Monetary Engineering

Bitcoin and
Blockchain Technology
Monetary Engineering
v2019.04.03
Comments, corrections, and questions: https://drive.google.com/open?id=1T2z4vfRvEv_wooerJI7FgD8IkxeTihlj
© 2019 Digital Gold Institute

View Slide

The Information Economy
▪ Data is transferred with zero marginal cost
▪ Why pay a fee to move bytes representing wealth?
▪ Why only 9-5, Monday-Friday, two days settlement?
▪ Who (and when) will gift humanity with a global instantaneous
free p2p payment network?
BAN
K
© 2019 Digital Gold Institute 2/93

View Slide

Reliable Internet eCash Will Be Developed
“The one thing that's missing, but that'll soon be developed, is a
reliable eCash, a method whereby on the internet you can transfer
funds from A to B, without A knowing B or B knowing A, the way I
can take a 20 Dollar bill and hand it over to you”
Milton Friedman, 1999
https://www.youtube.com/watch?v=ZoaXLzFhWIw

View Slide

Table of Contents
1. Cash, Electronic Money, Central Bank Money, eCash
2. About Money
3. Private Money and the Centralization Dilemma
4. The Double Spending Problem
5. Bitcoin as Digital Gold
6. Hayek Money: Elastic Non-discretionary Policy
7. Hayek Money: Dual Asset Ledger and Proof-of-Payment

View Slide

Cash vs Electronic Money
Cash
▪ Universal access: users are not
identified or authorized
▪ Bearer asset: it cannot be
recovered if lost
▪ Physical instance only:
banknotes and coins
▪ Privacy preserving
▪ Usually issued by a central bank
Electronic Money
▪ Identified eligible users: Know-
Your-Customers (KYC)
▪ If credentials are lost, money
can usually be recovered
▪ Purely digital
▪ Traced for Anti Money
Laundering (AML) and Contrast
to Terrorism Financing (CTF)
▪ Issued by both central and non-
central banks

View Slide

Cashless Society
▪ Ban cash in favor of electronic money
▪ Recently and frequently proposed to contrast the crime that
uses cash
▪ Pervasive controls would be dangerous when used by illiberal
governments: cash defends privacy
▪ Cash stands in the way of the state Leviathan: it protects
citizens from the fiscal aggression and the confiscation of wealth
via negative interest rates

View Slide

Central Bank Money
▪ Only selected financial institutions have access to electronic
central bank money in the form of central bank accounts
▪ Everybody else has access only to non-electronic central bank
money in the tangible form of cash
▪ A bank account balance is not central bank money: just the
promise of a private company that the account owner will be
able to redeem the balance for central bank money
▪ Not even true, if everybody wants to redeem their amounts at
the same time (bank run)

View Slide

Central Bank Digital Currency? 1/3
“[… it would be] appealing […] it would mean people have direct
access to the ultimate risk-free asset [...] it could exacerbate liquidity
risk by lowering the frictions involved in running to central bank
money [...] it could fundamentally and perhaps abruptly re-shape
banking”
Mark Carney, Governor of the Bank of England, June 2016
http://www.bankofengland.co.uk/publications/Documents/speeches/2016/speech914.pdf

View Slide

“Allowing the public to hold claims on the central bank might make
their liquid assets safer, because a central bank cannot become
insolvent. This is an feature which will become relevant especially
in times of crisis – when there will be a strong incentive for money
holders to switch bank deposits into the official digital currency
simply at the push of a button. But what might be a boon for
savers in search of safety might be a bane for banks, as this makes
a bank run potentially even easier”
Jens Weidmann, President of Bundesbank, June 2017
https://www.ft.com/content/414072b7-0de5-3864-9493-14438eab30ae

View Slide

eCash: Goals, Security, and Guarantees
▪ Reduce the cost of managing physical cash
▪ Provide with fast electronic cash
▪ Central bank or private issuer
▪ Coin issuance backed by fiat currency reserves
▪ Entrance/exit gateway (fiat currency → digital cash)
monitored with KYC and AML processes
▪ Electronic trails for investigators
▪ Issuer/admin able to confiscate coins to any address if
needed/required

