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Mises: Is Bitcoin Money of the Future or Old-Fashioned Bubble?

Is Bitcoin Money of the Future or Old-Fashioned Bubble?

Mises Daily: Tuesday, April 09, 2013 by Patrik Korda

Bitcoin has been all the rage lately. The stuff, or lack thereof, runs on peer-to-peer technology, is fully decentralized, has no patents, and is open source. Currently, there are almost 11 million bitcoin units in existence and the maximum amount of bitcoin units that will ever be created by the logic of its design are 21 million. For more details on how they work, see the recent Mises Daily “The Money-Ness of Bitcoins” by economist Nikolay Gertchev.

The Issue

While bitcoins are designed so that they cannot be hyperinflated in name, they certainly can be hyperinflated in substance. Already, there are numerous knockoffs such as litecoin, namecoin, and freicoin in place. This is a particularly valid point because bitcoin is a starfish, i.e., it is fully decentralized. As stated by Ori Brafman and Rod A. Beckstrom,

The starfish doesn’t have a head. Its central body isn’t even in charge. In fact, the major organs are replicated throughout each and every arm. If you cut the starfish in half, you’ll be in for a surprise: the animal won’t die, and pretty soon you’ll have two starfish to deal with.[1]

After the music-sharing service Napster went under, Niklas Zennström (the creator of Skype) stepped in with his creation called Kazaa, which had no central server that could be shut down. Eventually, such peer-to-peer programs became more numerous, to include Kazaa Lite, eDonkey, eMule, BitTorrent, etc. While this may be good news for people who like to download and share content for free, it certainly is not for people who are under the impression that bitcoin is a hedge against inflation. Those who compare bitcoin to a language neglect the fact that most people do not have an incentive to create a new language out of the blue. On the other hand, a great chunk of human history consists of people searching for the philosopher’s stone to magically produce gold. There can be no doubt that bitcoin has a built-in gold rush mechanism, which has already spilled over to litecoin and will be sure to spill over to
subsequent knockoffs as well.[2]

Money

Does bitcoin jibe with the Austrian stand on money? The only way to find out is to read what the great Austrians had to say. Let’s start with Carl Menger. In Principles of Economics, Carl Menger made the point that money, a general medium of exchange, has always tended to be the most “saleable” (i.e., “marketable” or “liquid”) commodity of the time.

What is saleability? It is not simply value. One may have a Picasso at home, which will fetch quite a sum at a Sotheby’s auction during a boom, but a Picasso, like a poem by Friedrich Shiller, a work of Sanskrit, or a decades-old bottle of red wine can never be the most saleable good. As Menger put it, saleability is the

facility with which [a good] can be disposed of at a market at any convenient time at current purchasing prices, or with less or more diminution of the same. (...) Compare only the number of persons to whom bread and meat can be sold with the number to whom astronomical instruments can be sold.

Menger went on to point out that cattle were the most saleable commodity in the ancient world. This is perfectly understandable in a world where bare-bones subsistence is a reality for most people and the structure of production is virtually nonexistent. As society progressed, however, cattle became less and less marketable.

As civilization progressed, Menger states that,

… peoples who were led to adopt a copper standard as a result of the material circumstances under which their economy developed, passed on from the less precious metals to the more precious ones, from copper and iron to silver and gold, with the further development of civilization, and especially with the geographical extension of commerce.

Gold won out due to a variety of reasons, such as being durable, amalgamable, malleable, divisible, homogeneous, and rare. Yet, the ultimate reason that gold won out is because it was the most saleable of commodities. As Menger went on to write,

Gold nuggets extracted from the sands of the Aranyos River by a dirty Transylvanian gypsy are just as saleable in his hands as in the hands of the owner of [the] gold mine, provided the gypsy knows where to find the right market for his commodity. Gold nuggets can pass through any number of hands without any decrease whatsoever in marketability. But articles of clothing, bedding, prepared foods, etc., would be suspect and almost unsaleable, or at any rate of greatly depreciated value, in the hands of the gypsy, even if they had not been used by him, and even if he had, from the beginning, acquired them only with the intention of passing them on in exchange.

This leads us to another criticism of bitcoin: It can never be the most saleable good. The reasoning for this is quite simple. Until the majority of the 7 billion or so people that inhabit this planet have either a smart phone or frequent access to the internet, a digital currency is out of the question.

