing at the time called â<a href="https://www.amazon.co.uk/How-EXPLAIN-BITCOIN-your-mum-ebook/dp/B07KCDM38F/ref=tmm_kin_swatch_0?_encoding=UTF8&qid=1605105835&sr=8-1">How to Explain Bitcoin to Your Mum</a>â.</p>
<p>The chapter was called âWhy Bitcoin WONâT workâ which was a counterpoint to the preceding chapter entitled, surprisingly enough, âWhy Bitcoin WILL workâ.</p>
<p>Some, however, questioned the validity of the underlying assumptions about the type of equipment used a reference point to calculate power consumption and some considered whether renewable energy had been given enough consideration overall. </p>
<p>While both points are far from resolved, the latter was revisited by the same analyst a year later when he produced another report entitled â<a href="https://www.sciencedirect.com/science/article/pii/S254243511930087X">Renewable Energy Will Not Solve Bitcoinâs Sustainability Problem</a>â, the main conclusion of which is probably self explanatory.</p>
<h2 id="the-size-of-theproblem">The size of the problem</h2>
<p>De Vries had done the best he could with the data available, as had many others when trying to answer the question of just how much power Bitcoin consumes, but the actual number varies considerably depending on who you ask and at what point in Bitcoinâs history you need an answer forâââand with good reason.</p>
<p>The <a href="https://digiconomist.net/bitcoin-energy-consumption">Bitcoin Energy Consumption Index</a> has long since estimated total power consumption and, as of today, estimates a figure of 74 TWh (Terrawatt Hour), which is roughly equivalent to the entire power consumption of Venezuela, at least according to their latest official estimate which, oddly, was way back in 2015. </p>
<p>Even getting accurate energy consumption data by country is surprisingly hard and often the range of official estimates varies according to which source you refer to. No single source, in fact, appears to have a consistently up to date list of energy consumption levels, a point I find interesting in itself but is beyond the scope of this article.</p>
<p>Nevertheless, it is certainly <em>possible</em> that Bitcoinâs current power consumption is more than Denmark, Hungary, Hong Kong, Portugal, Singapore, Bangladesh, Israel, Greece, Kuwait, Switzerland, Chile and Austria to mention just a few.</p>
<p>In fact, assuming this data <em>is</em> correct and Bitcoin was classed a country it would be ranked 39th in the world according to the <a href="https://www.cia.gov/library/publications/the-world-factbook/rankorder/2233rank.html">official list of countries by power consumption</a> provided, interestingly, by the CIA. Yes, <em>that</em> CIA. (Note: there are other lists, but they are not dissimilar)</p>
<p>Just the mere possibility of that is astonishing, but the reality is that it could be even higher. Recently, a note appeared on the official Bitcoin Energy Consumption Index that simply read:</p>
<blockquote>
<p>Study reveals Bitcoinâs electricity consumption is underestimated ⊠(August 2020).</p>
</blockquote>
<p>Following the link provided leads to a <a href="https://www.sciencedirect.com/science/article/abs/pii/S2214629620302966?via%3Dihub">new report</a> that concludes that, as of the end of 2019, the conservative estimate was actually 87.1 TWh of power, not 42 TWh as shown on the chart. By that reasoning and using the same formula, does it mean consumption is actually closer to 150 TWh today? </p>
<p>If so, that puts the Bitcoin network as the fourth biggest consumer of power on the planet. Bitcoin would therefore consume more power than every other country except the entire European Union combined, the United States and, of course, China.</p>
<p>Could this really be the case, and if so, what does it mean for sustainability and Bitcoinâs future?</p>
<h2 id="whoa-there">Whoa, there</h2>
<p>Before we get all carried way with this revelation, it should already be clear that there is significant doubt over just how accurate this data is. </p>
<p>After all, if countries themselves are unable to provide good, solid data for their own consumption figures, how can we possibly say with any accuracy what the true consumption of a disparate bunch of machines spread across the planet really is, especially when we donât really know quantities or specifications?</p>
<p>However, even as a proponent of the ideology and practicality of Bitcoin, I will absolutely concede that it is a) âa lotâ and b) set to consume more power as time goes onâââat least for now, a point we will revisit shortly. We need to examine what happens next, but since we have no universally agreed data as a starting point it is perhaps more useful to look at trends and take a broader view.</p>
<p>In fact, it may be the only way.</p>
<h2 id="theres-power-and-therespower">Thereâs power ⊠and thereâs power</h2>
