My EconLib Article on Bitcoin
At EconLib I have an article on Bitcoin. The first half is based on the article I already posted here with Silas Barta, but the second half has new stuff, sure to enrage half of you:
Economically, the chief attraction of Bitcoin is its mathematically guaranteed scarcity. Even a pure commodity like gold could eventually flood the market if a vast new stockpile—perhaps on the ocean floor or an asteroid—were discovered, or (more fancifully) if the “replicator” technology of Star Trek ever became reality, such that a machine could turn baser matter into gold bars.
…
Bitcoin has no such vulnerability. No external technological or physical event could cause Bitcoin inflation, and since no one is in charge of Bitcoin, there is no one tempted to inflate “from within.” If the computers in the Bitcoin network endorsed an illegitimate creation of new money, it would be akin to a majority of grammar teachers suddenly agreeing that “ain’t” is acceptable usage.
And:
Some critics rely on the work of Ludwig von Mises and his “regression theorem” to argue that the world will never embrace Bitcoin as a true money. According to this argument, Mises demonstrated that all money—even today’s fiat money—must have been, at some point in the past, linked to a commodity that was useful in the days of barter. Since Bitcoin has no such history, the critics argue, we have the authority of Mises himself to show that Bitcoin will never be more than a fad.
This article won’t address the question of whether this is a valid interpretation of Mises’ writings. Instead, I will make the modest point that if Mises is used to rule out Bitcoin’s acceptance as money, then it seems that Mises has already lost. If this logic is correct, then Bitcoin should never have been adopted as even a medium of exchange because it served no useful role as a regular commodity. (Recall that money is simply a medium of exchange that is accepted by everyone in the community.) But Bitcoin has already surpassed that hurdle, as there are websites on which people from all over the world exchange their bitcoins directly for goods and services.
Note the part in bold above (which I bolded here, not in the original). I am NOT saying, “Bitcoin blows up Mises.” What I’m saying is that the people who are deploying the authority of Mises to blow up Bitcoin, are taking a big gamble because what they think is impossible has already happened.
Bitcoin regresses into the current fiat currencies, which themselves regress back into commodity money. (Alternatively, in many senses, Bitcoin is a commodity – there is a fixed amount of supply and demand does exist. Economic goods need not be physical.)
I was going to say this, too. The idea of money couldn’t have come about other than Mises’ Regression Theorem posits, but any particular money today can just regress on a current money – after all, if the US Dollar is money and money is a commodity, then Bitcoin can proceed by the costs (in dollars) to make Bitcoins and the current and expected value of them can be judged in terms of their exchange with dollars. Over time, if Bitcoin became a true money, then this attachment would lose its significance, but I think it is a pretty significant link in the beginning.
Isn’t it impossible for bitcoin to have NOT been a “good” or commodity before it was a medium of exchange? I mean, before it was ever used to trade, someone had to value it, for any reason whatsoever. Didn’t the first few people to ever own bitcoins aquire them through gift or creation? The guys making it were thinking, “this would be a great money” and therefore gave it value, ex ente, by seeing it as something worth having, and this all happened before it became a medium of exchange.
What if bitcoin, though made to be a perfect money, never gained any popularity, and never made it to the category of “medium of exchange”? It still would have had goods character (ex ente) to the people trying to push it on others, and to the people who traded dollars for them.
Mises was right.
“Isn’t it impossible for bitcoin to have NOT been a “good” or commodity before it was a medium of exchange? I mean, before it was ever used to trade, someone had to value it, for any reason whatsoever. Didn’t the first few people to ever own bitcoins aquire them through gift or creation? The guys making it were thinking, “this would be a great money” and therefore gave it value, ex ente, by seeing it as something worth having, and this all happened before it became a medium of exchange.”
Steve you bring up a good point.
The confusion arises when people don’t distinguish between verbal statements of what Bitcoins “are”, and verbal statements of what Bitcoins are supposed to “be”, with what they are in a context of valuations and exchange.
