The current block size debate involves not only heated debates about how best to scale Bitcoin but, more fundamentally, what Bitcoin should be. There are a wide range of views on this topic. Some want Bitcoin to be a high speed payment system. Others, believe it or not, want Bitcoin to be nothing more than a speculative investment asset and tell people to just use dollars if they want to buy things. One view that is pretty widely held is that Bitcoin should be a “base layer” for higher level systems (such as banking or payment systems) built on top of it.

As Greg Maxwell, the primary champion of this view, put it:

A censorable or reversible base system is not very suitable to build powerful upper layer transaction processing on top of… and if the underlying asset isn’t sound, there is little point in transacting with it at all.

In other words, just like with the gold standard, Bitcoin needs to be, first and foremost, a digital token upon which various banking and payment systems can be layered on top. In this view it doesn’t particularly matter if the “base layer” is slow or so expensive to use that it’s only accessible to large scale enterprises, as long as systems can be built on top that regular people can use. In this sense we might refer to this type of system as a “Bitcoin standard”. Like the an actual gold standard, average people would not be interacting directly with the Bitcoin token, but rather with the various systems built on top of it.

On the surface this sounds like a good story. We keep the base layer uber-decentralized while allowing for a wide variety of systems built on top of it. However, my contention is that, to the extent such “higher level” layers are centralized or quasi-centralized, such a system will fall far short of Bitcoin’s revolutionary potential.

What is the Potential of Bitcoin?

To be completely honest I don’t see why people are involved in Bitcoin at all if all they want is a peer-to-peer speculative investment asset. I cannot think of a more boring use of the technology and certainly such an asset would do exactly zero to make the world a freer and fairer place.

Instead, like gold or the gold standard, I view Bitcoin as having the potential to end (or at least curtail) the massive upward wealth redistribution associated with government fiat money. It can also eliminate or dramatically reduce the chronic cycles of boom and bust that plague modern economies. In my view this would certainly happen if any modern economy would use Bitcoin in lieu of fiat money, but even if only a small portion of economic activity takes place in Bitcoin it would likely provide a critical check on the ability of central banks to inflate the money supply. That’s the ultimate revolutionary potential in my opinion.

But for this to happen Bitcoin must be used as money, that is, actually traded for goods and services. The small blockers who tell you to just use dollars if you want to actually buy things are totally undermining this vision. OK, that’s just a minority opinion (and let’s hope it stays that way!), but what about the notion of Bitcoin as a “base layer” with, very likely more centralized, layers built on top? Well, we have several hundred years of experience with such systems in the form of the gold standard. I’d be willing to bet that advocates of the “base layer” hold the rather naive view that the United States had a gold standard for large portions of it’s history and there’s no reason why it can’t have a gold standard, or better yet a “Bitcoin standard”, once again. I say this is a naive view because the history of the gold standard in the United States (and elsewhere around the world) is an extremely troubled history. At no point in the history of the United States did it have what could be described a “pure” gold standard. Heavy government regulation of the money supply, and the subsequent undermining of the qualities that make gold good money, was taking place since the very beginning. I’d like to provide a very brief history of money in the United States to support this point.

The History of Money in the US

Colonial America suffered enormously from hyper-inflationary government paper money. Prior to 1690, silver coins were the primary form of money in the colonies, but this changed thanks to the colonial government of Massachusetts. The Massachusetts government was perennially broke and would periodically send its soldiers out on pirating expositions to loot and plunder the French in Quebec. The soldiers would steal everything that wasn’t nailed down and a portion of the proceeds were used to pay the soldier’s salaries. On one of these expositions, the French were waiting for them and successfully defended their property. Since the soldiers came back empty handed, the Massachusetts government had no way to pay them. Out of desperation, they printed up some paper money which they promised would be redeemable for silver in the future (it never was) and gave it to their soldiers. Astounded that it actually worked and that the paper was actually traded as money (albeit at a discount), they ramped up the printing presses and started using paper money to pay for all kinds of things.

Furious that the more money they printed the more it depreciated, the colonial officials passed laws demanding that the paper trade on par with silver. The effect of this law was to drive all of the silver out of the colony leaving only government paper (see the proper interpretation of Gresham’s law). This “innovation” quickly spread to all the other colonies and pretty soon nearly all precious medals were driven from North America.

Feeling that the paper money was devaluing their colonial holdings, Parliament demanded the resumption of silver payments in 1764 but this lasted only a few short years until the American revolution when the colonial governments turned right back to money printing to finance the war.

