Bitcoin, Bitcoin Cash and the roadmap to replacing fiat
Is Satoshi's dream on the way out, or is it more vivid than ever before?
"I would be surprised if 10 years from now we're not using electronic currency in some way, now that we know a way to do it that won't inevitably get dumbed down when the trusted third party gets cold feet," Satoshi Nakamoto wrote to the Cryptography Mailing List on 16 January 2009, about two weeks after the launch of the Bitcoin blockchain.
"It could get started in a narrow niche like reward points, donation tokens, currency for a game or micropayments for adult sites," Satoshi continued. "It might make sense just to get some [Bitcoin] in case it catches on. If enough people think the same way, that becomes a self fulfilling prophecy."
In some ways, Satoshi was spot on.
Bitcoin caught on, getting some just in case proved to be a smart move, and cryptocurrency has been strongly represented in niches including reward points, donations, game currency and adult sites - as well in illicit transactions, of course.
In other ways, Satoshi was a bit off.
Ten plus years later, there's little use of cryptocurrency for payments. It looks like Satoshi expected Bitcoin to catch on through sheer usefulness, and that cheap, trustless, non-reversible transactions, previously-impossible international micropayments and a host of creative utilities would inevitably draw people to Bitcoin through sheer force of practicality, and that this would give it value.
That didn't happen. Instead, Bitcoin attained value purely as a speculative asset, despite seeing relatively little real world use. Every merchant that accepts crypto says almost no one ever pays with it, and even in Venezuela people mostly don't give a toss about crypto, regardless of the Bolivar's failings. Most cryptocurrencies, regardless of their original purpose, have followed Bitcoin into becoming purely speculative assets with minimal real world use.
The speculative cycle extends to dapps as well. Ethereum dapp usage just trucks along with market conditions. The number of active monthly Ethereum dapp users in December 2019 was under 200,000, in contrast to the half a million active users of January 2018. Most of them are just there for the games and the gambling dapps.
When it looked like cryptocurrency was about to get pressed into real world use, in the form of Facebook Libra, it immediately encountered the "cold feet" problem that Satoshi mentioned, where central authorities pressured Libra participants into leaving the project.
Summarised, it's a line of hard lessons.
We've learnt that utility can't drive mass adoption when you still have to tangle with issues like private key management. We've learnt that even in places with a very real demand for alternative currencies, most people's choices veer back towards the US dollar, and that when people do use crypto for utilities or remittances, they like it to be pegged to fiat.
We've also learnt that you can't drive adoption of a new currency by merchant acceptance alone, and that the prospect of buying Bitcoin cheap and selling it for fiat profits is infinitely more compelling to most than the idea of having an alternative currency, or accessing any of the utilities Satoshi envisioned. We've learnt that even dapps and utilities are driven primarily by people hoping to realise fiat profits, and that no matter how easy it is to switch between fiat and crypto, most people won't bother unless they think it will be profitable.
And most recently, we've also learnt that if a cryptocurrency ever seems to seriously stand on the brink of mass adoption, it will get stomped out. Meanwhile, central bank digital currency is arriving in force to fill the need that only became apparent with the creation of Bitcoin.
These are hard realities for most cryptocurrencies, but they hit "alternative currency" type digital coins, like Bitcoin Cash and Litecoin, especially hard. With so many lessons learnt, and so many obstacles ahead, is there still a realistic plan to drive adoption, or are they just caught in a loop of reheating Satoshi's dream, and trying to plate it up to an apathetic public?
Sign of The Times
There's a plan, said Bitcoin.com (the home of Bitcoin Cash) CEO, Stefan Rust. In fact, Satoshi's dreams are arguably more vivid now than the day Bitcoin was born. The goal is to try to get the ideal alternative currency ready to go if fiat currency falls out of favour.
It goes back to the Bitcoin genesis block, to which Satoshi added a hash of the following phrase: "The times 03/Jan/2009 Chancellor on brink of second bailout for banks." It was a reference to the front page news of the day. Between that and his other writings, it's pretty clear that Satoshi wasn't a fan of potential fiat currency debasement.
Today, the situation is arguably even more hair-raising.
Depending on where you look, interest rates are sitting near, at or under zero, central bank balance sheets are expanding, wage growth is stalling even as unemployment remains low, and the quantitative easing habit is proving hard to break.
"If you look at Europe, for example, the top 10 or 15 countries in Europe are all running negative interest rates up to fifteen years," Rust said. "Look at situations like that. Look at quantitative easing - the European government is buying 20 billion euros of assets back every single month. They haven't disclosed what assets, they haven't disclosed who they're buying it from, and why they're buying it from those entities, which are generally going to be going to be Deutsche Bank and Crédit Agricole, and Barclays Bank and Royal Bank of Scotland... so all of the established institutions are getting the money back from them."
"And the quantitative easing in the US! How many quantitative easings have we had, the repo disaster... All of these financial institutions and central banks are printing money, left, right and centre."
Right on cue, on 19 February 2020, gold and equities staged an unusual simultaneous rally even as bonds painted a pessimistic picture of the future value of money. If the world really is experiencing collective currency debasement, that's probably what it would look like.
