Is Bitcoin Sound Money?

Is Bitcoin Sound Money?

Is Bitcoin Sound Money?

 

This is an extension of my previous post “Is Bitcoin Money?” Its one thing to be considered money, but it is another thing to be considered sound money.

Again, this is a question that has both depth and breadth. We must quickly review what money is, and then discuss what sound money is. What has been used for money in the past, and what qualities did those monies have that made them good/bad money?

Relevant posts for background info are: A Brief History of Money and Is Bitcoin Money? that you can quickly refresh if you like.

 

The Definition of Money is:

  1. A means of exchange
  2. A store of value (wealth)
  3. A unit of account

Many people argue about whether or not Bitcoin satisfies the above definition. The real answer is that in some respect, Bitcoin does to some degree and capacity, satisfy the above definition of money. You can refer to my previous post on Is Bitcoin Money? for more details on this.

Before we proceed further, I want to take a quote from The Bitcoin Standard, by Saifedean Ammous:

“Sound money is chosen freely on the market for its salability, because it holds its value across time, because it can transfer value effectively across space, and because it can be divided and grouped into small and large scales. It is money whose supply cannot be manipulated by a coercive authority that imposes its use on others.”

– The Bitcoin Standard, pg 73 (Ammous)

Under those presumptions, we continue.

Is Bitcoin Sound Money?

We know that Bitcoin (as well as Ethereum and XRP) can be considered to be real money. Is it enough to be considered real money though? After all the Venezuelan Bolivar is real money… We need good quality money, also known as sound money.

Next, we must identify what is sound money, why is sound money better and does Bitcoin qualify as sound money?

Is Bitcoin Sound Money

 

What is Sound Money?

As described in Saifedean Ammous’ book The Bitcoin Standard, sound money has a few specific characteristics. These characteristics may seem simple, but they are difficult to find and maintain. Sound money must be able to hold value over long time frames, be used as a medium of exchange, and be highly divisible to function for large and small purchases. Moreover, sound money must have a limited, rare supply with a low supply growth to reflect its scarcity. These qualities can be reflected in the qualities below:

  1. Salability
  2. High Stock to Flow Ratio

Bitcoin Sound Money Requires Salability

What is salability? Salability is the ease with which a good can be sold on the market, whenever its holder desires, with the least loss in its price. Basically, salability is a property that might be confused with liquidity, but there are important differences.

Liquidity refers to the amount of something that is available to be traded. High liquidity means that a good/asset is being bought and sold in high volumes, so it would be relatively easy to find someone to buy or sell your asset to. The difference between salability and liquidity is that salability refers to the quality of an asset that gives it the ability to be bought/sold easily. Physical gold, for example, is difficult to mint into coin and to physically carry around and transfer. It is valuable and can have high demand but it is not as easily traded as Bitcoin, which can be exchanged very easily online.

Salability has two components: across time and across space.

Salability across time

For example, metal coins such as copper and iron will erode and rust, decreasing their values over time. More durable metals such as gold and silver do not rust or deteriorate as easily, making them more durable across time. However, physical gold (or silver) coins could be devalued by decreasing the percent of gold in each coin (inflation). If a gold coin is minted and sold onto the market with decreasing gold content, it is losing value. This devalues the currency, which violates the principle of salability, ‘the least loss in its price’.

Bitcoin will not rust or decay or break. Nor can Bitcoin be inflated artificially over time as metal coins can be diluted/inflated. Also, the Bitcoin blockchain has never been hacked and is considered the most computationally secure network in the world. Therefore, Bitcoin may be considered more salable across time than gold or silver.

Salability across space

Another quality of salability is the ease with which a good can be sold on the market. This has two components, (i) the physical ease; (ii) the demand.

The physical ease refers to how simple it is to transact. With physical gold or paper dollars you have to count, store, physically move. Possible, not too difficult, and has been done for generations. With Bitcoin (and other cryptocurrencies) it is much simpler. You can carry 0.01 $BTC just as easily as you can carry 1000 $BTC. You can cross borders with it and use it in ANY country. Software will count and divide it and keep track of transactions for you.

The demand refers to the notion that the thing being used as money must be a good that is wanted, or in demand. Back in the barter system, this was a huge problem and barrier to salability. Today we rarely think of “money” as a “product” that must be in demand. We are so used to the national dollar currency that we simply assume it is the unit of exchange and we rarely consider demand as a factor. Partly because the law mandates the dollar be used as a medium of exchange. Secondly, because we never experienced a situation where we questioned the demand for something as a factor in its value as a currency. Think about Venezuela now though, their currency, the Bolivar, is not in high demand. Other things can be used in Venezuela instead of their Bolivar, including Bitcoin, but also things of value like real jewellery, gold, silver, watches, vehicles, bicycles, services (medical, taxes, engineering) as IOUs.

Circling back, Bitcoin is salable because it does not lose value as it is exchanged or over time, and cannot be devalued like fiat currencies or minted metal coins. It can easily be bought and sold on the market, including being exchanged for goods and services. There is increasing demand for Bitcoin as its network grows and more and more use cases and infrastructure are being built around it, and as it permeates the world into different individuals and funds’ crypto wallets.

