The Bitcoin Standard: Can a Scarce Asset Make the World a Better Place?
04 May 2021
Scarcity refers to the situation when a resource is limited in quantity while the demand stays high or limitless. Such a scenario often negatively impacts society and the economy, but there are also cases when scarcity is beneficial.
For several years, national currencies were physically backed by gold, a rare precious metal with sound store of value qualities and a long track record of resisting inflation.
However, since 1971 when US President Nixon dropped the Bretton Woods system, all economies use fiat money, government-issued funds not backed by any physical commodity.
Instead, a fiat currency derives its value from the relationship of supply and demand as well as the issuing government's stability.
The only reason why fiat money has value is due to the fact that the issuing government maintains it.
However, since governments have complete control over fiat, they use this opportunity to print money out of thin air to finance their operations.
By increasing the supply of fiat currencies, more money enters into circulation, which creates inflation.
As a result, fiat's purchasing power starts to decrease, meaning that you will be able to buy less with the same amount of money over time (e.g., inflation drives a cup of coffee's price from $1.50 to $2 in 10 years).
While the central bank's policies determine how much money can be printed throughout specific periods, fiat currencies virtually have an unlimited supply.
It's a common practice for governments to increase the money supply over time, ensuring that your funds will be worth less than what they are now in the future.
For that reason, fiat encourages people to spend and consume more.
But what happens if we use a scarce asset with a limited supply like Bitcoin to back paper money? Will it collapse the economy or instead benefit society by facilitating stable prices and financial sovereignty?
Let's get these questions answered in this article, in which we explore scarcity, its use-cases, impacts on the economy and society, as well as its connection to Bitcoin.
Is Scarcity a Friend or a Foe?
Scarcity refers to the situation when a resource is limited in quantity while the demand stays high or limitless.
Such a scenario often negatively impacts society and the economy, but there are also cases when scarcity is beneficial.
When Scarcity Can Cause Harm
Scarcity often causes harm to consumers.
For example, when a product is rare, it's hard to find in most stores, and you need to do some extra legwork to track it down and purchase it – often for a much higher price than other goods in the same category.
A perfect case for the above is what happened with the newest generation of video gaming consoles.
Due to the global semiconductor shortage, neither Sony nor Microsoft could make enough gaming machines for their customers.
As a result, while consumer demand stayed very high, the lack of supply created an unfortunate situation in which gamers have to wait several months until they can purchase the products they seek.
And, even when a new stock hits the market, scalpers are using bots to quickly buy up thousands of consoles before "real" customers to sell them at a much higher price than the list price to make a profit.
While the lack of supply created an unfavorable scenario for gamers, it doesn't have dire consequences for society as video gaming consoles are non-essential (luxury) products people can live without.
However, scarcity can have a detrimental effect on society when it impacts crucial areas, such as the housing market (or water for that matter).
When apartments available for sale or rent – especially affordable ones – are very rare, but demand stays high, it drives up prices and makes housing more expensive for citizens.
As a result, many won't be able to afford their own homes which leads to people lowering their living standards to cope. During such a crisis, the rate of homelessness will increase while the savings of affected citizens will decrease significantly.
Also, the scarcity of affordable apartments could disrupt the balance of power between tenants and landlords, providing increased authority to the latter parties, like in the case of Ireland's ongoing housing crisis.
Similar impacts can be observed when job opportunities are scarce within a specific city, region, or country, decreasing the overall quality of life, raising unemployment, and giving employers an advantage over job seekers and employees.
When Scarcity Provides Benefits
Scarcity is often defined as an economic problem, which can impact humanity adversely, as explored in the last section.
However, there are some cases when scarcity provides excellent opportunities for us, which can be capitalized on to benefit the economy and society.
Take Bitcoin, for example, a highly scarce cryptocurrency that features a maximum supply limited to 21 million BTC. At the same time, the digital asset's new supply gradually decreases over time by cutting the number of coins that can be mined with each block in half roughly every four years during the halving event.
In fact, since all BTC will be mined by around 2140, Bitcoin is the first asset ever created that is absolutely scarce, meaning that it's impossible to extend its supply.
