Bitcoin: A Protocol for Quality (Part 1 of 2)

How perfect money can improve Quality and why Bitcoin is perfect money.

The Solution to Economic Irrationality

In Quality in an Abstract Economy, I explain that the primary factor in an economy that makes it abstract is the utilization of an inflationary monetary system, which comes in part from the decoupling of currency from money. In his Principles of Economics, Saifedean Ammous states that “monetary technologies” are “inextricably connected to time preference, for good or for ill.” The use of inflationary money shortens decision-maker’s time preference and makes them unable to sufficiently delay gratification. This makes them irrational when evaluating economic decisions in the long-term. I make the argument that, in an abstract economy, one must implement tools to delay gratification, such as a quality management system, to improve Quality within an organization or, at a minimum, avoid the Quality-reducing impact of the abstract economy. Ultimately, though, the final solution to this economic irrationality is to remove the influences on the economy that make it abstract in the first place.

Fiat currency, specifically the United States dollar (USD), is currently utilized as the monetary system for the global economy. It is an inflationary monetary system by design. Using the USD as money creates a layer of abstraction on top of all decision making. At its core, money should be a tool for delaying gratification and facilitating prosperity. “Good” money will delay gratification, and “ill” money will incentivize immediate gratification. The use of “ill” money is facilitating malinvestment and incentivizing decapitalization. It is stripping Quality out of our products, businesses, and ultimately out of our civilization. The solution to this economic irrationality is the utilization of “good” money, or better yet, perfect money.

What is Money?

Ludwig von Mises defines money as, “the commonly used medium of exchange (MoE)” in his The Theory of Money and Credit. Money only has utility in an economy where exchange is a possibility. In a subsistence economy, where individuals produce all goods necessary to satisfy their wants, there is no exchange and therefore money is unnecessary. In a barter economy, or an economy with only direct exchange, money also has no role. Both subsistence and barter economies are inefficient and limited in their ability to scale. A barter economy, or an economy that only implements direct exchange, is limited by the problem of the coincidence of wants (i.e., mutual desire for each other’s goods). Money emerged as the MoE to solve this problem. In an economy with money, indirect exchange is possible. I can trade the fruits of my labor for whatever my community uses as money, then I am able to trade that money for what I want, when I decide I want it. No alignment of desires is required to facilitate exchange. The fact that it is “commonly used” means I can do this with confidence the next party will also be willing to accept it for the fruits of their labor. Throughout history, many things have been adopted as money; cows, beads, giant immovable stones, and precious metals are a few examples. The adoption of this technology allowed for the division of labor to expand, and with more and more people specializing, the utility of money expanded with it.

Some communities throughout history cut out the middleman (i.e., the medium in the MoE) and created a centralized ledger to record the exchange of all goods and services. Some people still conceptualize money this way. For example, Elon Musk has recently described money as “a database for exchange of goods and services and for time shifting the exchange of goods and services.” If false exchanges are recorded on the ledger, it doesn’t magically generate more goods. Goods and services can only be exchanged if goods are able to be generated in excess of consumption. The same is true for monetary systems that use a medium, like precious metals or fiat currency. If we find a large deposit of unmined gold (such as we did with the discovery of the Americas), or if a government prints money to cover a spending deficit, it should be thought of as recording a false exchange on the ledger. This way of thinking about money is a good reminder that productivity is primary. Money does not have utility in the absence of productivity. Money facilitates prosperity, but it cannot create it in isolation.

A centralized ledger may have worked for some communities, but as the size and scope of an economy grows, it becomes increasingly difficult to utilize, particularly if the scope expands across cultures with varying degrees of trust or jurisdictions that operate under different sets of laws. The emergence of money and its utility in facilitating exchange enabled economies to proliferate, limited only by the trust in the money utilized. Historically, one of the major factors in establishing trust across cultures and jurisdictions was if a money was decentralized. The more trusted the money was, the larger the economy grew, and the more civilization was able to take advantage of the efficiencies of the division of labor. Today, for the most part, we have a global economy. The global economy was able to develop on the back of a trusted monetary system, but the continued strength and size of this economy is contingent on a shared trust in the money utilized. In a functioning economy, people trade the fruits of their labor for money. Something can only function as money if people can trust that it will retain its utility (i.e., when they require the fruits of someone else’s labor, it will also be accepted in exchange) and its value.

