Cryptocurrency: Whither Bitcoin?

[grarpamp]

https://bitcoinmagazine.com/markets/whither-bitcoin-monetary-restructuring

Whither Bitcoin?
by Eric Yakes

The world stands on the precipice of a monetary restructuring, with
bitcoin seemingly the most likely to be adopted... albeit slowly.

https://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.622.6336&rep=rep1&type=pdf

INTRODUCTION

The world is reorganizing. People are attempting to comprehend the
implications of recent events across a variety of dimensions:
politically, geopolitically, economically, financially and socially. A
feeling of uncertainty has eclipsed global affairs and individuals are
developing an increased reliance on the thoughts of those bold enough
to attempt comprehension. Experts are everywhere, but the expert is
nowhere.

I am not claiming to be an expert on anything, either. I read, write
and do my best to piece together an understanding of vague and complex
concepts. I’ve spent some time reading and thinking through various
concepts and believe we are witnessing an inflection point of global
trust.

My goal is to explain the framework that led me to this conclusion.
I’ll generally avoid discussing geopolitics and focus on the monetary
and financial implications of this shift we are witnessing. The best
place to start is understanding trust.
THE WORLD RUNS ON TRUST

We are witnessing a shift in global trust, setting the table for a new
global monetary order. Consider Antal Fekete’s introduction from his
seminal work Whither Gold?:

    “The year 1971 was a milestone in the history of money and credit.
Previously, in the world's most developed countries, money (and hence
credit) was tied to a positive value: the value of a well-defined
quantity of a good of well-defined quality. In 1971 this tie was cut.
Ever since, money has been tied not to positive but to negative values
-- the value of debt instruments.”

Debt instruments (credit) are built on trust — the most fundamental
construct of organization. Organization allowed humanity to
genetically eclipse its ancestors. Relationships, whether between
individuals or groups, hinge on trust. Societies developed
technologies and social structures to reduce the need for trust
through reputations, security and money.

Reputations reduce the need to trust because they represent an
individual’s pattern of behavior: You trust some people more than
others because of how they’ve acted in the past.

Security reduces the need to trust that others will not hurt you in
some form. You build a fence because you don’t trust your neighbors.
You lock your car because you don’t trust your community. Your
government has a military because it doesn’t trust other governments.
Security is the price you pay to avoid the costs of vulnerability.

Money reduces the need to trust that an individual will return a favor
to you in the future. When you provide an individual a good or
service, rather than trusting that they will return it to you in the
future, they can immediately trade money to you, eliminating the need
to trust. Stated differently, money reduces the need to trust that
positive outcomes will happen while reputations and security reduces
the need to trust that negative outcomes won’t happen. When money
became entirely unanchored from gold in 1971, the value of money
became a function of reputations and security, requiring trust. Before
then, money was tied to the commodity gold, which maintained value
through its well-defined quality and well-defined quantity and
therefore didn’t require trust.

Trust at a global level appears to be shifting across reputations and
security, and thus credit money:

    Reputations — countries are trusting each other’s reputations
less. The U.S. government’s reputation throughout recent history has
been a global pillar of political stability and standard of financial
and economic prudency. This is changing. The rise of U.S. populism has
hindered its reputation as a politically stable country that allies
depend on and rivals fear. Unprecedented economic and financial policy
measures (e.g., bailouts, deficit spending, monetary inflation, debt
issuance, etc.) are causing international powers to question the
stability of the U.S. financial system. A hindrance to the reputation
of the U.S. is a hindrance on the value of its money, to be discussed
below.

    Security — countries are witnessing a contraction in global
military order. The U.S. has been reducing its military presence and
the world is shifting from a unipolar to a multipolar structure of
order. The U.S.’ withdrawal of its military presence abroad has
reduced its role as the monitor of international order and given rise
to the military presence of rival nations. Reducing the assurance of
its military presence internationally reduces the value of the dollar.

