A tale of bitcoins and $500 suits: Will a rising-value currency not be used?

A common objection to bitcoin is that as its value rises, and especially if it is generally expected to keep rising due to its restricted and inelastic production characteristics, “people will never spend bitcoins; they will just hold onto them waiting for the value to go up, and therefore bitcoin cannot succeed as a currency.”

This fallacy commits a number of errors of economic reasoning. For example, it takes one factor, a presumed desire to save bitcoin in the expectation that its exchange value will rise still higher in the future, and treats it as the only factor, even though many others are also in play. It also assumes that all people are the same all the time and that their value scales never change. It treats a person’s entire holding of bitcoin as an indivisible block, or “hoard” (Smaug’s?), ignoring the possibility of marginal decisions about the use of smaller amounts relative to a total balance and specific decision contexts.

Playing directly opposite this supposedly monolithic motivation to hold for the indefinite future is the shift in valuations of a good relative to the value of a given bitcoin holding. As the exchange value per unit rises, the total exchange value of any given holding rises with it. To illustrate how this factor goes directly against the deflationary disuse story, here is a tale of bitcoins and $500 suits.

If Hayek has 100 bitcoins when the bitcoin price is $5, buying one $500 suit would leave him with one suit and no bitcoin. However, the same purchase with bitcoin at $50 would leave him with one suit plus a remaining balance of $4,500 worth of bitcoin. At $500 per bitcoin, he could get the suit and still keep a bitcoin balance worth $49,500. And so the story goes. Finally, at $5,000 per bitcoin, he could buy that same suit and still retain $499,500 worth of bitcoin.

The trade-off Hayek faces between the suit and the proportion of a given bitcoin holding that must be traded to obtain it varies with exchange value. As bitcoin’s exchange value rises (supposedly its fatal flaw as a currency), the cost of the same one suit as a percentage of Hayek’s total bitcoin holding declines, in the foregoing example, from 100% to 10% to 1% to 0.1%, as a direct implication. The choice between buying a suit with 100% of one’s bitcoin balance or with 0.1% of that same bitcoin balance is most dissimilar and it should be clear which of these two conditions is more likely to “stimulate” a retail purchase.

As the value of bitcoin rises, the position of one suit relative to a given unit of bitcoin on a given person’s value scale will tend to change in such a way that the same holder of 100 bitcoins might be increasingly likely, not less, to purchase a suit. This does not mean that other countervailing factors, such as a desire to delay spending in anticipation of a higher future exchange value are not also present. It means that the most oft-cited factor is not the only one and moreover that other important factors point in exactly the opposite direction of the deflationary disuse thesis.

Cross-posted at actiontheory.liberty.me.

“Bitcoin 2014 Panel: Economic Theory of Bitcoin” with time-based outline

It was an honor to be among the participants in this panel on 17 May 2014 at the Bitcoin Foundation Conference in Amsterdam. We addressed several issues that tend to recur in discussions of economic theory and bitcoin. The main topics were the regression theorem and bitcoin; bitcoin and the role of units of account and pricing; multiple value standards and the economics of altcoins relative to bitcoin; fractional-reserve banking, lending, and direct versus other-party control; and deflation and fixed versus elastic money supplies. I have added a time-based outline after the embedded video below to facilitate noting and locating particular topics.

Moderator: Jon Matonis (Executive Director, Bitcoin Foundation)

Speakers: Konrad Graf (Author & Investment Research Translator), Robert Sams (Founder, Cryptonomics), Peter Surda (Economist, Economicsofbitcoin.com, Robin Teigland (Associate Professor, Stockholm School of Economics)

1) Introductions, opening comments, and overview

00:00–03:05 Matonis: Introduction of panelists

03:05–07:57 Brief openings by each panelist

07:57–09:06 Economics profession and bitcoin

09:06–11:41 Matonis: Overview of topics

2) Regression theorem and bitcoin

11:41–12:12 Matonis: Introduction of topic

12:12–18:32 Surda: Liquidity, organized markets

18:32–23:16 Graf: Technical versus economic; theory versus history layers

23:16–23:50 Sams: Doubts this is relevant to bitcoin

3) Unit of account, price display, and price intuition

23:50–25:02 Matonis: Introduction of topic

25:02–27:00 Teigland: Depends on who; networks, sub-communities, generation change

27:00–27:23 Matonis: Can bitcoin overcome the existing network effect?

