Browsing "Gold – Sound Money"

Bitcoin: Addressing the Ponzi Scheme Characterization

By Lyn Alden, Updated January 31, 2021

One of the concerns I’ve seen aimed at Bitcoin is the claim that it’s a Ponzi scheme. The argument suggests that because the Bitcoin network is continually reliant on new people buying in, that eventually it will collapse in price as new buyers are exhausted.

So, this article takes a serious look at the concern by comparing and contrasting Bitcoin to systems that have Ponzi-like characteristics, to see if the claim holds up.

The short answer is that Bitcoin does not meet the definition of a Ponzi scheme in either narrow or broad sense, but let’s dive in to see why that’s the case.

Defining a Ponzi Scheme

To start with tackling the topic of Bitcoin as a Ponzi scheme, we need a definition.

Here is how the US Securities and Exchange Commission defines one:

A Ponzi scheme is an investment fraud that pays existing investors with funds collected from new investors. Ponzi scheme organizers often promise to invest your money and generate high returns with little or no risk. But in many Ponzi schemes, the fraudsters do not invest the money. Instead, they use it to pay those who invested earlier and may keep some for themselves.

With little or no legitimate earnings, Ponzi schemes require a constant flow of new money to survive. When it becomes hard to recruit new investors, or when large numbers of existing investors cash out, these schemes tend to collapse.

Ponzi schemes are named after Charles Ponzi, who duped investors in the 1920s with a postage stamp speculation scheme.

They further go on to list red flags to look out for:

Many Ponzi schemes share common characteristics. Look for these warning signs:

High returns with little or no risk. Every investment carries some degree of risk, and investments yielding higher returns typically involve more risk. Be highly suspicious of any “guaranteed” investment opportunity.

Overly consistent returns. Investments tend to go up and down over time. Be skeptical about an investment that regularly generates positive returns regardless of overall market conditions.

Unregistered investments. Ponzi schemes typically involve investments that are not registered with the SEC or with state regulators. Registration is important because it provides investors with access to information about the company’s management, products, services, and finances.

Unlicensed sellers. Federal and state securities laws require investment professionals and firms to be licensed or registered. Most Ponzi schemes involve unlicensed individuals or unregistered firms.

Secretive, complex strategies. Avoid investments if you don’t understand them or can’t get complete information about them.

Issues with paperwork. Account statement errors may be a sign that funds are not being invested as promised.

Difficulty receiving payments. Be suspicious if you don’t receive a payment or have difficulty cashing out. Ponzi scheme promoters sometimes try to prevent participants from cashing out by offering even higher returns for staying put.

I think that’s a great set of information to work with. We can see how many of those attributes, if any, Bitcoin has.

Bitcoin’s Launch Process

Before we get into comparing Bitcoin point-by-point to the above list, we can start with a recap of how Bitcoin was launched.

In August 2008, someone identifying himself as Satoshi Nakamoto created Bitcoin.org.

Two months later in October 2008, Satoshi released the Bitcoin white paper. This document explained how the technology would work, including the solution to the double-spending problem. As you can see from the link, it was written in the format and style of an academic research paper, since it was presenting a major technical breakthrough that provided a solution for well-known computer science challenges related to digital scarcity. It contained no promises of enrichment or returns.

Then, three months later in January 2009, Satoshi published the initial Bitcoin software. In the custom genesis block of the blockchain, which contains no spendable Bitcoin, he provided a time-stamped article headline about bank bailouts from The Times of London, likely to prove that there was no pre-mining and to set the tone for the project. From there, it took him six days to finish things and mine block 1, which contained the first 50 spendable bitcoins, and he released the Bitcoin source code that day on January 9th. By January 10th, Hal Finney publicly tweeted that he was running the Bitcoin software as well, and right from the beginning, Satoshi was testing the system by sending bitcoins to Hal.

Interestingly, since Satoshi showed how to do it with the white paper more than two months before launching the open source Bitcoin software himself, technically someone could have used the newfound knowledge to launch a version before him. It would have been unlikely, due to Satoshi’s big head start in figuring all of this out and understanding it at a deep level, but it was technically possible. He gave away the key technological breakthrough before he launched the first version of the project. Between the publication of the white paper and the launch of the software, he answered questions and explained his choices for his white paper to several other cryptographers on an email list in response to their critiques, almost like an academic thesis defense, and several of them could have been technical enough to “steal” the project from him, if they were less skeptical.

After launch, a set of equipment that is widely believed to belong to Satoshi remained a large Bitcoin miner throughout the first year. Mining is necessary to keep verifying transactions for the network, and bitcoins had no quoted dollar price at that time. He gradually reduced his mining over time, as mining became more distributed across the network. There are nearly 1 million bitcoins that are believed to belong to Satoshi that he mined through Bitcoin’s early period and that he has never moved from their initial address. He could have cashed out at any point with billions of dollars in profit, but so far has not, over a decade into the project’s life. It’s not known if he is still alive, but other than some early coins for test transactions, the bulk of his coins haven’t moved.

Not long after, he transferred ownership of his website domains to others, and ever since, Bitcoin has been self-sustaining among a revolving development community with no input from Satoshi.

Bitcoin is open source, and is distributed around the world. The blockchain is public, transparent, verifiable, auditable, and analyzable. Firms can do analytics of the entire blockchain and see which bitcoins are moving or remaining in place in various addresses. An open source full node can be run on a basic home computer, and can audit Bitcoin’s entire money supply and other metrics.

With that in mind, we can then compare Bitcoin to the red flags of being a Ponzi scheme.

Investment Returns: Not Promised

Satoshi never promised any investment returns, let alone high investment returns or consistent investment returns. In fact, Bitcoin was known for the first decade of its existence as being an extremely high-volatility speculation. For the first year and a half, Bitcoin had no quotable price, and after that it had a very volatile price.

The online writings from Satoshi still exist, and he barely ever talked about financial gain. He mostly wrote about technical aspects, about freedom, about the problems of the modern banking system, and so forth. Satoshi wrote mostly like a programmer, occasionally like an economist, and never like a salesman.

We have to search pretty deeply to find instances where he discussed Bitcoin potentially becoming valuable. When he did talk about the potential value or price of a bitcoin, he spoke very matter-of-factly in regards to how to categorize it, whether it would be inflationary or deflationary, and admitted a ton of variance for how the project could turn out. Digging around for Satoshi’s quotes on the price of value of a bitcoin, here’s what I found:

The fact that new coins are produced means the money supply increases by a planned amount, but this does not necessarily result in inflation. If the supply of money increases at the same rate that the number of people using it increases, prices remain stable. If it does not increase as fast as demand, there will be deflation and early holders of money will see its value increase.

___

It might make sense just to get some in case it catches on. If enough people think the same way, that becomes a self fulfilling prophecy. Once it gets bootstrapped, there are so many applications if you could effortlessly pay a few cents to a website as easily as dropping coins in a vending machine.

___

In this sense, it’s more typical of a precious metal. Instead of the supply changing to keep the value the same, the supply is predetermined and the value changes. As the number of users grows, the value per coin increases. It has the potential for a positive feedback loop; as users increase, the value goes up, which could attract more users to take advantage of the increasing value.