View Slide

eCash: A Proof of Concept
▪ Bitcoin core codebase
▪ Mining, i.e. transaction finalization, reserved to vetted nodes
(e.g. block signing from Elements)
▪ Thousands transactions per second
▪ Apps: wallets (iOS, Android, Desktop), blockexplorer, issuer
dashboard

View Slide

eCash: Regulators’ Feedback
Transactions must be attributed to known customers
→ electronic money, not cash
Allowed applications must be certified, i.e. closed network
→ client-server approach, not peer-to-peer

View Slide

“It doesn’t only matter how central bank money is created, but
also to whom it is issued.
From today’s perspective, there are no clear benefits from allowing
the general public to hold digital central bank reserves, in
particular in economies where demand for cash remains robust,
such as in the euro area. This assessment includes considerations
related to the potential impact of central bank digital currencies on
financial structures in general, and the stability of bank deposits in
particular.”
Benoît Cœuré, ECB Executive Board, May 2018
https://www.ecb.europa.eu/press/key/date/2018/html/ecb.sp180514_4.en.html

View Slide

Centralized eCash Does Not Need Blockchain
▪ Client-server solutions can be explored, e.g. SatisPay, even with
bitcoin-like cryptographic transactions
▪ What is relevant is which reserve asset is backing the digital
currency (if not issued by a central bank)
▪ If customers are identified, then it is electronic money, not cash

View Slide

Table of Contents
2. About Money

View Slide

Money As A Social Relation Instrument
▪ Human beings are born into a gift economy
▪ Enlarged relationship circle requires exchange economy
▪ Barter economy: coincidence of wants
▪ Trade economy: money as medium of exchange
▪ Global information economy: supranational digital money

View Slide

Properties of Money:
1. Medium of Exchange
▪ Swappable and fungible
▪ Portable
▪ Divisible
▪ Easily recognizable and resistant to counterfeiting

View Slide

Money Comparison
Medium of Exchange
Live cattle
Diamonds
Gold
Fiat coins and notes
• swappable
• fungible
• portable
• divisible
• recognizable
• resistant to
counterfeiting

View Slide

2. Store of Stable Value
▪ Reliably saved, stored, and retrieved
▪ Retain usefulness and storage properties over time
▪ Non-perishable and with low preservation cost
Its value stability does not depend on the storage properties,
but on its unit of account quality instead

View Slide

Money Comparison
Medium of Exchange Store of Stable Value
Live cattle
Diamonds
Gold
• swappable
• fungible
• portable
• divisible
• recognizable
• resistant to
counterfeiting
• reliably saved,
stored, and
retrieved
• retain usefulness
over time
• Maintain its
storage properties
• non-perishable or
with low
preservation cost

View Slide

3. Unit of Account
▪ used as numeraire, i.e. relative worth unit of measure: unit of
account against which the value of every other good is
measured
▪ the price system measures the value of goods relative to the
value of money
To best perform its role as unit of account, good money should
have stable value allowing for a reliable analysis of the price
dynamic and homogeneous comparisons
▪ Money supply must be controlled in some way

View Slide

Money Comparison
Medium of Exchange Store of Stable Value Unit of Account
Live cattle
Diamonds
Gold
• swappable
• fungible
• portable
• divisible
• recognizable
• resistant to
counterfeiting
• reliably saved,
stored, and
retrieved
over time
• Maintain its
storage properties
with low
preservation cost
• relative worth
unit of measure
• stable value for
stable price
comparison
• supply must be
controlled in
some way

View Slide

The Holy Grail of Stable Prices
▪ Gold standard, bimetallism, symmetallism
▪ Fixed value of bullion (Aneurin Williams 1892)
▪ Compensated dollar (1911-20 Irving Fisher)
▪ Commodity Reserve Currency (1932 J. Goudriaan, 1937-44 B.
Graham, 1942 F. Graham, 1951 M. Friedman)
▪ ANCAP basket (1982 Robert Hall)
▪ Futures contracts (1984 Miles, 1989-95 Sumner)
▪ Quasi-futures contract (1994 Kevin Dowd)
▪ Price index option (2000 Kevin Dowd)

View Slide

Trade Economy: From Gold Standard to Fiat
Money
▪ Gold: the commodity money standard
− scarce
− pleasant color, i.e. resistant to corrosion and oxidation
− high malleability
− relative easiness of its purity assessment
▪ Gold purity certification
▪ Representative money
▪ Fractional receipt money
▪ Fiat money and legal tender