27:23–28:01 Surda: Uncharted area, dollar likely to remain unless deep negative event for it

4) Multiple value standards, room for 300 crytocurrencies

28:01–28:49 Matonis: Introduction of topic

28:49–31:01 Sams: Need distinct specializations; mining costs limit

31:01–32:48 Graf: Strong tendency toward one unit; only other very strong factors could counter

5) Fractional-reserve banking and bitcoin

32:48–33:41 Matonis: Introduction of topic

33:41–38:08 Surda: Money substitutes, transaction costs, price differentials, “reserve” standards

38:08–39:57 Teigland: Other non-traditional financing systems, crowdfunding, P2P lending

39:57–41:34 Sams: FRB based on an illusion, one that cannot be created with bitcoin

41:34–44:12 Graf: Bitcoin allows opt-out from all “trusted” 3rd, 4th, 5th parties. Vote with your mouse.

44:12–46:47 Sams: Who owns what? a pervasive issue; first bitcoin lending likely dollar denominated

6) Deflation, only 21 million units, number of decimal points

46:47–48:37 Matonis: Introduction of topic

48:37–49:46 Teigland: People adapt over time to situations

49:46–53:38 Sams: Deflation arguments misplaced; overheld, underused; other crypto money supplies possible

53:38–55:36 Surda: No need to change the quantity of money, but more to investigate

55:36–58:29 Graf: “Rising-value currency;” any quantity of money will do for society as a whole

58:29–59:26 Sams: Elastic supply could help stabilize exchange rate relative to fixed supply

59:26–59:46 Surda: Unit of account function depends on liquidity not volatility

7) Q&A

59:46–60:55 Q1: Banks allowed to create money; unfair playing field?

60:55–62:28 A1: Sams: 100% reserve banking; taking away private money creation privilege

62:28–62:56 A1b: Teigland: Local alternatives, experimentation

62:56–63:19 Q2: Isn’t buying and holding bitcoins already an investment in all of bitcoin?

63:19–64:06 A2: Sams: To some extent, but could be more with different money supply rule

64:06–65:00 Q3: Fixed rate of supply ignores recent lessons of monetary theory

65:00–65:27 A3: Matonis: Already addressed; Surda: May need to unlearn some of those lessons :-)

Hyper-monetization reloaded: Another round of bubble talk

‘Tis the season again when the Bitcoin exchange rate rises fast and “bubble” talk resumes among some journalistic and other Bitcoin skeptics. Around the height of the previous most dramatic Bitcoin exchange rate movements of March and April 2013, I posted an article called “Hyper-monetization: Questioning the ‘Bitcoin bubble’ bubble,” which was widely circulated at the time and still referenced now. What follows is a blend of brand-new material and thoroughly revised highlights from the earlier article.

The objective was, and is, not to give advice or make predictions, but to draw on theory to develop alternative perspectives on what exactly a “bubble” may or may not be in relation to the distinctive case of a brand-new rising-value medium of exchange. “Medium of exchange” is fancy economic jargon for something one can pay for goods and services with. I define a money as the common unit of pricing and accounting in a given context (see my “Bitcoin as medium of exchange now and unit of account later: The inverse of Koning’s medieval coins,” 14 September 2013).

Behind popular price-bubble discourse often lies a thinly or not-at-all veiled general debate on whether Bitcoin is a valid system. Some degree of bubble-talk functions as a pop proxy for this. In April, some Bitcoin critics were citing rapid price movements in support of the contention that Bitcoin, as such, was only a bubble. When this bubble popped, the story went, Bitcoin units would supposedly return to their “inherent” value, which they claimed to be…nothing.

