Introduction
When the World Wide Web was created it promised a host of new opportunities. Emails, video conferencing and everyone with the ability to run their own radio or TV station. It was not anticipated, along with the ability to download music and pictures, and join groups of like-minded people without geographical borders, that learning about macroeconomics would be a favourite past-time for millions. Money is essential for everyone and thanks to the internet, it is now possible for everyone to understand how it works (and what do to when it doesn’t).
In 2008 there was a revolution in computer science. For the first time it was possible to create an immutable worldwide ledger that was independent of governments and banks. The native token of this ledger—the bitcoin—burst into life as a type of money. Not only did more people understand how money worked, they now had their own currency to play with! Advocates of the new system believe that bitcoin will eventually replace government-issued currencies. If so it will be the greatest wealth transfer of all time. This article explores the basis for that claim and how you can take advantage of it.
Warning: I am not a financial adviser and it is not investment advice. You must do your own research (some links are below).
After reading this article you should know:
what is money
the principles of cryptocurrencies
the games that governments play with money
how to buy and sell/spend cryptocurrencies
where to find more information
Definitions
Probably the most confusion in life, is generated by a failure to define the subject being discussed. Two people may disagree on a subject just because each of them defines the problem differently. If they could first agree on how to define the subject of the argument, they may find that they agree. This is apparent in the paragraph below ‘What is Money?’ Everybody has their own favourite list of what makes a money, but nobody agrees on exactly how to define each item on the list. As a result, there is no consensus.
The word ‘Bitcoin or bitcoin’ in this article is used broadly to refer to Bitcoin Core (BTC/XBT), and its derivatives Bitcoin Cash (BCH) and digital cash (DASH) and their respective networks/blockchains, and similar digital tokens. However there are many layers on top of Bitcoin and other tokens whose functionality is completely unlike bitcoin. it is not the scope of this article to go into these variants.
[Advanced note: Bitcoin the system is usually capitalised; bitcoin the money is usually not.]
Functions
Where a reference is made to a central bank (for example the US Federal Reserve Bank) the same principles broadly apply to all central banks (Bank of England, Bank of Japan, European Central Bank etc.). Similarly, references to the Chairman of the Federal Reserve (Jerome Powell) broadly apply to the Chairmen of other central banks (in the UK, Andrew Bailey); and references to the US Treasury Secretary (currently Janet Yellen) and other government chancellors (in the UK Chancellor of the Exchequer Rishi Sunak) can be considered similar. This does not mean they are following the exact same policy or are acting together, just that their roles are functionally similar.
What is money?
Money is a medium of exchange. It solves the problem where two people have something to sell, but neither wants what the other one is selling [there is no coincidence of wants] so bartering is not possible. You can store the value (see below) of your goods and services in money and redeem it later. The reason money is a medium of exchange is that by acting as a temporary store of value, it greases the cogs of commerce.
Money is ‘the most saleable good of indirect barter’ (Menger).
[Advanced Note: Cash is called a ‘bearer’ instrument because the person who bears/carries it owns it and can transfer it by simply handing it over. Most money is owned by third parties (banks) who use settlement systems (see below) to reconcile customers’ balances overnight. When you deposit your money in a bank it becomes their money, so if your bank goes bust you will be in a long line of unsecured creditors. To counter this, most countries boast some form of deposit guarantee (FDIC / FSCS). While this might work if one bank failed, if there was a general failure of the banks (Greece 2015, Cyprus 2012-13) then it is far more likely that the government would bring in cash rationing or levy a tax on all deposits).]
Money is a store of value A seller can exchange their goods or services for money which can be spent immediately or redeemed in the future. To an extent money is like a battery in which anything can be stored (for example an inheritance) and which can discharge anything later (for example a yacht). But not all batteries are the same. Due to excessive money printing by governments (see M2 money supply below), government money (sometimes called ‘fiat’ money) is a poor store of value. You can pay in a lifetime of work and in return get a ham sandwich. This phenomenon is called ‘loss of purchasing power’. As the government prints, more money chases the same amount of goods and services, so the purchasing power of your savings goes down and the cost of goods and services (‘consumer price inflation’) goes up.
[Advanced note: Just because money can be a store of value, this does not mean that it is going to store the value! It likely will not repay the same value/purchasing power that you put in. If you are going to store your wealth in money, choose your money wisely! The best monies come with a guarantee that they can be swapped at any time for a commodity with a real world price/value (such as gold) or are otherwise limited in their issuance (like some cryptocurrencies). This prevents governments from printing unlimited amounts of money because if they do then people will exercise their option to swap their worthless money for something of real value.]
Money is a unit of account. This means that the value of goods and services can be expressed in amounts of money. This makes price comparisons simple. For example you may know that a lemon is worth the same as an orange and that an egg is worth the same as a pint of milk, but that doesn’t tell you if a lemon is worth more or less than an egg. By expressing goods and services in an independent unit of account/currency you can solve this problem. If something is a unit of account, it means that goods and services can be defined by reference to it (can be ‘denominated’ in it). Almost anything can be used as a unit of account (you could express the value of everything in lemons for example). It is the least of all the properties of money but it helps if it is reasonably stable, the population is familiar with it and the maths is simple.