___

Maybe it could get an initial value circularly as you’ve suggested, by people foreseeing its potential usefulness for exchange. (I would definitely want some) Maybe collectors, any random reason could spark it. I think the traditional qualifications for money were written with the assumption that there are so many competing objects in the world that are scarce, an object with the automatic bootstrap of intrinsic value will surely win out over those without intrinsic value. But if there were nothing in the world with intrinsic value that could be used as money, only scarce but no intrinsic value, I think people would still take up something. (I’m using the word scarce here to only mean limited potential supply)

___

A rational market price for something that is expected to increase in value will already reflect the present value of the expected future increases. In your head, you do a probability estimate balancing the odds that it keeps increasing.

___

I’m sure that in 20 years there will either be very large transaction volume or no volume.

___

Bitcoins have no dividend or potential future dividend, therefore not like a stock. More like a collectible or commodity.

Quotes by Satoshi Nakamoto

Promising unusually high or consistent investment returns is a common red flag for being a Ponzi scheme, and with Satoshi’s original Bitcoin, there was none of that.

Over time, Bitcoin investors have often predicted very high prices (and so far those predictions have been correct), but the project itself from inception did not have those attributes.

Open Source: The Opposite of Secrecy

Most Ponzi schemes rely on secrecy. If the investors understood that an investment they owned was actually a Ponzi scheme, they would try to pull their money out immediately. This secrecy prevents the market from appropriately pricing the investment until the secret gets found out.

For example, investors in Bernie Madoff’s scheme thought they owned a variety of assets. In reality, earlier investor outflows were just being paid back from new investor inflows, rather than money being made from actual investments. The investments listed on their statements were fake, and for any of those clients, it would be nearly impossible to verify that they are fake.

Bitcoin, however, works on precisely the opposite set of principles. As a distributed piece of open source software that requires majority consensus to change, every line of code is known, and no central authority can change it. A key tenet of Bitcoin is to verify rather than to trust. Software to run a full node can be freely downloaded and run on a normal PC, and can audit the entire blockchain and the entire money supply. It relies on no website, no critical data center, and no corporate structure.

For this reason, there are no “issues with paperwork” or “difficulty receiving payments”, referencing some of the SEC red flags of a Ponzi. The entire point of Bitcoin is to not rely on any third parties; it is immutable and self-verifiable. Bitcoin can only be moved with the private key associated with a certain address, and if you use your private key to move your bitcoins, there is nobody who can stop you from doing so.

There are of course some bad actors in the surrounding ecosystem. People relying on others to hold their private keys (rather than doing so themselves) have sometimes lost their coins due to bad custodians, but not because the core Bitcoin software failed. Third-party exchanges can be fraudulent or can be hacked. Phishing schemes or other frauds can trick people into revealing their private keys or account information. But these are not associated with Bitcoin itself, and as people use Bitcoin, they must ensure they understand how the system works to avoid falling for scams in the ecosystem.

No Pre-Mine

As previously mentioned, Satoshi mined virtually all of his coins at a time when the software was public and anybody else could mine them. He gave himself no unique advantage in acquiring coins faster or more easily than anyone else, and had to expend computational power and electricity to acquire them, which was critical in the early period for keeping the network up and running. And as previously mentioned, the white paper was released before any of it, which would be unusual or risky to do if the goal was mainly about personal monetary gain.

In contrast to this unusually open and fair way that Bitcoin was launched, many future cryptocurrencies didn’t follow those same principles. Specifically, many later tokens had a bunch of pre-mined conceptions, meaning that the developers would give themselves and their investors coins before the project becomes public.

Ethereum’s developers provided 72 million tokens to themselves and their investors prior to any being available to own by the broader public, which is more than half of the current token supply of Ethereum. It was a crowdsourced project.

Ripple Labs pre-mined 100 billion XRP tokens with the majority being owned by Ripple Labs, and gradually began selling the rest to the public, while still holding the majority, and is currently being accused by the SEC of selling unregistered securities.

Besides those two, countless other smaller tokens were pre-mined and sold to the public.

A case can be made in favor of pre-mining in certain instances, although some are very critical of the practice. In a similar way that a start-up company offers equity to its founders and early investors, a new protocol can offer tokens to its founders and early investors, and crowdsourced financing is a well-accepted practice at this point. I’ll leave that debate to others. Few would dispute that early developers can be compensated for work if their project takes off, and funds are helpful for early development. As long as it’s fully transparent, it comes down to what the market thinks is reasonable.

When defending against the notion of being a Ponzi scheme, however, Bitcoin is miles ahead of most other digital assets. Satoshi showed the world how to do it first with a white paper months in advance, and then put the project out there in an open source way on the first day of spendable coins being generated, with no pre-mine.

A situation where the founder gave himself virtually no mining advantage over other early adaptors, sure is the “cleanest” approach. Satoshi had to mine the first blocks of coins with his computer just like anyone else, and then never spent them other than by sending some of his initial batch out for early testing. This approach improved the odds of it becoming a viral movement, based on economic or philosophical principles, rather than strictly about riches. Unlike many other blockchains over the years, Bitcoin development occurred organically, by a revolving set of large stakeholders and voluntary user donations, rather than via a pre-mined or pre-funded pool of capital.

On the other hand, giving yourself and initial investors most of the initial tokens and then having later investors start from mining from scratch or buy into it, opens up more avenues for criticisms and skepticism and begins to look more like a Ponzi scheme, whether or not it actually is.

Leaderless Growth

One thing that makes Bitcoin really interesting is that it’s the one big digital asset that flourished without centralized leadership. Satoshi created it as its anonymous inventor, worked with others to guide it through the first two years with continued development on open forums, and then disappeared. From there, other developers took the mantle in terms of continuing to develop and promote Bitcoin.

Some developers have been extremely important, but none of them are critical for its ongoing development or operation. In fact, even the second round of developers after Satoshi largely went in other directions. Hal Finney passed away in 2014. Some other super-early Bitcoiners became more interested in Bitcoin Cash or other projects at various stages.

As Bitcoin has developed over time, it has taken on a life of its own. The distributed development community and userbase, (and the market, when it comes to pricing various paths after hard forks) has determined what Bitcoin is, and what it is useful for. The narrative has changed and expanded as time went on, and market forces rewarded or punished various directions.

For years, debates centered around whether Bitcoin should optimize for storing value or optimize for frequent transactions on the base layer, and this is what led to multiple hard forks that all devalued compared to Bitcoin. The market clearly has preferred Bitcoin’s base layer to optimize for being a store of value and large transaction settlement network, to optimize for security and decentralization, with an allowance for frequent smaller transactions to be handled on secondary layers.

Every other blockchain-based token, including hard forks and those associated with totally new blockchain designs, comes on the coattails of Bitcoin, with Bitcoin being the most self-sustaining project of the industry. Most token projects are still founder-led, often with a big pre-mine, with an unclear future should the founder no longer be involved. Some of the sketchiest tokens have paid exchanges for being listed, to try to jump-start a network effect, whereas Bitcoin always had the most natural growth profile.

Unregistered Investments and Unlicensed Sellers

The only items on the red flag list that may apply to Bitcoin are the points that refer to investments that are unregulated. This doesn’t inherently mean that something is a Ponzi; it just means that a red flag is present and investors should be cautious. Especially in the early days of Bitcoin, buying some magical internet money would of course be a highly risky investment for most people to make.

Bitcoin is designed to be permission-less; to operate outside of the established financial system, with philosophical leanings towards libertarian cryptographic culture and sound money. For most of its life, it had a steeper learning curve than traditional investments, since it rests on the intersection of software, economics, and culture.

