Over the last few years I’ve been in dialogue with a math professor that has been kind enough to hear me express the importance I see in John Nash’s works Ideal Money. More recently he came to me with a question and if I recall it correctly the question was, “How can we have the same (secure) technology as bitcoin but without the energy waste?”
When I first heard this question I jumped at it too hard and gave what would have probably been received by the professor as an aggressive and not very helpful or coherent response.
Upon further reflection and the realization that I have never really tried to explain the economic argument Nash gives to this professor I realized that the question he asked is actually key.
Here we find relevance in an interesting passage by Nick Szabo where he explains that Satoshi’s great insight was in fact the computational (scaling) tradeoff (high energy/electricity cost) for the social scalability benefits bitcoin brings:
We need more socially scalable ways to securely count nodes, or to put it another way to with as much robustness against corruption as possible, assess contributions to securing the integrity of a blockchain. That is what proof-of-work and broadcast-replication are about: greatly sacrificing computational scalability in order to improve social scalability. That is Satoshi’s brilliant tradeoff. It is brilliant because humans are far more expensive than computers and that gap widens further each year.
Nick seems to be noting something that I often explain about bitcoin which is that the last problem to be solved, ie how to scale bitcoin, was effectively surpassed by the realization that bitcoin needn’t be scaled (computationally).
(This is akin to another problem that traditionally was sought to be solved which is how to make the supply elastic to the demand without a third party. And this of course was also solved by not solving it and limiting bitcoin to be an inelastic currency. More on this later in this article.)
On Gresham’s Law
We also need to understand the relevance of Gresham’s law to bitcoin. I think this is something that makes bitcoiners uncomfortable or at least those that aren’t willing to handwave empirically observed evidence.
There is two things to note about Gresham’s law. Firstly by Gresham’s observation bitcoin is not good money, or rather it is not a money that has a commodity value that is made of a non-money use case. In other words bitcoin by this wikipedia definition is in fact fiat, decreed as such by the market that creates its exchange price:
Fiat money is a currency without intrinsic value that has been established as money, often by government regulation. Fiat money does not have use value, and has value only because a government maintains its value, or because parties engaging in exchange agree on its value. It was introduced as an alternative to commodity money and representative money. Commodity money is created from a good, often a precious metal such as gold or silver, which has uses other than as a medium of exchange (such a good is called a commodity). Representative money is similar to fiat money, but it represents a claim on a commodity (which can be redeemed to a greater or lesser extent).[note 1]
What is often argued about bitcoin in regard to Gresham’s law is that bitcoin is not money that is given its value by GOVERNMENT decree and therefore it is not “bad money” like Gresham observed the Queen’s decreed money to be when she asked him to study her fleeting wealth.
This paper considers reform possibilities posed by a type of base money that has heretofore been overlooked in the literature on monetary economics. I call this sort of money “synthetic” commodity money because it shares features with both commodity money and fiat money, as these are usually defined, without fitting the conventional definition of either; examples of such money are Bitcoin and the “Swiss dinars” that served as the currency of northern Iraq for over a decade. I argue that the attributes of synthetic commodity money are such as might supply the basis for a monetary regime that does not require oversight by any monetary authority, yet is capable of providing for all such changes in the money stock as may be needed to achieve a high degree of macroeconomic stability.
I think the basic idea in regard to comparing bitcoin’s ultimate fate to Gresham’s observations is that there is some foreign or externally held value for the “good money” such that there is a reliability to the exchange value that the commodity can receive. This is relevant because if there is a government decreed money then that decree can only be relevant in the jurisdiction that the government oversees (thus causing the phenomenon of circulating bad money and hoarding or sending to foreign lands the good money).
Nash talks about Gresham’s observations in regard to the perceived value trend of the currencies. He uses “good in the Gresham’s sense” to imply some medium that is perceived as worthy of hoarding:
To be quite respectable, in a Gresham-advised sense, money needs only to be AS GOOD as other material commod-ities that might be hoarded.
Here the relevant observation becomes simple and clear. “Good money” doesn’t circulate. Or in other words if the net or average user is “hodling” or savings their bitcoins primarily (first) then they cannot also be spending their bitcoins primarily.
Gresham’s law points to a flaw in the bitcoiner’s theory that bitcoin will usurp the traditional banking system and cause “fiat” to hyperinflate. If it doesn’t circulate it cannot be called a currency.
