This year marks the fiftieth anniversary of the U.S. government closing the gold-exchange window and putting the world on a fiat monetary system. The vast majority of people alive today have never used anything but fiat money. This cannot be written off as an unexplained fluke, and economists should be able to explain how this system functions and survives, despite its many obvious flaws. Fiat’s longevity makes it unreasonable to keep dismissing it as an irredeemable fraud on the brink of collapse, as many of its detractors have done for decades. There are, after all, plenty of markets around the world that are massively distorted by government interventions, but they nonetheless continue to survive. It is no endorsement of these interventions to attempt to explain how they persist.
In his 1929 book The Thing, G. K. Chesterton tells the story of a man who finds a fence that appears to serve no purpose and decides to remove it. Another man counters, “If you don’t see the use of it, I certainly won’t let you clear it away. Go away and think. Then, when you can come back and tell me that you do see the use of it, I may allow you to destroy it.”1 Fifty years after taking its final form, and more than a century after its genesis, with a new competitor threatening to potentially remove it, an assessment of the uses of the fiat system is now both possible and necessary.
While fiat has not won acceptance on the free market, and though its failings and limitations are many, there is no denying that many fiat systems have worked for large parts of the last century and facilitated an unfathomably large number of trades all around the world. Its continued operation makes understanding it useful, particularly as we still live in a world that runs on fiat. Just because you may be done with fiat does not mean that fiat is done with you! Understanding how the fiat standard works, and how it frequently fails, is essential knowledge for being able to navigate it.
It is also not appropriate to judge fiat systems based on the marketing material of their promoters and beneficiaries in government-financed academia and the popular press. While the global fiat system has so far avoided the complete collapse its detractors predicted, that cannot vindicate its promoters’ advertising of it as a free-lunch-maker with no opportunity cost or consequence. More than sixty episodes of hyperinflation have taken place in countries using fiat monetary systems in the past century. Moreover, avoiding regular catastrophic collapse is hardly enough to make a case for it as a positive technological, economic, and social development.
Beyond the relentless propaganda of its enthusiasts and the rabid venom of its detractors, this book attempts to offer something new: an exploration of the fiat monetary system as a technology, from an engineering and functional perspective, outlining its purposes and common failure modes, and deriving the wider economic, political, and social implications of its use. Adopting this approach to writing The Bitcoin Standard contributed to making it the bestselling book on bitcoin to date, helping hundreds of thousands of readers across more than twenty-five languages understand the significance and implications of bitcoin.
Perhaps counterintuitively, I believe that by first understanding the operation of bitcoin, you can then better understand the equivalent operations in fiat. It is easier to explain an abacus to a computer user than it is to explain a computer to an abacus user. A more advanced technology performs its functions more productively and efficiently, allowing a clear exposition of the mechanisms of the simpler technology and exposing its weaknesses. My aim is to explain the operation and engineering structure of the fiat monetary system and how it operates in reality, away from the romanticism of governments and banks that have benefited from this system for a century.
The first seven chapters of The Bitcoin Standard explained the history and function of money and its importance to the economic order. With that foundation laid, the final three chapters introduced bitcoin, explained its operation, and elaborated on how its operation relates to the economic questions discussed in the earlier chapters. My motivation as an author was to allow readers to understand how bitcoin operates and its monetary significance without requiring them to have a previous background in economics or digital currencies. Had bitcoin not been invented, the first seven chapters of The Bitcoin Standard could have served as an introduction to explaining the operation of the fiat monetary system. This book picks up where chapter 7 of The Bitcoin Standard left off. The first six chapters of this book are modeled on the last three chapters of The Bitcoin Standard, except applied to fiat money.
How does the fiat system actually function, in an operational sense? The success of bitcoin in operating as a bare-bones and standalone free-market monetary system helps elucidate the properties and functions necessary to make a monetary system work. Bitcoin was designed by a software engineer who boiled a monetary system down to its essentials. These choices were then validated by a free market of millions of people around the world who continue to use this system and currently entrust it to hold around $800 billion of their wealth. The fiat monetary system, by contrast, has never been put on a free market for its users to pass the only judgment that matters. The all-too-frequent systemic collapses of the fiat monetary system are arguably the true market judgment emerging after suppression by governments. With bitcoin showing us how an advanced monetary system can function entirely independently of government control, we can see clearly the properties required for a monetary system to operate on the free market, and in the process, we can better understand fiat’s modes of operation and all-too frequent modes of failure.
