Nik Bhatia, CFA, author and university lecturer (previously worked as a bond trader and at OpenNode) joins me to talk about Bitcoin and its role in a layered money world. We talk about the concept of money operating in layers and what this might look like going into the future. We also chat about the idea that Bitcoin could be the safest layer to operate at.

Nik Bhatia links:

• Twitter: @timevalueofbtc
• Book: Layered Money

Sponsors:

• Swan Bitcoin
• Knox Custody
• Hodl Hodl
• Unchained Capital (code LIVERA)
• CypherSafe (code LIVERA)

Stephan Livera links:

• Show notes and website
• Follow me on twitter @stephanlivera
• Subscribe to the podcast
• Patreon @stephanlivera

Podcast Transcript:

Stephan Livera:

Nik welcome back to the show.

Nik Bhatia:

Thanks for having me Steph.

Stephan Livera:

So Nik, you’ve got a new book that’s coming out soon and I’ve had a chance to read it, but let’s hear a little bit from you. Why this book and why another book on money?

Nik Bhatia:

Yes, so the book is called layered money from gold and dollars to Bitcoin and central bank digital currencies. And the reason I wrote the book was because I come from a traditional finance background. I sat on a US Treasuries trading desk for several years and I traded bonds in the at the highest level of the asset management industry. But while I was doing that, I fell in love with Bitcoin and I felt that my background in traditional finance brings a unique perspective on Bitcoin and I feel that my way to explain it is a little bit different because instead of coming from an economic standpoint or a computer science standpoint, I’m coming from a purely capital market standpoint and I wrote this book kind of through that capital market lens, thinking about how United States Treasuries, the product that I used to trade are the worlds risk-free asset today.

Nik Bhatia:

And risk-free meaning not that it’s free of risk, but that it is considered the most counterparty worthy asset out there in the US dollar spectrum and how Bitcoin, the goal of Bitcoin it’s destiny, is to become that the next world risk-free asset and I think the path from going from treasuries to Bitcoin it takes a capital market approach to understand that because US treasuries are a capital market instrument and Bitcoin is on its way to becoming a full capital market itself. And it’s kind of the reason that I wrote the book.

Stephan Livera:

Of course, and I think that’s the thing when you’re coming at it from an Austrian economics perspective, it’s like, it’s not like the Austrian analysis is wrong. I think it’s more just like, as someone who has more of an insider view, you actually see some of those nooks and crannies of the actual system of how things are operating in practice a little bit more clearly. But I think it would be good to just kind of step back and talk about the title. So it’s called Layered Money. Why Layered Money?

Nik Bhatia:

Layered Money starts from a paper in financial academia that came out in 2012. Professor Perry Merhling is an economics professor and he wrote a paper called the inherent hierarchy of money. And I suggest to everybody go read the inherent hierarchy of money, maybe even before they read Layered Money. Professor Mehrling set up a framework in which he describes money as inherently hierarchical. Because if you look at the way that our financial system evolved, we had gold as the pure money, right? The counterparty free money. And then we have a hierarchy of balance sheets underneath gold, where central banks will issue currency that promise to pay gold. And then banks will issue deposit currency. That’s a promise to pay central bank currency. And so this three layered hierarchy Professor Merhling refers to it as the hierarchy of money. And it’s an academic framework as you’ll see in the paper. What I chose to do was take that framework and actually trace it to the beginning of its story and think about today’s financial system in this hierarchy framework, and then look to tomorrow and try to figure out where Bitcoin will land in the hierarchy of money tomorrow. And so that’s where the title comes from is so it combines this hierarchy model with, of course, this idea of lightning network and how it is a layer two technology of Bitcoin. And so it kind of merges these two ideas into this layered framework.

Stephan Livera:

I like that. And also it’s important to understand where we came from and how did things evolve in the way they did, because I think obviously many of us are critical of central banking and of Fiat money. But it’s, it’s probably fair to say that from their perspective, they thought they were doing the right thing. They thought they were from their perspective, they had a reason why the system evolved in a certain way. So perhaps we should go back to the beginning and try to think about why is it that people were not just and just natively, just transacting with gold, for example, why didn’t they just use only gold coins to transact?

Nik Bhatia:

Yeah. I mean, there’s a variety of reasons. One of them comes down to the convenience, right? And so that’s why, paper is easier to handle than metal. And so paper promises to paint metal can move a little bit more quickly than metal that’s one of the basic things, but as the Austrian school understands it, that today’s money system is a credit money system, which means that in order to expand the money supply money has to be lent into existence. And in order for people to transact back in the 13th, 14th century, when this book begins, it was a lot easier to extend credit in this form of bills of exchange, which is the credit, was the credit instrument of the day. And when people issued bills of exchange people the people that were buying these instruments, they weren’t necessarily paying for them upfront means that when they were issued, it was a loan.

