Read the entire issue on: https://lnmarkets.substack.com/p/46-lyn-alden-bitcoin-options-on-lightning?s=r
LNM: We often hear that Bitcoin will become mainstream one day, with less volatility and more institutional players. Could it be the other way around, with the dynamics of Bitcoin being the new way financial assets react to a broken financial system?
Lyn Alden: I think that one of the foundational problems in global finance today is that there has been a lack of good money.
Ever since we centralized gold and kind of shoved it aside in favor of putting one country’s sovereign debt at the heart of the global reserve system, it has been like building a house on sand and dealing with all of the problems that come with that.
So, we have had weak money globally. It consists of fiat assets backed by other fiat assets, circularly. In developed countries, we deal with gradually devaluing currencies that don’t keep up with inflation. In developing countries, they have it far worse, with more explosive currency devaluations from time to time.
And as a result, we monetize other assets. In developed countries, we add a monetary premium to houses, stocks, private equity, and all sorts of things, because the benchmark alternative currency (fiat cash and government bonds in various forms) is a melting ice cube. In many developing countries, it’s hard to save at all. And the whole system is permissioned, which is highly problematic in a world where half of the world lives in authoritarian regimes.
This system also creates global disruptions in terms of trade. For the host country of the global reserve currency (the US), it forces them into a structural trade deficit situation in order to provide the world with dollars. For developing countries, it is a form of neocolonialism because they have had little alternative besides reinvesting their trade surpluses into depreciating sovereign debt of the reserve country (US Treasuries). They continually fund a wealthy country’s fiscal deficits in negative inflation-adjusted terms, with their accumulated national savings.
Gold is decent money, except that it has the shortcomings of weak portability, divisibility, and practical accessibility. And that’s why it failed in some ways to maintain its status as practical money, and thus made it possible for this fiat system to grow in spite of it.
The creation of bitcoin gives a new possibility that there may be a money hard and good enough to push back on this existing system, and re-assert itself as an ideal savings asset. Thanks to bitcoin, anyone with a smartphone can access good money now, and can self-custody and transact with it if desired.
But naturally, the market has to test how hard this new money is. Can it withstand the emergence of thousands of imitators? Can it maintain its decentralization in the face of countless subtle centralizing forces? The longer it lasts with its inherent properties intact, the more it benefits from the Lindy effect. As more people and more institutions hold it, bitcoin becomes more liquid and with less capability for any individual entity to move the market, and the range of probable outcomes starts to shrink, and so volatility starts to shrink as well.
So, when we talk about bitcoin becoming more mainstream, I think we’re ultimately talking about this monetization process, where its hardness is tested and it comes to be researched and appreciated by more consumers and market participants, until it reaches its total addressable market.
Other financial assets will react to the broken system in various ways, including making use of this technology, but I don’t think there is an “other way around” here, unless bitcoin fails.
If bitcoin does not become mainstream, with greater adoption and less volatility, and instead we have a more fractured or highly diversified monetary environment for the foreseeable future, then basically it means that bitcoin wasn’t hard enough to reach protocol status and dominate market share as the asset with the biggest monetary premium.
LNM: Pushing further this idea, do you think a few stocks could play, for a part at least, the same role as Bitcoin today: people would rather trust big private companies than central banks? It would be a complete inversion of trust where Bitcoin would be the most trusted asset, followed by private companies, and then central banks and fiat money.
Lyn Alden: I think we already do that today. We treat the S&P 500 as better money (in terms of being a long-term store of value) than dollars. Americans have a record high percentage of their net worth stored in equities today. Apple for example has a hardware and software ecosystem that people like, and its supply of shares decreased from 26 billion to 16 billion at a time when the broad US money supply increased from 10 trillion to 21 trillion. Which would we rather hold and trust more for preserving our value? Dollars or Apple shares?
Apple’s desirability could certainly change over time. Companies usually lose their touch after a few decades, and run into inertia where they get too big and stop innovating. So instead of holding Apple stock alone, we pick a basket of similar stocks to minimize single company risk while still keeping with the idea that shares of large corporations are a better store of value than fiat currency.