To begin, it is important to understand that the fiat system was not a carefully, consciously, or deliberately designed financial operating system like bitcoin; rather, it evolved through a complex process of compromise between political constraints and expedience in managing government default. The next chapter illustrates this by examining newly released historical documents on just how the fiat standard was born and how it replaced the gold standard, beginning in England in the early twentieth century and completing the transition in 1971 across the Atlantic. This is not a history book, however, and it will not attempt a full historical account of the development of the fiat standard over the past century, in the same way The Bitcoin Standard did not delve too deeply into the study of the historical development of the bitcoin software. The focus of the first part of the book will be on the operation and function of the fiat monetary system, by making an analogy to the operation of the bitcoin network, in what might be called a comparative study of the economics of different monetary engineering systems.
Chapter 3 examines the network topography and underlying technology behind the fiat standard. Contrary to what the name suggests, modern fiat money is not conjured out of thin air through government fiat. Government does not just print currency and hand it out to a society that accepts it as money. Modern fiat money is far more sophisticated and convoluted in its operation. The fundamental engineering feature of the fiat system is that it treats future promises of money as if they were as good as present money because the government guarantees these promises. Government coercion can maintain such a system for a very long time, even if it would not survive free-market competition.
Chapter 4 examines how the fiat network’s native tokens come into existence. As fiat money is credit, credit creation in a fiat currency results in the creation of new money, which means that lending is fiat’s antiquated and haphazard version of mining. Fiat miners are the financial institutions capable of generating fiat-based debt with guarantees from the government and/or central banks. Unlike with bitcoin’s difficulty adjustment, fiat has no precise or engineered mechanisms for controlling issuance. Credit money, instead, causes constant cycles of expansion and contraction in the money supply, with devastating consequences.
Chapter 5 then analyzes balances on the fiat network, exploring how many, if not most, users have negative account balances—a unique feature of the fiat network. The ability to mine fiat by issuing debt means individuals, corporations, and governments all face a strong incentive to get into debt. The monetization and universalization of debt is also a war on savings, and one which governments have persecuted stealthily and quite successfully against their citizens over the last century.
Based on this analysis, Chapter 6 concludes the first section of the book by discussing the uses of fiat and the problems it solves. The two obvious uses of fiat are that it allows for government to easily finance itself, and it allows banks to engage in maturity mismatching and fractional reserve banking while largely protecting themselves from the inevitable downside. But the third use of fiat is the one that has been the most important to its survival: salability across space.
I must confess, attempting to think of the fiat monetary system in engineering terms and trying to understand the problem it solves has given me an appreciation of its usefulness and a gentler assessment of the motives and circumstances that led to its emergence. Understanding the problem this fiat system solves makes a move from the gold standard to the fiat standard appear less outlandish and insane than it had appeared to me while writing The Bitcoin Standard, as a hard money believer who could see nothing good or reasonable about the move to an easier money.
Seeing that the analytical framework of The Bitcoin Standard was built around the concept of salability across time, and the ability of money to hold its value into the future, and the implications of that to society, the fiat standard initially appears as a deliberate, nefarious conspiracy to destroy human civilization. But writing this book and thinking very hard about the operational reality of fiat has brought into sharper focus the property of salability across space, and, in the process, has made the rationale for the emergence of the fiat standard clearer and more comprehensible. For all its many failings, there is no escaping the conclusion that the fiat standard was indeed a solution to a real and debilitating problem with the gold standard, namely its low spatial salability.
Fiat’s low temporal salability remained a problem, but a tolerable one, because of its advantages in transferring value across space. More importantly, fiat allowed governments worldwide tremendous leeway to bribe their current citizens at the expense of their future citizens by creating the easy fiat tokens that operate their payment networks. Fiat was convenient for users, but it was more convenient for the government officials who controlled the only full nodes. As we take stock of a whole century of operation for this monetary system, a sober and nuanced assessment can appreciate the significance of this solution for facilitating global trade, while also understanding how it has allowed the inflation that has benefited governments at the expense of their citizens, present and future. Fiat may have been a huge step backward in terms of its salability across time, but it was a substantial leap forward in terms of salability across space.