Some SEC officials have said that Bitcoin and Ethereum are not securities (and by logical extension, have not committed securities fraud). Many other cryptocurrencies or digital assets have, however, been classified as securities and some like Ripple Labs have been charged with selling unregistered securities. The IRS treats Bitcoin and many other digital assets like commodities for tax purposes.

So, in the early days, Bitcoin may have indeed been an unregistered investment, but at this point it has a place in tax law and regulatory frameworks around the world. Regulation changes over time, but the asset has reached the mainstream. It’s so mainstream that Fidelity and other custodians hold it for institutional clients and J.P. Morgan gives their price targets for it.

Many people who have not looked deeply into the industry lump all “cryptocurrencies” together. However, it’s important for prospective investors to look into the details and find important differences. Lumping “cryptocurrencies” together would be like lumping “stocks” together. Bitcoin is clearly not like the others in many attributes, and was launched and sustained in a way that looks more like a movement or a protocol than an investment, but that over time became an investment as well.

From there, folks can choose to look into the rabbit hole of thousands of other tokens that came in Bitcoin’s wake and make their own conclusions. There’s a big spectrum there from well-intentioned projects on one side, to outright scams on the other side. It’s important to realize, however, that even if real innovation is happening somewhere, doesn’t mean the tokens associated with that project will necessarily have durable value. If a token solves some novel problem, its solution could end up being re-adapted to a layer on a larger protocol with a bigger network effect. Likewise, any investment in those other tokens has an opportunity cost of being able to purchase more Bitcoin instead.

Section Summary: Clearly Not a Ponzi Scheme

Bitcoin was launched in the fairest way possible.

Satoshi first showed others how to do it with the white paper in an academic sense, and then did it himself months later, and anyone could begin mining alongside him within the first days as some early adopters did. Satoshi then distributed the development of the software to others and disappeared, rather than continue to promote it as a charismatic leader, and so far has never cashed out.

From the beginning, Bitcoin has remained an open source and fully transparent project, and has the most organic growth trajectory of the industry. Given available information, the market has priced it as it sees fit, out in the open.

The Broader Definition of a Ponzi

Because the narrow Ponzi scheme clearly doesn’t apply to Bitcoin, some folks have used a broader definition of a Ponzi scheme to assert that Bitcoin is one.

A bitcoin is like a commodity, in the sense that it’s a scarce digital “object” that provides no cash flow, but that does have utility. They are limited to 21 million divisible units, of which over 18.5 million have already mined according to the pre-programmed schedule. Every four years, the number of new bitcoins generated per ten minute block will be cut in half, and the total number of bitcoins in existence will asymptotically move towards 21 million.

Like any commodity, it produces no cash flows or dividends, and is only worth what someone else will pay you for it or trade you for it. And specifically, it is a monetary commodity; one whose utility is entirely about storing and transmitting value. This makes gold its closest comparison.

Bitcoin vs Gold Market

Some people assert that Bitcoin is a Ponzi scheme because it relies on an ever-larger pool of investors coming into the space to buy from earlier investors.

To some extent this reliance on new investors is correct; Bitcoin keeps growing its network effect, reaching more people and bigger pools of money, which keeps increasing its usefulness and value.

Bitcoin will only be successful in the long run if its market capitalization reaches and sustains a very high level, in part because its security (hash rate) is inherently connected to its price. If for some reason demand for it were to permanently flatline and turn down without reaching a high enough level, Bitcoin would remain a niche asset and its value, security, and network effect could deteriorate over time. This could begin a vicious cycle of attracting fewer developers to keep building out its secondary layers and surrounding hardware/software ecosystem, potentially resulting in quality stagnation, price stagnation, and security stagnation.

However, this doesn’t make it a Ponzi scheme, because by similar logic, gold is a 5,000 year old Ponzi scheme. The vast majority of gold’s usage is not for industry; it’s for storing and displaying wealth. It produces no cash flows, and is only worth what someone else will pay for it. If peoples’ jewelry tastes change, and if people no longer view gold as an optimal store of value, its network effect could diminish.

There are 60+ years of gold’s annual production supply estimated to be available in various forms around the world. And that’s more like 500 years worth of industrial-only supply, factoring out jewelry and store-of-value demand. Therefore, gold’s supply/demand balance to support a high price requires the ongoing perception of gold as an attractive way to store and display wealth, which is somewhat subjective. Based on the industrial-only demand, there is a ton of excess supply and prices would be way lower.

However, gold’s monetary network effect has remained robust for such a long period of time because the collection of unique properties it has is what made it continually regarded as being optimal for long-term wealth preservation and jewelry across generations: it’s scarce, pretty, malleable, fungible, divisible, and nearly chemically indestructible. As fiat currencies around the world come and go, and rapidly increase their per-unit number, gold’s supply remains relatively scarce, only growing by about 1.5% per year. According to industry estimates, there is about one ounce of above-ground gold per person in the world.

Similarly, Bitcoin relies on the network effect, meaning a sufficiently large number of people need to view it as a good holding for it to retain its value. But a network effect is not a Ponzi scheme in and of itself. Prospective investors can analyze the metrics of Bitcoin’s network effect, and determine for themselves the risk/reward of buying into it.

Bitcoin vs Fiat Banking System

By the broadest definition of a Ponzi scheme, the entire global banking system is a Ponzi scheme.

Firstly, fiat currency is an artificial commodity, in a certain sense. A dollar, in and of itself, is just an object made out of paper, or represented on a digital bank ledger. Same for the euro, the yen, and other currencies. It pays no cash flows on its own, although institutions that hold it for you might be willing to pay you a yield (or, in some cases, could charge you a negative yield). When we do work or sell something to acquire dollars, we do so only with the belief that its large network effect (including a legal/government network effect) will ensure that we can take these pieces of paper and give them to someone else for something of value.

Secondly, when we organize these pieces of paper and their digital representations in a fractional-reserve banking system, we add another complicated layer. If about 20% of people were to try to pull their money out of their bank at the same time, the banking system would collapse. Or more realistically, the banks would just say “no” to your withdrawal, because they don’t have the cash. This happened to some US banks in early 2020 during the pandemic shutdown, and occurs regularly around the world. That’s actually one of the SEC’s red flags of a Ponzi scheme: difficulty receiving payments.

In the well-known musical chairs game, there is a set of chairs, someone plays music, and kids (of which there is one more than the number of chairs) start walking in circles around the chairs. When the music stops, all of the kids scramble to sit in one of the chairs. One slow or unlucky kid doesn’t get a seat, and therefore leaves the game. In the next round, one chair is removed, and the music resumes for the remaining kids. Eventually after many rounds, there are two kids and one seat, and then there is a winner when that round ends.

The banking system is a permanent round of musical chairs. There are more kids than chairs, so they can’t all get one. If the music were to stop, this would become clear. However, as long as the music keeps going (with occasional bailouts via printed money), it keeps moving along.

Banks collect depositor cash, and use their capital to make loans and buy securities. Only a small fraction of depositor cash is available for withdrawal. A bank’s assets consist of loans owed to them, securities such as Treasuries, and cash reserves. Their liabilities consist of money owed to depositors, as well as any other liabilities they may have like bonds issued to creditors.