    Money — countries are losing trust in the international monetary
order. Money has existed as either a commodity or credit (debt).
Commodity money is not subject to trust through the reputations and
security of governments while credit money is. Our modern system is
entirely credit-based and the credit of the U.S. is the pillar upon
which it exists. If the global reserve currency is based on credit,
then the reputation and security of the U.S. is paramount to
maintaining international monetary order. Trust in political and
financial stability impacts the value of the dollar as does its
holders’ demand for liquidity and stability. However, it’s not just
U.S. credit money that is losing trust; it’s all credit money. As
political and financial stability decline, we are witnessing a shift
away from credit money entirely, incentivizing the adoption of
commodity money.

U.S. DEBT IS NOT RISK FREE

Most recently, the reputation of U.S. credit has declined in an
unprecedented way. Foreign governments historically trusted that the
U.S. government’s debt is risk free. When financial sanctions froze
Russia’s foreign exchange reserves, the U.S. undermined this risk-free
reputation, as even reserves are now subject to confiscation. The
ability to freeze the reserve assets of another country removed a
foreign government’s right to either repay its debts or spend those
assets. Now, international observers are realizing that these debts
are not risk free. As the debt of the U.S. government is what backs
its currency, this is a significant cause for concern.

When the U.S. government issues debt, and demand from domestic and
foreign buyers of it isn’t strong enough, the Federal Reserve prints
money to purchase it in the open market and generate demand. Thus, the
more U.S. debt countries are willing to buy, the stronger the U.S.
dollar becomes — requiring less money printing by the Fed to
indirectly enable government spending. Trust in the U.S. government’s
credit has now been damaged, and thus so has the credit of the dollar.
Further, trust in credit is declining in general, leaving commodity
money as the more trustless option.

First, I will examine this shift in the U.S. which applies
specifically to its reputation and security, and then discuss the
shifts in global credit (money).

U.S. Dollar Dominance

Will foreign governments attempt to de-dollarize? This question is
complex as it not only requires an understanding of the global banking
and payment systems but also maintains a geopolitical background.
Countries around the world, both allies and rivals, have strong
incentives to end global dollar hegemony. By utilizing the dollar a
country is subject to the purview of the U.S. government and its
financial institutions and infrastructure. To better understand this,
let’s start by defining money:

The above figure from my book shows the three functions of money as a
store of value, medium of exchange and unit of account, as well as the
supporting monetary properties of each below them. Each function plays
a role in international financial markets:

    Store of Value — fulfilling this function drives reserve currency
status. U.S. currency and debt is ~60% of global foreign reserves. A
country will denominate its foreign exchange reserve assets in the
most creditworthy assets — defined by their stability and liquidity.

    Medium of Exchange — this function is closely tied to being a unit
of account. The dollar is the dominant invoicing currency in
international trade and the euro is a close second, both of which
fluctuate around ~40% of total. The dollar is also 64% of foreign
currency debt issuance, meaning countries mostly denominate their debt
in dollars. This creates demand for the dollar and is important. Since
the U.S. issues more debt than domestic and foreign buyers are
naturally willing to buy, they must print dollars to buy it in the
market, which is inflationary (all else equal). The more foreign
demand they can create for these newly printed dollars, the lower the
inflationary impact from printing new dollars. This foreign demand
becomes entrenched as countries denominate their contracts in the
dollar, allowing the U.S. to monetize their debt.

