Description

In this episode, we discuss Bitcoin and Layered Money by Nik Bhatia. Layered Money, discussing the history of money and its evolution through layers. Bhatia explains how different forms of money, from gold coins to fiat currencies, have built upon each other, creating a complex system with inherent risks like counterparty risk. He uses the Florentine florin and the Bretton Woods agreement as key historical examples to illustrate this layered structure. The conversation also explores the role of fractional reserve banking, the velocity of money, and the potential impact of Bitcoin as a foundational layer in a future monetary system, along with discussions of central bank digital currencies and stablecoins like Tether. Finally, the interview touches upon the potential for government regulation of Bitcoin and the implications for the future yield curve.

Key Themes and Concepts

1. Layered Money:

• Core Idea: Bhatia argues that money is not monolithic but rather a layered system. He draws on the work of economic professor Perry Mehrling. The podcast explores the inherent hierarchy of money and suggests that Bitcoin is poised to become the first layer of money in the future, similar to gold historically.
• Quote: "When I read his [Perry Mehrling's] paper I realized that bitcoin was going to be the first layer of money in the future in the same vein as this paper that this professor had written."
• Historical Context: The discussion uses the Florentine florin as a prime example. The florin’s stability (unchanged in purity and weight for over 300 years) enabled it to act as a reliable base for the next layers.
• Quote: "What was remarkable about the florin was that it went unchanged in purity and weight spanning four centuries you know for over 300 years which is mind-blowing."
• Subsequent Layers: The second layer emerges with deferred settlement practices (promises to pay), which arose due to the risks of physically moving gold and the need for more efficient trade. The third layer is commercial banking deposits, representing modern fiat currency.

1. Unit of Account and Economic Activity:

• Common Language: The florin's standardization allowed businesses to denominate their accounting with consistency across Europe, leading to increased trade.
• Quote: "The advancement in denominating everything in florin was that in you know before the florence stability when you had a world of coins changing purities all the time nobody had a common language in terms of how to account."
• Bitcoin as a Potential Unit: Bhatia sees Bitcoin potentially becoming the global unit of account in the future similar to the dollar today.
• Quote: "and you know i think bitcoin is going to become that and it's already on its way but back then the florin being the coin or the measurement the unit of account the denomination that everybody rallied around it was the first time that it ever happened in you know our modern history."

1. Fractional Reserve Banking & Money Creation:

• Bank's Power: Banks create money through loans. Unlike governments creating money by minting coins, banks create credit money with their bookkeepers' pens by issuing debt.
• Quote: "Within the double entry accounting system where the secrets of how bankers could create money not by minting a coin but from their balance sheet"
• Disciplinary Constraint: Gold provided a disciplinary constraint on banks’ ability to create money via fractional reserves. However, governments intervening and inserting themselves between the layers have removed that constraint by privileged lending.
• Quote: "when the government inserted themselves between the first and second layer of money they lent money to themselves in a privileged manner and benefited from that money they lent to themselves being on par with all the other gold-backed money"

1. Counterparty Risk:

• Inter-Bank Distrust: The current financial system has inter-bank counterparty risk issues, where banks don't trust each other, particularly during economic stress due to a moral hazard created by central banks' tendency to offer bailouts.
• Quote: "The problem with our current financial system is the inter-bank counterparty risk where banks don't trust each other when things get tough because they all are expecting the fed and the central banks to come in and save the situation."
• Flight to Treasuries: During crises, the demand for U.S. Treasuries skyrockets, pushing prices up and rates down because these are the only assets you can physically own to assure yourself of dollars tomorrow.
• Quote: "you have 30 trillion and safe and 300 trillion in everything else you know if you understand like at the margin demand for treasuries because if you think of the 30 trillion supply let's say 25 of it are locked up in very strong hands so the marginal availability of these treasuries is not that big relative to the size of money in the world and this is what everybody needs in order to settle their counterparty risk"
• Accelerating Risk: Bhatia believes counterparty risk is accelerating as central banks backstop the financial system more and more, further eroding trust and forcing banks into a state of dependence on the Fed.

1. Bretton Woods & the Breakdown of the Gold Standard:

• Dollar as Global Currency: The Bretton Woods agreement (1944) designated the U.S. dollar as the global reserve currency, convertible to gold. Other currencies pegged to the dollar.
• Dollar Supply Growth: The dollar supply grew unchecked which made the redemption of dollars for gold increasingly difficult and less desirable.
• Quote: "the dollar supply was not in check in any way so the amount of dollars that were issued after 1944 the the supply kept growing and growing and growing but the price of gold in terms of dollars was unchanged"
• The End of Discipline: The failure of the gold standard resulted in the removal of any physical discipline on money creation, with central banks becoming the new arbiters of value.
• Quote: "that's what broke the gold peg and that's what broke the disciplinary constraint forever on money and discipline transferred from a precious metal to a consortium of central banks around the world and now discipline only exists in their minds"
• Quote: "the period between 1944 bretton woods and 1971 i like to think of it as 68 71 and 73 because 68 the gold pool broke 71 was the closing the gold window in 73 was when the official brenton woods agreement ended and currencies free-floated against each other and the relationship between gold and the dollar and currencies was ended forever"

