I have written before about the technical superiority of Bitcoin’s lightning network compared to Bcash’s block size increases. In this post I want to highlight the economic differences between these two methods, and draw some parallels with competing economic theories. As the following chart outlines, I believe Bitcoin’s solution of building the Lightning Network is a much slower path to scaling that will, in the long run, provide infinitely greater transaction throughput (and cheaper transaction costs) than simple block size increases. Bitcoin only very grudgingly spends its block space, preferring to save it for a future day when it will be far more productive. As advocated by the Austrian school of economics, Lightning is an example of a more complex capital structure that requires time and patience to build, but repays its investors many-fold in the long run.
|CURRENCY||ECONOMIC SCHOOL||TIME PREFERENCE||BLOCK SPACE||SCALING SOLUTION|
|Bitcoin||Austrian||low (patient)||save||Lightning Network|
|Bitcoin cash||Keynesian||high (impulsive)||consume||bigger blocks|
In contrast, Bcash is happy for users to consume as much block space as they want. Bcash first “upgraded” their network to support 8x bigger blocks, and recently provided another 4x increase. (This despite the fact that those potentially 8 MB blocks were rarely larger than 1 MB. Very few people actually use Bcash for transactions.) If those 32 MB blocks were to fill up completely, the hard disk and bandwidth burden on Bcash node operators would also increase by 32x! This would lead to fewer people running their own full nodes, leading to centralization of the network. Your own full node is necessary for 100% financial sovereignty, and without one you must trust someone else to provide you with accurate transaction information. The whole point of Bitcoin is to eliminate the need for trust in other parties, thus providing security against powerful entities such as governments and big tech.
Impulsive Keynesian vs Patient Austrian
In his recent book, The Bitcoin Standard, Saifedean Ammous describes the nature of Keynes’ mistakes: “[Keynes] theory begins with the (completely unfounded and unwarranted) assumption that the most important metric in determining the state of the economy is the level of aggregate spending across society. When society collectively spends a lot, the spending incentivizes producers to create more products, thus employing more workers and reaching full-employment equilibrium…Recessions, for Keynes, are caused by abrupt reductions in the aggregate level of spending.” (Ammous, p. 138)
“Keynes could not understand that increased savings’ impact on consumption in any present moment is more than outweighed by the increases in spending caused by the increased savings of the past. A society which constantly defers consumption will actually end up being a society that consumes more in the long run than a low savings society, since the low-time-preference society invests more, thus producing more income for its members. Even with a larger percentage of their income going to savings, the low-time-preference societies will end up having higher levels of consumption in the long run as well as a larger capital stock.” (Ammous, p. 143, emphasis mine)
Time-preference is the value that people place on having a good now rather than later. A high time-preference indicates great urgency to obtain the good right now. Low time-preference indicates a willingness to wait for some future day to obtain that good. People are complex, and their preferences differ depending on the specific good and their larger financial context. There is no single time-preference that fully describes anyone. I usually have a low time-preference and prefer saving and investment over consumption. However, I paid $400 for a Nintendo Switch during a period when the supply was very low. A few months later the price dropped to $300. Even so, I didn’t regret my early purchase. I desperately wanted to start playing Breath of the Wild, and that made the extra $100 worthwhile. For that specific purchase, I had a very high time preference.
The Virtuous Cycle of Productivity
Saving and spending are not opposites: in the long run the impatient Keynesian will spend far less than the patient Austrian. He will be like a man catching fish by hand, while the Austrian (or his descendants) commands a deep-sea fishing vessel which catches the Keynesians lifetime supply of fish in a matter of days. In this extreme case, the Keynesian is at the level of a subsistence farmer or hunter-gatherer. He does not have even an excess supply to sell at the market. All this while the Austrian has generated dozens, if not hundreds of jobs: the manufacturers of his ship and nets, the drillers for oil that power it, and the crew he employs to actually do the fishing.
This is the Austrian answer to Keynes’ obvious flaws. Production must come before consumption. We who are disciplined and patient in building up our capital structure (which often means our own skills and education) will, in the future, be capable of producing the same amount of goods more efficiently. This will leave excess time and money for leisure and consumption, or for investment in new entrepreneurial ventures. These new ventures further increase our productivity and the virtuous cycle continues.
The nature of Bitcoin’s extended capital structure
This post focuses on the economic presuppositions of Bitcoin and Bcash. However, I do want to explain briefly the nature of the more complex, and more efficient, capital structure I’m advocating. Bitcoin Cash supporters argue that Bitcoin scaled smoothly for years simply by using bigger blocks. “If it ain’t broken, don’t fix it!” We should scale Bitcoin out to the whole world by continuing that same pattern. If the blocks fill up, just make them bigger. The problem is that continuing this method of scaling will lead to exponential growth of the blockchain as Bitcoin use increases. Blockchain tech has fundamental limitations: namely that every single transaction has to be broadcast to and stored by every full node. It is excessive for tens of thousands of Bitcoin nodes to be notified of and store the data for your purchase of a Starbucks coffee. This is a gross overconsumption of resources, both hard disk space and bandwidth.
