Wealth Formula Episode 289: Is Bitcoin the Next Layer of Money?

Buck: Welcome back to the show, everyone. Today. My guest on Wealth Formula podcast is Nik Bhatia. Nik is a financial researcher, a CFA charter holder and adjunct professor of finance and business economics at the University of Southern California Marshall School of Business, where he teaches applied finance and fixed income securities. Now previously, Nik worked on the US Treasury’s trading desk for a large institutional asset manager, extensive trading experience in money markets and interest rate futures. He is the author of a book called Layered Money: From Gold and Dollars to Bitcoin and Central Bank Digital Currencies. Nik has got a BA in Social Sciences from the University of Southern California, Masters in Finance from Ie Business School in Madrid, Spain, and he lives in Los Angeles. So Nik, welcome to Wealth Formula podcast.

Nik: Thank you for having me, Buck. I appreciate it.

Buck: Yeah. So I want to kind of just jump into the book if you would tell us first of all, Layered Money: From Gold and Dollars to Bitcoin. I guess the question is, why did you write it? First of all, and what message, fundamentally, are you trying to educate people on?

Nik: I wrote the book because I come from the asset management world and the traditional finance world. And somewhere along the way in 2016, I found Bitcoin in a very real way and became completely obsessed with it to the point where I couldn’t turn my attention away from it. And I saw the information asymmetry between the people who knew about Bitcoin, understood it and owned it and my world, which was traditional finance and people in the investment management industry. And so I started to bridge that gap by writing things about Bitcoin 2018. And eventually I wanted to write my explainer for the world about Bitcoin, why it exists, what the history of money is really, which is what you need to explain before understanding Bitcoin itself and then project into the future what I think the world will look like from the monetary perspective in the next ten years.

Buck: How does Bitcoin fit into the natural progression of obviously, we’re talking about gold and then Fiat currencies. How does Bitcoin evolve from that? Because I think fundamentally, people who are Bitcoin advocates and go down that rabbit hole, including me, probably not to the depth of you, but we all kind of believe that this is not something theoretical anymore. It’s real, and it’s a natural progression. But how do you explain that to people who maybe don’t understand it?

Nik: From a historical perspective, we had commodity money dominate for thousands of years. You can think about the feathers and shells era, but then also gold and silver. These are commodities, tangible things. And we progressed away from commodity money to balance sheet money, financial systems, issuing deposits, reserves, notes, all these instruments that are monitoring instruments, they don’t have intrinsic value. They have a counterparty and a draw on some value in the future. And Bitcoin is a new type of commodity. So in the evolution, really, it’s taking away some of the balance sheet components of monetary instruments and reintroducing a commodity component. And so for people that aren’t familiar with Bitcoin, it is a virtual or a numerical commodity of sorts, in which when you have your private key, this is simply a number. And that number gives you property ownership of a fraction of the Bitcoin network, which has an algorithm that is limited to 21 million total coins, which is subdivisible by 100 million. So you have these finite units. And people have viewed that to be a commodity. And so to answer your question, it’s really an evolution back toward commodity money. And then I think we will see a balance sheet money built on top of Bitcoin.

Buck: So I guess the question is, why the way you view it, why do we need Bitcoin? Why don’t we just go back to gold then? Because ultimately, what you’re talking about is money with intrinsic value, and people who are gold bugs will make the same argument. Right?

Nik: Yes. And I studied gold and actually owned gold before I got into Bitcoin and really understood what it was. So I do agree with that perspective. Why do we really need Bitcoin? We already have gold. But once you see Bitcoin and it’s advantages over gold, it’s almost like gold is obsolete now. And I’m not one of those people that think gold is going to go away or lose all value rapidly in the face of Bitcoin. However, in the digital age, Bitcoin has a lot of the properties that gold does, and it’s scarcity it’s difficulty to create in its relatively low flow in relation to a stock, the stock to flow model that several people have talked about written about before the digital nature of it and the mathematical nature of it as well, in which you can use software and test the purity of your Bitcoin instantly. Anybody can do that around the world. And you think about the gold bars with tungsten inside of them that it’s actually very difficult to test gold for the average person. You think about physical coins and all these restrictions that come with this physical form of money. And Bitcoin really makes a lot of it just go away. All those problems go away.

