I've long believed that bitcoin is the ideal store of value and medium of exchange for the Internet. What I've struggled with, however, is the notion that bitcoin could be the preferred unit of account for debts, wages, and anything else where payment is due in the future.
Like many others, I've tended to think that debts ought to be priced in a way that preserves purchasing power in real terms. Given the inevitability of positive and negative economic shocks even in a hyperbitcoinized world, I doubted whether bitcoin could ever be used as a unit of account in long-term contracts. This led me down a rabbit hole of trying to make sense of Bitcoin as a store of value and medium of exchange in a world where it is not the unit of account (#243270, #334513). I realize now that I was wrong, and I’d like to share why I changed my thinking.
In the competition for the dominant form of money, the money that is most likely to gain adoption is the money that promotes the greatest economic efficiency. A money that makes existing debts harder to service when the economy overheats and easier to service when the economy contracts will tend toward stability and promote greater economic efficiency than one that does neither.
Money is a crucial ingredient in the formation of price signals that inform economic behavior. Pegging debts to a basket of goods and services eliminates a crucial price signal that tells people when to adjust their behavior.
Bitcoin solves this problem in a passive self-regulating manner, without Keynesian-like intervention in the economy. Here's how:
Economic Stability amid Hyperbitcoinization
A hyperbitcoinized world is one that accepts bitcoin as a universal method of payment, denominates contracts in bitcoin, and values bitcoin at the maximum extent possible. Under this implicit social contract, the purchasing power of bitcoin in aggregate is equivalent to the total real wealth of the world.
The result: a unit of bitcoin can always purchase a constant fraction of the world's total wealth.
We can immediately make several observations. First, if the value of an asset relative to total wealth does not change, its price in bitcoin does not change. Second, if the income of a person grows at the same rate as total wealth, their income in bitcoin does not change.
Most importantly, bitcoin provides a counter-cyclical price signal that helps self-regulate the economy. Let's consider what happens when the economy overheats or is in a recession.
Overheating Economy (Wealth Growth > Income Growth): When the economy is booming and speculation is rampant, asset prices tend to rise faster than incomes. If bitcoin represents a constant fraction of wealth, debts become more expensive to service relative to incomes. This acts as a natural brake on further spending and investment, cooling down the economy.
Overcooling / Contracting Economy (Wealth Decline > Income Decline): Conversely, during a recession, asset prices tend to fall faster than incomes. If bitcoin represents a constant fraction of wealth, debts become easier to service relative to incomes. This reduces the risk of widespread defaults and frees up cash flow for individuals and businesses, helping the economy recover.
The beauty of a hyperbitcoinized world is that the economy naturally self-regulates through price signals, rather than through government intervention. This aspect of bitcoin is rarely discussed, perhaps because we're still years away from a world in which it's applicable. Until people denominate contracts in bitcoin, its self-regulating properties as a unit of account will remain purely theoretical.
Conclusion
The three recognized functions of money are store of value, medium of exchange, and unit of account. The virtues of bitcoin as a store of value and a trustless medium of exchange has been widely written about, but its viability as a unit of account, particularly for transactions where payment is due in the future, is under-discussed. Understanding why bitcoin can be an excellent unit of account requires understanding the precise mechanism through which bitcoin self-regulates a hyperbitcoinized economy.
This self-regulating mechanism is predicated upon bitcoin's ability to purchase a constant fraction of the economy's total wealth. If we limit ourselves to the economy of people already living on a bitcoin standard, this assumption may not seem far-fetched - their wealth is already predominantly stored in bitcoin. If we consider the open global economy, however, this assumption would not yet be appropriate.
The value of bitcoin relative to total global wealth is far from constant today. It is steadily growing, though, and it is reasonable to conclude that it will represent a stable fraction of total wealth in a hyperbitcoinized world. If and when that happens, bitcoin will serve all three functions of money better than any money is able to do today.