[Advanced note: Just because you don’t see goods and services priced in the shops in bitcoin does not mean it isn’t a unit of account—in the same way that you don’t see goods priced in Yen in the US. The lack of goods with price tags denominated in bitcoin is often used as an argument that it is not a unit of account and therefore not a money. But as we have seen, almost any good or service can be a unit of account and potentially a money.]
The Great British Pound (£/GBP) is the oldest money still in existence. This is not because it is successful or clever. In fact you could argue that it is not still in existence, by any meaningful comparison to previous incarnations.
It's longevity is due to the dogged refusal by the UK over many centuries to give up the benefits of having its own currency, (mainly devaluing sterling to disguise the failure of government economic policies).
What is a digital money?
In 2008 a person or group of people using the pseudonym ‘Satoshi Nakamoto’ made a breakthrough in computer science called blockchain technology. This is a decentralised and very secure way of storing and agreeing data globally, that does not rely on third parties like governments or banks. It is possible for anyone to access this distributed database and practically impossible to alter information once it has been uploaded. A blockchain can therefore be used as a permanent record to which everyone has read access.
The tokens that powered the blockchain (bitcoins) were awarded to people who maintained the system, allowing them to add new data. These bitcoins became useful and scarce, which made them valuable and the fact that ownership is recorded on the blockchain means they are an ideal type of digital money.
[Advanced note: Previous attempts at digital money failed because they relied on a trusted third party to keep track of every transaction to prevent double spending. Blockchain technology handles this automatically.]
The original blockchain token bitcoin (BTC/XBT) is now used as a worldwide settlement system (similar to FedWire). It is not suitable as a currency due to sometimes high, variable and unpredictable transfer charges. A separate layer (‘Lightning’) has been constructed on top of bitcoin (BTC) to handle smaller payments, however it lacks many layer 1 safeguards and in some ways is emerging as a new ‘banking’ system.
Variations like Bitcoin Cash (BCH) and Bitcoin Digital Cash DASH (DASH) are better suited for smaller day-to-day cash-like transfers as they are instant and have negligible fees.
Accounting
Single-entry accounting was first used by the Sumerians about 5,000 years ago. As humans started to record information on clay tablets, they kept a record of who owed what. Only one party (the custodian of the ledger) was necessary to falsify the record.
Double-entry accounting was adopted in Venice in 1400 AD and spread via the printing press. Both sides to a transaction kept a record (of credits and debits). If their records agreed then each would know the other was honest but they could join forces to defraud a third party.
In 2008, blockchain technology enabled triple-entry accounting. Not only do both sides keep a record of transactions, but there is a pseudonymous third copy (the blockchain) that is publicly accessible. This serves as an immutable record of the truth, so no accounting fraud is possible.
Digital versus Digitised
Digital money can be stored in a wallet app on any digital device (mobile phone, PC) or on a piece of paper, or in the form of 12-24 words and is transmitted from person to person with no intermediaries. Examples of digital money are Bitcoin Cash and DASH. The balance on your ‘phone wallet app is a statement of the money in your phone. Digital money is sovereign money, like gold. It is not created by lending, and preserves your financial security and privacy. It is a thing in itself.
Digitised money is a new way of showing bank balances that were previously kept on paper in bank vaults. Digitised money is owned, recorded and transferred by a third party (a bank). For example, you can view your balance on your ‘phone but it is not stored on your ‘phone. Digitised money is created by depositing or lending and gives the bank visibility into your finances. The balance on your ‘phone is a window into your claim on your bank’s money.
[Advanced note: You can of course keep your digital money on an exchange and view the balance like a bank. For smaller amounts a third party custodian might be a good idea, but for larger amounts and advanced users, it is recommended that you act as your own custodian.]
History of money
It has not always been the Government’s job to control and print money. In the past, people deposited gold or valuables at a bank and got a receipt (a bank ‘note’). Bank notes were exchanged for goods and services and could always be redeemed for gold at the issuing bank. But bank notes from banks on the east coast were not much use in shops on the west coast and vice versa. Banks would routinely print more notes than they had reserves (‘fractional reserve banking), because they knew it was unlikely that everyone would cash in their notes at the same time. There was a risk that issuing banks would print too many notes and go bust; so eventually Governments insisted on the right to issue and control the money supply.
Governments maintain demand for their money by
only accepting tax payments in government money (under threat of force)
insisting that paper money is good in settlement of all debts (‘legal tender’)
severely punishing counterfeiters to restrict supply
How much money needs to be in circulation depends on the level of economic activity. It is set by the central bank’s monetary policy which determines the money supply.
