If and when bitcoin becomes the reserve currency of the world (which I think it will), we will have an equity-based monetary system, instead of a debt-based monetary system, and this will be a very good thing.

Bitcoin is basically deflationary. There are only ever at most 21 million bitcoins in existence. Some people lose their bitcoins, and those bitcoins usually wind up lost forever. So the total supply of bitcoin is some amount less than 21 million, and it decreases slowly over time.

As there is economic progress, the value of each bitcoin (in terms of what it can buy) tends to go up. This is because while there are more goods, there are fewer bitcoins, so the ratio of goods in existence to bitcoin in existence goes up. Each bitcoin can buy more goods. This is a deflationary monetary system, and it’s a good thing, in spite of what some bad economists may say. The bad economists don’t like deflation because it discourages spending—if your money is going to be worth more in the future than it is today, then why would you spend it now instead of saving it for tomorrow? Of course, their whole view is predicated on the false idea that consumer spending drives the economy, but that’s a separate issue that will have to be dealt with at another time. For now, let’s examine the actual consequences of a deflationary monetary system:

1. If you have bitcoin (capital), you are, relatively speaking, incentivized to save it rather than spend it.
2. It’s relatively hard to pay back bitcoin-denominated loans, and it’s relatively risky to make such loans.
3. The market rate of interest will vary widely by creditworthiness, but for most people, loans will be hard or impossible to get.
4. Investment will tend to be in the form of equity rather than debt.
5. This equity-based system will be more stable than the current debt-based system.
6. Production, productivity, and the proportion of economic gains that goes to labor will be relatively high, leading to generalized economic prosperity, high social mobility, and relatively high wages.

This is a lot to cover, so hang onto your hat.

If you have bitcoin (capital), you are, relatively speaking, incentivized to save it rather than spend it. This is pretty easy to see. If one bitcoin buys a car today, and you have a reasonable expectation that it will buy two cars in a few years, then, unless you really need that car, you’re more likely to delay purchasing the new car. Bitcoin encourages saving and long-term thinking, rather than spending and short-term thinking.

It’s relatively hard to pay back bitcoin-denominated loans, and it’s relatively risky to make such loans. If you borrow 1 bitcoin to buy a car today, and you promise to pay that bitcoin back over the next 5 years, but the value of a bitcoin doubles over that time period, then you have to really work hard to pay all that value back, with interest. For example:

Year 1: 1 bitcoin = 1 car. You borrow 1 bitcoin to buy 1 car, on a five year payment plan. To keep things simple, let’s say there’s 0 interest. You pay back about 1/5 of the loan the first year, or 0.2 btc, or about 0.2 cars-worth of value.

Year 2: 1 bitcoin = 1.25 cars. This year you’re expected to pay back another 0.2 btc, but the value of bitcoin has gone up, and you’re paying back .25 cars this year.

Year 3: 1 bitcoin = 1.5 cars. Again you’re paying back 0.2 btc, but this time that’s 0.30 cars.

Year 4: 1 bitcoin = 1.75 cars. 0.2 btc is .35 cars.

Year 5: 1 bitcoin = 2.0 cars. 0.2 btc is .4 cars.

Even though you paid zero interest, you borrowed one car’s worth of value and ended up paying back 0.2 + 0.25 + 0.30 + 0.35 + 0.40 = 1.5 cars. You had to pay back one car with one and a half. In reality, whoever loaned you the bitcoin would be asking for some nonzero interest rate, which means you would really have to pay back even more than 1.5 cars.

Under deflation, it can be hard to pay back a loan. And because it’s hard, that means people who have capital (bitcoin) will tend to make fewer loans and only in less risky scenarios.

The market rate of interest will vary widely by creditworthiness, but for most people, loans will be hard or impossible to get. If you go back to our example, notice how hard it is to pay back a loan at zero interest — if the lender insisted on a high interest rate on top of all that, it would be nearly impossible. You may end up having to pay back one car with two or even three! Why would you take that deal?

And furthermore, why would the lender be willing to lend you bitcoin in the first place, when it seems so unlikely that you’ll be able to pay it back? In the case of a car loan, usually the lender has as a last resort the option to take the car back. But in this case, the amount owed is more than the original car. So even after taking the down payment, repossessing the car, and selling it, the lender still comes up short if you don’t pay. One way around this is to require a really high down payment, say 50% of the car’s value or more. But coming up with a large down payment is not nearly as accessible to most people. Only the best creditors — a highly profitable company, say — will be able to find loans.

Investment will tend to be in the form of equity, not debt. In fact, ordinary purchases will be made via equity. But what do I mean by equity? To most people it’s a funny word that isn’t used much outside of accounting, so let me say what I mean. Equity is direct ownership of an item, company, or money. For example, if I own shares of a company, I have equity in that company. If I own my house outright (I’ve paid down the mortgage), then the house is my equity. In the case where I do have a mortgage, my equity in the house is the amount that my house’s value exceeds the amount of debt I have on the house.

Now back to ordinary purchases in our bitcoin world. Car loans are impossible to find, so what do you do if you need a car?

.

.

.

It’s so simple it’s almost obvious. You save money, wait, and then buy the car with your savings. You have equity in the car. You bought the car with equity, not with debt. Bitcoin encourages saving and planning for the long term, rather than short-term thinking.