The utility of money is as a MoE, but that is not the only characteristic it must have. The best forms of money have high salability across time and space, meaning they don’t degrade, and they are easy to move. If something has high salability, it means that it will retain its value throughout the required transaction processes and throughout time. So, although money emerged as a MoE, good money must also be a store of value (SoV). Perfect money would be an immutable record of exchanges and would transfer value generated today indefinitely into the future.

For a long time, cows were the most salable good across time and space. A medium’s utility as money is a relative one, though. Cows are more salable than wheat, but less so than gold. As gold started to be utilized as money, cows were demonetized. That doesn’t mean cows have no value, but their value is now in line with their utility. Parker A. Lewis makes the point in his Gradually, Then Suddenly, that monetary systems ultimately “converge on one medium.” He claims that this occurs due to the fact that their “utility is liquidity and exchange rather than consumption or production.” This convergence will necessarily be focused on the most salable thing and a global economy ultimately demands one money.

Brief History of Money

As Lewis explained, monetary systems “converge on one medium.” The history of money is a long and painful journey, but for the sake of time, we will skip over the monies that came before precious metals. Precious metals have claim to the longest tenure as money due to their immutable characteristics, relative scarcity, and decentralized nature, which gave them not only high salability across time and space, but the trust to be able to scale. Gold, in particular, rose to the top of the competition of commodities and held its position as money for over 5,000 years. This was due to it having the largest stock-to-flow ratio of any physical commodity in the world, or in other words, the amount of a thing that currently exists divided by the amount of a thing that is generated over a period of time. Gold is very difficult to make or find more of and is also very difficult to destroy or corrupt. Gold was, and continues to be, an exceptional SoV, but it has weaknesses as a money, and as the economy grew in size and scope, they became exposed.

It was revealed that, although it has high salability over space compared to cows or other commodities, it does not have sufficient salability over space to support a global economy, where transactions can be made instantly between parties on opposite sides of the world. For example, to achieve final settlement in a transaction with gold between two parties, one in the US and one in France, it needs to be physically sent across the Atlantic Ocean. The cost of shipping large quantities is costly and undesirable. Gold and other precious metals have additional weaknesses as well, such as high cost to secure and verify. An argument can be made that with the emergence of a global economy, the weaknesses of gold (i.e. relatively low salability over space) outweighed its strengths (i.e. salability over time), and left an opening for technological innovation or disruption.

It isn’t the first time that gold’s weaknesses provoked innovation, and as with the other times, the solution was for increased centralization. In the past, the high cost to verify gold was solved by kings and rulers providing their seigniorage to the coins used in their jurisdictions. This changed the incentive structure and imbued the money with trust, since anyone looking to corrupt it now risked the wrath of their ruler. Similarly, the high cost to secure gold was solved by banks storing a community’s gold and providing the depositors with paper receipts that they were able to utilize as a MoE in its place. The banks would centrally store and protect the gold, reducing the cost of security, and simply move it from one vault to another when the appropriate papers were provided. In both cases, once the money was centralized, it created an opportunity for exploitation. Kings would demand the return of the gold for reminting and would shrink the size of the coins, keeping the residual to fund their kingly desires. Bankers noticed that no one was withdrawing their gold and realized they could print more receipts than there were deposits (i.e., fractional reserve banking), leveraging and adding risk to the whole economy to increase personal profits.

The history of money can be thought of as an ebb and flow of centralization and decentralization to try and solve the imperfections of the mediums used. The most recent ebb of centralization came with the adoption of government currency as a global monetary system. First with the British sterling and then with the USD. Initially, both Britain and the US tied their currency to gold (i.e., the gold standard), meaning the quantity of currency printed was coupled to the quantity of gold in reserves. For a long time, they held to this, which made the currencies trusted in the global economy. The sterling in particular was commonly referred to as “as good as gold.” The adoption of government currencies in the global economy solved the problem of salability over space, and when the currencies were tied to gold, they retained gold’s properties of salability over time. This worked while it worked, but as with prior ebbs of centralization, the absolute power granted, corrupted absolutely.