Ethereum, whose blockchain is much younger than Bitcoin’s, is already over 500 GB and growing fast. It has become increasingly difficult for users to run full nodes. They must simply trust the few (wealthy) users who have the resources to run a full node. The Bitcoin community foresaw this problem years ago and decided not to allow blocks to get any bigger. However, Bitcoin Cash is not learning from the mistakes of Ethereum.
Instead, they are skeptical of the need for investment in more robust scaling tech such as the Lightning Network. Part of this skepticism is linked to rhetoric emphasizing “Satoshi’s vision” and the whitepaper as Bitcoin’s inspired scripture. We cannot require Satoshi to have foreseen all the implications of Bitcoin and reference them in the whitepaper. The implications of fundamental discoveries take decades to fully come to light. The possibility of second-layer networks was always implicit in the design of Bitcoin. But it required nearly nine years from the genesis block to conceive of and begin implementing Lightning. It will likely take several more years before it attains widespread use. This is the slow-but-steady nature of technological development. Again, many Austrians claim such slow, generation-by-generation development is the foundation of civilization itself. So why are Bcash supporters so opposed to it?
Keynesian Bias 1: Mistaken emphasis on consumer payments
I think it is partly due to a sneaky, Keynesian presupposition which still has a hold even on those of us who are followers of the Austrian school. Many Bitcoin Cash supporters, some of whom were early supporters of Bitcoin, are libertarians and Austrians. Most prominent of these is Roger Ver, who I deeply respect for his courage to live out his libertarian convictions. But why would Roger and other libertarian supporters of Bitcoin Cash be so panicked about losing the market for consumer payments? This reflects the mainstream focus on consumerism more than anything. This attitude was summed up clearly in a recent New York Times article: “The new efforts [by the parent company of the NYSE] to trade Bitcoin don’t help answer basic questions about what makes the virtual currency useful in the real world. Most attempts to use Bitcoin for everyday commerce haven’t gained traction, and investors have treated it as a speculative commodity like gold or silver.”
The NYT writes that Bitcoin is not “useful in the real world,” explaining that its uses for “everyday commerce haven’t gained traction.” Most Bitcoin Cash supporters would agree wholeheartedly. They saw Bitcoin losing market share to altcoins. They saw some merchants dropping Bitcoin support due to increasing fees. And they panicked, threw aside the Lightning Network because it was “taking too long,” and doubled-down on increasing the block size. I believe the libertarian supporters of Bitcoin Cash have good intentions—they truly want Bitcoin to succeed. But ultimately, Bitcoin is not about consumer payments. Its core value proposition is sound, uncensorable money. Bitcoin transactions are not subject to government capital controls, account freezes, or central bank inflation. We cannot sacrifice the world’s best example of decentralized, free-market money for consumer payments.
I’m saddened that even many of the Libertarians involved in cryptocurrencies have been sucked into this Keynesian emphasis on consumer payments. Just listen to any of the debate between Bitcoin and Bcash: you will hear well-meaning, libertarian Bcash supporters championing the Keynesian cause. They give lip service to the importance of security against centralized control…but quickly dismiss it since “it hasn’t happened yet.” I would argue that, no, in fact it has happened already. Not in cryptocurrencies, but in the internet which is dominated by Facebook, Google, Amazon, and a handful of other big tech companies. These companies have repeatedly given in to requests for government censorship and surveillance. Government pressure on cryptocurrencies is inevitable. We must always prepare for that day. And Bitcoin, BTC, is the only one with a fanatical focus on making centralized control impossible.
Keynesian Bias 2: Gold and Bitcoin are merely “speculative commodities”?
The NYT article also implies that gold and silver are are not useful in the real world. Bitcoin is grouped with gold and silver as another “speculative commodity.” The Keynesian bias could not be more clear. Sound money with a constrained supply—such as gold or Bitcoin—is not useful in itself. Money is primarily for “everyday commerce.”
This is a typical Keynesian misunderstanding of Bitcoin. Even the Austrians among us have been so deeply conditioned by consumption-focused propaganda that we get it wrong. Again, Bitcoin is not, at its core, about fast and cheap consumer payments. It’s unique value proposition is uncensorable financial transactions. If you’ve never had banking troubles, you probably don’t realize just how easy it would be for the government to stop/reverse specific payments or even freeze your entire account. Aside from these active steps, they can (and do) passively observe all the payments and transactions you make. In contrast, no government can stop you from sending a Bitcoin payment. Bitcoin’s value is independent of government backing, just as the value of gold is government-independent. Gold was around long before the recent crop of inept governments, and it will still be around, and likely still be valuable, long after they are gone.