In economics, the law of supply and demand is what determines prices.
When the supply increases and demand stays the same, it will lead to a decrease in an asset's value. In the opposite case, if demand outweighs supply, the instrument will experience price growth.
Since scarcity involves limited supply and virtually limitless demand, rare assets usually experience long-term price appreciation.
Bitcoin benefits from the above mechanism due to its absolute scarcity. Even if demand stays the same throughout the years, BTC's decreasing supply growth rate will ensure a stable increase in its price in the long run.
For that reason, highly scarce assets like Bitcoin can provide tremendous benefits to society, especially if we compare it with fiat currencies where inflation eats into their purchasing power over time.
While the inflationary nature of fiat makes people spend more, BTC allows them to save by holding on to their funds to take advantage of the cryptocurrency's long-term price appreciation.
In the next sections, we will look at how scarce instruments can be used to improve the economy and society's well-being.
Scarcity's Impacts on the Economy: What Happened During the Gold Standard?
Throughout humanity's history, civilizations have always searched for scarce and durable assets to either use as money or to back their currencies with.
From cowry shells and barley to bronze and copper coins, various commodities were used as money in the economy.
While silver also played an important role for a time, governments eventually discovered gold's unique properties, which made the precious metal the best commodity to use as sound money.
Unlike most materials found on Earth, gold is a chemically stable asset that is impossible to destroy and synthesize from other components.
Instead, gold is available in limited quantities and has to be mined and then extracted from its unrefined ore, which is a highly expensive and complex process.
Due to its chemical stability and the thousands of years of demand to accumulate it, gold has never been actually consumed. Instead, refined gold can be found in possession of humans in the form of jewelry, bars, and coins.
For these reasons, we have accumulated a massive supply of gold throughout history, which is by miles greater than the actual amount of the precious metal that can be produced in a year.
According to the World Gold Council, the total gold supply increases by around 2% annually, which has historically remained relatively stable, even with advancements in technology.
As a result, gold's stock-to-flow model – a way to measure the scarcity of an asset by dividing its total stockpile ever created with the annual flow of new supply – equaled 71.85 by 2019's end.
A stock-to-flow of 71.85 means that it takes nearly 72 years for humanity to produce as much gold as there's currently on the market.
For that reason, even when demand for gold surges to record levels, miners are unable to match it, even by increasing the production significantly. As a result, gold can be considered a highly scarce asset that has maintained a long-term price increase throughout history.
Gold was first minted into regular coins by the Greek king Croesus, a practice that has become increasingly popular later on. It's no surprise as it offered economic stability for multiple nations, including the Roman Empire, Byzantium, and Renaissance Italy.
Eventually, during the 1800s and early 1900s, many countries adopted the gold standard, a monetary system in which national currencies were backed by physical gold.
With the gold standard, the paper money of participating nations represented different weights of physical gold, which allowed easy conversion between currencies. At the same time, citizens were able to redeem their national currencies in the precious metal at any time.
While the precious metal reserves were stored in banks, financial institutions could only issue as much paper money that equals the value of the physical gold they kept.
As a result, if they adhered to the rules of the gold standard, governments weren't able to print money out of thin air. For that reason, while their cash reserves were limited this way, it prevented them from inflating their national currencies.
Actually, it created an opposite scenario, in which the national currencies of countries adopting the gold standard appreciated in value over time.
As you can see in the chart above, after the British Empire tied GBP to the price of gold in 1821, the currency's purchasing power experienced a 33% increase by the end of the century.
Unlike today's world, where the value of our fiat holdings decreases over time, the gold standard helped citizens increase their savings, creating major economic growth among participating nations.
However, the main drawback of the gold standard was that it required a high level of centralization to work efficiently.
Banks and central banks were in control of gold reserves – and, therefore, money issuance –, which could be easily seized by governments.
As a result, governments started to break the system's rules and issued more paper money than the value of their reserves.
A good example of the above is what happened during the United States Civil War. To finance the war, both sides started printing money without the backing of precious metals.
As you can see in the chart above, this practice led to the USD's purchasing power falling from 1860's $1.01 to $0.52 by the end of the civil war in 1865, with the money-printing-fueled hyperinflation taking away 48.5% of the dollar's value in five years.