Monetary policy versus fiscal policy
Monetary policy is determined by central banks, according to a mandate given to them by Government. It concerns things like the amount of money and interest rates (the 'price' of money).
Critics say that fixing interest rates by committee distorts the true market price of money which leads to poor investment decisions. Risky businesses have access to lending at artificially low rates, which leads to bankruptcies and an inefficient economy.
Fiscal policy is set by the Government. It concerns things like tax and benefit levels.
If the Government does not have enough income, it sells bonds, which are IOUs that pay a fixed rate of interest. If nobody wants to lend the Government money by buying bonds, the central bank buys them, so the Treasury can print new money. This is the way that Government debt is monetised (turned into new money) causing inflation of the money supply. [See Hidden Secrets of Money ep 4].
The cost of debasing the money is not borne by future generations as is generally thought; it is borne NOW by everyone who has assets denominated in Government currency, because its purchasing power is immediately decreased. As the central bank becomes increasingly the only buyer and monetiser of government debt, the lines between monetary and fiscal policy become blurred. The Government can’t spend unless the Central Bank creates the money.
Quantitative easing (QE) (or ‘asset purchasing’) is a monetary policy tool that central banks can use to stimulate an economy by creating and injecting new money into an economy through the purchase of financial assets, (usually government bonds/IOUs). QE becomes useful as the bank rate/borrowing costs approach zero (0) per cent. While a central bank can reduce the ‘bank rate’ to zero in effect paying people to borrow, for practical purposes it is difficult to go below zero because the financial edifice is designed to function with a positive time preference (money now is worth more than money in the future). Reversing the process, apart from causing antiquated bank software everywhere to throw an exception, introduces all sort of perverse incentives (for example the bank would pay you to buy a house) and so it is avoided (although it was tried in Switzerland and Japan).
According to the House of Lords’ Economic Affairs Committee document ‘Quantitative easing: a dangerous addition?’ published July 2021, ‘the Bank of England now holds a substantial portion of the debt issued by the Government (para. 23)’. The effect of this is to release a flood of newly minted money into the market which raises asset prices such as stocks/shares, (but not wages). As stocks/shares tend to be owned by the wealthy whereas the working class merely have their wages, this increases the gap between the rich and the poor.
You will sometimes hear that ‘the public owes the debt to themselves, so they need not worry’. This is a fallacy. Let us assume that QE has doubled the money supply and everyone who has lost 50 per cent of their purchasing power demands that the process is reversed. The Bank of England sells the bonds back to the Government and destroys/deletes the proceeds. Could the Government get the money back from the institutions that received it, or would it raise it through general taxation? If the latter, then the population has paid to have its currency restored. Heads you lose, tails you lose. If you hear someone say ‘We owe it to ourselves’, you can reply ‘‘We’ weren’t the ones who got it in the first place!’
[Advanced note: Other methods of QT are: refusing to ‘roll over’ the debt by buying new bonds; or selling the bonds on the world market. In all cases the Bank of England is bulletproof and protected from any loss by an unpublished ‘Deed of Indemnity’ which commits the taxpayer/HM Treasury to paying ‘unquantifiable’ financial losses suffered by the Bank of England as a result of QE.
[Advanced note: In the US, President Trump (fiscal) complained that the Chairman of the Federal Reserve Bank, Janet Yellen (monetary) was not keeping interest rates low enough. Under Joe Biden, Janet Yellen was appointed US Treasury Secretary (fiscal). The current Fed. Chairman Jerome Powell (monetary) is complaining that he has put as much money into the economy and reduced interest rates as much as he can, and that Congress (fiscal) should pull their weight by giving away more to the public, hence Congress’ $1,200 and $1,400 stimulus checks and trillion dollar spending packages. Attempts to prevent the Federal Reserve monetising Government debt and put in a debt ‘ceiling’ have both failed.
money supply Inflation v consumer price inflation
“The way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation.”
“Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
“I do not think it is an exaggeration to say history is largely a history of inflation, usually inflations engineered by governments for the gain of governments.”
Inflating something is to increase its volume—for example: inflating a balloon. Inflation was historically used to mean an increase in the amount of money. If the government prints too much money (‘inflates the money supply’) then after a year or two, goods and services increase in price (‘consumer price inflation’). [See Milton Friedman] This is because the purchasing power of the currency has fallen as the increased money supply chases the same amount of goods and services. This is an important point. People complain when the cost of living increases, but cheer when the price of their house price goes up, but both are symptoms of the same disease—the loss of purchasing power of money.
Governments (and their enablers, the central banks) keep quiet about increases in the money supply (which they use to fight expensive foreign wars and run budget deficits to get re-elected) and put emphasis on the inevitable increase in consumer prices—which they blame on greedy retailers, suppliers and trade unions. In extreme circumstances they impose price and wage controls. The real solution is to shrink the size of government. See also Cantillon effect, below.
Money supply measures are referred to as M0/1, M2, M3 etc. M0 money is included in the M1 money, which is, in turn, included in the M2 money etc.