View Slide

Gross US Public Debt

View Slide

Gross US Public Debt as GDP Percentage

View Slide

Take Money out of the Hands of Government
“I don't believe we shall ever have a good money again before we
take the thing out of the hands of government, that is, we can't
take them violently out of the hands of government, all we can do
is by some sly roundabout way introduce something that they can't
stop.”
Friedrich August von Hayek
https://youtu.be/EYhEDxFwFRU?t=19m23s

View Slide

Hyperinflation

View Slide

USD has lost 96% of its Purchasing Power
since Federal Reserve establishment in 1913
$0.00
$0.10
$0.20
$0.30
$0.40
$0.50
$0.60
$0.70
$0.80
$0.90
$1.00
US Dollar Purchasing Power

View Slide

Friedrich August von Hayek
“Denationalisation of Money”
▪ history of coinage is an almost uninterrupted story of
debasements; history is largely a history of inflation engineered
by governments for their gain
▪ why government monopoly of the provision of money is
regarded as indispensable? It deprived public of the opportunity
to discover and use a better reliable money
“Blessed will be the day when it will no longer be from the
benevolence of the government that we expect good money but
from the regard of the banks for their own interest”
A Free-Market Monetary System, Gold and Monetary Conference, New Orleans, Nov. 1977, https://mises.org/daily/3204
Denationalisation of Money, The Institute of Economic Affairs, http://www.mises.org/books/denationalisation.pdf

View Slide

Table of Contents
2. About Money

View Slide

Permissionless Innovation:
Gentle, Fast, and Effective
▪ No centralized security mechanism, no barrier to enter, no
editorial control
− Email has not been designed by a consortium of postal
agencies
− Internet has not been developed by a consortium of telcos
▪ Will a new money and its decentralized transactional network be
designed by a consortium of banks?

View Slide

Private Monies
▪ A medium of exchange issued by a non-governmental body,
without legal privileges
▪ Private monies do not have to be generally acceptable; they
merely have to be accepted in a given economic community
▪ Public demand for private currencies:
− hold them in the expectation that they will not diminish in
purchasing power as state money has
− wish to be part of a movement against increasing state
control of economic and personal behavior
− conduct illegal activity
− just want better money

View Slide

A Cypherpunk’s Manifesto
“Privacy in an open society also requires cryptography […] We
cannot expect governments, corporations, or other large, faceless
organizations to grant us privacy out of their beneficence. […] We
must defend our own privacy if we expect to have any. […] We are
defending our privacy with cryptography, […] with digital
signatures, and with electronic money”
Eric Hughes, A Cypherpunk's Manifesto
https://www.activism.net/cypherpunk/manifesto.html
Cryptography is the slingshot that David, the little man, can use to
kill Goliath, the dystopian Big Brother

View Slide

Bitcoin Precursors
▪ Ecash, David Chaum, 1982 (blind signature)
▪ Hashcash, Adam Back, 1997 (Proof-of-Work)
▪ B-money, Wei Dau, 1998 (distributed database)
▪ Bit gold, Nick Szabo, 1998 (distributed database, sequential
money creation)
▪ Anonymous Electronic Cash, Tomas Sander and Amnon Ta-
Shma, 1999 (anonymity)
▪ Reusable Proof-of-Work, Hal Finney, 2004

View Slide

Liberty Dollar: 1998-2009
▪ Private mint that issued gold and silver coins; also issued notes
redeemable in precious metals
▪ Periodically revalued against USD: the value of the latter fell
over time against precious metals
▪ Specifically designed to function in parallel with and in
competition to USD
▪ Never marketed or represented as official US currency
▪ Highly successful: it became the second most popular currency
in the US
▪ Its use declared a federal crime by the US government
▪ Its founders convicted for counterfeiting, fraud and conspiracy
against the United States