    Unit of Account — Oil and other commodity contracts are often
denominated in U.S. dollars (e.g., the petrodollar system). This
creates artificial demand for the dollar, supporting its value while
the U.S. government continually issues debt beyond amounts domestic
and foreign buyers would be willing to purchase without the Fed
creating demand for it. The petrodollar system was created by Nixon in
response to a multi-year depreciation of the dollar after its fixed
convertibility into gold was removed in 1971. In 1973, Nixon struck a
deal with Saudi Arabia in which every barrel of oil purchased from the
Saudis would be denominated in the U.S. dollar and in exchange, the
U.S. would offer them military protection. By 1975, all OPEC nations
agreed to price their own oil supplies in dollars in exchange for
military protection. This system spurred artificial demand for the
dollar and its value was now tied to demand for energy (oil). This
effectively entrenched the U.S. dollar as a global unit of account,
allowing it more leeway in its practices of money printing to generate
demand for its debt. For example, you may not like that the U.S. is
continually increasing its deficit spending (hindering its store of
value function), but your trade contracts require you to use the
dollar (supporting its medium of exchange and unit of account
function), so you have to use dollars anyway. Put simply, if foreign
governments won’t buy U.S. debt, then the U.S. government will print
money to buy it from itself and contracts require foreign governments
to use that newly printed money. In this sense, when the U.S.
government’s creditworthiness (reputation) falls short, its military
capabilities (security) pick up the slack. The U.S. trades military
protection for increased foreign dollar demand, enabling it to
continuously run a deficit.

Let’s summarize. Since its establishment, the dollar has served the
functions of money best at an international level because it can be
easily traded in global markets (i.e., it’s liquid), and contracts are
denominated in it (e.g., trade and debt contracts). As U.S. capital
markets are the broadest, most liquid and maintain a track record of
secure property rights (i.e., strong reputation), it makes sense that
countries would utilize it because there is a relatively lower risk of
significant upheaval in U.S. capital markets. Contrast this idea with
the Chinese renminbi which has struggled to gain dominance as a global
store of value, medium of exchange and unit of account due to the
political uncertainty of its government (i.e., poor reputation) which
maintains capital controls on foreign exchange markets and frequently
intervenes to manipulate its price. U.S. foreign intervention is rare.
Further, having a strong military presence enforces dollar demand for
commodity trade per agreements with foreign countries. Countries that
denominate contracts in dollars would need to be comfortable trading
away military security from the U.S. to buck this trend. With
belligerent Eastern leaders increasing their expanse, this security
need is considerable.

Let’s look at how the functions of money are enabled by a country’s
reputation and security:

    Reputation: primarily enables the store of value function of its
currency. Specifically, countries that maintain political and economic
stability, and relatively free capital markets, develop a reputation
for safety that backs their currency. This safety can also be thought
of as creditworthiness.

    Security: primarily enables the medium of exchange and unit of
account functions of its currency. Widespread contract denomination
and deep liquidity of a currency entrench its demand in global
markets. Military power is what entrenches this demand in the first
place.

If the reputation of the U.S. declines and its military power
withdraws, demand for its currency decreases as well. With the shifts
in these two variables in front of mind, let’s consider how demand for
the dollar could be affected.
OVERVIEW OF THE GLOBAL MONETARY SYSTEM

Global liquidity and contract denomination can be measured by
analyzing foreign reserves, foreign debt issuance, and foreign
transactions/volume. Dollar foreign exchange reserves gradually
declined from 71% to 60% since the year 2000. Three percent of the
decline is accounted for in the euro, 2% from the pound, 2% from the
renminbi and the remaining 4% from other currencies.

More than half of the 11 percentage point decline has come from China
and other economies (e.g., Australian dollars, Canadian dollars, Swiss
francs, et al.). While the U.S. dollar decline in dominance is
material, it obviously remains dominant. The primary takeaway is that
most of the decline in dollar dominance is being captured by smaller
currencies, indicating that global reserves are gradually becoming
more dispersed. Note that this data should be interpreted with caution
as the fall in dollar dominance since 2016 occurred when previous
non-reporting countries (e.g., China) began gradually revealing their
FX reserves to the IMF. Further, governments don’t have to be honest
about the numbers they report — the politically sensitive nature of
this information makes it ripe for manipulation.

