Translation | How did Bitcoin’s status as a store of value become a consensus?

When the market forms a consensus that "Bitcoin is a store of value", the market demand for Bitcoin will increase, and it will eventually naturally become a medium of exchange.

Original author: Fernando Ulrich | Austrian economist, Brazilian cryptocurrency expert

Authorized translation: Carrie | Chain Hill Capital

Original title: How Bitcoin attains the status of a good store of value

Original link: https://medium.com/@Ulrich_98986/how-bitcoin-attains-the-status-of-a-good-store-of-value-6b812395713c

This article was translated and reprinted by Chain Hill Capital with the authorization of Fernando Ulrich. Reprinting without authorization is strictly prohibited. The following is the translation:

Will Bitcoin become digital gold?

This is the third of five articles in a series.

For Bitcoin to be considered a good store of value , the market must understand and trust the soundness and robustness of the value proposition established by the core properties and rules of its protocol. The immutability of Bitcoin’s monetary policy (i.e., the hard cap of 21 million or 2.1 trillion satoshis), the highest level (and paranoid) of security, and decentralization are all classic examples of its protocol rules that reinforce each other.

Reliable protocol development means strict adherence to rules to protect these core properties. Developers, including core maintainers and other contributors, are part of this process and leaders in technical implementation. However, developers cannot and should not decide the future of the protocol alone, as users must also play an important role in shaping and strengthening this ethos.

Strict compliance with the rules requires Bitcoin nodes to be independent, decentralized, self-verifying, and enforcing the rules, which can only be guaranteed in the long term if the cost of running a full node remains moderate. Excessive operating costs will undermine the ability of nodes to self-verify and enforce the rules, thereby undermining the principles of decentralization and strict compliance with the rules.

Reliable protocol development also implies conservatism, including advocacy for backward compatibility and defense of the status quo (i.e., maintaining the status quo in the face of controversial changes or improvements). This philosophy was championed by Satoshi Nakamoto, who wrote that “the nature of Bitcoin is that once version 0.1 is released, its core design will not change for the rest of its life.” This assertion is significant and consistent with the premise that Bitcoin is primarily a store of value or digital gold.

For Bitcoin to become a recognized store of value , its core properties must become unwavering and immutable laws , especially its supply schedule and issuance cap properties. This is similar to the laws that protect the supply and irreproducibility of gold. Because if alchemists discovered a way to replicate gold and destroy its natural scarcity, then the demand for gold as a store of value would collapse and its status as a safe haven asset would be destroyed.

The Alchemist in Search of the Philosopher's Stone (painting by Joseph Wright, 1771)

When it comes to gold, it is worth pondering why it has withstood the test of time for thousands of years in a wide variety of societies, and why, to this day, central banks around the world still hold a large portion of their reserve assets in gold, but there is no currency in the world that is backed by or redeemable for gold?

This is not because gold has lower narrow transaction costs than most media of exchange, nor because it has unrivalled transaction capabilities. Therefore, it is definitely not because it is the best medium for facilitating actual transactions.

No one is better qualified to answer this question than the central banks themselves. According to a recent survey by the BullionStar blog:

In their own words, there are many reasons why central banks hold large amounts of gold. However, there is a common thread in the central banks’ answers. Many respondents mentioned the ability of gold to be called upon in a crisis, such as: “Gold reserves can be activated in an emergency”, gold is an “emergency reserve in a crisis”, “a contingency against unforeseen events”, a form of “insurance”, or as the Bank of England put it, a “war fund” and “the ultimate asset to have in an emergency”. Therefore, almost all central banks refer to gold as a safe haven asset. In addition, many central banks mentioned the high liquidity of gold, and some mentioned the ability to use gold to obtain foreign currency liquidity, and even the possibility of foreign exchange intervention through gold. Many central banks’ answers mentioned the role of gold as a hedge against inflation, which explains why central banks regard the gold price as a barometer of inflation expectations. Many banks also pointed out that due to the unique properties of physical gold, such as limited supply and mining, gold does not have any counterparty risk or credit risk, and, since it is not issued by the government, it has no default risk.