Rust's concerns are echoed by a growing pool of analysts.
"This will eventually end badly," predicts Guggenheim Investments CIO Scott Minerd. "I have never in my career seen anything as crazy as what’s going on right now."
The end of the cycle
We're reaching the end of the an economic cycle, Rust suggested, and the economic symptoms we're experiencing today are a consequence of a world whose technology has run too far ahead of its financial infrastructure. In its current form, fiat currency is part of that legacy system.
"I think if you look at the financial system that is built today, it is aged. It is legacy-based," Rust said. "It's the end of the cycle. We have new technologies that have come about, we haven't taken those technologies into account. We clear the books at every end of every month or every day. Why can't we do it instantaneously? We have computers that can do all that."
The cause, effect and answer to the repo crisis provides a good example of how a disconnect between the technological backbone of the economy and the real world can result in frictions.
The repo crisis oversimplified
The repo market is basically a great big marketplace for borrowing and lending money. It has two sides.
- Institutions that own a lot of securities, but want access to more cash.
- Institutions with a lot of cash that want to earn some interest on it.
The repo market is where the first type of entity gets loans from the second type, by putting up their securities as collateral.
It's useful, because by their nature some types of financial institutions, such as hedge funds and banks, hold lots of securities, while others such as money market mutual funds holds lots of cash. Repo markets let them both get more of what they need, which keeps the money flowing and helps keep the economy ticking.
The repo market is enormous. About $2 to $4 trillion is traded through it each day. In a very real sense, it grease the wheels of the global capital markets. And it all ticks along just fine until it doesn't.
The overnight repo rate is how much interest the borrowers pay on their loans in the repo market. It tends to hang around 2%. But something unusual happened in late 2019, when a simultaneous influx of securities and outflow of cash drove the overnight repo rate all the way up to 10%.
This change poked a stick into the spokes of the economy. It risked limiting institutional access to cash, and may have caused hedge funds and other investors have to cut their holdings, causing volatility in other markets.
The solution was to print lots of money for the repo market.
The cause of the crisis was multi-fold, but it's believed that some of the combined factors behind the repo rate spike were:
- Timely factors, such as corporate tax season, the end of the quarter and the sale of government bonds to fund the latest batch of US tax cuts, which combined to see a natural withdrawal of cash from the market.
- The introduction of tighter banking regulations following the global financial crisis, which required banks to maintain larger reserves, reducing the amount of cash available.
- The Federal Reserve winding back its quantitative easing program, and reducing its balance sheet.
Regarding that last factor, what basically happened is the Fed pumped trillions of dollars into the economy as part of the GFC recovery program, with the expectation of it being a temporary measure. Once the economy had strengthened, it started reducing its assets and liabilities, which means pulling cash out of circulation.
The repo crisis cut that plan short, and forced a return to quantitative easing in late 2019.
The chart below shows the Federal Reserve balance sheet over time, which indicates the amount of USD in circulation. As you can see, things have gotten pretty funky in the last decade.
Federal Reserve Balance Sheet
Looking at the repo crisis as an example, we can see how factors such as inflation rates and the value of a dollar are directly affected by how technology is (and isn't) being used in financial infrastructure.
Using new technology to question assumptions
Many elements of that arcane, amorphous amoeba we call "the economy," are based on some fundamental truths, such as: Money is money, transactions are not instant, you have to use the local currency, consumers keep their money in banks, only banks can move money, value can only be exchanged through third parties, floating international exchange rates are normal and the US dollar is the global reserve currency.
The role of the repo market hinges on several of those assumptions, as does the current role of central clearinghouses, commercial banks, central banks and other cogs in the machine.
Even challenging one of these truths — that transactions are not instant — can result in a cascading series of benefits, Rust said.
"The economic growth will be far beyond what we can imagine; instantaneous gratification, instantaneous settlement, and not only between the user and the merchant, but also between the user and the government, because tax can also be paid instantaneously."
"You go into a merchant, the sales tax is immediately deposited with the government, so it doesn't have to wait a whole year to get the tax money. It doesn't have to pay huge fees to do a whole audit... it's simple, quick and they got their money instantaneously at a much more efficient cost basis."
"If you look at the main reason why money was established, it was established in order to enable barter and simplify — increase the velocity — of an exchange between a chicken and a stone, or a piece of gold, or whatever it might be," Rust said.
"So as we invented money, that was an evolution to increase the velocity of transactions, thereby creating jobs and creating economic growth. Tokens are going to do the same thing money did to barter. That evolution is going to drive faster economic transactions and increase the velocity of money, thereby creating different types of roles and jobs, thereby increasing economic growth across the globe."
Consider how this system may have affected the course of the repo crisis. It would have freed up a lot of cash from nostro accounts, clearinghouses and other couch cushions, it may have helped mitigate the sudden impact of corporate tax time on cash availability and it may have allowed lenders to respond to the rising repo rate more quickly, preventing it from rising so far or so sharply.
Other developments, such as the vision of spending all kinds of digital assets as currency, may be similarly impactful.