Nash’s explains this when speaking of the possibility of the advent of a “good” international currency that arises without official government establishment:
But the famous classical “Gresham’s Law” also reveals the intrinsic difficulty. Thus “good money” will not naturally supplant and replace “bad money” by a simple Darwinian superiority of competitive species. Rather than that, it must be that the good things are established by the voluntary choice of human agencies.
On an Ideal Basis for Money
In a recent talk I did with a few others it was said that Nash’s Ideal Money doesn’t have an explicit thesis and I vehemently disagree. What Nash’s works is about is arranging our global financial system in a neo-gold-standard-LIKE fashion using a basis (not gold) that doesn’t have the same flaws that the gold standard had.
Here Nash opens with an explanation on the “tremendous value” such a system would imply:
Here he explains why gold is a flawed basis (although in other sections he notes reasons why it was a reasonable or decent standard for its time):
Nowadays, however, few would propose a return to the actual use of simply the metal gold as a standard, for the following reasons.(i) The cost of mining gold effectively does depend on the technology. Recent cyanide leaching techniques have made it possible again to profitability mind gold at formerly abandoned sites in the U.S. so that it is now a big producer. However, the unpredictability of the cost is a negative factor.(ii) The location of potential gold-mining locations may not be “politically appealing.” so it would seem undesirable to make a political choice to enhance the economic importance of those particular areas.(iii) There is some negative psychology about gold such that even if it were the most logical choice after all, the unpopularity of the idea could be very obstructive
These weaknesses move Nash towards the idea of a basket of commodity prices that would be used as a possible ideal basis for our global financial system, however, this is confusing for many bitcoiners that subscribe to the idea that money should be backed by a commodity and/or not fractionally reserved.
What such people don’t understand is that a currency’s worth is very related to the supply AND demand for it which is also very tied to the underlying economy that the currency serves. The USD gets its value from the usefulness it provides to those that use it rather than any promise of a commodity that it should be exchangeable for.
In a sense it is still backed and redeemable but albeit for a very complex set of commodities via a very complex (ie unwritten) contract.
For those that see money in this limited way, that it should be redeemable or backed by commodity, it is very difficult for them to understand why and how a money should be seen as “good” in the Gresham’s sense (or rather not bad) simply because it is issued for stability versus a universally held basket of commodity prices.
I am sometimes asked ‘if our fiat systems were pegged to an ICPI, or even just the price of bitcoin, would central banks need to hold components of the ICPI or bitcoin respectively’ and the answer is no just like central banks don’t hold components of their CPI’s that they currently use on a national level to target inflation.
What the introduction of the ICPI does is solve some of the centralization problem that using just gold presents. It would take some of the geopolitical pressure of the significance of the production of it and it would also help shield the basis from production shocks that could happen with advances in technology (that might only apply to one or some commodities rather than many or all).
It is towards the direction of a more ideal basis but as Nash notes the idea still has a (fatal) flaw:
We can see that times could change, especially if a “miracle energy source” were found, and thus if a good ICPI is constructed, it should not be expected to be valid as initially defined for all eternity. It would instead be appropriate for it to be regularly readjusted depending on how the patterns of international trade would actually evolve.
Here, evidently, politicians in control of the authority behind standards could corrupt the continuity of a good standard, but depending on how things were fundamentally arranged, the probabilities of serious damage through political corruption might becomes as small as the probabilities that the values of the standard meter and kilogram will be corrupted through the actions of politicians.
On Elastically Supplied Demand Satisfying Money
And here is where the great debate begins where bitcoiners try to suggest that bitcoin will take over all the existing currencies leaving us with one world currency. This is in contrast to the central banking viewpoint that bitcoin’s inelastic supply, what most bitcoiners tout as its most important feature, precludes it from circulating and being favored as money.
This is where the Gresham’s law becomes problematic. Gresham says “good money” because it is the hoardable medium but Gresham isn’t giving an argument that “good money” (ie hoardable) is the money that will ultimately circulate.
Good in the Gresham’s sense is not an argument for why bitcoin is a superior money to fiat, in fact it is an argument against bitcoin becoming a world currency.
A currency (from Middle English: curraunt, “in circulation”, from Latin: currens, -entis), in the most specific use of the word, refers to money in any form when in use or circulation as a medium of exchange, especially circulating banknotes and coins. https://en.wikipedia.org/wiki/Currency
Furthermore, bitcoin has no mechanism to stabilize its purchasing power which is one of the most important roles of modern day central banking. Having reasonably stable prices or money with reasonably measured stable purchasing power is a very important efficiency that our banking system gives us.