M0 or M2 are most accurate, because as the numbers/suffixes get higher, money starts to get double-counted. [View M2 money supply].
• M0 (Cash) - Notes and coins in general circulation (not including cash stored at the Central Bank and depository institutions).
• M1 (Liquid money) - The M0 plus travellers' cheques from non-bank issuers and other current deposits that can be immediately withdrawn.
• M2 (Money on notice) - M1 plus savings deposits, time deposits less than $100,000, and money-market deposit accounts for individuals.
An increase in M1 without a corresponding increase in M2 means that the economy is moving to money it can spend quickly (liquidity).
Consumer price inflation is measured using various indexes/indices. In the UK, the Retail Price Index (RPI) measured the change in the cost of a sample of retail goods and services until 2013 when it was replaced by the Retail Price Index Jevons (RPIJ). In 2018 the RPIJ was replaced by a mixture of the RPI and the Consumer Price Index (CPI). The CPIH is a new measure of the annual rate of UK consumer price inflation that includes the costs of living in one's own home. Critics of consumer price indices point to the frequent changes in method, manipulation of the samples and suspiciously low rate, which has the effect of suppressing public sector pay rises.
There are two ways that governments react to inflation:
If the increase in the money supply is predominantly private/business debt caused by excessive bank lending (such as in the 1930s, 1970s and 2010s), then they allow interest rates to rise above the rate of inflation, reducing borrowing/the money supply. As less money chases goods and services, inflation comes under control.
If the increase in the money supply is incurred by government spending, with the debt being monetised by the central bank (fiscal/monetary debt) (such as in the 1940s or the 2020s) then the government keeps interest rates low to maximise the rate at which the debt is inflated away. Private debtors also benefit, but lenders and savers get wiped out. This is the basis for saying that inflation ‘wipes out the middle class’ which has fiat-denominated assets. An increase of 1 per cent in interest rates means 300 billion more interest every year, on a 30 trillion debt.
The government keeps interest rates low by creating money to buy its own IOUs (bonds). Since bonds pay a fixed rate of interest, keeping their value high keeps the interest rate on them low. This is called ‘yield curve control’.
Governments can also put pressure on central banks monetary policy committees not to raise rates.
See https://www.lynalden.com/may-2021-newsletter/
Value and wealth
To be valuable, something must be useful and scarce. With no guarantee to the public of reimbursement in commodities that cannot be manipulated (post 1971 Nixon Shock), governments inevitably print too much money, mainly to run budget deficits (to get re-elected) and to fight expensive foreign wars. Because of this, all government monies cease to be scarce and end in hyper-inflation. Eventually, the world lending market insists on higher interest rates from Governments to cover the risk of money supply inflation and interest payments on existing Government debt gets out of control [See Sovereign Debt Crises].
To maintain confidence in the economy, governments print money to buy stocks and shares and corporate bonds, causing stock markets to rise. This principally benefits the wealthy (pension funds who have their wealth in shares and the rich who own shares). Company directors use this cash to buy back their own shares, causing their share price to rise and benefitting from large price-driven bonuses. The extra money created reduces the purchasing power of money saved by the middle class and spent by the poor. As a result wealth is taken from the poor and given to the rich. Normal checks and balances that would prevent this are not working, because central banks have limitless cash and the will to spend it.
It is not possible to print your way to economic success. If that was the case then the most successful countries would be Zimbabwe and Weimar Germany. Normally any country that is printing money far in excess of its output (GDP) would have to pay high rates of interest to compensate for the loss of purchasing power of its currency. But Governments have discovered a mechanism to keep interest rates close to zero. Remember Government bonds (IOUs) pay a fixed rate of interest. If you can keep the cost of bonds high then you can artificially depress interest rates, so you just print money to buy Government bonds from anyone who wants to sell them (including yourself). Nobody can complete with a limitless cash machine, so bond prices stay high and interest rates stay low. This means you can easily afford the interest.
But surely this roundabout has to stop at some point? Yes—it stops when people realise your currency is worthless and stop using it, in other words when there is a currency crisis. When will this happen? Nobody knows. It could be 10 years or it could be tomorrow, but every day is one day closer.
DISinflation
Disinflation is reducing the inflation in the money supply to let the national income catch up. The four ways to do this are:
Live within the country’s means and pay back the debt - Greatly increase taxes, halt money printing, greatly reduce spending on the welfare state, default on pensions, public sector pay, armed forces and Government debt. This is how we used to run the country from 1816 onwards, but the current debt burden and public expectations make this course impossible. This is not just austerity—it would be Armageddon.
Grow the economy faster than the debt. We are past the point at which this could be done but this is the only narrative you will hear in the media, to prevent panic. It gives people hope that the debt might disappear in an orderly fashion without wiping out middle-class wealth. But the debt is already growing faster than any possible increase in Gross Domestic Product (national income) so this option is unrealistic and not going to happen.