For the United States, banks collectively have about 20% of customer deposits held as cash reserves:

Bank Cash Reserves

Chart Source: St. Louis Fed

As the chart shows, this percentage reached below 5% prior to the global financial crisis (which is why the crisis was so bad, and marked the turning point in the long-term debt cycle), but with quantitative easing, new regulations, and more self-regulation, banks now have about 20% of deposit balances as reserves.

Similarly, the total amount of physical cash in circulation, which is exclusively printed by the US Treasury Department, is only about 13% as much as the amount of commercial bank deposits, and only a tiny fraction of that is actually held by banks as vault cash. There’s not nearly enough physical cash (by design), for a significant percentage of people to pull their capital out of banks at once. People run into “difficulty receiving payments” if enough of them do so around the same time.

As constructed in the current way, the banking system can never end. If a sufficiently large number of banks were to liquidate, the entire system would cease to function.

If a single bank were to liquidate without being acquired, it would hypothetically have to sell all of its loans and securities to other banks, convert it all to cash, and pay that cash out to depositors. However, if a sufficiently large number of banks were to do that at once, the market value of the assets they are selling would sharply decrease and the market would turn illiquid, because there are not enough available buyers.

Realistically, if enough banks were to liquidate at once, and the market froze up as debt/loan sellers overwhelmed buyers, the Federal Reserve would end up creating new dollars to buy assets to re-liquidity the market, which would radically increase the number of dollars in circulation. Otherwise, everything nominally collapses, because there aren’t enough currency units in the system to support an unwinding of the banking systems’ assets.

So, the monetary system functions as a permanent round of musical chairs on top of artificial government-issued commodities, where there are by far more claims on that money (kids) than money that is currently available to them (chairs) if they were to all scramble for it at once. The number of kids and chairs both keeps growing, but there are always way more kids than chairs. Whenever the system partially breaks, a couple more chairs are added to the round to keep it going.

We accept this as normal, because we assume it will never end. The fractional reserve banking system has functioned around the world for hundreds of years (first gold-backed, and then totally fiat-based), albeit with occasional inflationary events along the way to partially reset things.

Each individual unit of fiat currency has degraded about 99% in value or more over the multi-decade timeline. This means that investors either need to earn a rate of interest that exceeds the real inflation rate (which is not currently happening), or they need to buy investments instead, which inflates the value of stocks and real estate compared to their cash flows, and pushes up the prices of scarce objects like fine art.

Over the past century, T-bills and bank cash just kept up with inflation, providing no real return. However, this tends to be very lumpy. There were decades such as the 1940s, 1970s, and 2010s, where holders of T-bills and bank cash persistently failed to keep up with inflation. This chart shows the T-bill rate minus the official inflation rate over nine decades:

Real Interest Rates

Chart Source: St. Louis Fed

Bitcoin is an emergent deflationary savings and payments technology that is mostly used in an unlevered way, meaning that most people just buy it, hold it, and occasionally trade it. There are some Bitcoin banks, and some folks that use leverage on exchanges, but overall debt in the system remains low relative to market value, and you can self-custody your own holdings.

Frictional Costs

Another variation of the broader Ponzi scheme claim asserts that because Bitcoin has frictional costs, it’s a Ponzi scheme. The system requires constant work to keep it functioning.

Again, however, Bitcoin is no different in this regard than any other system of commerce. A healthy transaction network inherently has frictional costs.

With Bitcoin, miners invest into customized hardware, electricity, and personnel to support Bitcoin mining, which means verifying transactions and earning bitcoins and transaction fees for doing so. Miners have plenty of risk, and plenty of reward, and they are necessary for the system to function. There are also market makers that supply liquidity between buyers and sellers, or convert fiat currency to Bitcoin, making it easier to buy or sell Bitcoin, and they necessarily extract transaction fees as well. And some institutions provide custody solutions: charging a small fee to hold Bitcoin.

Similarly, gold miners put plenty of money into personnel, exploration, equipment, and energy to extract gold from the ground. From there, various companies purify and mint it into bars and coins, secure and store it for investors, ship it to buyers, verify its purity, make it into jewelry, melt it back down for purification and re-minting, etc. Atoms of gold keep circulating in various forms, due to the work of folks in the gold industry ranging from the finest Swiss minters to the fancy jewelers to the bullion dealers to the “We Buy Gold!” pawn shops. Gold’s energy work is skewed towards creation rather than maintenance, but the industry has these ongoing frictional costs too.

Likewise, the global fiat monetary system has frictional costs as well. Banks and fintech firms extract over $100 billion per year in transaction fees associated with payments, serving as custodians and managers for client assets, and supplying liquidity as market makers between buyers and sellers.

I recently analyzed DBS Group Holdings, for example, which is the largest bank in Singapore. They generate about S$900 million in fees per quarter, or well over S$3 billion per year. Translated into US dollars, that’s over $2.5 billion per year USD in fees.

And that’s one bank with a $50 billion market capitalization. There are two other banks in Singapore of comparable size. J.P. Morgan Chase, the largest bank in the US, is more than 7x as big, and there are several banks in the US that are nearly as large as J.P. Morgan Chase. Just between Visa and Mastercard, they earn about $40 billion in annual revenue. The amount of fees generated by banks and fintech companies around the world per year is over $100 billion.

It requires work to verify transactions and store value, so any monetary system has frictional costs. It only becomes a problem if the transaction fees are too high of a percentage of payment volumes. Bitcoin’s frictional costs are fairly modest compared to the established monetary system, and secondary layers can continue to reduce fees further. For example, the Strike App aims to become arguably the cheapest global payments network, and it runs on the Bitcoin/Lightning network.

This extends to non-monetary commodities as well. Besides gold, wealthy investors store wealth in various items that do not produce cash flow, including fine art, fine wine, classic cars, and ultra-high-end beachfront property that they can’t realistically rent out. There are certain stretches of beaches in Florida or California, for example, with nothing but $30 million homes that are mostly vacant at any given time. I like to go to those beaches because they are usually empty.

These scarce items tend to appreciate in value over time, which is the key reason why people hold them. However, they have frictional costs when you buy them, sell them, and maintain them. As long as those frictional costs are lower than the average appreciation rate over time, they are decent investments compared to holding fiat, rather than being Ponzi schemes.

Section Summary: A Network Effect, Not a Ponzi

The broadest definition of a Ponzi scheme refers to any system that must continually keep operating to remain functional, or that has frictional costs.

Bitcoin doesn’t really meet this broader definition of a Ponzi scheme any more than the gold market, the global fiat banking system, or less liquid markets like fine art, fine wine, collectable cars, or beachfront property. In other words, if your definition of something is so broad that it includes every non-cashflow store of value, you need a better definition.

All of these scarce items have some sort of utility in addition to their store-of-value properties. Gold and art let you enjoy and display visual beauty. Wine lets you enjoy and display gustatory beauty. Collectable cars and beachfront homes let you enjoy and display visual and tactile beauty. Bitcoin lets you make domestic and international settlement payments with no direct mechanism to be blocked by any third party, giving the user unrivaled financial mobility.

Those scarce objects hold their value or increase over time, and investors are fine with paying small frictional costs as a percentage of their investment, as an alternative to holding fiat cash that degrades in value over time.

Yes, Bitcoin requires ongoing operation and must reach a significant market capitalization for the network to become sustainable, but I think that’s best viewed as technological disruption, and investors should price it based on their view of the probability of it succeeding or failing. It’s a network effect that competes with existing network effects; especially the global banking system. And ironically, the global banking system displays more Ponzi characteristics than the others on this list.