After the Constitution went into effect, Alexander Hamilton convinced Washington to sign a law creating the nation’s first central bank ― the First Bank of the United States. Since its notes were considered “legal tender” it was able to get away inflating the supply paper money well above that of gold and silver. The new commercial banks popping up in that era followed suit, pyramiding their notes on top of the notes of the central bank notes and causing the money supply to expand by about 400%.

The renewal of the central bank’s charter was narrowly defeated in 1811 only to have Congress create the Second Bank of the United States in 1816 for the purpose of printing money to pay the debts accumulated during the war of 1812. The massive money printing by the second bank would lead to the first major economic crisis in the United States in 1819.

Andrew Jackson notoriously hated the Second Bank of the United States: “Gentlemen! I too have been a close observer of the doings of the Bank of the United States. I have had men watching you for a long time, and am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You tell me that if I take the deposits from the bank and annul its charter I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin! Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves. I have determined to rout you out, and by the Eternal, (bringing his fist down on the table) I will rout you out!” Jackson unilaterally shut down the bank, an act which earned him censure from Congress, ushering in the “free banking” era in the United States.

The free banking era was a brief period of virtually no Federal government intervention in the money and baking system that lasted from around 1839 to the start of the Civil War (though state government regulations still remained). This period was one of the most prosperous and stable periods in US history but it didn’t last long.

Lincoln probably did as much if not more than any US president to ruin the nation’s monetary system. Not only did he resume the printing of government paper money to finance the Civil War, but he passed the egregious, crony-capitalist piece of legislation, the National Banking Act, which was designed to enrich the Wall St banks by creating a system in which all other banks were required to hold their liabilities, allowing Wall St. to inflate with fear of bank runs.

Not only did the National Banking Act not remove the consequences of inflation, but by tying all the banks liabilities together it ensured that small scale banking crises would balloon into full blown economic calamities. The following decades were replete with one crises after another.

In this environment, the banks started scheming for the ultimate fix ― a new central bank that could print money and bail them out whenever their inflation got them in trouble. In November 1910, representatives of the largest banks in the world wrote what would become the Federal Reserve Act of 1913. In February 1911, a group of top bankers met in Atlantic City to discuss the proposed legislation. The President of the First National Bank of Chicago, James Forgan, got up in front of the group and said, “The purpose of this meeting is to discuss wining the banking community over to government control, directed by the bankers, for their own ends.” The Federal Reserve Act went into effect in 1914.

In 1933, FDR ended what could only nominally be considered the gold standard by this time by declaring the Federal Reserve would not make gold payments and by criminalizing the holding of gold and embarking of large scale gold confiscation. After WWII gold redemption would be restored but only for foreign central banks.

In 1971, Nixon made the United States default on all of its international obligations by ending gold payments to foreign countries, thus ending the last vestiges of the gold standard. Having removed all remaining checks on money printing the Federal Reserve would go on to embark on monetary central planning the likes of which the world has not seen and for which we still do not know the outcome.

Back to Bitcoin

Wow OK so that was a short version of the longer version of US monetary history. The purpose of going through that exercise was to show that there was never such a thing a “base money” with “higher level” systems build on top, that weren’t thoroughly corrupted by the government or by crony-capitalists. Advocates of the gold standard have been fighting a losing battle with the system for over 200 years. Not only has the United States never had what could be considered a genuine gold standard, but as years go by we get farther and father away from it.

So we have to ask, why would we expect Bitcoin to succeed where gold has failed? Does “Bitcoin as base money” have any qualities to it that would produce a different outcome than gold? At first glance we might think the Bitcoin system as a whole to be less costly than a gold standard, after all gold needs to be stored somewhere (Bitcoin does as well but it’s probably cheaper). But, of course, Bitcoin is burning massive amounts of energy in mining so it’s not clear that system would actually be cheaper (maybe but not by leaps and bounds). Is there anything else?

Well, I think Bitcoin does have something that gold does not have ― the ability to transfer it peer-to-peer over the internet in a way that cannot be censored. All of the problems that have plagued the gold standard in the past can be avoided if people simply have the ability to bypass corruptible institutions and trade directly with each other. THIS is the primary advantage of Bitcoin and why Bitcoin might have a chance where prior attempts have failed miserably. However, notice that these “higher level” layers that people want to create do not have the censorship resistance property. They represent those very same corruptible institutions that created the depressing monetary history of the United States.

One may say “well Bitcoin wont be of any use to anyone if it becomes centralized”. True, but it does suggest that our focus should be on optimizing Bitcoin ― finding ways to securely increase capacity, shard the blockchain, and increase confirmation speeds rather than actively trying to push users off onto corruptible “higher layers”.