Gold, on the other hand, is easily recognizable, as opposed to silver that may be mistaken for other metals such as nickel. Moreover, it melts at a relatively low temperature and is a relatively soft metal, which provides superior amalgamation and partly explains why it historically won out over metals such as platinum. If one questions the role of gold in the present monetary system, one only has to walk down the street in a metropolitan area and see a ‘We Buy Gold’ sign. Moreover, central banks hold gold and lots of it. They do not hold cattle, wheat, soybeans, copper, silver, or bitcoins.

Menger also wrote,

I am ready to admit that, under highly developed conditions of trade, money is regarded by many economizing men only as a token. But it is quite certain that this illusion would immediately be dispelled if the character of coins as quantities of industrial raw materials
were lost.
[3]

While it may very well be true that some early adopters valued bitcoins with what Menger described as imaginary value, the point of the most saleable good bears repeating. Gold is and has been seen as an object of beauty since the dawn of civilization. Thus, the argument that bitcoins are in accord with the regression theorem because a handful of people consume them as they would a Picasso, is like saying paper money has value because John Law or Ben Bernanke really enjoy playing monopoly. In fact, we might as well say that alchemy works, considering that a significant amount of human history and energy was spent in attempting to find the philosopher’s stone. Some people may enjoy work just for the sake of working. Unfortunately, this is not a sufficient justification for slavery nor the labor theory of value.

Anonymity

With the imminent hyperinflation meme fading away and no longer holding much water, the new reason to hold bitcoins is the anonymity, nay, the freedom that it provides. Want to gamble online or buy something illegal? Bitcoins are the solution. It is a way of circumventing the authorities and uplifting free and voluntary trade, or so goes the story. Unfortunately for many of the misinformed, the reality is toto caelo. It would be best to take it from bitcoin developer Jeff Garzik himself. The fun starts at 3:20.

The ironic part about this is that anyone and everyone who has participated in illegal activity using bitcoins, presumably because they thought it was anonymous, now has a permanent record of every single one of their transactions contained on the public ledger. Those who think they are clever by using add-ons such as Tor are just as foolish as those who think prepaid cards or smart phones are anonymous. Imagine if bitcoins existed 50 years ago. Chances are, none of the last three presidents (including Barack Obama) would have run for office.

Bubble Time?

The question left to be answered is whether or not bitcoin is once again taking the shape of a bubble. The answer is yes. There is present a reflexive pattern of people buying because prices are rising, and prices rising because people are buying. The myopic are extrapolating the price trend of the past four months, which they deem is normal, and in so doing they exacerbate it to the upside, thus attracting even greater fools. The inflection point will come when the continuity of bullish thought is broken. One thing is for sure, the amount of suckers left who are willing to jump on the moving and ever-accelerating train is drawing thin, and so are their pockets.

When prices for any asset go parabolic, it does technical damage to a chart. It is sort of like someone deciding to go full speed in the middle of a marathon. Surely, one would look good for a few minutes. However, at a certain point one would inevitably collapse, with the possibilities of finishing the race being greatly diminished, let alone doing as well as they would have otherwise.

Gold went parabolic toward the second half of 2011 to $1,900/oz., which did a lot of technical damage to the charts that gold is just now beginning to shake off. Like Icarus, who had soared too high and melted the wax on his wings, parabolic moves always end in a correction, and if prolonged, a crash. Ironically, the best thing that can happen for bitcoin naysayers is if bitcoin skyrockets to $300/btc within a week.

There is nothing anti-Austrian about acknowledging that there exists in the market place a lot of naïve, irrational, and misinformed players. During the dotcom bubble, for example, a maintenance and building company called Temco Services almost tripled in a matter of minutes in 1998. The reason is because by 1998 every other layperson was involved in the market. Thus, the level of competence significantly dropped. The ticker symbol for Temco is TMCO, which was fairly close to that of Ticketmaster Online, which was TMCS. Ticketmaster Online (then TMCS) just happened to trade publicly for the first time on the day that Temco Services (TMCO) tripled. Rising asset prices create euphoria, and euphoria significantly drops the IQ of the participants.

