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Lyn Alden and Nic Carter: Swan Signal Live E26

Posted 9/3/20 by Brady Swenson

Lyn Alden and Nic Carter sat down for a lively conver­sa­tion about the future of transi­tioning the world away from dollars and onto a Bitcoin standard. They discussed what a free-banking Bitcoin system could look like, the drawbacks of central bank digital curren­cies, and why Bitcoin will never suffer the same fate as gold.

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Summary:

0:00 Intro­duc­tion

1:36 Views on the Micros­trategy and Fidelity news

6:10 Will Bitcoin be rehypoth­e­cated the way gold was?

10:38 Are exchanges already fraction­ally reserve banking?

14:00 Views on the Fed’s new infla­tion policy

22:50 How will the election affect the economy?

27:56 Can Bitcoin produce a yield like treasuries?

33:30 Finan­cial products built on Bitcoin

38:17 Do use cases for crypto dollars exist?

44:35 Concerns about the end of the Bitcoin block reward?

51:17 History of finan­cial­iza­tion

59:43 How would the finance industry be different on a Bitcoin standard?

1:09:13 Thoughts on central bank digital curren­cies

1:14:47 Wrap up

Transcript:

Brady Swenson:

Hey everyone. Welcome back to Swan Signal Live. I’m your host Brady Swenson, Head of Educa­tion at Swan. We have another fantastic pairing for you today. Really excited to be here with Nic and Lyn. I will intro­duce them in just a moment, but first I will Swan for you for just a moment, talk to you about what we built here at Swan. We have built the best way to accumu­late Bitcoin with automatic recur­ring buys. It’s just one, two, three. You set your bank account, connect your bank account. You set the frequency and amount you want to buy.

Brady Swenson:

We buy it for you and then you can withdraw it automat­i­cally if you’d like as well. So, we do that with extremely low fees up to 57% lower than Cash App and up to 80% lower than Coinbase. Get off Coinbase, get on Swan. In case you missed it, we’re setting up daily buys. It’s going to be launching soon. So, you can buy every single day, catch those dips a little better even than on the weekly. You can sign up for that at swanbitcoin.com/dailybuys. All right.

Brady Swenson:

I’m thrilled to welcome Lyn Alden back to the show. She’s an invest­ment strate­gist. Lyn was previ­ously on Episode 21 with Jeff Booth. That has been so far the top Swan Signal episode yet. Lyn, welcome back to the show.

Lyn Alden:

Thanks for having me again.

Brady Swenson:

All right. Nic Carter, partner at Castle Island Ventures, well known of course for his great Bitcoin writing. Excited to have you here, Nic, along with Lynn, for your first appear­ance.

Nic Carter:

First time. Thank you. Glad to be here.

Brady Swenson:

Exciting for this one. All right, so let’s dive into talking about some news that came up recently. You are on, Lyn, a great episode of Preston Pysh’s The Investors Podcast with Jeff booth and Luke Gromen. I think it was about 10 days ago. This was after the MicroS­trategy news, but before Fidelity announced that it is launching a Bitcoin-only fund. Both of these of course are on the heels of big macro investors becoming incred­ibly bullish and revealing positions in Bitcoin, Paul Tudor Jones, Raoul Pal, etc. These are some pretty big dots, starting to form a pretty bright line. What’s your take on MicroS­trategy and the Fidelity announce­ments?

Lyn Alden:

I think those are impor­tant parts of this whole narra­tive because in each halving cycle, basically, Bitcoin reaches a new kind of group of investors, right? So, largely up until now, it’s been mostly retail driven asset class, but in the past couple years, it’s starting to get more insti­tu­tional access points. So, seeing corpo­ra­tions, at least small corpo­ra­tions begin to diver­sify to Bitcoin, and seeing some of the big players begin to allocate to it. So, there’s already been a certain amount of family office partic­i­pa­tion, a little bit of hedge funds, but seeing kind of bigger names go into that space is definitely very impor­tant for the asset class as we go into this next cycle. I’m sure Nic can talk more about the Fidelity action. I think that he probably has more to say there.

Nic Carter:

Well, I haven’t been out of Fidelity for a couple years. I’m not really privy to all the details there. But I will say that Fideli­ty’s commit­ment to Bitcoin since 2014 has been unques­tion­able. They kept building products relating to Bitcoin that whole time. Although it’s a long journey like any large finan­cial insti­tu­tion, it takes a long time to get full buy in.

Nic Carter:

But I think to me, it’s impor­tant just to kind of sit back and realize that the finan­cial plumbing in terms of access points to Bitcoin is so superior today as compared with 2017. It’s almost incom­pa­rable. So, there’s vehicles like what appears to be this new Fidelity funds. The CME is a highly liquid venue now. There’s a lot of partic­i­pants that can only really trade those CME futures, wasn’t really liquid or meaningful in 2017.

Nic Carter:

And then you have really high-quality custo­dial offer­ings, obviously, like the one Fidelity offers, but there’s others now as well. These things just funda­men­tally didn’t exist in 2017. So, the Bitcoin’s markets capacity to absorb new capital from a more diverse set of partic­i­pants has also progressed signif­i­cantly, which is why I think there’s no boundary to where this could go this time.

Lyn Alden:

Yeah, I cited a Fideli­ty’s custo­dian solution in my Bitcoin article from a couple months ago. So, it’s not like Fidelity is entering the first time obviously. It’s just they’re building on the fact that they’re already in the space. So, I agree. It’s a totally different world than it was three, four years ago.

Brady Swenson:

It really is. Go ahead, Nic.

Nic Carter:

I was just going to say, the funders thought a lot of details around it, but once you have those little pieces built like custom, you can build all sorts of other finan­cial products, finan­cial manage­ment products on top of it. Now that we have those puzzle pieces in place, I think we’re going to see a lot of different asset managers jump into the mix. I think we even saw a Bitcoin product release in Austria today on a Viennese Stock Exchange. You see this kind of gradual devel­op­ment. There was a 3iQ on in Canada recently. You just see more ways to express an opinion on Bitcoin and more juris­dic­tions emerging all the time. It’s just like this steady march of progress.

Brady Swenson:

Yeah, and I would expect that we’ll continue to see more news like that in the coming months and years. It just feels like it’s sort of building. It’s like a snowball rolling down the mountain and it’s just kind of exponen­tially advancing, which is what we would expect from this network technology built on top of other network technolo­gies using the network effect of money. There’s all kinds of exponen­tial reinforcing going on with Bitcoin.

Brady Swenson:

So, when we’re talking about these finan­cial products like this Fidelity funds, CME futures, etc, there’s kind of I guess a contin­uing concern among Bitcoiners that using these kind of tools, rehypoth­e­ca­tion Bitcoin or creating paper versions of Bitcoin, etc, might suppress price or maybe even bringing Bitcoin under control like it did with gold. I talked with Preston Pysh about this last week on this show, and he had a good answer for it. He said that Bitcoin democ­ra­tizes final settle­ment, right? Since final settle­ment is so much easier with Bitcoin, that that risk of rehypoth­e­ca­tion and kind of control of the asset is dimin­ished. I would love to hear what you guys have to say. Nic, you want to start?

Nic Carter:

Yeah, I have a similar answer. You just compare Bitcoin with gold and look the settle­ment charac­ter­is­tics. Because it’s easy to take physical final delivery of an arbitrary quantity of Bitcoin, if you’re concerned about your custo­dian or bank or credit provider or broker, you can withdraw your coins. Obviously, if it’s in the terms and service, you can never withdraw, then obviously you can’t. But at that point, you never really had owner­ship of actual Bitcoin. You only ever had an IOU.

Nic Carter:

But any service that allows for withdrawal, if you become the slightest bit concerned, you can opt out of that system. That’s different I would say from gold. Not to disparage gold, but gold is physi­cally instan­ti­ated. It lends itself to being trapped in these kind of walled gardens, where every link in the supply chain from refiners to custo­dians to finan­cial insti­tu­tions is heavily authen­ti­cated and it’s costly to get gold outside of that supply chain. We saw these dislo­ca­tions between New York gold and London gold earlier this year, because you had to physi­cally trans­port gold on planes. Whereas with Bitcoin, that physical final settle­ment is easier and cheaper.