Basically, investments used to be considered risk capital; today investments are expected to be the bulk of your life savings. Because there have been few good alternatives to that model, with currency being as weak as it is.
This high allocation to equities in the US isn’t really the case globally, though. Most stock markets have a mixed track record of holding value. Since the US runs structural trade deficits with the rest of the world, those dollar surpluses to other nations have to be reinvested into dollar assets of some sort, and many of those dollars find their way to the US stock market. As a result, the foreign sector owns a larger and larger percentage of the S&P 500, and drives up the valuations. And the bulk of the returns came from the big US internet companies with network effects.
But many people in the world cannot access the S&P 500 or other top stock markets. My family in Egypt for example doesn’t hold any stocks; they hold real estate, local currency, and some US dollars. Stock ownership is pretty rare there, whether it be for local stocks or foreign stocks.
Right now, fiat currencies and corporate shares basically compete for the most trusted slot for liquid savings, with bitcoin being the smaller market.
If bitcoin continues to thrive and its hardness continues to hold up to testing, then I expect it to rise up the ranks to the top slot. Below that, I think we’ll still have a mix of assets, with corporate shares on average probably having a higher trust level than government currencies.
LNM: Are we currently witnessing the end of the US Dollar standard, in place since 1971?
Lyn Alden: Yes, basically.
More specifically, I think we’re seeing a restructuring of the dollar standard. In the post-WWII environment, and especially in the 1970s-to-present petrodollar environment, the US has had a rather uncontested ability to strengthen the network effect of its currency and government bonds. The dollar has been the main funding currency globally for governments and corporations to borrow in, and the Treasury has been the main reserve asset that countries store their sovereign currency reserves in.
Due to higher debts, the emergence of new technology, and because the US is a shrinking share of global GDP, I think we’re shifting to a world that has more diverse payment channels, and a re-emphasis on scarce neutral reserve assets as being the best global reserve assets.
In a hypothetical world where bitcoin was never created, gold would likely be the main beneficiary once again; its properties would be reconsidered and it would likely be brought back into being the biggest reserve asset. And even today with bitcoin at a $1 trillion market cap or less, gold is still basically the main option that large central banks have. Ever since the global financial crisis, gold has indeed been doing pretty well in terms of central bank allocation and price appreciation relative to Treasuries.
But over a long enough timeline, bitcoin represents another possibility for a neutral reserve asset. It has to grow into that role, and be tested along the way to see how suitable it is. So far it has been a great 13 years.
LNM: Last October, you said “The innovation I see in the Bitcoin ecosystem impresses me every day. The Lightning Network in particular- what's going on there is remarkable”. What do you find impressive about Lightning?
Lyn Alden: Back in January 2021, I tweeted that I think people are sleeping on the potential importance of the Lightning network.
I wrote this because I saw two main things. One was that the network was reaching a degree of liquidity, development, and critical mass to be truly usable. Two was that with Strike, we were seeing the potential emergence of the separation between bitcoin the network and bitcoin the asset. Lightning could be used to send fiat-to-BTC-to-fiat payments, instantly and globally.
This separation between bitcoin the asset and bitcoin the network is something I first heard from Elizabeth Stark; the idea that people may one day use bitcoin without even necessarily knowing they are using bitcoin, kind of like how most of us don’t know the full stack of protocols that we indirectly interact with when we use the internet.
And throughout 2021, we indeed saw an explosion of activity on Lightning. Lightning capacity began climbing a lot, and more integrations began happening. My statement in October 2021 was basically confirming that this observation from earlier in the year is playing out; Lightning is in the early stages of fulfilling some of its promise. What I saw from Impervious also contributed to my October 2021 statement specifically; that Lightning might end up being used for more applications than I originally envisioned. Taproot in late 2021 gave Lightning developers more ammo to work with as well. Now we have Cash App having integrated it, and I think more big integrations are likely coming over time.
Basically, bitcoin is an excellent foundation to build on. This layered/modular approach maximizes both immutability and programmability, with an immutable base layer, and more programmability on higher layers. Between Lightning, Liquid, RSK, and others, the market will determine which layers and apps work and add value, and which ones do not. There are already some great projects out there on these various layers, and certainly more are coming that I haven’t thought of yet.