Shoot the Rationalist #2: Betting on Chaos

I can't remember the last time I posted on back-to-back days, but here I am, collecting auto-votes like the selfish content creator you know I am. Yesterday I talked about politics. Today, I'm talking about Bitcoin. Am I a Bitcoin maximalist? No. But it's the only coin I actually feel like I can understand. So, let's talk about it.

So, I won't bore you on why Proof-of-Work is a revolutionary technology advancement that creates a secure foundation for a digital ledger. I'm sure some of you learned that when Steem was sub-51% attacked by Justin Sun and then the hard fork happened. The nice thing about Proof-of-Work is that you have to waste a ton of electricity to change the ledger (and even MORE energy to enforce protocol changes on the ledger).

But who cares about digital money that is resistant to manipulation? Under ideal conditions, Bitcoin is a novel technology that serves very little practical purpose. It is too slow as a transaction medium taking minutes for transactions to be locked into the ledger. Secondly, there is a technical learning curve that needs to be climbed in order to grasp the idea of a digital wallet and how it acts as a key to your money on the blockchain rather than actually hold any money itself. Both things go against Bitcoin as money in normal operating conditions, but as you well know, these aren't normal conditions.

Bitcoin was created in the aftermath of the 2008 financial crisis. A chain reaction of failures in multiple financial systems that lead central governments to intervene in order to maintain the current system. The alternative was living with the potential devastating consequences of multiple banking institutions and insurance companies failing in the midst of reckless gambling on less than stellar subprime mortgage packages. This led to the US Federal Reserve "temporarily" expanding its balance sheet (making money out of thin air) to purchase treasuries in order to stabilize rates and add liquidity to the system. The problem with inventing money on demand is that it undermines the policy for a currency (without a hard policy, you can't have hard money) and you either eventually have to unleash it into the system if you can't unprint it through contraction of the balance sheet. Bitcoin doesn't suffer from flexible policy as a result of its design. It's hard money (but not as useful as soft money normally).

Note that there is nothing inherently wrong with what the Federal Reserve did. While they expanded the money supply, it remained somewhat locked in place in treasury markets. Sure, they are manipulating the economy, but I've yet to explain why that is bad or why it is negative for ordinary folks. The issue today is that the Fed has yet to successfully pullback on that monetary expansion and are now aggressively "buying" assets across the entire bond market, not just treasuries. While this is done to avoid massive deflation from a retracting economy, when things return to normal, a lot of the "printed" money will be loose in the economy, which likely flips us from a deflationary environment to an inflationary environment. As a debtor this is useful as it decreases the effective weight of your debt. As a saver, this undermines the weight of your savings.

So, why is Bitcoin useful? It is a bet on chaos and insurance for savings in the inflationary case. It is a bet that central governments can only temporary prop up economies built on cheap debt and overvalued assets. That easy short term solutions often have some negative consequence or side effect associated with them. In an ideal situation, you want Bitcoin to fail (or be useless). If Bitcoin works, it means that something else failed. Bitcoin's strongest property is that its security preserves its value and its strict inflationary policy. But it only works against currencies that are self-destructing. Bitcoin isn't necessary gaining value as much as certain assets are having their value eroded away. Venezuela sees massive gains in its stock market, but Venezuela stocks are trash because their metric of measurement (their currency) is trash.

Although some folks are optimistic about a quick turnaround in the economic system after the virus passes, I am weary of the side effects that linger. The coronavirus may be the first is a series of dominoes ready to fall. How many industries will either collapse or need to be propped up? How many derivative bets exist on those industries? How much soft money will that take to alleviate those problems? Is it possible that faith in the dollar will begin to erode? What about the other countries that are using similar tactics but don't have the advantage of being the United States? There are a lot of questions and lots of uncertainty.

I'm more confident in Bitcoin than ever before. Not as an investment in an undervalued and underutilized asset, but as insurance against chaos and the collapse of systems that have been propped up for too long. Systems that are in desperate need of deleveraging in order to reduce layers of toxic and unproductive debt. Instead we are continuously tempted to borrow from our futures in order to attempt to control the uncontrollable. And is often the case with things we try to control, nature comes back with overwhelming vengeance.