Bitcoins are not money because someone says they are money. Not even the designer can make Bitcoins money simply by saying so.
Bitcoins become money in a context of catallactics. As more and more individuals value Bitcoins, i.e. exchange them, Bitcoins become closer and closer to a medium of exchange.
Even if a single person in 50,000 BC thought “You know, this gold I found would be a great medium of exchange. I’m going to start spreading the word, and my plan is for money to be generally accepted”, and gold later ended up as a medium of exchange, it was still the catallactics that did it, not his statements.
Guy-“Hey, Satoshi Nakamoto, why are you making those things you call ‘bitcoins’?”
SN-“I’m not sure, guy. They haven’t popped up on my internal subjective value scale, yet.”
They do have intrinsic “coolness factor” amongst certain people. I mean the dumbest stuff is collectible if you just find the right collectors. That probably isn’t enough to satisfy the Mises’ regression, but it does represent some sort of intrinsic. I think at the moment maybe 50% of Bitcoin users are just doing it for novelty value and coolness factor, but over time that will change.
I think this is just a classic case of subjective vs objective use value. Now, bitcoins might have zero use value (to you) outside of medium of exchange. But, like I said, there must have been some point in the past where somebody owned bitcoins while they were not yet used as a medium of exchange. For whatever reason, they valued bitcoins enough to act to acquire them.
The first person to ever accept bitcoins in exchange couldn’t possibly have done it because bitcoins were already a medium of exchange, since he was the first person to ever accept them. Even if he is hoping that bitcoin will soon be accepted in trade, it seems to me that a good being used as a medium of exchange is an an empirical fact, not a subjective speculation.
Whether they will soon become “accepted in trade” or “used as a medium of exchange” is irrelevant.
The early adopters of Bitcoin acquired it presumably because they believed it would provide positive utility to them – most likely through price appreciation. Whether the price appreciation happens because “someday Bitcoin becomes money” or it happens because “someday this will become a really cool thing people want to have, but they won’t use it as a medium of exchange” doesn’t really matter.
As far as a good being used as a medium of exchange being an “empirical fact” I would have to disagree. Every good can *potentially* be used as a medium of exchange. I’m sure as I type this right now, somebody somewhere is exchanging, say, a candy bar for a can of pepsi. Are candy bars and cans of pepsi mediums of exchange? Not commonly, but occasionally.
At the same time, for the vast majority of the global population, you could hand them $1 million worth of Bitcoin right now and they would have absolutely no idea what to do with it or how to exchange it. It would be useless to them at present, and they would not consider it to be a valuable medium of exchange.
Yes, it’s irrelevant if they become mediums of exchange, and that was my point.
If someone trades candy for cola that is direct exchange, no medium of exchange needed. Unless you are trading your candy for cola so that you can use the cola to get another good you actually wanted, but couldn’t trade for it with the candy.
A medium of exchange is something that you accept in trade, not to consume, but to trade for another good.
Whatever good DOES happen to become a medium of exchange is a matter of historical fact. But it has to be a good before it can be a medium of exchange. Mises is right. That’s all I was trying to say.
Ex ante I meant
I’m not enraged, but I think one of your points is not quite correct.
I would argue that the chief attraction is the network of other Bitcoin users. That is to say, vendors willing to sell products and services are what gives Bitcoin a value. Essentially all the gain comes from division of labour, so if I do a job for myself I don’t need Bitcoin (nor any other currency) to do everything myself, but if I want to get someone else to do that for me then I will need some medium for exchange. Since division of labour entails a very large efficiency gain, the medium of exchange derives its value from the people who use it.
That may sound nit picky, but what I’m getting at here is that “mathematically guaranteed scarcity” serves only the purpose of making the system attractive to new users. If you buy into the Bitcoin network, either directly with labour, or indirectly by exchanging other currency at an exchange point, then you want the confidence that something protects your investment. So the logical chain of cause and effect is:
[A] mathematically guaranteed scarcity
[B] confidence amongst users and investors
[C] people join the network and offer goods
[D] division of labour and efficiency gains
But [D] is the value-add step, the place where the tangible wealth comes from, the others just facilitate that to happen.