Another reason why bitcoin is so susceptible to bubble behavior is because it is perceived as being something new. “New era” thinking always attracts lots of attention. The tulip was introduced to Europe by way of Turkey in the middle of the sixteenth century. (In fact, the word tulip came from the Turkish tulipan, which means turban.) The tulip was perceived as something new to Amsterdam, a country which at the time possessed an abundance of newly discovered gold and silver from the New World. Likewise, the Mississippi bubble, which was perpetrated by John Law, promised vast riches to be had from the New World. The manias in railways, the radio, the internet, you name it, most of them involved something new or something perceived to be new.

There is no doubt that bitcoin is a spontaneous answer to the monetary instability that we see all around us today. On one side of the pond people are worried about the glorified currency peg known as the Euro and on the other about the amount of damage that Bernanke is willing to inflict upon the world’s reserve currency. However, let us not become so enamored of an innovative stateless solution that we forget Austrian economics and hitch libertarianism’s wagon to something heading for a crash.

- - - - -

Patrik Korda holds a bachelor’s degree in political science from BISLA and currently lives in New York, NY, where he works in market research. Follow him and Professor Mark Thornton on Fighting Apoplithorismosphobia. See Patrik Korda's article archives.

You can subscribe to future articles by Patrik Korda via this RSS feed.


creativecommons.org

Notes

[1]
The Starfish and the Spider
was originally published in 2006

[2]
Consider that bitcoin started at $35/btc in March and is currently at $185/btc, this is an increase of 429%. However, litecoin started at $0.07/ltc in March and is currently at $4.49/ltc, this is an increase of 6,314%. It makes perfect sense for people to pile into knockoffs because the potential profits, due to starting from a much smaller base, are exponentially higher. This is the gold rush mechanism at work.

[3]
Underline added by the present writer

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Speculative bubble...

..it has no end-user demand, and the parabolic move is classic indication of speculative mania. Right now, we're watching the bust phase, with bitcoin down more than 50% on the day.

"Alas! I believe in the virtue of birds. And it only takes a feather for me to die laughing."

Buy low, sell high. I think

Buy low, sell high. I think people understand this.

Huh?

What I'm saying is that btc is nothing but speculation, since it has no end-user demand. It is not a viable alternative currency, it is more like a pump and dump penny stock.

"Alas! I believe in the virtue of birds. And it only takes a feather for me to die laughing."

Even a pump and dump penny stock in theory has value.

Even a pump and dump penny stock in theory represents something of value that actually exists and has some type of productive ability.

BitCoin is simply a pyramid scam.

Please explain "no end-user

Please explain "no end-user demand". Sure it's in demand.

Ben Bernanke here . . .

Hi guys, Ben Bernanke here. I don't like what you folks are planning with this Bitcoin thing, so I've come up with a sure-fire plan to smash it. My plan is so fool-proof, I don't mind telling you about it, because you won't be able to do a darn thing to stop me. Start sweating.

I'm going to use some of my endless supply of FRNs to buy up about a gazillion bitcoins, deliberately bidding up the price to something really dizzying.

Then I'm going to sell. And sell. And sell. Until the value of a bitcoin approaches that of used toilet paper. Will I take a loss? Who cares? FRNs are just paper promises that somebody else has to keep -- or not. But that loss is trivial, compared to the loss my lovely FRNs would suffer if people found something better to use as money. So I am going to make people absolutely terrified of digital currency by making it even more unstable than the Zimbabwe dollar. Who knows, if my timing is good, I might even make a HUGE profit, selling BTC at the newly inflated price!

I probably won't have to pull off this lovely little trick more than once -- but I can do so if I need to. Repeat as needed.

I can be stopped -- how? Blowing bubbles is what I DO.

Recommended reading: The Most Dangerous Superstition, http://www.amazon.com/Most-Dangerous-Superstition-Larken-Ros...

Your paper money is meaningless to us.

Your paper money is meaningless to us. The USD exchange rate of Bitcoin can be $0.01 or $1M, it's irrelevant. The point is that we'll still be using a medium of exchange that can't be seized your war-monger friends.

And once there are enough bitcoin users out there, the exchange rate will be perceived as "how many fake dollars you can buy with a Bitcoin"...

...so good luck with that.