Nic Carter:

The other thing I would say is the verifi­ca­tion is cheaper for Bitcoin. I can prove that a Bitcoin payment I’m receiving is genuinely Bitcoin and it’s the real thing. The equiv­a­lent with gold would be to use an XRF spectrom­eter or something like that to verify the atomic proper­ties. A third party can prove to me that they own a certain quantity of Bitcoin, which is very impor­tant. This is why I’m always blath­ering on about proof reserves, because a third party can prove that they are in theory solvent or at the very least they have a quantity of Bitcoin that they claim to have.

Nic Carter:

So, that’s why I think the custo­dial environ­ment for Bitcoin is not so concerning to me, because A, we have the ability to hold these custo­dians more account­able through these crypto­graphic opera­tions. B, because if shit hits the fan basically, we can withdraw and take final owner­ship over our physical Bitcoin effec­tively.

Lyn Alden:

I agree. So, some of the people that brought up those concerns I think had good basis to be concerned about that, because any asset that has a reason­ably high stock-to-flow ratio is subject to more market manip­u­la­tion compared to an asset where most of what’s produced is consumed in the same year. So, golds had this long-standing history, where if you look at the paper markets, there’s far more paper assets than the under­lying gold metal most of the time. So, a lot of people think they own gold, except if they were to all try to withdraw their gold at the same time, basically the exchange would cease to function in most of those environ­ments.

Lyn Alden:

So, golds always had that that issue, but I think there’s kind of two reasons for Bitcoin to have less of it. One is this issue that it’s much easier to authen­ti­cate and trans­port digitally. And then two, because it’s so volatile that it’s a much less kind of lever­aged area at least for these major exchanges than gold. So, a lot of the custo­dians that value is more like deriv­a­tive contracts, they want more under­lying Bitcoin exposure than they would for gold, would tend to be far less volatile and larger asset class.

Brady Swenson:

We have a related question coming in from our Telegram chat. It’s at t.me/swansignal, if anybody’s inter­ested in jumping in there and chatting. We also have quite a few people chatting in the YouTube, youtube.com/swansignal. So, this is from Joe Rogers. He says that he’s heard specu­la­tion from our friend, Hass McCook, a Bitcoiner, well known at Bitcoin Twitter, about fractional Bitcoin reserves being an issue that is suppressing price. Also, Nic, you’ve been a pretty strong advocate for proof of reserves as you were alluding to earlier. Can you share your overall opinions if you think exchanges are indeed fractional reserve banking Bitcoin? What are the long-term impli­ca­tions if so?

Nic Carter:

The truth is currently for a lot of these offshore exchanges, we have no way of knowing whether they’re fractional or not. We just have to take them at their word that they’re effec­tively not commit­ting fraud against their depos­i­tors. It would be much better if there were self-regula­tory forces in the industry where depos­i­tors had a habit of using exchanges, which did a test to the existence of reserves. So, market forces, that would be my kind of ideal situa­tion whereby users were to migrate over to exchanges there are more serious about proving the existence of reserves. Barring that, I think what’s also possible is that you get a regula­tory outcome which would be kind of adverse. Assuming there’s more Quadrigas, I’m sure there’s other Quadrigas lurking out there, especially the offshore exchanges.

Nic Carter:

Assuming there’s more Quadrigas, regula­tors could say like they did in Canada, “Hey, we’re actually going to effec­tively disallow custo­dial owner­ship of bitcoins at all. We’re going to demand that exchanges issue or brokers issue bitcoins on a pass-through basis.” They are not allowed to hold them on behalf of depos­i­tors at all, which is kind of a bad outcome. Looks like that’s we’re going to get in Canada at some point. That’d be a bad outcome, because there’s always demand for banks. I think that’s a reason­able thing to exist, to want inter­me­di­ated access to your coins if you don’t feel equipped to hold them for yourself.

Nic Carter:

But yes, I’m not 100% sure that there’s other exchanges which are covertly fractional. It could be due to bugs. It could be due to mistakes, accounting errors. From what I’ve seen it, a lot of exchanges don’t really have a good appre­hen­sion of their balance. Maybe they end up with a bunch of stranded UTXOs that are uneco­nom­ical to withdraw for instance due to fees. There’s a lot of ways that exchanges can kind of tip over into fractional terri­tory.

Brady Swenson:

Lyn, do you have any thoughts on fractional reserve banking in Bitcoin?

Lyn Alden:

Not totally, because it’s not an area that I go into that much depth on. From what I’ve seen, there’s more risk in some of these offshore smaller opera­tions, where there’s more leverage, I think. Whereas, if we’re talking about kind of more insti­tu­tional custo­dian type situa­tions and futures contracts, things like that, a lot of them have pretty strict require­ments. Yeah.

Brady Swenson:

Yeah. All right. Well, let’s move on then. Thanks for the answer there. I hope that answered your question, Joe. Let’s move on to the Jerome Powell speech. So, as usual, the content of the speech was pretty well under­stood before it happened. But Powell did confirm that the Fed will tolerate infla­tion over 2% for short periods of time. Last week, we had Andy Edstrom, like you said with Preston. He said that “Powell is now the anti-Volcker.” But is this really a change in policy or just a small kind of recog­ni­tion of the reality of an even more expan­sionist policy that may be required at this point? Lyn, you want to start on that one?

Lyn Alden:

It’s kind of a small change in policy. So, it’s actually really nothing new, because they were already telegraphing this ahead of time. So, anyone who reads the Fed meeting minutes saw that they were willing to allow for an overshoot of infla­tion. Even going back all the way to 2018, they’ve been empha­sizing their 2% infla­tion target as a symmetric target. So, they started to slip in the word symmetric more and more. And then in 2020 due to the pandemic, they started to more directly say, “Well, we want to overshoot it.” And then at Jackson Hole, he went out and call it average infla­tion targeting.

Lyn Alden:

The main thing was kind of just more directly saying it and publi­cizing it at a big venue, compared to only sticking in their meeting minutes, which are all to some extent subject to disagree­ments. Because for example, some things can show up in the meeting minutes, but not neces­sarily become official policy, because the different partic­i­pants can discuss and agree and disagree with each other. So, for the Fed chair to say to Jackson Hole was a little bit more of an adamant outcome.

Lyn Alden:

The main thing I think to keep in mind is that the Fed doesn’t have a lot of tools to directly create infla­tion. They’ve been wanting higher infla­tion by the way they measure it, which is the PCE. They haven’t reached that target very often again according to the way they measure it. So, if you look at histor­i­cally, it’s in this sort of environ­ment where rates at zero and where the Fed’s expanding the monetary base and kind of using tools like that. It’s really more about deficit spending that tends to be somewhat more infla­tionary outcome.

Lyn Alden:

So, the Fed is kind of indicating that they’re not going to get in the way of higher infla­tion, but they’re not really the causes of that. It’s more about the fiscal authority, how they choose to spend, if they want to give out more stimulus checks, more unfunded tax cuts. Whatever they want to do, they could poten­tially cause more infla­tion. And then if that happened, the Fed can just kind of standby. So, we have seen a rebound in infla­tion expec­ta­tions from the March low. Although currently they’re hovering under 2% for most of the durations. So, it’s really just kind of a rebound in infla­tion rather than higher infla­tion expec­ta­tions.

Nic Carter:

Lyn, I wanted to ask you something actually. So, many times, you’ve indicated you think we’re headed into a more infla­tionary environ­ment poten­tially kind of stagfla­tion even. The rebuttal I always hear is that kind of demographics are destiny. We’re going to have a funda­men­tally hard time finding infla­tion and growth, which I guess is closely related due to the aging workforce and so on, those other kind of funds and defla­tionary factors. In light of this, I know, it doesn’t really change much, but what do you make of the prospects for actually causing infla­tion in the US, especially given like the Japan example, which everyone always talks about?

Lyn Alden:

Sure. Yeah, there’s a couple things to unpack there. So, definitely, demographics play a large role as does technology, which is what I talked to Jeff Booth about last time. So, technology, of course, is a very strong defla­tionary force. That’s what we saw in many decades before, including the last time we’re in one of these long-term debt cycles, this last kind of period of kind of a rebound and infla­tion which started back in the 1930s and 1940s. They had a lot of technology come online, they had high debts. It caused a pretty big disin­fla­tionary trend until they inten­tion­ally devalued their currency.

