Humanity is transitioning to a new era of global connectedness. Our global systems are stressed, and there are signs that we may be on the brink of another global recession: the US 2-year and 10-year bond yields inverted recently, which it has done so before every recession since the 1980s¹, the IMF projects 2020 to have the lowest global growth since 2008–2009², and governments around the world are ignoring the principles of economics and omitting the time value of money by issuing negative-yielding bonds. Technology often plays a role in systemic change and bitcoin is poised to be an influential component of the next systemic transition.
What kind of systems do we live in?
Naturally, human beings are disorganized without structure. People, corporations, cities, and countries all have systems in place to organize themselves to increase their productivity or economic output or to achieve a goal, meet a target, or meet a partner. As a society, we have had civilizations based on feudalism, mercantilism, monarchism, communism, capitalism, conservatism, and socialism among many others in various forms.
But things change; towns become cities, corporations merge, countries move borders and eventually, the systems we have put in place fail to achieve the ends for which they were established. All systems either break down and make way for new systems, evolve into new forms or they have yet to do so. Every civilization, past and present, has had unique circumstances, strengths, and technical capabilities, so the various implementations of civil-organization have had varied results. The British Empire, at its peak in 1920, had control of 26% of the surface of the earth. No other monarchy was able to rise to such heights, though many others have risen and fallen, now lost to history. Systems in of themselves are not special, they are not something to cling to, they are a tool to be used to advance the objectives of those who implement them. If unable or unwilling to upgrade to modern tools, nations will be left in the modern equivalent of the dark ages with technologically driven nations leading both in productivity and development.
Today, we find ourselves in a system that is not globally ubiquitous but is globally connected. We are, for the most part, no longer governed by isolated local governments or rulers. In western democracies, we live in towns or cities that operate forms of government within counties or districts which operate their own forms of government within states or provinces within nations which may be democratic governments or constitutional monarchies, etc.. Additionally, our national governments are (more or less) obliged to international agreements, laws, standards, treaties, and alliances. That is to say, our global systems are complex, built layer upon layer, and born in a time before the internet.
Due to technological advancements in travel and communication, individuals are more likely to communicate and travel internationally than ever before. Ordering something from the other side of the planet, over the internet, to be delivered to your doorstep is now commonplace. We can live video chat anywhere and with anyone connected to the internet. The citizens of the world have gained a lot of perspective over the last 20 or 30 years as we have become more and more aware of how the rest of the world lives.
Tech giants such as Facebook, Google and Amazon are also learning a lot about people. They are monetizing our personal data and are becoming more pervasive in our everyday lives. A recently popular meme comes to mind:
The revenues of these companies rival those of nation sates. Amazon has generated $263 billion USD in the last 4 quarters. To put that in perspective consider that the budgeted revenue for the entire Federal Government of Canada in 2019 is $338.8 billion CAD or about $258.4 billion USD at today’s exchange rate. Large multinational corporations lobby governments to create laws in their favor but also have the flexibility to relocate to favorable jurisdictions. This dynamic forces governments to the will of the lobbyists or face the consequences of being labeled as bad for business.
The modern global economy and how we got here (the substantially abridged version)
A fundamental way we connect is through exchanging goods and services, typically with money. Within a nation, the government controls the supply and minting of its currency. Most people earn money in their country’s currency and spend their money within their own borders. However, when one wants to buy something internationally, most often the currency must be converted to another. Today, most countries function on fiat currencies which only have value because people believe it to have value. Largely because their government states that it is the official currency of their country. The exchange rate that an individual receives at a bank is largely set on open international foreign exchange markets where banks and financial institutions trade their reserves of each currency.
In the distant past, we used gold as money. But in terms of being used at money, it is difficult to produce and difficult and dangerous to transport to make payments. We eventually updated our money systems and began making paper money, which represented gold or silver stored in a bank. So, how did we get to using fiat money?
A key event that led us here was the Bretton Wood’s Conference of 1944. The Bretton Wood’s Conference was held in the US during a time of great global strife, near the end of World War II. It was attended by all the Allied nations and put into motion the eventual creation of the United Nations (UN), the International Monetary Fund (IMF) the World Bank and the end of the gold standard.
The European Allied nations were facing financial hardships as they had spent most of their reserves on war efforts and now needed massive spending to repair damaged infrastructure. They were tired of war and financial turmoil, having recently gone through the First World War, the great depression then the Second World War, they were determined to have peace and prosperity. They sought a solution whereby they could afford to quickly rebuild without bankrupting their governments. With the US being the largest holder of gold, they negotiated to be the one country to remain on the gold standard while the rest of the agreement participants held US dollars to back their currencies. This was likely difficult for many nations to concede but the world was in a state of upheaval and swift, monumental action was required.
