Bitcoin: A Digital Lifeline for a Debt-Ridden World
The specter of global debt looms large over the world economy. A mountain of liabilities, accumulated over decades of borrowing and spending, threatens to destabilize financial markets and stifle economic growth. As this debt burden continues to mount, it becomes increasingly evident that traditional solutions are insufficient because traditional economic growth has failed to keep pace with debt growth. A new approach is needed to expand the global economic frontier to pay for the excess debt. Like always, this expansion in the economic frontier will be led by technology, it will not be linear, and it will disrupt the traditional notions of collateral, even though collateral will remain key to credit expansion and as such growth.
The Weight of Debt on Global Growth
Global debt has skyrocketed in recent decades. According to the Institute of International Finance (IIF), global debt reached a staggering $340 trillion in the first quarter of 2023, surpassing 320% of global GDP. This alarming figure underscores the urgent need to address the growing debt burden.
The excessive accumulation of debt has far-reaching consequences. It weighs heavily on economic growth, as governments and businesses are forced to allocate a significant portion of their resources to debt servicing. This reduces their capacity for investment, innovation, and job creation. Moreover, high debt levels increase the risk of financial crises, as borrowers may struggle to meet their obligations.
To be clear, sovereign debt is not quite like household debt. Instead of being paid off, it gets refinanced. But all debt needs to be paid for just the same and economic growth is how debt levels are justified. When appropriate growth cannot be realized against preexisting debt levels, it necessitates a currency debasement. Central bankers and governments, especially in richer countries, have multiple tools to delay and manipulate this debasement, but the current levels of global debt suggest we are nearing the end of the road.
In this World Bank study, the economists note 77% as a key threshold for the debt-to-GDP ratio, suggesting that each additional percentage point of debt above this threshold will cost 0.017 percentage points of annual real growth. Can you spot below which countries are currently running the risk of suppressed growth and by way of corollary, financial repression in the absence of real growth?
So there are two key things to keep in mind while understanding where we are with sovereign debt and where we are headed: 1) Economic growth requires credit but too much credit weighs down on growth (think economies of scale, but decreasing and negative economies of scale), and 2) Quality of collateral defines how high is the interest you pay on your credit. As collateral gets overburdened by credit, its quality depreciates and default risks increase.
The Limitations of Traditional Collateral
Traditional collateral assets, such as government bonds, real estate, and commodities, have served as the bedrock of the global financial system for centuries. However, these assets are increasingly inadequate to support the growing demand for collateral.
Demographics: The current and projected decline in global demographics with continuously rising inequality exposes physical assets to newer risks. Can housing continue to rise while leaving more and more people as tenants, or worse, homeless? If there is a theoretical peak in the prices of real-world assets as a percentage of GDP, there is a theoretical peak in the percentage of collateralized debt that these assets can support. And we are all better off not finding the terminal capacity of these assets. The only way to get out of the global debt spiral, assuming hyperinflation is not a feasible solution, is to have assets that can further productive credit creation and lead the economic miracle necessary to protect the poor and the middle class from the burden of sovereign debt around the world. However given the level of debt already supported by traditional assets, there is a shortage of assets to fund future growth. Demographics also play a key role in defining long-term yields on government bonds. A country that’s getting increasingly older, much of Europe, Japan, and even China in the coming years, will struggle to grow at the pace required to keep up with its prior debt expansions. So economic growth is not simply a question of rising standards of living or the pain of the people when economic growth is hard to come by. At high levels of debt, it is a question of funding the government, first and foremost.
Counterparty Risk: When using traditional collateral, there is always the risk that the counterparty may default on its obligations. This can lead to significant financial losses. The 2008 crisis, with all the repercussions that were felt across the world in the years that followed, is a great example of counterparty risks. As opposed to the mainstream understanding of the crisis, it was not a subprime crisis. Most of the defaults were from prime borrowers, not subprime borrowers. It was also not a financial crisis, but a monetary crisis with huge implications on the bank balance sheets that led to the global financial system collapsing. At the heart of this monetary crisis was the deterioration in the collateral quality, especially mortgage-backed securities, resulting in a shortage of collateral required for short-term funding needs. And hell froze over. And then Greece defaulted. And then the Europeans cried about the cheats cheating. No, not Greece that broke all kinds of norms of sovereign borrowing but the hedge funds that shorted the Euro. Try modeling the counterparty risk and hedging against that risk when the counterparties are the central banks of the world.
Opaqueness: Traditional collateral, like real estate, is largely opaque. So all forms of credit built on top of it carry the risk of the presumed value of the collateral not being realized. The opaqueness of the collateral was one of the central themes in 2008 and why MBSs became increasingly risky to hold. Free markets work because they continuously help remove information asymmetries. When you add opaque collateral that leads credit creation which underpins global economic growth, you add structural information asymmetries globally. These information asymmetries can play out over decades, but they do what information asymmetries have always done: benefit the few at the expense of many. The nature of the collateral is quite simply the biggest economic inefficiency globally and resolving this inefficiency is critical in expanding the economic frontier.
