June 5, 2021
The House of Medici, Bitcoin
Of Cosimo di Giovanni de' Medici, Pope Pius II said, “All questions are answered in Cosimo’s house. The man he chooses holds office. It is he who decides peace and war. He is king in all but name.” His father, Giovanni, learnt his trade in Rome at a bank owned by his uncle. After the uncle’s death , Giovanni moved the bank to Florence in 1397, marking the beginning of the Medici Bank. Over the next 100 years, the Medicis would transform the banking system, become the wealthiest family in Europe and the Godfathers of Renaissance. Over the decades, they would install Medici men as Popes and wed into royal lineages in England and France.
When Cosimo inherited the family business, he was not the only wealthy banker at that time. But, he was the first to address the two requirements businesses crave - information and credit. The familiar bank branch where all of us have gone at some point is a Medici invention. To be able to deposit money in one place and withdraw it at another revolutionized trade. The Medicis set up each branch as a partnership with themselves as the majority shareholders. This provided the blueprint for banking for centuries. The double entry ledger - the accounting mechanism that records a transaction on two sides of assets and liabilities - was institutionalized. This reduced fraud and made the Medici Bank a reputable institution.
In the 15th century, global trade was booming as traders travelled back and forth from Europe to Asia along the Silk Road. The Medicis pioneered the use of the Letter of Credit, another crucial innovation. It meant that traders no longer had to carry vast amounts of cash when travelling. By the time Cosimo died, the Medici Bank had branches from London to Constantinople.
Trade is at the heart of human society. It creates the need for something that can store value and can be exchanged at a later time. Such a ‘store of value’ needs to be constant in form and quantity for it to work. For a long time, it was gold. Today, governments attempt to deliver a store of value with paper money. Most governments are successful at this most of the time. Initially, paper money was backed by gold. In 1973, Nixon severed the link between gold and the dollar. Thus, the US dollar and every other currency came to be backed by nothing more than a legal “fiat” - a decree that the currency is worth the number printed on it. We now live in a world of fiat currencies.
Yet, gold continues to be valued. Why?
Most governments, when their backs are against the walls, bend the rules. They print more money. Each time they print money, they make all money less valuable. This is known simply as inflation.
Think about it for a second. If you had to choose between spending “good” money (gold) or “bad” money (inflating paper), what would you do? You’d spend the bad paper and hoard the good gold, right? This is how paper came to be in circulation and gold continued to be precious.
It is very very hard to imagine the US dollar losing value. But, there is a non-trivial possibility this will happen in our lifetimes. At some level, it is the law of nature. Everything eventually fades and is replaced. Which is why central banks and other institutions still buy gold. Today, central banks own 20% of all the world’s gold, with the US treasury being the biggest holder.
This brings me to Bitcoin. Everyone’s talking about it. So, let’s talk about it.
[Due disclosures: I own Bitcoin. This is not investing advice.]
Bitcoin is touted as many things - the new gold, digital gold, the currency that will someday supplant fiat currencies, and so on.
What is bitcoin? What is it worth?
Bitcoin is essentially a new type of asset. It’s digital, meaning it exists only as bits and bytes on computers. It is based on a technology called blockchain, a fancy word for the 15th century Medici innovations. Blockchain is a digital, public and shared ledger. In other words, multiple parties are required to complete a transaction, reducing chances of manipulation. Bitcoin is just one type of asset built using blockchain. There are 100s, maybe even 1000s of others, called cryptocurrencies. The way it is designed, Bitcoin’s supply is capped at 21 million odd. This makes Bitcoin unique in the world of cryptocurrencies. Fixed supply, store of value… sound familiar? Yep. Bitcoin sounds a lot like gold. Like gold, it has no intrinsic value. Like gold, Bitcoin is valuable only if everyone believes it to be valuable.
