13 November 2023
It has become commonplace to normalize the extremity of fiat. The last such instance was in September when the federal government broke another record by crossing the $33 trillion national debt threshold. A decade ago, the USG’s outstanding borrowings have already outpaced the US’ annual GDP.
The Congressional Budget Office (CBO) now projects a 2% federal debt increase per year. The established dynamic is one of increased borrowing because there is simply no way to patch up budget deficits with tax revenue alone. This year alone, the USG had to pay $711 billion on net interest payments.
Ultimately, the Federal Reserve, as the purveyor of money, has to keep increasing its balance sheet so the USG can keep up with its debt obligations. Inevitably, the ex nihilo creation of new money leads to devaluation of the dollar, the world’s dominant measurement of value.
And as previous monetary cycles taught us, when value measurement is warped, extremities can balloon to cartoonish levels.
Destabilized Legacy of Modern Money
As the Weimar Republic led to World War II, and as the war concluded, the new binding framework was put in place in 1944. Known as the Bretton Woods Agreement, it established the dollar as the world reserve currency. Although it technically collapsed in the early 1970s, it left behind the IMF, the World Bank and the legacy of debt-fueled growth.
More precisely, Bretton Woods positioned the dollar as having the largest Net International Investment Position (NIIP). The USG maximally extracted this advantage, as evidenced by the NIIP turning negative decades ago, making the US owe more to foreigners than they owe to the US.
The US’ NIIP as of Q2 2023. Source: Bureau of Economic Analysis (BEA)
Where does this leave the world?
Simply put, in a state of unsound money. Last year, borrowings for OECD nations increased 43% above the 2011-2019 average. Simultaneously, borrowing costs more than doubled since 2021, creating a situation wherein much of economic output goes to debt service.
And as governments borrow more money to pay off debt, this leads to elevated debt expenditures. In turn, money printing becomes the go-to remedy to pay off debt, instigating inflation. But as high interest rates are introduced to clamp down on inflation, higher debt levels need to be served.
This is the spiral of currency devaluation. The destabilized macro landscape places a pressure to seek other venues to preserve wealth and outpace the money erosion. Some seek bond yields, some stock dividends, but others turn to a reimagined monetary system outside of central banking.
Bitcoin’s Decentralized Promise
For money to become sound, a core prerequisite has to be followed. Because the creation of new money depends on the government’s hunger to spend outside its means, the money itself has to be detached from the government.
This way, the moral hazard can be cut at the root. At a glance, this task seems impossible:
On a given territory, a hierarchy always emerges to rule it. In one way or another, the top echelon has to maintain legitimacy in order to rule.Legitimacy comes down to money issuance and management.
In turn, it is that money they issue that is perceived as legitimate, becoming legal tender to price goods and services. Yet, even if that tender itself is physically sound, by virtue of counterfeiting such as gold, it can be seized and manipulated.
Bitcoin broke through that impossibility barrier, forever changing the perception of money. Bound by math, cryptography and computing power, Bitcoin removes the need for central authority.
Bitcoin’s record of account – the blockchain – is maintained in a decentralized manner, and everyone with internet access can participate in its verification. In addition to having permissionless access to public ledger, Bitcoin is both government and nation-agnostic.
For the first time in monetary history, it became possible to send and receive borderless payments, without entangling any bank or foreign exchange bureau. Although this can be performed anonymously, Bitcoin’s public ledger is at all times auditable.
Removing Moral Hazards: Path to Sound Money
When it comes down to it, incentives govern behavior. With fiat money in place, the government always has an incentive to extravagantly spend. It then prints money to make up for balance sheet holes, while leaving the taxpayer with another form of tax – inflation.
Inflation is the immediate manifestation of central banking, but there are many others. During the Great Recession of 2007 -2009, central banks bailed out financial institutions that took too much risk to the tune of $498 billion. These banks had to be bailed out in order to keep the entire financial system stable, but if this is baked into the cake, then risk-taking becomes the norm.
It is from this great moral hazard that pseudonymous Satoshi Nakamoto took the plunge with Bitcoin. Moreover, as central banks shift monetary policies, they tend to generate financial bubbles. Low interest rates caused major bubbles to pop, the tech bubble in the late 1990s and the housing bubble in the early 2000s.