Operation Bernhard (The option preferred by Governments) This is a type of default. If you run the printing presses until it takes £1,000 to buy a ham sandwich, you can inflate your debt away! It doesn't matter if you owe £1 million if that's the cost of a small car. It is the only viable remaining option but anyone holding GBP-denominated debt that is not index-linked (saving accounts, pensions) will be wiped out. The gap between rich and poor increases, the middle-class is eliminated and poverty increases..
The UK budget deficit (income minus spending) that was forecast to be minus £55 billion is now forecast to exceed minus £355 billion or 16.9 percent of GDP, in the 2020-21 fiscal year. Debt (the Government overdraft) climbed to over 100 per cent of GDP [See Public Sector Debt].
Default This only occurs when the Government guarantees to exchange the currency for something that is valuable, like gold. The US government defaulted against gold in 1971. The UK defaulted against gold in 1931; and the dollar and practically everything else since 1971.
The government might introduce measures to frustrate the market including
exchange controls (prohibiting people from taking money out of the UK to exchange it) [see Harold Wilson’s £50 limit on holiday money]
wage controls, to prevent wage inflation pushing up factory prices
price controls, to prevent manufacturers passing on increased costs to consumers
All of these measures eventually fail. In the meantime they distort the market (for example a manufacturer will not produce goods or employ workers at a loss—thereby causing shortages and unemployment).
Deflation
Deflation is where the population and/or the supply of goods and services expands faster than the supply of a ‘hard’ money like gold or bitcoin. Consumer prices fall and your money buys more every year. This is the case where the currency is redeemable in some scarce commodity, like gold (see Gold Standard 1844-1931).
ACTUAL > REAL > Nominal interest Rates
The nominal rate is the ‘headline’ rate on a loan. As you would expect, ‘nominal’ just means ‘number. For example you could take a loan out at 6 per cent nominal rate.
The real rate is the ‘actual’ rate which accounts for inflation/loss of purchasing power each year. If inflation is running at 4 per cent and you are borrowing at 6 per cent, then your ‘real’ rate is 2 per cent (6-4). If you are a borrower, then inflation is your friend, as it eats away at your payments. If you are a lender then inflation is your enemy, as it will eat away at your income. This leads banks (for example) to charge a positive real rate on their loans.
The issue is complicated however when central banks/governments collude to suppress interest rates (by buying bonds) and ‘fixing’ the Consumer Price index to keep it low. It is possible to make payments on a loan which appear to be at a positive ‘real’ rate but which are below the actual rate of inflation. When inflation is higher than interest rates, this is called a negative real rate. This is good for borrowers and bad for lenders. Housebuyers, for example, end up with an asset that has not depreciated in value compared to the money that has been used to pay for it and has appreciated greatly in cost/sale price.
Negative real rates cause other problems. If you have loaned out money it ceases to be an asset and turns into a liability. Similarly if you have borrowed then your liability turns into an asset. Borrowers might cease to repay loans, particularly if their interest rate is fixed, or below the rate of inflation, or preferably both.
Time Preference
The time preference of money relates to when it is received. In a system where the purchasing power of money stays the same, it is better to receive money now, than in the future. This is because you can earn interest/take some risk with the money and turn it into more money in the future. For example, if you receive £100 and invest it at 1% (assume no inflation) then in a year’s time you will have £101.
Inflation/loss of purchasing power can undermine your strategy. If prices are rising at 2 per cent, then the purchasing power of your £101 in one year will be roughly equivalent to £99 today. If you are a bank lending money for house purchases, then you would need to charge an interest rate greater than the rate of inflation (a positive ‘real’ rate)
On the other hand, if the purchasing power of money is going up, then you might want to receive your £100 as far in the future as possible. Under those circumstances, debts are assets and loans are liabilities.
Covid19 to the rescue
Surely all this money printing is to help the economy and people impacted by a global pandemic? No. Governments require banks to have a certain level of reserves. Banks who are short of reserves put up some collateral and borrow overnight on the 'Repo' market (so-called because the collateral is ‘re-purchased’ in the morning).
On 17 Sep 2019, a bank (the Regulator won't say which) pledged some government bonds paying 2 per cent and couldn't find a lender who would charge them less than 10 per cent for a loan. [Read Caitlin Long's excellent article]. The Federal Reserve eventually lent the money, but on 17th September, the game of musical chairs nearly stopped and according to Long, approximately two-thirds of banks would not have found a seat. This event, which was seen by some as the harbinger of a full-blown crack-up boom, predates CoViD19 by any measure. To fix it, the Federal Reserve planned to create and inject $400 billion into the overnight market. At this point it became apparent to some that Government debt monetisation was spiralling out of control.
CoViD19 has not required that the Government create so much debt, but it has been a good smoke-screen to do so.
