Amid this current crisis, the Bitcoin halving highlights core differences between fiat and crypto monetary systems and the distribution of power in both.
One of the core narratives of Bitcoin (BTC) since inception is the oft-stated goal of separating money and state. While this has certainly been a powerful creed in the currency’s early adoption by the crypto-anarchist and techno-libertarian communities, what does this actually mean? It’s quite simply a call for a neutral form of money.
When stripped of the more political messaging, Bitcoin is fundamentally the introduction of a credibly neutral, global system of value transfer that is open and permissionless yet cryptographically secure and verifiable. This burgeoning crypto economy is still relatively early in its development, yet in the ten-plus years since its launch, it has fundamentally shifted the discourse around what money could or ought to become in the future.&
Bitcoin’s third halving on May 11, a 50% reduction in the BTC block subsidy that rewards miners for validating transactions and securing the network, represents a clear distinction between fiat monetary systems governed by whim and crypto monetary systems executed through software. A global crisis such as the one we’re facing now is a crucible for any monetary system, often showing what the priorities of the powers that be are.&
The unlimited ability to print money in the fiat world operates in stark contrast to Bitcoin periodically reducing the issuance through an immutable monetary policy. The Bitcoin halving in the context of the pandemic provided an interesting starting point in discussing the core difference between the fiat and crypto paradigms and the distribution of power in both.
Fiat monetary systems
The predominant monetary systems of the world are fiat systems that are backed by the sovereign entity of the state through arbitrary decree. Such currencies have value because the state enforces their use as a medium of exchange, store of value and unit of account: the three qualities of money. The most obvious evidence of this enforcement is that the state requires taxes to be paid in the national currency.
This relationship between state authorities and money goes back hundreds of years to when governments and empires would stamp the visage of the current ruler of the territory into the hard metal currency. Today, fiat money takes the form of printed pieces of paper issued by a central mint overseen by a state department. This money is backed by the state rather than any commodity.
The United States used to operate on a gold standard, with bank notes backed and redeemable for precious metal reserves, but the mass capital flight to a secure store of value in gold during the Great Depression prompted the government to untether the dollar from the underlying commodity. The systemic challenges of a monetary system based on gold would have inevitably led to the state further abstracting the connection to the underlying resource to the point where the scaffolding would have become the building, in a sense. In short, fiat currency can be seen as a technical response in simplifying the management of money at great scale.&
There is a multitude of fiat currencies circulating throughout the global economy, but only one has achieved hegemonic status: the U.S. dollar. Following the end of World War II, an agreement established the dollar as the global reserve currency. Even though the agreement implied that the dollar would be backed by gold and thus ended when the gold standard was abandoned outright during the Nixon administration, organizations like the International Monetary Fund and the World Bank were formed to maintain a neutral, international monetary system — with the dollar at the center.
As the government is able to print pieces of paper backed by nothing but the power afforded to it by itself, people place a lot of trust and responsibility in the government to properly oversee the mint and avoid economic instability. If a government prints too much money, inflation occurs, sharply devaluing the value of the money in the economy. Some governments have severely mismanaged the money supply, leading to hyperinflation where the volatility for the price of a country’s currency against other global currencies starts to decrease rapidly, eventually becoming more valuable as kindling or paper-mache than a reliable medium of exchange.
Does this make the state a boogeyman that chains the populace into arbitrary financial systems that it can’t opt out of? There are certainly many proponents of Bitcoin that would support that claim, but let’s look at the larger pattern. The reason why state-managed currencies gained prominence is because people agreed to the unwritten social contract behind the money, entrusting the state to manage the complexities of such a system. This issue of trust is paramount and is essential to understanding what Bitcoin brings to the table.&
The Bitcoin paradigm
While fiat monetary systems feature monetary policies highly subject to what the lawmakers believe is necessary, Bitcoin and other cryptocurrencies are decentralized, autonomous monetary systems with rules hardcoded from their launch. Programmable, predictable and trust-minimized from day one, cryptocurrencies are radical experiments in value creation and distribution enforced through an unrivaled display of digital certainty.
Bitcoin’s monetary policy is unique in that it is executable through open-source software rather than a central mint overseen by treasurers and politicians. Its core features include a capped supply of 21 million BTC, around 10-minute block times, an incentivized issuance mechanism for minting BTC and an adaptive mining difficulty to maintain this economic clock.&
A critical part of Bitcoin’s monetary policy, the halving, is a periodic change to the BTC supply schedule that occurs every 210,000 blocks, or roughly every four years. This preprogrammed, automatic deflationary measure is unprecedented in the history of money and presents a stark contrast to the dominant fiat systems of the world.&
These protocol design choices, combined with novel economic incentives and cryptographic security, allow Bitcoin to uphold four core attributes: resistance to confiscation, resistance to censorship, resistance to counterfeiting and resistance to inflation. Or to put it simply, resistance to the very failings that have beset monetary systems past and present.&
So, where does this place Bitcoin in relation to fiat currencies? While many narratives have waxed and waned over the years — electronic cash, “End the Fed,” digital gold, “bank the unbanked,” etc. — the most relevant one at the time of writing and perhaps moving forward is the notion of money neutrality.
