Monetary Engineering - Speaker Deck

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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

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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

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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 © 2019 Digital Gold Institute 3/93

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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 © 2019 Digital Gold Institute 4/93

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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 © 2019 Digital Gold Institute 5/93

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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 © 2019 Digital Gold Institute 6/93

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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) © 2019 Digital Gold Institute 7/93

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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 © 2019 Digital Gold Institute 8/93

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Central Bank Digital Currency? 2/3 “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 © 2019 Digital Gold Institute 9/93

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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 © 2019 Digital Gold Institute 10/93

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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 © 2019 Digital Gold Institute 11/93

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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 © 2019 Digital Gold Institute 12/93

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Central Bank Digital Currency? 3/3 “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 © 2019 Digital Gold Institute 13/93

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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 © 2019 Digital Gold Institute 14/93

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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 © 2019 Digital Gold Institute 16/93

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Money Comparison Medium of Exchange Live cattle Diamonds Gold Fiat coins and notes • swappable • fungible • portable • divisible • recognizable • resistant to counterfeiting © 2019 Digital Gold Institute 18/93

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Properties of Money: 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 © 2019 Digital Gold Institute 19/93

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Money Comparison Medium of Exchange Store of Stable Value Live cattle Diamonds Gold Fiat coins and notes • 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 © 2019 Digital Gold Institute 20/93

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Properties of Money: 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 © 2019 Digital Gold Institute 21/93

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Money Comparison Medium of Exchange Store of Stable Value Unit of Account Live cattle Diamonds Gold Fiat coins and notes • 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 • relative worth unit of measure • stable value for stable price comparison • supply must be controlled in some way © 2019 Digital Gold Institute 22/93

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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) © 2019 Digital Gold Institute 23/93

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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 © 2019 Digital Gold Institute 24/93

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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 © 2019 Digital Gold Institute 27/93

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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 © 2019 Digital Gold Institute 29/93

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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 © 2019 Digital Gold Institute 30/93

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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? © 2019 Digital Gold Institute 32/93

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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 © 2019 Digital Gold Institute 33/93

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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 © 2019 Digital Gold Institute 34/93

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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 © 2019 Digital Gold Institute 35/93

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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 © 2019 Digital Gold Institute 36/93

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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’ © 2019 Digital Gold Institute 37/93

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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 © 2019 Digital Gold Institute 38/93

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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 © 2019 Digital Gold Institute 40/93

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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 © 2019 Digital Gold Institute 41/93

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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 © 2019 Digital Gold Institute 42/93

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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 © 2019 Digital Gold Institute 43/93

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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 © 2019 Digital Gold Institute 44/93

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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) © 2019 Digital Gold Institute 45/93

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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! © 2019 Digital Gold Institute 47/93

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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 © 2019 Digital Gold Institute 49/93

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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 © 2019 Digital Gold Institute 50/93

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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 © 2019 Digital Gold Institute 52/93

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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 © 2019 Digital Gold Institute 53/93

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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” © 2019 Digital Gold Institute 54/93

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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 © 2019 Digital Gold Institute 55/93

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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 © 2019 Digital Gold Institute 56/93

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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…” © 2019 Digital Gold Institute 57/93

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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! © 2019 Digital Gold Institute 58/93

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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) © 2019 Digital Gold Institute 59/93

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The Ultimate Fate of Bitcoin: To Serve as a Reserve Currency https://bitcointalk.org/index.php?topic=2500.msg34211#msg34211 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. © 2019 Digital Gold Institute 61/93

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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 © 2019 Digital Gold Institute 62/93

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Money Comparison Medium of Exchange Store of Stable Value Unit of Account Live cattle Diamonds Gold Fiat coins and notes Bitcoin • 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 • relative worth unit of measure • stable value for stable price comparison • supply must be controlled in some way © 2019 Digital Gold Institute 63/93

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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 © 2019 Digital Gold Institute 64/93

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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 © 2019 Digital Gold Institute 65/93

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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. © 2019 Digital Gold Institute 66/93

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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 © 2019 Digital Gold Institute 67/93

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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» © 2019 Digital Gold Institute 68/93

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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? © 2019 Digital Gold Institute 70/93

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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 © 2019 Digital Gold Institute 71/93

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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 © 2019 Digital Gold Institute 76/93

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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) © 2019 Digital Gold Institute 77/93

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▪ 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 © 2019 Digital Gold Institute Hayek Money Dual Asset Ledger 79/93

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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 © 2019 Digital Gold Institute 80/93

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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. © 2019 Digital Gold Institute 81/93

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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 © 2019 Digital Gold Institute 82/93

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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: ∙ + ∙ = © 2019 Digital Gold Institute 83/93

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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 © 2019 Digital Gold Institute Reserve Asset Bank: Seigniorage Shares 84/93

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↑ . : 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 © 2019 Digital Gold Institute 85/93

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↓ . : 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 © 2019 Digital Gold Institute 86/93

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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 © 2019 Digital Gold Institute 87/93

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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 © 2019 Digital Gold Institute 89/93

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▪ 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 © 2019 Digital Gold Institute Transaction Validation: Proof-of-Payment 90/93

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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» © 2019 Digital Gold Institute 91/93

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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 © 2019 Digital Gold Institute 92/93

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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 © 2019 Digital Gold Institute 93/93

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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"