05 - But... why?
During the past few newsletters, we’ve discussed the foundational principles of blockchains and digital assets. What we haven’t discussed is why blockchain technology was created in the first place. For a system like the Island of Yap’s to work in today’s world, you need buy-in from thousands of people. They need to invest time and resources for ongoing support of the network. So why are people willing to do this? In a word: money.
A Brief History of Money
Money was first created in Ancient Mesopotamia (as far as we know), five thousand years ago. Money consisted of clay tablets that entitled the bearer to specific amounts of barley upon harvest time. During the reign of the Roman Empire, money was gold,silver and bronze coins, bearing the head of the current emperor. In the East, all sorts of collectibles could be accepted as money. Shops in China issued private notes that would serve as deposit receipts, resembling the modern day equivalent of banknotes, that could later be exchanged for whatever was deposited.
For most modern civilizations, money was a paper note that was issued by an authoritative body (king or government); and it represented some form of scarce resource. The money was to purchase goods and services, but it could also be exchanged with the king or government for an item of limited supply (gold, silver, barley) and with tangible value. The idea that money was “backed” by something with a limited supply was important because it acted as a control on the creation of the paper. A government could only increase the money supply by acquiring more of that item.
The Alpha and the Omega of Money
Fast forward to the age of the United States world dominance. For anyone who’s not a finance nerd, the US dollar is the backbone of the world economy. Countries the world over issue debt in US dollars, hold US dollars in their central banks; and much of the world's trade is denominated in US dollars. US dollar dominance is nothing new and dates back to the end of World War II.
The year was 1944, and the war-torn world met in Brenton Woods, New Hampshire to decide how they were going to re-stabilize their respective economies.The US, which was the least impacted (and most respected country) after the war, suggested that every other country in the world back their currency with United States dollars. Every country would be allowed to exchange dollars for gold at a stable price of $35 dollars per ounce. The other countries, without having too much of a choice, agreed. Over the next 27 years, this system remained in place and worked somewhat effectively.
During the 50’s and 60’s however, the US got a bit too assertive in eastern Asia, spending billions of dollars to exert influence in Korea and Vietnam. These wars were expensive, and to finance them, the US government began to print money. Over time, the world began to speculate that the US had over extended itself and was not able to maintain the $35 exchange that was the backbone of this system. If every country began to redeem US dollars for gold, then the US would be in trouble. Foreign countries began to get spooked, but before there could be a true run on the US Federal Reserve, President Richard Nixon announced that the dollar would no longer be backed by gold.
What good old Richard did was remove checks and balances from the dollar. The US government was now free to print dollars at will and without constraint. Today, money backed only by the word of the government issuing it is called “fiat money.” If you spend any amount of time in the blockchain space, you will eventually come across this term. At the time, President Nixon marketed this shift as a good thing, saying that it would prevent “international money speculators “ gaining from and even encouraging economic crises. Ironically, an untethered dollar would play a role in many financial crises to come, including the 2008 crisis that would serve as the catalyst for another change.
A Catalyst for Change
At the height of the 2008 crisis, when the US government was printing money like it was going out of style, a disgusted and anonymous person or persons published a post on a cryptography blog that outlined a peer to peer payments network that could serve as a direct competitor to the traditional financial system. The person(s) who published this post referred to themselves as “Satoshi Nakamoto” and to this day nobody knows who they were.
What this payment network would track was a scarce resource called bitcoin. What makes bitcoin somewhat confusing is that the network/blockchain (the ledger system) and the value that is being tracked on the network/blockchain (the stones) are both called “bitcoin.” Capital “B” Bitcoin refers to the network, and lower case “b” refers to the value being tracked on it. Other networks have solved this problem by separating the name of the network from the value it tracks.
Taking a step back and speaking at a very high level, money printing the way the US has in recent decades is bad because it lowers the purchasing power of the dollar. Purchasing power is the concept of “what can my money buy me?” If a cup of coffee costs $1 today and then $2 tomorrow, my money has lost purchasing power. I cannot buy the same amount of coffee today as I could yesterday. $1 now only buys me half a cup of coffee.
Supply and demand dictate that the more of something there is, the less value it has. The same concept applies to money–the more that is printed, the less valuable those dollars are. If coffee still has the same value but dollars have less value, then it is going to cost more dollars to buy the same cup of coffee.
The supply of money matters because the majority of the world earns money from a salary. Salary income is not adjusted for the change in supply of money, so as more money gets printed, the less valuable a salary becomes. A person earning $75,000 salary will only be able to maintain their lifestyle (buying groceries, gas, and other necessities) if they get a raise that at least equals the percent increase in the money supply. Since the US dollar backs the entire world's financial system, the printing of dollars means that the ability for the average person anywhere in the world to exist, let alone build wealth, is greatly hindered.
The purpose of Bitcoin was really to provide people another option. The excessive printing of money was bound to cause massive inflation, devaluing people's wealth, and demoralizing civilization. Satoshi’s goal was to create a system with set rules that served as another option. That system is a blockchain. Blockchain technology was created to solve the problem of poor financial management. Blockchains were created FOR bitcoin. The rules encoded in the Bitcoin Blockchain limits the amount of bitcoin that can be created. Just like a dollar issued against gold, there is again a limitation on the creation of money.
The original disciples of bitcoin were drawn to it for philosophical reasons which are still at the heart of Bitcoin today. No one knows if Satoshi is alive or is even a single person. It's safe to say that regardless, he/she/they would be appalled at the money printing response to the COVID-19 virus. The future is uncertain, and there are many answers to the question of how to stop your wealth from evaporating. Bitcoin acts as a very good one.
Huge shout out to my collaborators from Foster: Phil Hendricks, David Burt, Christine Cauthen