How much is it worth? The short answer is somewhere between zero and hundreds of thousands of dollars, depending on your worldview. If you think that the US dollar is in terminal decline, then the bitcoin story becomes interesting. If you think that the governments will not allow their power to be challenged, then maybe not. There are, however, a couple of interesting trends.
1) Institutions have begun to quietly replace gold with bitcoin. There is about 9 trillion dollars worth of gold. If some or all of that is replaced with bitcoin, things could get interesting.
2) Millennials have climbed enthusiastically aboard the bitcoin train. Millennials are expected to inherit $28 trillion over the next 25-30 years. They’re going to invest some of that money somewhere.
We humans have told ourselves a lot of stories over the years. The story of money has been fascinating so far. Bitcoin is the latest chapter in this story. How it will end, who knows?
And oh, the Medicis are back after 500 years. Prince Lorenzo de’ Medici, a descendant of the famed House of Medici, recently re-opened the Medici Bank. This time, it’s crypto-friendly.
In other news, Biden and Putin will soon meet in Geneva for their first ever summit since Joe became POTUS. Biden has called Putin “soulless” in the past. Putin has hacked into the US elections in the past. Things are going to be awkward. There’s always a bit of an edge when a person who just replaced a wannabe dictator runs into an actual one.
Alabama recently overturned a decades long ban on teaching yoga in public schools. The measure will still prohibit chanting of Sanskrit words and will require a parent’s consent to acknowledge yoga’s connection to Hinduism. I’m just surprised to hear that they are still teaching stuff in Alabama schools.
Stay safe. Have a great week ahead.
Yet another very interesting piece Srini. When gold backing was no longer required for US dollar (and world currencies), each government is behind its own currency. Infact, this is the best way to dinstinguish counterfeit versus genuine currency. I have always wondered who is backing the bitcoin? After all, it is the guarantee of a government that gives the value to a piece of paper. You addressed it by saying that the supply is capped at ~ $21M, comparing it to gold. But you know, gold like diamond (which is nothing but carbon) has intrinsic value by its appeal for ornaments and jewellery. What intrinsic appeal does bitcoin have?
We have traversed a very very long way, from the world of a couple of centuries back, when, persons with worthwhile articles or assets, and requiring some they want to possess for ever, resorted to BARTER TRADE. Through the ages, it has travelled a long distance, and only about 50/60 years back, the GOLD STANDARD came into existence, and the world turned topsy- turvy , with even TOM, DICK AND HARRY, started resorted to amassing GOLD AND HOARDING IT, thinking that it was at last the only solution to hold something worth possessing, to be considered as a rich or prosperous person. I remember that in between 1945-55, every single house-hold purchased GOLD with the available resource of cash available, at a price of Rs 50 per gramme, with the present price of GOLD IN 5 digits. The transformational change, replacing it with BITCOINS, may have to run it’s course for a couple of more years or decades, to be replaced, by a much more innovative INSTRUMENT FOR EVALUATION OF THE WORTH OF THE PERSON, holding it close to his chest, to be considered as one among the TOP 10 RICHEST PERSON IN THE WORLD. This evolutionary process of systematic replacement , of one by another, thought to be much more stable and durable, is visible in every facet of human activity, either of riches, human perceptions, values etc , is an irreversible process of the EVOLUTION, at the bottom of such HUMAN FRAILTY IN EVALUATING THE WORTH OR OTHERWISE of anything, worth keeping or preserving. ( Example: The CONCEPT OF DEMOCRACY itself) . As rightly stated by you, already, the BITCOINS, are gradually being replaced by CRYPTOCURRENCY, and though, a student of ECONOMICS, i am really flabbergasted to understand either the reasons, or the logic behind it, as also the implications of such novel schemes, brought, more by human ingenuity , than anything else. LOKO BINNA RUCHIHI is much more applicable here in evaluating things, than in any other field of human endeavour. I thank you for educating me into the MYSTERIES OF BITCOINS, which, was far beyond my sense of comprehension, till date.