Buck: o effectively you’re talking about. Okay, you have a commodity, but now it has qualities that, first of all, like you said, it’s hard to fake Bitcoin. You can’t really fake Bitcoin. It has the security elements, obviously, it’s a lot more mobile than gold. It’s not really theoretically confiscated. Right. So then how do you view it, though? In the sense that I think one of the things that I’ve been sort of. I’ve had these discussions with Bitcoin people before, a lot of Bitcoin maximalists as we talk about. It seems like they often share this view. And I’m not saying that you do in any sort of way, but have this view of Bitcoin arising through the Ashes of the zombie apocalypse, right where everything Burns down and Bitcoin is there to save the day. And that seems to me like something that the Bitcoin maximalist often seemed to have. This dystopic view of where Bitcoin comes in. My argument on that end has been and who knows what the reality is. But if you look at actually what’s happening with Bitcoin, there’s almost sort of an integration with the modern financial markets. And so much to the chagrin of people who would think of Bitcoin as a completely independent asset, an asset that has no controls or something out of the monetary system. To me, when I look at what’s actually happening, it’s becoming adopted more and more into mainstream financial markets. And I’m curious about what your perspective on this is, and how does that change the Bitcoin thesis?

Nik: Your description is very accurate. I really like that because we are seeing a full integration of Bitcoin into the current system in addition to the adoption of Bitcoin by young people around the world without access to that traditional system. So you’re seeing both happen in parallel. And I don’t believe in some collapse of the financial system and Bitcoin rising up. It really is this slow integration and transition away. And simply if you think about like a twelve year old person that downloads a Bitcoin wallet for the first time before they have a bank account that is happening X millions around the planet and will continue to as all the kids start to become aware of money and what that means millions and then potentially billions of people will have a Bitcoin wallet before a bank account, and some might never have a bank account at all. But the people that already have bank accounts like you and I, we are long Bitcoin. We have it either inside or outside of the financial system. And hopefully once you understand Bitcoin more and more, you’re able to keep some or all of that outside of the financial system. If your goal is to preserve your property and have it remove counterparty risk away from because if you have your Bitcoin on an exchange, for example, you still have full counterparty risks to that exchange, you could lose your Bitcoin tomorrow. Let’s be honest, it’s not yours if you don’t if you don’t have it. But there are insurance mechanisms and established institutions and now regulatory framework that make all of these counterparties somewhat legitimate in the eyes of everybody that uses the traditional financial system. So you have both happening together.

Buck: I guess the question is you can see sort of the ghost of Satoshi looking at this and frowning. Right. Like this is not the way Bitcoin was meant to be. Is that fair?

Nik: So that’s where I would disagree. I think that if you look at Bitcoin’s performance relative to other assets and price increases in stocks, for example, on real estate, you look at Bitcoin relative to those other assets. It’s still telling you a story that keeping things denominated still within the traditional dollar system is a losing proposition over the long term. That’s the story that Bitcoin price is telling us. And so I think that story is quite loud and it is starting to be heard. And so I don’t think that Satoshi’s basically goal of providing this parallel outside, separate financial system from the dollar. I don’t think that that’s being lost because people are denominating theirselves, their businesses, their mentalities and Bitcoin and those people are all around the world. And that network is increasingly strong. And I think that was Satoshi’s vision.

Buck: Along the lines of sort of the adoption into mainstream financial markets. You could say that Bitcoin is starting to obviously has attracted the interest of governments. It’s attracted the interest, particularly of the IRS. How does any of that affect what’s going on with Bitcoin is that just again, a natural evolution. Now the IRS sees it as a real commodity, and this is just the way it is. Now you have to look at it like any other type of asset that you own. It’s just that now it’s being recognized not as money, fake stuff, but real stuff, real commodities. Do you see any influence from governments and these various things like the IRS that actually are going to change the trajectory of Bitcoin?

