How do you get Bitcoin (BTC) to tip to a true network?
I live in Australia. In theory I could never leave Australia. I could use Australian dollars (AUD) for the rest of my life and rely on the 100% network effect it has here. I never need to use another currency.
I understand that I have a proxy to foreign currency as Australia is a net importer of goods. I pay a premium on my goods for this currency risk as the importer buys this risk from me. That is how capital markets and producers make profits.
BTC has no network effect yet. I can not use BTC to pay for my food, my kids school fees or my mortgage.
Both my assets and liabilities are expressed, calculated and exchanged in AUD, not BTC.
For me to feel comfortable using BTC, I would need both my assets and liabilities to be expressed in BTC rather than AUD.
To give an example. The largest asset I own is my house. The largest liability I have is my mortgage. These are both in AUD.
Imagine if my employer decides to pay me in Bitcoin (BTC) rather than in AUD. I have moved from a network where everyone accepts AUD, to BTC where the network is small and acceptance is rare. There is currently no network effect in BTC in Australia.
My mortgage is currently in AUD and my bank requires me to pay my interest and principal monthly in AUD. So how do I use my BTC to pay the mortgage?
3 outcomes spring to mind.
- Convert BTC to AUD on an exchange and then pay my mortgage
- Convince my bank to accept BTC instead of AUD
- Convince my bank to write my loan in BTC
So let’s think about that. In scenario 1 I am taking massive conversion risk.
I may not have enough money to pay my mortgage if at the end of the month the value I get for my BTC is less than my AUD mortgage payment. That is not good. I might lose my house.
Or I may have more AUD than I need. That is how uncertainty works.
Under scenario 2 I have convinced the bank to take this conversion risk. They do not know what they are going to get at the end of the month. If they have their liabilities in AUD then they have the same problem I had in scenario 1.
If I get the bank to take this risk then it is on their books. How would shareholders feel about the volatility in the carrying value of their asset? How would the regulators feel?
I am guessing the bank is going to want to price this risk in. They may want me to pay 130% more in BTC to absorb this risk. This is how capital markets work.
Under scenario 3 I am covered. I have matched my assets and liabilities. I am back where I started when my employer paid me in AUD. I don’t care what happens to BTC now, unless I change jobs, or bank.
How will BTC take over from the network effect that is the AUD?
How do any network effects get build? How do you incentivize people to build a network for BTC? Unless my assets, liabilities and my method of exchange are one and the same I will always have conversion risk.
I think for a new network to take over the old the benefits of the new network have to be orders of magnitude better than the existing network.
With BTC I am not sure the benefits are in order of magnitude greater than the AUD network effect. Scarcity is the only advantage BTC has over AUD currently.
Ethereum, however, is trying to solve the chicken and egg network effect problem by incentivising the use of a smart contract network with the issue of protocol tokens. The more people use this protocol the more valuable the tokens become as the supply of tokens is limited.
Ethereum seems to have a better way of building a network effect than BTC.
I get the ideal of decentralised networks that replace the centralised rent seekers and elites.
But I am reminded of Charlie Munger’s Psychology of Human Misjudgement where he talks about Deprival Super reaction syndrome.
Put simply when you take something away from someone it will cause that person or a group to get upset and do all they can to protect what they see as theirs.
Taking away the keys from the elites will be a revolutionary challenge. A revolutionary challenge greater on a scale of the French or Russian revolutions? No great beneficial change over history has been achieved without the cost front loaded.
I understand the benefits of the decentralised system of the Blockchain. But I am struggling to see how Bitcoin is going to build a true money network effect.