Nik Bhatia:

And these bills of exchange allowed people to transact money across borders, across geographies and across currencies more importantly. And that’s where the word exchange come from in bills of exchange, where it’s a simultaneous wire transfer to another part of the world, but also a currency conversion. And that was a very convenient monetary instrument to use at that time. And bankers, the ones that were issuing these bills did so as an instrument of credit or a loan or a way to issue money. And so I think this really convenient way of transacting and bills of exchange is one of the main reasons why we have a credit money system today is because people found that these customizable contracts could bring money into existence and it developed a culture of promises.

Stephan Livera:

So it was essentially that these other layers had some kinds of features that straight, basically our money didn’t have at the time. And I guess that also brings up this question, which you explore in the book, which is deferred settlement versus final settlement. What does that mean?

Nik Bhatia:

Deferred settlement versus final settlement, it comes down to this idea of counterpart risk. A deferred settlement is a situation where you have counterpart risk and the settlement of the money is in the interim. Whereas final settlement is, the money has settled into your hands. And however you consider final settlement is up to you. So if you determine during that time gold or silver, were the only way that you would accept final payment than anything except gold and silver coins is a form of deferred settlement because it’s a promise to pay you in the future. So it really is just think of it like counterparty risk, deferred settlement has counterparty risk, and final settlement does not

Stephan Livera:

Fascinating. And it’s interesting. And we can get into all the parallels with Bitcoin and the lightning network and settling closing your lightning channel and so on, later on. But I think just generally people would consider the risk differently. So if they are holding the bearer asset, then it’s like, they’re not taking that risk on. And so the different layers have different levels of risk. And so I think this is an interesting point in the book as well, where it’s like people during times of uncertainty, they retreat back to safer layers. So can you outline that dynamic for us?

Nik Bhatia:

Yeah. You’re absolutely right. And what you said earlier about how different layers have different features, that is true. And it goes hand in hand with the risk that exists on different layers. So, in my framework, a first layer of money is you know, historically gold, right? It doesn’t have counterparty risk, but the next layer of money, it has there are promises to pay gold. They have more convenience with them, but then they have it introduces risk right into the, into the picture. And on down you go, on the third layer of money you are now exposed two times to risk. Once you’re exposed to the currency, the national currency or the central bank currency. And then the central bank currency is exposed to the metal, right? The currency has its own default risk and the bank has its own default risk. So as you go on down the layers, it gets riskier to hold each instrument, even though each layer on down can come with an additional convenience to it.

Stephan Livera:

Right. And I think it’s also an interesting point too, as we’re going to sort of start earlier and move forward into the future or move forward in history, the interesting nature of accounting and how double entry accounting evolved. And I, I believe I can’t remember. I can’t recall exactly, but I think we’re talking 13th or 14th century in Italy where it was popularised. So what’s the significance of double entry book accounting?

Nik Bhatia:

I think that double entry accounting, the reason why it was so important was because it brought everybody onto the same page on how we treat books and specifically credit between bankers. So the system of double entry accounting that was formalised at the end of the 1400s in Italy and had been developing for a couple centuries in Europe, before that those methods, once they were formalised, it allowed even more financial instruments to be issued because bankers across borders they could balance their debits and credits with each other on in the same exact language. And how people call mathematics, the language of accounting, the accounting is the language of banking, right? And so it really comes down to language of the double entry accounting. Accounting had existed for thousands of years. We know the tally sticks and the clay tablets from thousands of years ago. But when everybody around the continent got onto the same accounting page, they were all speaking the same language. And that’s what allowed economic activity, specifically banking activity to flourish.

Stephan Livera:

And in earlier days, it’s that the Goldsmiths were functioning as a banker weren’t they?

Nik Bhatia:

That’s right. Well, in England the Goldsmiths were the bankers before the bank of England started to monopolize the issuance of money. And the reason was because the Goldsmiths were the most capable of storing the gold and they became deposit issuers because people wanted to keep their gold with the Goldsmiths. And the Goldsmiths would issue paper deposit saying, I owe you one piece of gold. Here’s a piece of paper. Those pieces of paper started to circulate as cash because people, there were certain Goldsmiths that were trustworthy enough where you would accept that a piece of paper issued by that Goldsmith in place of a gold coin. And then they started to develop more sophisticated financial like techniques like discounting them and things like that.

Stephan Livera:

Yeah, it’s fascinating as well. When you think from a Bitcoin perspective because Bitcoin banks of today, if you will, some of them are kind of like Bitcoin exchanges, but we are not yet in a scenario where people trade the IOU’s around of let’s say one exchange versus another and treat them at par value. So it’s a bit of the future remains to be seen. But I think in Bitcoin, we obviously have the strong self custody culture, but if the system were to evolve in that way, then that would be a kind of a similar, I guess, a historical parallel. Right?