The Great Recession itself was partly caused by low interest rates, as they made it easier for borrowers to get mortgages, leading to the subprime mortgage crisis.
In turn, as bubbles pop, central banking leaves recession in its wake. At the bottom, it becomes difficult for people to orient themselves towards the future. Then, as bubbles, taxes, government spending and inflation continue to pile up, what was previously the norm becomes a far-flung dream for many.
Home Price Affordability in the United States, source: DQYDJ
On the international stage, vying for monetary supremacy can further lead to destabilization to the point of financial exclusion. The Russia-Ukraine conflict clarified this point acutely, as the USG weaponized the dollar to inflict pain on its geopolitical rival.
In the middle, Europe suffered the most as sanctions against Russia, abundant in natural resources, boomeranged against Germany, the EU’s economic engine. For individuals and nations both, Bitcoin becomes a potential self-sustained wealth machine outside the moral hazards of central banking and politicking.
In the distant alternative future, one has to wonder if large-scale conflicts, alongside infrastructural/economic devastation, would even be possible with fiat money out of the picture.
The Path Forward: Institutional Adoption, Speed, Efficiency and AI
After many market busts and custodial learning opportunities, cryptocurrency at large is on the verge of a legitimacy breakout. This is best exemplified by BlackRock’s application to launch a Bitcoin exchange-traded fund (ETF). Larry Fink, the head of the world’s largest asset manager, at $9 trillion AuM, made a complete pivot from his previous Bitcoin hostility.
In contrast to 2017 statements framing Bitcoin as “ shows you how much demand for money laundering there is in the world,”, Fink is hyping up Bitcoin to an unprecedented level:
“We do believe that if we can create more tokenization of assets and securities – that’s what bitcoin is – it could revolutionize finance”
Yet, Fink also said that “it costs a lot of money right now to transact Bitcoin”. Although he inferred it in the context of general cryptocurrency investing, it is a fact that Bitcoin mainnet is not suitable for daily currency usage.
For global mass adoption, the Bitcoin blockchain’s 7 transactions-per-second capacity would have to increase drastically to offer near-instant payments for either online shopping or in-store merchants. This is where Bitcoin scaling comes into play, the most popular example being the Lightning Network.
At an average base fee of 865 mSats ($0.000243), the Lightning payment highway has also proven near-instant as more nodes are added.
Source: mempool.space
Taking advantage of smart contract programmability, Lightning Labs have also integrated artificial intelligence (AI). Thanks to LangChainBitcoin and Aperture, AI agents can directly interface with Bitcoin via LN, allowing for exchange of funds both on-chain and on the Lightning Network.
This opens up a whole new arena of applications, without even having to resort to credit cards or fiat for payment rails. In the near future, we can expect to see real-time cost settlements, pay-per-use AI models, content micropayments, lending, and equitable resource sharing as LN’s smart contracts automate subscriptions, rent or even salaries.
We could even see AI-powered underwriting, risk assessment and financial advisors, all using Lightning Network’s smart contracts to execute investment strategies.
Although Bitcoin’s core code is conservative, Ordinals have showcased that functions could be attached without any forking, soft or hard. During just the first two months of Ordinal hype, as non-fungible tokens (NFTs) creation grew, over 350k were inscribed to Bitcoin’s mainnet.
Most recently, Bitcoin developer Robin Linus released the “BitVM: Computing Anything on Bitcoin” whitepaper. Again without any forking, it showcases that Bitcoin’s smart contract logic can be executed off-chain but verified on-chain.
Linus forecasts greatly expanded use for Bitcoin if BitVM is implemented in writing/debugging Bitcoin contracts.
“Potential applications include games like Chess, Go, or Poker, and particularly, verification of validity proofs in Bitcoin contracts.”
Yet, all that potential remains in the “putting the cart before the horse” stage. Bitcoin’s primary job should be to push for financial emancipation from the vagaries of the central banking system. With the Lightning Network in the game, even the Federal Reserve admitted that the necessary ingredients are there.
This is a guest post by Shane Neagle. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.