<p>When breaking down the âa lotâ figure, there are a few caveats that we need to mention, specifically different types of energy classed as renewable, stranded or unsold energy.</p>
<p>While itâs usually claimed that âmostâ Bitcoin mining is carried out via renewable energy (hydro, wind, solar etc), the <a href="https://www.jbs.cam.ac.uk/faculty-research/centres/alternative-finance/publications/3rd-global-cryptoasset-benchmarking-study">University of Cambridgeâs September 2020 report challenges this</a>âââat least partially.</p>
<p>It certainly agrees that some 76% of miners use renewable energy as âpart of their energy mixâ but states that, overall, only 39% of total energy is genuinely from renewables, most commonly hydroelectric power. </p>
<p>This is to do with the allocation of hash powerâââwhile the Asia-Pacific (APAC) region still produces most of it, their percentage of renewable energy is only 29%, whereas itâs as high as 70% and 66% in Europe and North America respectively where hash output is lower.</p>
<p>However, since the world is, generally, moving towards renewable energy at an ever increasing rate, it is clear that this percentage will increase over time, but itâs hard to say what timescale is needed to make the difference.</p>
<p>In addition, there are some circumstances where there are some directly positive outcomes of Bitcoin mining.</p>
<p>âStrandedâ energy, for example, refers to energy that would otherwise be wasted or unused, most commonly gas that has to be deliberately flared due to lack of pipeline capacity or is simply located where it is not cost efficient to transport.</p>
<p>In those cases, such as the mining farms created in Texas and North Dakota for exactly that reason, there is an unquantifiable benefit of avoiding that action.</p>
<p>Finally, there are areas in the world where too much power is produced and thereâs no efficient way of transporting it anywhere or to reduce the power output in a way that makes economic sense. This is common, for example, around hydroelectric dams. </p>
<p>Here, power is sold very cheaply to mining operations on condition they locate themselves in these areas. This creates a win-win for the provider, consumer AND environmentalists since no extra power is technically produced. Mining farms are one of the few industries that can operate pretty much anywhere as long as an internet connection is available.</p>
<p>However, in truth there is currently no way of quantifying the beneficial aspects against the obvious negative ones of coal or oil fired power generation, but we can safely assume that the former is much smaller than the latter and the net effective is still a negative one.</p>
<p>The bigger question would have to be this: if ALL Bitcoin mining was done on a renewable energy basis, would that ultimately be considered a satisfactory outcome for all concerned? For some, yes, but for others, no.</p>
<p>Even without the power issue, there are still environmental concerns. ASICs (the machines used by Bitcoin miners) can only do one task and when they reach of life, they are not easy to recycle, if at all. Almost certainly, hundreds of thousands of these machines have found their way into landfill with the promise of more to come.</p>
<p>Not only that, but mining rigs produce a lot of heat and either need more power to cool them (this is, in fact, a significant part of the quoted power consumption figures) OR they need to be located where it is cold.</p>
<p>In the latter case, could there be a long term environmental issue caused by dumping a giant heater in a cold place? Logic would dictate that there certainly could be.</p>
<p>It seems the problems for Bitcoin keep mounting up.</p>
<p>But, of course, weâve been here before.</p>
<h2 id="deja-vu">Deja Vu</h2>
<p>Any âgold rushâ for new tech leaves a path of destruction behind it. It has always been the case and probably always will be.</p>
<p>Whilst trying to think of a solid analogy, I decided (after rejecting many other possibilities) the most appropriate one was probably the PC itself.</p>
<p>After all, the explosive growth in PC use is still within living memory, the global tech development race was similar and these items were all designed to be used as tools to support and use the main non-sovereign, non-physical product that was initially hard for people to get their heads aroundâââi.e. the internet.</p>
<p>According to historical data collated by Gartner and presented on <a href="https://en.wikipedia.org/wiki/Market_share_of_personal_computer_vendors">Wikipedia</a>, between 1996 and 2003 some 922 million PC units were sold globally. I chose these dates because this was the era of proper âfirst genâ home computing, where connectivity to the net, such as it was, was possible, but difficult. After 2004, ADSL lines and other solutions started to become widely available and the tech began to change accordingly.</p>
