Layered Structure of the Monetary System : Interview with Nik Bhatia(All Interviews)

Nik Bhatia is the author of Layered Money: From Gold and Dollars to Bitcoin and Central Bank Digital Currencies. Previously, he was a trader of US treasuries at a large investment management company in California, and his job was to both trade interest rate products and help set strategy for clients. Nik Bhatia is a former Wall Street trader, adjunct professor at the University of Southern California Marshall School of Business, and a private asset counselor. He helps onboard to Bitcoin both in a retail and institutional setting. He is also a counselor for investment managers with clients that are demanding a solution to get allocated to Bitcoin.

Interview Date : 3rd February 2021

Nik Bhatia(All Interviews)

How did you come to write Layered Money?

Layered money is another way of saying that we are in a credit money system, meaning, those forms of money that everyday people use are all forms of credit. They’re a liability of some financial institution issued to us as a debt instrument or credit instrument. For example, a checking account has dollars or yen in it called a deposit. The deposit is on the liability side of the Banks balance sheet. In the context of layers of money, the bank deposit that everyday people have is actually on the third layer of money. The second layer of money would be the central bank’s liabilities, for example, the Bank of Japan’s reserves in the system which are the assets of the private banking system.

The first layer of money would be JGBs (Japanese Government Bonds) where the government bonds are the assets backed by the central banks. So, government bonds become the first layer of money.

I didn’t write it for people that already believe in Bitcoin necessarily. I wrote this book for people that are interested in Bitcoin, and especially people that have a background in traditional finance. So, I’ve written a book in their language to explain why Bitcoin is an exciting part of our monetary future.

Why do you explain it as layers of money?

It is to show that in the past gold, and today and in the future Bitcoin are both first-layer monies. They don’t originate from the balance sheet of a financial institution. They are commodities and assets, not liabilities. Cash deposits are all liability forms of money, so your PayPal balance and any other deposit account are electronic interfaces where we interact with dollars or yen. Bitcoin, just like gold, is not the liability of anybody. Now, if you have a balance on a Bitcoin exchange, you are on a second layer Bitcoin because you don’t own the Bitcoin yourself, you own the liability of the Bitcoin exchange. Thus, Bitcoin still can have a layered structure to it. However, the very unique thing about Bitcoin is that anybody can have access to the first layer of money.

Why is it important to have access to the first layer of money? 

Because you don’t have to be in a situation where you have to trust any counterparty. For example, if you are holding a bank deposit, you have to trust that the bank will not fail. If your deposit is insured by your government, you have to trust that if the bank fails the government will pay you out an insurance claim. Therefore, if you hold paper money that is a liability of the central bank and the government, you have to trust that your money is going to have value in the future. This is not to say that government currencies are bad and Bitcoin is good, it’s saying that people will, and they already are, demanding an alternative to holding money that is a liability of a government or a central bank. They prefer the option to have the freedom to denominate their earnings and their savings in a currency that doesn’t rely on anybody.

Wouldn’t there be chaos if everyone was their bank?

I do believe that most people will not take custody of their Bitcoin or be entirely in control of their savings and monetary future. They will continue to trust banks, governments, financial institutions, and financial technology companies to do that for them because people like insurance. People like having a mechanism to recover if they lose or misplace their assets. For that reason, not everyone is going to take control of their money on the first layer in the future. I do believe that a layered money structure is quite natural where some will demand a counterparty free money and others will be consenting to trust a bank or a government to take custody of their money.

What is Bitcoin about?

It is all about the freedom to choose, and you should be able to choose two things at once as well. If you want to hold half of your wealth in dollars and half of it in Bitcoin, you should be free to do so. It is not to say that Bitcoin will replace all currencies of governments and take banks out of the equation completely.  Bitcoin is just a choice and people are using Bitcoin as that alternative today.  I believe that’s a trend that will continue. 

How did a layered structure of the monetary system start?