Source: IMF

Foreign debt issuance in USD (other countries borrowing in contracts
denominated in dollars) has also gradually declined by ~9% since 2000,
while the euro has gained ~10%. Debt issuance of the remaining
economies was relatively flat over this period so most of the change
in dollar debt issued can be attributed to the euro.

Source: Federal Reserve

The currency composition of foreign transactions is interesting.
Historically, globalization has increased the demand for cross-border
payments primarily due to:

    Manufacturers expanding supply chains across borders.

    Cross-border asset management.

    International trade.

    International remittances (e.g., migrants sending money home).

This poses a problem for smaller economies: the more intermediaries
that are involved in cross-border transactions, the slower and more
expensive these payments become. High-volume currencies, such as the
dollar, have a shorter chain of intermediaries while lower-volume
currencies (e.g., emerging markets) have a longer chain of
intermediaries. This is important because it is these emerging markets
that stand to lose the most from international payments and for this
reason alternative systems are attractive to them.

Source: Bank of England

If we look at the trend in composition of foreign payments it’s
evident that the dollar's share of invoicing is materially greater
than its share of exports, illuminating its outsized role of invoicing
in proportion to trade. The euro has been competing with the dollar in
terms of invoicing share, but this is driven by its usage for export
trade among EU countries. For the rest of the world, export share has
been, on average, greater than 50% while invoicing share has remained
less than 20% on average.

Source: Journal of International Economics

Lastly, let’s discuss the volume of trade. A currency with high volume
of trade means that it is relatively more liquid and thus, more
attractive as a trade vehicle. The chart below shows the proportions
of volume traded by currency. The dollar has remained dominant and
constant since 2000, expressing its desirability as a liquid global
currency. What’s important is that the volume of all major global
reserve currencies have declined slightly while the volume of “other”
smaller world currencies has increased from 15% to 22% in proportion.

Source: BIS Triennial Survey; (Note: typically these numbers are shown
on a 200% scale — e.g., for 2019 USD would be 88.4% out of 200% —
because there are two legs to every foreign exchange trade. I’ve
condensed this to a 100% scale for ease of interpretation of the
proportions).

The dollar is dominant across every metric, although it has been
gradually declining. Most notably, economies that are not major world
reserves are:

    Gaining dominance as reserves and thus world FX reserves are
becoming more dispersed.

    Utilizing the dollar for foreign transactions in significantly
greater proportions than their exports and limited by a long chain of
intermediaries when attempting to use their domestic currencies.

    Hurt the most by long chains of global intermediaries for their
transactions and thus stand to gain the most from alternative systems.

    Increasing their share of foreign exchange volume (liquidity)
while all the major reserve currencies are declining.

There exists a trend whereby the smaller and less dominant currencies
of the world are expanding but are still limited by dollar dominance.
Pair this trend with the global political fragmentation occurring and
their continued expansion becomes more plausible. As the U.S.
withdraws its military power globally, which backs the dollar’s
functions as a medium of exchange and unit of account, it decreases
demand for its currency to serve these functions. Further, the
dollar’s creditworthiness has declined since implementing the Russian
sanctions. The trends of declining U.S. military presence and
creditworthiness, as well as increased global fragmentation, indicate
that the global monetary regime could experience drastic change in the
near term.
THE GLOBAL MONETARY SYSTEM IS SHIFTING

Russia invaded Ukraine on Feb. 24, 2022, and the U.S. subsequently
implemented a swath of economic and financial sanctions. I believe
history will look back on this event as the initial catalyst of change
towards a new era of global monetary order. Three global realizations
subsequently occurred:

Realization #1: Economic sanctions placed on Russia signaled to the
world that US sovereign assets are not risk free. U.S. control over
the global monetary system subjects all participating nations to the
authority of the U.S.

Effectively, ~$300 billion of Russia’s ~$640 billion in foreign
exchange reserves were “frozen” (no longer spendable) and it was
partially banned (energy still allowed) from the SWIFT international
payments system. However, Russia had been de-dollarizing and building
up alternative reserves as protection from sanctions throughout
previous years.

