Bitcoin Will Fail At Destroying Fiat
The Digital Asset Will Actually Help Fiat Currency Survive
While bitcoin may have been created with the aim to destroy fiat, I believe that in reality bitcoin will end up enabling fiat currency to survive, let alone flourish, into near-perpetuity.
Bitcoin will be co-opted by government(s) via allowing the digital asset to be custodied within traditional financial system. The FDIC has been working since spring 2021 to try and develop a framework to enable just this relationship. Meanwhile we have institutions like BNY Mellon rolling out custody solutions, and JP Morgan getting their trademark for a crypto wallet with fintech functionality.
At the turn of this year I had published a piece where I argued that the Federal Reserve should do precisely this; throw bitcoin on the balance sheet. Following this strategy effectively allows for a better gold peg. However, the most important aspect of this mechanism, is that by utilizing bitcoin, you have a digitally-native, scarce asset that is not limited by physical space. What this means is that there is a diminished need for physical space and effort dedicated to security or exchange. One of the major issues of using a gold peg is that as the coffers of gold grow, the need for physical space and services to maintain it, secure it, let alone exchange it, grows rapidly. By not being limited by space, or time (essentially), we effectively have an asset that can absorb the excesses of liquidity enabled by a pure fiat currency.
A Blackhole For Excess Liquidity
This asset, that operates like a black hole for currency; the more funds that get dumped into the asset does not change its state or nature. Making it a perfect use for for collateral, and the backing of a currency. It also solves the issue of trust due to the fact that there is no single individual or organization that exerts explicit control over the issuance, or operations, of the asset and it accompanying network. Could there be a future where bitcoin is transacted peer-to-peer (P2P) in de minimis amounts with the help of layer-x solutions, like the Lightning Network (LN)? Absolutely.
This is capable now and costing fees that are fractions of a penny and settled near instantaneously. However, firstly, the LN is still young, and should be given ample time to prune and perfect the network to iron-out potential attack vectors, including bugfixes. Second is the true economic activity that could be capable on such solutions built atop the sound foundation of the bitcoin asset requires significant market saturation. Much more than where we are right now. Suggesting that we will need the USD (or whatever currency the globalized market determines is “best”) to persist in the interim in order to facilitate a proper network transfer. With as little fire and destruction as possible.
Back to the problems with how fiat currencies are effecting us today and where a bitcoin backing may help. Markets have become aggressively financialized due to monetary debasement of fiat currencies, particularly the USD. Assets that, when financialized, produce referring complications. Assets that, in my opinion, have no business being financialized into investments, either entirely or at the very least to the extent to which they are financialized currently. For example one of my favorite points of this conversation; real estate.
Real estate and the ability to own a home has become so financialized and inflated due to excess liquidity sloshing throughout the market, trying to find a home. This has caused a demographic issue that is preventing generations of average citizens from being capable of owning a home. Then consider how this plies out effects into commerce: when there is less home buying, there is less structure to family formation, which not only directly means less citizens being born, but also much less wealth creation. Presumptively, whatever little “wealth” is created then gets gambled in over-inflated markets in the hopes of making it big in short time. Giving us not only wild volatility in markets, but also the over-inflation of collectibles like shoes and trading cards and digital images that can be screenshotted. This gambling activity causes wealth to accumulate to the most patient participants, which tends to favor those of already higher socioeconomic status. These individuals’ ability to remain patient helps avoid falling prey to the most pervasive of emotions; fear. Fear of Loss (FOL) drives markets just as potently as FOMO (Fear of Missing Out). In all honesty, I would argue that FOL is more pervasive than FOMO. Ultimately resulting in an increasing widening of the wealth inequality gap.
With bitcoin as the base-layer asset, the excess liquidity can cease the violent sloshing activity reminiscent of an indoor pool during an earthquake. Making a home within bitcoin, over time, would then allow for not only more efficient means of value transfer but also credit deployment. With a pristine form of collateral, significant layers of risk can be eroded (including the obfuscation of risk through interpersonal secrecy, such as those deployed in the FTX-SBF debacle). Which is also a source of inefficiency within the current system; the reliance on bureaucracy and regulation. With something like bitcoin, automation can handle these dealings in seconds. Without needing to pay CPAs, lawyers, or administrators — which also comes with the costs of salaries, health benefits, commute to the office, etc.
Bitcoin is simply an iteration in innovation. Why fight something that improves efficiencies with reach of such depth and breadth?
Ultimately, it is my opinion that bitcoin will fail at destroying fiat. Banks & governments (both current and future) will have a use/need for credit, and will utilize bitcoin for collateral. But it will succeed in enabling and enforcing responsibility and accountability. By utilizing both an asset that we know, without question, is finitely scarce as the foundation and alongside utilizing responsible credit we may get an economic system that actually makes sense.
Or at least until that system gets gamed to nefarious ends again.
Actually there is a very good reason for Bitcoin-backed banks to exist, issuing their own digital cash currency, redeemable for bitcoins. Bitcoin itself cannot scale to have every single financial transaction in the world be broadcast to everyone and included in the block chain. There needs to be a secondary level of payment systems which is lighter weight and more efficient. Likewise, the time needed for Bitcoin transactions to finalize will be impractical for medium to large value purchases.
Bitcoin backed banks will solve these problems. They can work like banks did before nationalization of currency. Different banks can have different policies, some more aggressive, some more conservative. Some would be fractional reserve while others may be 100% Bitcoin backed. Interest rates may vary. Cash from some banks may trade at a discount to that from others.
George Selgin has worked out the theory of competitive free banking in detail, and he argues that such a system would be stable, inflation resistant and self-regulating.
I believe this will be the ultimate fate of Bitcoin, to be the "high-powered money" that serves as a reserve currency for banks that issue their own digital cash. Most Bitcoin transactions will occur between banks, to settle net transfers. Bitcoin transactions by private individuals will be as rare as... well, as Bitcoin based purchases are today.
- Hal Finney, December 30th, 2010 — Bitcointalk.org