The Real Story of Bitcoin

Olav Syrstad , associate professor of finance at BI, Norwegian Business School, recently wrote “The Faritale of Cryptocurrencies,” in which he compares cryptocurrencies to the current monetary system. While getting some facts right, the blog post is, unfortunately, much closer to a fairytale than reality.

In the blog post, Syrstad rightfully describes how credit issuance makes the effective money supply in a society elastic. He then goes on to argue that even on a Bitcoin standard, that would continue to be the case. I agree with Syrstad on this, but that is also where the agreement ends.

The real backing of bank deposits

As I understand it, Syrstads's core argument in favor of the current monetary system, based on bank-issued credit money, is that it is backed by banks' financial assets, which themselves are claims on real assets, and that this somehow guarantees the real value of bank deposits.?

However, Syrstads's argument has a big hole. Bank depositors do not hold a claim on the bank's assets. Depositors hold a right to demand government money, a claim on the Central Bank, in exchange for their deposit.?

Further, a claim on the central bank gives you a claim on, well, nothing. You cannot go to the central bank with your cash and demand anything in return. Historically, you, or eligible institutions, could typically redeem cash in gold or silver, but no longer.?

The current monetary system is a pure fiat system, backed by its network effects and trust, but nothing more. In other words, it has the same fundamental backing as Bitcoin: social consensus.

Money’s two pillars of trust

In his text, Syrstad points out that for something to be treated as money, its users must trust that both the nominal value and the exchange value (real value in Syrstad’s terminology) should have some level of (expected) persistence.?

He elaborates on how regulation and government backstops help establish trust in the nominal value of bank money but elegantly skips discussing how this trust can be established internationally between countries or for those who live under the risk of government sanctions and censorship.?

When he moves over to explain how trust in exchange value is maintained, he claims that bank money will keep its value as the central bank increases interest rates in the face of price inflation and that this increase in interest rates will “compensate for higher prices.” This is so obviously wrong, as evidenced by the historically large fluctuations in real interest rates (interest rates adjusted for price inflation), that it is hard to understand why he is putting forward this claim.

Moving on to Syrstad’s assessment of Bitcoin, he claims that because Bitcoin is not a claim on anything but itself and because of the competition in the crypto space, Bitcoin is likely to lose both its nominal and exchange value. This is a spectacular claim but lacks any evidence.

Trust in math, not rulers

The truth is that Bitcoin is highly unlikely to disappear anytime soon. It has already acquired substantial exchange value and established strong network effects, as hundreds of millions of people worldwide view its features as attractive.?

First, you can safely hold bitcoin yourself. There is no need for trust in any regulatory body, judiciary system, or government to trust the nominal value. If I keep 5 BTC myself, those are mine regardless of where or who I am. I have to protect the private key, but as long as I do that, there is no risky financial industry that may blow up on me and result in a haircut on my holding, as happened to bank depositors in Cyprus in 2013. When you hold bitcoin, you trust in math, not rulers.

Secondly, as bitcoin isn’t a claim on anyone, it is also completely borderless. With Bitcoin, you can instantly send money to the other side of the world and make an immediate and final settlement. With bank money, that is impossible.?

All bank money is a claim on a specific bank. To send it to the other side of the world, you have to go through a long chain of banks that trust each other and successively exchange claims with each other (the correspondent banking system). This is both expensive and slow, and increasingly difficult in an ever more fragmented world where USD has been weaponized, as exemplified by the confiscation of Russian reserves.

Thirdly, unlike central banks, where independence can be removed as fast as the political landscape changes, e.g., in the face of unsustainable government debt with interest expenditures exceeding those of the military budget as in the US, the supply of bitcoin is perfectly predictable.?

This means that economic actors can plan around a perfectly predictable constant and that no money printers are available to save bitcoin-credit institutions that take too much risk.?

This is likely to remove the moral hazard of being too big to fail and will make depositors and creditors pay attention to the risks that are taken. If they don’t, their bitcoin will be lost.

Conclusion

The list of features valued by those who voluntarily buy bitcoin goes on. I could have elaborated on how Bitcoin's open source and permissionless nature make it evolutionary superior to the current monetary system with its central planning, control, and permissions or I could have looked deeper into how bitcoin may emerge as an apolitical global reserve currency. But I believe that by now the point should be clear.?

Bitcoin is money with the same fundamental backing as bank money: social consensus. The difference is that the current financial system builds this consensus on control, regulation, and coercion, while Bitcoin is built on math and voluntary participation. Unlike many hardocre Bitcoiners, I don’t believe that Bitcoin will upend the state and its desire to control money, but at least it offers a viable alternative and should not be dismissed as something that is likely to go away or fail anytime soon.