Currency in crisis
The subject of money neutrality is enfolded in a much larger discourse on the distribution of power in society. The circulation of currency indicates the overall health of the economy and its inhabitants. If resources such as currency are not widespread or accessible in different strata of society, pathologies develop — much like disrupted blood flow in a human body.
The true crucible for complex systems such as money or the economy is how they adapt to crises. The sudden arrival of crises — unprecedented or severely ignored — tends to reveal the inherent weaknesses within our infrastructure and where the priorities of the powers that be truly lie.
Quantitative easing and the hierarchy of money
Within a few months, the ongoing coronavirus pandemic has incapacitated entire economies, supply chains and various systems that support people’s health and well-being. Much of the core infrastructure of society has been and will be disrupted by the first- and second-order effects of the virus.&
In times of crisis, such as an oncoming recession or potential risk of inflation, governments will implement a monetary policy known as quantitative easing, or QE, in which the central bank prints a large amount of money and injects said money into the economy by buying financial instruments such as stocks, bonds and others. While the goal is to keep the economy afloat by maintaining target inflation levels, ensuring the stability of the monetary system and securing citizens’ trust in the currency, it can result in increased inflation and distrust in the currency, even making cryptocurrencies appear a viable alternative to investors and the populace alike.&
A large portion of the U.S. government’s multitrillion-dollar stimulus package is using QE to combat the precipitous drop in the market. In doing so, the government is favoring large corporations over small to medium-sized businesses — which have limited loan programs — and the millions of individuals and families adversely affected by the pandemic set to receive a single $1,200 check (at the time of writing). Why does it appear that the government is prioritizing keeping banks and corporations afloat, printing trillions of dollars to do so, rather than ensuring the well-being of its citizens first and foremost?&
To no small degree, the weaknesses and contrivances of the legacy financial system are a system design problem. A particularly useful framework for understanding how the situation came to be is the Cantillon effect, an 18th-century theory developed by French banker and philosopher Richard Cantillon that states the printing and distribution of money and wealth in society often follows a top-down hierarchy of institutions before reaching the common people.&
The financial systems and intermediaries at the top of the pyramid in closer proximity to the rulers operate better than the disjointed and inefficient systems further down the chain. Thus the rich have initial access to new money by design, with the value eventually trickling down to everyone else over time — something that many do not have. This is an easily observable phenomenon of a legacy financial system that favors Wall Street over Main Street.&
Consistency in chaos
While fiat systems are subject to full control by their overseers, cryptocurrencies such as Bitcoin are governed entirely by the execution of software that is itself rooted in high mathematical certainty. While fiat systems as implemented by the U.S. government are showing considerable strain and favoritism in the midst of a global crisis, the economic clock of Bitcoin is ticking without interruption in a series of predetermined protocol upgrades of its supply schedule based not on a whim but by programmable design since launch.&
Bitcoin halving is the antithesis of the quantitative easing monetary policy of the fiat world. Rather than rapidly increasing the supply of money, Bitcoin’s monetary policy reduces the issuance of the BTC currency in set intervals of time in a process some have called “quantitative hardening” or “quantitative tightening.” The entire ecosystem of stakeholders in the Bitcoin space — the miners, traders and holders — have to adapt to the rules of this software, never the other way around.
However, there are some considerations to make in assessing the distribution of power in the Bitcoin network and its neutrality. Firstly, if we analyze Bitcoin through the lens of the Cantillon Effect, we can indeed see a hierarchical distribution of value in motion. While the network is distributed and decentralized, as opposed to the fiat system with a literal central bank, the issuance of Bitcoin goes through certain intermediaries before it can circulate freely: the miners.
The block subsidy is not only the economic incentive for miners to allocate considerable resources in securing the network but also the minting process for the currency itself. The first new Bitcoin in existence is held by miners as they compete to solve the proof-of-work algorithm. While the sell rate varies according to business models, operating expenses, capital expenditure costs and so on, Bitcoin does not circulate until miners sell it into the open market, which is in turn rife with speculation.&
Miners are theoretically the only entities capable of compromising the network through collusion with over 50% of the hash power. While there are strong economic incentives in place to prevent this from happening, it is important to acknowledge that the distribution of power — in a literal sense as well —vastly favors these particular actors in the network.&
Also, one can point out that having an absolutely immutable monetary policy can produce complications down the line. Certainty and determinacy are unique and powerful features of Bitcoin and other cryptocurrencies, but this does not protect the system from unpredictable volatilities and distortions in the future.&
For example, in the field of chaos theory, there is the notion that seemingly deterministic systems can shift to disorder or chaos because they are highly sensitive to their state of initial conditions. In the context of Bitcoin, the proof-of-work model could perhaps lead to further consolidation and monopolization of the network such that its decentralization and distribution is minimized to a cartel of industry players. Furthermore, the pyramidal distribution of wealth in the crypto ecosystem may also repeat the sins of fiat.&
An advantage of an open-source financial system is that such discourse around Bitcoin’s resilience can enrich and influence its ongoing development. While it may not adapt fast, it will ultimately do so through a global consensus.&
Is Bitcoin a perfectly neutral monetary system? Not yet. It is, however, the crest of a powerful techno-social movement that aims to build credibly neutral systems that support lives and well-being. In an age of uncertainty, a monetary system owned and maintained in common by a global network of peers and bound by a shared set of rules could become increasingly attractive as the cracks begin to show within the legacy structures to which humanity has become accustomed.