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What is Nakamoto-Gresham’s Law – Bitcoin Magazine : Bitcoin News, Articles, Charts & Guides

Bitcoin is money. That means it openly competes with the existing fiat monetary regime. A co-circulation of two kinds of money is not unprecedented, and the economic principle that describes the outcome is known as Gresham’s law. Applying Gresham’s insight to the bitcoin-fiat dynamics, we find that HODLing is economically rational under the current circumstances. “Good and bad coins cannot circulate together.” — Thomas Gresham, 1558 The Hierarchy of Monetary Needs To understand the rationality of HODLing, let’s briefly summarize why an advanced civilization needs well-functioning money. Human action is purposeful behavior, and the main purpose of everyone’s mind is to meet their most pressing needs first. If a person has money and his basic needs are not met, he will most likely choose to exchange his money for food, clothing and shelter. It is only when their basic needs are met that money can be saved to meet more advanced needs in the future. Money should primarily act as a medium of exchange. But the urgency of this function is quickly saturated and the value-store function of money quickly becomes the most important. Medium of exchange or store of value? We can illustrate the two functions of money and their relationship in the form of buckets. The medium of exchange is the first bucket we need to fill to meet our basic needs. Once that bucket is full, it overflows into the value store bucket. The medium of exchange has a limited capacity as there is a limited amount of goods and services that we have to buy and consume in a short period of time. The value storage bin, on the other hand, has an infinite capacity, because we can always increase our savings. The problem is that fiat money is not a very good piggy bank. Fiat is money with an infinite supply, and each new dollar dilutes the purchasing power of all outstanding dollars. In the 20 months since January 2020, the money supply in US dollars has increased by 35% – that is, by $5.4 trillion – and this has resulted in prices exploding across the board: consumer goods, materials, homes, financial instruments. Fiat is a very leaky bucket, because everything that is saved will gradually lose its purchasing power. With those insights, let’s take a look at how Bitcoin fits into that. Gresham Meets Nakamoto Bitcoiners sometimes invoke Gresham’s law as the reason why Bitcoin will succeed, but the truth is that in its original form it does not apply to the current situation. Gresham’s analysis concerns a case of two currencies where the nominal value of both currencies is determined by the government. The best historical example of Gresham’s law in action is the era of bimetallism. Between the years 1792-1873, the face value of gold and silver was established – initially in the ratio of 15 to 1 – so that 15 ounces of silver were equated to one ounce of gold. But the problem was that the price ratio of gold and silver fluctuated around this parity over time, making one metal overvalued and the second undervalued. The government made several adjustments to this fixed, face value ratio, until it finally abandoned the idea of ​​bimetallism and moved to a pure gold standard in 1873. The market relationship between gold and silver was volatile during the US bimetallic period. The fixed ratio between the two metals was 15:1 in 1792-1837, later changed to 16:1 in 1837-1873. Silver has been undervalued in the last period, being driven out of circulation and eventually abandoned in favor of the pure gold standard (Source). As Murray Rothbard points out in “What Has Government Done With Our Money,” the correct wording of Gresham’s law is not the popular “bad money drives out good money,” but rather “money artificially overvalued by government will artificially expel from circulation “undervalued money.” Obviously, this does not apply to the bitcoin-fiat dynamics, as the government does not set bitcoin’s face value. So to apply the insights of Gresham’s law in the context of bitcoin, we need to parse Gresham’s insight and come up with a modified version of the original law that takes into account a co-circulation of fiat and non-fiat money. To do that, I think we need to further reformulate Rothbard’s interpretation of Gresham’s law. What does it really mean that one type of money drives another out of circulation? Through the lens of monetary functions, this means that one currency acts as a medium of exchange and the other as a store of value. So the parsed version of Gresham’s original law would then read: Overvalued money will become the dominant medium of exchange in the economy, while the undervalued money will become the dominant storehouse of value. This is exactly what happened in the era of bimetallism, when gold became the preferred medium of exchange, while silver was ‘hoarded’ as a store of value. To finally apply this insight to bitcoin vs fiat, we need to remove the overvalued and undervalued parameters. I believe these can be replaced by a forward-looking review of the respective monetary policies of fiat and bitcoin. Fiat is a currency with a potentially infinite issuance, while bitcoin is a currency with a guaranteed, fixed issuance. (For those wondering whether bitcoin issuance is really guaranteed, I recommend reading Parker Lewis’s “Bitcoin Is Not Backed by Nothing” where he explains the credibility of bitcoin’s monetary policy). It is safe to assume that fiat will continue to rise, thus diluting the purchasing power of all outstanding units. It is also safe to assume that bitcoin will remain true to its fixed issuance monetary policy, so the purchasing power of the outstanding units will not dilute in the future. Now we can reformulate Gresham’s law to account for the co-circulation of fiat and non-fiat money. Serving up, Nakamoto-Gresham’s LawBitcoin expels fiat as a store of value.Fiat expels bitcoin as a medium of exchange. In layman’s terms it is rational to spend fiat and HODL bitcoin. Fiat loses value over time, so naturally we look for ways to get rid of it. Bitcoin gains value over time, so naturally we look for ways to hold onto it. We will see the amplifying effects of the Nakamoto-Gresham law as more people realize that (1) fiat will continue to fail in its role as a store of value, and (2) bitcoin will continue to gain momentum for its store of value function, primarily through its increasing credibility as the world’s only monetary instrument with predictable monetary policy. However, there are two conditions to Nakamoto-Gresham’s law: Condition A: Fiat is usable as a medium of exchange. This is not the case in some countries (especially with cross-border payments), so we can see bitcoin being used as a medium of exchange in such places as well. The increasing use of the Lightning Network in El Salvador for remittances is a striking example of the use of bitcoin as a medium of exchange due to fiat’s shortcomings. Condition B: A person or company receives fiat revenue. Fiat earners will try to get rid of fiat before bitcoin. If the given person or company is already fully bitcoinized and only processes bitcoin, then bitcoin naturally also becomes a medium of exchange. Bitcoin Prevents Civilization Degradation Economists, pundits and all kinds of talking heads who criticize bitcoin for not being a widespread medium of exchange are missing the point. In the leaky bucket environment we find ourselves in, we don’t need another medium of exchange, especially when fiat is still fulfilling this role satisfactorily and most of our wages are still in fiat. It would be rather irrational to spend bitcoin while we still have fiat to spend. HODLing bitcoin is a purely rational act because it provides us with the store of value function that fiat is increasingly failing to sustain. When fiat no longer fulfills the role of the medium of exchange, or when individuals receive all of their income in bitcoin, only then does it make sense to regularly spend bitcoin on everyday purchases. Bitcoin becoming a widespread store of value could turn out to be a civilization-saving event. Advanced civilizations need a reliable store of value to build and maintain wealth. If we don’t build up savings and instead spend everything we earn (and more, through debt), our infrastructure becomes fragile, societal values ​​become corrupt and the future is deeply discounted. We see where this leads through many historical examples: currency depreciation of ancient Rome led to the collapse of the empire; Hyperinflations of the 20th and 21st centuries led to war, totalitarianism and famine. We can escape this fate, both on an individual and societal level, by embracing Bitcoin. This is a guest post by Josef Tětek. The views expressed are entirely their own and do not necessarily reflect those of BTC, Inc. or Bitcoin Magazine.
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