1. Money Velocity:

• Definition: Money velocity is how quickly money changes hands. It is a measure of how quickly people transact, but today it is also measured by central banks.
• Historical Velocity: Velocity accelerated with paper money, but is now slowing due to eroding inter-bank trust and reduced lending.
• Quote: "money velocity accelerated with the advent of paper money of promissory notes during the 16th century in antwerp"
• Bitcoin's Impact: Bitcoin could greatly increase velocity due to its speed of settlement and potential for second-layer solutions (like the Lightning Network), which enable very fast transactions.
• Quote: "because the final settlement is so easy to do that we can have lower layers of money that just move at light speed"
• Reorganization and Shuffling of Capital: A move to bitcoin as money may cause a reallocation of capital into assets that provide a yield in Bitcoin. This may cause an increase in money velocity as it gets reorganized and flows to new sectors.

1. Bitcoin & Risk Mitigation:

• SHA-256 Cryptography: Bitcoin is underpinned by SHA-256, which if compromised, would be a red flag.
• Price as Truth: Bhatia believes the price of Bitcoin is a strong indicator of its health and viability. A dramatic price drop would signal a problem.
• Quote: "My favorite saying as a trader and i use it as a as an adjective professor is that price is truth it's my favorite quote in the world because the price tells you everything you need to know"
• Quote: "if the price of bitcoin went to below one thousand dollars that would be a cause for alarm because that means something is really wrong with it"
• Acceptance of Bitcoin: Despite some fear mongering, Bitcoin has become widely accepted by the U.S. government and regulators are taking a measured approach to regulating it.
• Quote: "the united states government which is the most powerful influential regulatory government in the world still is wildly accepting of bitcoin and full embrace"

1. Regulatory Landscape and Potential Future Scenarios:

• Bitcoin's Resistance: Despite attempts by some countries to ban Bitcoin, it has proven to be a resilient technology.
• Quote: "number one bitcoin is a form of speech because it's a form of cryptography and number two that there is nobody you can send a letter to subpoena in bitcoin and therefore it's an independent concept and cannot be constrained they realize this"
• Scenario of Bitcoin Adoption: If Bitcoin experiences rapid price appreciation, it may induce a debt market collapse and increased central bank intervention and could cause a push for global regulatory control.
• Quote: "they're looking at this and saying oh god if this thing becomes the new money and this thing is a reflection of where interest rates are going to be based this thing that i'm holding in fiat currency becomes totally impaired worthless and they start selling off in the debt market"
• United States Strategy: Bhatia's strategic recommendation if he had the ear of government leadership, would be to accelerate and embrace Bitcoin by legalizing it as a rail in the financial system, which allows dual denominated balance sheets and gets the country on the right side of Bitcoin adoption. He advises not being committal to any collaborative bans.
• Quote: "i would double down and make united states the home of bitcoin the most friendly and allow a world of dual denomination where banks can right away start running parallel balance sheets in dollars and bitcoin"

1. Bitcoin as a Heartbeat:

• Nature of Growth: Bitcoin's growth is described as cyclical, with boom and bust cycles. These cycles may serve as natural defense mechanisms that prevent adoption at a rate that would antagonize central authorities.
• Quote: "the way that bitcoin grows is like a heartbeat it pumps and then it pumps again and each time it pumps it it leaves something in its wake and that seems to be the natural evolution bitcoin is alive"

1. Yield Curves in a Bitcoin Future:

• Upward Sloping: A bitcoin based yield curve would be naturally upward sloping due to a liquidity premium.
• Premature Speculation: It's too early to speculate on the exact shape and rates of a future Bitcoin yield curve, because it lacks a lot of current liquidity data.

1. Derivatives Market:

• Arbitrage Opportunities: Spreads in the derivatives market for Bitcoin are wide due to a lack of traditional financial participants comfortable with executing arbitrage strategies.
• Quote: "the comfort in executing or let's just say the confidence that you can close on the arbitrage opportunity isn't well developed yet and that will happen with time and with enough participants that trust each other"

1. Central Bank Digital Currencies (CBDCs):

• Helicopter Money Tool: CBDCs will be used for "helicopter money," allowing central banks to give money directly to individuals instead of solely through banks.
• Timeline: CBDCs are moving quickly, with many nations likely implementing them within the next year or two.
• Wallet Accessibility: Banks will easily integrate CBDC wallets into their existing platforms.
• Control potential: Some CBDCs will likely be programmed to control how they are spent, while others will remain more freely usable.

1. Tether:

• Diminished Importance: Tether's role is diminishing, and is believed to be approximately 75% reserved with USD and despite having a partial reserve system it trades at par. Other fully backed stable coins exist and if Tether were to fail they would likely take its place.
• Quote: "the market has demanded them and they exist and so i think that tether is uh its importance is really dwindled in the grand scheme of things"

Conclusion:

Nik Bhatia's framework of layered money provides an insightful lens through which to analyze the evolution of monetary systems and the potential future of Bitcoin. The podcast suggests that Bitcoin could become a foundational layer of money due to its speed and decentralized nature, while