Now Russia is looking for alternatives, China being the obvious
partner, but India, Brazil and Argentina are also discussing
cooperation. Economic sanctions of this magnitude by the West are
unprecedented. This has signaled to countries around the world the
risk they run through dependence on the dollar. This doesn’t mean that
these countries will begin cooperating as they are all subject to
constraints under an international spiderweb of trade and financial
relationships.

For example, Marko Papic explains in “Geopolitical Alpha” how China is
heavily constrained by the satisfaction of its growing middle class
(the majority of its population) and fearful that they could fall into
the middle-income trap (GDP per capita stalling within the
$1,000-12,000 range). Their debt cycle has peaked and economically
they are in a vulnerable position. Chinese leaders understand that the
middle-income trap has historically brought the death of communist
regimes. This is where the U.S. has leverage over China. Economic and
financial sanctions targeting this demographic can prevent growth in
productivity and that is what China is most afraid of. Just because
China wants to partner with Russia and achieve “world domination” does
not mean that they will do so since they are subject to constraints.

The most important aspect of this realization is that U.S. dollar
assets are not risk free: they maintain a risk of appropriation by the
U.S. government. Countries with plans to act out of accordance with
U.S. interests will likely start de-dollarizing before doing so.
However, as much as countries would prefer to opt out of this dollar
dependency, they are constrained in doing so as well.

Realization #2: It’s not just the U.S. that has economic power over
reserves, it’s fiat reserve nations in general. Owning fiat currencies
and assets in reserves creates uncertain political risks, increasing
the desirability of commodities as reserve assets.

Let’s talk about commodity money vs. debt (fiat) money. In his recent
paper, Zoltan Pozsar describes how the death of the dollar system has
arrived. Russia is a major global commodity exporter and the sanctions
have bifurcated the value of their commodities. Similar to subprime
mortgages in the 2008 financial crisis, Russian commodities have
become “subprime” commodities. They’ve subsequently declined
materially in value as much of the world is no longer buying them.
Non-Russian commodities are increasing in value as anti-Russia
countries are now all purchasing them while the global supply has
shrunk materially. This has created volatility in commodity markets,
markets that have been (apparently) neglected by financial system risk
monitors. Commodity traders often borrow money from exchanges to place
their trades, with the underlying commodities as collateral. If the
price of the underlying commodity moves too much in the wrong
direction, the exchanges tell them that they need to pay more
collateral to back their borrowed money (trader get margin-called).
Now, traders take both sides in these markets (they bet the price will
go up or that it will go down) and therefore, regardless of which
direction the price moves, somebody is getting margin-called. This
means that as price volatility is introduced to the system, traders
need to pay more money to the exchange as collateral. What if the
traders don’t have more money to give as collateral? Then the exchange
has to cover it. What if the exchanges can’t cover it? Then we have a
major credit contraction in the commodity markets on our hands as
people start pulling money out of the system. This could lead to large
bankruptcies within a core segment of the global financial system.

In the fiat world, credit contractions are always backstopped — such
as the Fed printing money to bail out the financial system in 2008.
What is unique to this situation is that the “subprime” collateral of
Russian commodities is what Western central banks would need to step
in and buy — but they can’t because their governments are the ones who
prevented buying it in the first place. So, who is going to buy it?
China.