Having laid out the mechanics for the operation of fiat in the first section, the book’s second section, Fiat Life, examines the economic, societal, and political implications of a society utilizing such a form of money with uncertain and usually poor intertemporal salability. Fiat increasingly divorces economic reward from economic productivity, and instead bases it on political allegiance. This attempted suspension of the concept of opportunity cost makes fiat a revolt against the natural order of the world, in which humans, and all other animals, have to struggle against scarcity every day of their lives. Nature provides humans with rewards only when their toil is successful, and similarly, markets only reward humans when they can produce something that others subjectively value. After a century of economic value being assigned at gunpoint, these indisputable realities of life are unknown to, or denied by, huge swaths of the world’s population who look to their governments for their salvation and sustenance.
The suspension of the normal workings of scarcity through government dictate has enormous implications on individual time preference and decision- making, with important consequences to many facets of life. In the second section of the book, we explore the impacts of fiat on family, food, education, science, health, fuels, and international governance and geopolitics. This section focuses on analyzing the implications of two causal economic mechanisms of fiat money: the utilization of debt as money and the ability of government to grant this debt at no cost. Part 2 concludes with a cost-benefit analysis of the fiat monetary system.
While the title of the book refers to fiat, this is still a book about bitcoin, and the first two sections build up the analytical foundation for the third part of the book, which examines the all-too-important question with which The Bitcoin Standard leaves the reader: what will the relationship between fiat and bitcoin be in the coming years? Chapter 13 examines the specific properties of bitcoin that make it a potential solution to the problems of fiat.
While The Bitcoin Standard focused on bitcoin’s intertemporal salability, The Fiat Standard examines how bitcoin’s salability across space is the mechanism that makes it a more serious threat to fiat than gold and other physical monies with low spatial salability. Bitcoin’s high salability across space allows us to monetize this hard asset itself, and not credit claims on it, as was the case with the gold standard. At its most basic, bitcoin increases humanity’s capacity for long-distance international settlement by around 500,000 transactions a day and completes that settlement in a few hours. This is an enormous upgrade over gold’s capacity, making international settlement a far more open market and much harder to monopolize. This also helps us understand bitcoin’s value proposition as not just harder money than gold, but also money that is far easier to transport. Bitcoin effectively combines gold’s salability across time with fiat’s salability across space in one apolitical, immutable, open-source package.
By being a hard asset, bitcoin is also debt free, and its creation does not incentivize debt issuance. By offering finality of settlement every ten minutes, bitcoin also makes the use of credit money very difficult. At each block interval, the ownership of all bitcoins is confirmed by tens of thousands of nodes all over the world. There can be no authority whose fiat can make good a broken promise to deliver a bitcoin by a certain block time. Financial institutions that engage in fractional reserve banking in a bitcoin economy will always be under the threat of a bank run as long as no institution exists that can conjure present bitcoin at significantly lower than the market rate, as governments can do with their fiat.
Chapter 14 discusses bitcoin scaling in detail and argues that it will likely happen through second-layer solutions, which will be optimized for speed, high volume, and low cost, and involve trade-offs in security and liquidity.
Chapter 15 builds on this analysis to discuss what banking would look like under a bitcoin standard, while Chapter 16 studies bitcoin’s consumption of electric power, how it is related to bitcoin’s security, and how it can impact the market for energy worldwide.
Chapter 17 then performs a cost-benefit analysis to upgrading from fiat to bitcoin.
The final chapter tackles the questions: How can bitcoin rise in the world of fiat, and what are the implications for these two monetary standards coexisting? Various threats to bitcoin are assessed from the economic perspective, and the economic incentive for bitcoin’s continued survival is presented. Will bitcoin’s rise necessitate a hyperinflationary collapse of fiat? Or will it be more like an orderly software upgrade? How will credit market dynamics and the rise of central bank digital currencies affect this relationship?