<p>Thatâs a huge amount of boxes, but how many of those do we still use today? The answer, almost certainly, is none. Well, apart from the one my mum keeps in her spare room to play solitaire on occasionally.</p>
<p>Almost a billion units have been thrown away and, since these were the days before recycling, they also probably made it to the landfills too. And what about the billion or so modems we produced in the days before ADSL? Now all gone too. It was expensive both in terms of environment and dollars, but things have settled down considerably since then.</p>
<p>Last year just 261 million units were shipped compared to the peak in 2011 of 353 million, a drop of 102 million units in a trend that is still falling. We use other devices these days instead of just computers and we tend to upgrade far less frequently anyway as the gap between hardware and software capability has narrowed.</p>
<p>The PCs we do still use are far more energy efficient than their ancestors, especially in terms of monitors, so as the amount of connections to the internet have increased over the years, itâs likely that power consumption hasnât increased proportionately.</p>
<p>My view is that, over time, we will see the same with Bitcoin.</p>
<p>Right now, weâre in an arms race where even a slightly better machine is sought after at almost any price in the same way a 66Mhz processor was favored over a 33Mhz processor in the early, frantic days of computing.</p>
<p>But like PCs, over time this will settle down and many of the issues will be resolved, something I may seem overly confident about.</p>
<p>Hereâs why:</p>
<h2 id="the-future-and-context-of-proof-ofwork">The Future and Context of Proof of Work</h2>
<p>Although I am a self-confessed optimist on, well, pretty much everything really, I am also quite cynical about certain aspects of human nature. The bottom line is that, collectively, we just wonât care enough about things like the environment unless a) it affects us directly and b) it makes us money.</p>
<p>The trick, therefore, is to align global needs with selfish needs, or, to put it another way, to ensure that making money happens to coincide with things that are beneficial to the planet. </p>
<p>And although Bitcoin seems to be the opposite at first, from a long term perspective thereâs a natural alliance that could actually turn out to be very beneficial for all parties concerned.</p>
<p>Making money as a Bitcoin miner is all about efficiency and, as time goes on for technical reasons, this becomes more and more important. </p>
<p>Right now, weâre using the mining equivalent of the huge, extremely inefficient engines that were prevalent in American cars in the 70âs and got 8â10 miles to the gallon. After all why not? Fuel was cheap, plentiful and the environment (whatever that was) was fine with it, right?</p>
<p>But youâd never buy a new car like that now, partly due to a change in social awareness, but also because it would be too expensive to run. As soon as it becomes more about money, we pay attention.</p>
<p>Right now, new, sleeker tech is being developed. Each generation will produce more hash power for less energy and as these lines convergeâââas they always doâââit simply wonât be cost effective to run older, hotter, juicier equipment that needs to be frequently upgraded.</p>
<p>As time goes by, and even as Bitcoinâs hashrate and influence increases, I bet you any money (<em>in bitcoin please, not dollars</em>) that its carbon footprint doesnât increase in proportion to that growth. </p>
<p>This will be partly because of the equipment itself, but also due to the fact that earlier this year a whole swathe of reports, <a href="https://www.carbonbrief.org/solar-is-now-cheapest-electricity-in-history-confirms-iea">such as this one</a>, came out confirming that solar and wind are now the cheapest forms of energy production on the planet. Renewables, like Bitcoin, are here to stay and will now grow faster than any other sector as a result.</p>
<p>About time too.</p>
<h2 id="a-net-reduction">A net reduction?</h2>
<p>I further bet you based on what weâve seen historically, applications of Mooreâs Law (the concept rather than the technical absolute) and the fact that we humans, collectively, are predictable when it comes to money, that <strong>this power consumption will plateau and</strong> <em><strong>even fall</strong></em> <strong>eventually.</strong></p>
<p>Itâs a bold statement and itâs definitely not something that will happen next yearâââalthough certainly could within the next decadeâââand Iâm happy to go on record with that forecast.</p>
<p>Thereâs always a counter position of course, and the most relevant one in this case is the LED light argument, covered in <a href="https://advances.sciencemag.org/content/3/11/e1701528">this article</a>. The crux of this report is that overall power consumption in lighting has increased, even though much less power is now required to produce the same amount of light.</p>