View Slide

E-gold: 1996-2007
▪ Digital payment system with gold as unit of account
▪ User accounts backed by gold reserves
▪ By 2005, e-gold had grown to be second only to PayPal in the
online payments industry: 1.2M accounts and $1.5B
transactions
▪ Indicted in April 2007 by US law enforcement services
▪ Charges: unlicensed money-transmitting entity and a means of
moving the proceeds of illegal activities
▪ Never proven and even the judge expressed major doubts
▪ ‘Offshore’ payment system rather than a money transmitter or
bank as defined under then-existing regulations, not least
because gold was not legally ‘money’

View Slide

The Centralization Dilemma
▪ To remove the weakness of a central point of failure, distributed
technologies seemed promising (e.g. BitTorrent)
▪ Anyway, in digital cash schemes a single digital token, being
just a file that can be duplicated, can be spent twice: a
centralized trusted party is required to avoid double spending

View Slide

Table of Contents
2. About Money

View Slide

Double Spending Problem
▪ To securely transfer value using digital means has been possible
for decades
▪ In digital cash schemes, a single digital token, being just a file
that can be duplicated, can be spent twice
▪ How can we forbid Alice from spending the same bitcoins a
second time to Carol’s address? Which transaction should be
valid: the one to Bob’s address or Carol’s address?
▪ A centralized trusted party has always been required to prevent
double spending

View Slide

Bitcoin Network: A Distributed Back-office
▪ All network nodes validate and clear all transactions
▪ Mining nodes provide the additional computational power
required for transaction settlement
▪ Without a central trusted party, how do they reach distributed
consensus on the transaction history? How does the Bitcoin
protocol reach consensus on transaction history ledger?
▪ Consensus in a distributed asynchronous network with faulty (or
malicious) nodes is a very hard problem: Computer Science
even provides impossibility results

View Slide

Bitcoin's Public Ledger: A Chain of Blocks
▪ Transactions are bundled in blocks (about one block every 10
minutes) and sequentially chained
▪ The cryptographic link between blocks requires computing
power to be created
▪ A block is valid only if it includes valid transactions

View Slide

Mining
▪ Miners compete to finalize (settle) a new block of transactions
▪ The winner providing proof-of-work for the finalization of a new
block is rewarded with the issuance of new bitcoins in a special
coinbase transaction included in that same block
▪ Miners solve the double spending problem:
− A double spending transaction would invalidate the block
− an invalid block would be rejected from the network
− the bitcoin reward would be removed from transaction history
− the winning miner would have wasted his work

View Slide

Nakamoto Distributed Consensus
Practical Byzantine Fault Tolerant (PBFT) distributed consensus is
achieved using (game theory) economic incentive for the mining
nodes to be honest
▪ Double spending is solved without a central trusted party
▪ Bitcoin can resist attacks of malicious agents, as long as they do
not control network majority
▪ Miners are compensated for their proof-of-work using
seigniorage revenues, i.e. issuance of new bitcoins
▪ Seigniorage revenues subsidize the network

View Slide

Seigniorage Revenues Cover Consensus Cost
▪ Seigniorage revenues subsidize the network, making transactions cheap
▪ 144 block/day, 365 day/year, 12.5 BTC/block
▪ About $7 billions per year (as of November 2017, BTC=$10,000)

View Slide

Virtuous Cycle
hash
power
Bitcoin
security
bitcoin
price
mining
reward

View Slide

Proof-of-Work
▪ Resources consumed as proof-of-work make bitcoin valuable
▪ Miners are willing to destroy resources to acquire bitcoins: they
are the first to recognize bitcoin value!

View Slide

Table of Contents
2. About Money

View Slide

Validation Process: Block Generation
The proof-of-work difficulty is adapted about every 2 weeks (2015
blocks) to the overall available computing power ensuring about
one block every 10 minutes

View Slide

Bitcoin Monetary Rule
▪ 2009: 50BTC per block, every 10 minutes
− halving every 4Y
▪ This is the only way new bitcoins are released
▪ It is called mining because of its similarity with the progressive
scarcity of gold extraction
▪ Supply is free of discretionary intervention

View Slide

Bitcoin Inelastic Supply:
Deterministic Decreasing Rate
2029: 96.88%
of all BTC
issued
2141: last
satoshi
(0.00000001
BTC) will be
issued