One way to get an influx of cash would be to drop the gold standard and just print money, however, in the past this led to hyperinflation. In attempts to curb the effects of dropping the gold standard, they agreed to all move away from the gold standard to the US dollar as the standard, while the USD remained tied to and convertible with gold at $35/oz. This allowed the Allied nations more flexibility than being strictly tied to a gold standard but also decreased volatility compared to having no standard at all.
The by-product of this decision has tethered the globe to US economic dominance as they remained the only country able to print the de facto global currency. By the early 1970s, the US was facing simultaneous inflation and recession. To try to curb inflation President Nixon devalued the dollar relative to gold to $38/oz. This had the unintended consequence of sparking a gold run by other nations requesting their gold back in exchange for their US dollar reserves. This subsequently caused Nixon to make the decision to unilaterally sever the direct international convertibility of US dollars to gold, thereby ending the Bretton Woods Agreement. Despite the USA breaking the agreement, the global financial institutions it created remain and have been in place now, post-agreement, for longer than the agreement was in place. Since that time, however, the USD share of global official reserves has fallen.
This year, at Bretton Woods 75, the managing director of the IMF Christine Lagarde said:
“…the system over the course of [the past] 75 years has adapted and changed from being the referee of exchange rates between currencies to actually leaving the gold standard in the 70s to reforming in the wake of the great financial crisis the IMF has adjusted, [it has] has evolved. And today we are probably yet again, at the moment when we need to adjust and change and improve. And this is so because the landscape is changing. The landscape is shifting either due to geopolitical developments or due to economic shifts from west to east or because of the rise of non-state actors that collect and disseminate data.”
So far we have discussed some major global monetary system changes which took place over the past 75 years (a relatively short period of time, in terms of civilization scale systems). Looking further back in time we see monetary systems taking several different forms, and taking longer to transition between systems.
Now… Looking at our current global systems from 10,000 feet, they look complex, built piece by piece, layer on layer. To digital native Millennials, they seem antiquated and slow. Most Millennials can log in to their social media platform of choice and essentially vote, like, thumbs-up, or upvote and impact and influence their social networks. This, however, has little impact on their finances (apart from a select few internet influencers). It is not overlooked by them, that the systems which have more impact on our finances are voted on with much less frequency. If voted on, most government representatives are elected every 4 years at a minimum. Compare that to someone who gives 100 likes in a day.
Can we move to a new system or is the current system too entrenched? Recently, a plane was accidentally shot down in Iran. On social media, some people were calling for war, others discouraging it. A fitting quote, from Iranian author Marjane Satrapi, was retweeted several times, it reads:
“The world is not divided into countries. The world is not divided between East and West. You are American, I am Iranian, we don’t know each other, but we talk together and we understand each other perfectly. The difference between you and your government is much bigger than the difference between you and me. And the difference between me and my government is much bigger than the difference between me and you. And our governments are very much the same.”
If everyone in the world had a vote on something important, and we knew that the results would and could be enforced, do you think we all would vote the same way that our collective governments currently do? Another way to “vote” is with your money.
The future is not clear, but it’s not a question of if the system is going to change but how? Now we turn to discuss the future of the monetary system. Technological advancements are often at the forefront of systemic change and Bitcoin may have provided us with the technology to move into the next global monetary system.
How could bitcoin or other blockchains be used to change our monetary system? As a soft step, individuals can purchase bitcoin or other cryptocurrencies as a hedge against national currencies. Going a bit further, central banks could buy and hold bitcoin as part of their reserves, decentralizing control of the global monetary system and increasing sovereignty. The Washington Post states: “Control of these [monetary] networks allows the United States to issue “secondary sanctions” against countries, businesses or individuals that it wants to target, obliging non-U.S. actors to adhere to the sanctions or risk substantial penalties”³. As a more dramatic step, blockchains could be used as the backbone of future governance structures, decentralizing control of global institutions.
Are we going to formalize our modern-day corporatocracy and adopt Facebook’s Libra or something like it? There is a reasonable chance that given Facebook and its subsidiaries have a user-base of 3 billion people (almost 40% of the global population), they will be able to penetrate the cryptocurrency market. Their biggest challenge won’t come from lack of funding, organization or platform awareness but from their reputation… If the world is moving away from national currencies towards some kind of digital currency, not backed by an individual government, we may see something like the Libra battling head-on with Bitcoin, representing centralization vs decentralization. If that’s what’s happening, the next few years are going to be interesting.