The USD has ostensibly been used as money for the past 100 years. During this tenure, it was decoupled from gold several times, but it was decoupled for good in August 1971. A government currency not tied to a hard money standard is known as a fiat currency. Fiat, the Latin term for “let it be done,” refers to how the government currency can be printed on demand. This gives the USD an incredibly variable stock-to-flow ratio (i.e., salability across time) that fluctuates on the whims of the US government. This transition of the USD from a hard money standard to a fiat currency made it inherently less trustworthy. That being said, the world has hundreds of fiat currencies, and the USD is the only one that exhibits monetary properties (i.e., it serves as a global MoE). It is inflationary by design, but in relative terms, it is better than most other fiat currencies, resulting in its adoption (and continued begrudging acceptance) as money. It has served our civilization relatively well during its time as money, but that does not mean we are at the end of monetary history.

A Protocol for Perfect Money

Bitcoin was created on January 3, 2009, and it has been slowly entering the global zeitgeist ever since. At this point most people have heard of it, but still today its value proposition isn’t widely understood. Detractors say that it is a speculative asset and point to its volatility as evidence. They say that it has no “intrinsic value,” when comparing it to gold or say it has no “cash flow” when comparing it to equities. The worst critics call it a Ponzi scheme. These misunderstandings are a symptom of the abstract economy. Bitcoin is not a speculative asset or a Ponzi scheme, and it does not need “intrinsic value” or “cash flow” to have economic value.

Currently, its number one use case may be speculation, but some communities are beginning to use it to exchange goods and services. Increasingly, people are starting to save in it. Countries and companies all across the globe are investigating how they can utilize it to their benefit.

Ultimately, regardless of how Bitcoin is utilized at the current moment, it is best described as a protocol. A protocol is fundamentally a set of rules or standards that govern how something operates. Similar to the English language, Base Ten mathematics, or HTTP, Bitcoin is a protocol. In Bitcoin’s case, it is a protocol for perfect money.

The Bitcoin protocol operates on a decentralized network of computers (nodes). The transactions on this network occur directly between users via the internet without permission from intermediaries. In addition to the inherent benefit of being trustless, this also reduces the transaction costs, and the time needed for settlements. The protocol is also open source, meaning its underlying code can be reviewed, audited, and potentially improved by anyone, although changes require consensus among the users of the network. Additionally, and importantly, the supply cap of Bitcoin is built into the protocol (i.e., there will only ever be 21 million bitcoins), making it the scarcest asset ever in existence and brilliantly creating the first ever digital scarcity.

On that point, Bitcoin exists purely in digital form; there are no physical coins or notes. It's managed and secured through cryptographic means. Cryptographic techniques are utilized to secure transactions and to control the creation of new units. Additionally, the protocol runs on a proof-of-work (PoW) basis, requires miners to solve complex mathematical puzzles, which necessitates significant computational power. This process secures the network by making it prohibitively expensive to attempt fraudulent activities like double-spending or altering the blockchain. The difficulty of the puzzle adjusts to ensure that blocks are added approximately every 10 minutes, regardless of how much computing power is on the network. This maintains the network's stability and security. Once transactions are confirmed, they are very difficult to reverse, providing a sense of finality and security for transactions. The network serves as an immutable record of these transactions.

Bitcoin is decentralized, digital, permissionless, immutable, open source, secure and scarce.

Bitcoin has a higher salability across time than gold, the previous winner in that dimension, and it has substantially lower costs to secure and verify. Bitcoin also has a higher salability over space than USD, the current winner in that dimension, but does not require trust in a centralized authority. Lewis says Bitcoin “possesses all the desirable traits of both physical gold, and the digital dollar combined in one, but without the critical flaws of either.” Bitcoin outcompetes all alternatives in every property of money that we understand. It serves as an immutable record of exchanges and is capable of transferring value generated today indefinitely into the future. It does this all while being decentralized and trustless. It is a money that cannot be manipulated. If we can expect monetary systems to converge on one medium, that medium will be Bitcoin.

The adoption of Bitcoin as money will offer our civilization a permanent exit strategy from the abstract economy. It will realign incentives to value delayed gratification, and increase time preferences, so it is rational to make Quality decisions again. The adoption of Bitcoin as money will make it so that decision-makers no longer have to think about money. They can simply think about how best to add value to their customers and stakeholders. In a real economy, human action is rational, both in the short-term and the long-term. The Quality of our products and businesses will experience the intrinsic benefits of restoring the rationality of human action. This is something to look forward to, but not something most of us can do anything about. In the meantime, decision-makers don’t have to wait to utilize Bitcoin to improve Quality in their organizations. More on that in Part 2.