In summary, central banks around the world hold gold because it is a recognized store of value. All of gold’s other properties derive from this foundation.

Historically, gold has been in demand by individuals and businesses because it is a superior store of value and its scarcity cannot be manipulated. As liquidity increased, gold gradually transformed into a spontaneous medium of exchange until it achieved unparalleled liquidity and became a unit of account. However, because it was "designed to not scale," many ways to use it to pay were created without moving gold. Banks, banknotes (the forerunner of modern paper money), certificates of deposit, and payment networks based on the banking system are all examples of transactions (off-chain) without physically handling the underlying currency (on-chain).

As a result, gold has been the de facto monetary standard at many different times in history, again not because of its lower transaction costs in the narrow sense, but because of its natural scarcity and unforgeable production costs.

Only if Bitcoin has the same rigidity as gold can it achieve and maintain its status as a premium store of value, which requires that its fundamental protocol properties are as stable as gold. This may mean that the protocol eventually becomes "ossified", i.e., does not make non-backwards-compatible changes; this requires Bitcoin to avoid hard forks except in critical or fatal emergencies. Based on the belief that Bitcoin's core role is a store of value, being able to stand firm in the face of controversial change proposals is itself an improvement.

Bad Money Drives Out Good Money and Bitcoin HODLers (“Holders”)

When people can choose to pay with good or bad money, they will always choose the bad money and hoard the good money. In other words, spend the overvalued money while holding the undervalued money. This idea is the essence of the famous Gresham's Law, which states that "bad money drives out good money." However, this phenomenon can only occur when the exchange rate between currencies is artificially fixed by law, which has historically happened with gold and silver.

As economist Friedrich A. Hayek pointed out, when buyers can (unilaterally) choose to pay with good or bad money, they will undoubtedly choose the bad money and keep the good money for other purposes. However, when the exchange rate between currencies is determined freely by the market , that is, when there is free competition between currencies, Groshen's law does not apply .

As a HODLer, I admit that paying with Bitcoin is exciting, but it doesn't make much economic sense at this point. (By the way, I tend to use more Bitcoin when the price goes up, which contradicts the predictions of mainstream economists, but that's another topic). Why would I give up an excellent store of value (according to my subjective assessment) if I can pay with a depreciating local fiat currency? Why would anyone pay with an asset that is appreciating (or has good prospects for doing so) instead of an inflationary fiat currency?

Economists who suffer from “deflation phobia” will immediately respond that a deflationary currency will never succeed because no one will pay with it. However, this answer sidesteps a crucial aspect of voluntary transactions: the choice of currency is not a unilateral decision. Unless you live in a country where fiat currency is mandatory (for example , in my home country of Brazil, it is illegal to refuse payment in local currency), good money tends to drive out bad money because the seller has a say in economic transactions. Therefore, the seller can rightfully refuse payment in bad currency or insist on payment in good currency. In countries with a history of currency crises, citizens have historically turned to the US dollar, especially in large transactions such as real estate transactions. In these cases, the seller will demand payment in US dollars and will not accept other methods (if you don’t believe me, try buying a property in Uruguay with pesos).

The same economic reasoning applies to Bitcoin HODLers. Today, if the seller has no preference, I will not give up my Bitcoin and will pay him in local fiat. However, if there is growing awareness that Bitcoin is a good store of value (good money), then I will have to give up my Bitcoin because the seller is not willing to accept a depreciating currency. In this sense, I think what we need to see is merchants themselves wanting to receive Bitcoin payments, not just finding ways to get them to accept Bitcoin they have no intention of holding.

Those who continually urge the use of Bitcoin payments today do not seem to understand sound money, fiat currency, or Graham’s Law.