Oh dear me . . .

what you say is perfectly true: "once there are enough bitcoin users out there, the exchange rate will be perceived as "how many fake dollars you can buy with a Bitcoin"..." I do agree. That is why this thing has to be stopped in its tracks NOW. I can't afford to let it catch on, to compete with my fake dollars.

Where you are entirely wrong is in saying that my paper money is meaningless to you. The Bitcoin economy is miniscule and increasingly unstable. Money is supposed to be used as a store of value; a medium of exhanche that maintains a relatively stable purchasing power. A rapidly appreciating currency is NOT an optimal currency. Buyers will be reluctant to spend an asset that is quickly rising in value, just as they would be eager to spend a currency that is rapidly depreciating. In either case, economic distortions occur.

My paper money remains the preferred medium of exchange in the real economy, and I will do my best to keep it that way! Surely you realize that I COULD have my stooges in the government criminalize your little crypto-currency, but I consider how effective their criminalization of liquor and drugs have been, and have decided on a different approach: I will lure greedy fools into Bitcoin with dreams of instant profits, as they see the price skyrocketing.

And then the skyrocket will explode. And my FRNs will lose another potential competitor. How very sad.

Best wishes to you all,
Ben

Recommended reading: The Most Dangerous Superstition, http://www.amazon.com/Most-Dangerous-Superstition-Larken-Ros...

Anyone using Bitcoins for profit alone

Anyone buying Bitcoin for profit alone deserves to lose their money.

The rest of us will be unshaken and continue to grow, slowly and steadily as we have been for years now.

Bitcoin adoption grew before the exchange rate started to skyrocket, and that won't change, regardless of the price in USD.

A most touching expression of faith.

People DO buy Bitcoin because they intend to preserve -- and hopefully increase -- their purchasing power. That IS a profit motive. If they see their purchasing power plummeting instead, do you REALLY think they will be unshaken? Do you REALLY think they will continue to exchange a relatively stable FRN (slowly depreciating, it is true) for a wildly fluctuating Bitcoin? Bitcoin adoption grew because people thought it would be a stable store of value.

I will prove to them that it is not! Bwahahahahah!

Love,
Ben

Recommended reading: The Most Dangerous Superstition, http://www.amazon.com/Most-Dangerous-Superstition-Larken-Ros...

Yes, I do really think so.

Yes, I do really think so.

Your little Bernanke charade is cute and I know you think it's helping you illustrate why you think Bitcoin will fail, but obviously there's something about Bitcoiners that you do not understand:

Bitcoin is to the Banking Elites what the Liberty Movement is to the Political Establishment.

We are tiny. We are facing seemingly insurmountable odds, and WE ARE READY TO GET BATTERED. But one by one, we will wake people up. And sooner or later, we will triumph.

dabooda here . . .

Ben had to go. And I really wish he would.

I think we've boiled away the fat and are down to the bone of the problem with Bitcoin. If people BELIEVE that Bitcoin is not a stable store of value, they will not use it as money. They may play investment games with it, alternately hoarding or selling it, but they won't use it as it was intended to be used: as a medium of exchange for real goods and services. Investors look for the best bang-for-the-buck, but the general public simply wants bucks that won't go "bang!". A tiny number of committed ideologues may hold on despite their best economic interests, but they will need to be economically suicidal in their determination. Spend $200 to buy a bitcoin this week, and next week you have $10 purchasing power -- who's going to play that game for long?

But there is a bright side for Bitcoiners: unlike the markets for gold and silver, Bitcoin is entirely a "physical" market (There's a lovely irony in so describing an electronic currency, I know), in the sense that Bitcoins cannot be counterfeited or sold short -- mechanisms that are used to suppress gold and silver prices. What would the prices of the precious metals be like, do you think, if JP Morgan did not have free rein to sell "naked" silver contracts? If the gold and silver ETFs actually held 100% of the physical metal they claim to have? If the bullion banks did not have "leasing" programs that create multiple owners/leaseholders of every bar of gold? What if "gold" bars could not be fabricated of titanium in gold plating?

None of that can happen with Bitcoin, so the price suppression methods that the banksters can use against it are pretty much limited to pump-and-dump. The success of the suppression is NOT certain, if enough buyers step in to purchase Bitcoins as the price drops. The banksters can only sell Bitcoins they actually own -- Bitcoins can't be sold short. In that sense, Bitcoin is actually a better money than precious metals!