China could print money and effectively bail out the Russian commodity
market. If so, China would strengthen its balance sheet with
commodities which would strengthen its monetary position as a store of
value, all else equal. The Chinese renminbi (also called the “yuan”)
would also begin spreading more widely as a global medium of exchange
as countries that want to participate in this discounted commodity
trade utilize the yuan in doing so. People are referring to this as
the growth of the “petroyuan” or “euroyuan” (like the petrodollar and
eurodollar, just the yuan). China is also in discussions with Saudi
Arabia to denominate oil sales in the yuan. As China is the largest
importer of Saudi oil, it makes sense that the Saudis would consider
denominating trade in its currency. Further, the lack of U.S. military
support for the Saudis in Yemen is all the more reason to switch to
dollar alternatives. However, the more the Saudis denominate oil in
contracts other than the dollar, the more they risk losing U.S.
military protection and would likely become subject to the military
influence of China. If the yuan spreads wide enough, it could grow as
a unit of account, as trade contracts become denominated in it. This
structure of incentives implies two expectations:

    Alternatives to the U.S. global monetary system will strengthen.

    Demand for commodity money will strengthen relative to debt-based
fiat money.

However, the renminbi is only 2.4% of global reserves and has a long
way to go towards international monetary dominance. Countries are much
less comfortable utilizing the yuan over the dollar for trade due to
its political uncertainty risks, control over the capital account and
the risk of dependence on Chinese military security.

A common expectation is that either the West or the East is going to
be dominant once the dust settles. What’s more likely is that the
system will continue splitting and we’ll have multiple monetary
systems emerge around the globe as countries attempt to de-dollarize —
referred to as a multipolar system. Multipolarity will be driven by
political and economic self-interest among countries and the removal
of trust from the system. The point about trust is key. As countries
trust fiat money less, they will choose commodity-based money that
requires less trust in an institution to measure its risk. Whether or
not China becomes the buyer of last resort for Russian commodities,
global leaders are realizing the value of commodities as reserve
assets. Commodities are real and credit is trust.

Bitcoin is commodity-like money, the scarcest in the world that
resides on trustless and disintermediated payment infrastructure.
Prior to the invasion of Ukraine, Russia had restricted crypto assets
within its economy. Since then, Russia’s position has changed
drastically. In 2020, Russia gave crypto assets legal status but
banned their use for payments. As recently as January 2022, Russia’s
central bank proposed banning the use and mining of crypto assets,
citing threats to financial stability and monetary sovereignty. This
was in contrast to Russia’s ministry of finance, which had proposed
regulating it rather than outright banning it. By February, Russia
chose to regulate crypto assets, due to the fear that it would emerge
as a black market regardless. By March, a Russian government official
announced it would consider accepting bitcoin for energy exports.
Russia’s change of heart can be attributed to the desire for commodity
money as well as the disintermediated payment infrastructure that
Bitcoin can be transferred upon — leading to the third realization.

Realization #3: Crypto asset infrastructure is more efficient than
traditional financial infrastructure. Because it is disintermediated,
it offers a method of possession and transfer of assets that is simply
not possible with intermediated traditional financial infrastructure.

Donations in support of Ukraine via crypto assets (amounting to nearly
$100 million as of this writing) demonstrated to the world the
rapidness and efficiency of transferring value via just an internet
connection, without relying on financial institutions. It further
demonstrated the ability to maintain possession of assets without
reliance on financial institutions. These are critical features to
have as a war refugee. Emerging economies are paying attention as this
is particularly valuable to them.

Bitcoin has been used to donate roughly $30 million to Ukraine since
the start of the war. Subsequently, a Russian official stated that it
will consider accepting bitcoin, which I believe is because they are
aware that bitcoin is the only digital asset that can be used in a
purely trustless manner. Bitcoin’s role on both sides of the conflict
demonstrated that it is apolitical while the freezing of fiat reserves
demonstrated that their value is highly political.

Let’s tie this all together. Right now, countries are rethinking the
type of money they are using and the payment systems they are
transferring it on. They will become more avoidant of fiat money
(credit), as it is easily frozen, and they are realizing the
disintermediated nature of digital payment infrastructure. Consider
these motivations alongside the trend of an increasingly fragmented
system of global currencies. We’re witnessing a shift towards
commodity money among a more fragmented system of currencies moving
across disintermediated payment infrastructure. Emerging economies,
particularly those removed from global politics, are postured as the
first movers towards this shift.