Of course, Bitcoin failed to oblige them once again. Yet each time Bitcoin does not fulfill this pop empirical prediction, and instead eventually goes much higher in price later on, one nevertheless hears the same prediction repeated the next time around. In contrast, there are several ways to take a much longer-term view, one that is able to both account for price manias and also acknowledge the possibility that Bitcoin could be a valid system, and an ever more reliable one in the making.

Hyper-monetization reloaded

Many observers have likened the rise of Bitcoin to an asset bubble. Another less common word introduced in this context is hyper-deflation. Some say such a thing is horrible, others that it is great. I suggest a quite different interpretive concept to apply in addition: hyper-monetization.

I came across the term hyper-deflation, intended in a positive sense of rapidly rising value, when Bitcoin’s exchange rate was climbing fast from the low thirties to the high thirties over a few days in early March 2013. While a few specialists of a certain persuasion understand “deflation” to be a great thing for ordinary people, the word still has major problems. It has several possible definitions. It can refer to price-level changes or to quantity of money changes, depending on who is talking or when. It is assigned a quite negative interpretation in most conventional economics circles. Finally, it has a general public-relations problem. It just sounds depressing as a word. Whatever its real net effects on society might be, “deflation” just sounds like a bad thing no matter what. Which child most wants a deflated balloon?

The word hyper-monetization occurred to me as a more positive alternative to hyper-deflation, one that also provides an antonym to the catastrophic hyper-inflations that have repeatedly killed off fiat paper monies throughout history. The exact opposite of the death of an old money at the debt-dripping hands of state/bank alliance managers would be the birth of a new medium of exchange at the creative hands of the market.

The term de-monetization denotes the more general concept of a widely used medium of exchange ceasing to function as one. A total hyper-inflationary collapse is one way this can happen. Another is bimetallist legal-tender price-fixing schemes driving one precious metal, say silver, out of circulation in favor of another, say gold, or vice versa. Yet another historical example is when a pure fiat paper standard is created after monetary authorities permanently “suspend redemption” of legal tender notes into the precious metals that had been promised in exchange for such notes (that is, note-issuer default is “legalized”). Paper and account entries then remain as money, while the metals that had formerly “backed” them are de-monetized and trade as commodity assets, bought and sold in terms of what replaced them in the actual role of money. The rhetorical line from some well-meaning sound-money promoters that “gold is money” is simply untrue, except, of course, in regard to those times and places where it actually was.

The opposite process, “monetization” in this sense, denotes something that was not a money beginning to function as one. When euros took over the jobs of various European national currencies, euros were monetized and the previous national currencies de-monetized. The French franc and Italian lira do not now function as monies; they are historical relics.

Something that gains its own exchange value from scratch on the open market contrasts sharply with any such forced legal conversions. When a freely chosen unit monetizes through market processes, and does so quite rapidly, it might then reasonably be described as being in a process of “hyper-monetization” (for a detailed treatment of origin-of-money issues, see my recent paper, “On the origins of Bitcoin: Stages of monetary evolution,” revised version, 3 November 2013, PDF).

A problem with the “bubble” bubble

Bitcoin’s high price volatility is unquestioned. However, it is unsurprising for at least two reasons. First, it is not widely understood as a technology and is in a very early stage of development. Second, its exchange value (market price) tends to react to news that highlights regime uncertainty. It should be noted that this is a type of “government failure” in that the scope and variability of policy uncertainty across multiple jurisdictions greatly increases market uncertainty.

Something else to consider in relation to the eternally-recurring “Bitcoin is a bubble” claim is that in a normal asset bubble, certain key factors differ. To whichever height the prices of typical bubble assets such as houses climb, a given house remains the same good in a physical sense as when it exchanged for less money. In the case of a monetization event, in contrast, the actual utility of the trading unit—which is mainly its utility as a trading unit—may actually rise. This is due to monetary network effects, named in reference to the value that comes from the extent of the network of people willing and able to deal in a particular trading unit.