While it took several years for the USD to reclaim its purchasing power, returning to a precious metal-backed monetary system restored the currency's value to $1.01 by 1899.
However, what ultimately led to the fall of the gold standard was World War I, when both sides engaged in the practice of printing money out of thin air.
Change in value against the Swiss Franc (1913-1918)
As a result, all the participants' currencies have depreciated in value compared to the Swiss Franc, which continued to maintain its gold backing during the war.
While allied powers didn't suffer as many financial losses as central powers, the currencies of Germany and Austria-Hungary lost 48.9% and 68.9% of their values compared to the CHF.
Several years after the war, many countries returned to a form of the gold standard but often with ultimate governmental control.
For example, during the Great Depression, the US government, led by Franklin D. Roosevelt, banned gold exports and forced the owners of significant amounts of the precious metal to exchange their gold holdings into USD at a fixed rate.
Such measures made gold-backed monetary systems highly efficient, eventually leading to eliminating the practice of precious-metal backing in 1971 when President Nixon ended the Bretton Woods system, a gold exchange standard operating since 1944 that tied the exchange rates of many nations to the USD and gold.
Since then, nations all over the world have been using inflationary fiat currencies, effectively eliminating all the benefits of scarce asset-backed monetary systems.
How Can the Economy Take Advantage of Bitcoin's Scarcity?
In the previous sections, we have explored the impacts of scarcity and how humanity used gold, a rare asset with unique properties, to create economic stability.
However, after exploiting the vulnerabilities of the gold standard, nations have completely eliminated precious metal currency-backing, creating a global economy that is deprived of the benefits of scarcity-based monetary systems.
Fortunately, the launch of Bitcoin changed the landscape of opportunity, providing the ability for everyone to hold an absolutely scarce digital asset that maintains a long-term value appreciation by limiting its total supply to 21 million BTC and gradually decreasing its new coin supply.
For these reasons, Bitcoin has tremendous potential to improve financial integrity and the economy. And, since its network can function efficiently within a decentralized architecture, BTC lacks the caveat of the gold standard that ultimately led to the system's fall.
The question is: how can society take advantage of Bitcoin's scarcity?
Peer-to-Peer Electronic Cash System
Bitcoin's anonymous creator, Satoshi Nakamoto, meant BTC to be used as a currency in a blockchain-powered peer-to-peer (P2P) electronic cash system.
This core documentation of Bitcoin arguably doesn't focus on BTC's scarcity but instead on the cryptocurrency's benefits for payments in a blockchain network that is open for everyone, highly decentralized and transparent, as well as lacks intermediaries. Some in the space have argued that this was a tactical move on the part of Satoshi to avoid premature governmental scrutiny.
While payments are perhaps the cryptocurrency's original use case, in reality, most users utilize Bitcoin as a store of value.
Instead of using it for everyday payments, most people invest in digital assets as they can maintain long-term value growth and effectively resist inflation to grow their wealth and hedge against the general market's uncertainties.
One of the reasons behind this phenomenon is due to Bitcoin's limited scalability. Since BTC can process only around seven transactions per second (TPS), its network can easily get congested with heavy usage, which eventually leads to slow transfers and high fees.
According to BitInfoCharts, the average BTC transaction fee increased from $0.0827 on May 1, 2014 to $22.45 as of May 1, 2021, representing a growth of over 27,000% in seven years.
As a result, while early adopters could effectively use Bitcoin for everyday transactions – such as for the infamous 10,000 BTC pizza purchase in 2010 –, BTC's expensive costs have discouraged many from using it as a payment method.
Also, in the meantime, cryptocurrencies like Ripple (XRP) and Stellar (XLM) have emerged, featuring highly scalable networks while offering near-real-time settlement with super low fees. For these reasons, they are currently better suited for everyday payments than BTC.
That said, Bitcoin's use-case as a peer-to-peer electronic cash system can potentially return in the near future with the launch of layer-two scalability solutions like the Lightning Network, which enables instant and inexpensive BTC transactions.
Store of Value
As mentioned earlier, Bitcoin is primarily used as a store of value.