Nik Bhatia:

And I can almost guarantee you that that’s going to happen Steph. If you look at the way that the cryptocurrency landscape has evolved since the first altcoins, you can almost call every other, you can almost call every Altcoin , a second layer of Bitcoin because of a price relationship where prices, all of their base prices are Bitcoin. And maybe when you think of tether its value is derived from the fact that it can be priced in Bitcoin or that it buys Bitcoin on those exchanges. And so if you think about a future where we’ll have BTC denominated, stable coins, which are targeting a one-to-one price with Bitcoin, just so they can circulate out there and issuers can offer benefits that go along with holding those BTC replacements or BTC deposits or BTC stable coins. However you want to describe them. I can almost guarantee that’s going to happen.

Stephan Livera:

Yeah. I’m curious, actually there, because I think it depends on which way the culture goes, because if the culture is more like if it’s not my keys, then it’s not my coins. And that’s an IOU, that’s not real Bitcoin. So, what in your view means that people would cede that kind of thinking?

Nik Bhatia:

Well, I mean, people already keep their Bitcoin on exchanges and with custodians today. So when those deposits or exchange balances start to trade themselves or get liquidity themselves, then I think that’ll just be an evolution of those instruments and not necessarily a comment on the culture of the people that are using it. I think the culture is already kind of spoken for where the people that want to self custody do, and the people that don’t care about it keep their Bitcoin on exchanges. And we already know that the statistics are out there that the vast majority of the hundred million cryptocurrency owners around the world are keeping their Bitcoin on exchanges. So I think eventually we’ll see those balances trading.

Stephan Livera:

Yeah. That’s a fascinating question. And I think there are sites and things like glassnode, for example. So now I’ve interviewed Rafael Schultze-Kraft on the show. And he has spoken about how, I think if you look on glass node, their metrics are something like 2 million or so coins. And it seems that the number is actually coming down at a time. So 2 million of the, let’s say today about 18.6 million coins are sitting on an exchange or probably with some kind of custodian. But yeah, I guess it’s an open question there. Also one other factor that might be interesting as well is nowadays with cryptography and the technology that we have available to us. I wonder whether things like Liquid Bitcoin and this kind of idea of cryptographically ensuring that the system remains full reserve, so to speak, but then people still trade around as an example, a liquid Bitcoin IOU token and would people treat a liquid Bitcoin the same as an on chain Bitcoin? And what do you think about that?

Nik Bhatia:

Yeah, I think that’s a great point. And I think Liquid is a great example of this BTC substitute that has really these new blurred definitions of what counter party risk really is. And in the book, and I have these graphics in there, you’ll see that the relationship between layers of money used to be only balance sheet relationships, then it started to form evolve into price relationships. Like when in 1944, we had the Bretton woods agreement and countries came together and said, our currencies are not valued in gold anymore. They’re all valued in dollars only. And so then you have a price relationship between the layers of money. Now with lightning network, for example, you have a relationship in layers of money that only is related to smart contracts it has nothing to do with price or balance sheets or counter parties right? because of the way that lightning network is designed.

Nik Bhatia:

So Liquid is something that is right there in that smart contract type of relationship where we know that it’s reserved and that’s a fascinating something that is totally unique to Bitcoin. It just can’t exist anywhere else. Like think of think of a gold ETF that had to prove its reserves 24/7. What do you have, like a video stream of all your vaults, four hours a day on the web? Like, it doesn’t make sense in the old term in the old financial system, but in the future with Bitcoin, we can imagine these things.

Stephan Livera:

Right. And I guess just to just for any listeners who might not be following along Liquid essentially requires peg in and peg out of Bitcoins. And so I’ve got an episode with Allen Piscitello from Blockstream. So that’s the episode to go and look out for listeners, but I guess the important point to note is that it is custodial in some sense, right? So you are trusting that your peg out of liquid Bitcoin back into, on chain real Bitcoin quote unquote, is not going to be denied by two thirds of the I think the Federation or the functionaries, like the members of the liquid foundation, which is kind of like independently operating, but it’s like a blockstream, product that they support. But it’s an interesting sort of parallel to in the past historically where this idea of gold tickets, and let’s say paper tickets that represent a claim on those pieces of gold, just to make it simple that those pieces of paper circulating around in the community if those are not fully reserved then in the Austrian school that’s, the leading that’s one of the factors behind what creates the business cycle.

Stephan Livera:

And so that’s now that is a debate even among the full reserve Austrians of which I’m in that camp versus some of the others who believe in a more fractional free market example where they think actually they will be fractional reserve but it will be kind of in a different way. But I suppose bringing it back to how Layered Money evolves. I think another interesting historical component to explain is what happened in Antwerp. So can you tell us what happened there?