To imagine how this special case of medium-of-exchange utility growth might differ from an ordinary asset bubble in, for example, housing, it would be as if not only the prices of houses were rising during a buying rush, but in addition, their actual sought-after qualities as physical houses were improving as well. Such fantastic houses might sprout new rooms with no one building them. New paint jobs might appear mysteriously overnight without any painters having visited.

For a medium of exchange, a rising general usability for facilitating the purchase of goods and services (separate from the relative value of each unit) is not directly tied to its exchange rate against other monetary units. Still, this aspect is likely to positively influence such exchange rates. Conversely, rising exchange rates, if they generate news and wider attention, can then lead to enhanced network effects through increased recognition, creating a network-growth cycle.

For those who have been following Bitcoin news closely, for months on end there have been seemingly daily announcements of new ways and places for consumers to spend bitcoins, new or improved wallet services to manage bitcoins, new or improved payment processor services to receive bitcoins, and new exchanges at which to buy and sell bitcoins—all on a global basis. Bitcoin payment processor BitPay announced in September that it had 10,000 merchant customers, up 10x from 1,000 a year earlier. In the past 12 months, the number of wallet accounts listed at the popular Blockchain.info My Wallet service has risen 13.9x from 38,460 to 534,575. These are just two specific services and do not reflect horizontal expansion in the number of competing services or the direct use of the Bitcoin network to facilitate transactions on the part of consumers and merchants using directly controlled software without intermediated assistance from service companies.

“Is” a bubble versus “is in” a bubble phase

Bitcoin does have its manias and crashes. The hyper-monetization concept seems useful especially in a longer-term perspective for addressing the view that Bitcoin is nothing more than a speculative bubble. The most insistent proponents of this view elaborate along these lines: “Bitcoin has no ‘intrinsic’ value and is therefore ultimately destined to fall to its ‘inherent’ value, which is zero.

However, claiming that Bitcoin is a bubble (total dismissal of the system as such) is quite different from claiming, perhaps helpfully, that Bitcoin’s exchange rate may be showing signs of being in a temporary bubble phase or mania at a given point in time. That said, every significant rise in price cannot just be reflexively attributed to a mania. There is certainly more to this story and there are many specific matters of degree and interpretation. Among these is recognizing that a young currency such as this would naturally vary in price quite a bit more as it is being discovered in waves than later after it has gained more widespread adoption.

At a theoretical level, unlike a simple asset bubble mania, the more people begin using or expanding their use of a particular medium of exchange, the more its actual utility rises, and the more valuable it actually is in this function from the point of view of its users. The exchange value of a medium of exchange unit is related to, among other things, each holder’s expectations of being able to use the unit in future exchanges. How many people will accept the unit, how readily, and for what?

At least when it comes to the aspect of monetary network-effect growth in any season, ‘tis the more the merrier.

The m's and b's of millibitcoin redenomination

We could change where the display shows the decimal point. Same amount of money, just different convention for where the [commas and periods] go…moving the decimal place 3 places would mean if you had 1.00000 before, now it shows it as 1,000.00.

—“Satoshi Nakamoto,” February 10, 2010

In the Kingdom of Geekdom, my €2.60 espresso this morning might have cost 0.0283 BTC (at the 90-day weighted moving average of €92/BTC), perhaps pronounced “point zero two eight three bitcoins.”

Such a string of sounds could only happily emerge from the mouths of card-carrying Geekdom denizens channeling Mr. Spock himself, but it would be most unlikely to pass the lips, or be long tolerated by the ears, of the average Katie, Hans, Taiwo, or Eijiro on the streets of this planet.

And thus a resurgence of interest in changing the standard Bitcoin denomination from a bitcoin (1 BTC) to a millibitcoin (0.001 BTC) has taken shape on the Bitcoin Forum with an informal survey. The top responses to “Should we start using mBTC as the standard denomination?” are 53% for “Yes,” and 20% for “After the price is at $1,000, dollar parity for the mBTC.”

Maybe, but what do we say at checkout?

