The Costs that Haunt Your Dreams of Hyperbitcoinization
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The Costs that Haunt Your Dreams of Hyperbitcoinization
By Emil Sandstedt
Posted September 3, 2020
Capitalism, Division of Labor and Money
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. This profit seeking is conducted by utilizing money, 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 — 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.
In Mises’s Evenly Rotating Economy 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. Since everyone knows the future, they have lent out or invested their money, and the value of money has fallen to zero. 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. Money is for uncertainty.
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 — an idiom from a time when the weather could not be well predicted. From these prerequisites — two sides of the same coin — it follows that money can only stay money and stay valuable as money if transaction costs are low. 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.
Costs of Bitcoin
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 hyperbitcoinization proceed. Bitcoin is monetarily rather unique in this regard, that it becomes more expensive to use the more people that are using it — a point previously made by Deryk Makgill 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 — 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 Mengerean theory of money and saleableness. In this theory of money, the winner-takes-it-all effect leaves little room for insufficiencies. This is why Bitcoin transaction costs become incredibly important when speculating about hyperbitcoinization. Somewhere around here, in this mess we call money and economics, is where some people get confused.
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. So, in an attempt to make up for the sub-optimal prospects of a subset of Bitcoin’s congestion related costs, it is tempting to point to the solution of hodling. 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; by hodling 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. In other words, through hodling, 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 hodling) may be artificial and therefore shatter in real economic situations.
At a glance, the logic behind lowering costs through hodling 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. But anyone decreasing costs by hodling 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. The reason a person can’t 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. Another opportunity cost — the inability to act during future economic uncertainty — will take its toll as well for those finding themselves hodling Bitcoins for the sole purpose of lowering costs. 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.
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. This means that hodl, by the very nature of how money is successfully used, can’t help make Bitcoin money in and of itself. Only functional scaling can, and that road is full of uncertainty and danger. Hyperbitcoinization then stands or falls with, among other things, the attempted technical solutions’ ability to drastically lower total costs, and not with any collective hodl 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.
On a slightly different, albeit more ridiculous note, some Bitcoiners have pursued hodling as part of their sacrifice to the collective. 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.
Money or not — how much does it matter?
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. The exclusivity born out of this definition takes us to an interesting focal point. 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.
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. 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.
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. But there are other focal points involved. 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 can’t be money, and so there won’t be any such hyperbitcoinization. This scenario is, it seems to me, not unlikely. Instead, being, and having been for over a decade, the first, most valuable and most liquid cryptocurrency, is a sound focal point as well, with a similar exclusivity extracted out of its definition. It is likely that, given that decentralization, a non-changing code base, and other prerequisites don’t 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. 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.
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 Enemy’s 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. 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. 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.
Special thanks to Daniel Krawisz and Deryk Makgill from whom I silently borrowed ideas about how money works.