 

Bitcoin Sound Money Requires a High Stock to Flow Ratio

What is stock as referred to in sound money?

Stock is the supply of a currency, or item used as currency.

The higher the stock the more units of currency are available. You need a high enough stock for a global currency to be used worldwide. Moreover, the durability of a currency plays a role in its stock. If a currency is not durable (for example, copper or grain) then its stock will decrease relatively rapidly. The more durable a currency is, then the stock will be maintained.

Flow refers to the new units of currency minted. Relative to the stock, sound money has low flow. Would holding gold be valuable if miners were able to produce 20% more gold year after year? Absolutely not. Even 8% is too high flow. Gold hovers between 1% to 2.5% flow annually. And its stock remains high due to its durability.

A higher stock to flow ratio supports a more durable, resilient and reliable money. It is in a community’s interest to have a large supply with a limited inflow of currency.

As an example, if grain were used as a medium of exchange, you might have a high stock, but it is constantly consumed by humans or livestock, and if not consumed, then it will rot over a certain timeframe. So the stock is limited in how high it can become. Moreover, the flow for grain is generally quite high since if you have a good farm year you can produce a large surplus of grain. And if you have a bad crop yield, then you will quickly burn through stockpiles and have low stock. This makes grain as a medium of exchange rather poor.

Another example is copper as money. Copper is relatively abundant in the Earth compared to a metal like gold. Copper is also less durable than gold as it will rust and break down and copper also has industrial use cases that make it used up more commonly than gold. Since copper will deteriorate and is used up industrially, it does not hold a high stock. Moreover, owing to its abundance in the Earth, there is a high flow as well. This makes it a terrible money since its stock is used up and in low supply and if enough effort is made in mining it, the flow can increase to destroy the value of whatever copper is in the stock supply.

 

Gold, Silver Sound Money

 

The next example is gold. Gold has a high stock since it is a highly durable metal and is not popularly used in industry. Moreover, gold is a relatively rare Earth metal and mining efforts are expensive with small success owing to gold’s rarity in the Earth. This gives gold a low flow. Gold has a high stock and a low flow. This means that the units in existence are durable and large enough to be used as a currency and its flow is low enough to not devalue the supply at any given time.

Let’s look at the $USD. It certainly has a high stock. I’d say that since most fiat currency is in digital (non-crypto) format that it is pretty durable. However, with the incessant printing of fiat money, its flow is quite high – although I cannot find a definite flow rate. As described in my previous post, the $USD has lost significant buying power as its flow has increased and inflated its value so that one ounce of gold costs $1200 today, when it used to be $35 fifty years ago.

Now, on to Bitcoin. Its total stock is ~21,000,000. However, not all of that has been mined yet. The circulating supply of Bitcoin is approaching ~17,600,000 (at the time of writing). Although, we must consider that Satoshi Nakamoto has ~1,000,000 BTC locked up in a wallet. And in the early crypto days many people didn’t realize how valuable Bitcoin would become and they lost their private keys. We can estimate that about another million bitcoin private keys are lost. So its real total stock is likely around ~15.5 million. With another 3.4 million BTC to be mined over the next 140 years.

The flow of Bitcoin is decreasing every 4 years. Currently, it sits at 12.5 BTC per block, and will soon be reduced to 6.25 BTC per block, then four years later, 3.125 BTC per block then 1.5625 BTC per block. As the stock increases, the flow decreases – compounding the effect of the qualities of sound money.

As time goes on, the stock to flow ratio of Bitcoin becomes higher and higher (stock goes up, flow goes down). Thus making Bitcoin more durable, stable and valuable to the global population.

 

Markshire Crypto Conclusion – Is Bitcoin Sound Money?

Bitcoin is sound money. Most definitely.

Bitcoin satisfies the definition of money as a medium of exchange, a store of value and a unit of account.

Moreover, Bitcoin is highly salable in its physical/digital durability.

Bitcoin also has a high stock to flow ratio. This makes it a highly desirable and stable currency that is resistant to debasement.

I highly recommend The Bitcoin Standard by Saifedean Ammous, which is where I gathered the vast majority of the information for this post.

 

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Please comment with any new information, questions, or constructive criticisms!

 

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Author: Markshire Crypto

Millennial cryptocurrency investor, writer and marketplace researcher. Founder of Markshire Crypto. Mark has been involved in the cryptocurrency industry since 2017, following the industry daily and creating content.

2 thoughts on “Is Bitcoin Sound Money?

  1. Beautiful article on Bitcoin as sound money. I am interested in Bitcoin but you kind of clear my understanding a little. Thank you. Since Bitcoin operate like share this requires that one has to be patient. Thank you

    1. Hi Augusta! I’m glad that you enjoyed the article. I’m also glad that I was able to clear your understanding. Bitcoin although does not operates like shares… analysts are not sure how to value it or analyze it. Some think its a combination of gold and network effort. But there are no profits or earnings to assess the value of a Bitcoin.

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