Companies will also tend to finance with equity rather than debt. Highly profitable companies may be able to find a loan, but most companies will need to sell shares in order to raise capital, and they will need to be able to really convince their investors that their idea is good enough that it’s going to make a greater return than the investors could have had by just sitting on their bitcoin and watching it appreciate in value. That’s a tall order. Only the best companies will find investors, and they will find lots of investors.

Finally, we won’t need fractional-reserve banking. Banks, if they exist in present form, will be much more careful about who they lend money to, and they will have to disclose any kind of fractional-reserve lending they do. Depositors can choose to deposit with an institution that makes loans, and maybe make some greater returns, but they will have to realize that any additional gains come at the cost of additional risks (namely, the risk that the bank goes under or is hit by a bank run). FDIC insurance won’t be reasonable under bitcoin, because the cost will be too high to the government if it can’t print money and may not even be able to borrow money in a pinch.

This equity-based system will be more stable than the current debt-based system. When a company goes bankrupt, and all of its investors are equity-based investors, the investors lose their equity. It’s tough to be one of those investors, for sure, but life goes on for the rest of us. In our current debt-based system, however, if company A goes bankrupt and it owes a bunch of money to another company B, B might have been depending on the payments from A to make payments to their lender company C. As you can see, the interlocking debts tend to make the entire system unstable. That’s why we had the banking crisis in 2008. It’s not necessary to have institutions that are too big to fail, but it might be if we stick to the current debt-based monetary system. Equity-based systems are much more stable.

Production, productivity, and the proportion of economic gains that goes to labor will be relatively high, leading to generalized economic prosperity, high social mobility, and relatively high wages. I can’t realistically speak to all of this in this short blog post, but I can say a few things. Under a deflationary monetary system, those who are prudent and careful investors will tend to win in the long run, compared to those who gamble and take out sized risks compared to the rewards. Furthermore, the government won’t be able to distort capital markets by printing money and capitalizing projects that wouldn’t normally be able to survive in the market. So called “mal-investment” will be minimized, which will tend to level off the boom-bust cycles and create maximum productivity.

Social mobility today is restrained by many things, but one of them is the difficulty of saving. Lower and middle class people tend to save money by putting it in the bank. The problem is, the bank is not a very safe place to store wealth. Rich people understand that true wealth is assets, and that having too much cash is a good way to have your wealth inflated away. Under a bitcoin-based system, everyone gets to benefit from having real, appreciating assets. Even the poor and middle class. Thus if you start life at the bottom of the economic system, but you are a hard worker and a prudent saver, you can actually build real wealth, because the money you save isn’t inflated away into higher costs of living. Each fraction of a bitcoin you save grows in value over time. So even the lowly janitor can save up and buy a car, a house, and eventually live the dream. Ugh, it’s so beautiful it puts tears in my eyes.

Why will wages be high? Think about it from the capitalist’s point of view. The person who has bitcoin / capital may not want to invest or spend it, but they need things. They need food, housing, and services. Except for the very few that go out to the woods and create their own house, farm their own land, and do their own plumbing, most everyone is going to have to pay for goods and services. They will pay whatever the going rate is, and that rate will tend to be high because there’s equity and capital everywhere. Everyone who can save any money at all is an investor, and has capital. The only scarce resource becomes the labor to do the actual work. So labor can drive as hard a bargain as it likes.

Generalized economic prosperity comes from maximizing production. As we saw earlier, a bitcoin-based deflationary monetary system will tend to optimize the allocation of capital across society, and it will tend towards a better-capitalized economy overall. The gains will tend to be shared broadly in society because labor is revealed as the only truly scarce resource. A more meritocratic society results, with capital going to where it can be used best, to best serve the largest portion of society.

A pax bitcoin is within our grasp! We just need to understand it and begin to live our lives accordingly.

Once upon a time, money was physical. Maybe it was gold, maybe it was silver, or maybe it was paper notes. Regardless, it was physical. And that meant that there was value in keeping your money somewhere safe. Say, down at the vault.

The vault owner could charge you for keeping your physical money safe. Eventually, however, he learned to lend your money out and earn some interest. And you eventually learned to ask for a share of that interest.

There’s an issue here, which is that if he lends too much out, you might come asking for your money and he might not have it. Thus the notion of reserves — an amount of your money that the bank keeps on hand in case you come asking to withdraw. The reserve is fractional because he only keeps a fraction of your deposit amount on hand.

Keeping a fraction of deposits on hand kind of works, most of the time, but if depositors get spooked, say, and they all want their money at the same time, the system still breaks down. That’s why we have FDIC insurance in the US: the government steps in if there’s a run on a bank.

And they all lived happily ever after.

Stepping out of history now, we find ourselves in 2020 with a system that was designed around physical money that needed to be kept safe in a vault; and yet our money is anything but.

Money is a number in a computer now, with your name attached to it. It sounds so simple, but we keep up pretenses like it’s something else that needs to be safeguarded in a vault.

And we continue to perpetuate the unstable system of fractional reserve banking, when there’s no need. People could keep their money in the bank, and decide if and when they want to loan it out (say, as a CD) or invest it. There would be no need for FDIC insurance, and the financial system would be that much more stable.