Final Thoughts

Any new technology comes with a time period of assessment, and either rejection or acceptance. The market can be irrational at first, either to the upside or downside, but over the fullness of time, assets are weighed and measured.

Bitcoin’s price has grown rapidly with each four-year supply halving cycle, as its network effect continues to compound while its supply remains limited.

Ponzi Bitcoin

Chart Source: St. Louis Fed

Every investment has risks, and it of course remains to be seen what Bitcoin’s ultimate fate will be.

If the market continues to recognize it as a useful savings and payment settlement technology, available to most people in the world and backed up by decentralized consensus around an immutable public ledger, it can continue to take market share as a store of wealth and settlement network until it reaches some mature market capitalization of widespread adoption and lower volatility.

Detractors, on the other hand, often assert that Bitcoin has no intrinsic value and that one day everyone will realize for what it is, and it’ll go to zero. Rather than using this argument, however, the more sophisticated bear argument should be that Bitcoin will fail in its goal to take a certain percentage of persistent market share from the global banking system for one reason or another, and to cite the reasons why they hold that view.

The year 2020 was a story about institutional acceptance, where Bitcoin seemingly transcended the boundary between retail investment and institutional allocations. MicroStrategy and Square become the first publicly-traded companies on major stock exchanges to allocate some or all of their reserves to Bitcoin instead of cash. MassMutual became the first large insurance company to put a fraction of its assets into Bitcoin. Paul Tudor Jones, Stanley Druckenmiller, Bill Miller, and other well-known investors expressed bullish views on it. Some institutions like Fidelity were onboard the Bitcoin train for years with an eye towards institutional custodian services, but 2020 saw a bunch more jump on, including the largest asset manager in the world, BlackRock, showing strong interest.

For utility, Bitcoin allows self-custody, mobility of funds, and permission-less settlements. Although there are other interesting blockchain projects, no other cryptocurrency offers a similar degree of security to prevent attacks against its ledger (both in terms of hash rate and node distribution), or has a wide enough network effect to have a high probability of continually being recognized by the market as a store of value in a persistent way.

And importantly, Bitcoin’s growth was the most organic of the industry, coming first and spreading quickly without centralized leadership and promotion, which is what made it more of a foundational protocol rather than a financial security or business project.

Lyn Alden website https://www.lynalden.com/

In Gold we Trust Report

2020 Report by Incrementum AG

Ronald-Peter Stoeferle has written the annual In Gold We Trust report for well over a decade. Since 2013 it has been co-authored by his partner Mark Valek.

Over the years, the gold study has become the industry standard publication on gold, money and inflation.

It provides a “holistic“ assessment of the gold sector and the most important factors influencing it, including real interest rates, opportunity costs, debt, central bank policy etc.

Download the report

Time to learn about money

By By Alasdair Macleod of Goldmoney.com  May 07, 2020

An unexpected destruction of fiat currency has been advanced by the monetary and fiscal response to the coronavirus. Financial markets have yet to discount the possibility of such an outcome, but in the coming months they are likely to awaken to this danger.

The question arises as to what will replace fiat currencies. In the past the answer has always been gold but today there are cryptocurrencies as well, whose enthusiasts are more aware than most of fiat money’s failings.

This article describes the basics about money, what it is and the role it plays in order to understand what will be required by the eventual replacement for fiat. It concludes that gold will return as the world’s medium of exchange, and secure cryptocurrencies, unable to provide the scalability and stability of value required of a medium of exchange will be priced in gold after the demise of fiat. But then the rationale for them will be gone, and with it their function as a store of value.

The destruction of fiat money

These are strange times. Circumstances are forcing governments to destroy their money by debasing it to pay for their obligations, real and imagined. If central bankers had a grasp of what money really is, they wouldn’t have got into a position where they are forced to use their seigniorage to destroy it. They are so ignorant about catallactics, the fundamentals behind economics, that they cannot see they are destroying the means of exchange they have imposed upon their citizens with far worse consequences than the abandonment of the evils they are trying to defray.[i]

Unless you believe in a financial form of perpetual motion you will know that all else being equal if you double the quantity of money you approximately halve its purchasing power. It is therefore an incontestable fact that if a central bank doubles the quantity of a circulating fiat currency, it is taking to itself half of the value of everyone’s cash, currency deposits, profits and salaries. It makes everyone poorer and it is simply a travesty to promote monetary inflation as a costless form of economic rescue. Yet the major central banks are now unashamedly admitting to a policy of deploying an infinite expansion of circulating currency.

The effect on capital allocation is equally destructive, because it undermines economic calculation. The suppression of interest rates and increasing quantities of currency tempt businessmen into unprofitable investment decisions which only appear profitable. But inflationism periodically fails as any follower of credit cycles will attest. And the more extreme the policy of inflationism, the more capital is misallocated, and the worse the periodic failures. Today, we can add to these woes monetary and interest rate policies intended to prevent any and all businesses from going to the wall in a final act of capital misallocation.

We now stand on the edge of a global monetary crisis brought about by a new, rapid acceleration of money-printing. Never before have we seen our own governments and those of all our trading partners embark on the same policies of monetary destruction. Never, therefore, will we have seen the scale of global wealth destruction that we about to experience. Unless governments change their inflationary policies, they will lead to the miseries we read about in countries such as Venezuela and Zimbabwe being visited upon us all.

It is extraordinary that modern economists are blind to the true effects of inflation, which have been known since the dawn of money. Nicolas Oresme, a French bishop in the fourteenth century and a notable translator of Aristotle, warned of debasement:

“I am of the opinion that the main and final cause why the prince pretends to the power of altering the coinage is the profit or gain which he can get from it… the amount of the prince’s profit is necessarily that of the communities’ loss but whatever loss the prince inflicts on the community is injustice and the act of a tyrant and not of a king, as Aristotle says. And so, the Prince would be at length able to draw to himself almost all the money or riches of his subjects and reduce them to slavery and this would be tyrannical, indeed true and absolute tyranny as it is represented by philosophers, and in ancient history.”[ii]

As a description of inflation, it was a continuity statement of what was known from classical times. In Oresme’s day and before, the principal form of debasement was of the coinage. It is no different from issuing any form of money or credit unbacked by a valuable metal. Apart from alchemists dreaming of creating gold out of something else, the principal deniers of the true purpose of inflationism have been John Law in eighteenth century France, Geog Knapp and his chartalists in Bismarck’s Germany, and Lord Keynes the consequences from which we are suffering today. Oresme was spot on. The whole purpose of debasement is to fund the state, and the state licences banks for that purpose, extending monetary favours to big business as well. Forget the flummery about stimulating us; that amounts to a cover for statist robbery of our wealth.

The coronavirus is not the cause of this folly. It has only shortened timescales, the likely time before we discard fiat currencies entirely. It has brought forward the time when homo economicus anticipates the total loss of the government currency’s purchasing power. From that moment, those of us unwilling to descend into barter will seek a new medium of exchange. In desperation, governments are likely attempt to provide alternatives. If so, it almost certainly will be a variation on the fiat theme, which they find impossible to abandon for lack of finance. They will then discover that a lasting money is not to be chosen by the state, but by the people.

This has been the lesson of history. Those who think economics as a science started with Keynes, and preceding theories were thereby invalidated, are in for a primal shock. It is time to relearn the basics about money so that we can anticipate what form of money will endure as a replacement for the failure of government fiat currency.