Gold and silver have been used as money by human beings for thousands of years, but in the 13th century, some city republics in northern Italy, such as Florence and Venice, issued a gold coin by their mint that had been changed to purity. This was unprecedented and such an event had never happened before where a coin had such stability and a government didn’t devalue the currency like it had done in the past,  such as during the Roman Empire and the Greek city-states. Because of the stability of the Gold Florin, the coin of Florence, and also the gold Ducat in Venice, this new class of merchant bankers started to issue promises to pay Florin and Ducat. People held these promises as if they were money. So, for the first time, you had this layered situation where the first layer of money was the gold coins that had stability and the second layer was the promise to pay the first layer of money. However, that deferred settlement was trusted. There was a culture of trust that started to develop in Europe where bankers were willing to issue these promises to pay and people were going to accept them. That situation gave birth to this layered money system that we live in today.

How does the dollar work today?

In 1971, the United States removed gold from its currency’s convertibility, meaning, gold was removed as the first layer of money in the framework and the government currency stood on its independent of the historical anchor to the whole system for the first time. That is the system that we still live in today. It is its asset. People still gold and demand it, and the gold price has been doing quite well over the last decade. Just like gold,  neither is Bitcoin in our monetary system. We can transition to a world where Bitcoin is at the top of the new digital layered money system, and that is developing, but the size of that system is still quite small relative to the traditional dollar system. I think it will be a lot more gradual, and it will co-exist with government currencies.

What is the current trend of interest rates?

I wrote my thesis on where interest rates are going in the United States and I was very vocal in my prediction that rates are headed to a significantly lower number in the coming years. We are amidst a 40-year trend downward in interest rates for government bonds around the world. Japan, Germany, and the United States all have extremely low-interest rates. Japan reached those lows earlier than the rest and the rest of the western world did. And I realized why Bitcoin and gold were being demanded and their prices were going up. I transitioned to a thinking framework in which Bitcoin was amidst gold and US treasuries as the 3 most desired assets in the world going forward for the next 10 years.

Can we predict inflation if interest rates are lowered?

Predicting that inflation is coming because interest rates are low is something that has proven to be ineffective for several years. We don’t see inflation even though rates have been 0 or negative in most of the developed world for the last several years.  Inflation does not get off the ground in Europe, Japan, and the United States. Real estate and many other different assets are used by people to hedge way inflation. However, asset classes like gold, art, and even classic cars are used like that as well. There are forms of equity-ships in certain entities that resemble this wealth preservation. When you see billionaires from Russia purchasing Apartments in London, paintings by Picasso, and shares in JPMorgan Chase, they’re trying to diversify their wealth in many ways which they feel will preserve their purchasing power in the long run. So, one cannot afford to look at this narrowly. Bitcoin has very much officially joined that club of real estate, fine art, Classic cars, and prime equity positions in the United States and other western-based domiciled corporations.

How much bigger can Bitcoin grow with respect to Gold?

So far, only companies like Apple and Amazon are in that realm of 1 trillion-dollar evaluation, and gold is approximately a $10 trillion asset around the world. So, as Bitcoin approaches a $1 trillion market cap, it’s already reaching 10% of the size of gold that warrants it being in the same conversation.

Why does Bitcoin not have Time Value?

 Bitcoin not having time value is the same thing as gold. If you hold a gold-bar in your pocket or a vault somewhere, that gold is not accruing any income to you. You are likely paying to have it stored properly. So, you have what we call a Negative Income associated with holding gold. Now, if you have a US government bond that still has a positive interest rate, any share inequities, or an apartment building, you have income coming towards you. You may have interest income,  dividend income, or rental income, meaning you have the time value of money occurring to you with these other asset classes. Gold nor Bitcoin do have that. Bitcoin itself does not have any accrual function where you can earn with the Bitcoin itself. Rather, if you are to hold  Bitcoin properly and securely yourself, you are likely spending money on equipment and security for that which would be a theoretical negative income, thus Bitcoin does not have time value.