By the way, as more people join the network, the value of each coin rises (because you have more options of where to spend it). This in turn attracts greater confidence [B] because people are more comfortable doing the things they see others doing. Once it gets critical mass it should feed onto itself.
The chief attraction to Bitcoin specifically is going to vary from person to person. What you are describing is the chief attraction to money in general.
Imagine a seller that allows for multiple forms of payment including dollars and Bitcoins. Would it make any sense to say that the buyers who prefer using Bitcoin do so because they like the division of labor or the fact that other people use it? Cannot the same could be said of dollars?
Facilitating trade is an attraction of money in general… but Bitcoin can only facilitate trade amongst the people who regularly deal in Bitcoin.
Think of it this way, if three people in the whole world traded Bitcoin amongst themselves, it would still be a medium of exchange right? I mean it would still be money to those three people.
But if three million people were trading Bitcoin amongst themselves it would be a much more significant medium of exchange and thus more attractive for both vendors and buyers to get involved. Something a bit like this:
http://en.wikipedia.org/wiki/Network_effect
So yes, it does matter exactly WHICH currency you use, over and above the fact that you use some sort of currency. The great global power of the US dollar comes from large numbers of non-Americans who will accept those dollars. As more countries step away from the US dollar and make other arrangements, the value of the US dollar goes down.
That’s all fine, but it still doesn’t make sense to say that someone who chooses to use Bitcoins over dollars does so because of the number of people using it. Yes, ubiquity is generally a desirable feature for a medium of exchange to have. But literally no one is choosing Bitcoins over dollars for this reason.
Furthermore, many people who choose to use Bitcoin over dollars do so because it is not yet ubiquitous. What I mean is, if Bitcoin were to hold a more significant role in the economy, it would draw more attention from regulators and law enforcement. That attention would certainly flush many of the people who are currently using Bitcoin for its pseudonymous nature out of the market.
Lastly, doesn’t it bother you a little that the chief attraction that you’ve claimed for Bitcoin is the fourth step in your chain? Shouldn’t the chief attraction be the underlying attraction from which all other attractions are derived? Are you claiming that people were attracted to Bitcoin before it had a chief attraction?
There can be more than one effect happening at the same time… and I don’t discount that a certain experimental value or overall geek enthusiasm might contribute towards bootstrapping this currency. Raw numbers are at best a crude indication, if fashion magazines are selling on Bitcoin and I’m not much interested in fashion then it doesn’t matter to me if 2 or 10 or 50 or 1000 different fashion magazines are available, thus the network effect requires not only numbers of people in total, but also requires that those people have some compatible and complimentary requirements in order for them to trade.
Now I think there’s a different perspective between the basic notion that facilitating division of labour is that makes a currency valuable, even in principle and then comparing what makes people choose one currency over another. Bob said:
but that’s a somewhat different statement to a hypothetical Bob saying:
One is an absolute concept, the other is a relative concept. Maybe I’m misreading what Bob intended by that, or just being overly nit picky but the difference seems significant to me. Clearly the US dollar has a massive network effect already. It is the most widely accepted currency in the world, but the same network effect that is (right now) supporting the US dollar could (in principle) transfer to something else.
I just feel that it is important never to lose sight of the ultimate goal here. Suppose I said that a very valuable item sits on top of a mountain; we need to climb that mountain so you go off and find yourself a quality pair of boots. That’s not dumb because good boots are very helpful in climbing a mountain, but if all you think about is boots then you have lost sight of the goal and got distracted by an intermediate step.
So the actual purpose of any currency is to facilitate division of labour. That’s where the value comes from. That’s the pay-dirt as it were (not to get hung up on a gold analogy or anything). The other steps represent a way of getting to the pay dirt, but not necessarily the only way, nor even the best way.