Defining money

There are two incontrovertible facts that underlie economic analysis and the role of money. The first is that the division of labour is more productive than the work of isolated individuals. That is to say, individuals maximise their productivity by deploying their individual skills, relying on their enhanced output to acquire all their other needs and wants from other specialising producers in their community. Not even Marx denied this, nor all the other socialists who emerged on the economic and political scene from his time onwards. Only Keynes denied it in order to impart validity to his General Theory.[iii]

Socialist economists even agree with the second incontrovertible fact, that, ascetics aside, individuals prefer a higher productivity of their labour to a lower one. Socialist arguments were not against these facts but dispute which way of dividing labour is most productive. Marxists have argued that the division of labour should be harnessed for the benefit of the state, and that instead of being exploited by employers, labourers would become happier and more productive. Less extreme socialists simply believe that there is little or no difference of production output in a business controlled by the state, compared with one in private ownership.

It therefore follows that to facilitate the division of labour, the role of money is to facilitate an exchange of goods. It enables people to choose between goods and services, and therefore for people to exercise their judgement of the relative values they place on different goods. It enables them to choose.

Value is not to be confused with prices. Value is an expression of a graded preference between goods, the assessment of one against another. Money is the commodity whose sole function is to facilitate the transfer of production into needed and desired consumption in order to satisfy individual scales of value. The difference between value and its realisation as a price in a transaction devolves into subjective values placed by different individuals for goods and services being exchanged and into a common objective value for money.

Separately from money’s objective transactional value, transacting individuals have different values for money itself relative to a particular product within money’s objective context. In a transaction it follows that one party will value a given quantity of money more than the good at the point of exchange, while the other party will value the good more than the quantity of money demanded; otherwise an exchange cannot take place. The exchange is recorded as a price expressed in money terms.

This description crams into a few paragraphs the relationship between value and money. It is a topic rarely addressed by modern economists, which is one reason the catallactic role of money is poorly understood. A second, and no less important reason is the defining literature on the subject originated in Austria in German, with the unfamiliar names to the Anglo-Saxon ear of Menger, Böhm-Bawerk, Wieser and Mises amongst others. Instead, the neo-classical economics of today ignores all subjectivity and has evolved into an inflexible mathematical macroeconomic certainty, eliminating unpredictable human action, melding value with prices.

But from these basics all other roles of money are derived. Clearly, while one party wants the money more than the item being exchanged and the other prefers the item to the money, both parties in a transaction will require a medium of exchange that is stable. They can then agree an objective value at the time of the transaction. But when an individual or business sells his, her or its production, the money gained is not immediately exchanged for other goods. Money must therefore have more than an objective value at the time of a transaction, because it is also the temporary storage of labour or of a business’s output.

It is fundamental that all economic actors are confident that the purchasing power of money does not alter for the time they are likely to possess it in lieu of the goods and services yet to be acquired, else they will either dispose of the money more rapidly than they would otherwise, or alternatively hoard it to a greater extent than they would normally require. And when the division of labour is organised into a cooperative system, such as a business involving numbers of people, rewarding them for production by paying fixed salaries, it is a fundamental assumption of all employment contracts that the salary does not alter in its purchasing power.

The stability that qualifies money as the medium of exchange over time is also fundamental to related functions, such as the ability of transacting parties to agree deferred payment terms and the facility of money to permit adjustment for risk factors between a transaction and its final settlement. Other than deferred payments based purely on trust, deferred settlements will reflect a level of time preference agreed between acting parties. This is the measure of the difference between values of immediate possession and deferred possession for the period agreed.

The greatest value for transacting parties is for possession sooner, with future possession valued less. All commodities are subject to this rule. Furthermore, money’s time preference is also subject to this rule and will reflect money’s own characteristics as well as those of goods being exchanged.

Instead of being expressed as a discount to current possession, the time preference of future possession is expressed as an annualised interest rate. Assuming a current valuation of a future value, a time preference value of 95 per cent of current ownership in one year’s time is the same as an interest rate of

(100-95)/95 = 5.26%.

Time preference can only be agreed between transacting parties, and it is impossible for outsiders, such as the state, to know what that value is. With respect to money, this is commonly termed the originary rate of interest, shorn of other considerations, such as transactional risk and anticipated changes in the prices of future goods, which are additional factors.

It should be apparent that a medium of exchange discharges its functions most effectively when the transacting public has the greatest confidence in the money’s stability, leading to a relatively low level of time preference. Policies of state inflationism undermine this condition and, if continued, inevitably leads to the loss of confidence in fiat money altogether. Recent events, the combination of a downturn in the credit cycle and the economic consequences of the coronavirus, have committed central banks to an unlimited increase of monetary inflation, which in addition to the suppression of all time preference, by imposing zero and negative interest rates on economic actors, will bring forward the day when faith in fiat currencies is lost entirely.

We can therefore anticipate the death of today’s fiat currencies. It is a mistake to think it will be a gradual process: it has already been gradual since the late 1960s, when the remaining fig-leaf of gold convertibility was finally abandoned with the failure of the London gold pool. Since then, measured in gold the dollar has lost over 97% of its purchasing power compared with gold. Given this latest acceleration of monetary debasement, it is likely to be the nail in the coffin for the fiat dollar. Instead of a continuing decline, the outcome is likely to be a final collapse, not just through its over-issuance, but because fiat money will have lost all its derivative functions. The only thing missing is public awareness.

The end of fiat money can be defrayed by reverting to a gold standard, turning it from pure fiat to a representative of gold. But that will only be a lasting solution if the state stops intervening in the economy, runs balanced budgets and embraces free markets. Unfortunately, inflationism in the form of neo-Keynesian economics is so ingrained in political thinking that many central banks will look to invent new forms of fiat money instead of returning to a gold exchange standard.

One of the alternatives being experimented with is state-issued cryptocurrencies, but it is not yet clear what purpose they are intended to serve. Crucially, they are sure to differ from bitcoin and similar cryptocurrencies by having a centralised ledger under state control. Apart from the questions raised by wider uncertainties surrounding the durability of a cryptocurrency’s use-value, unless the state version is backed convincingly by gold, it will be no more than a dressed-up fiat currency, a successor to failure unlikely to obtain enduring public trust. For the moment, we must dismiss state issued cryptocurrencies as irrelevant to our analysis, because independent cryptocurrencies are better stores of value due to their distributed ledgers.

Gold as money

The inflationists deny that gold should play any monetary role, for the simple reason that it hampers inflationist policies. Being the most likely way of securing a currency, for a gold exchange standard to work will require strict rules-based monetary discipline.

A gold exchange standard is comprised of the following elements. The new issues of state denominated currency must be covered pro rata by additional physical gold, and it must be fully interchangeable at the public’s option. The state is not required at the outset to cover every existing banknote in circulation, but depending on the situation, perhaps a minimum of one-third of the issue should be covered by physical gold at the outset when setting a fixed conversion ratio. The point is that further note issues must be covered by the issuer acquiring physical gold.

Banknotes which are “as good as gold” are a practical means of using gold as the medium of exchange. Electronic money, being fully convertible into bank notes must also be convertible into gold.