Lyn Alden:

So, all of those trends in practice are very disin­fla­tionary. So, weaker demographics, more technology, more debt, all of those are disin­fla­tionary forces, until they cause enough of a breaking point that policy­makers use more aggres­sive tactics to devalue their currency. So, back in the 1930s and 1940s for example, first, they devalued the dollar versus gold, and then they ran very large deficits in cap yields for treasuries below the infla­tion rate for about a decade.

Lyn Alden:

So, the combi­na­tion of that kind of one-two punch, devalued currency pretty consid­er­ably, and devalued debts relative to nominal GDP by exten­sion, even though nominal debts barely came down at all. There’s maybe 12 to 15% nominal reduc­tion in debt, but percentage of GDP collapse consid­er­ably. You can point to some places like for example, Argentina. They don’t have phenom­enal demographics, but they have no problem getting infla­tion, right? Because in some extreme cases, those monetary condi­tions and fiscal condi­tions can override demographics issues or technology-based issues. Japan is kind of a unique situa­tion, because they are the world’s largest creditor nation, which means that they own more foreign assets than foreigners own of their assets by a wide margin.

Lyn Alden:

So, they’ve kind of had this massive savings glut. So, even though they have high debt, sover­eign debt relative to GDP, a lot of that debt is held inter­nally, and then they also hold a ton of foreign assets. So, as a result… Also, they run roughly balanced trade balance, but then positive current account balance. So, they kind of have more money flowing into their economy than out every year. So, that that tends to be kind of supportive for currency. Whereas the US is kind of the opposite situa­tion, where we’re the world’s largest debtor nation. So, due to running persis­tent trade deficits and current account deficits, over the past several decades, we’ve devel­oped a deeply negative inter­na­tional invest­ment position. So, we’re somewhat more and more vulner­able to a cycle trend in infla­tion.

Lyn Alden:

So, my primary outlook is to kind of see these large monetized deficits eventu­ally kind of spur higher infla­tion. Now, I think that can take a lot of forms. So, for example, I see people, calling for like hyper­in­fla­tion by the end of the year, next year. That’s not the kind of approach I’m looking at. It’s more like a trend change from ever lower disin­fla­tion to kind of a bottoming process and then a poten­tial rise in that trend towards a more infla­tionary situa­tion.

Nic Carter:

So mindful of this, I mean, what is the metric for infla­tion that you pay atten­tion to? I mean, a lot of people would say that asset prices reflect infla­tion. Is it like the dollar index and the CPI? What is the jurist metric for actually measuring this?

Lyn Alden:

A couple different ways. I look at CPI, I look at PCE, things like that, those kind of under­stated asset prices are definitely a big thing. That’s been more over the past decade, because we’ve had the monetary base expan­sion, but not really aggres­sive fiscal spending to really get that in the real economy. So, it all concen­trated towards the top and got into asset prices. I also look at, for example, precious metals, gold in partic­ular, because it’s a large asset class. So, it doesn’t move a ton on its own, other than some of these more infla­tionary expec­ta­tions or in response to real yields. So, I like to look at things like the S&P 500 is pricing in gold or just the nominal price movement of gold, things like that. In addition, I also look at the expan­sion of broad money supply itself.

Lyn Alden:

So, histor­i­cally, the year of Euro change in M2 broad money supply has gone with infla­tion but tends to be higher than infla­tion rate, because we also get other disin­fla­tionary forces of better technology, better produc­tivity, things like that. But histor­i­cally, some of the big spikes in broad money supply have eventu­ally led to higher infla­tion levels. So, I kind of look at a variety of different metrics to kind of measure that over time. And then the main metric I look at that kind of precede infla­tion is deficit spending by the fiscal authority, because that’s what histor­i­cally tends to drive kind of deal with a long term debt cycle, and then bring a more disin­fla­tionary shift into a more infla­tionary shift.

Brady Swenson:

So, let’s talk a little bit about those fiscal author­i­ties. We have a big election coming up. I know that that’s something that macro investors and strate­gists need to pay atten­tion to. Do you think, Lyn, that we’re going to see any differ­ence in terms of econom­i­cally speaking and fiscally speaking? And then of course, as it relates to infla­tion, poten­tial infla­tion, CPI and assets, whatever, between the two possible outcomes of this election.

Lyn Alden:

Yeah, I think you can get different outcomes obviously. There’s different types of spending they want to do. One thing I’ve been empha­sizing is more than two outcomes, right? Because in terms of who wins, that’s obviously the big binary choice, right? Which Presi­dent is here next year? But it’s also if the Congress is gridlocked with that Presi­dent or not. So, for example, you could get a Biden victory, but then the Senate could stay red, for example, right?

Lyn Alden:

And then we’re more in a situa­tion like we saw in, for example, Obama’s second term, where there actually wasn’t a lot of fiscal spending, because we were more in gridlock. Whereas if you get a Trump win and Senate stays red and you have a pretty strong kind of red sweep, then Trump’s a very spendy presi­dent, either in the form of spending or in the form of unfunded tax cuts, for example.

Lyn Alden:

On the other hand, if you get a blue sweep, you’re also likely to see a pretty good amount of spending. Biden would probably spend more, but also could pretend to raise taxes more. So, it’s unclear whether the debts are bigger in either of those scenarios. I think one of the poten­tials for a more disin­fla­tionary period would be to see, for example, like I said, a Biden win and the Senate red hold, and then you have gridlock and then probably less of both things. So, I think that the long-term trend is tracking a probable shift from a disin­fla­tionary trend to a more infla­tionary trend.

Lyn Alden:

But ever since we kind of run off this fiscal cliff at the end of July, right? So ever since the PPP loans were not really happening and ever since the extra unemploy­ment benefits stopped going out and the stimulus checks are long since spent, I’ve been saying, “Okay, we had this big refla­tionary rebound, but now they’re back in gridlock. So, we have to see what happens in the next couple months to see if we’re probably…” It might take something like either more civil unrest or another big asset price decline to spur policy­makers to do something, because as long as stocks selling go up, as long as Tesla’s going up, as long as the stock prices soar and there’s not kind of a ton of protesting and things like that, they don’t really have a strong incen­tive to do another big fiscal boost.

Brady Swenson:

Nic, have you been thinking about this at all?

Nic Carter:

Yeah, I think Lyn covered it well there. What I would say is I’ve noticed that the conser­v­a­tives are not a party of fiscal respon­si­bility anymore. That time seems to have long since gone. Both parties seem united on their desire to just spend exces­sively and grow the size of govern­ment funda­men­tally. I haven’t really noticed much of a differ­ence between the two of them. The only differ­ence is the kind of I guess spending programs they would pursue. Although there’s certainly some common­al­i­ties, but it seems to me that there’s a polit­ical demand in this country or growing polit­ical demand or normal­iza­tion of kind of unfet­tered handouts in the form of either tax cuts or UBI like programs. These have been kind of normal­ized the last 18 months. They’re uncon­scionable two years ago.

Nic Carter:

Yang kind of brought them into the conver­sa­tion. Now, it’s effec­tively mainstreamed the notion of kind of semi-perma­nent gover­nance stimulus directly to individ­uals. I think that’s notable because I call it a high velocity issuance, because that’s directly into the actual economy, especially if that’s going right to house­holds. As opposed to QE, which has kind of a hard time making it into the real economy, so to speak.

Nic Carter:

So, I think regard­less, we’re going to get signif­i­cant spending. My view of this is that’s fine. Some amount of spending is appro­priate, but the govern­ment is not the allocator of funds. I think the free market does a better job at that. So, I never see this question or scruti­nize the notion that the govern­ment could be the primary allocator of capital on the economy, especially as the govern­ment spending share of GDP grows from kind of 30, 35%, where it normally is to north of 50% where it effec­tively is today.

Brady Swenson:

So, I want to turn to talking about Bitcoin as collat­eral. Raoul Pal posted yesterday a couple screen­shots from his monthly GMI reports newsletter that’s going out to subscribers. He discussed Bitcoin collat­eral and he called Bitcoin, ‘pristine collat­eral’. He described how the debase­ment of collat­eral has created this environ­ment where the tail risk of really bad outcomes are much better than we are comfort­able with. And then he continued to say that all we need to get Bitcoin from where it is now is a form of collat­eral to the future of collat­eral for a global economy is that it can produce a yield curve. Lyn, I heard the term ‘yield curve’, and I thought of you. Can you talk to us about what you think Raoul is saying here? How could Bitcoin produce a yield curve now or in the future?

