Bitcoin - an essay on money, freedom, and elites

20 Jun 2023 · 11 min read

What is Money?

Money is a technology which serves as the physical representation of time and energy: it is the physical instantiation of the time and effort needed to extract and process materials into another form. To borrow from Friedman, the pencil whilst seemingly trivial requires a large input of energy and time to be manufactured. Raw materials must be extracted and combined by many labourers in order to make something fundamentally new. In a pre-monetary society one who wished to produce a pencil would face a lot of challenges, mainly due to their effort and time being the limiting factor for the conversion of raw materials into the form of a pencil.

With the technology that is money, labour (essentially energy multiplied by time) can be extracted from many others who wish to gain something else without them themselves having to do it – thus multiplying the productive capacity of a group several times over. But wait you may say, surely people could just exchange their time and effort directly for what they specifically want? However, this would rely on double coincidence of wants – the phenomenon by which two individuals both have exactly what the other wants and are both willing to trade. The double coincidence of wants can be worked around via multiple trades however this system is time consuming and can be value diminishing to the goods and services traded. Due to this inefficiency any system that involves trade between multiple individuals will naturally develop a form of universal exchange which in English is referred to by the word money.


Functions of Money

Money has three main functions: a means of exchange; a store of value across spacetime; and a unit of account. Money serves as a way to buy the goods and services that one needs without the use of bartering or producing the wanted good by oneself. In order to help facilitate that money must be able to store its value across spacetime.

A pound today in London must be worth the same amount in a year in Liverpool or Newcastle in order to facilitate trade and allow for saving. If money decayed every ten days, we would not be able to make long term decisions and save because the future would be at most ten days away.

Finally, money is a unit of account. This means that money can be used to measure things – chiefly the prices of goods and services.


Gold, Money, and Banks

Now that we have identified what money is in an arbitrary sense, we will now discuss a type of money that has been used for the ages: gold. Gold is a metal which in its pure form it is rarer than diamonds. Many forms of money have been used ranging from cowry shells to tobacco. The supply of these forms of money has been relatively easy to increase simply with human effort which has made them very prone to inflation. Gold on the other hand is a rare metal with a finite supply which, can only be extracted from the ground via mining (energy multiplied by time).

Whilst one can increase their mining operation of gold, the profits that they make is limited by the value of the gold which they mine. So, the mining cost per ounce of gold is asymptotically capped at the market price per unit of gold which discourages large increases in mining – stabilizing inflation of the supply of gold to 1-2 percent annually.

Gold’s fixed supply use for jewellery and art, stable inflation rate, and decent geographical distribution all over the world are the reasons why gold used to be used as a medium of exchange however, the large bottle neck for gold was portability and security. If one wanted to purchase a piece of real estate for one million dollars (large for an individual but chump change for an institutional investor), would require 25kg of gold, for 10 million dollars 250kg of gold, so on and so forth. People don’t want to be encumbered by a large weight of gold which is very susceptible to theft via armed robbery so, goldsmiths began taking in gold and giving out receipts for which gold could be exchanged at that same goldsmith – the first banks.

Banks at this early stage of their development gave loans back by their reserves from which they profited off of interest. This system, expectedly, led to bankers getting greedy and giving out receipts for gold that cumulatively were in excess of their reserves. This practise enabled bank crashes which could create panic shockwaves causing panic withdrawals from other banks and for these other banks to crash. The solution was a central bank which housed reserves of all the banks and enabled each individual bank to always be able to pay their loans (so long as everyone in the economy didn’t withdraw their deposits from all banks at once).


The Gold standard

With the establishment of national currencies came the Gold standard. This was a means of tying the values of currency to set amounts of gold. This aimed to prevent inflation by all money being backed by a physical and finite reserve asset: gold. The standard was implemented various times throughout history but has typically broken-down during periods of political tension and war in favour of inflationary policies. The standard was last officially implemented in the US in 1946 under the Bretton Woods system, and most countries pegged their currencies to the value of the dollar – crowning the dollar as the world’s reserve currency.


