The Benefits of Bitcoin: Economist Explains

Does bitcoin have the potential to become the new monetary standard? What are the benefits of bitcoin over fiat?

According to economist Saifedean Ammous, there are two properties that determine how suitable something is for use as money: ‘salability’ and ‘hardness,’ and bitcoin has both of them. Then there’s the issue of trust in the payer: The form of money can influence the likelihood of a transaction failing due to nonpayment.

We’ll discuss each of these factors, in turn, to show why Ammous thinks bitcoin makes good money.

Bitcoin Has Good Salability

As Ammous uses the term, ‘salability’ is the ability of something to transmit value. He says there are three dimensions to salability: scale, space, and time.

Scale-Salability

One of the benefits of bitcoin is its scale-salability—that is, its ability to transmit value between purchases of different size. For example, maybe you sell something of great value, like a house, and then you want to use a little bit of the money from the sale to purchase something of small value, like a loaf of bread. The scale-salability of something that is used as money depends mostly on how easily divisible it is into units of different value. 

Bitcoins have excellent scale-salability because they’re easily divisible in practice: The bitcoin network supports transactions as small as 0.00000001 bitcoin. So you could sell a house for 25 bitcoins and buy a loaf of bread for 0.00015 bitcoins without any trouble.

Space-Salability

The space-salability of something is its ability to transmit value over geographical distances. For example, maybe you want to sell a house in New York and buy one in Colorado. If your buyer offered to pay in either gold or cattle (both of which Ammous notes have historically been used as money), it would be much easier to carry 250 gold coins with you across the country than to transport 250 head of cattle. As such, gold has much better space-salability than cattle.

Bitcoins have excellent space-salability because they only exist as entries in a digital ledger, which is stored redundantly on many “nodes” throughout the world and accessed via the internet. So you can access your bitcoins from anywhere in the world, provided you can connect to the internet. 

Time-Salability

The time-salability of something is its ability to transmit value across time. For example, maybe you want to save up for a big purchase over a period of years or decades. Ammous warns that if you try to save up your money in dollars or other fiat currency, your savings will lose value over time due to inflation. 

At present, bitcoin’s time-salability is not as good as its scale-salability or space-salability because its value fluctuates unpredictably. Ammous discusses several factors that contribute to bitcoin’s volatile price. 

For one thing, bitcoins exist only as a digital currency, whereas many other things that have been used as money have commercial uses that give them tangible value to begin with. For example, the price of gold never drops below a certain threshold because of the commercial demand for gold to be used in making jewelry and certain electrical components. Bitcoins don’t have this basic commercial value, so their value can fluctuate more erratically.

For another thing, the price of bitcoin is the only factor that can adjust to match supply with demand because the supply of bitcoin at any given time is fixed. By contrast, both supply and price are variable for most other goods. When the demand for a commodity rises, driving up prices, the higher prices motivate producers to increase production. This increase in supply helps to balance out the increased demand, so the price doesn’t rise as much. 

So too, if the demand for a commodity drops, prices start to drop, and suppliers cut back on production. But because the supply of bitcoin is fixed, its price fluctuations can’t be ameliorated by increases or decreases in supply, so its price will fluctuate more dramatically in response to fluctuations in demand. 

Ammous observes that the effect of demand fluctuations is amplified by the relatively small market for bitcoins and by the temperament of the people who hold them: Many bitcoin holders tend to buy or sell large quantities of bitcoin, depending on whether they think the price will go up or down. This results in proportionately larger fluctuations in demand for bitcoin relative to other currencies and commodities.

However, Ammous also contends that this could change. If the bitcoin market continues to grow, demand may become less volatile. And if central banks build stockpiles of bitcoin to back other currencies (which is an important step toward adopting a Bitcoin Standard) this would also tend to stabilize the value of bitcoins. 

Will the Value of Bitcoin Ever Stabilize?

Economists differ on the question of whether or not it’s even hypothetically possible to stabilize the value of bitcoin, let alone whether or not its value will eventually stabilize in practice.

Experts argue that the supply and demand issues Ammous references are part of a larger ecosystem of influences that affect bitcoin’s value at any given time. Media hype and government intervention are two other significant drivers of bitcoin volatility. They observe that when bitcoin makes the news in a positive way (such as an announcement that a prestigious securities trading firm will now begin trading in bitcoins) the price of bitcoin tends to skyrocket. 

Conversely, when bitcoin makes the news in a negative way, or especially in a way that could raise concerns about its future availability or legality (such as a news story about the government shutting down a bitcoin-based business for engaging in illegal activities, or a government announcing prohibitions on the use of bitcoin by its citizens) the price of bitcoin tends to plummet. 

Ammous would probably point out that regulatory concerns and media hype are simply factors that influence demand. If these are indeed the primary factors behind its volatility, then this volatility will likely diminish with time: Eventually, governments will settle on their cryptocurrency policies, reducing concerns about bitcoin’s legality or regulatory status changing. And the more bitcoin matures, the less media hype it’s likely to generate. 

But others contend that bitcoin’s strictly limited supply makes it fundamentally unstable, arguing that the price volatility of bitcoin cannot be eliminated without a mechanism to regulate the money supply of bitcoins the way central banks regulate the supply of fiat currencies. One university team proposed creating an alternative cryptocurrency that would operate similarly to bitcoin, but with an additional algorithm built into the code to monitor exchange rates and adjust the supply of the cryptocurrency to keep the exchange rates consistent.