Lyn Alden:

I didn’t look into his tweet in specific, so I don’t want to talk for him. I’m mostly approaching Bitcoin similar to gold at the current time, but as a kind of a smaller growth version of it, right? So, whereas treasuries, for example, histor­i­cally pay you yield, but they have counter­party risk. Most of them are not infla­tion adjusted, and even the ones that are infla­tion adjusted are adjusted to the govern­ment’s defin­i­tion of infla­tion. Whereas gold and Bitcoin and some other commodi­ties are scarce yield-less assets, right? So, in an environ­ment histor­i­cally, if you look at gold store price perfor­mance compared to treasuries, for example, people often think of it as an infla­tion hedge, but it’s really a negative real yield hedge.

Lyn Alden:

So, gold’s year-over-year price change tends to inversely corre­late to real treasury yields or real bank account yields. So, if you can put cash in a bank and say infla­tion is low, it’s 2%, and you can get 4% from your bank, your treasury, you’re making a positive 2% real yield. So, there’s a strong incen­tive to save in that way, to save in fiat. It puts kind of a higher oppor­tu­nity cost on things like gold that are yield-less, but kind of scarce infla­tion adjusted asset.

Lyn Alden:

On the other hand, when you have periods where real yields are negative, those yield-less assets suddenly become a lot more attrac­tive because they’re scarce. But they have no counter­party risk and they can’t be inflated away. The whole oppor­tu­nity costs for them either goes away or becomes negative. If a zero yield is better than what you’re getting from real treasury yield, suddenly, there’s an oppor­tu­nity cost to holding treasuries instead of holding gold or silver or Bitcoin and things like that. So, I’m focusing less on the yield itself.

Lyn Alden:

I think over time, if Bitcoin becomes a larger asset class, just that there used to be monetary systems built on gold as an asset class, you could conceiv­ably have more and more monetary system built on Bitcoin. Of course, we already see that in the form of some of these ways to get yield from it, which is basically operating like a bank. To my knowl­edge, currently, not FDIC insured or anything like that. So, there’s more kind of nominal risk there. But yeah, as things build out, you can get more systems built on top of that under­lying collat­eral.

Nic Carter:

Yeah, I’ll just add to that. So, there is a vibrant credit market that exists on Bitcoin already. It’s because there are entities that seek to borrow in Bitcoin terms and their actual revenues are denom­i­nated in Bitcoin terms too, so it makes sense. It kind of stands to reason, it would have Bitcoin denom­i­nated financing require­ments. We also see this with Ethereum. I know not supposed to mention that on here.

Brady Swenson:

It’s okay.

Nic Carter:

Or stable coins. There’s a very vibrant, kind of stable coin lending market. We’re talking about entities that they want to obtain capital efficiency denom­i­nated in stable coins. They don’t want to exit the crypto ecosystem. They want to stay on crypto finan­cial infra­struc­ture, so they want to borrow in kind. With Bitcoin, big borrowers would be miners, for instance, who received their payouts in Bitcoin, obviously from the protocol or entities that are performing the GBP arbitrage? I know that’s kind of a shorter-term play that’s maybe not going to be around forever. But there’s certainly credit that exists on top of Bitcoin. Obviously, that’s not risk free. I don’t think there really is anything such as a risk-free rate. I think that’s kind of a misnomer, anyway.

Nic Carter:

Gener­ally speaking, the whole point of Bitcoin is that it’s a liability free asset. It’s no one’s liability just like gold. So, it shouldn’t deter­min­is­ti­cally come with a yield. That yield has to be produced by opera­tional­izing it and conducting under­writing like any of these lenders do for instance, but it just so happens that the Bitcoin credit market is so vibrant right now that those yields on Bitcoin and most of the larger lenders are kind of 6 to 9% which is kind of confusing to some people, given that that’s so struc­turally high. But I would say that’s because we have kind of a trapped little silo here, that’s not that well integrated into the rest of the finan­cial system. So, they Bitcoin-flavored loans is still a very attrac­tive thing. That’s why borrowers are getting paid richly for that.

Brady Swenson:

So, Raoul contin­uing, you can mention Ethereum on this podcast, on this show, Nic. It’s okay. In fact, I have a question for you. That will mention Ethereum in just a minute. So, Raoul then stated… I know you may not have read this yet. It just came out yesterday and that’s fine if you guys want to pass on this. But he went on to say, “The revolu­tion in DeFi is doing just that, estab­lishing a forward curve, a future value.”

Brady Swenson:

He said that it will estab­lish the time prefer­ence for Bitcoin over 30 years or more. He’s talking about estab­lishing a long-term yield curve like you would with treasuries. So, Nic, does that make sense to you, DeFi on Bitcoin and using basically like you’re talking about kind of finan­cial products on top of Bitcoin to produce what we can evaluate as the time prefer­ence for Bitcoin over a 30-year period?

Nic Carter:

Yeah, was it Nick Bhatia’s comments in his writing on how Light­ning could be the source of an interest rate for Bitcoin. You can certainly see how that would come to pass. DeFi on Bitcoin, I mean, I wouldn’t even call it DeFi neces­sarily, but yeah, the instru­men­tal­iza­tion of Bitcoin as collat­eral, which is maybe like a more precise way to describe it, DeFi. That has always made a lot of sense to me, and it’s very compelling too. We’re already seeing it. It’s much more conve­nient for lots of Bitcoiners to take out dollar loans against Bitcoin that they held for tax efficiency purposes, just pure conve­nience purposes. This is a vibrant segment already. It totally makes sense.

Nic Carter:

Moving forwards, I would expect to see that being formal­ized as the creation of stable coins on top of Bitcoin collat­eral, which would be effec­tively way porting over the make-or-die system to Bitcoin. I’m sure that can be done with a number of different sorts of techno­log­ical path. I don’t think it’s impos­sible. I think it’s actually possible with current Bitcoin script poten­tially. Definitely, if we include some of Jeremy Rubin stuff with Covenants. But yeah, I think instru­men­tal­izing Bitcoin as the base asset in this system and under­standing that the base layer is more intended and it’s more suited for settle­ment as opposed to inserting every single payment onto that base layer, that makes sense.

Nic Carter:

Part of that is also more on banking. Bitcoin banking is effec­tively a way of creating that layered model. I would look back to the free banking era where gold was the kind of base liability, free collat­eral used for reserves by those free banks. They issued notes against that gold. It’s something that Hal Finney talked about in 2010. I’d love to see more devel­op­ment in that domain whereby you have exchanges issuing nodes against Bitcoin held on deposit and poten­tially mutually accepting each other’s nodes creating a vibrant system like that. I think that is a vectoral ability, but it’s kind of unexplored so far.

Lyn Alden:

That’s essen­tially how I’m viewing it. So, yeah, if you look back a century ago, you had gold as an under­lying settle­ment asset, and then you had dollars and other curren­cies kind of based on gold. Entities could deposit them, lend them, get a yield on them, right? Because it’s money built on top of that settle­ment asset in a more conve­nient package and in a more kind of debt pay system. Whereas the other under­lying asset is the key collat­eral. Even today, it’s less common, but for example, India, they release some gold bonds, right?

Lyn Alden:

So, India as a country, their borrowing rate is pretty high, even for the sover­eign, because the currency is histor­i­cally not very good at holding value. So, they intro­duced some gold-backed bonds, where you get a lower yield than their fiat bonds, but it’s payable I believe in either gold or you can take the fiat. So, it’s basically collat­er­al­izing alone and saying, “There’s more substance to that borrowing in exchange for lower yield.” Then from the perspec­tive of the buyer of that bond, it’s a way to get yield on gold exposure, but by taking counter­party risk.

Lyn Alden:

So, you’re taking to some degree of counter­party risk. It’s not super high, because it’s a sover­eign, but you’re taking some counter­party risk and you’re getting yield for that. So, we’re starting to kind of see in an accel­er­ated way, Bitcoin do some of the same things that we saw gold do over the centuries, which is become an under­lying sell man asset. And then to see more and more systems built on top of it.

Brady Swenson:

It’s great. All right, so here’s the Ethereum question for you, Nic. Well, this is going to lead into it. So, this is from Nate on Telegram, and he wonders, “Are there any specific use cases for crypto dollars…” Which is your turn to describe Tether and USDT, etc. “… that have surprised you as you’ve been researching its growth?”