Fiat versus Sovereign money
If you were walking along and found a gold nugget (worth $1 million), congratulations, you are wealthy! You own it free and clear. Gold is a form of Sovereign Money, like bitcoin, cash and other bearer bonds.
If you don’t have enough Government fiat paper/plastic rectangles to pay your taxes, the Government will eventually lock you up. You can also obtain goods and services and courts cannot legally object to you settling the debt in Government money. The Government makes something a money by decree (‘fiat’). Saving some Government ‘fiat’ money is useful because it saves you from being locked up, otherwise it is better to exchange it for hard money, or commodities.
Money versus currency
Money which is in widespread use is the ‘currency’. Note that volatility does not prevent something being a money.
A good series on the history of money is Mike Maloney’s Hidden Secrets of Money. (Note: Maloney uses a slightly non-standard terminology. He calls gold ‘money’—but Government fiat (which he says always becomes worthless), he calls ‘currency’.
ordinary funds v hedge funds
A fund usually invests in stocks/shares (e.g. the energy sector or S&P500) or a commodity (e.g. gold). Buying into a fund gives you exposure to any price movement in the underlying asset, either up or down. In addition the fund may charge management fees. Shares in funds are traded on exchanges, so they are called Exchange Traded Funds (ETFs) or Exchange Traded Commodities (ETCs). You make money if the fund goes up, and lose it if it goes down.
A hedge fund is also allowed to make bets that pay off when stocks/shares or commodities fall in price/value (hence the saying ‘hedging your bets’. In effect, they can make money when things go up, but also make money when things go down. It is much easier to spread Fear, Uncertainty and Doubt (FUD) than optimism, so hedge funds have a big advantage over ordinary funds when making financial bets. Trying to move markets with FUD, or buying/selling stocks/shares or commodities that you do not own (‘naked trading’) is illegal in many countries.
[Advanced Note: Originally, ‘hedging’ a bet meant ‘hedging it in/putting a hedge around it’. It referred to the process of limiting the risk on an unexpectedly large bet/book by laying some of it off to smaller bookmakers to avoid an unmanageable loss. Now it is used to describe a risk that has been to some extent counterbalanced by a contrary risk.]
[Advanced Note: Privileged access to money-making business is not restricted to funds. In the latter part of the 21st century, Lloyds of London, an insurance market, was composed of syndicates, each consisting of several wealthy individuals who acted as unsecured underwriters or ‘Names’. In exchange for handsome tax benefits and the promise of substantial returns, the Names pledged to cover losses which, in many cases, far exceeded their means. In addition, their collateral was not required to be held by Lloyd’s which meant that they could invest it separately, earning interest on it twice! Claims for [inter alia] asbestosis meant that individual losses range from £120,000 to £5m, with many of the Names forced to sell their houses and businesses.]
Keynesianism versus
Austrian School economics versus
modern monetary theory
John Maynard Keynes was an economist who was influential in rebuilding the world monetary system after World War II. He said that at times of high unemployment, governments should print money without regard to inflation, to prevent a depression.
Fabian socialist and the godfather of modern day economic planning, in his 1919 work, The Economic Consequences of the Peace, he wrote:
“By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth.
“[…]. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.”
He also argued that in times of plenty, governments should destroy money to rebalance the supply. Of course they never do this and the purchasing power of money is greatly reduced.
Austrian School economists believe that Governments should promise to exchange their money at any time for a scarce good, like gold. In this way their ability to print money would be strictly limited by their gold reserves. This results in a ‘hard’ money that does not lose its purchasing power. This was the case until 1971 [See Nixon Shock].
Governments have been searching for a theory to back up their endless money printing. Currently this is Modern Monetary Theory which can be summarised as ‘Keynes without the rebalancing’. MMT proponents argue that money should be printed until we have full employment, without worrying about inflation.
Protecting your spending power
So, why now? People have always griped about Government spending, budget deficits and inflation. The difference is that since 2008 we have had a ‘hard’ money which is independent of Governments and banks and which can be used to preserve wealth. Bitcoin can be converted into and out of Government currency and increasingly spent direct on goods and services.
The correct response to excessive Government printing is to transfer your wealth into hard assets such as property, land, gold, silver, assets overseas and cryptocurrencies. These assets are inflation-proof because they are useful and scarce.
Property is subject to property taxes and requires maintenance. It is also easy to increase taxes on property owners who are generally regarded as ‘the wealthy’ or confiscate it, as it must be registered.
Land can be tax free (for example farm land or forestry) and retains its value while have amenity value or producing a crop. There is a considerable gain if it can be developed.
Treasury Inflation Protected Securities (TIPS) in the US, or UK government inflation-linked bonds (index-linked gilts). In theory these should protect your purchasing power from inflation, however there are concerns about the indices that are used to uprate their value and they are complex financial instruments. (Lynn Alden explains TIPS).