A gold exchange standard also requires the state to radically alter course from its customary inflationary financing. The economy, which has similarly become accustomed to future flows of apparently free money, will have to adjust to their future absence. Consequently, the state has to reduce its burden on the economy, such that its activities become a minimal part of the whole; the smaller the better. It must privatise industries in its possession, because it cannot afford to absorb any losses and inefficient state businesses detract from overall economic performance. At the same time, the state must not hamper wealth creation and accumulation by producers and savers as the means to provide investment in production. Government policy must be to stop all socialism, allowing charities to fulfil the role of welfare provision, and let free markets have full rein.

Broadly, this was how British government policy developed following the Napoleonic wars until the First World War, and the proof of its success was Britain’s commercial and technological development, entirely due to free markets. But the British made one important mistake, and that was in the Bank Charter Act of 1844, which in England and Wales permitted the expansion of unbacked bank credit. For this reason, a cycle of credit expansion developed, punctuated by sharp contractions, the boom and bust that led to a series of banking crises. A future gold exchange standard must address this issue, by separating deposit-taking into a custodial role and the financing of investment into an agency function.

It is a common error of neo-Keynesian economists to believe gold is an unsuitable medium for financing modern trade and investment, because, it is often alleged, it lacks an interest rate. Since interest rates existed throughout gold standards, the confusion arises from assuming an interest rate attaches to paper currency. But if a paper currency is fully convertible into gold, then interest rates are effectively for borrowing and lending gold, and do not apply to the currency. The best measure of what savers may gain by lending their gold savings risk-free is the yield on government debt, repayable in gold and realisable in the market at any time. This is illustrated in Figure 1.

GOLDMONEY 460

Shortly after the introduction of the gold sovereign in 1817, the yield on undated government debt gradually fell to 2.3% in 1898. This reflected a natural decline in time preference as free markets delivered increasing benefits and accumulating wealth for the British population. Following the gold discoveries in South Africa, between the early-1880s and the First World War global above-ground stocks of gold doubled, and the inflationary effects led to a rise in government Consols yields to 3.4%.

The encouragement to investors to provide financial capital for investment in industry and technology was two-fold. A family’s investment in 1824 rose in value due to the long-term fall in Consols yields. By 1898, invested in Consols it would have appreciated by 65%. At the same time, the rise in the purchasing power of gold-backed sterling increased approximately 20%. Saving and family inheritance were rewarded.[iv]

Importantly, above ground gold stocks have grown at approximately the rate of that of the global population, imparting a long-term stability to prices in gold. For this reason, it is often said that measured in gold the cost of a Roman toga is not much different from that of a modern lounge suit. Other money-related benefits of gold and gold exchange standards compared with those of pure fiat also follow from this stability.

Between countries that use gold and gold substitutes as money, except for short-term settlement differences covered by trade finance, balance of payments imbalances only existed to adjust price levels between different nations. If a country exports more goods and services than it imports, it imports gold or gold substitutes on a net basis. The increased quantity of gold in that country tends to adjust the general level of prices upwards to the general level of prices in countries that are net importers of goods and services, which find the outflow of gold has moved their prices correspondingly lower. The ability to issue unbacked currency has been removed, so net balance of payment flows become a pure price arbitrage. This is in accordance with classical economic theory and has its remnants today in concepts such as purchasing power parity.

In summary, gold retains the qualities that ensure it will always be the commodity selected by people to act as their medium of exchange. It offers long term price stability and is the ultimate fiscal and monetary discipline on governments, forcing them to reduce socialist ambitions, to accept the primacy of free markets, and to permit acting individuals to earn and accumulate wealth. Being fully fungible, gold is suitable backing for substitute coins and banknotes. It is an efficient medium for providing savings for the purpose of capital investment. And the tendency for prices measured in gold to fall over time driven by natural competition and technology ensures a low and stable originary rate of interest.

Bitcoin and similar distributed ledger cryptocurrencies

Now that we have defined money and identified why fiat currency is on an accelerating path to failure, we must look at the much-mooted alternative to gold of cryptocurrencies, the most notable of which is bitcoin. For simplicity we shall comment on bitcoin only.

The principal characteristics of bitcoin are its pre-programmed limited and capped rate of issue, and its distributed ledger otherwise known as the blockchain. The former distinguishes it from fiat currencies, which as we have seen are beginning their final inflation run, and the latter ensures governments cannot gain control or otherwise interfere with it.

While governments can confiscate their citizens’ profits, close down cryptocurrency exchanges and direct their licenced banks not to accept or make payments in connection with cryptocurrencies, they have yet to do so. So far, when authorities have intervened, the reasons given have been to tackle fraud, real and imagined, and alleged money-laundering. For governments to shut cryptocurrencies down would probably require international cooperation by all governments to deny the right to own cryptocurrencies. An agreement on these lines would be almost impossible to achieve and would take many years of intergovernmental negotiation, given the violation of property rights involved and the precedents created. Due to the accelerated timescale of the demise of fiat currencies, intervention of this sort seems unlikely.

Bitcoin will therefore survive government intervention to become a possible replacement for fiat currencies. But there is the practical problem of exchange being broadly limited by users looking for investment and speculation, rather than being used as payment for goods. This is for good reason: in any transaction an acting man will want all the price subjectivity to be reflected in the goods being exchanged and objective values to be confined to the currency. Currently, bitcoin’s volatility is extreme as shown in Figure 2, which compares bitcoin priced in gold ounces with gold priced in dollars.

GOLDMONEY 462

Gold’s volatility against the dollar approximates to the volatility of any another currency, and its upward trend principally reflects the declining purchasing power of the dollar. Even priced in gold ounces, bitcoin’s volatility has been dramatic, too dramatic to act as the objective value in an exchange for goods.

Unless bitcoin’s volatility subsides sufficiently so that it becomes widely accepted as a medium of exchange, it cannot act as efficient money in the catallactic sense. Furthermore, the blockchain system is too cumbersome for a global medium of exchange, currently limited to about half a million transactions daily when trillions are required.

While accepting that bitcoin’s other monetary features have yet to be developed, volatility would also appear to rule out agreements between lender and borrower on the value of time preference as the basis of using it for deferred settlement. For now, bitcoin appears to be good for buying with a view to selling in return for another form of money, rather than acting as money itself. Undoubtedly, owners of bitcoin, or hodlers as the slang term puts it, are valuing them in dollars, and thinking of taking profits in dollars. It appears that hodlers are speculating on bitcoin’s rise, rather than the dollar’s fall, though that will change as the general public begin to ditch their fiat currencies.

When hodlers finally understand this distinction, in the absence of fiat money and using bitcoin for day-to-day exchanges for goods, what will they sell them for? If we rule out purchases of other cryptocurrencies, the answer can only be for metallic money, gold, or properly constituted gold substitutes.

While we can draw attention to a cryptocurrency’s lack of monetary characteristics, it does not mean we can dismiss them as being merely speculative counters. Circumstances change, and it is likely that when the general public finally understands that fiat currencies are worthless, it will look for alternative stores of wealth. Bitcoin enthusiasts are among the first to understand the benefits of hoarding wealth against failing fiat currencies. Furthermore, technological innovation could provide solutions to bitcoin’s lack of transactional scalability.

Central banks are also running cryptocurrency and blockchain projects, so far with little apparent sense of direction beyond trying to keep abreast of developments. The most advanced state appears to be China, which is trialling a digital version of the yuan. But far from having the characteristics of a cryptocurrency, any version of the yuan digitised or not is, for the moment at least, just a fiat currency.