Nic Carter:

I’m not about surprised neces­sarily. The pace of adoption for crypto dollars has certainly surprised me, even though I was probably among the more optimistic kind of watchers in terms of its growth. I mean, exploding from $4.5 billion at the start of this year to $16 billion today. The monetary base of crypto dollars is just prepos­terous growth. It’s in end. The use case is as we under­stand them that you can kind of put the puzzle pieces together.

Nic Carter:

A lot of it has to do with evading capital controls in China for better or for worse. Maybe a lot of people don’t like that reality or wish that it was something more innocuous, perhaps. But there’s a huge wealth outflow right around those capital controls or barrier to commerce and people are naturally routing around them. It seems like Tether is actually the favorite vehicle for doing that. Now, whether that can be sustained indef­i­nitely is unknown to me, I don’t know if that’s possible.

Nic Carter:

I’d like to see more usage of crypto dollars kind of in a closed loop context instead of just interex­change settle­ment or as a way to hold collat­eral to interact with crypto exchanges. Yeah, there’s a plethora of uses out there. I think the most inter­esting one was definitely the dollar­iza­tion events that we’re seeing in Latin America in partic­ular Venezuela, where crypto dollars are relevant today. Just recently, Juan Guaidó, the kind of Presi­dent in exile took owner­ship of something like $18 million worth of funds. They’re seized by the Treasury that were seized from the Maduro regime and distrib­uted them or began a program and distrib­uting them back to Venezuela nurses and doctors through Ethereum, which is a kind of a crypto appli­ca­tion.

Nic Carter:

So, we’re seeing this relevance, this digital dollar­iza­tion happening in places like Venezuela right now. A lot of that is Bitcoin kind of focused. I mean, it relies on the kind of Bitcoin infra­struc­ture that’s been built up through local Bitcoins. So, I think it’s pretty syner­gistic with Bitcoin too.

Brady Swenson:

Do you think that Bitcoin specif­i­cally has a use case or ability to create crypto dollars on top of Bitcoin, or is that just like a use case that is clearly separate from Bitcoin to avoid Bitcoin’s volatility for the time being?

Nic Carter:

I think there will certainly be ways to do that. It’s just a question of exploring them. I know some Bitcoiners dismiss DICE, but I think DICE is the most inter­esting one of all the crypto dollars there because it’s refined and that DICE are ultimately backed for the most part by Ethereum collat­eral. That would be an inter­esting model to repli­cate on Bitcoin, with those dollar-denom­i­nated liabil­i­ties, ultimately causing reser­va­tion demand for Bitcoin. So, I think we actually have something to learn from that system for sure.

Brady Swenson:

Nice. Okay, one more Ethereum-based question then we’re going to move on. You tweeted earlier today that Ethereum fees all-time high. That’s worth revis­iting an article that you wrote a while back. The TL;DR being fee bearing blockchains optimized ruthlessly for the most econom­i­cally dense trans­ac­tions at the exclu­sion of all else. So, let’s talk a little bit about this idea. And then I’d love to hear your thoughts on this as well. We’ll let Nic start, but maybe we can talk about this idea of ruthlessly optimizing for econom­i­cally dense trans­ac­tions. And then kind of segue into your latest piece about threats to Bitcoin’s fixed supply.

Nic Carter:

Yeah, so I’ll lay out the idea of, first of all, so it’s a very simple idea. Effec­tively if block space is capped and it effec­tively has to be in my opinion, because there’s a limit to the kind of compu­ta­tional power that’s avail­able on commodity hardware. There’s a limit to bandwidth. There’s a limit to storage. All these three bottle­necks mean that node opera­tion which is single threaded, there’s a maximum size to any node. There’s a maximum size to the bandwidth that everyone in that network can consume and the resources that they can consume. So, because of that kind of physical thermo­dy­namic reality, there’s only so much space avail­able for trans­ac­tions.

Nic Carter:

The emergent conse­quence of all that is that the most ethically conse­quen­tial to the largest degree trans­ac­tions are the ones that pin that access to block space for sound smaller and more frivo­lous trans­ac­tions. This isn’t really a problem in Bitcoin, we kind of saw it happen. A lot of those more frivo­lous use cases got forced out as fees rose, but now with the fear in fees rising too, some of these Ethereum nerves being punctured a little bit about using it for arbitrary uses. Instead, it’s for finan­cial uses that are winning out on Ethereum, especially settling large amounts of value in partic­ular stable coins. So, that’s kind of an inter­esting outcome that’s happening.

Nic Carter:

I guess the pushback you could say is that while Ethereum is going to be able to generate a lot more block space, kind of TBD on that. We’ll see. In its current form, it’s pricing out all of their marginal kind of non-finan­cial use cases. It’s only the largest trans­ac­tions that are actually winning space in the ledger round, which is pretty inter­esting phenom­enon to witness.

Brady Swenson:

Lyn, I mean, have you thought much about like the fee market, the blockchain, the poten­tial for Bitcoin in the future to become more insecure because of a dying fee market? There’s no subsidy anymore coming in from the blocks, block reward to miners. Perhaps Bitcoin wouldn’t be able to sustain security based on fees alone. Does that frighten you at all, or is it an attack vector that you’ve consid­ered viable?

Lyn Alden:

Something I’ve consid­ered. Back in 2017 when I was examining the protocol and I didn’t invest at the time. It was towards the end of the previous halving cycle, the big run up in 2017 I was watching that whole debate about block size and things like that, especially as someone who’s not a… I’m a more macro focused person, not a Bitcoin or crypto focused person. So, I was just kind of watching that. It kind of came down to whether or not Bitcoin is intended as a medium of exchange first and foremost or more of a store of value first and foremost. My invest­ment case in Bitcoin is more about the store of value.

Lyn Alden:

So, I perceive it more as like a digital gold as a long-term setup an asset, as a way to store something in scarcity. I welcome any sort of more efficient systems built on top of that, secure and efficient ways to break that apart. I agree with Nic that just looking at the math of it, obviously less detail than him, but essen­tially, the way it works is that if you have a finite space, you have to prior­i­tize largest trans­ac­tions as you shift more and more towards a fee based system. Because the fees become larger, but that becomes less conse­quen­tial if the trans­ac­tion is very large. It’s one of the inherent risks of Bitcoin as you shift towards a more fee-based model.

Lyn Alden:

You could have, for example, seen a version of Bitcoin that has all the same identity, but say, instead of a hard 21-million cap, you could have had something that still increases by a small fixed rate every year. In that sense, the block subsidy stays there and there’s a very tiny low infla­tion rate. That kind of pays for the ongoing security to network, right? So that is one option they could have gone with, but of course that takes away from the story of absolute scarcity and things like that. Even though I person­ally would still invest in a network like that, because at least the scarcity still known, right?

Lyn Alden:

So, even if it’s not a hard cap, if it’s a very slow increasing cap, what you’re basically doing would be you’d be taking… Basically in the fee model, you’re kind of taxing the people that are using it to transact. You’re not really taxing people that are using it to store long term. Whereas if you had that kind of built-in small infla­tion, you’d be kind of chipping away both the people using it for storage and for trans­acting. That’s kind of a design choice, and it could have gone either way. It went one way, in partic­ular.

Lyn Alden:

So, I think as we go down this route, as the halving cycles continue, we are going to look more and more towards trans­ac­tions. I think it’s something to watch, something to see how the protocol develops, how security develops around that. I think it’s a risk to be aware of. I think it’s still early pretty much in that process. But I think that next approach makes sense, which is that as that develops over time, it’s going to prior­i­tize bigger trans­ac­tions and increase the impor­tance of these other types of networks that are on top of it.

Brady Swenson:

Yeah, Nic, you have a good kind of visual­iza­tion, a metaphor for thinking about blocks in Bitcoin. I know we have a lot of new user or new Bitcoiners, new coiners that listen to this show and watch the show. Could you kind of describe or give us a metaphor about how… I think it’s the tanker ship metaphor and what I like to call it. That’s yours, right?