Who will benefit from Bitcoin the most?

Bitcoin is storage for wealth today, so it primarily is still a savings technology. While it experiences this huge wave of adoption and high volatility, the main people that will benefit from Bitcoin are the people that don’t spend it and hold it. As the user base of Bitcoin grows far beyond 100 million people and we start to approach maybe 1 billion cryptocurrency users around the planet over the next few years, more goods and services will be priced in both fiat currencies and Bitcoin at the same time. Good and services may be priced exclusively in Bitcoin only, and that whole Bitcoin denominated economy will continue to develop. Right now, it is still a little young but it is developing one user at a time, and one merchant, one company, and one government at a time. This will not exclusively cancel our currency; we are going to do a dual denominated balance sheet where we have everything accounted for in dollars and Bitcoin. That is the vision I have for the future.  

How can Bitcoin be bought through Bond Issuance?

I wrote an article a couple of months ago called “Bond Issuance and Bitcoin buying”  about the company MicroStrategy that issued bonds, meaning they issued debt and raised dollars to immediately use that cash for purchasing Bitcoin. They believe that Bitcoin is a superior treasury asset to the dollar, and decided to take that bold move. It was the first of its kind and something very exciting from a financial theory perspective. The bond market and bond issuance itself is an enormous market with 10s of trillions of dollars per year in bond issuance in which the government and companies borrow money through it. People issue bonds and they owe bond companies that money in the future but they get that cash today to use it for investments, boosting their earnings, for research and development, etc., but MicroStrategy used the money to just buy Bitcoin. And, if other companies around the world mimic that activity, it has the potential to blast the Bitcoin price to the moon. Besides, there’s so much money that is waiting to buy bonds that if that money is a conduit or if the bond market itself is a conduit to purchase Bitcoin, it brings a whole new buyer base and a slew of demands that previously didn’t exist.

How did Microstrategy impact Bitcoin’s price?

MicroStrategy has set a precedent. Their huge purchases and accumulation of over 1 billion dollars’ worth of Bitcoin was done at a price that is currently 50% lower than the current price today. That bond issuance happened at 17000 dollars/BTC. This is not to say that the Bitcoin price rose because of one bond issuance, but we can’t rule out the effect it had. That purchase was a huge influence on the price, and that was just one company. So, imagine other companies around the world and even governments getting involved in issuing bonds, getting capital, and start pouring it into  Bitcoin. There is only a finite supply of Bitcoin, and this supply-demand dynamic has the potential to boost the price of Bitcoin. 

Does Bitcoin OTC negatively affect the market?

I don’t think it does. Off-chain or Over-The-Counter transactions are an important part of the market. Bitcoin is this wild west type of free market in which there is no single price of Bitcoin. Everybody loves to say Bitcoin is at this or that price, but which price are you looking at? There are hundreds of exchanges around the world and those are only the prices we can see. Where Michael Sailor bought it, and how much he paid for it, etc., that has been hidden from us, and that’s okay. In the end, the real price will eventually be discovered by the marginal buyer or the marginal seller. Bitcoin trades 24/7, 365 days a year in every corner of the planet, both digital and by hand. Bitcoin buying and selling that goes on in the shadows is a natural thing and probably a good thing for the market because people know that if an exchange closes there’s a market somewhere else where they can get on. Besides, a lot of OTCs happen over text messages on Signal or Telegram apps.

It’s important to separate one from every other cryptocurrency out there because Bitcoin doesn’t have an issuer; it’s an algorithmic issuance. There is nobody that controls it, so the government cannot subpoena any farm or person to shut down Bitcoin. The OTC market is available to the everyday person. People can purchase and sell Bitcoin through peer-to-peer markets now, without going through an exchange. Also, there are several OTC market platforms around the world where people hand to hand are buying and selling Bitcoin for cash. It is a market where you can conduct such transactions pseudo-anonymously. You do not have to go through KYC and share your personal information. I don’t think that large buyers are necessarily at an advantage by being able to do so in OTC markets,  and OTC markets are just a different corner of this market’s nature. Small buys and sells and very large buys and sells aren’t going to happen in the same place.