View Slide

What after 2141?
▪ We are all dead ;-)
▪ Gradually switch over to a fee-based system: as block space is
limited, market is already requiring a growing satoshi/byte fee
for transactions to be included into a block.
After all it is only natural that transacting on the most secure
network in the world will command high fees
▪ Switch to a different paradigm? We have about 120 years to
evaluate alternative solutions

View Slide

What Makes Bitcoin Special?
▪ Digital and scriptural: it only exists as validated transaction
▪ Asset, not liability
▪ Bearer instrument
▪ It can be transferred but not duplicated (i.e. it can be spent, but
not double-spent)
▪ Scarce in digital realm, as nothing else before
▪ It mimics gold monetary policy of decreasing incremental
extraction

View Slide

What Makes Bitcoin Special?
Bitcoin is digital gold
with a secure uncensorable embedded
settlement network
▪ More a crypto-commodity then a crypto-currency
▪ This is the groundbreaking achievement by Satoshi Nakamoto,
not blockchain “technology”

View Slide

Bitcoin Relevance
If one thinks about the role of physical gold in the history of
civilization, money, and finance
the digital equivalent of gold could be disruptive
in the current digital civilization and the future of money and
finance
Bitcoin can be the new global reserve asset
It is disconcerting that people are still, continuously,
underestimating bitcoin

View Slide

Explain Money to an Alien
Traditional (fiat) money
▪ No intrinsic value (social
contract)
▪ Currency security based on
paper/ink
▪ Discretionary governance
▪ Wicksellian interest-rate
approach
▪ Coerced upon everybody
with legal tender
bitcoin
▪ No intrinsic value (digital
gold)
▪ Currency security based on
math/cryptography
▪ Algorithmic governance
▪ Deterministic supply
▪ Available as free non-
binding choice

View Slide

Different Opinions
Alan Greenspan
“It’s a bubble. It has to have
intrinsic value: you have to
really stretch your imagination
to infer what the intrinsic value
of Bitcoin is. I haven’t been able
to do it. Maybe somebody else
can. I do not understand where
the backing of Bitcoin is coming
from”
Lloyd Blankfein
“The list of things that are
conventional today that I use
every day that I thought would
never make it is a very long list.
If bitcoin works, I say to
myself… 'Hmmm, maybe that
was a natural progression from
hard money to fiat money to
consensus money.' So who's to
say…”

View Slide

The Schelling Point of Consensus Money
▪ In game theory Schelling point is: “focal point[s] for each
person’s expectation of what the other expects him to expect to
be expected to do”
▪ E.g. two people unable to communicate are urged to select a
square among a series of similar squares and rewarded only if
they select the same one
▪ They will look for a choice that might seem more natural,
special, or relevant: the red one
Bitcoin is the Schelling point of consensus money!

View Slide

Bitcoin Transactions Are Not Taking Off
▪ There is evidence that bitcoin is not really used for transactions
▪ Max number of transactions per second
− VISA: 60,000 tx/sec
− Bitcoin: 7 tx/sec
▪ Bitcoin can only scale with second layer solutions, e.g. Lightning
Network, Sidechain (Liquid)

View Slide

Two Pizzas for 10,000 Bitcoins… really!!
https://bitcointalk.org/index.php?topic=137.msg1195#msg1

View Slide

The Ultimate Fate of Bitcoin:
To Serve as a Reserve Currency
Hal Finney (1956–2014) was a noted cryptographic activist. He was the second PGP Corporation developer
hired after Phil Zimmermann. He created the first reusable proof-of-work. He was an early bitcoin user and
received the first bitcoin transaction from bitcoin's creator Satoshi Nakamoto.

View Slide

Unit of Account: Money as Numeraire
▪ Relative worth unit of measure: money is the unit of account
against which the value of every other good is measured
▪ The price system measures the value of goods relative to the
value of money
To best perform its role as unit of account, good money should
have stable value allowing for a reliable analysis of the price
dynamic and homogeneous comparisons
▪ Money supply must be controlled in some way

View Slide

Money Comparison
Medium of Exchange Store of Stable Value Unit of Account
Live cattle
Diamonds
Gold
Bitcoin
• swappable
• fungible
• portable
• divisible
• recognizable
• resistant to
counterfeiting
• reliably saved,
stored, and
retrieved
over time
• Maintain its
storage properties
with low
preservation cost
• relative worth
unit of measure
• stable value for
stable price
comparison
• supply must be
controlled in
some way

