Broken Money

1. Money is fundamentally a ledger, evolving from physical to digital forms

At its core, money is a ledger.

Historical evolution. Money has taken many forms throughout history, from shells and beads to precious metals and paper currencies. However, the underlying function has always been to serve as a record of value – a ledger. This ledger tracks who owns what and facilitates exchanges between parties.

Forms of ledgers:

• Physical commodities (e.g. gold, silver)
• Government-issued currencies
• Bank deposits
• Digital cryptocurrencies

As technology advanced, money became increasingly abstract and digital. This shift allowed for faster and more efficient transactions but also introduced new complexities and risks.

2. The speed gap between transactions and settlements led to financial centralization

The speed and ease with which this occurred was only possible due to the abstraction of gold as money.

Technological mismatch. The invention of telecommunications in the 19th century created a significant disparity between the speed of transactions and settlements. While information could travel at the speed of light, physical money (gold) still moved slowly.

Centralization effects:

• Banks gained control over fast long-distance transfers
• Central banks emerged as ultimate settlement authorities
• Governments could more easily manipulate money supply

This speed gap led to the creation of complex financial systems built on credit and promises, ultimately resulting in the centralization of monetary power in the hands of banks and governments.

3. Central banks and governments gained unprecedented control over money

When the music on this highly leveraged system stopped, either IOUs (bonds and bank deposits) were going to collapse downward toward the size of the monetary base through massive defaults, or the monetary base would need to be expanded upwards to "make good" the large number of dollar IOUs that had been created during prior years and decades.

Monetary policy control. Central banks gained the ability to create and destroy money at will, manipulating interest rates and money supply to influence economic conditions. This power allowed governments to finance wars, bailouts, and other large expenditures without immediate consequences.

Consequences:

• Erosion of the gold standard
• Transition to fiat currencies
• Increased economic instability
• Growing wealth inequality

The ability to "print money" gave central authorities enormous power but also led to long-term economic distortions and the potential for currency debasement.

4. Fiat currencies inevitably lead to inflation and wealth redistribution

By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.

Inflationary bias. Fiat currencies, not backed by physical commodities, are susceptible to inflation as governments and central banks face constant pressure to increase the money supply. This leads to a gradual but persistent loss of purchasing power for savers.

Effects of inflation:

• Erosion of savings
• Asset price bubbles
• Wealth transfer from savers to debtors
• Increased financialization of the economy

Over time, inflation acts as a hidden tax, redistributing wealth from the general population to those closest to the source of new money creation, such as governments, banks, and large corporations.

5. Bitcoin offers a decentralized, digital alternative to traditional money

A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.

Revolutionary design. Bitcoin, created by Satoshi Nakamoto in 2009, combines cryptography, peer-to-peer networks, and game theory to create a decentralized digital currency. It aims to solve the problems of trust and centralization inherent in traditional financial systems.

Key features of Bitcoin:

• Fixed supply (21 million coins)
• Transparent and immutable ledger (blockchain)
• Decentralized network of nodes and miners
• Programmable money (smart contracts)

Bitcoin represents the first successful attempt at creating digital scarcity without relying on a central authority, potentially reshaping our understanding and use of money.

6. Proof-of-work is essential for Bitcoin's security and decentralization

Energy is the arbiter of truth, in this case.

Unforgeable costliness. Bitcoin's proof-of-work consensus mechanism requires miners to expend real-world energy to secure the network. This creates an objective, verifiable way to order transactions and prevent double-spending without relying on trusted third parties.

Benefits of proof-of-work:

• Resistant to Sybil attacks
• Provides objective "weight" to the blockchain
• Allows for permissionless participation
• Creates a fair initial distribution of coins

While energy-intensive, proof-of-work is crucial for maintaining Bitcoin's decentralization and security properties, distinguishing it from more centralized alternatives.

7. Bitcoin's energy usage is proportional to its utility and value

Bitcoin's energy usage in the long run is strictly limited by the utility it provides to users.

Self-regulating system. Bitcoin's energy consumption is often criticized, but it's important to understand that the network's energy usage is directly tied to its economic value. Miners will only expend energy if it's profitable to do so, creating a natural equilibrium.

Factors affecting Bitcoin's energy use:

• Bitcoin's market price
• Mining difficulty
• Halving events (reducing block rewards)
• Transaction fees

As Bitcoin matures, its energy usage is likely to stabilize as a small percentage of global energy consumption, potentially replacing less efficient financial systems and incentivizing the development of renewable energy sources.

8. The Lightning Network enables Bitcoin to scale as a payment system

The Lightning network does that too, on a bigger scale, and without credit.

Layer-2 scaling solution. The Lightning Network is a second-layer protocol built on top of Bitcoin that enables fast, cheap, and scalable transactions. It addresses Bitcoin's base layer limitations while preserving its security and decentralization.

Lightning Network features:

• Near-instant transactions
• Very low fees
• Increased privacy
• Potential for millions of transactions per second

By moving most small transactions off-chain, the Lightning Network allows Bitcoin to function as both a store of value and a medium of exchange, potentially competing with traditional payment networks.

9. Bitcoin faces challenges but has potential to reshape the global financial system

There's no guarantee that Bitcoin will be successful in the long run, but to whatever extent that it will be, it's almost guaranteed to be very cyclical along the way, with higher-highs and higher-lows as it repeatedly washes out speculative traders that try to attach leverage to it.

Ongoing evolution. While Bitcoin has made significant progress, it still faces numerous challenges on its path to wider adoption. These include technical limitations, regulatory uncertainty, and competition from both traditional financial systems and other cryptocurrencies.

Potential impacts of Bitcoin:

• Reducing the power of central banks
• Providing financial inclusion for the unbanked
• Serving as a global, neutral reserve asset
• Enabling new forms of programmable money

Despite the challenges, Bitcoin's unique properties and growing network effect give it the potential to fundamentally change how we think about and use money in the digital age.

Last updated: January 22, 2025