Part XII of the Bitgenstein Serialization

picture by Wikilmages, via Pixabay

“An amount of money lent to a government, and the interest amount charged, is assumed to be risk-free because it is in turn assumed that a government can tax, borrow, or print further amounts of money to pay its debt. These three options are indeed available to a modern government, but one must not ignore the fact that the government has no access to risk-free rates of return when investing the borrowed money. The above mentioned options are in fact nothing more than means of passing on the bill to others when the fact of a non-risk-free physical system eventually reasserts itself.”

- Tarek El Diwany

To date, it has been very difficult to conceptualize what value, exactly, has peacefully opted out of fiat and into Bitcoin. Pricing only happens at the margin, and marginal fiat exchanged for bitcoin is just a bank liability that the bank relabels. Bitcoin exchanged at the margin likely engenders lower time preference, as discussed above, hence lower consumption of garbage, but which is conceivable only counterfactually.

This will change when people start selling not just their fiat, and not just their time, but when they start liquidating real assets. Gold will probably be the first victim, for readily understandable reasons as Bitcoin is an upgrade in almost every respect. But gold is not systemically important. This shift will be noticeable but not otherwise impactful. When the accumulation drive hits short-term credit, real estate, and passive equity, that is when the party will really start.

These three are artificially large asset classes given they are de jure productive, hence cash generative and priced on yield, yet de facto speculative savings instruments given long-term saving with fiat is impossible. But more vitally still, they are systemically important. Their prices, in aggregate, affect capital formation. The TLDR of Part Two, The Capital Strip Mine, is that these prices are wrong, and hence the capital is being strip-mined as quickly as it is being formed. Reversing this is the long-term hope, but anticipating the short-term mechanics of this reversal is another matter entirely.

The key insight is that if these assets were actually priced on yield, the kind of flows I anticipate would have no impact on long-term holders beyond minor disappointment. But because they are not, any substantial outflow can easily become a self-fulfilling prophecy. Corporations use short-term credit as ersatz cash with an inflation-hedging yield, however minuscule these days. But this is not an “investment”. There is no upside, but just-sure-enough downside protection. If the downside protection disappears then the entire proposition evaporates — and note this could easily happen without substantial selling but simply a neglect to continue buying, given the whole point of short-term credit is that it continuously rolls over. What would likely happen next is central banks stepping in to “support” these markets with asset purchases, which, of course, is the best imaginable endorsement of Bitcoin’s utility.

Behind all of this is the seemingly straightforward question of bitcoin’s “fair value”. There will always be a hesitancy to shift savings from something as well understood and naturally priced as short-term credit to bitcoin on the basis of being entirely unsure of how to compare bitcoin’s price to its “fundamentals”. What will gradually be realized is that, with Bitcoin, the traditional relationship is inverted. I do not think it is quite accurate to say that bitcoin’s price is its fundamentals, but certainly its price is a largely reflexive function of its fundamentals: as the price goes up, the fundamentals go up (and we must be mindful also that as the price goes down, the fundamentals go down. Sustained attack that drives the price down for long enough is by far the biggest risk). Bitcoin was weakest when smallest, but less so the more time passes. Bitcoin is a black hole sucking unsustainably artificial value beyond its event horizon. As it grows, so does its pull. Bitcoin is gravity.

The “store of value realization” argument for its gravitational pull is by far the most obvious, the least creative, and is only scratching the surface of its likely continued evolution. Consider the implications of deepening liquidity, which, note, is subtly different from “price” alone. This is a necessary precondition for increasingly large purchases in the first place. MicroStrategy could not have done what it did a year earlier. Apple and Berkshire (dare I say?) still cannot do what they likely one day will.

But market deepening has far more interesting implications. It enables Strike, for example, Zap’s soon-to-be-widely-copied, soon-to-be annihilation of FX markets:

Strike combines ever-tightening spreads on fiat liquidity pools with Lightning’s instant settlement and relative programmability to offer unmatchable FX transfers. There are several astonishing features here that it is worth making absolutely sure we understand.

First, this service cannot be matched within the fiat settlement infrastructure. I don’t mean that it is difficult; I mean that it is impossible. Interbank payments with the same currency and within the same jurisdiction can be more or less free and instant, and in many places are, since all this amounts to is relabelling a bank liability or, at worst, a net flow between mutual counterparty banks that can be batched and properly settled at enormous scale, hence offered to the end-users at low or zero cost. But across currencies, jurisdictions, or both, this is impossible — fundamentally because fiat is a debt instrument. What we might think of as a simple “payment” in this context is really more like a credit relay. Each party needs to trust the next party in the chain, and price not only the operational expense but this perceived risk, before passing it on, given the actual claim will be settled much, much later. And payment streaming? Fuhgeddaboudit. Not in your wildest dreams. With Strike, none of this is relevant. Lightning has no lower bound on value and settles instantly, and that’s the end of that.