Designed for convenience at much lower value levels, the initial standard “bitcoin” unit, which equals 100 million satoshis, the more fundamental unit within the Bitcoin system, has grown to become far too valuable for most people’s ordinary way of thinking and speaking about prices. A bitcoin has traded over the past several weeks mainly in the $110–$130 range with the 90-day weighted moving average now just shy of $120. Unlike bitcoin exchange values from earlier years—a few cents and later a few dollars—most ordinary items now have to be bit-priced entirely within the decimal point range, although the luxury houses and cars at Bitpremier could just stay priced in bitcoins. A hypothetical rise to $1,000/BTC would greatly amplify this situation.

A redenomination would only impact the way price numbers are displayed and discussed and would make no fundamental changes to values held. A person with 1 bitcoin could just as well be said instead to have 100 centibitcoins or 1,000 millibitcoins.

In contrast, when political money managers talk of devaluation, redenomination, and most recently “easing,” such machinations actually do signal an active manipulation of purchasing power (always to its detriment). This current discussion simply seeks consensus on practical and linguistic conveniences by, for, and among the wholly self-selected community of participating Bitcoin developers, service providers, merchants, consumers, traders, and even observers.

Yet the difficulties of finding spoken language for naming this new unit, language capable of seeing wide global adoption in everyday use, have proven a lingering challenge. To address this topic, I will draw on conventional pricing usages in several different countries and languages in search of common patterns to use as criteria. I will then apply these criteria to existing proposals for a spoken-language name for the too technical “millibitcoins,” and then offer two suggestions, the second of which I have not yet seen proposed elsewhere.

Before moving on, let us be sure to put this whole “problem” in perspective. This is a “sound-currency problem,” in the sense of the “first-world problems” meme. A rising currency and falling prices of goods and services denominated in it are the kinds of “problems” most people ought to be happy to face. The long, sad history of declining political currency values has systematically punished savers and planners and rewarded debtors and those with less effective foresight, leading to shortening time horizons and eroding senses of personal responsibility.

Falling currency values leave families struggling to meet ever-rising prices for goods and services. By several estimates, the United States dollar, for example, has lost some 97%–98% of its value since its “management” was assigned to the Federal Reserve System in 1913 (I refer those who fear falling prices, the deflation-phobic, to my 29 March 2013, A short Bitcoin commentary on “Deflation and Liberty” and the works linked from it).

Speaking of prices

Since the Bitcoin network spans this entire planet, such linguistic research ought to begin by at least attempting to reference practices in several countries and major languages. I will select examples below from the US, Germany, and Japan, based simply on my own degree of direct familiarity with each (please add other instructive usage examples in the comments). The three numerical examples below are of roughly similar purchasing power in each zone, probably enough to buy another espresso.

The first thing I notice is that it is common to use two decimal places, “cents” after a main unit. Second, in shopping language, the unit names are often omitted altogether. Thus, in the US, a spoken “two-sixty” means two dollars and sixty cents ($2.60). In Germany, “zweisechzig” likewise means two euros and sixty cents (€2.60), or more formally “zwei euro sechzig” (but still most often omitting “zent”). Omitting the unit is facilitated in both cases in the same way: two individual numbers are spoken in sequence, the first specifying the whole unit; the second, hundredths of it.

In Japanese, ¥260 is “nihyaku rokujuu-en”. Here, there is no decimal point, but in effect “hyakuen” (¥100) takes the place of the base unit in the dollar and euro examples. The “yen” (actually pronounced “en”) is not omitted in speech, but it only takes a quick syllable to say it and units are not optional in general. The “hyaku,” also lightning fast to say in Japanese, already works to create a division in ¥260 between the two hundreds and the sixty. This makes it less functionally different from the English and German examples than it might at first appear.

Generally speaking, when the names of currency units are not contextually omitted in speech altogether, they can almost always be pronounced in just two syllables: dollars, euros, pesos, kronas, rubles, rupees…bitcoins. In contrast, “millibitcoin” or “mBTC” (pronouncing each letter) each take up a hefty four syllables and are as such unlikely to survive in non-technical spoken usage.

The bit is dead; long live the bit?