Nik: And that’s the key. No, I don’t think there’s anything governments can do that can change the trajectory of Bitcoin, but there are a lot of positives to take out of what’s happening in the United States. For example, the IRS has treated Bitcoin as property for seven years now, and if you sell Bitcoin for a gain, you have a capital gain that you have to pay tax on. And the IRS does try to enforce that. Now that gets Bitcoin a lot of legitimacy. Let’s just say in the United States, people know that the IRS isn’t trying to, they don’t have a policy of seizure of Bitcoin or that it’s an illicit activity. They regard it as virtual property and you have to pay tax on it if you make a game. Okay. But also there are efforts within States. And then at the federal government level as well, try to get Bitcoin de minimis transactions exempt from this capital gains so that it can be used as currency in the day to day transactions. And that would be enormous for Bitcoin, because then it’s already achieved this level of price and market value with being taxed as capital gain in the United States. And if you remove an additional tax burden, if you remove a tax burden from Bitcoin and make it exchangeable without this capital gains declaration, every single time you buy coffee with it, it can accelerate the Bitcoin adoption in the United States. And the US does set an example for the rest of the world. That’s one side of the story, the other is that Bitcoin because it’s digital will flock to wherever it’s allowed to be transacted and owned in a legal way. So you have Singapore, Switzerland, having very progressive Bitcoin legislation being passed, and so money will flee toward those countries if the United States doesn’t get on board. And so I’m extremely optimistic about the US regulatory framework toward Bitcoin being leading cutting edge. And I hope to be involved with some of that writing policy statements and things of that nature to try to influence this in the correct direction. So we can use Bitcoin. It doesn’t have an unnecessary tax burden, and we can set an example and not lose business to the rest of the world.

Buck: When it comes to the actual. You talked a little bit about this idea of Bitcoin being buying coffee with Bitcoin and stuff like that. Obviously, when you look at sort of the digital currency, but it’s still not an easy transaction to do in a few Bucks. A few months ago, a guy I know named Samson Maw on the show, Samson’s chief strategy officer with Blockstream. As you probably know, he envisions a world. Ultimately, that, to me, really parallels the gold standard. The American dollar almost, right. The dollar pegged to he envisions a second layer in which these transactions can occur very quickly. Visa, Lightning networks, and that kind of thing that are then later settled in Bitcoin is that kind of what you envision.

Nik: So it is what I envisioned. But now I can tell you from my own perspective, I’ve been doing business in Bitcoin for my book for a year, and it’s all lightning all the time, and it moves instantly. And we as the people that are using Bitcoin for commerce are using lightning because we can settle whenever we want on our own. But in the interim, we use the smart contracts to exchange Bitcoin with each other instantly, and we know that it’s real like you say, you can’t fake Bitcoin. And so if I’m using a Lightning network wallet that I trust that I vetted, I know that once that transaction comes to me and it instantly hits my wallet, that Bitcoin is mine, no matter when I choose to settle it to whatever keys I decide to send it to eventually. And so 90% of my transactions, like my day to day book transactions that I do in Bitcoin are enlightening now. And so it’s amazing how fast it happened. The only people that don’t use Lightning now either have some no difficulty issue where they couldn’t connect to their note at home. Or, to be honest, they are much older and have Bitcoin only in Coinbase and are using it like that. I’m astounded at the Lightning adoption, and I know this is just a very small sample set. We’re talking about probably less than 100 books that I’ve sold in Bitcoin this year, but it’s across the world on every continent. And I’ve done other transactions enlightening as well for different business reasons. And so it’s really amazing to see that.

Buck: It’s actually good to know, because again, a few weeks ago, I was in Dallas for a meetup and I had dinner with some friends included in there with some of the guys didn’t know who was apparently number 19 in Etherium as an investor. So he was a very early adopter, and he had plenty of negative stuff to say about lightning and everything related to it. But it’s good to hear that functionally that it’s working quite well because his take on it was very negative, which I was surprised about after speaking with Samson as well. So one question that comes up frequently, especially for people who are new to Bitcoin and cryptocurrency is, how do you view Bitcoin in the context of the rest of the cryptocurrency ecosystem? And I’m giving you my perspective, because sometimes it’s helpful for people to understand my explanations. And I’m just curious what your take is. I see Bitcoin is different fundamentally, and I’m not saying it’s better in one way or another, but simply different. And that Bitcoin is, I think, becoming increasingly accepted across the world, as you talked about as a commodity, as a true source of value. It has intrinsic value and all those features. When I look at everything else, I kind of look at everything else. As a tech company, it’s like comparing apples to oranges. Bitcoin is gold in this different world, and then investing in Solana or whatever is investing in trying to find the next Google, trying to find the next Facebook. You know what I mean? Essentially, the next tech platform or Cisco might be a better example. What do you think of that analogy?