I would say that right back to the original design, there was some speculative imagination that in future, the Bitcoin network would grow. People can do that; plan for the future and react to events that have not happened yet (amazing when you think about it). They could be wrong, and if it all tanks no doubt those people will lose on the deal.
“I would argue that the chief attraction is the network of other Bitcoin users.”
Critique that theory.
Suppose the network is there, but the promise of scarcity isn’t there.
Can emails qua emails become as valued as Bitcoins?
“That is to say, vendors willing to sell products and services are what gives Bitcoin a value.”
Why would vendors think to value Bitcoins more highly than other “network” concepts?
Right, well is MAY be that a promise of scarcity is required to get people involved in using a new currency. That’s another logical step though, because certainly a lot of people right now seem willing to use fiat currencies that absolutely promise there is no limit to the printing they will resort too. If you want to prove that scarcity is a requirement, you have to explain all those nutters out there.
Well if you are trying to say that scarcity is the ONLY reason then I can think of quite a few others. Bitcoin is very portable. We have cops pulling people out of cars and looting all the cash they can find. Bitcoin does solve that particular issue.
People also feel that banks might be a bit unstable and can’t be trusted to deliver cash when required to (see also Cyprus and the massive losses suffered by bank depositors). Bitcoin solves that particular issue too.
There are some people who value anonymity (for various reasons) and Bitcoin provides that as well.
Great explanation, Bob! The whole mining as verification of transactions amazes me. So does the way it is essentially a network protocol.
I think some of the subjective value comes from a sense of shared community among tech loving types, particularly electronic freedom types. There’s a lot of value in transactions that work like email, too.
“Instead, I will make the modest point that if Mises is used to rule out Bitcoin’s acceptance as money, then it seems that Mises has already lost.”
Here is my article on money that argues against both Bitcoin as well as Mises:
– http://www.vforvoluntary.com/articles/the-theory-of-money-in-the-tradition-of-carl-menger-part-i.html
– http://www.vforvoluntary.com/articles/the-theory-of-money-in-the-tradition-of-carl-menger-part-ii.html
That sounds awful.
Two stray questions:
1) if a central bank pursued the Bitcoin Rule concerning the money supply, what type of policy would you call it?
2) Do you think increasingly scarce currency can have the effect of increasing the economic value of the trasactions required to gain units of the currency or does neutrality hold in this scenario as well?
“No external technological or physical event could cause Bitcoin inflation”
I understand your meaning with this statement, but it is conceivable that new technology exposes an encryption vulnerability in the Bitcoin standard that enables malicious actors to inflate the supply of Bitcoin.
True, in theory. Fortunately, well tested cryptosystems are almost never broken “all at once”, but rather, are whittled down slowly until, by a very conservative definition, they are considered not good enough.
To give an idea of what this definition looks like, cryptographers will consider a system “broken” (perhaps due to a discovery of the sort you mention) it can be broken with 2^110 guesses instead of the 2^128 it was designed to require. But even though the break allows cracking with millions of times less effort, it’s still extremely secure in an absolute sense.
This gives the network time to transition to another protocol, which it can do by consensus. To extend Bob’s example, it would be like grammar teachers all finding out that the word “aint” prevents cancer, in which cases its much more likely that they would come to a consensus that it really is acceptable usage.
This “consensus” issue…
How exactly is “consensus” brought about and enforced?
Same basic way it is in a basketball game (or any game). Anyone can claim their team has infinity points; the others may or may not accept this claim and will probably ignore it.
If you start deviating from the protocol, your computer will appear, to others on the network, like it’s saying “I have infinity coins” — they’ll refuse to update their ledgers based on what you say.
So the network can fragment, in that one of them uses ledgers that agree with protocol A, and the other will do the same for protocol B, and both will regard the other’s as wrong, to the extent that the results differ from their own protocol (which will become more significant over time).
Good updates to the protocol will be accepted by its users and become standard; bad ones will fragment it or fail to get adopted at all.