The Digital Frontier: A Path to Economic Salvation
As global debt levels soar and economic growth falters, it becomes clear that the expansion of the economic frontier is inevitable (I do not subscribe to doom-porn and will steer clear of addressing analyses that conclude that the world is primed to collapse on its head). However, unlike in previous eras, this expansion will not occur in the physical realm. With declining demographics and overextended traditional assets, the physical world offers limited opportunities for growth. Instead, the frontier will be digital.
This digital expansion is already underway, driven by advancements in artificial intelligence, robotics, and a burgeoning ecosystem of crypto assets, including NFTs and various tokens. These innovations represent the next wave of economic growth, but like all growth, they require financing. Financing digital growth requires collateral that follows the laws of math and physics rather than the whims and fancies of the central bankers.
In this rapidly evolving digital landscape, traditional collateral is inadequate. The need for a new form of collateral is urgent, and Bitcoin emerges as the ideal candidate because of its unique qualities.
Predictability: Bitcoin’s capped supply of 21 million coins provide a level of predictability that is unmatched by any other asset, digital or physical. This fixed supply is not just a theoretical concept; it’s a tangible reality that plays out in the precision of Bitcoin’s issuance schedule, down to the very second. In a world where financial stability is often elusive, Bitcoin’s predictability offers a foundation of certainty.
Transparency: The Bitcoin blockchain offers complete transparency, with every transaction recorded on a public ledger. This stands in stark contrast to traditional forms of collateral, which are often opaque and riddled with hidden risks. In the digital realm, where trustlessness is paramount, Bitcoin’s transparency makes it a superior form of collateral.
Decentralization: Bitcoin’s decentralized nature is another key attribute that sets it apart. It is not subject to the whims of any central authority, making it resistant to censorship and manipulation. As the world grapples with unsustainable debt levels and the increasing weaponization of financial systems, Bitcoin’s decentralized architecture ensures its reliability and trustworthiness as a global collateral asset. Counterintuitively, the trustlessness is what drives the trustworthiness.
As the economic frontier expands into the digital realm, the need for robust, reliable collateral will grow. Bitcoin, with its unique qualities, is poised to become the cornerstone of this new financial landscape, supporting the next wave of digital innovation and economic growth.
Bitcoin as a Global Collateral Asset
In December 2022, the Bank for International Settlements (BIS) issued guidelines for central banks to hold digital assets as reserve assets. While the guidelines cover a range of digital assets, they effectively place Bitcoin in a category of its own. You can read the fine print here. These guidelines, set to be implemented by January 1, 2025, suggest a subtle yet significant shift in the stance of central bankers toward Bitcoin. While Bitcoin as a currency poses a challenge to their control over monetary policy, Bitcoin as collateral offers a stabilizing force for a fragile monetary and financial system. Central bank adoption of Bitcoin is likely closer than many anticipate. Although Bitcoin’s price remains volatile today, its growing maturity as an asset class, particularly with central bank backing, is expected to reduce this volatility. This trend will be further reinforced by clearer global crypto regulations and mainstream adoption through instruments like ETFs.
Bitcoin’s unique properties will make it an exceptional global collateral asset. By using Bitcoin as collateral, lenders and financial institutions can enhance economic efficiencies on a global scale. Unlike traditional collateral, which is subject to the limitations and risks of local economies, Bitcoin operates in a borderless environment designed for a global standard that can reduce friction in international transactions, lower borrowing costs, and increase access to credit across diverse markets. This increased access will also not prevent the lenders from having a clear and immutable understanding of the collateral backing their loans like in the case of traditional assets. Its decentralized nature offers a level of security and resilience that traditional assets cannot match. Even in times of financial crisis, when traditional financial systems may falter, Bitcoin’s decentralized network can continue to operate, providing a reliable form of collateral.
Bitcoin also offers protection against hyperinflation, particularly for people in poorer countries where local currencies may be prone to rapid devaluation. As a globally recognized and accessible asset, Bitcoin can serve as a hedge against the failures of local monetary systems, offering individuals and institutions a stable store of value in times of economic turmoil. This protection extends beyond just wealth preservation; it also enables continued economic participation and credit access in regions where traditional financial systems may be collapsing.
Conclusion: A New Dawn for Global Finance
As the world grapples with unprecedented levels of debt, stagnating economic growth, and the limitations of traditional collateral, it is clear that the status quo is unsustainable. The expansion of the economic frontier into the digital realm offers a pathway out of this quagmire, driven by innovations in technology and the rise of digital assets. However, this new frontier requires a foundation of robust, reliable collateral to support its growth, and Bitcoin is uniquely positioned to fulfill this role.
Bitcoin’s predictability, transparency, and decentralization make it an ideal candidate for global collateral, offering a level of stability and security that traditional assets increasingly fail to provide. By adopting Bitcoin as a global collateral asset, the financial system can achieve greater efficiency, reduce counterparty risk, and protect against the economic vulnerabilities that have plagued the world for decades.
As central banks and financial institutions begin to recognize the value of Bitcoin in this capacity, we may be witnessing the dawn of a new era in global finance — one where digital growth is supported by digital collateral, and where Bitcoin serves as the bedrock for a more resilient, equitable, and sustainable financial system. In this new landscape, Bitcoin is not just a lifeline for a debt-ridden world; it is the cornerstone of the next chapter in the evolution of global economics.