In short, a store of value refers to an asset with the ability to retain its value over time. In other terms, it is capable of maintaining a stable price appreciation in the long run.
The two most important properties that make an asset a good store of value are scarcity and durability.
As we have discussed, Bitcoin features absolute scarcity, with its maximum supply limited at 21 million coins.
After reaching its hard cap, it will be impossible to mine new BTC or increase the cryptocurrency's supply in any other way.
At that point, Bitcoin's stock-to-flow will converge to infinity (21 million stock divided by 0 yearly flow).
Interestingly, while BTC's stock-to-flow currently stands at 56.91 (with a current stock of18.696 million and an annual new supply of 328,500), which means it takes roughly 57 years to mine the same amount of coins as the current stockpile (in theory, as that would exceed Bitcoin's maximum supply).
While the above value is lower than gold's (71.85), the next Bitcoin halving will drastically increase the cryptocurrency's stock-to-flow ratio.
The next halving is expected to take place after 158,437 blocks on March 16, 2024, which will reduce the new BTC that can be mined every 10 minutes to 3.125 coins.
On the day of 2024's halving, the total Bitcoin supply is expected to grow to 19.686 million coins.
On the other hand, the annual BTC flow will decrease to 198,900 (68,400 in 76 days with a rate of 6.25/block + 130,500 in 290 days at 3.125/block), which will boost the digital asset's stock to flow to 98.97.
As a result, Bitcoin will officially become more scarce than any other popular asset with good store of value qualities (including gold).
At the same time, as BTC is present on the blockchain in digital form, its quality can't really deteriorate over time.
Instead, Bitcoin's durability is based on the network's resilience, which has been extremely stable, featuring an uptime of nearly 99.99%.
Due to the large number of Bitcoin nodes, the record-high hashrate, as well as its decentralized infrastructure secured by public-key cryptography, BTC features state-of-the-art security and effective resistance against both internal and external threats.
For that reason, Bitcoin is highly durable, a quality that makes it an excellent store of value along with absolute scarcity.
As a result, most users see BTC as a store of value and a safe haven asset, investing money in the digital asset to avoid the inflation of fiat currencies, hedge against the global economy's uncertainties, and grow their wealth in the long term.
In addition to retail investors, institutional players – such as Tesla, MicroStrategy, Square, and Grayscale – hold large amounts of BTC (6.78% of the circulating supply), confirming Bitcoin's use-case as a store of value, which it derives mainly from its scarcity.
The Bitcoin Standard
Currently, Bitcoin can be used as a currency for money transfers and also as a store of value.
However, there can be a third, future use-case, in which humanity leverages the cryptocurrency's scarcity to combat inflation and create economic stability by backing national currencies with BTC.
Doing so would create the Bitcoin standard, in which the digital asset plays a role similar to gold's in the 1800s and early 1900s.
So how would that look like in reality?
Let's see an example scenario of the theoretical Bitcoin standard.
Say that the governments of participating nations purchase Bitcoin to back their currencies with the digital asset. Let's say they will use the coin to issue both paper money and their own cryptocurrencies for electronic payments (think of them like CBDCs but with their values tied to BTC's).
Each country will use a certain amount of BTC for their national currencies.
For example, 1 USD will represent 100 satoshi (0.000001 BTC) while GBP and EUR are defined in 150 satoshi (0.0000015 BTC) and 120 satoshi (0.0000012 BTC), respectively. As you can see, the process is very similar to the one used in the gold standard era, in which governments tied their currencies to different weights of gold.
As they feature value pegs to the same asset, the Bitcoin standard will reintroduce fixed exchange rates between different national currencies – for example, 1.2 for the EUR/USD (120/100 satoshi).
To achieve the above, central banks will use the BTC they purchased as reserves.
When they issue new currency (either electronically or physically), they will move the equivalent amount of Bitcoin to a specific address where the funds are locked up and stored securely. Think of howWrapped Bitcoin (WBTC) is issued on the Ethereum blockchain.
Interestingly, this can also be a smart contract address if Bitcoin rolls out native support for self-executing digital agreements in the future (or it's an address in the Lightning Network, which has smart contract compatibility).