Money is money
Intercontinental Exchange is one of the companies rethinking those fundamental economic truths as it focuses Bakkt on the consumer payments space. It's specifically challenging the fact that "money is money."
As Intercontinental Exchange founder and CEO Jeff Sprecher said:
"The legacy payments infrastructure is ripe for disintermediation. The Internet should make it possible to create a direct payment system that doesn’t use a third-party set of rails. It hit us that making rewards cash-like would be a step in that direction."
But where Bakkt is converting airline miles and other rewards points into monetary value, cryptocurrencies can also monetise less tangible factors, Rust said.
Some of these factors can be quite practical, such as the monetary value of the data generated from web browsing activity, or the attention given to advertising. Others are fuzzier, such as whatever monetary value can be associated with a sense of community, or the shared appreciation of a meme.
This can already be seen with some cryptocurrencies, and tokens launched on the Bitcoin Cash Simple Ledger Protocol (SLP), Rust said.
"We've launched mint.bitcoin.com, where anybody can now go to mint their own tokens," he explained. "There are already some really unique use cases that have been created out of that. One of them is the Spice token, where basically it was created by a community."
"It was started off by three people, it then launched and scaled up. They built a Twitter bot and a tip bot on Telegram, so all of a sudden you can start tipping people and sharing it and the community started to grow. Then they acquired Spice Casa so now you could actually play games with it. The dividends from Spice Casa get shared with all Spice token holders, so if you hold tokens there's a value returned back."
"They then got it listed on an exchange, so all of a sudden you can now start exchanging it and trading it. It's got a value associated with it. From nothing, within the course of a year, you've created two million dollars worth of a currency that people appreciate - that people value, as it relates to that specific community."
"The social object has shifted from your photo in your Instagram, your gif in your Tik Tok, to your cryptocurrency token... that becomes the social object. I think we're shifting in terms of values. I'm still going to have my Instagram where I can share my photos, I'm going to have my Tik Tok where I can share my videos, and I'm going to have my Bitcoin Cash wallet where I can share my SLP tokens."
"I think that is the potential of an evolution in the future, that we're trying to propagate: what we call modern money. DeFi, I think, is a service that's going to be derived out of that," Rust said. "The users don't care if it's on Bitcoin Cash, or even on the blockchain. They care that it's a service they trust, that is reliable and is sustainable, particularly when it relates to money - it's something hugely emotive to a lot of people."
Can money really be backed by fuzzy factors like the litness of memes or a sense of a community? And is that really a good thing? After all, pyramid schemes and cults tend to pull on the same levers, and it sounds like a lot like a return to the blind mania of 2017.
But it's also perhaps not as outrageous as it sounds.
Traditional stores of value like gold derive their value from similarly fuzzy social constructs, and central banks are currently dropping the dollar and buying gold at record levels. The idea has also been given serious consideration by figures like current current European Central Bank president Christine Lagarde. As Lagarde said:
"The fintech revolution questions the two forms of money... coins and commercial bank deposits. And it questions the role of the state in providing money. The town square is back – virtually, on our smartphones. We exchange information, services, even emojis, instantly... peer to peer, person to person. We float through a world of information, where data is the new gold."
"Money itself is changing," Lagarde said. "We expect it to become more convenient and user-friendly, perhaps even less serious-looking. We expect it to be integrated with social media, readily available for online and person-to-person use, including micro-payments. And of course, we expect it to be cheap and safe, protected against criminals and prying eyes."
Lagarde's wishlist of currency features is similar to what Bitcoin Cash developers are going for.
It's already integrated with social media, readily available for online and peer to peer use, including micropayments, and it's introducing those privacy features to protect users from prying eyes. Meanwhile, SLP makes it easier for information, services and even emojis to directly act as currency.
These features notwithstanding, BCH isn't seeing much real world use, even compared to BTC which is itself barely-used compared to fiat.
"Modern money" hasn't yet made its way to street level, but eventually consumers will start demanding its features, Rust predicts, and the goal is to be ready when they do.
Central banks and cryptocurrencies are like the quintessential incumbents and disruptors in Clayton Christensen's Innovator's Dilemma, he said, where fiat currencies are being built for an established customer base, and cryptocurrencies are being designed for the next generation of users.
Per the Innovator's Dilemma theory, the incumbent customer base demand improvements to the current product, while the disruptors are building an entirely new product for the next generation. The disruptor doesn't have the luxury of a large customer base, but the incumbent's product will plateau before the disruptor's, at which point the incumbent quickly loses market share to the disruptor.
A growing disconnect between what consumers demand and what the incumbent product delivers is one of the factors that can drive adoption. The potential of fiat devaluation, and that gap between what technology can deliver and how the financial system works, may be growing that disconnect.
People still need to realise that they do have a choice of currencies though, Rust said.
"You never had a choice between religion and not in the past. When church and state were the same, you had to be religious... and then all of a sudden we managed to separate church and state, and all of a sudden you had the ability to choose on religion."
"I think money is going to be the same."
Disclosure: The author holds BNB, BTC at the time of writing.