Gold (or any commodity). In theory, you could invest in any good, for example oil or pork bellies. In practice it is inconvenient to have an oil tanker or several tons of frozen pork turn up at your house, so gold and silver are the commodities of choice. Other popular commodities include platinum (used in catalytic converters), palladium, rare earth metals (used in exotic electronics) and copper (increasingly necessary for electric cars). Even uranium is suggested, based on a move away from coal, oil and gas-generated electricity.
Investing in commodities is very much based on your guess as to what will be useful in the future. Gold has lasting appeal but Uranium may be replaced in reactors by molten salt or Thorium. There may be a breakthrough in nuclear fission.Platinum may fall out of favour because electric cars don’t need catalytic converters.
If you trust a third-party to ‘store’ your gold it adds costs, and there is a high risk that it will not be there when you ask for it, particularly if everybody else is asking for it at the same time. Therefore you should give serious consideration to self-custody (storing coins at home). Gold coins are a convenient size for the storage of wealth. Gold Sovereign coins are exempt from VAT and Capital Gains Taxes (CGT) in the UK because they are technically ‘money’. Foreign gold coins (Krugerrands) are not exempt from CGT.Silver is not regarded as money therefore 20% VAT is payable on purchase. This means you have to wait until it rises by 20 per cent before you break even.
Assets overseas (for example stocks and shares, houses, land or bonds) in jurisdictions with sound economic fundamentals are technically difficult to arrange and manage.
To do this you would have to pay a fund manager that would drain any gains. [Alternatively see Nomad Capitalist]
Cryptocurrencies are easy to acquire. They are not subject to VAT but gains are currently subject to Capital Gains Tax when they are sold. The first £12,300 in gains every year is tax free (see CGT allowance).
Capital gains tax
This is a tax on assets that increase in price. It was designed to prevent people being paid in goods, to avoid income tax. Like most taxes, without any intervention it increases over time because thresholds for paying it are not increased to allow for inflation. Where there is no adjustment for inflation, the government is merely confiscating property. For example if you bought an asset for £50,000 and 20 years later it sells for £500,000 due simply to monetary debasement, then should the government be entitled to £450,000 or 90 per cent (or any part) of the asset?
Milton Friedman argued that asset prices should be adjusted to allow for debasement of the money supply/inflation, before CGT is applied. It is possible to go further and argue that a businessman who risks his capital to set up a business should be allowed to reduce his gain by a percentage to reward him for the risk incurred, in addition to inflation.
How to obtain digital currency
You can convert GBP into digital currencies on currency exchanges.
Open an account on a regulated exchange like Kraken or Coinbase or Gemini. Optionally, choose one that allows you to set up regular payments (see Cost Averaging).
Fund your account with pounds (GBP) by bank transfer or debit or credit cards
Exchange your GBP on the exchange for crypto. Research your purchases thoroughly beforehand. You must do your own due diligence.
Monitor your currency portfolio using the exchange app.
How to spend digital currency
Method A - Direct
Transfer your cryptocurrency from the exchange to a crypto wallet (such as Coinomi)
Spend it at any merchant who accepts it or transfer it to someone with a compatible wallet for goods or services
Method B - indirect
Exchange your cryptocurrency for GBP at the market rate on the exchange
Transfer your GBP balance from the exchange back to your bank account
method C - hybrid (ADVANCED)
Transfer your crypto balance to a Debit Card that supports crypto
Spend directly at any outlet that accepts Mastercard or Visa. The outlet will be paid in their preferred currency.
That’s all very well, but what should I buy??
Here are some questions that might guide your decision.
Are you a libertarian who wants to live ‘off grid’ financially? Try BTC, BCH or DASH
Do you believe in bitcoin as a settlement layer / reserve currency? Try BTC
Do you believe in bitcoin as a peer-to-peer form of cash? Try BCH or DASH
Are you buying to get rich? Avoid trading or speculating in derivatives, untested coins etc. Research and expect to hold long term to make a profit.
Do you want to day trade, possibly with leverage? Don’t.
Do you want to buy a coin for 1p on the basis if it goes up to 2p you’ve doubled your money? 1p coins are usually 1p for a reason.
Are you buying because someone has given you a tip? They probably know less than you do and are just trying to pump their bags.
Are you going to complain if the value of your holdings fall? Don’t buy.
Are you going to check the balance of your holdings every 10 minutes? That’s quite normal.
Do you think that the government will shut Bitcoin down? Re-read this article!
[Advanced note: Most money is made by buying and holding (hodling). HODL does not stand for ‘Hold on for dear life’ but was a misspelling in this Bitcoin Forum post.]
TAXes on money
Bitcoin is a new asset class which has the characteristics of two existing asset classes
Monetary good: Monies (including foreign currencies) are not subject to taxes when they are exchanged. When Bitcoin is used as a money it should not be taxed. Bitcoin is a ‘private' money that is not issued by a government.
Digital asset: This is the way the UK government (incorrectly) regards Bitcoin. Digital assets such as stocks/shares and bonds pay dividends and gains are subject to Capital Gains Tax. Some may be regulated as securities. Bitcoin does not pay a dividend and it is not a share in a joint enterprise.