But don't rule out the bankster/fascist's last resort: criminalization. To stop drug dealers and save the children, of course. Bitcoin transactions COULD continue to happen after criminalization, but every time one entered a Bitcoin transaction, one would have to worry that it could be a "sting," designed to "make examples" to scare people away from Bitcoin usage. If that happens, Bitcoin could still be used to buy and sell products online, but it will NOT be usable for personal services or for products purchased in a store. Any time you actually MEET the other party to a Bitcoin transaction, you both would have to wonder: "Is he a Fed? Will he inform on me? If he is ever prosecuted, will he turn over my name, to get a lesser sentence for himself?" That would radically curtail the demand for Bitcoins, hm?

So: just when things look brightest for Bitcoin, expect the worst -- because that's when the banksters and politicians will start to panic, and "go Stalin." Hard times ahead, I'm afraid.

All that being said, I think you're exactly right about this: "Bitcoin is to the Banking Elites what the Liberty Movement is to the Political Establishment." That makes it all worthwhile.

P.S. I just saw that TODAY Bitcoin has been as high as $266 and as low as $36. I hear Ben giggling.

Recommended reading: The Most Dangerous Superstition, http://www.amazon.com/Most-Dangerous-Superstition-Larken-Ros...

I don't believe your claims are false at all...

I don't believe your claims are false at all... They WILL attempt to manipulate it, pump it, dump it, hack the exchanges, even hack users, maybe...

That, to me, only further proves that it's a good thing!

BTW, the low price at mtGOX, the exchange with the most volume was $105. ;)

manipulation

Do you think they have done this or will do the same to gold and silver?

yes & yes

Where there are markets to be played, there are players.

That is a new way of looking at it...

"Service backed"

I find the whole "saleability" factor flawed. Gold is great, but here is where I lose him.

You and I are sitting at a table, you can easily transfer a bitcoin via our phone, it's secured and tax free. There is a system, or third party, involved to insure the transaction occurred.

I would much prefer this, as would most once bitcoin has had some to to acclimate, to you throwing a chunk of gold on the table and using it as tender

1. How do I know this is real gold
2. Even if it is real, how do I know how pure it is
3. Do you have paperwork?, How do I know the paperwork isn't forged
4. How much does the gold weigh, I don't carry a precise scale, also, what is the going rate for gold (we might need our smart phones in both transactions, whether it be through bitcoin or gold!)

Now, don't get me wrong, gold is king, but bitcoin needs some time to settle out, people you are quoting in these articles couldn't even begin to imagine this form of currency.

By the way, once you transferred your secure bitcoins to me, I would then transfer them tax free into dollars, then to gold. Or maybe directly to gold...not sure how to do that yet!

www.coinabul.com

www.coinabul.com

"We’ve moved beyond the Mises textbook. We’re running in the open market." - Erik Voorhees

So if the guy has gold and

So if the guy has gold and bitcoins, you'd be willing to trade for bitcoins, and then buy his gold with those bitcoins?

End The Fed!
BTC: 1A3JAJwLVG2pz8GLfdgWhcePMtc3ozgWtz

No...

The gold hasn't been established as worthy by a 3rd party, like a dealer (I am not an expert in gold, or it's properties) The point is I trust bitcoin more then a raw hunk of gold from a street dealer...

I get the snarkiness though...

Ummm....

the 1) nitric acid test and the 2) density test are super easy and trivially cheap to perform on metal to determine if the gold is real.

.
~wobbles but doesn't fall down~

What if

it's gold plated...

snark below...

http://www.zerohedge.com/news/tungsten-filled-10-oz-gold-bar...

OHHH, nitric acid that $hit!!! What? The density, specific gravity test, water displacement tests won't work?

http://www.youtube.com/watch?v=5FvM_4B7Pkc

Hold on partner, let me break out my ultrasound machine...

The density test...

will detect gold-plated. All you need is a scale and graduated beaker.

To be able to pull off the tungsten trick requires a high-level of technical sophistication that only a few labs can accomplish and are exceedingly rare. If you are buying a large bar like that you need to do a core test on it. They are pretty much standard practice for large bars. It's unfortunate the shop in the article didn't do one.