View Slide

Bitcoin is Digital Gold, Not a Good Unit of
Account
▪ no salaries, no
mortgages, no
stable purchasing
power
▪ successful at
getting rid of a
centralized
monetary authority,
bitcoin has given up
the flexibility of an
elastic supply of
money

View Slide

Bitcoin as (Digital) Gold
in the History of (Crypto)Money
gold
▪ Its adoption was not
centrally planned
▪ For centuries it has been
the most successful form of
money
▪ It has bootstrapped all
monetary systems we know
of
▪ It has been surpassed by
other kind of money without
becoming obsolete
bitcoin
▪ Its adoption has not been
centrally planned
▪ It is the most successful
form of cryptocurrency
▪ It is bootstrapping new
monetary systems
▪ It might be surpassed by
more advanced type of
cryptocurrencies without
becoming obsolete

View Slide

Bitcoin Is Not Loved… Gold Too!
▪ 1933 Gold Act "forbidding the hoarding of gold coin, gold
bullion, and gold certificates within the continental United
States".
▪ 1966 Greenspan: “This is the shabby secret of the welfare
statists' tirades against gold. Deficit spending is simply a
scheme for the confiscation of wealth. Gold stands in the way of
this insidious process. It stands as a protector of property
rights. If one grasps this, one has no difficulty in understanding
the statists' antagonism toward the gold standard.”
▪ 1972 Nixon shock: unilateral cancellation of the convertibility of
the United States dollar to gold.

View Slide

IMF Special Drawing Rights
▪ Special Drawing Rights are international reserve assets, created
in 1969 to supplement existing official reserves of member
countries
▪ SDRs address the lack of a non-national currency to be used as
reserve asset
▪ F. Saccomanni: “cryptocurrencies could be an effective
monetary policy instruments [...] we should pay more attention
to the geniuses working on them, try to understand what of
interest they could teach us”
https://it.finance.yahoo.com/notizie/saccomanni-non-bisogna-demonizzare-cripto-valute-172912255.html
http://www.ufficiostampa.rai.it/pdf/2014/2014-10-09/2014100928490498.pdf
▪ IMF sponsored token: possible, but unrealistic as it would
severely undermine US dollar predominance

View Slide

Geopolitical Implications
▪ To challenge the USD supremacy as reserve asset is hard
▪ Monetary engineering might be not only the next cypher-punk
frontier, but a weapon of geopolitical «wars»

View Slide

Table of Contents
2. About Money

View Slide

Hayek Money:
A New Generation of Cryptocurrencies
▪ The cryptocurrency monetary standard of elastic non-
discretionary supply
▪ Price stability paradigm with respect to a given reference basket
▪ Bitcoin can be used as reserve asset
▪ Concurrent cryptocurrencies competing in monetary policy
definition and reference basket choices
▪ Private monies competing with legal tender monies: separation
of Money and State?

View Slide

Fixed USD Exchange Rate
▪ USD/BTC: 15-Apr-11 1.0, 29-Mar-14 500.0
▪ x500 increase for BTC demand relative to USD
▪ 29-March-14: 12.5M bitcoins in circulation
▪ Inflate their number 500 times to 6250M
▪ On 29-Mar-14 it would have been equivalent
− to own BTC1 worth $500
− or (rebased) RBTC500 each worth $1

View Slide

USD-Parity (Daily) Rebased Bitcoin
▪ Adopting the USD Consumer Price Index
▪ 6% inflation in the period March 2011-2014
1.06
72/93

View Slide

Avoid USD Monetary Policy:
Brent-Wheat Commodity Price Index

View Slide

Brent-Wheat Commodity Price Index
Rebased Bitcoin

View Slide

USD/RBTC vs USD/EUR Exchange Rate

View Slide

Rebasing Bitcoin?
No, not really!
▪ Bitcoin has been used for the sake of discussion, basically to
leverage its historic price time series
▪ Bitcoin is good as it is: more a cryptocommodity than a
cryptocurrency, bitcoin is digital gold