Fiat currencies

A fiat currency is a form of currency that is government issued and not backed by a commodity such as gold. Fiat currencies have no intrinsic value and are backed by the belief and faith in the government who issued the currency. Fiat currencies give central banks greater control because they can print whatever amount of currency that they want in order to achieve specified economic goals and agendas. Fiat currencies enable the monopolization of money by the government. Such monopolies are in practice always used to extract wealth from the masses and redistribute it according to how the governments sees fit. Printing money increases the supply of money in an economy which enriches those who first get the money and spend it by decreasing the purchasing power of others. This feature of fiat currencies causes the long run value of a fiat currency to tend to zero.

The temptation to monopolize fiat in the long run always proves to be far too great for governments to not succumb. All countries that participate in wars throw their balance books into ideological oblivion in order to finance their military campaigns. This is good for them in the short term but will ultimately lead to an inflationary effect within the economy that reduces the purchasing power of the average person.

The process of inflation has effects other than diminishing purchasing power. Unexpected inflation causes the muddling of price signals. Prices are the fitness markers which guide actors in free markets. Inflation makes price signals harder to understand and can cause people to make bad decisions due to their lack of knowledge. To illustrate my point lets looks at the example of a pencil manufacturer. Say a pencil manufactures feels that business is good and decides to take out a loan to multiply his profit by 1.5 times, and the cost of the loan will be about 1.1 times his profit – a net gain of 0.4 times his original profits. After taking out the loan, this manufacturer sees that the natural resources needed to produce the pencils as well as machinery which he was planning to buy have increased by 1.5 times – several other pencil manufacturers had the same idea as him.

These other manufactures all took out loans and purchased assets which inflated his costs to 1.6 times his original profits – our manufacturer is now in loss. Inflation does this in the economy on a wider but less noticeable scale. The introduction of money into the money supply doesn’t have an immediate effect. When money is printed those who first spend it benefit with zero cost to themselves however, with time an increase in price levels will occur. This phenomenon is known as the Cantillon effect and is analogous to pouring honey onto a plate – the honey clumps at the centre and slowly flattens out to cover the rest of the plate. This staggard increase in price causes a lag between decision making and reflective prices becoming available which, weakens markets and individual entities operating in them. When markets are prevented from pricing assets correctly long-term volatility and an eventual crash are certain. As of 1972, the dollar was taken off of the gold standard by Richard Nixon and made into a fiat currency.


Bitcoin’s Arrival

In 2008 during the aftermath of the financial crash caused by the failures of centralized systems of power, the domain bitcoin.org was registered and the bitcoin white paper posted. In 2009 the opensource bitcoin protocol was released and the ultimate form of sound money was created. The Bitcoin protocol is an opensource network which facilitates transactions of the digital asset Bitcoin. The protocol makes use of a Blockchain to prove the order of transactions and prevent fraud (double spending of coins) in a way that removes the need for trusted institutions. A consensus on the order of transactions is achieved via a concept called proof of work

A hash function is an algorithm which maps an input phrase of arbitrary length to a non-random output value. The bitcoin protocol uses double SHA-256 [double Secure Hash Algorithm 256-bit = SHA256(SHA256(𝑥))]. This produces a 256-bit number – a number between 0 and (2^256 – 1). Each transaction on the bitcoin network contains transaction data, a timestamp, the hash of the previous block and a Nonce (number only used once). The data is combined into a string of information and the nonce is changed until the output of the function is lower than a target value. The target changes every 2016 blocks that are mined and is made less or more difficult to ensure that the average rate at which a block is mined stays at ten minutes. The current target is 20.6 trillion ~2^44. This means that each block has to guess a nonce which when combined with the data in that block begins with 212 zeroes. The double sha256 of “hello” is: “d7914fe546b684688bb95f4f888a92dfc680603a75f23eb823658031fff766d9”,
which in decimal form is: “97504006689031266106313558736195978061851485905106955345991800701364517431001”.