Gold was often held hostage by government
However, gold has often been confiscated and tightly controlled by governments to keep it from playing its traditional role as the money chosen by the free-market. How does Bitcoin maintain its resistance to government control? The key, as one Bitcoin supporter explains, is decentralization: “Napster was easily shut down as the US courts could force one company to flip a switch to the off position. BitTorrent on the other hand can’t be shut down because it’s “everywhere” with no central server. Bitcoin works on the same principle. There is simply no way to switch Bitcoin off without shutting down the Internet. So clearly Bitcoin is decentralized in the same way that BitTorrent is decentralized. There is no currency more decentralized than Bitcoin anywhere. Bitcoin’s digital nature as well as it’s permission-less design makes it more decentralized than either fiat or gold.”
More decentralized than even gold? The problem with gold is that it is heavy and expensive to securely store or transport. As a result, throughout the 1800s and early 1900s gold flowed towards central banks, which issued paper money that could be exchanged by the bearer for gold. That paper money was “gold-backed” and this system was called the “gold standard.” Unfortunately, due to the centralized storage of gold, it was very easy for governments to confiscate it when the time came. Under the excuse of promoting national security, governments decreased the quantity of gold redeemable for a given amount of paper money, outlawed redemption entirely for awhile, devalued the paper money again, then finally severed the connection between government-issued notes and gold completely. And there was no way for the citizens to stop this government overreach, because the central banks already had physical possession of the gold!
In contrast, Bitcoin makes it relatively trivial to store and transport even enormous amounts of wealth. Although right now this takes some degree of technical knowledge, the situation is improving as more user-friendly solutions are being developed by dozens of individuals and startups. There is no central repository for Bitcoin wealth as there used to be under the gold standard.
Mental barriers to low-time preference decisions
Before concluding, I want to answer another objection that Bitcoin Cash supporters raise against Bitcoin. Why did Bitcoin not allow even a small block size increase? Surely this would buy us more time to figure out more sustainable scaling solutions like the Lightning Network?
A full answer to this objection would require me to explain in some detail the history of the scaling debate. I hope to write on that topic sometime. For now, I just want to answer using the notion of time inconsistency, which is a helpful supplement to our earlier discussion on time-preference. In the Dao of Capital, Mark Spitznagel has written about the difficulty of acting with a low time preference. The movement toward the roundabout solution of developing a more efficient solution feels like “going against the grain of our very nature.” He continues,
“This requires a complete inversion of a behavioral pattern known as time inconsistency (and generally expressed mathematically with a hyperbolic discounting model). This pattern, present in all of us and distorted to extreme and even dangerous levels in the cases of addictions, is to be impatient now, all the while holding fast to the self-delusion of being able to be patient later. (And, of course, when later becomes now, we are just as impatient.) We expect to act very differently through time than we actually do, predictably throwing a wrench in our best-laid plans, especially the more roundabout ones. This phenomenon plagues us in all aspects of life; not just in financial decisions, but also things such as weight loss, learning a foreign language, catching up with old friends, and so forth. We always want to do something a bit onerous that will shower us with long-term benefits, but we never want to do it today.” (Spitznagel, p. 140, emphasis mine)
It is possible that Bitcoin should have increased the block size to 2 MB long before the Bcash hard fork. There is nothing sacred about 1 MB blocks. And probably a single such block increase would do no lasting harm. But I worry it would lead to complacency and the tendency to push a real solution further and further into the future. What happens when, as they inevitably would, those 2 MB blocks became full? Would we then declare another emergency increase of the block size to 4 MB, allowing more time to implement a more complete scaling solution? It would be tempting to use this easy solution for multiple “emergency” space increases. As Spitznagel says, faced with a difficult and unpleasant task, we all have a tendency to put it off to an imagined future in which we have more willpower.
Bitcoiners are patient
Bitcoin users and programmers are willing to wait. Unlike the companies that supported Bcash and segwit2x, Bitcoiners have no investors or shareholders to placate. Many are already financially independent and simply want the most robust, uncensorable, independent network possible. And this will take time to build. More efficient capital structures always take more time. We defer immediate consumption of the block space to write code that will enable that block space to be used far more efficiently. From the beginning, Bitcoin has attracted an unusually high number of Libertarians and others who hate cheap Keynesian money. We prefer the hard money advocated by Mises, Rothbard, and other Austrian economists. And we prefer the slow, steady but overwhelmingly powerful solution of improving our capital structure.
As Nassim Taleb writes in the forward to Ammous’ book: “In its present state, [Bitcoin] may not be convenient for transactions, not good enough to buy your decaffeinated espresso macchiato at your local virtue-signaling coffee chain…But its mere existence is an insurance policy that will remind governments that the last object the establishment could control, namely, the currency, is no longer their monopoly. This gives us, the crowd, an insurance policy against an Orwellian future.”