Nik: I’ve actually used it. Yeah. It’s the exact analogy that I use. Bitcoin is gold, and everything else is a tech company. It’s a startup, and it doesn’t mean that they won’t have value. They obviously do. Look at the market. I’m a firm believer in price truth. So the price is telling us that all these things have value. It’s also telling us that gold. I mean, sorry, gold bitcoins dwarfs everything else in terms of market value. And then we can even start to separate empirically what are short lived fads versus maybe the core competitors to Bitcoin. But even in those core competitors, there are a lot of company-like characteristics about them and very few commodity-like characteristics about them. So price is truth. Look at the price of Bitcoin in terms of market cap relative to the rest of these things. And until that is challenged in any material way. And that’s why people do talk a lot about Ethereum is because on a relative basis, I’m not exactly sure right at this moment, but it’s about one third, one quarter to one third the size of Bitcoin Ethereum. And that’s enough to warrant it on the commodity level. If people want to have that discussion is not something that I research entirely too much. But Bitcoin has the commodity components to it. The burden of proof is on everything else to prove that they are a commodity. And until that moment, they are a startup. And I think the SEC will play some role in that discovery process, where they’ve come out very boldly and called Bitcoin, not a security. Many years ago, the SEC has and they’ve called other things securities that are in the cryptocurrency landscape. So I’m interested to see the SEC rule on a lot of these other things because they will be doing the due diligence and things like that. And I think we’ll get some information discovery out of that as well. In terms of what central points of control there are within certain coins. And if there are central points of control, then it will not pass that test that the SEC uses to determine whether or not something is a security. I believe it traces back to some Orange Robe case in the 40s, where that’s how they use this test to determine.

Buck: Yeah, the Orange Grove test. Let’s talk a little bit about China’s influence on Bitcoin. What’s going on? You kind of alluded to it before, but I’m just curious if you can kind of give us a take. I mean, obviously China had some various bands on mining, which has actually been potentially really big opportunity for the rest of the world, especially in the US here. There’s also, Conversely, seems to be interest in China in digital currencies, but maybe more like a digital yuan and adoption. But I’m curious what your take is because China has played such a major role in Bitcoin through history of Bitcoin and what’s going on there that you think is of significance to the ecosystem.

Nik: There are so many things going on in China that are worth talking about. First of all, their ban of mining, probably a huge geopolitical blunder, but I don’t necessarily think that it had everything to do with Bitcoin and more to do with their energy grid and their desire to put on a clean energy face for the world. So I think that that might be part of it. But there are also so many and millions of people in China, part of the Chinese Communist Party itself, that have mined Bitcoin and own Bitcoin. We know this because obviously, miners were in China for many, many years and earned all those block rewards. So we know that they own it. And we also know that the Chinese yuan is not convertible currency, and it was used to purchase Bitcoin in Hong Kong and move money out of China over the last several years. We saw the correlation between the two at times when that activity spikes. So we know Chinese people own Bitcoin. We know there’s Bitcoin in China. So for us to think that they’re just going to ban it or they’re not going to own it anymore is a little naive, but banning mining activity is definitely going to be beneficial to the United States. We’ve already seen Texas be a huge beneficiary of that. And then separately on the Chinese central bank, digital currency. That’s the full green light that they’re going to launch, that it’s already being tested. But they’re going to launch it at the Winter Olympics next year. And I think that they’re hoping to internationalize the currency even more, use it as a geopolitical tool, as a surveillance tool and all these types of political motives to that digital currency. So giving Bitcoin a bad name in China to the Chinese people might make them more excited about this new digital yuan that the government is issuing. So that might be a possibility. And then the last thing I’ll say is that the Chinese Communist Party has a social Sciences. They translated and published my book, Layered Money in the country and got a prominent professor to write the Forward. And they’ve been doing seminars to promote the book. And the Forward says that while we do not agree necessarily, that Bitcoin is going to be the basis for the financial system. This layered framework is an important one and important to explain Bitcoin and why it exists. So it’s not black and white in China. Buck, that’s what I’m trying to say here. There’s people that are for Bitcoin against Bitcoin, and we’ll just have to see how it plays out.