Nic Carter:

Oh, yeah, it was that along with individual trans­ac­tions being like bundles of money trans­ac­tions. That’s pretty much the metaphor. Yeah. So, the impor­tant thing on a sort of Bitcoin transi­tion include many payments, and there’s a fixed overhead in every single trans­ac­tion. But for mecha­nisms like batching, you can reduce that fixed cost for many payments and people don’t know that single Bitcoin trans­ac­tion can include 3,000 outputs, for instance. Obviously, an arbitrary amount of value. So,

Nic Carter:

I think the challenge of the big consumers of block space is to engage in those efficiency gating measures, which actually to their credit, Coinbase finally did this after about two years demur­ring. I wrote an article two years ago saying, Coinbase wiring and batching, you should do it. And then two weeks ago, I think they said, “Hey, we’re batching now.” So that fee pressure, it does some inter­esting exter­nality of punishing the entities that use the blockchain that aren’t using it efficiently. So, it relent­lessly forces optimiza­tion from those end uses of the blockchain, which is another really nice exter­nality of the fees. It forces you to engage in the space saving measures.

Brady Swenson:

Yeah, yeah. That image always stick on my mind is thinking about Bitcoin as sort of like a tanker ship. The blocks is these little containers on the ship and not as these little tiny trans­ac­tions for coffee and stuff. It’s like these giant internet settle­ment trans­ac­tions. Yeah.

Nic Carter:

The point is really if you look at Bitcoin analogs, we’re talking about Fedwire or the Inter­bank Clearing House Systems. We’re not talking about Venmo neces­sarily or PayPal, because those are systems that are built on top of these other clearing houses and settle­ment networks. Bitcoin is the settle­ment network. Bitcoin isn’t neces­sarily the payment system. You could, in theory, go about your day making all your trans­ac­tions with bank wires, you could do that. There’d be a $10 fee.

Nic Carter:

So, I had a bank wire yesterday. I had to get on the phone to my bank for 45 minutes, and there’s a $10 fee. It’s going to take two days to settle or whatever. So, you could do that the same way that you could use Bitcoin base layer for all of your everyday quotidian payments. But ultimately, I think that’s not the way it’s going to go. I think there’s going to be other systems built on top of Bitcoin. Bitcoin will kind of fulfill it’s destiny as the settle­ment network.

Brady Swenson:

Yeah, yep. All right. So, on your podcast, Nic, you had a Lyn on maybe a couple months ago or six weeks ago or so. On The Brink Podcast, it’s Nic’s podcast. Castle Island Ventures produces it. You guys started talking about the finan­cial­iza­tion of our global economy, and then kind of moved on to something else, but I’d like to dive more into it. So, Lynn, can you give us kind of a rundown of the history of the finan­cial­iza­tion of the economy over the past few decades? What role the Fiat standard has played in that process?

Lyn Alden:

You mean as it pertains to kind of the global reserve status or the more domestic focus?

Brady Swenson:

Both, but yeah, I think start with like the global reserve aspect.

Lyn Alden:

Sure. So, actually, it’s actually twitching points that I find often discussed in media is the way that the global reserve status works. So, one is the idea that there’s always a global reserve currency kind of like the one we have now. So, the one now is actually against what the media often describes. The one that’s been in place since the early ’70s is actually very unique. So, in prior kind of histor­ical periods, precious metals, especially gold, was the under­lying settle­ment asset. And then you had some paper curren­cies that for time, were broadly accepted, because those countries had the biggest navies. They went around the world, they did the most trade.

Lyn Alden:

So, they were recog­nized curren­cies that that were accepted in many places. But of course, as the world got smaller, as we got more inter­con­nected, and of course, the big climax of World War II, that’s when the dollar took the role as the global reserve currency. At the time, it was backed by gold and other curren­cies backed themselves to the dollar. So, you had this big fixed exchange system. And then that all broken in 1971. And then in the early ’70s after that, they kind of redevel­oped it as the petrodollar system. So, it’s the idea that most oil around the world is priced in dollars and most other commodi­ties as well.

Lyn Alden:

So, even if France buys oil from Saudi Arabia, they pay in dollars, even though the dollar is neither their under­lying curren­cies. So, that’s kind of forced the dollar as a global reserve currency in a way that previous global reserve curren­cies never had. So, no previous global reserve currency had a world­wide lock on commodi­ties, that pretty much all commodity pricing world­wide happens in that currency. So, that’s kind of a unique thing about this period, which is starting to cause some problems.

Lyn Alden:

The second thing is the idea that if the dollar in any way loses currency reserve status, that it means that another currency has to come along, another fiat currency has to come along and take it. So, if you say that the reserve status might change a little bit, the first question is, “Well, who’s going to replace it? Is it going to be the Euro? Is it going to be the Chinese currency?” Of course not, right? So, they’re not better than the dollar. So, the kind of answer to that approach is that after World War Two, because Europe and Japan were so devas­tated and emerging markets are so small, the United States was nearly 40% of global GDP.

Lyn Alden:

So, they had a big enough money supply and could do enough commodity consump­tion and could run big trade deficits. They could basically supply the world with this currency that they now have a hard lock over. But over time as Europe develop back up and as Japan develop back up and as emerging markets grew, especially China, United States percent of global GDP shrank. So, now, it’s in the ballpark of 20%, or even less if you look at purchasing power parity. The United States is no longer world’s largest commodity importer. That’s China.

Lyn Alden:

So, we’re kind of at a situa­tion now, where there’s no individual country or currency that’s large enough to be the global reserve currency. There’s no money supply for a specific country that is big enough and running big enough trade deficits and doing all these things that there’s enough of it around that only that currency can be used for oil pricing. So, over time, we’ve seen slowly chipping away at the dollars lock. So, for example, since the Euro was created over the past 20 years, we’ve seen the dollars percentage in currency reserves declined from about 70% to about 60% world­wide. If you actually include gold, that’s gone down even more so.

Lyn Alden:

So, gold has taken a stronger role, especially in the past five, six, seven years. So, even just last couple years, if you look at, for example, China’s trade with Russia, so more than two years ago, that was almost entirely dollar based. But over the past two years, especially in 2018 and to some extent 2019, they de-dollar­ized a lot of that. So, a lot of that is now Euro base, even though Euros is not really their primary currency, but they’ve diver­si­fied their currency exposure in their trade. Because it’s Russia, most likely involves energy. So, we starting to see kind of things like that play out, where we’re most likely headed towards a more multi­polar currency world, rather than one currency having a lock on all global commodity pricing. That’s kind of been the trend that I’ve been following to some extent.

Brady Swenson:

Yeah, Nic, anything to flesh out there in the history of inter­na­tional finan­cial­iza­tion? And then I want to come back to talking about the domestic finance industry too, and some of the things that have happened in deriv­a­tives, on deriv­a­tives, etc.

Nic Carter:

Well, Lyn is obviously the expert there and I learned a huge amount from her commen­tary as well. But I would say that as we see this multi­polar world emerging, there’s going to be plenty of room for credibly neutral settle­ment assets. The same way that when you had the inter­na­tional maritime trade system that devel­oped initially, the unit of account for that trade was gold and silver, as opposed to any other more local kind of commodi­ties or ROUs or credit instru­ments or anything like that, because there’s a liability free.

Nic Carter:

The same thing with digital commodi­ties like Bitcoin does make for great neutral assets to conduct commerce in. I’m not saying that it’s destined to be the global reserve currency or anything like that. But it’s great that it exists as a suitable alter­na­tive as poten­tially this kind of New York-based dollar clearing system loses some of its influ­ence maybe as an alter­na­tive to SWIFT emerges, as the world just gets more fragmented and inter­na­tional finance becomes slightly more diffi­cult.

Lyn Alden:

I agree to partic­u­larly his point about kind of neutral asset being pretty impor­tant in that system. So, for example, over the past five, six years, as we’ve seen foreign central banks have not really continued their accumu­la­tion of treasuries, right? So, we’ve seen a flatlining of treasuries. We’ve seen an uptick in their gold purchases, right? So, especially last couple years, we’ve seen 50-year highs in Central Bank gold purchases. And then if you sort it by which countries are most aggres­sively de-dollar­izing, so Russia is near the top. Over the past 5, 10 years, they’ve been buying gold hand over fist. So, they’re not loading up on tons of euros. They’re not loading up on tons of yuan, right? They’re relying heavily on gold as their kind of settle­ment asset.