Nik Bhatia:

So Antwerp, but what was fascinating in Antwerp was that these bills of exchange these credit instruments previously before Antwerp they never had liquidity, which means that they could never be sold before they matured. They had to be held to maturity or exchanged with the underwriter for cash or precious metal, but in Antwerp what happened was for the first time merchant bankers bought and sold bills on a daily basis from each other and created a money market and liquidity for second layer money meaning that for the first time ever pieces of paper that promised to pay, got prices themselves. And that really birthed the whole money market and what we think today as these monetary instruments, these short-term debt obligations that trade like treasury bills or discount notes or commercial paper, or other monetary instruments like that, like Eurodollar deposits or certificates of deposits. These are all monetary instruments that have their root in Antwerp because for the first time ever those pieces of paper were treated like money themselves and cash even.

Stephan Livera:

Right. And so it’s kind of crucial that people, how people treat those equivalents, if you will. Right.

Nik Bhatia:

So I’ll just quickly say that the only thing that was considered cash before Antwerp, but these developments were coins themselves. And so we can see that the most important thing that happened there was that our thought our idea of cash really transitioned from metal to paper.

Stephan Livera:

Right. I see. Yeah and I taking it to nowadays with money market funds. I think that was also another interesting element, which you skillfully explained in the book, what are money market funds and why do people use them?

Nik Bhatia:

Yeah. So money market funds are these tiny monetary instruments that allow huge sums of capital to be stored safely with daily liquidity. The example that I give in the book, it’s imagine that you win the lottery and you win a billion dollars, but your tax bill is going to be $999 million next month because your government has some obscene tax on lottery winnings. So how do you store, you can take the million dollars and go and spend it, but how do you store the $999 million for a month until your tax bill is due? You can’t just, take dollar bills. You’re not going to want to just leave it on deposit with your deposit bank, because then that is beyond your federally insured deposit amount. And if the bank goes belly up next week, you owe your government $999 million and you have no recourse.

Nik Bhatia:

So how do you store your money? Today we use these things called money market funds, which are these essentially fund vehicles that go out and buy treasury bills and other bank deposits and other short-term liabilities, and essentially diversify your exposure to all the different types of money out there. But it allows you to buy and sell on a daily basis. So if you need your money tomorrow, you can sell your money market fund shares and get cash for the next day. And the unique thing about money market funds is they all target par, meaning you’re supposed to be able to get a dollar for every share all the time. It’s like a fund with a perpetual dollar price. It’s always worth a dollar. And that fact that it’s always worth a dollar makes it really convenient to the world. So there are several trillion dollars in money market fund assets out there. And these are big players in the industry. And they played a role in the great financial crisis of 2008. And some of the risk was legislated away. In 2016, I believe if I remember correctly when money market reform happened, but they still do carry a significant amount of risk in the financial system because so much capital is concentrated there.

Stephan Livera:

Right and so I think it’s kind of like in some weird way, keeping the money in the money market fund is safer than leaving it in the bank account. And that’s why when we’re talking about large amounts of money, not necessarily retail level people, but for businesses and large entities, that’s the kind of a situation where it’s theoretically safer for them, right.

Nik Bhatia:

Magnitudes safer. I mean, do you want to be exposed a hundred percent to a single bank? Like, imagine if you’re in Europe and you win this lottery in Europe and you have to keep your money at Deutsche bank BNP Paribas but, these banks have had so much trouble that anything can happen at any time to any one of these banks. And we know that, so why would you just be exposed to one bank with that type of scenario? And of course this is a hypothetical, but you’re going to want to own a money market fund instead of a bank deposit to a single bank all day.

Stephan Livera:

Yeah. I think that’s also an interesting point because, when we look at bond markets and you look at, okay, well, the real return on these things is obviously so negative. So why is anyone holding these things? And it kind of points you towards that answer some people have to hold it for regulatory reasons. And maybe this is also part of the reason why some of these markets are so large is that there are certain systematic reasons why it still makes sense for people to hold these things.

Nik Bhatia:

Well, you can’t see me right now, Steph, but I have a huge smile on my face because you hit the nail on the head right there. This is something that I’ve been hammering the table on for several years, starting when I was on the trading desk on why rates are going lower and have been going lower and will continue to stay low, it has nothing to do with anything except what you just described, which is that the demand for safety, the demand for these types of instruments that have the next level of safety relative to literally everything else out there, that’s why the price is so high and why the interest rates are so low and even negative in so many parts of the world, because it is the alternative to being exposed to the banking system. That’s how people should look at negative rates.

Nik Bhatia:

It’s just a premium on safe money. That’s, that’s all it is. It’s the certainty that you’ll get par back that you’ll always get par whether or not that par is devalued in your home currency. People that are denominated in that currency, they don’t really care about that. There’s nothing they can do about that. That’s why people leave their denomination for Bitcoin, is they try to escape that. But if you can’t escape that, or if you’re not ready to make that jump out of the denomination, you buy government bonds, you buy them all the way down into negative interest rates, and you keep rolling that position when you keep buying it, when it matures, you buy it again and you buy it again and rates. I do not talk about this in the book because I didn’t feel like it really would have added to the story. It’s really difficult to kind of explain this idea that interest rates are going to stay low forever because of this reason. You have to explain a lot more, but it’s a very important point. And thank you for bringing it up.

