31 Dec 2013

Yet More on Tyler Cowen on Bitcoin

Bitcoin 10 Comments

Say what you will about him, Tyler is a sport and retweeted this guy, who has a “Tyler vs. Tyler” post up. The money excerpt:

…Tyler is able to derive the following theorem: “the value of WitCoin should, in equilibrium, be equal to the marketing costs of its potential competitors.” To put this in simpler terms, Bitcoin’s network externalities should drive the value of Bitcoin. Tyler says in theory you could argue that Bitcoin’s price reflects these fundamentals, but he doesn’t buy it. Therefore, Bitcoin is due for a crash.

I agree with Tyler’s theorem, or at least my simpler paraphrase. Nevertheless, I am not so convinced by Tyler’s conclusion. As a wise man once said (in an addendum to the same post), “expected price changes usually get compressed into the present and [] an overall expected rate of return equality must hold.” So the network externalities that matter in determining Bitcoin’s equilibrium price are mostly expected future ones, not present ones. Is it so unreasonable to expect that future Bitcoin network externalities would equal $20 billion or more?

Well, that depends on whether network externalities in currencies in general tend to be strong or weak. To answer that question we might turn to an expert such as Tyler Cowen, who in 2011 argued (1, 2) that currency network externalities are so strong that Bitcoin couldn’t possibly succeed. Now Tyler is arguing that currency network externalities are so weak that Bitcoin can’t possibly succeed. Who are we to believe?

Beautiful. I wouldn’t change a word, except I’d put in “Whom” for “Who” at the end there…

Since I see that others are linking to my wisealeck previous post about Tyler’s commentary, let me clarify something: I was perhaps a bit too flippant, when I argued that Tyler’s whole argument rested on people being willing to sell something for $400 when they were sure it would quickly appreciate to $500.

In context, Tyler was talking about issuers of competing cryptocurrencies. So yes, maybe a new issuer would be willing to sell “undervalued” money, in order to get people to hold it. For an analogy, if you had a foolproof USD printing press in your basement, you would have no problem selling $100 counterfeit bills for only $90 in genuine USD on some type of black currency market, to account for the risk or whatever. By the same token, if the only way I could get the public to accept BobCoin were to issue it “below par,” then it would still make sense for me to do that, rather than hold all the BobCoin myself, forever.

Yet even though this type of reasoning is what Tyler had in mind, you still get the odd result that nobody else would be willing to spend the cryptocurrency, at least until all of its units had been issued and it no longer appreciated in price faster than the market rate of interest. But then that means there would be no liquidity in these alternate currencies, until they had been fully issued, at which point we would have to see what their market would be, for the first time, in order to get a sense of their purchasing power. This outcome clearly doesn’t make much sense.

All in all, I think the discussion surrounding Bitcoin shows that economists really don’t have a firm grasp on how to think through these issues. This shouldn’t be too surprising, since we all spent a few weeks arguing about whether QE would cause prices to rise or fall–something Nick Rowe cleverly likened to an econ equivalent to the Sokal hoax, except it wasn’t a hoax!

10 Responses to “Yet More on Tyler Cowen on Bitcoin”

  1. Darien says:

    If you do issue BobCoin, I will happily become an early adopter.

  2. Max says:

    Waiting for someone to issue BitTulips. Unlike so-called real tulips, the supply of BitTulips will be strictly limited, so this investment can’t fail. Every BitTulip will be equally beautiful and aromatic, ensuring a liquid market. And since BitTulips are “grown” rather than “mined”, they will appeal to the environmentally conscious.

  3. Peter Šurda says:

    This odd dichotomy (so weak vs. so strong) is not atypical of economists. William J. Luther, for example, wrote among other things two papers in 2013, in one he argues that Bitcoin gained much market share, and in the other he wonders why hasn’t it gained much market share yet (I’m paraphrasing, I don’t have the exact quotes easily accessible but that’s my recollection).

    • Peter Šurda says:

      And even some Austrians argue simultaneously that for a commodity to evolve into money takes thousands of years, and that Bitcoin can be dismissed because it is not money yet.

    • Silas Barta says:

      You think that’s bad? I’ve spent the last week trying to untangle the arguments of people (like Krugman) who want to argue BOTH that:

      a) Bitcoin will fail because nothing backstops it’s value.


      b) Bitcoin will fail because of secular deflation (unbounded gain in value).

      Related to the latter, I’ve even gotten some ultra confident posters to (intermittently) admit that they’re arguing that Bitcoin will gain so much value it’ll be worthless. Yep, I found the reincarnation of Yogi Berra.

      • Bob Murphy says:

        Silas I understand exactly what you are claiming, but can you point me to Krugman saying point (B) explicitly?

        • Silas Barta says:

          Almost any Krugman criticism of it. For example this early one, where he highlights his correct expectation that “gross Bitcoin product” has collapsed ( though it’s gotten much higher since):

          The dollar value of that cybercurrency has fluctuated sharply, but overall it has soared. So buying into Bitcoin has, at least so far, been a good investment.

          But does that make the experiment a success? Um, no. What we want from a monetary system isn’t to make people holding money rich; we want it to facilitate transactions and make the economy as a whole rich. And that’s not at all what is happening in Bitcoin.

          And because of that, there has been an incentive to hoard the virtual currency rather than spending it. The actual value of transactions in Bitcoins has fallen rather than rising. In effect, real gross Bitcoin product has fallen sharply.

          So to the extent that the experiment tells us anything about monetary regimes, it reinforces the case against anything like a new gold standard – because it shows just how vulnerable such a standard would be to money-hoarding, deflation, and depression.

          • Peter Šurda says:


            Krugman is not arguing that Bitcoin will fail, but that it would be bad for the economy. Whatever problems with his arguments are, at least he separates those two.

  4. Major_Freedom says:


    The confusions prevailing in the econosphere over Bitcoins, or, in general, competing money, from economists who grew up in a dollar money monopoly system, is not unlike Soviet economists being unable to present an intellectual case for markets because they grew up in a socialist economy.

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