.
~wobbles but doesn't fall down~

You better be accurate

for 400oz bars, its definitely possible, but anything in the 1 oz range, accuracy starts becoming a problem.

Ultrasound...

Ultrasonic thickness machines can detect if gold items contain non-gold inclusions. You can get them for as low as $100-200:

http://www.amazon.com/s/ref=nb_sb_noss?url=search-alias%3Dap...

.
~wobbles but doesn't fall down~

Has someone determined

...that it's to be an either-or thing?

Peter Surda's response:

Patrik,

I already explained to you several times how the network effect works. You appear to think that if we can't understand the reasons why people do or do not switch between goods subject to the network effect, they do not exist. You arbitrarily pick some historical data regarding the network effect, show that you do not understand why the switch occurred, and provide this as "proof". But that's not how it works. There is always a reason for the switch, even if we do not understand it. Similarly, I argue that there is no reason to switch from BTC to LTC. And alas, I already wrote once that prices are irrelevant, relevant is liquidity. LTC does not have the liquidity of BTC and it's very unlikely that it will overtake BTC. And I already told you this before. Alas, the price of LTC increased and you are using it as a "proof".

Your counterargument regarding languages is weird, because you appear to use something like the labour theory of value. Merely because you invest more resources into creating new goods, it does not follow that market actually will accept them. You appear to think that merely because a market is subject to the network effect, anyone can start such one good. But that's bogus.

Last but not least, you ignore that there are media of exchange that are not money, and that competition occurs on transaction costs. Even if we accepted your conclusion that Bitcoin can never be the most salable good (which we don't know, but for the argument's sake let's assume it), it does not mean that it can't be the best payment system, for example.

The truth is, people who use Bitcoin for transactional purposes do not have anything else to switch to. Other cryptocurrencies have lower liquidity, and other media of exchange have higher transaction costs. It's like saying that the internet is not good because anyone can create a new protocol, and it can never be the most common communication protocol anyway, so people and people will use libraries or the post office instead.

"We’ve moved beyond the Mises textbook. We’re running in the open market." - Erik Voorhees

More than a currency, though

The discussion ignores one of the other functions of Bitcoin - namely, as an autonomous payment processing system. The developers have pointed out elsewhere that it's entirely possible for Bitcoin to become a component of new or existing payment processing systems, with the conversion between BTCs and local currencies taking place automatically and invisibly.

It's also a bit surprising that so far no one has mentioned Bitcoin's vulnerability to network outages (whether technical or "official"). Fortunately, the current interest in community wireless mesh networking parallels the interest in currency decentralization. WMN is fault tolerant, doesn't require a physical infrastructure like cable or telco, can be mobile (rapid recovery from outages) and readily handles VoIP. These characteristics are entirely consistent with the concept of survivable communities, without the shrink wrap of government "social management." It is also potentially a technological end run around entrenched telecommunications monopolies.

The FCC and commercial interests hijacked U-NII (the originally planned wireless extension of the Internet), but wireless technology is inexpensive and widely available. Tests with simple 802.11 devices have demonstrated reliable broadband communications over remarkably long distances, so as time passes it could become decreasingly necessary to depend entirely on centrally controlled Internet providers.

However desirable precious metals may be, the number of venues for sending or receiving them in commercial transactions is still quite limited. Bitcoin will never replace PMs in physical possession, but it could serve as a proxy or venue for transacting in PMs. Moreover, even if Bitcoin doesn't provide complete anonymity, it does impair routine government monitoring of what should be private transactions anyway.

The emergent wisdom is to use PMs in physical possession to preserve wealth, and use digital currency for commercial transactions over distance.

decreasingly necessary to depend entirely on ISPs

http://retroshare.sourceforge.net/

http://project-byzantium.org/

https://www.torproject.org/

http://www.vanheusden.com/pgp.php

"We’ve moved beyond the Mises textbook. We’re running in the open market." - Erik Voorhees

Markets work to find what individuals call fair value.

Anything can be undervalued or overvalued at different times for different people.

What is the value of anonymous transaction?

A bank wire transfer is $15, and is heavily taxed and regulated to the government's benefit.

Gold is an asset based money. Bitcoin is a service backed money.

Free includes debt-free!