Only time will tell what path we take. In the meantime, however, there is good reason to believe bitcoin is poised to grow in value.
It is a peer-to-peer electronic payment system. Individuals, companies, and governments can digitally exchange value without the need for an intermediary. It is not run by a company or a government. In fact, the software that runs the Bitcoin network is free and open-source. Anyone with a modern computer can download the software and participate in the network.
The system was set up to incentivize cooperation since if you’re going to spend vast sums of money on it, you may as well participate in it rather than undermine it because a system that is vulnerable isn’t as valuable. A secure system is worth more than an insecure system so breaking the system is self-defeating.
Bitcoins are scarce. There will only ever by 21 million bitcoins. Considering unspendable coins, unclaimed rewards and lost keys, the number is even less. Scarcity, combined with advanced security, divisibility, and fungibility with the ability to transfer anywhere, cheaply and easily, might be the recipe for gold 2.0.
Bitcoin is gold 2.0 Gold was used as a reserve currency for thousands of years (before the 1900’s when most countries moved to fiat) and is still used as an investment to store value to hedge against currencies. But as with any system, over time, technological advancements allow us to adapt and change old models or systems to be more efficient. 1,000 Bitcoin could be transferred over the internet for about a dollar. Try sending the equivalent store of value in gold so cheaply. Additionally, the security costs for storage and transportation of gold far exceed that of bitcoin. Verifying holdings is also easier with bitcoin.
Gold is valuable because of its historical use, robustness, cost, effort to produce and scarcity. Like gold, bitcoins are scarce. Unlike gold, the mining intensity has a negligible effect on the rate of bitcoin production and there are only ever going to be 21 million bitcoins of which over 85% have already been issued (and at least a million assumed to be lost).
What makes something a good store of value? A prevailing theory popularized with reference to bitcoin by Twitter user PlanB and developed by Antal E. Fekete in Szombathely is the stock to flow ratio (SFR). The SFR is the number of years at the current production rate, it would take to produce the total existing supply. For example, the World Gold Council estimates the above-ground stock of gold to be 193,472 tonnes and the USGS estimates the global gold mining output to be 3,260 tonnes /year. Therefore, the gold SFR is 59.3. The following graph shows gold, silver, palladium, platinum, and bitcoin SFRs and market value.
An interesting aspect of the bitcoin network is that the supply schedule is predetermined therefore the SFR can theoretically be calculated into the future. The historical SFR and price are correlated. Creating a regression model between the SFR and historical prices yields the following price prediction model.
It looks like real market prices lag the jumps in SFR when a halving occurs (The amount of bitcoin generated decreases by half roughly every 4 years). But do the changes in the SFR cause the changes in the price? Or have they just been correlated so far? Will the price deviate from this trend? Only time will tell. The SFR model predicts the price of bitcoin to go over $100,000 USD after the next halving in May of this year. With market prices lagging by a year to year and a half and eventually settling towards the SFR modeled price that puts the price around $100,000 near the end of 2022.
How could this be supported? If each bitcoin were $100,000 at the end of 2022, miners would be generating $90 million worth of bitcoin a day or $32 billion a year, who would buy those bitcoins?
The Market for Stores of Value
There is a market for secure stores of value. Gold continues to be mostly used as a store of value. The current gold market sector demand as per the World Gold Council is shown below. If you consider jewelry to be 50% store of value, technology to be zero and the rest of the demands to be fully used as a store-of-value, the weighted average of gold demand for store-of-value is 72%.
The USGS estimates the global gold mining production in 2018 was 3260 tonnes⁴. Therefore, at least 2340 tonnes were mined and used as a store of value. The global average all-in sustaining costs for gold mining operations were near 1000 $/oz in 2018. Therefore approximately $75 Billion was spent on mining gold to be used as a store of value in 2018⁵.
Other precious metals, real estate, stocks and bonds, and global currencies are all used to some degree to store value. Index funds are usually considered a long-term investment and so could be considered as a store of value. Over the past decade, an average of $330 billion USD of net flows was added to US-based index funds.
The total annual market size for store-of-value products is greater than the sum of the gold and US-based index funds markets ($405 billion USD). How much greater can only be assumed. We feel it’s conservative to estimate 50%, which means the global store-of-value market is estimated to be $600 billion USD. (Further refinement of this assumption may be a subject of future research.)