Buck: And then there’s what’s actually happening in China, which is who knows, right? They can say whatever they want, but we never really know what’s happening in China. You brought up the central bank, distributed coins. And I’m curious. First of all, on the China side, is that on an Ethereum platform, or is that an Ethereum based?

Nik: No. It’s a fully proprietary system that they have that the PBOC is piloting. So it’s not a cryptocurrency in any way. It’s just a digital token issued by a bank. It doesn’t have any blockchain to use the term. It doesn’t have any blockchain component to it.

Buck: Okay. Got it. So I don’t really understand what the use of that would be then.

Nik: It’s political, right? Paper money leaves things out of your control if you’re a government. Yeah, digital money gives you control. And if we think if I just interrupted a step forward into the Fed issuing it, it’s going to be political. It’s going to be so they can issue UBI direct payments to people instead of doing QE. That’s what a CBDC will be used for. It’s all political.

Buck: What do you know or think about a Fed coin production in the US? Is that something that you believe is going to happen? Do you know anything about it right now?

Nik: It’s definitely going to happen. They are years away. The Fed has published several papers now, and the Boston Fed and MIT are officially working on Fed coin already. That’s public information. So we know it’s going to happen. It will take them maybe many years, right? It might take them another five years. I don’t know, maybe before, but I think in less than five years we’ll have a Fed coin at least introduced. What will it resemble? Will it resemble cash? Meaning will it replace paper money in the United States, the Federal Reserve Note? Or will it be only a banking instrument that the Fed and banks use? Like they use reserves, reserve balances, and they do QB. Will it modernize the internal financial infrastructure? I think it’s going to do all of it. I do think that commercial banking as a business model is somewhat in jeopardy all around the world. I’ll just hop over to Europe just to give you, because they’re a little bit further along than the Fed is. The ETB has put out some FAQs on the digital Euro. One of them explains how they will limit the amount of digital Euro a person can own, and above that will start to implement negative charges, meaning negative interest rate on balances. And they specifically say this is to protect the commercial banking deposit industry. Because why would you own Deutsche Bank deposits or Barclays deposits when you can just own digital Euro in your wallet? You won’t need commercial deposit banking anymore. So the CBDC threatens commercial banking in a very real way that the Fed and the ECB both understand this. So they have to be careful in how they do it. China has basically said we might be replacing commercial banking altogether in our country with the digital remnant B. And it is what it is. So it’s an important example to look at.

Buck: So I’m curious, though, like on that front, if you look at what you just said and your background in financial markets, if digital currencies are an existential threat to the banks, what do they do in response? Because listen, the Fed at the end of the day, obviously it’s a cartel of banks, right? It’s not a government thing. So you’re talking about really an existential threat to the Fed Visa vision with the banks. So how does that obviously can’t predict the future. But how do you look at that threat and what a rational decision making process might look like on the commercial business and Fed side?

Nik: Yeah. So in game theory, I see Congress taking more power away from the bank side of the Fed and making it more political. So Congress saying Fed coin is ours, we’re going to issue Fed coins to the people, not the Fed. So the government taking control back a Fed coin and that banks issue stable points, which JPM is already doing. They have JPM coin. They will introduce stable coins to compete with Fed coin, so that in the dollar spectrum, people will still put their money at banks by attracting more attractive interest rates on stable coins versus Fed coin. And have that arbitrage play out in the free market. And Bitcoin stands alone as something separate outside of the system, a neutral currency, a non balance sheet currency that people use for that component of it all to keep money, not in the dollar in any way.

Buck: Fascinating stuff, Nik and I could just keep going on and on, but we have probably knocked out at some point. The book, again, is Layered Money: from Golden Dollars to Bitcoin and Central Bank Digital Currencies. Nik, can you get this anywhere? Pretty much Amazon, the usual.

Nik: Absolutely. It’s on Audible as well. I know a lot of people love the audiobook, so it’s done very well as well. And you guys can find me at layeredmoney.com as well. And I’m on Twitter at timevalueofbtc.

Buck: Fantastic. Thanks again for joining us.

Nik: Thanks for having me, Buck. I appreciate it.

Buck: We’ll be right back.