While I don’t expect that the dollar will lose primacy anytime soon,
its creditworthiness and military backing is being called into
question. Consequently, the growth and fragmentation of non-dollar
reserves and denominations opens the market of foreign exchange to
consider alternatives. For their reserves, countries will trust fiat
less and commodities more. There is a shift emerging towards trustless
money and desire for trustless payment systems.
ALTERNATIVES TO THE GLOBAL MONETARY SYSTEM

We are witnessing a decline in global trust with the realization that
the age of digital money is upon us. Understand that I am referring to
incremental adoption of digital money and not full-scale dominance —
incremental adoption will likely be the path of least resistance. I
expect countries to increasingly adopt trustless commodity assets on
disintermediated payment infrastructure, which is what Bitcoin
provides. The primary limiting factor to this adoption of bitcoin will
be its stability and liquidity. As bitcoin matures into adolescence, I
expect this growth to increase rapidly. Countries that want a digital
store of value will prefer bitcoin for its sound monetary properties.
The countries most interested and least restrained in adopting digital
assets will be among the fragmented developing world as they stand to
gain the most for the least amount of political cost.

While these incremental shifts will be occurring in tandem, I expect
the first major shift will be towards commodity reserves. Official
reserve managers prioritize safety, liquidity and yield when choosing
their reserve assets. Gold is valuable in these respects and will play
a dominant role. However, bitcoin’s trustless nature will not be
overlooked, and countries will consider it as a reserve despite its
tradeoffs with gold, to be discussed below.

Let’s walk through what bitcoin adoption could look like:

Source: World Gold Council; Advanced reserve economies includes the
BIS, BOE, BOJ, ECB (and its national member banks), Federal Reserve,
IMF and SNB.

Since 2000, gold as a percentage of total reserves has been declining
for advanced economies and growing for China, Russia and the other
smaller economies. So, the trend towards commodity reserves is already
in place. Over this same period gold reserves have fluctuated between
nine and 14% of total reserves. Today, total reserves (both gold and
FX reserves) amount to $16 trillion, 13% of which ($2.2 trillion) is
gold reserves. We can see in the below chart that gold as a percentage
of reserves has been rising since 2015, the same year the U.S. froze
Iran’s reserves (this was ~$2 billion, a much smaller amount than the
Russia sanctions).

Source: World Gold Council.

Reserves have been growing rapidly in China, Russia and smaller
economies as a whole. The chart below shows that non-advanced
economies have increased their total reserves by 9.4x and gold
reserves by 10x, while advanced economies have increased total
reserves by only 4x. China, Russia and the smaller economies command
$12.5 trillion in total reserves and $700 billion of those are in
gold.

Source: World Gold Council.

The growth and size of smaller economy reserves is important when
considering bitcoin adoption among them as a reserve asset. Smaller
countries will ideally want an asset that is liquid, stable, grows in
value, disintermediated and trustless. The below illustrative
comparison stack ranks broad reserve asset categories by these
qualities on a scale of 1-5 (obviously, this is not a science but an
illustrative visualization to facilitate discussion):

Countries adopt different reserve assets for different reasons, which
is why they diversify their holdings. This assessment focuses on the
interests of emerging economies for bitcoin adoption considerations.

Bitcoin is liquid, although not nearly as liquid as fiat assets and
gold. Bitcoin isn’t stable. Standard reserve assets, including gold,
are much more stable. Bitcoin will likely offer a much higher capital
appreciation than fiat assets and gold over the long run. Bitcoin is
the most disintermediated as it has a truly trustless network — this
is its primary value proposition. Storing bitcoin doesn’t require
trusted intermediaries and thus can be stored without the risk of
appropriation — a risk for fiat assets. This point is important
because gold does not maintain this quality as it is expensive to
move, store and verify. Thus, bitcoin’s primary advantage over gold is
its disintermediated infrastructure which allows for trustless
movement and storage.