<p>Iâm sure thatâs true as population and applications have grown on a global level, but when I switched all my lights at home to the latest-gen LED lighting, I noticed an immediate and significant reduction in both power consumption and energy bills as well as a far superior light. I have also never had to replace any bulbs as yet, something I definitely would have done several times over by now using the old, hot, inefficient tech.</p>
<p>I think we can safely assume Bitcoin miners, on an individual level, will consistently seek to do the same. After all, their livelihoods depend on it.</p>
<p>And thereâs also one more consideration worth noting.</p>
<p>Itâs easy to overlook that the traditional banking and global payment processing sectors also require enormous amounts of power to run, although itâs even harder to calculate what these numbers might actually be. Thereâs no single network to base assumptions on and thereâs literally thousands of independent companies and organizations who are often not exactly forthcoming about their carbon footprints.</p>
<p>However, we can safely assume that this power consumption, globally, must be <em>at least</em> what Bitcoinâs requirement is.</p>
<p>Bitcoin, in my view, will never replace that existing banking system, nor should it, but there is at least the <em>possibility</em> of reducing it in the long term. For example, every transaction that takes places over the Bitcoin network is, mathematically speaking, a transaction that does not take place on the traditional network.</p>
<p>Itâs a very simplified view, but on a big enough and prolonged enough scale, this could make a difference, especially when it comes to decisions about power hungry physical premises and data centers by incumbent financial institutions.</p>
<p>The size of that impact may ultimately be tiny or it may be significant, and my guess is that it will be somewhere between the two. On a global scale, this is therefore a redirect of power resource rather than a requirement for more, and that can be considered a benefit of the Bitcoin network.</p>
<h2 id="the-bottomline">The bottom line</h2>
<p>I think Alex De Vries work is actually very good as he embarked on a difficult task with little hard information. It has limitations, but these are clearly explained through caveats. </p>
<p>However, I disagree entirely with his prognosis as it assumes that what is happening right now will be the same going forward. I propose that this will not be the case because the parameters will change, the tech will change and as for the rule bookâââwell, we havenât even got round to writing that yet.</p>
<p>Although I have no doubt that De Vries work is right in the short term while we power through this crazy growth-spurt-cum-gold-rush phase of Bitcoinâs lifecycle, the adoption and management phases will see a different, more measured approach where power efficiency will become ever more important.</p>
<p>This means there will be an even more absolute and direct link between the power consumption of the miners and their standard of living. You can bet, therefore, they will continually seek out the lowest cost energy sources (already proven to be renewables), and the most efficient, lowest heat producing machines that have the best longevity. Yâknow, a bit like my LED lights.</p>
<p>They will also do this with a level of motivation that would outweigh anything in the traditional banking sector because they would be directly incentivized to do so.</p>
<p>And when individual needs align with things that are good for the planet, you know they will get done, even if itâs not for the reasons weâd prefer.</p>
<p>Still, weâll take it.</p>
<p>And so will Mother Nature.</p>
<hr />
<p><em>This post is published for Cryptowriter in association with Voice.</em></p>
<p><strong>Disclosure</strong>:Â <em>The author of this opinion piece has been heavily involved with bitcoin for several years and holds a substantial cryptocurrency portfolio, including bitcoin. He also has a mining operation running the SHA-256 algorithm based in Siberia and is a published author on the subject of promoting the understanding of cryptocurrency.</em></p>
<p>Jason is an analyst at <a href="https://quantumeconomics.io/"><em>Quantum Economics</em></a><em>, specializing in Bitcoin and macro economics.</em>ï»ż</p>
<p><strong>Disclaimer:</strong>Â <em>Investing in any asset class is risky. The above should not be taken as financial advice, nor construed as so. Always do your own research before investing or consult with a professional financial planner.</em></p>
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<!--End mc_embed_signup-->Jason DeaneJason makes the case for Bitcoin driving power generation innovation.