Stephan Livera:

Well, there you go. And where if I think of what other people in the Bitcoin world are talking about, they’re saying, well, that’s probably a big market that is ripe for people for Bitcoin to kind of take over because there’s a lot of these people who are just stuck in some sense, either for regulatory reasons or just the reasons you were just outlining that they’re buying bonds and they’re staying in these for perceived safety. But the reality is we are starting to see, and particularly in Europe, we’re starting to see some banks start to levy a negative interest rates, and basically it’s like a cost of carry. So, and I’ve been commenting on this as well. That’s in the fiat world, we got accustomed to having basically a free cost of carry. And now the game is changing, well over the recent years that has been changing and it is continually going in that direction. And so now what happens when you have to pay 0.25% or 0.75%, I think in some cases where you could hold a large amount of Bitcoin for a small fraction of that cost.

Nik Bhatia:

Absolutely. I mean, it has to be one of the reasons that people are driven into Bitcoin and the risk profile is so unique in Bitcoin that you can’t make the same relative value assessments. And so what do I mean by that? When you’re a traditional manager denominated in US dollars and let’s say there are only two instruments out there available to you. There’s three of US treasuries, and there’s a basket of corporate bonds. The corporate bonds have higher return and a higher risk, and obviously the treasuries have a lower yield and a lower risk. And when you make that judgment, you are looking at the spread of interest rate between the corporate bond and the treasury, and you are determining whether that spread or whether the spread and the risk combined to make it the right decision for you to get out of the treasury and to buy the corporate bond.

Nik Bhatia:

Because in the absence of the corporate bond, you own the treasury, right? That’s your risk-free asset, that’s your base instrument. You don’t own nothing, you own treasuries. So when you make that decision to jump out of treasuries into corporate bond, you make that that a good risk assessment, and you decide to make that decision well, in Bitcoin, the decision you’re not looking at relative risk and a relative interest rate, it’s a whole separate risk assessment that you’re making, which is, do I need to be in this denomination or do I need to hedge away from the dollar itself? Because people that look at Bitcoin’s return just only in USD terms they’re going to have a hell of a time, dealing with that type of volatility and writing letters to their clients and explaining, why the returns are so up and down. But if you’re not thinking in those terms, and you’re actually thinking in terms of, I should be outside of the dollar for the next five years for this percentage of my portfolio, because there is an X percent risk that the dollar rapidly loses value because of reasons X, Y, Z, I want to make that decision. And so, to answer your question it just is a totally separate way to evaluate that relative value. Yeah.

Stephan Livera:

And as people start to become more acutely aware of these things, right in personal finance circles, for example, they’ll say things like, Hey, you need to look at your returns net of fees and taxes, because those are the returns you can actually eat. But it’s funny because in the normal Fiat banking world, they’re not thinking in purchasing power terms. And because if they did, they would really start to see, okay, look, inflation is actually more like 10 or 15% or in some things it’s even higher. Whereas yes Bitcoin is volatile, but historically over the last 10 years, its returned 200% per year on average. So it’s kind of like, I think it’s going to be a matter of time until more people wake up to that reality.

Nik Bhatia:

Yeah. The volatility does prevent certain people from adopting Bitcoin and that will persist in that as part of the reason why the volatility will still continues because the Bitcoin price behaves in this very hype boom bust type of pattern. And we see that it seasonal in terms of halving cycles. And we’ve had enough at the third post halving rally like this. And I’m sure that it will go too far and correct itself. And before the next rise, it’s something that I think is becoming very obvious to at least the Bitcoin world when we’re paying attention to this four year seasonality. And I think that that’ll persist.

Stephan Livera:

Yeah, Another interesting point when we’re talking about Fiat money inflation is that there are parts of the system that the US Federal reserve does not have good oversight. One example is the Eurodollar system. And I know Jeffrey Snider is probably the most famous person for talking about this and really bringing attention to this. But you also mentioned it in the book as well. So can you tell us a little bit about that? What is the Eurodollar system of offshore dollars?

Nik Bhatia:

Sure. And I do thank Jeffrey Snider in my book because his work on the Euro dollar has been eyeopening. And he’s been one of the loudest voices that is out there pounding the table again on the fact that people need to be paying attention to this offshore dollar system or the way you described it, the dollar system that is outside of the federal reserve’s purview. And yes, the federal reserve doesn’t they’re not able to see all the dollars out there because for example, dollars that are issued as deposits outside of the United States, while they might appear to be dollars outside of the United States, they’re not actually dollars within the federal reserve definition of them. And that breakage, that dichotomy, and it has to do with Basel 3 regulations and things that are maybe a little bit beyond the scope here, but the fact that dollars outside of the United States, aren’t fungible with dollars inside of the United States creates really the state of disrepair of the dollar, where the system can break in different parts of the world.