In the final analysis, whether bitcoin becomes money is down to what the transacting public decides. But for now, it remains a hedge to fiat currency risk, with the potential for the price to rise, not just reflecting the demise of the dollar and other fiat currencies but rising in its own right. The market for bitcoin is potentially huge, far larger than the feed into any speculative bubble in history, with billions of people possessing mobile phones capable of acquiring them.

Concluding remarks

The inflationists, encompassing the entire financial establishment and their epigones, fail to see the ending of fiat currencies. But a rational and objective analysis coupled with empirical evidence tells us that the sudden and rapid escalation of monetary expansion, aimed to ensure financial assets do not fail, will lead to the destruction of the dollar as the world’s principal medium of exchange. And with the reserve currency gone, it is very unlikely the other major fiat currencies will survive.

The question then arises as to what will replace fiat currencies. Government attempts to extend the life of fiat money by issuing new versions imitating cryptocurrencies will fail, only likely to extend the life of fiat by a matter of months, if at all. Existing cryptocurrencies, even the best of them, are not currently suitable replacements due to their lack of scalability and volatility. Furthermore, for now bitcoin is the preserve of investors and speculators, taking a punt on the demise of fiat, without an exit plan other than to measure or take profits in a fiat currency.

The same accusation can be levelled at gold, which is probably even less used in transactions for goods than bitcoin. But gold has the advantage of a track record of always returning as the money of public choice after fiat fails. Together with its suitability for deferred settlements, we can therefore be certain that gold will be money once again, while we cannot be so certain of the future for cryptocurrencies.

This is not to say that cryptocurrencies will not afford protection for individuals as fiat fails, only that an exit route has yet to evolve, other than being spent as money. Consequently, cryptocurrencies might retain investment or speculative value, but it will end up being measured in gold. That being the case, the reasons for using cryptocurrencies as an escape from failing fiat will disappear when gold becomes money again, along with a future role for cryptocurrencies as mediums of exchange.

Perfect Storm for Gold

by Alan Currie

Bank of International Settlements ( The central Bank of central Banks) report recently said this:

“A 0% risk weight will apply to (i) cash owned and held at the bank or in transit; and (ii) gold bullion held at the bank or held in another bank on an allocated basis, to the extent the gold bullion assets are backed by gold bullion liabilities. ” BIS on Basel III

Previously Gold Bullion had a 50% risk weighting meaning if a bank held 100 million dollars in Gold Bullion in their vault they could only show $50 million in gold assets on their balance sheet.

This will now encourage banks and central banks to own and store much more gold bullion. The Perth mint reported recently that they have seen a doubling of central bank purchasing last year from their supplies.

There is an accepted practice that investors should have about 5-10% of their investment portfolio in precious metals like gold and silver. But recently Silver Doctors podcast it was reported by  Jeffrey Christian and the CPM Group that number is quite higher.

In late 2016, Jeff and his firm re-ran those numbers in a backtest from about 1968 to late 2016. What they found was if you took a portfolio of 50% S&P and 50% T-bills and you added gold to it in 5% increments, the optimal gold allocation was actually about 27% to 30% gold depending on whether you used T-bills or T-bonds respectively.

On that same podcast it was reported by Jeff that gold producers are now holding back on about 20% of their annual production in order to start storing the bullion they mine in anticipation that the pricing will go up.

In Australia Gold has gone up on average over 20-30 years about 10% per year. The moment Gold passes $1360 USD then it will have broken a very important trading trend line and most are expecting Gold to enter another long term upward trend.

Further Gold research check out
https://www.youtube.com/channel/UCom1i7_NVeSUNyJyuR_NbMQ

CPM Group is a commodities research

Forbes report on Central Bank buying

Gold and Silver price manipulation has now been proven!

This was a FBI investigation! CNBC says “13-year J.P. Morgan veteran, said that he learned how to manipulate prices from more senior traders and that his supervisors at the firm knew of his actions”

“As part of his plea, Edmonds admitted that from approximately 2009 through 2015, he conspired with other precious metals traders at the Bank to manipulate the markets for gold, silver, platinum and palladium futures contracts traded on the New York Mercantile Exchange Inc. (NYMEX) and Commodity Exchange Inc. (COMEX), which are commodities exchanges operated by CME Group Inc.”

Check out these reports

Justice Department Press Release

JP Morgan Manipulation CNBC report

 

Fiat Currency System

100Trillion Dollars

Do you know what Fiat Currency is? You used it every day!

The technical definition is “paper that the government has declared to be legal tender that is NOT not backed by a physical commodity” ie Gold.

This paper (or in the case of Australian money its polypropylene polymer) that we all use- as if it has intrinsic value, (which it doesn’t) it only has value because other people will exchange it for a commodity or service of REAL value like food, petrol, air plane ticket, pay taxes and bills. It only has value while we have confidence that others will accept it as payment for what we really want and use.

There is about 167 official national currencies circulating around the world, even though there is 196 countries in the world – 19 counties use other nations currencies.

No one really knows how much of this “Paper” currency is floating around the world but in 2010 it was thought to be close to $55 Trillion US dollars – ($13 Trillion was in USD currency as at June 2013)

According to a study of 775 fiat currencies by DollarDaze.org, there is no historical precedence for a fiat currency succeeding. Twenty percent failed through hyperinflation, 21% were destroyed by war, 12% destroyed by independence, 24% were monetarily reformed, and 23% are still in circulation approaching one of the other outcomes.

Founded in 1694, the British Pound Sterling is the oldest fiat currency in existence. At a ripe old age of 321 years it must be considered a highly successful fiat currency. However the only reason why it has existed so long is because it was often pegged and exchangeable for gold and silver. A British pound coin was originally weighed as one troy pound of sterling silver! This is why it is still called Pound Sterling – but there is nothing sterling about it now, because in March 2015 it will cost you 164 pounds to buy 1 pound of silver!

So now it’s worth is less than 1/164 or 1.6% of its original value. Therefore the most successful long standing currency in existence has lost 98.4% of its value.

US Gold Backing

Only 56 years ago in 1971 the US dollar was fully exchangeable for Gold Bullion, which was the requirement of the agreement made at Bretton Woods during the post 2ww global financial reconstruction. In 1971 it cost $1.8 USD to buy 1 ounce of silver and $ 40 USD to buy 1 ounce of gold. In March 2015 it costs $1289 USD to buy 1 ounce of Gold and $17 USD to buy an ounce of silver.

What happened in 1971 – every economics follower would tell you it was the year Nixon took the US Dollar totally off the gold standard and refused to honor the agreement to redeem US dollars for gold. That was the beginning of a massive growth in inflation, the sign the US and the west was beginning a steady decline in living standards and purchasing power.

Today there is about 120,000-140,000 metric tons of gold above ground in the world and about 2270 tons of gold is mined out of the ground each year. Interesting China No 1 and Australia No 2 are the two top gold producers today.

The US Gold Reserve is supposed to be just over 8,000 tonnes – which is about 6% of the total gold ever mined. It is worth about $200 billion, or 1.8% of the US national debt. Total US Debt (State and Federal) by end of 2015 is expected to grow to appox $22 Trillion.

Conclusion

This means that roughly 4.46% of US dollars in circulation are ‘backed’ by gold, the rest backed by false promises and goodwill.

Simply put, the price of gold would have to rise 20-25 times in order for the US and British governments’ gold assets to match the supply of money in circulation.

History has a message for us: No fiat currency has lasted forever. Eventually, they all fail.