Recently, one of the software updates introduced an accidental protocol difference: depending on which version of the software you used, you would reject different transactions. The community noticed this quickly and the developers decided that the new version was invalid and everyone should continue to use the old one.
People could have continued to go by the update, but since the lead developers’ announcement was credible, and accepted to be credible, no one wanted to risk being part of the “losing” block chain, so they adhered to the decision.
If they had waited longer, it may have fragmented the network.
Thanks Silas.
“Good updates to the protocol will be accepted by its users and become standard; bad ones will fragment it or fail to get adopted at all.”
This is as long as individuals who use Bitcoins continue to agree to a certain set of constraints as to what constitutes “good” and “bad” protocols, right?
I mean, by analogy, in history, enough individuals believed in, and enough individuals who weilded power, created the fiat money system.
Is it *possible* for Bitcoins to become monopolized?
Your ability to spend bitcoins depends on your ledger (and protocol) matching everyone else’s. In the sense that someone can wield control over enough computers to become a dominant fragment, yes, it’s possible to monopolize the network.
There’s a similar problem with the mining: if someone controls over 50% of the mining cycles, they can control which ledgers get published to the other nodes (by virtue of having the updates, or “blocks”, with the most demonstrable computation invested in them). This wouldn’t allow them to fake transactions (which requires users’ private keys), but they could e.g. halt exchanges by continuously publishing a “no trades happened” update. Or they could show different ledgers to different sections of the network, allowing them to spend the same coins twice.
Both of these are kind of unavoidable when you want a system with bitcoin’s properties, which include it being anonymous. It’s implemented under the idea of “one compuer cycle, one vote”, rejecting any attempt to call one person’s cycles invalid because of who it came from. This necessarily comes with the problem that bad people could control most of the cycles, but it’s a cost of keeping it anonymous and non-discriminatory.
Thanks again.
“In the sense that someone can wield control over enough computers to become a dominant fragment, yes, it’s possible to monopolize the network.”
So by wielding control over enough computers, does that mean a monopolist controlling the internet itself, or controlling individual computers via malware/viruses, or something else?
“There’s a similar problem with the mining: if someone controls over 50% of the mining cycles, they can control which ledgers get published to the other nodes (by virtue of having the updates, or “blocks”, with the most demonstrable computation invested in them).”
Do these types of risk, or rather, do the effects of the downside risk, get reduced as more coins are mined, closer to 21 million?
I’m thinking that with a cap of 21 million bitcoins, the long term exchange value would likely continually go up, such that 1 bitcoin would one day be worth many factories, or an entire industry, so maybe these risks never gets eliminated.
Do you envision a possible future “digital war” where states fight to take control, which could make us all unwitting fools in handing a world digital currency system over to an elite?
Nick Rockefeller once admitted that the ultimate goal of the central banking elite is to have a world digital currency controlled by a banking elite.
So by wielding control over enough computers, does that mean a monopolist controlling the internet itself, or controlling individual computers via malware/viruses, or something else?
In the case of someone trying to shut down the protocol itself, they would need a majority of the cycles. In the case of just trying to destroy the economic value, they would have to control a majority of the users; otherwise, people could just pick the most reliable fragment to recenter on.
Do these types of risk, or rather, do the effects of the downside risk, get reduced as more coins are mined, closer to 21 million?
The attack depends on attacking the ledger/block updating event, which continues forever, even after all coins are mined, so it’s always a risk.
Do you envision a possible future “digital war” where states fight to take control, which could make us all unwitting fools in handing a world digital currency system over to an elite?
Not sure. I would need to know the mechanism by which they intend to take it over or otherwise make it a battleground. Bitcoin has the advantage of making manipulation a bit easier to detect (in the attacks I mentioned, people would notice if suddenly the new blocks started showing no transactions).
I agree that it is unlikely that someone finds and exploits a technological vulnerability in Bitcoin. But it is not significantly more unlikely than the market being flooded with a large new supply of gold, which is a conclusion that one could come to after reading Bob’s article.