Nik Bhatia:

And the Fed has to go put band-aids on this country’s banking system or that country’s banking system by issuing a central bank swap line. The most famous example of this is in December, 2007, when it was clear that the Eurodollar apparatus was going down as LIBOR was increasing at an alarming rate relative to other money market interest rates. And that represented that the European interbank trust had died and it was dead. And until the fed said to the ECB, we will let you print Euro’s and post them to us as collateral and borrow dollars so that you can lend those dollars to your banking system. That’s when the fed had to capitulate on the Eurodollar and they still have that implicit bandaid on the whole system, even though they can’t really see or control how much of it is being issued. And that’s a problem.

Stephan Livera:

And interestingly, you mentioned how they had to capitulate on this because previously their policy was against this kind of practice, right?

Nik Bhatia:

Yes. I mean they’re not going to implicitly back the world’s lending activity, but when the instabilities built up over the course of the five, six, seven years before 2007, when the notional derivatives were getting into the, almost to the one quadrillion range that instability the fed, they have to capitulate they can’t go out there and say, you shouldn’t be doing this in 2004, 2005, 2006 to the European banks, because they’re outside of their regulation. But then when the system broke, it’s all denominated in dollars and banks are about to fail. The Fed has to step in because the financial system goes through the US dollar. And if there’s any instability there the Fed is the one that’s on the hook. So you have to save the currency. And that’s why the fed views, these decisins to implement central bank swap lines as they view them as mandatory or necessary now.

Stephan Livera:

Yep and I think it’s an interesting idea to just kind of idea of like all these people outside of the US had made their own almost like a synthetic dollar, if you will. And I guess it’s kind of, maybe it’s not a perfect example or it’s a bit of a strange analogy, but it’s almost like if you look at some of those Bitcoin only exchanges, like BitMex, for example, they don’t actually have any US dollar it’s all synthetically done. So it’s kind of like imagine if the world was all doing like US dollar on like BitMex and other similar exchanges, right?

Nik Bhatia:

Yeah it is a synthetic, the word synthetic is a good way to describe the Eurodollar. And there are definitely parallels in the Bitcoin world where we have these synthetic dollars that are circulating because they’re easier to transact than the real dollars, which move on what we know to be the ancient financial rails not the cryptographic financial rails that the world is heading in that direction.

Stephan Livera:

Yeah. And you had an interesting framing with the federal reserve in the book, because you say it is the, now most people would know it as the lender of last resort and you frame it as the lender of only resort. Why is that?

Nik Bhatia:

Yeah, it’s just like we talked about the, the whole financial system is now wholly dependent on the Fed for support. The reason is because anytime we get a correction in prices, the Fed steps in, and so they’ve analogy of being hooked on drugs has been used with the fed every the whole system is hooked on this monetary stimulus and this reserve creation that they do, or the central bank swap lines that they issue or now the treasury repo facilities that they’re willing to lend on limited capital against all treasury collateral. They are basically the only source of liquidity because nothing is allowed to fail anymore. If things were allowed to fail, then we wouldn’t have to call them the lender of only resort because things could fail and they wouldn’t be the lender of only resort.

Nik Bhatia:

But the truth is that every time something happens the fed comes in and bails out whoever needs to be bailed out. And that happened in 2007, eight, nine, 10. And then they took a break for a few years and they tried to raise interest rates under the Janet Yellen term. And when they hit 2%, the markets broke. I was on the desk at that time, the markets completely broke. The fed had to say, we’re done hiking rates, and then the markets still didn’t respond. And then they had to start cutting rates so that prices started to go up again talking about stock prices for example we all know that the Fed’s third mandate is the S&P 500, and it’s unofficial, but it’s as official as you can get.

Nik Bhatia:

All you have to do is watch the price of the S&P 500 and listen to the fed speak, and you can see that and they haven’t been shy about this let’s be honest they have said, and Bernanke said this during QE, we are targeting the wealth effect. So if we can get stock prices to go up and home prices to go up, Americans will feel wealthier and they will spend that is their economic justification for QE. And it’s their economic justification for having their third unofficial, but official mandate being the price of the S&P 500 index. So, they’re not shy about it.

Stephan Livera:

Yeah, certainly a very troubling situation that the world is in right now. But I also want to get to the point in your book where you talk Bitcoin as a and Bitcoin’s role going forward in this kind of Layered Money vision. So can you tell us a little bit about what your vision is there with Bitcoin as part of the financial system going forward?