This argument is about the principle that a private individual exchanging one money for another should not pay tax on the exchange. This principle is already accepted by tax authorities. When exchanging GBP for foreign Government currencies no tax is payable.
Taxing private money is unfair, will stifle innovation and prevent a currency of the internet. Unfortunately, (largely due to a lack of experience of a digital asset that can also function as a money), governments are coming down on the side of bitcoin being like a stock or share despite the fact it does not pay any dividends and is not a share in a common enterprise.
S.35 of the Finance Act (2012) (https://www.legislation.gov.uk/ukpga/2012/14/section/35) amended the Taxation of Chargeable Gains Act (1992) so that gains made on withdrawals from foreign bank accounts are not liable to capital gains tax with effect from 6 April 2012. In the process, the requirement (s.252 of the TCGA (1992)) https://www.legislation.gov.uk/ukpga/1992/12/section/252 that the foreign bank account(s) must represent currency acquired by the holder for personal expenditure outside the United Kingdom, was also removed.
Buying
The best times to buy tokens are:
Before a big conference. Delegates get enthused by progress, announcements are made and everybody decides to top up their holdings.
At the time a token is listed on a big exchange, or is offered as a fund. If a token is added to Coinbase (for example) then it becomes readily accessible to a much larger market. Similarly if a token is offered to institutional investors as part of a fund, then that greatly expands the market and will cause an increase in the price. You can assume that the exchange or fund has done the work of analysing the winners and performing the due diligence/vetting on the team behind it.
If a big investor mentions it. Occasionally, when interviewed, a crypto angel investor will be asked what they are currently working on and will say something like ‘we’re very impressed by what 'XYZ' token is doing' or ‘ABC token is doing something very innovative’. If these tokens are listed on an exchange and you agree there is a use case, this can be a chance to get in at an early stage.
Cost averaging
Once you have committed any initial lump sum, cost-averaging is then the most effective method of accumulating a volatile asset.
Commit to spending the same amount regularly on a fixed schedule. In this way you will buy fewer units if the price increases, but more if the price drops. This has been shown mathematically to produce the best conversion rate from one asset to another.
Trying to time buys and sells to take advantage of market peaks and troughs (trading) almost always results in losses and any profits from trading may be subject to income tax.
Useful principles
Gresham's Law: ‘Bad money drives out good (in general circulation)'. If people have a choice between two monies, that according to legal tender laws have equal face value, people will prefer to spend the bad ones (rusty coins, damaged, dirty or defunct notes, money going out of circulation or with less backing)—and keep the good ones. As a result all the money in circulation will be of the worse type. There is competition between money, meaning people might hoard (hodl) bitcoin and spend their fiat money if required.
Thier's Law: ‘Good money drives out bad’ at first glance might appear to contradict Gresham's Law, but it describes what happens where merchants can choose which free market money to accept for their goods (in the absence of legal tender laws) and gravitate towards the best money.
Cantillon Effect: Richard Cantillon (1680s-1734) suggested that price inflation occurs gradually and locally. The original recipients of newly-printed money (Governments and financial institutions close to them) enjoy higher standards of living at the expense of later recipients (the public) which have to buy at inflated prices.
Thucydides Trap: a tendency towards war, when an emerging power (China) threatens to displace an existing great power (USA).
Recommended reading/listening
Joshua Scigala (Vaultoro) - bitcoin supporter, sound theory but skewed towards gold custody
Milton Friedman (‘Inflation is always and everywhere a monetary phenomenon’ see https://www.youtube.com/watch?v=B_nGEj8wIP0). Also a proponent of adjusting capital gains for inflation, before paying Capital Gains Tax.
Matthew Mežinskis / Fernando Ulrich (Cryptovoices)
Ron Paul Liberty Report (ex US Congressman and libertarian)
Roger Ver (bitcoin.com)
Jeffrey Tucker (Libertarian and Economist)
Eric Vorhees (founder of ShapeShift and proponent of decentralised / non-custodial exchange).
Lynn Alden: Investment strategist.
Money Dethroned - Emil Sandstedt.
Drives home the point that every money with an open-ended supply is doomed to fail, either through increased production, arbitrage or debasement.
PODCASTS (Audio)
The Peter Schiff Show Podcast - Peter is excellent at macroeconomics but consistently wrong on bitcoin (he prefers gold)
CoinDesk Podcast—excellent daily news summary
CryptoVoices (in particular https://cryptovoices.com/basemoney)
Speaking of Bitcoin
Reports
kraken.com/subscribe/intelligence
SubReddits
/r/Bitcoin—not very useful but sometimes has some breaking news about BTC. Heavily censored in favour of BTC.
/r/BTC—dedicated to bitcoin Cash (BCH), friendlier, most topics allowed.
/r/dashpay—dedicated to Bitcoin Digital Cash (DASH)