So, what might that unit be called in ordinary speech? Some commentators have identified a problem with “coin.” It is by nature indivisible. On the other hand, “the coin of the realm” does give a more uncountable sense of a money in use in a particular place.

Either way, this provides an easy opportunity to cut out a syllable, and with “coin” duly exiled, proposals for spoken options for millibitcoin have included “millibits,” “embits,” “mills,” “mill,” “millies,” and “bits.” Those thinking way ahead have already termed a microbitcoin (0.000001) a “Mike,” presumably the thin, but loving partner of the much heftier Millie.

“Millibits” came out ahead in an informal naming poll for millibitcoin way back on May 14, 2011. Unfortunately, at three syllables, it is still a mouthful for everyday speech, exceeding the conventional two syllable mainstream for currency unit names.

You want change? Anybody got some tools?

“Bits,” at just one syllable, already have a long and storied history in coinage. For centuries, the Spanish silver dollar was a preferred unit of global trade due to its relative freedom from debasement of silver content and its wide international adoption. The peso de a ocho coin was worth eight reales and became known as “pieces of eight” in English, giving pirate parrots something to prattle on about. It has also been said that certain coins were physically cut into eight pieces or “bits” as a way to improvise around small-change shortages using the resulting sharp metallic pie pieces. I am not sure of the ratio of fiction to fact on that one.

The resulting related use of “two bits” to mean a quarter dollar has only recently been fading out of informal use in the US after a long run. Unfortunately, fiat inflation eventually left a quarter dollar unable to buy much of anything and the meaning of “two-bit” declined with it, coming to characterize something of poor quality. A “two-bit coffee” might thus sound rather dilute to modern ears.

Could “bit” be brought back in a decimal-based, high-tech reincarnation? A millibitcoin (0.001 BTC) is now trading at about US $0.13. Twenty of these might buy that espresso at $2.60 and “twenty millibitcoins” (20 mBTC; 0.020 BTC) might be shortened in speech to “twenty bits.”

The centibit challenge and foodie what-ifs

If such bits stood for centibitcoins (0.01 BTC) instead of millibitcoins (0.001 BTC), that espresso might cost about “two bits” after all (assuming $130/BTC). With centibitcoins, a family sushi dinner that might add up to $65.95 would come to “fifty (bits) seventy-three,” or the waiter could say, “in Bitcoin, that’s fifty seventy-three.” That’s 50.73 centibitcoins versus 507.3 millibitcoins and 0.5073 bitcoins.

A centibitcoin redenomination could thus bring things into a familiar range for dollar and euro users right away. At around $130/BTC, a centibitcoin would trade for $1.30, €1.00, and ¥100. That seems intuitively perfect, but only under approximately current rates.

Bitcoin exchange values could stay level or fall. Expecting a long, level trend or modest decline would speak in favor of centibitcoins as the standard unit. If Bitcoin does continue to climb impressively, though, how long before its dollar exchange value adds another digit?

Let us say that the bulls have it and the exchange value of a bitcoin moves to $500 and then $1,000 over the next several years. How would these two alternative redenominations then play out with some everyday examples?

At $500 per bitcoin, a $2.60 espresso would cost 0.0052 bitcoins, 0.52 centibitcoins, and 5.20 millibitcoins. Millibitcoins would win according to the balance of the above criteria (“in Bitcoin, that’ll be five twenty”). The big sushi dinner would be 0.1319 bitcoins, 13.19 centibitcoins, and 131.90 millibitcoins. In this case, either one might look okay.

At $1,000 per bitcoin, the espresso would cost 0.0026 bitcoins, 0.26 centibitcoins, and 2.60 millibitcoins. Millie would win. The sushi would then come to 0.06595 bitcoins, 6.595 centibitcoins, and 65.95 millibitcoins, and millie would win again.

While a centibitcoin transition would make sense for now, an assumption of further exchange value growth would point in favor of the proposed millibitcoin unit. Either way, a redenomination could well be positive. A key challenge for Bitcoin entrepreneurs is helping to broaden adoption into more frequent everyday payments and purchases. Making Bitcoin units easier for contemporary people to talk about in everyday language and think about closer to everyday price numbers could well be helpful.