Does Bitcoin have time value on the Lightning Network?

The Lightning Network changes the time-value aspect of Bitcoin because Lightning Network is a network of Bitcoin peers that agree to financial contracts that allow them to transact Bitcoin instantly with each other. Now if you have your Bitcoin dedicated to this network, you can facilitate payments between people. And, when facilitating the payment, you can earn an income for providing liquidity. So, with Lightning Networks, Bitcoin gains the time value of money in which you can earn income. Now, it’s not Bitcoin in cold storage anymore where it’s offline in your keys are private, rather it is now in a hot environment where your Bitcoin in an online environment and it’s being used. It will be locked up by hash time-locked contracts, HTLC, which are smart contracts the Lightning Network uses to function. In brief,  while your Bitcoin is tied up in a smart contract in the Lightning Network, it will gain time value, but if it’s not, it won’t have time value.

My very first research paper was called “The Time Value of Bitcoin” in 2018-19. It was about the idea of the Lightning Network bringing time value to Bitcoin, and there was a Japanese enthusiast who was the first person to translate my article into a foreign language, which I appreciate until this date. My role in this Bitcoin world is to present the financial theory behind this new technology. 

Isn’t there a risk to giving Bitcoin time value?

Absolutely, there is a risk factor. However, this risk isn’t a counterparty risk like we have in the traditional banking system. It is not a small risk either, and it is a risk factor most people don’t know how to manage properly. Using HTLC, there might be the risk of entering the wrong amount, you may mismanage the computer science aspect of it, your equipment may fail and you might lose your money. So, there are several risks involved in dedicating your Bitcoin to the Lightning Network and earning an income.

How can the average person manage a node?

Managing a node isn’t something that the average person is going to do or even be interested in doing.  The average person has 99+ % of their wealth in deposit banking, so we know that there is an absence of the average person’s desire to take custody of their money, or to take responsibility for the custody of their money. I am no computer scientist, no programmer nor an expert, and I don’t have my  Lightning Network node either.  I am not experimenting with earning income in the Lightning Network with Bitcoin because I don’t believe that I have the technical capabilities to do that. I haven’t signed up for managing my assets on the Lightning Network and earn with my Bitcoin because my expertise is in financial research, theorizing, writing,  and it’s not computer science. Most people aren’t going to be node operators and that’s okay. Most people aren’t even going to their  Bitcoin private keys, and I won’t go out as far as to say that that’s okay, but it is a natural state where people will trust exchanges to hold Bitcoin for them. In the United States, we can see that Coinbase is one of the largest holders of Bitcoin on the planet. Another entity called GBTC, an investment fund started by Grayscale, is one of the largest holders of Bitcoin on the planet because people trust Grayscale to hold their Bitcoin or give them exposure to Bitcoin.

Even if most people do not take custody of their  Bitcoin, it hasn’t negatively affected Bitcoin. We can confirm that by looking at the price: we are at all-time highs and Bitcoin keeps growing and getting stronger. Even though it has these huge swings up and down, it is on a steady increase in the long term.

How can I learn about taking custody of my Bitcoin?

If you want to truly be on the first layer of money and not have any counterparty disclosure,  know your  Bitcoin and figure out your custody. It is not that difficult for people that want to learn. You can buy a book on Bitcoin programming and wallets. You can research different hardware wallets, different software wallets, and how to make your wallets. I’m not a programmer but I learned some of it. I didn’t have anything except YouTube, Google, and the great people that have helped build Bitcoin to help me figure it out. Also, there’s a lot of great people that are willing to help you learn how to do this yourself, and Bitcoin is so empowering for that reason. It does empower people, like me, to learn computer science and to hold my private keeps.

Interviewer , Editor : Lina Kamada


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