The oxymoron of “digital scarcity”. When proponents tout the properties of “scarcity” in Bitcoin – a digital currency – it is often met with valid skepticism. Digitalisation practically brought the marginal cost of producing virtual goods and services to zero; there is no cost to duplicate a pdf or copy an image. As such, digitalisation is often associated more with abundance than scarcity. The appearance of digital currency, similarly, gave governments near infinite margins on seigniorage (the difference between the face value of currency and their cost of production); where it once cost governments energy and material expenses to mint paper bills or coins, it now costs nothing to change digits on a smartphone. Why would digits denominated in Bitcoin be any different?
Below, we shed light on three ways that the Bitcoin network replicates physical scarcity in the digital realm.
1. Decentralisation – Money in the hands of people, not institutionsStick it to the man. Decentralisation in monetary terms simply means that control over monetary policy and design is taken out of the hands of a single authority and transferred to the hands of the users of said money. Centralisation is typically not a concern that keeps people awake at night; case in point, most of us don’t lose sleep over the fact that our cash deposits are the liability of an institution such as a bank. Yet, the events of recent years (bank failures, central bank QE, fiscal extravagance) have repeatedly undermined institutional credibility, leading to greater willingness to explore decentralised money alternatives. Bitcoin’s pseudonymous inventor, Satoshi Nakamoto, puts this succinctly:
“The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve.”
In good times and bad. That said, the above episodes of crisis are not the only causes of currency devaluation. The very fact that central banks set an inflation target of 2% means that it is a key priority of governments to continuously debase your savings by 2% per year relative to goods and services, even in the good times. Therein lies the agency problem – it is in the interest of an indebted government to debase money to repay its debt, yet it is in the interest of savers to have a harder money that preserves purchasing power. Unfortunately, in our world today, only governments hold the keys to money creation.
Enter Bitcoin. In 2009, Satoshi Nakamoto created Bitcoin, which is a distributed public ledger (as opposed to centralised private ledgers used in traditional banking) of digital asset ownership. Anyone with a laptop and an internet connection can participate in the network as a node operator by running a free and open-source software application – essentially democratising money and putting decision-making power back into the hands of users rather than the issuers. Using an extreme example, if a developer went rogue and decided to update the software with a line of code that doubles the amount of Bitcoin for every user (effectively a hard fork), the node operators are unlikely to see this debasement as a welcome change, not perform the update, and maintain the ledger based on the previously accepted software protocol. In other words, the users will always have a voice in how their money is designed – and would logically vote for the preservation of its value.
2. Block subsidy protocol – Disinflationary monetary base expansionScarcity is code, and code is law. Speaking of monetary design, another key feature that proponents tout is the finite monetary base of 21mn bitcoin. This protocol is perhaps the most critical in replicating physical scarcity in the digital realm, making bitcoin more like commodity-based money (such as gold) instead of fiat; there is a theoretical limit on the amount of gold that could be mined out of the earth, while there is seemingly no limit to the amount of fiat currency that can be printed. New bitcoin is minted only through the process of mining – where miners compete to solve a cryptographic puzzle through trial and error. The first to solve it gets to add the next block of transactions to the blockchain and receive a reward in bitcoin (block subsidy).
Diminishing rewards, augmenting returns. The block subsidy reward began at 50 bitcoin per block added and is halved every four years or so in seeming replication of another physical reality of gold – that it gets harder to mine the more it has been mined. The current block subsidy is 3.125 bitcoin per block and is set to halve again around the year 2028. At present, c.19.9 out of the 21mn bitcoins have already been mined, while the diminishing subsidy implies that the final fractional bitcoin would only be mined by the year 2140. This disinflationary monetary base expansion – hard-coded in its protocol – underpins bitcoins limited supply.
3. High energy utilisation – A critical security featureProof-of-work is proof-of-security. As we have established, money today relies on the trust that the centralised institution (i.e. bank) is updating their internal ledger databases fairly and securely. How does one reimagine the same level of trust in a peer-to-peer network with no central authority? Proof-of-work emerged as an elegant solution – those who had invested the “work” of solving the cryptographic puzzle (which requires energy and time) are rewarded with the authority to add to the blockchain. In Satoshi’s words, the longest blockchain itself is “proof that it came from the largest pool of CPU power”.
High costs have a way of incentivising right behaviour, just like how fines deter individuals in society from breaking the law. How much does it cost to attack the bitcoin network? In theory, if a single entity can permanently control more than 50% of Bitcoin’s hashrate (computing power), it could decide every block that is added henceforth (a 51% censorship attack). As it stands today, even if Google, Amazon, and Microsoft dedicated their combined cloud infrastructure towards attacking the network, they would not even make a dent against the millions of ASICs currently mining bitcoin 24/7. It would require billions of dollars for any single entity to attempt to do so today. In this case, security is rarity; Bitcoin accounts for c.98% of the total market cap of proof-of-work blockchains – there is no other peer which can compete with Bitcoin in the scale of its network or its track record.
Scarcity comes in many shapes and forms. In a world where money printing has turned from extraordinary to ordinary policy, scarcity is increasingly found in shapeless forms such as Bitcoin. It would require an open mind to understand that rarity is not just an attribute of the physical; digital monetary scarcity would become increasingly invaluable, especially in contrast with the proliferation of digitalised goods and services, including fiat. As with all things scarce, the only thing standing between its price and its true value – is time.
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