No matter the method used for storing and locking up BTC, as national currencies will be backed by real cryptocurrency, citizens will be able to redeem their government-issued money in Bitcoin at any time.
Until governments started to exercise increased control over the money supply, citizens were able to do the same with their paper money during the gold standard era.
However, it would be much easier to convert national currency back to Bitcoin on a blockchain network, taking only a few minutes for the process to complete (burning the BTC-backed governmental tokens to redeem Bitcoin).
As you can see, it's entirely possible to establish a Bitcoin standard, which would provide citizens all the benefits as gold did during the gold standard era.
However, Bitcoin has some advantages over the precious metal in this field.
First, since Bitcoin's network is decentralized and governed by the community, it will provide less chance for governments to exploit the monetary system.
For example, as Bitcoin resides on the blockchain, authorities will have a much harder time confiscating the BTC holdings of citizens, especially if many are aware of the best practices of crypto wallet security.
Also, suppose a government decides to eliminate the ability to convert national currency into Bitcoin. In that case, citizens may still be able to redeem their government tokens in BTC via vaults by burning the prior coins.
And, even if the state succeeds in preventing citizens from doing so, over-the-counter (OTC) desks, P2P exchanges, and other alternative ways will be available for them to buy BTC with national currency to avoid inflation.
That said, governments will still be able to devalue their national currencies by simply printing more cash than their actual BTC holdings.
However, due to the transparency of the blockchain that allows anyone to audit transactions recorded on the chain, people will know whether the government's Bitcoin reserves match the money supply.
In case the money supply is higher than the BTC reserves, citizens can easily exchange their national currencies to the cryptocurrency to protect their funds from depreciating in value.
If many citizens follow the above practice, it will lead to more people using Bitcoin (or other assets backed by the cryptocurrency) than the actual national currency.
As a result, the government will likely back off and reverse its actions, restoring the Bitcoin standard to avoid dire consequences for the economy.
Furthermore, unlike with gold, the Bitcoin standard doesn't need to be centralized to function efficiently.
For that reason, instead of governments or central banks, private companies or decentralized autonomous organizations (DAOs) could issue their own BTC-backed tokens, potentially replacing national currencies.
As a result, the state is prevented from exercising control over the money supply.
No matter the actual implementation of the Bitcoin standard, it is definitely many years away if it will actually happen.
For BTC to be used to back national currencies worldwide, the digital asset has to achieve mainstream adoption first, with a significant share of the global population holding it and using cryptocurrency regularly for payments or other transactions.
Also, for Bitcoin's redeemability to work, the cryptocurrency's developers have to either enhance its on-chain scalability or completely implement Lightning Network or other layer-two solutions.
Leveraging Decentralization and Scarcity to Achieve Financial Sovereignty
Scarcity can both be a friend and foe to society and the economy.
However, in terms of money, backing national currencies with scarce assets has more benefits than drawbacks.
During the 1800s and early 1900s, the gold standard created economic stability even though governments exploited the weaknesses of the monetary system.
In addition to its use-cases as a currency and a store of value, Bitcoin could potentially be used to restore the scarcity-related benefits of the gold standard era but without the need for governmental control and increased centralization.
That said, we can't tell how BTC will be used in the future or whether the Bitcoin standard will be implemented at some point.
What we know is that Bitcoin provides financial sovereignty for individuals, which is maybe the most important value proposition of the cryptocurrency.
As part of a decentralized blockchain network, Bitcoin is the first asset ever created that allows anyone in the world to access money that is free from any centralized authority's control.
Despite its high volatility, with a fixed supply and the deflationary halving mechanism, the cryptocurrency can preserve its value in the long term, protecting holders against the inflationary nature of fiat currencies.
However, due to Bitcoin's limited scalability, transaction fees can significantly increase with heavy usage, discouraging users with small budgets from using the cryptocurrency.
For that reason, while it offers financial sovereignty for individuals, BTC has to improve its inclusivity by leveraging layer-two or on-chain scaling solutions to keep transfer fees at a low level to allow everyone to hold even a minimal amount of the coin in their wallets.
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