This service does not expose the user to the price of bitcoin at all. And yet, the fact of its existence and usage deepens the markets, which directly contributes to bitcoin’s fundamentals, hence price, increasing. And if heavy users of this system one day decide they’d prefer to keep the transfers they receive in sound, open-source, programmable money, well, that makes the process even simpler still …

It doesn’t even end there. The Lightning infrastructure is still young and small and it needs staked value to grow. What better way to put bitcoin-denominated capital to work than seeking a return on competitive liquidity and routing? As bitcoin’s fiat value grows, so do the incentives to contribute to scaling Lightning, which increases the efficiency of fiat payments routed via Strike-and-others over Lightning, which increases the depth of the fiat markets for bitcoin. And the more Lightning scales, the more the prospect of payment streaming opens up opportunities for better funding decentralized infrastructure — for example, incentivizing running Tor exit nodes, the storage and routing building blocks sought by the likes of Sci-Hub, accessible and portable economies in gaming, off-platform content monetization and advertising-free content-driven apps, but also things literally nobody has yet imagined. All of which increases Lightning’s utility, which increases Bitcoin’s utility. The more falls into this orbit, the bigger the orbit gets. The Jevons paradox in the metaverse!

Deeper markets also indirectly legitimize lending fiat against bitcoin reserves. While nominally tailored to allowing synthetic institutional leverage, normalizing this service will reduce the incentive for anybody to ever sell, in inverse proportion to how widely accepted bitcoin is for regular payments at a given time. It will be Pierre Rochard’s speculative attack, but without even requiring awareness or intention. It will just be the sensible thing to do. If or when miners are able to access this service to pay for electricity, even partially, marginal supply will evaporate. It will also make increasingly viable credit card rewards programs, salary allocations, and, once again, things literally nobody has yet imagined, which might read as negligible in nominal terms, but are more about buying mindshare than fiat. Small buys lead to big buys.

Properly sophisticated, grown-up, Ivy League MBA, CFA-accredited readers might liken this entire line of reasoning, and my enthusiasm for it, to GameStop, the finance hilarity du jour, in the sense of uppity retail thinking they are sticking it to the man but really just blowing their savings on a practical joke from which Citadel will be the ultimate winner (not my reading, to be clear, but a common one. Mine is that these people knew exactly what they were doing and that you can prove it if you are willing to just look). I would encourage such readers to think more seriously about the game theory involved in all of this, particularly if gold and then short-term government credit fall into Bitcoin’s orbit.

You might think this leads precisely nowhere at all, but the central banks of Venezuela, Iran, North Korea, and Singapore would disagree with you, that we know of so far. Central bank accumulation will become the defining macroeconomic issue of the decade, and advocacy for accumulation by the tech-savvy one of the defining political issues. Entirely mobile, unseizable capital will be attracted to, and will compound physically, wherever it is most welcomed, as will the human capital that likely comes with it. Countries with geopolitical rivals who decide to ban Bitcoin will be cutting off their nose to spite their face. When China starts to pay Russia for natural gas first in dollar stablecoins on Bitcoin, then in bitcoin, don’t say I didn’t tell you to think about it a little more than not at all.

Come to think of it, even GameStop can be non-ironically tied to this discussion. It has turned out a decent amount of faux-populist rancor was misplaced and the real culprit for screwing the little guy wasn’t shady backroom deals between Citadel, Sequoia, the SEC, and the Fed, but rather the limitations of equity clearing and settlement given the mechanics of counterparty risk. Try to imagine, if only for a moment, tokenized equity certificates pegged to a secure digital bearer asset, with no counterparties, that settle in T+right now. Can you imagine that? Citadel might be the short-term winner in all this, but the long term is all about tokenized equity on sidechains.

continue to Part XIII:

or go back to Part XI:

n.b. This is a serialization of my previous trilogy on Bitcoin, economics, and capital markets: Wittgenstein’s Money, The Capital Strip Mine, and, Bitcoin is Venice.

follow me on Twitter @allenf32

maybe a squirrel. maybe not. views my own, not my employer’s.