Nik Bhatia:

Yeah, so it really comes down to the freedom to choose your currency denomination. And I think that the reason a lot of people own Bitcoin today is they desire to have a money that is not tied to a government. We’ve talked about the separation of money and state for a long time in Bitcoin. And I think it is one of the main drivers of people owning it besides the obvious number go up technology that it has, if that is the case, and people are free to choose their currency denomination, Bitcoin becomes the new neutral currency of the world. And I think it already is on its way there. And I wrote the book because of that reason. I think that we have already determined as a global society, that Bitcoin is the new neutral money now because Bitcoin is the new neutral money.

Nik Bhatia:

Then all other currencies will be measured in Bitcoin. And I am projecting out a few years here and with a lot more Bitcoin adoption worldwide going from a hundred million users to a billion users, but it’ll happen quickly. It only take a couple of years for us to get to a billion cryptocurrency users in some shape or form around the world. And when that happens, you’re just going to have all these state bank issued, stablecoins, central bank digital currencies, all of these cryptocurrencies they’ll or most of them or many of them will have the ability to be atomically swapped back into Bitcoin in some sort of trustless way. And in that sort of scenario, Bitcoin scarcity, it’s incorruptibility, it decentralisation and its neutrality, it’s lack of a leader. If lack of a single jurisdiction where it’s under all of these factors make Bitcoin the centre of digital money.

Nik Bhatia:

It already is the centre of digital money today in terms of it being the reserve currency of the cryptocurrency landscape, but it will progress to the centre of the whole digital monetary realm, especially when central bank digital currencies are built on distributed layer technologies that enable atomic swaps. Then you’re going to have central banks that are trading between their currency and Bitcoin, because they’re targeting the Bitcoin price of their CBDC. And it will take time for this to unfold. I think it really comes down to the fact that this neutrality of Bitcoin can never, arguably, can never be duplicated again in the way that it was with Satoshi in 09. And it really is an earth shattering innovation and monetary history. And that is what I wrote the book about. I do officially claimed that the monetary and cryptography sciences have merged. They merged on January 3rd, 2009, or October 31st, 2008. However you want to say it we didn’t know it at the time, but we know it now and we have to go back and Mark that date or what Satoshi did for what it is. And it was a monetary Renaissance. And just look at the way that we’re tracking.

Stephan Livera:

Yeah, certainly if it had been a very rapid advancement up to where we are today in January 2021. And I guess as part of that transition period, there may be a period where central banks have a Bitcoin trading desk. So what does that look like to you?

Nik Bhatia:

Yeah, it comes down to think of the example in the 60’s of the gold pool. This is when governments came together to try to keep a lid on the price of gold at $35 per ounce by basically selling gold into the market to bring that supply heaviness and try to try to keep a lid on the price. So that type of activity is basically a government’s way of saying that we don’t want the base price of our currency to be devalued. And so they’ll try to keep the price. And I do imagine in the future that central banks will try to replicate that sort of activity to keep a lid on the Bitcoin price of their currency and they’ll need a trading desk to do it. And certain central banks will be able to be way more successful than others.

Nik Bhatia:

And I do believe that in 10, 20 years from now, we’re going to have a lot fewer currencies government currencies aren’t going away, but I think that there’s going to be a tremendous amount of consolidation, and that’s not something that people are talking about today really is that we have over 200 countries and we’ll have only 50 government currencies in 10 years. But I think that that sort of thing can happen at, especially if the smaller central banks aren’t able to keep a Bitcoin desk and keep a lid on the price of their currency in Bitcoin terms.

Stephan Livera:

Maybe then I guess the whole projecting that is likely that the whole CBDC central bank digital currency thing happens. But those of us who are smart hold Bitcoin instead, and over time, it’s going to be extremely bullish for those people who do hold Bitcoin, because that’s actually the scarce one, as opposed to the central bank digital currencies, which will just simply have to reflect existing monetary policy.

Nik Bhatia:

Yeah, I do believe that it accelerates the adoption of Bitcoin and it certainly demonstrates to anybody who wasn’t already in Bitcoin, that Bitcoin rails are the future of the financial system. And then it’ll drive people into it and CBDCs are themselves a capitulation to Bitcoin. And it’s obvious. I mean, why would they be creating these things if Bitcoin had never existed? They wouldn’t have any FOMO, but they do. And so they have to get on board and it’s just actually driving the Bitcoin adoption. It’s driving the awareness that money doesn’t need to be issued by a central bank. And they’re definitely coming. I read all the research reports while I was researching this book. The one that the ECB issued, I read the fed papers from a couple of years ago. The reserve bank of Australia is already now testing. We already know that China is in the lead in terms of who’s going to be the first big major countries central bank. That’s going to put one out and be in public circulation. So they’re all on their way. But I don’t think it for a second does anything to change the direction we’re going, which is a Bitcoin centric financial system. That’s built on these cryptographic rails.