View Slide

Hayek Money:
This First Simplistic Implementation
▪ Results:
− Price stability
− Salaries, mortgages, forward payments are now possible
▪ Problems:
− Number of coins in a wallet changes without direct in/out flows
− Purchasing power of a given wallet is not stable
− Coins still have speculative investment appeal and so
enjoy limited transaction usage (do not buy pizza with
them)

View Slide

Table of Contents
2. About Money

View Slide

▪ Split transactional and speculative money demand with two
non-fungible assets
▪ Blockchain technology tracks ownership and transactions for
both: dual asset ledger
▪ A Reserve Asset Bank act as issuer, issuing both
− (stable) transactional coins
− (unstable) speculative shares
▪ The market will assign respective prices
and
Hayek Money Dual Asset Ledger
79/93

View Slide

Monetary Policy Target
▪ Make the coin stable in purchasing power with respect to a
given reference basket
▪ The coin is pegged to parity:
−
≅ 1 unit of the reference basket
− corridor: 1 − ϵ <
< 1 + ϵ (e.g. 0.95 <
< 1.05)
▪ Coins must not be inflated/deflated arbitrarily

View Slide

Monetary Policy Goal
If
≅ 1 always, coins lose any speculative appeal!
▪ Money velocity and transaction volume increase
=
Where:
− M is the money supply (total amount of money in circulation;
− V is the velocity of money for all transactions in a given time frame;
− P is the price level;
− T is the aggregate real value of transactions in a given time frame.

View Slide

Reserve Asset Bank: Market Operations
▪ The Bank needs reserve assets to enforces the coin price
corridor 0.95 <
< 1.05 by market operations
▪ Floor enforcement: existing coins are always bought (then
burned, destroyed, or removed) at 0.95 using reserves (until
completely depleted), avoiding
< 0.95
▪ Ceiling enforcement: newly minted coins are always available
for sale at 1.05 (increasing reserves), avoiding
> 1.05
▪ The enforcements should be algorithmically deterministic, not
discretionary

View Slide

Reserve Asset Bank: IPO
▪ Raises bitcoins as reserve asset in quantity
Better to avoid non-crypto reserve assets:
a custodian legal entity would be required, re-introducing centralization
▪ Issues in return coins and shares
▪ ∙ 0.95 ≪ at IPO
▪ Hopefully, ∙ 0.95 < at every later time
▪ The market will assign prices
and
▪ The monetary base being backed by , at equilibrium:
∙
+ ∙
=

View Slide

Seigniorage: profit made by a currency issuer, especially the difference between the
face value of coins and notes and their production costs
▪ Shareholders are in charge of reference basket maintenance;
it is only fair: it is their coin, they backed it with their capital
▪ The share price is free to float
▪ Share value = assets - liabilities
∙
= − ∙ 0.95

= Τ
− ∙ 0.95
▪ Shareholders absorb monetary policy’s profits and losses,
shielding coin holders from volatility
▪ No compelling reason to ever burn/destroy existing shares
Reserve Asset Bank: Seigniorage Shares
84/93

View Slide

↑ . : Profits for Shareholders
▪ Ceiling enforcement: newly minted coins are always available
for sale at 1.05 (increasing reserves), avoiding
> 1.05
▪ For every new minted coin:
− Reserve assets increase by 1.05
− Coin liabilities increase by 0.95
− Net effect:
↑
▪ Seigniorage shares enjoy seigniorage revenues

View Slide

↓ . : Losses for Shareholders
▪ Floor enforcement: existing coins are always bought (then
burned, destroyed, or removed) at 0.95 using reserves (until
completely depleted), avoiding
< 0.95
▪ If the selling pressure does not stop:
− If < ∙ 0.95:
coin is dead, Bank defaults,
= 0
− If > ∙ 0.95:
coin is dead, Bank does not default,
> 0
i.e. there is no interest for stable coins; shares are equivalent
to bitcoins

View Slide

Leverage Bitcoin As Reserve Asset
▪ Bitcoin is the first and most successful instance of an
intrinsically scarce digital asset: it’s digital gold
▪ When used as reserve asset, its qualities are magnified!
▪ Its limits are lessened. No more need for:
− scaling to huge (cash + bank accounts + credit cards)
number of transactions
− supporting economically inefficient micropayments
− lowering confirmation time
The Reserve Bank IPO raises bitcoins,
issues seigniorage shares and stable coins

View Slide

The Ultimate Fate of Bitcoin:
To Serve as a Reserve Currency
Hal Finney (1956–2014) was a noted cryptographic activist. He was the second PGP Corporation developer
hired after Phil Zimmermann. He created the first reusable proof-of-work. He was an early bitcoin user and
received the first bitcoin transaction from bitcoin's creator Satoshi Nakamoto.