With these considerations in mind, I believe the smaller emerging
economies that are largely removed from political influence will
spearhead the adoption of bitcoin as a reserve asset gradually. The
world is growing increasingly multipolar. As the U.S. withdraws its
international security and fiat continues to lose creditworthiness,
emerging economies will be considering bitcoin adoption. While the
reputation of the U.S. is in decline, China’s reputation is far worse.
This line of reasoning will make bitcoin attractive. Its primary
value-add will be its disintermediated infrastructure which enables
trustless payments and storage. As bitcoin continues to mature, its
attractiveness will continue to increase.

If you think the sovereign fear of limiting its domestic monetary
control is a strong incentive to prevent bitcoin adoption, consider
what happened in Russia.

If you think countries won’t adopt bitcoin for fear of losing monetary
control, consider what happened in Russia. While Russia’s central bank
wanted to ban bitcoin, the finance ministry opted to regulate it.
After Russia was sanctioned, it has been considering accepting bitcoin
for energy exports. I think Russia’s behavior shows that even
totalitarian regimes will allow bitcoin adoption for the sake of
international sovereignty. Countries that demand less control over
their economies will be even more willing to accept this tradeoff.
There are many reasons that countries would want to prevent bitcoin
adoption, but on net the positive incentives of its adoption are
strong enough to outweigh the negative.

Let’s apply this to the shifts in global reputations and security:

    Reputations: political and economic stability is becoming
increasingly riskier for fiat, credit-based assets. Bitcoin is a safe
haven from these risks, as it is fundamentally apolitical. Bitcoin’s
reputation is one of high stability, due to its immutability, which is
insulated from global politics. No matter what happens, Bitcoin will
keep producing blocks and its supply schedule remains the same.
Bitcoin is a commodity that requires no trust in the credit of an
institution.

    Security: because Bitcoin cannot trade military support for its
usage, it will likely be hindered as a global medium of exchange for
some time. Its lack of price stability further limits this form of
adoption. Networks such as the Lightning Network enable transactions
in fiat assets, like the dollar, over Bitcoin’s network. Although the
Lightning Network is still in its infancy, I anticipate this will draw
increased demand to Bitcoin as a settlement network — increasing the
store of value function of its native currency. It’s important to
understand that fiat assets will be used as a medium of exchange for
some time due to their stability and liquidity, but the payment
infrastructure of bitcoin can bridge the gap in this adoption.
Hopefully, as more countries adopt the Bitcoin standard the need for
military security will decline. Until then, a multipolar world of fiat
assets will be utilized in exchange for military security, with a
preference for disintermediated payment infrastructure.

CONCLUSION

Trust is diminishing among global reputations as countries implement
economic and geopolitical warfare, causing a reduction in
globalization and shift towards a multipolar monetary system. U.S.
military withdrawal and economic sanctions have illuminated the lack
of security within credit-based fiat money, which incentivizes a shift
towards commodity money. Moreover, economic sanctions are forcing some
countries, and signaling to others, that alternative financial
infrastructure to the U.S. dollar system is necessary. These shifts in
the global zeitgeist are demonstrating to the world the value of
commodity money on a disintermediated settlement network. Bitcoin is
postured as the primary reserve asset for adoption in this category. I
expect bitcoin to benefit in a material way from this global
contraction in trust.

However, there are strong limitations to full-scale adoption of such a
system. The dollar isn’t going away anytime soon, and significant
growth and infrastructure is required for emerging economies to
utilize bitcoin at scale. Adoption will be gradual, and that is a good
thing. Growth in fiat assets over Bitcoin settlement infrastructure
will benefit bitcoin. Enabling a permissionless money with the
strongest monetary properties will spawn an era of personal freedom
and wealth creation for individuals, instead of the incumbent
institutions. Despite the state of the world, I’m excited for the
future.

Whither Bitcoin?