I think that Bitcoin’s main vulnerability is the way it works by consensus as you point out. I could imagine a government secretly setting up a massive and wide network of good Bitcoin citizens. After years of development they gain a large majority of the processing power in the Bitcoin network. Then they flip a switch, a majority of once good Bitcoin citizens become malicious attackers, and Bitcoin suffers a catastrophic crash.
“Instead, I will make the modest point that if Mises is used to rule out Bitcoin’s acceptance as money…”
Bob, isn’t the argument that there are problems with pricing Bitcoin because you can’t tie it to a pre-money valuation and not necessarily its acceptance per se?
When you offer your goods and services in exchange for bitcoin you are essentially acquiring bitcoin at your “cost of goods”. For example: if the cost of your goods or services is half of your retail price, then you are essentially acquiring bitcoin at a 50% discount.
“even Bob Murphy, the most hard core Misesian admits…”
This article won’t address the question of whether this is a valid interpretation of Mises’ writings. Instead, I will make the modest point that if Mises is used to rule out Bitcoin’s acceptance as money, then it seems that Mises has already lost. If this logic is correct, then Bitcoin should never have been adopted as even a medium of exchange because it served no useful role as a regular commodity. (Recall that money is simply a medium of exchange that is accepted by everyone in the community.) But Bitcoin has already surpassed that hurdle, as there are websites on which people from all over the world exchange their bitcoins directly for goods and services.
Good point, Anne_C._Combs, albeit a tad unoriginal and plagiaristic…
An overarching Austrian theory of money leads to the conclusion that essentially anything COULD be money; it all depends on perception, i.e., what the people are willing to accept as a medium of exchange. So to use Mises to claim that Bitcoin isn’t money is indeed a fallacy.
Having said that, something can be money and still not be a stable currency (e.g., the U.S. dollar). Applying Austrian macro theory within a larger Austro-libertarian framework leaves much to be desired regarding Bitcoin’s long-term prospects. We’re talking about a currency that is under heavy scrutiny by the state’s economic regulatory bodies and which fundamentally depends upon electronic transmission. And who controls access to electronic transmission mediums? The state. What would happen to the Bitcoin market during a regulatory crunch or a crisis situation?
Point being, Bitcoin may meet the Austrian definition of money, but that doesn’t mean that it’s foundation is strong.
Bob has missed the boat here, and badly, when he writes “Mises has already lost….Bitcoin has already surpassed that hurdle, as there are websites on which people from all over the world exchange their bitcoins directly for goods and services.”
That’s like saying Ron Paul is already President of the US because 5 people voted for him. Here is a thought experiment. If Joe Shmoe and his brother decide to use oil soaked rags as money when they buy and sell from each other, does that make oil soaked rags into a medium of exchange, or a money even?
You get the idea. There is a certain minimum numerical threshhold that has to be passed before we can even talk about something being a medium of exchange that may become money. Joe Shmoe and Bro are two people. Too small a number.
Here are the things to consider: What per cent of any given persons exchanges are made in bitcoin? How many people have even heard of it, much less use it? How many people just buy bitcoins and never resell them, making them a speculation for them, like a lottery ticket, and not a medium of exchange at all?
From experience I know there will be howls of protest about this argument from the bitcoin crowd. But they can howl all they want, for Smiling Dave has answered all their arguments, complete with facts and figures, right here: https://smilingdavesblog.wordpress.com/2012/08/03/bitcoin-all-in-one-place/
How sad that people think a so called money that has lost 75% of it’s supposed value in two months is to be taken seriously. But hey, you learn, you get experience. One time bitcoin loses 90% of value in a day, another it loses 75% over two months [and still dropping as we speak]. Soon you begin to notice a pattern.
I bet all those stores that took bitcoins are crying now it turns out they sold their wares at a 75% discount.
Let’s see how much longer they can stay in business.
Guys, please reply at my website, as I visit here rarely.
“people …are taking a big gamble because what they think is impossible has already happened.”
Like ID peddlers and evolution?