The miner who first guesses a valid solution gets to mine a block and attach it to the chain. They then receive the right to create new bitcoins and send it to their wallet as a transaction fee. Today the mining fee is 6.25btc. This fee halves every four years until the last bitcoin is mined in 2140. Sha256 makes it impossible to add false transactions to a mined block because, that would change its hash and alert the other nodes of an attack. In the case of forks (when a split occurs due to different user opinions on transaction history) the nodes on the network work on the longest chain. In order for a malicious agent to commit fraud, he would need to fork the network, enter a faulty transaction, before catching up with and superseding the honest chain. This would require the attacker to have more compute power than all the nodes on the honest chain (about 83000 at $3000 - $10000 per node). If someone had that many nodes, why not just mine on the legitimate chain?


What is the Value of bitcoin?

Bitcoin’s value is its decentralization, portability, as well as its soundness and transparency in terms of its supply. There will only ever be 21 million bitcoins. The rate of inflation of bitcoin’s supply is scheduled and maintained by adjusting computational effort. All transactions are recorded on a distributed ledger available to everyone. It is the soundest form of money ever invented with a terminal inflation rate of zero%. Money is freedom to do what you want, and central banks rob people of that freedom when they choose to print new fiat currency. Some will may say that inflation serves as a means to get people to use money however, that involves theft from everyone else. The reason why gold is used as a reserve asset is because it is divisible, has a stable inflation rate, a finite supply, and a good geographical distribution. Bitcoin is better than gold in all those metrics and has greater portability. gold has a market cap of ten trillion. If Bitcoin is at least twice as good of a reserve asset than gold is, what market cap would that justify?


Why I think that Bitcoin would be subverted


Who are Elites?

Elites are people in an organization or society with the ability to control the resources within said society. There are often different strata of elites. I personally subscribe to Samo Burja's theory of Empire's and Competitive Landscapes. He posits that we can class individuals within an empire (an organization or society that exists on a fitness landscape) into different tiers of actors of the following categories: high, mid, low, and outside. A high has the ability to leverage and control large amounts of resources, a mid can mobilize a sizeable amount of resources, but not as much as a high; if a mid level agent wishes to compete with a high then the mid player is likely to have to mobilize a much large proportion of his resources than the high. As such, mids often form coalitions to compete with highs (imagine the nobility vs a King). A low is someone that can challenge a mid but not a high, to continue the medieval analogy a Knight may be able to challenge a petty lord but never a King. Some lows are more akin to resources think of potentially serfs. The definition of who can be considered an elite is somewhat fluid. However, the more resources that they can mobilize, the likelier they are to be an elite.


Elite Aspirants and Elite Overproduction

Elite Aspirants on the otherhand are non-elite persons who wish to join the elite class through some means. Elite overproduction is a phenomenon, coined by the Historian Peter Turchin, which sees the number of elite aspirants drastically outmatch the number of open spaces within the elite. This leads to elite aspirants galvanising the common people to try and achieve revolutionary change. Examples include the French Revolution of 1789 in which the Bourgeois transferred power from the Ancien Regime to themselves, and the Russian revolution of 1917 which saw the transfer of power from the Tsar to Bolshevik intellectuals. Elite Overproduction should not be confused with intra-elite competition (a sociological phenomenon which sees competing patronage networks of elites vie for power and control of resources within an empire). In my opinion, Bitcoin is likely to be subverted by a relatively small group of elite aspirants who wish to convert their technical know-how and capital into power, via the exertion of control over a bitcoin based financial system. I think that if Bitcoin became more widely used, large holders of bitcoin would co-ordinate to make the system work for them similar to OPEC. According to Rafael Schultze-Kraft 71.5% of all available Bitcoins are held by 2% of the on-chain entities, also There are only around a million bitcoin miners today (likely with a similar distribution of hashrate compute). Furthermore, widely used systems require legislation and governance which the largest holders of Bitcoin are in a very good position to provide. Looking at how some companies have centralized supposedly de-centralized products, I am not hopeful that crypto-currencies won't be subverted in a similar way.