Lyn Alden:

So, in that sense, curren­cies in that sort of multi­polar world shift a little bit more towards medium of exchange, rather than as stores of value, which is essen­tially the system you saw before the petrodollar system where it was really gold that was the global reserve currency, with the dollar kind of being the more conve­nient layer onto that. And then other curren­cies were layered on to the dollar. And then before then, you had other global reserve curren­cies that were backed by gold and they were accepted because of their associ­a­tion with gold.

Lyn Alden:

So, going forward, it definitely increases the impor­tance of whether it’s gold or whether it’s other neutral kind of counter­party-free scarce assets that they kind of can underlie that system, more so than having one currency, kind of the one ring to rule them all sort of situa­tion, right? There’s no one ring. There’s a bunch of rings, and they have to negotiate between themselves what they’re going to accept as either recog­nizing each other’s credit worthi­ness or what they’re going to use as a medium of exchange.

Brady Swenson:

Great, great. All right, let’s do a quick one on the domestic question here. So, the American finan­cial industry has devel­oped. I want to know how is the Fiat standard enabled that or inter­acted with that devel­op­ment anyway? How would the finance industry look different on a Bitcoin standard?

Lyn Alden:

Well, there’s a couple different layers to that question. So, a theme that I’ve been pointing out over the past couple years is the long-term debt cycle, which is phrasing that Ray Dalio of Bridge­water uses. Which is over 5 to 10-year business cycle, the domestic economy accumu­lates debt as a percentage of GDP and then that becomes increas­ingly fragile in leverage. In some sort of catalyst happens, sometimes it comes out of nowhere, sometimes just an asset bubble collapses. Other times there’s some external catalysts like a pandemic or something. And then that forces an economic slowdown, which then enforces a period of delever­aging, which can then further the economic slowdown until the system kind of resolves itself and starts building up from there.

Lyn Alden:

The problem though is that in every one of those cycles as interest rates get lower and lower, it encour­ages more and more debt accumu­la­tion. So, every cycle ends up with a higher level of debt than the previous cycle. So, you only deleverage half the way, you build up from there, you hit new highs, then you do leverage half the way again. So, you keep building up. And then what happens eventu­ally is interest rates hit zero. So, you hit the zero bound. Histor­i­cally, that tends to happen. If you go back in history, the last time that happened was the 1930s, right? So, Ray Dalio often likes to refer to the 80-year long term debt cycle. But of course, the exact timeframe can vary.

Lyn Alden:

If you look back in previous… You can track those debt bubbles all the way back for centuries. But they tend to be smaller because the economies are less finan­cial­ized. They have less compli­cated or sophis­ti­cated invest­ments and vehicles that can allow for that level of debt accumu­la­tion. But when you have a very kind of inter­con­nected, very fast, very kind of finan­cial­ized economy, they can build up much higher debt levels. But that means that that when you start to unwind that, it can be a lot more painful.

Lyn Alden:

So, in addition to each short-term debt cycle kind of building on the previous one, each one of these long-term debt cycles sends a hit a higher peak than the one from nearly a century ago. That’s kind of where we are now. I can chart and kind of 30 different ways how 1930s and 1940s have a lot of similar­i­ties so far to the 2010s and the 2020s, kind of directly each one of the other. So, as you go forward, I think we’re seeing a gradual definan­cial­iza­tion probably happening, but a lot of that can depend on policy and a lot of that can depend on kind of the details of how this plays out. But definitely that current cycle is now pressured.

Brady Swenson:

If we were to an economy on a Bitcoin standard, how would that be different? I mean, as we were talking about earlier, it’d be more diffi­cult to rehypoth­e­cate and create deriv­a­tives based on Bitcoin, because it is so easily settled. The final settle­ment is democ­ra­tized, if you want to put it that way. So, could a finan­cial industry like the one we currently have even existed on a Bitcoin dominated world?

Lyn Alden:

Probably not to the same level of debt. So, for example, one of the compli­cated things about gold standards is that in theory, a gold standard should restrict spending and should kind of lead to more finan­cially prudent decisions. What happens in practice is that they build up that anyway and they have to de-peg from gold in order to resolve that. So, you basically build up such a big debt burden and it starts kind of all unrav­eling like a Jenga tower and then they de-peg it. So, even though gold didn’t fail, the gold peg end up failing. So, that’s kind of the histor­ical case with kind of a gold peg or trying to have non-fiat currency. It doesn’t fix human nature essen­tially. It kind of grounds human nature but it doesn’t kind of stop that process from happening.

Lyn Alden:

Now Bitcoin standard, sure. It definitely opens up new kinds of approaches to try to solidify that. So, you can authen­ti­cate reserves to use Nic’s point. We know how much United States, for example, claims to have in gold reserves, but do we know how much gold they have? Same thing with China, they claim to have a certain amount. A lot of people think they have far more. We don’t know, no one really knows. We just see what they say they have.

Lyn Alden:

Same with a lot of countries in Europe. They have a certain amount of gold that they claim they have. Bitcoin can authen­ti­cate that more if you had kind of that newer technology instead. There’s also, yeah, how quickly it can settle, things like that. It all really comes down to how many layers you want to build on top of something and how kind of easily people trust those layers. And then what kind of fiscal monetary policy are happening so that people are more inclined or less inclined to trust those various layers?

Brady Swenson:

Sure, sure. Nic, there’s a lot there to chew on. Do have any reactions you wanted to share here?

Nic Carter:

Yeah, I really like Lyn’s point that you can’t change human nature. The whole notion of a standard is one where you peg your currency to a monetary commodity, but there’s still only doing that pegging and maintaining the peg. In some cases, discre­tionarily de-pegging. We see this time and again with democ­ra­cies. The scope of what that state is expected to do gener­ally grows over time, and then you end up with a reckoning over time so as entitle­ments kind of come due. It’s kind of an intrinsic problem. You don’t even know if the monetary commodity at the base of the system. I don’t know if that can actually help the problem. But the beauty of Bitcoin is that it allows us to decouple our finances from the state’s purview.

Nic Carter:

If this state is illegit­i­mate or in the process of failing, we can exit that state at least from a finan­cial sense. Although then obviously, you have to complete the exit in all the other contexts in which you exist in that state. But to me, that’s impor­tant thing is that it gives you that discre­tion to exit in exten­u­ating circum­stances. We are liter­ally seeing the crypto industry being used to evade capital controls for asylum seekers, for people that are fleeing states that have no legit­i­macy, have no credi­bility. I’m hoping that won’t be the case in the US. I would vote for the US to kind of regain its authority.

Nic Carter:

But the impor­tant thing is that we do have a state indepen­dent monetary commodity, which is highly portable, which individ­uals can use to poten­tially opt out and maybe create smaller or more novel little units. So, I’m not optimistic about the US adopting a Bitcoin standard or any such mecha­nism. But I am optimistic about individ­uals being empow­ered relative to the Leviathan, so to speak, relative to the state and poten­tially being able to exit if they need to.

Lyn Alden:

That’s how I view it. So, a couple points there. If you look back in US history after the previous big long term debt cycle, the big high debt to GDP period in the 1930s, there is a nearly 40-year period, where if you bought and held treasuries, you under­per­formed infla­tion, right? So, you lost purchasing power by holding govern­ment debt or by holding money in a bank account. Coinci­den­tally, during that almost exact time period was when gold was illegal for Ameri­cans to own both in the US and they couldn’t even own it outside of the country. You just were barred legally from owning it.

Lyn Alden:

Now, a lot of people still owned it. It’s hard to enforce, but it was illegal from the mid-30s to the mid-70 for Ameri­cans to own gold. That was the exact period where people would want that release valve, where the fiat money was not holding. Its value was devaluing. So, even though debts didn’t really decrease nominally that much, they were reduced as a percentage of GDP partially from growth and partially from infla­tion.

Lyn Alden:

So, gold is, to some extent, one of those off ramps people can use, and Bitcoin is a more acces­sible way to do that and a more efficient way that people can quickly opt in and out of a system. So, I bring up Raoul because you brought up Raoul earlier. He’s pointing out that that’s happening to some extent in Turkey, for example. They’ve had some currency challenges recently, and Bitcoin repre­sents one of the ways that they can pull capital out and then put it back in and pull it out, pull back in, as a way of preserving wealth. So, I think to have that system so easily acces­sible kind of world­wide, it definitely changes the game, right? Because if people have that quicker release valve, it definitely changes how fiats have to operate, if they want not to have a ton of accidents that way.