So how about just putting “m” and “B” together?

“Embies” (mB) is another option I have proposed based on pronouncing “m” and “b”. The B can also be written with the proposed Bitcoin currency symbol when it makes its way into standard character sets. Embie matches the conventional two-syllable criteria. It strikes me as easy to pronounce on a multilingual basis. It also seems friendly and familiar; it could be a pet’s name. I find it easier to say than the two-syllable “embits” candidate. Not all sets of two syllables are equally easy to pronounce.

Still, some people seem to hate it, while others like it. It may be that the name for BTC 0.001 that will prevail in the end has not yet been coined.


For additional articles on this topic, visit my Bitcoin Theory page on this site.


Short-term Bitcoin exchange trends as Rorschach tests of economic views

What might Hermann Rorscach (8 November 1884 – 1 April 1922) see in all this?Whatever the current excitement on any given day about short-term Bitcoin price charts, what stands out for me as a watcher of the theoretical underpinnings of discourse on these events is how they bring various economic-theory concepts out into view as the people who have them in mind use them to interpret current events. As Keynes famously put it: “even the most practical man of affairs is usually in the thrall of the ideas of some long-dead economist.”

I try to stay at least 98% positive in general; critique can be more tempting than contribution. That said, sometimes understanding can be advanced by considering contrasting examples. Here are three.

Realized/unrealized gains/losses

First, it appears that the distinction between realized and unrealized gains and losses could be kept more firmly in mind by most. The take-home point is that for all those Bitcoin market participants (whether bull or bear) who did not actually trade today or recently, nothing much actually happened during the rapid headline price changes on the exchanges (of course, the changes might lead some to adjust their future plans according to their various forward-looking judgments). What these exchange prices actually indicate is merely the current record of transactions that are occurring on those exchanges. It is only the collection of such discrete “real time” recorded exchange events that provide the data for the construction of the lines on the trend graphs.

At times of temporary disruption of access to websites, low visibility prevails. Pre-placed automated orders execute and panicking short-termers flee. The price graphs (as they become accessible after the disruption) show the actual trades and volumes at particular times during this course of events. The price graph on a given exchange indicates actual marginal activity, at given moments, on that exchange. These exchange services are specific businesses; not magical, instant oracles of “price” in general or “value” in general. In the event, the top two exchanges, it appears from preliminary reports, were most likely under active manipulation in a possibly partly orchestrated move (and do not forget that this may well have included both upward and downward elements).

What a difference a few days can make.

A spiral into absurdity

Second, the good old “deflationary spiral” fallacy (maybe market observers will get a couple days off from hearing that one now?) apparently misses the significance of the fact that BOTH a buyer and a seller are required to form any given data input for market price graphs. With no transactions occurring, which is what is posited in this imaginary world of “no one will sell when it is so valuable,” there is no “price” at all. Thus, the market “price” could not be too high, because it would be non-existent under the stated assumption that no transactions were occurring. Reductio ad absurdum. These exchange prices form an up-to-date historical record at a given time of actual recent buying and selling on a given exchange.

Look for the verb

Finally, it has been a little surprising just how many Bitcoin critics employ the concept of “intrinsic value” in making the claim that Bitcoin does not have any. It was members of the Austrian school of economics, with the so-called subjectivist marginal revolution, that had seemingly put the final nail in the coffin of this ancient economic fallacy. Beginning in the 1870s, Austrian school scholars began to re-emphasize the view that value is ultimately the result of valuation, in reference to the verb to value, which is an act that can only be performed by living people (We now understand that some of the Late Scholastics of Salamanca also had this point reasonably clear several centuries earlier). After Carl Menger, this view gained steam with Eugen Böhm-Bawerk and unmistakable clarity with Ludwig von Mises’s 1912 Theory of Money and Credit and later works. This further application of the subjective theory of value clarified that the concept of “intrinsic value” is ultimately incoherent, not only with regard to goods in general, but to media of exchange as well. Mises was rather strict on this point in TMC, pp. 61–62:

Our terminology should [help to overcome] the naive and confused popular conception of value that sees in the precious metals something “intrinsically” valuable and in paper credit money something necessarily anomalous. Scientifically, this terminology is perfectly useless and a source of endless misunderstanding and misrepresentation.


