An Energy Standard Of The 21st Century

If you’ve been enjoying my writing, I want to encourage you to subscribe to the notification list so that you never miss when I post a new blog! It may even prompt me to write more often :) And now to the new post!

You can see so many articles written and experts talking about possible ways for Bitcoin to fail. Some argue the government will bring Bitcoin to an end by banning it. This "school of thought" has been on the rise lately, especially after the first Congressional hearing on bitcoin mining in the US. At least it looked so to me. 

As an amateur bitcoin enthusiast, this made me think whether I should worry that Bitcoin is doomed to fail. However, I believe I found an argument for why it is in the governments' best interest, especially in the US, to see Bitcoin stay.

Energy Standards

A quick recap - the Bitcoin network is an energy-based system. It requires a vast amount of energy to produce new coins and to secure the network.

However, the concept of connecting the monetary system to energy is not novel. Energy standards have been common throughout history, for instance, the gold standard. 

Gold is valuable because it is hard to find and requires energy to extract from the ground. And when money was connected to gold, one could only produce more money by putting more energy to extract more gold.This allowed money to retain its value, mainly because its supply couldn't be easily increased.

The US brought the gold standard to an end in 1971. But, as it turns out, this did not signal the end of the energy standard. Not long after, the US and Saudi Arabia struck a military pact that led to the creation of oil-backed dollars, or petrodollars. 

From then on, dollars became the sole currency for buying oil from the oil-rich nations. If a country or a company wants to buy oil, it must acquire dollars. So as long as someone pumps oil out, there will always be a need for US dollars.

But what is so important about never-ending demand? The answer lies on the supply side.

When you have a stable demand for a good, you can ramp up the production without worrying that the price will drop. This is precisely what has happened with US dollars over the past several decades. Growth in crude oil consumption coincided with the increase in money supply in the US and the increase in the US government debt. In other words, since the "launch" of petrodollars, the US Federal Reserve has been slowly printing dollars and not worrying about their value loss.

Bitcoin-Dollars

You may ask, how is all the above connected to Bitcoin? The Bitcoin-related industry has become another predator devouring newly printed US dollars.

Mark Goodwin, who came up with the idea of bitcoin-dollars, wrote in his article "The Birth of The Bitcoin-Dollar" last September that we've spent these 13 years building infrastructure around and on the Bitcoin protocol that is denominated in US dollars. (Yes, this post was inspired by this article). Let me explain.

The BTC/USD trading pairs are the most commonly used and traded based on volume. A US dollar-denominated and Bitcoin native stablecoin -- Tether -- is the third-largest cryptocurrency by market capitalisation as of the time of writing. 

And over the past year or so, we saw an increasing number of companies buying bitcoin (MicroStrategy and Tesla).

All these mean that we've unwillingly connected a new energy-based monetary system to the monetary policy of the US.

So what? The dollar-pegged stablecoins, like Tether, must be backed by the actual US dollars. It means that for every issued stablecoin, Tether, the company behind the coin, must add one US dollar to its reserves. So, as more people buy Tether, they will implicitly drive demand for the US dollars. Doesn't it sound familiar? Here is another example.  

Every company that bought bitcoin has to perform the same actions as Tether because of Basel III requirements that came into place on January 1, 2022. To put it simply, Basel III requires any bank, investment firm or any company to back its bitcoin or gold holdings by an equal amount of dollars or dollar-denominated securities. The more companies or financial institutions dip their toes into the Bitcoin space, the more US dollars will have to be assumed.

Economic realities

Let's take a quick macroeconomics detour. Those watching the macro news know that inflation rates across the major developed economies have been on the rise lately. And it is not surprising given the governments' response to the pandemic.

The standard central banks' response to increasing inflation is to hike interest rates. Some central banks have already started raising the rates, such as the Bank of England, while others could follow soon.

However, it is easier said than done because most developed economies have not been shying away from spending and racked up significant amounts of government debt. If a central bank increases interest rates, it will increase the debt servicing costs and the debt level. 

On the other hand, keeping interest rates close to current historic lows allows governments to easily finance their debt and keep it growing by printing more money. Rising inflation is actually good for government debt because the real value of debt will gradually decrease, even as the nominal value of debt increases. Russell Napier referred to this as a period of "financial repression," similar to the post-WWII years in the US.  

It looks like this option is the most preferable one because, as Chris Brightman from Research Affiliates put it, governments can't afford to move nominal interest rates above the inflation levels.

But won't inflation hurt the US dollar and the US economy? This is where the bitcoin-dollars mechanism steps on stage.

Like the old petrodollars, bitcoin-dollars will allow the US government to print money to inflate the debt. But rather than negatively impacting the demand for the dollar (and the purchasing power of the dollar system), the USD will be forced into the Bitcoin monetary system. We've covered these inflow channels above.

The purchasing power of the dollar system refers to how strong the US dollar is compared to other countries. In other words, if we convert one US dollar into one Euro, what would be the difference in apples that we would be able to buy compared to just using the Euros. Thanks to the bitcoin-dollars mechanism, the demand for US dollars will remain firm even as the supply increases, ensuring that the above number of apples bought with US dollars stays unchanged.

However, on a micro-level, the individual purchasing power of a dollar will continue to decline as the US continues to print money. More US dollars in the economy will be chasing the same amount of goods and services, leading to higher prices (or inflation).

One of the logical responses to inflation is the broader interest in Bitcoin from both individuals and companies as an inflation hedge. At the same time, companies investing in bitcoin will also acquire US dollars to comply with the regulations, bringing us back to the money printing press.

Conclusion

The bitcoin-dollars mechanism provides a new outlet for expanding dollar supply at nearly zero cost to the US government.

Besides, it is doubtful that the petrodollar mechanism will support demand for US dollars in the long term as we are making colossal efforts to phase out oil for environmental reasons. So to me, bitcoin-dollars sound like a logical successor, which also has fewer negative externalities for our society, as some can argue. 

By making an aggressive move against Bitcoin, the US could lose more than it gains. 

As Mark Goodwin wrote in his article:

The United States has proven time and time again that they will do whatever is necessary to protect the purchasing power of the dollar system.

Disclaimer: This blog post is not intended as financial advice. It is provided for information and entertainment purposes only. Do your own research.