Others have created other cryptocurrencies and attempted to stabilize their value by backing the cryptocurrency with either fiat currency reserves such as US dollars, physical commodities such as gold or real estate, or financial securities, such as stocks.

Ammous would probably be skeptical of these solutions. As we’ve discussed, he is concerned that fiat money has poor time-salability because of inflation. So cryptocurrencies that are backed by fiat currency or whose supply is adjusted to maintain a consistent exchange rate with them would suffer from the same problem and lose one of bitcoin’s significant advantages. Similarly, a cryptocurrency backed by commodities or financial securities would be only as stable as what it was backed by. Moreover, it would require a trusted central entity to hold the reserves. But, as we’ve discussed, the decentralized structure of bitcoin that obviates the need for a trusted third party is another one of its significant advantages.

Bitcoin Is Hard Money

As we’ve discussed, bitcoin’s time-salability isn’t ideal because bitcoin’s value tends to fluctuate, but Ammous asserts that despite these short-term fluctuations, bitcoin does have good time-salability in the long run because it is a very “hard” currency, and thus does not lose value due to inflation. In this section we’ll discuss the “hardness” of money, which is another factor that, along with salability, determines how good a type of money is.

Ammous explains that the “hardness” of a type of money is the ratio of the total quantity in circulation to the maximum amount that could be added in a given amount of time, usually one year. 

For example, wheat has a very low hardness, because it is produced and consumed every year, and so the total supply is about the same as the annual production. By contrast, gold has a very high hardness, because it is relatively scarce and humans have been stockpiling it for thousands of years, so the amount of gold produced by gold mines in any given year is only a tiny fraction of the world’s total gold supply. 

Bitcoin is designed such that bitcoins are added to circulation at a predictable rate that is halved every four years, and will cease altogether once the total number in circulation reaches 21,000,000 bitcoins. Thus, bitcoin has a high hardness, and that hardness will continue to increase until all the bitcoins are in circulation, at which point its hardness will become infinite.

Hard Money Prevents Inflation From Redistributing Wealth 

Ammous demonstrates the importance of hard money by observing what happens to a society that uses money with low hardness: Over time, all the real value in that society goes to those who provide the supply of money.

As Ammous explains, this is because there’s always a demand for any material that a society uses as money (such as gold or silver), which motivates people to produce it (for example, by mining gold). Yet, increasing the money supply decreases the value of the money that’s already in circulation. 

It takes time for the economy to adjust to changes in the value of money, so when producers of money (such as gold miners) sell their product, they receive more payment for it than it will be worth once the economy adjusts to the increased money supply. This is what allows the producers of money to accumulate a greater and greater fraction of society’s real wealth over time.

If the society uses hard money, such as gold or bitcoin, the magnitude of this effect is small. But it gets larger the faster the money supply increases. For example, if the money supply abruptly doubles, then the value of money will be cut in half, so the people who increased the supply will acquire half of the total value that the money supply represented before it doubled.

Bitcoin Is Based on Verification Instead of Trust

Ammous asserts that the final desirable characteristic of bitcoin is its system of complete verification, which eliminates the need for trust. 

He explains that many other types of transactions require a degree of trust: If someone writes you a check, you’ll only accept it as payment if you trust that their check won’t bounce. If someone pays you with a credit card, the credit card company acts as a trusted third party, verifying her credit and guaranteeing payment of her debts. But that means the credit card company can block any transaction that it disapproves of, even if the payer and the payee both approve of it. But with bitcoin, there’s no need to trust either the payer or a third party because of its system of complete verification.

Complete verification means that the network first checks to make sure the payer can make the payment (they have sufficient funds in their account) and then irreversibly transfers the funds, ensuring that the payer does make the payment. Furthermore, these checks are performed not just by a single payment processor, but by a majority of the network—a large number of independently-operated servers all over the world. To default on a payment or make a fraudulent payment, the payer would have to gain control of a majority of the entire bitcoin network, which, as we’ve discussed, would be virtually impossible. This is how the network ensures that the payer can’t default, eliminating the need for trust.

Ammous points out that this is ideal for settlements between parties located in different countries, who might have limited options for enforcing an agreement to pay. It also means that all bitcoin transactions are final, irreversible, and immune to third-party stipulations, much like paying someone in cash or gold. 

But, as Ammous concedes, this approach also creates a large amount of redundancy (relative to using a trusted third party like a credit card company) since each transaction is independently verified by a majority of the entire network, not just a single server. This redundancy reduces the efficiency and speed of processing transactions. 

The Benefits of Bitcoin: Economist Explains

Darya Sinusoid

Darya’s love for reading started with fantasy novels (The LOTR trilogy is still her all-time-favorite). Growing up, however, she found herself transitioning to non-fiction, psychological, and self-help books. She has a degree in Psychology and a deep passion for the subject. She likes reading research-informed books that distill the workings of the human brain/mind/consciousness and thinking of ways to apply the insights to her own life. Some of her favorites include Thinking, Fast and Slow, How We Decide, and The Wisdom of the Enneagram.

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