We can imagine the havoc on pricing systems merchants use if bitcoin were the unit of account throughout its rise to $20k USD and back down to $3k USD (while the USD remained otherwise stable by all traditional measures and exchange comparisons with other currencies etc).
This is simply something that most bitcoiners are unwilling to admit (or don’t understand) is problematic for bitcoin’s ultimate adoption as a global money.
On the Great Equilibrium
Now I am thinking of how to explain something that is very much needed to be understood by anyone that has any sort of opinion on bitcoin’s fate.
Bitcoin serves a demand, and that demand at this point is very in its infancy. So we should expect some amount of meteoric rise in price and relevance-however much that might be.
At some point however that demand should be satiated whether much or only some of the world comes to use bitcoin. At that point I think bitcoin, although not very comparatively stable to other centrally banked currencies, might itself be seen as “reasonably” stable in regard to what could be an optimal basis for our existing currencies.
This is something that is inline with George Selgin’s explanation of how a free banking “land” would levate a (synthetic) commodity money for the purpose of high value settlement (clearing):
Commodity money, formerly used in circulation to settle exchanges outside Ruritania’s banks, might now be used to settle clearings among them. To really economize on commodity money rival banks have to exchange notes frequently enough to allow their mutual obligations to be offset. Then only net clearings, rather than gross clearings, need to be settled in commodity money. Thus banks can take further advantage of the law of large numbers, and more commodity money becomes available for nonmonetary uses.~ George Selgin: The Theory of Free Banking
Here “nonmonetary” use is not so applicable to a synthetic commodity money which has the same hoardable properties as a commodity money but not a non money use case. The result of the difference would simply be a lessened pressure on the purchasing power of the synthetic commodity.
Here we have an interesting convergence and a new mechanism for inter-relational stability of the existing centrally banked currencies. We can understand that if the central banks do very poor jobs at managing their local inflation then bitcoin will comparatively rise in its (local) exchange value.
Put another way if there is an expectation that the local “fiat” will fall in purchasing power then there would likely be a corresponding run towards using bitcoin at least primarily as a savings device.
This would in turn increase the velocity of the centrally banked money and so I would suggest that central banks would be very cautious to not inspire such a phenomenon.
On the Optimal Supply of Money In Relation to an Ideal Basis For a Money Standard
Here we come to a conclusion that is both strange and quite amazing. That money has a demand and it can be served or not served perfectly by central banks suggests that if such monies were put on a stage of competition those that did the best would most perfectly serve their demand with their corresponding supply.
In relation to bitcoin you have either an upward trend, a downward trend, or perfect stability.
If fiat gains in purchasing power versus bitcoin then this wouldn’t be ideal for centrally banked economies because the fiat would be “good” in the Gresham’s sense and be hoarded and not relevant as a circulating currency.
If fiat is losing value versus bitcoin then central banks must urgently respond to the inflation that the run on fiat would imply.
Here then we can see the importance of the great equilibrium and how it would imply that all centrally banked currencies would tend towards a single order (or value trend) thus giving us a universal pricing system.
But unlike a bitcoin only world this universal pricing system would still allow for all of the existing central banks to regulate the supply of their currencies thus allowing them to retain sovereign control of their economies.
On Bitcoin and Thermodynamics
I don’t understand what people mean by bitcoin and thermodynamics. I think maybe its a fad for some to talk about. But in relation to the original question the professor asked he is really asking how we can make bitcoin or a new technology which gives all the benefits of bitcoin but without the costs.
He is asking how we can make bitcoin an even better money, an ideal money, but not Nash’s definition of “Ideal Money”.
From the Nashian perspective and thinking about the tremendous value he cites in a global monetary standard it is not important to reduce the cost to produce new bitcoin’s (or rather new blocks). What is important is that the price signal that bitcoin exudes through its exchange value remains apolitical.
Put another way it is not more efficient or important for the goal Nash paints that the cost to produce blocks is reduced. Only that the price discovery is of a commodity that can handle the types of political pressures that Nash explains gold or the USD or the British pound could not handle.
Ironically then the actually implemented ideal basis is a single, decentralized, commodity (bitcoin) rather than an array of commodity prices. But this understood only through Nash’s philosophical pursuit:
The ultimately launched concept of “ideal Money” become possible when I conceived of a practical basis of a standardization of the comparison of the value of the currency with an appropriate standard of ideal.
Trying to reduce the cost to secure bitcoin’s network might be an important future goal but it is nowhere near as important as understanding that bitcoin serves as an ideal basis for Nash’s argument.