Thursday, April 18, 2013

The Bitcoin Money Myth?

Over at LRC, Frank Shostak has a discussion about bitcoins. He concludes that bitcoins are not money and never will be. I agree with his conclusion, but not the road he has taken to get to that conclusion.

Shostak writes:
Electronic money will not replace fiat paper money. The belief that it can stems from a failure to understand the nature and function of money and how it emerges on the market. 
To see where this view goes wrong, let's first see how money comes about. Money emerges out of barter conditions that permit more complex forms of trade and economic calculation. The distinguishing characteristic of money is that it is the general medium of exchange, evolved from private enterprise from the most marketable commodity.
This is true. Money has to start off as a marketable commodity, but it can take quite a circuitous route from there. For example, consider the dollar, it is not a marketable commodity. It is merely a medium of exchange.   How did it get to be so? Because at one time the dollar was convertible into gold.Without that link the dollar would have never become a medium of exchange. Over time, people in the U.S., with the help of the government, began to forget about the dollar link to gold and traded the dollar as the medium of exchange.

Shostak seems to understand this on some level. He writes:
Once a thing becomes accepted as the medium of exchange, it will continue to be accepted even if its non-monetary usefulness disappears. The reason for this acceptance is that people now possess previous information about its purchasing power. This in turn enables them to form the demand for money.
 In short the key to the acceptance is the knowledge of the previous purchasing power. It is this fact that made it possible for governments to abolish the convertibility of paper money into gold, thereby paving the way for the introduction of the paper standard. Again the crux here is that an object must have an established purchasing power for it to be accepted as general medium of exchange, i.e. money. 
In today's monetary system, the core of the money supply is no longer gold, but coins and notes issued by governments and central banks. Consequently coins and notes constitute the standard money we know as cash that are employed in transactions. Notwithstanding this, it is the historical link to gold that makes paper money acceptable in exchange. 
So if the dollar is now money, why can't the same type evolution occur into bitcoins?  There is an exchange ratio between bitcoins and the dollar, just like there is between the dollar and euros, the pound sterling, etc.

If someone were to offer me, euros, the pound sterling, etc. for my Drudge Formula, I would check the exchange rate and give them a price. I could do the same with bitcoins. Over time, I could get to know the bitcoin purchasing power for goods.

This means that Shostak's argument doesn't hold when he writes:
Observe that a bitcoin is not a thing; it is a unit of a non-material virtual currency. A bitcoin has no material shape; hence from this perspective the notion that it could somehow replace fiat money is not defendable. 
Bitcoin can function only as long as individuals know that they can convert it into fiat money, i.e. cash on demand (see, e.g., Lawrence H. White "The Technology Revolution And Monetary Evolution," Cato Institute's 14th annual monetary conference, May 23, 1996). 
Without a frame of reference or a yardstick, the introduction of new forms of settling transactions is not possible.
That it is not a "thing" does not matter. As long as it can be converted into dollars (or euros or pounds), it meets the only criteria necessary for it to have an exchange rate with dollars. Once it has an exchange rate, it has the potential to become money, since if enough people use it and start pricing products in terms of the bitcoins, over time the purchasing power of bitcoins is established.

Murray Rothbard, although discussing commodity monies, certainly understood the "use" factor in something developing as a money:
 As they are more and more selected as media, the demand for them increases because of this use, and so they become even more marketable. The result is a reinforcing spiral: more marketability causes wider use as a medium which causes more marketability, etc
Bitcoins could increase in marketability for sure. BTC also has a number of advantages. The ability to create anonymous transactions (although this requires some work on the part of an individual bitcoin user to execute) is possible and the ease of transferring bitcoins once they are transferred from dollars to bitcoins is an edge.

Thus, bitcoins have many characteristics that make BTC a potential money down the road: and that is its greatest weakness.

Governments love to control the medium of exchange. It has always been this way. They actively moved money from gold to paper money that they could control. They were instrumental in shutting down egold. They will, in my opinion, not allow bitcoin to survive long enough to develop into a money. It would be a money they couldn't control. They will at some point shutdown the exchanges that convert dollars into bitcoins. I believe the recent Treasury announcement that money laundering rules apply to bitcoins exchanges is the first step.

When the full shutdown occurs, it will be game over for bitcoins. That's the problem that will haunt bitcoins, not the fact that it is an electronic currency.


  1. It really doesn't matter what you guys think about bitcoin. It IS money because it is being used as such. Your oughts and ought-nots are irrelevant.

  2. Very nice analysis. I continue to be astounded at how people argue that the Regression Theorem does not apply to bitcoins. It applies to bitcoins the same way it applies to fiat dollars, as you have explained. You are also correct in that the biggest danger to bitcoins is the State.

    1. The Regression Theorem is an observation about the transformation of scarce and limited items into money, things widely acceptable in trade. Historically, the scarce and limited items had to have a use value and be traded to start down that road. In a world where money is fiat and severely degraded, as well as taxed, the Regression Theorem may have to be expanded to include items, such as Bitcoins, that make the jump merely because of their scarcity and limited production, not because of their use value. Bitcoins could become money because the alternatives are worse.

      Also, look at all the locally produced monies, the labor coupons, the wooden nickels, and all the rest that have no use value and yet function as money for some, even though they defy the Regression Theorem. Those who quote it while declaring Bitcoin as eventual money is an impossibility have just stopped thinking and observing.

  3. There are exchanges all over the world. Do you think US government would be able to shut down an exchange in Russia?

    1. I am sure the US gov't and the Russian gov't could reach a nice, cozy, tit-for-tat deal rather quickly, should bitcoin threaten the dollar.

  4. The govt can "shut down" BTC as effectively as they've "shut down" P2P filesharing.

    They play whack-a-mole with some low-hanging fruit for a while, bigger players emerge behind more anonymity, and users adapt.

  5. I think bitcoin is like casino chip. We use cash to exchange for the casino chip, and we can use it for any purpose within the casino. The casino gets to keep the cash. But the casino will never give us back the cash. We can only trade the casino chip for cash with another "pilgrim". The system can only be sustained if it can continue to attract "pilgrims" to the casino. When everybody realizes that gambling is not a good habit, the casino chip will lose all its value because the casino boss is nowhere to be found and the casino chip is not accepted at another casino.

  6. The Coming Attack on Bitcoin and How To Survive It

    Bitcoin: A New Commodity Created To Serve Market Demand

    Expect bitcoin to be “banned” – expect the ban to be ignored

  7. Rubbish analysis and comments. Both confuse "money" with "currency".