View Slide

Transaction Validation: Proof-of-Payment
▪ Block generation is rewarded with the issuance of a new share
▪ Instead of the hardware and electric power expenses of proof-
of-work, bitcoins are irrevocably paid to the Reserve Asset Bank
by validating nodes (proof-of-payment)
▪ Chances of being appointed for the next block generation are
proportional to the overall submitted payments, i.e. to the
accumulated proof-of-payment
▪ When a node is picked up for block generation its proof-of-
payment resets to zero; other nodes are not affected

View Slide

▪ If a node is not picked up, its payments are not discarded: they
are valid for the next lottery, but never reimbursed
▪ Since
= Τ
− ∙ 0.95 , that should be the price a
rational agent is willing to commit as payment
▪ Share price estimation in bitcoin is obtained as by-product of
the lottery
▪ Existing shareholders are not really diluted: for the issuance of
each new share, increases accordingly
Transaction Validation: Proof-of-Payment
90/93

View Slide

Bibliography
▪ Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash
System (2008) https://bitcoin.org/bitcoin.pdf
▪ Saifedean Ammous, The Bitcoin Standard: The Decentralized
Alternative to Central Banking (2018)
▪ Bitcoin as Digital Gold (2018), United Nations Department of
Economic and Social Affairs; video: https://goo.gl/NkEC9w;
slides: https://goo.gl/szzBXh
▪ Blockchain Needs A Native Digital Asset (2016),
https://www.finextra.com/videoarticle/1241/blockchain-needs-
a-native-digital-asset
▪ Pedro Franco, “Understanding Bitcoin”, Wiley
− chapter 3 «Economics»

View Slide

Stable Coins: Bibliography
▪ Ferdinando M. Ametrano, Hayek Money: the Cryptocurrency Price
Stability Solution (2014), http://ssrn.com/abstract=2425270
▪ Massimo Morini, Inv/Sav Wallets and the Role of Financial
Intermediaries in a Digital Currency (2014),
http://ssrn.com/abstract=2458890
▪ Robert Sams, A Note on Cryptocurrency Stabilisation: Seigniorage
Shares (2014),
https://github.com/rmsams/stablecoins/blob/master/00-main.pdf
▪ Vitalik Buterin, The Search for a Stable Cryptocurrency (2014),
https://blog.ethereum.org/2014/11/11/search-stable-cryptocurrency/
▪ Ferdinando M. Ametrano, Cryptocurrency Price Stability With
Seigniorage Shares And Reserve Bank (2016),
http://ssrn.com/abstract=2508296
▪ Ferdinando M. Ametrano, Bitcoin: crittovaluta di riserva per nuovi
standard monetari (2018), http://bit.ly/2NQg9VJ

View Slide

Takeaways
▪ Central bank digital currency is not going to happen anytime
soon
▪ Private digital cash backed by fiat currency reserves is possible
▪ In both cases blockchain technology is not really needed
▪ Bitcoin solves the double spending problem relying on
seigniorage revenues
▪ Bitcoin, being digital gold, could be as relevant as physical gold
for history of civilization and future of money & finance
▪ Bitcoin is bootstrapping new monetary systems: price stability
can be achieved with a Hayek Money implementation using Dual
Asset Ledger and Proof-of-Payment

View Slide

Ferdinando M. Ametrano
Executive Director
[email protected]
Paolo Mazzocchi
Chief Operating Officer
[email protected]
www.github.com/dginst
www.facebook.com/DigitalGoldInstitute
www.twitter.com/DigitalGoldInst
www.dgi.org/feed.xml
[email protected]
www.dgi.io
www.linkedin.com/company/digital-gold-institute
"Scarcity in the Digital Realm"

View Slide

Monetary Engineering

Monetary Engineering

Ferdinando M. Ametrano

More Decks by Ferdinando M. Ametrano

Featured

Transcript