Stephan Livera:

So previously some of our earlier episodes, were about the lightning network. I think it’d be interesting now to just talk a little bit about that and whether there’s been any evolution in your thinking on this idea of the lightning network reference rate or how well yeah. Whether you’re thinking has shifted there?

Nik Bhatia:

No, none of it has shifted. It’s only gotten stronger and shout out to the lightning labs team for pool and the product releases this year centred around lightning network routing activity, lightning network, liquidity, and transaction types and all these fascinating innovations that are going on. We do now see that people are talking about the income that they’re earning on the lightning network in interest rate terms, which was the goal of my work. When I set out to write the time value of Bitcoin in 2018. So I’m thrilled that the capital market has taken a turn in that direction and people will now be reference referencing a lightening network, interest rates, whether they call it LNRR or not really doesn’t matter anymore. The fact is that the rates are out there and it’ll only get more public and we’ll get more data as the number of users grow in the lightning network.

Nik Bhatia:

But one of the things that I didn’t think about back then in terms of the potential of the lightning network is the fact that these hashed Time lock contracts that are now available with Bitcoin because of lightning network enabled this world of atomic swaps with Bitcoin via lightning that really will drive the Bitcoin centric financial system. So it’s not the fact that people will use every digital currency. They get and automatically atomic swap it into Bitcoin using the lightning network and that’ll pump the price forever. It’s the fact that you have this instant way to transact between currencies and with Bitcoin as the ultimate form of digital scarcity. It does allow people to again, going back to double entry, accounting. Bitcoin is called triple entry accounting. It’s the first language that we’ve ever shared as a world on the internet with money, the first ever language, that’s really a common tongue.

Nik Bhatia:

And that is why Bitcoin is the most important monetary invention since the world settled around gold as its consensus money. So it is a once a millennia or more innovation. And I think the lightning network to get back to your question plays an important role in the future, and it really comes down to SegWit and these and the BIPs that set up SegWit, check sequence verify, and check lock time verify. These updates to Bitcoin have made Bitcoin a full monetary system platform in addition to this meme of digital gold, which it is, and it’ll continue to be. So that’s probably the most exciting thing about lightning network. And I do cover this briefly in the book about the atomic swaps.

Stephan Livera:

Yeah, That’s a really cool part to acknowledge. And so with the creation of lightning Pool, as the first, we can call it a channel marketplace when people want to open channels to each other, they can put up a bid and then say, Hey, I want some inbound liquidity for this much money, and I’m willing to pay this much. And that’s where the basis of some of this first lightning network reference rates can come. And that’s where you are essentially earning a non-custodial return. So it’s not without risk. There is a hot wallet risk, obviously, but it’s non-custodial. So that’s probably the key part, because basically as you were saying, the smart contracting and the way when you update the state of your lightning channel, you’re basically passing back and forward a new state and you’re revoking the old state. And you’re saying, this is the new one at any given point, let’s say, I’ve got a channel with you either of us can unilaterally close that channel and claim back our funds on chain. So that’s a really interesting aspect, and it kind of ties back to what we were saying earlier about final settlement as well.

Nik Bhatia:

Yeah, absolutely. And like you said, it’s not without risk. Your risk is coming down to your technical expertise in the channel management risk and all these other things, but like you said, you still have the unilateral power over your funds. And that is something that it can’t really exist in the physical world. And that’s part of what makes Bitcoin so unique.

Stephan Livera:

So any other points in terms of the outlook on the future of money and what it’s going to look like with Bitcoin as the centre of this Bitcoin Layered Money future?

Nik Bhatia:

You know, I think that we talked about really the neutrality and that’s really the point to drive home here, is that in the realm of digital currencies, it doesn’t matter. It’s not going to matter necessarily what the counter party is. If the money it won’t be able to compete with Bitcoins neutrality. And I think that that’s something that will drive Bitcoin’s adoption going forward. As people realise that their money doesn’t have to be issued in the way that they previously thought most people walk around with bank deposits and in my framework, that’s a third layer of money, but they could be walking around with first layer money, Bitcoin and just completely avoid counter party risk. And once that sets in, and I hope that the Layered Money framework elucidates that for people I think Bitcoin will just continue on its current adoption path, which is an exponential rise.

Stephan Livera:

So we could maybe summarize that as Bitcoin as the safest layer.

New Speaker:

That’s right.

New Speaker:

Very cool. All right, Nik. Well, I think it’s probably a good point to finish off here. Where can listeners find the book and follow you online?

Nik Bhatia:

So I’m hoping that the book is live on Amazon by the time that this airs the book is called Layered Money. You can find it on Amazon. It’ll be available in both print and ebook format of the audible version is on its way that should be out in February. So you guys can find that and just go to Amazon Layered Money. You can find me@layeredmoney.com and I’m on Twitter @timevalueofbtc

Stephan Livera:

Fantastic. Well, I really enjoyed chatting with you. Thank you for joining me today.

Nik Bhatia:

Thanks Stephan.