Brady Swenson:

Yeah. All right, we’re going to slide in one last question here before we head out. So, next week, we’re going to have Eric Townsend on the show. He’ll be along with our Co-Founder, Yan Pritzker. They’ll be talking about CBDCs or Central Bank Digital Currency in Bitcoin. Eric is a fan of Bitcoin. He wants Bitcoin to work as a liber­tarian and to empower people as we’ve been talking about here, but he’s of the opinion that Central Bank Digital Currency like the Fed coin or as he calls it the Orwell will be mandated essen­tially upon the world or at least this country and have all the opposite proper­ties of Bitcoin. So, Nic, what are your thoughts on the prospects of CBDCs and the prospect of an Orwell coin devel­oping and kind of making Bitcoin impotence?

Nic Carter:

I certainly think that that’s likely actually, the first part of that state­ment, not Bitcoin being impotent. I think it’s likely that we do get a CBDC effec­tively digital repre­sen­ta­tion of cash in this country. I’m not optimistic that that would have the same privacy or autonomy charac­ter­is­tics that physical cash gives you.

Nic Carter:

My reasoning for that is that physical cash been system­at­i­cally devalued in terms of what you can do with it by US jurispru­dence over the last 40 years effec­tively with the Bank Secrecy Act and in some Supreme Court cases, including the instal­la­tion of the third party doctrine. That means that effec­tively, you have no trans­ac­tional privacy in the US and also cash trans­ac­tions need to be reported at a lower and lower real threshold. So, the scope of things you can do with physical cash in this country keeps getting smaller and smaller.

Nic Carter:

My guess is that that’s unlikely to change anytime soon. In fact, if we do get a digital form of cash that repre­sents Federal Reserve dollars, there’s going to be very limited privacy unfor­tu­nately. All the discourse, I’ve seen treats privacy is kind of an imple­men­ta­tion detail, rather than sort of a core value that the system would enshrine.

Nic Carter:

Now, where I would disagree with there, it could be in the allega­tion that because we’re going to get some sort of panop­ticon coin, which is govern­ment admin­is­tered, that means there’s no scope for Bitcoin. I would say that is an enormous argument in favor of the existence of Bitcoin, that you would have something which is state indepen­dent. I’m not optimistic that the United States would be able to control every­body’s trans­ac­tional usage and privacy. First of all, I think it’d be uncon­sti­tu­tional to have such an enormous invasion of privacy. I think the fact that the US to a certain degree embrace Bitcoin already is a really great sign.

Nic Carter:

So, I don’t think the US is destined to go down this total­i­tarian path of kind of finan­cial surveil­lance the same way China has so far. My guess is that there always be space for Bitcoin. But if it does, Bitcoin is going to demand for Bitcoin even greater, because the alter­na­tive would be much worse. So, I think to the extent that there is some sort of CBDC, which lacks privacy quali­ties, there will be a counter­vailing demand for Bitcoin as something which gives you much greater autonomy and poten­tially privacy.

Lyn Alden:

I agree. Again, that the first part of that, I think that treasuries and central banks around the world over time will probably adopt some of these technolo­gies for better or worse. In some ways, it makes things more efficient. It makes tax fraud harder to do, things like that, but then it violates privacy. Another thing that they want to go to do with it, for example, is do more targeted stimulus. So, for example, they can hand out those types of kind of controlled coins. And then they can have them, so that they’re programmed to be only usable in a certain juris­dic­tion or only usable within a certain time period or only usable on certain types.

Lyn Alden:

So, that kind of technology gives them greater control, which, of course, can take very dark roots, especially if you look at China and their social credit score and the kind of the degree that they’re willing to go to take away freedoms. But even in the US, consid­ering what’s consti­tu­tional, the fact that the United States banned gold for over 40 years, they just kind of like looked at property rights and went, “Eh, it’s not conve­nient.” So, the thing about Bitcoin is that it’s much harder to enforce that. So, it’s already actually very hard to enforce that on gold. So, very few prose­cu­tions or legal issues happened around people owning gold. So, it was a very harsh to enforce, not heavily enforced law, even though it was illegal and punish­able by pretty severe conse­quences.

Lyn Alden:

So, with Bitcoin, you can’t raid someone’s house and get it unless they just have their private wallet sitting there. So, there’s more ways to protect it, it’s harder to prove someone has it. It’s a more inter­na­tion­ally portable thing. We’ve already seen that govern­ments, including the most govern­ments, including the US have gone in the direc­tion of accepting it more and more.

Lyn Alden:

So, now that we see more insti­tu­tional interest in the asset class, it kind of gets less likely every day that that the govern­ment tries to ban it. Because as you get bigger and bigger, it becomes messy and messier to try to ban that. We’ve already seen periods of civil unrest, right? So, imagine if there’s a currency issue. It’s kind of like the period where they’d want to ban Bitcoin is kind of like… So, when they ban gold in the US, the next thing they did was almost cut the dollar’s value in half compared to gold, right?

Lyn Alden:

So, actually, the best thing you want to do is somehow, if you could, own gold. So, with Bitcoin, it’s like if they ever get to the point where they try to outright ban property, that means likely something’s not going well with the currency, right? So, you’re likely to see kind of pushed back against that. Again, it’s a harder to enforce thing. It’s almost like that’s exactly the sort of asset that people would want to own. Of course, I would never publicly say anyone should violate the law or anything, but just looking at the history of how those laws are diffi­cult to enforce, it’s not a very elegant solution on the behalf of govern­ment to try to ban those sorts of things.

Brady Swenson:

Yep, yeah, well said, well said. Alright, thank you guys so much for joining us today. I really appre­ciate your time. It was a lot of fun. We’ll wrap it up real quick. Remember, you can sign up for daily buys at swanbitcoin.com/dailybuys. We have Eric Townsend and Yan Pritzker on next week. That’ll be a great show, tune in. We also have Raoul Pal and Vijay Boyapati on the sleeve for later in September, already confirmed. That’s going to be a great show. So, subscribe to the YouTube channel now at youtube.com/swansignal. Turn on those notifi­ca­tions. If you like the audio, you can find the podcast at swansignalpodcast.com. Thank you, Nic. Thank you, Lyn. Really appre­ciate your time.

Lyn Alden:

Thanks.

Nic Carter:

Thanks very much.

Other Episodes:

Episode 8 –Andy Edstrom and Ansel Linder

Episode 9 –Rockstar Devel­oper and Jeremy Rubin

Episode 10 – Bitcoin TINA and CK Snarks

Episode 11– Gigi and Knut Svanholm

Episode 12 –Adam Back and Preston Pysh

Episode 13 –Alex Gladstein and Matt Odell

Episode 14 –Robert Breedlove and Tuur Demeester

Episode 15 –Isaiah Jackson and Max Keiser

Episode 16 –Gigi and Udi Wertheimer

Episode 17 –Aleks Svetski and Jimmy Song

Episode 18 –Stephan Livera and Marty Bent

Episode 19 –Mark Moss and Ben Prentice

Episode 20 –Samson Mow and Parker Lewis

Episode 21–Lyn Alden and Jeff Booth

Episode 22– Robert Breedlove and Cory Klipp­sten

Episode 23 — Saifedean Ammous and George Gammon

Episode 24 –Jameson Lopp and Eric Martin­dale

Episode 25 –Preston Pysh and Andy Edstrom

Links:

Swan Bitcoin

Swan Bitcoin — the best place to buy and invest in Bitcoin

Swan Bitcoin on Twitter

Swan Signal on YouTube

Swan Signal on Facebook

Swan Signal on Twitch

Swan Signal Podcast

Swan Signal Telegram Chat Room

Lyn Alden

Lyn Alden on Twitter

Lyn Alden’s personal website

Lyn Alden on LinkedIn

Nic Carter

Nic Carter on Medium

Nic Carter on Twitter

Nic Carter on LinkedIn

This blog offers thoughts and opinions on Bitcoin from the Swan Bitcoin team and friends. Swan Bitcoin is the easiest way to buy Bitcoin using your bank account automatically every week, month, or paycheck, starting with as little as $10. Sign up or learn more here.

Brady Swenson

Brady is the Head of Education at Swan Bitcoin, the best place to buy Bitcoin with easy recurring purchases straight from your bank account. Brady also hosts Citizen Bitcoin, a podcast focused on documenting his journey learning Bitcoin, featuring some of the biggest names in the Bitcoin world.

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