Note: I discuss value theory in simple terms with illustrative examples in Resolving the paradox of value. For a more detailed discussion, see IN-DEPTH | The sound of one bitcoin: Tangibility, scarcity, and a “hard-money” checklist.


For additional articles on this topic, visit my Bitcoin Theory page on this site.


Hyper-monetization: Questioning the "Bitcoin bubble" bubble

What is the opposite of this? Sweeping up in 1946 after the hyperinflation of the Hungarian pengő. Source: Wikimedia Commons, Magyar Nemzeti Múzeum Történeti Fényképtára, Budapest.

What is the opposite of this? Sweeping up in 1946 after the hyperinflation of the Hungarian pengő. Source: Wikimedia Commons, Magyar Nemzeti Múzeum Történeti Fényképtára, Budapest.

Many observers have likened the rise of Bitcoin to an asset bubble. It is so customary today to use the “bubble” word in articles about Bitcoin that there may in fact be a sort of “bubble” bubble.

Another less common word introduced in this context is hyper-deflation. Some say such a thing is horrible, others that it is great. I suggest a quite different possible interpretation of these events and a word to label them: hyper-monetization.

I first heard the term “hyper-deflation” (used in a positive sense) when Bitcoin was rising rapidly from the low thirties to the high thirties over a few days in early March (Yes, this was only a month ago). While a few specialists of a certain persuasion understand “deflation” to be a great thing for ordinary people (see, for example, my 30 March 2013 post, “A short Bitcoin commentary on Deflation and Liberty”), the word still has a public-relations problem. Along with some technical issues from its several possible definitions (price level changes versus quantity of money changes, for example), and negative interpretations in conventional economics circles, it just sounds depressing, regardless of the stated technical sense in which one attempts to use it.

The word “hyper-monetization” first occurred to me around that time as a more positive term, and perhaps a more accurate antonym for the catastrophic hyperinflations that have repeatedly killed off fiat paper monies throughout their history. A related term, “de-monetization,” denotes the process of a widely used medium of exchange ceasing to function as such.

A total hyperinflationary collapse is one way de-monetization can happen. Another type of historical example of de-monetization is “bimetallist” legal tender price-fixing schemes driving one precious metal, say silver, out of circulation in favor of another metal, say gold. Yet another historical example is when a pure fiat paper standard is created after monetary authorities permanently “suspend redemption” of their legal tender notes into the precious metals they had promised to deliver.

The opposite process of “monetization” denotes something that was not a money beginning to function as one. When euros took over the respective jobs of various European national currencies, euros monetized and the previous national currencies de-monetized. Now they are historical paper relics, but no longer function as monies.

In contrast to such a legal tender conversion/transition, however, something that gains exchange value from scratch on the open market (rather than taking up exchange value through a conversion)—and does so at a logarithmic pace—might then reasonably be described as being in a process of “hyper-monetization.”

The trouble with the “bubble” bubble

Bitcoin’s high historical and current price volatility is unquestioned. However, one problem with the “bubble” analysis is that in an asset bubble, certain fundamental matters are quite different. In a business cycle mania phase, prices of the most popular asset classes for that particular cycle are bid up as people pile their freshly printed fiat money and freshly produced fiat bank account digits into booming fields. Each party in this rush competes with all the others to acquire some of the bubbling assets. These people are misled by artificially low interest rates to bid up certain asset prices unsustainably, and this all eventually collapses, as described in Austrian business cycle theory.

However high the prices of bubble assets go, they do remain the same goods. In the case of a monetization event, though, the practical use-value of the trading unit (not only its price in terms of other goods or monies) actually does rise with the number of people using it and the depth of the market. To imagine how different this is from a classic asset bubble, it would be as if not only the price of bubble-era houses were rising, but also that their actual sought-after qualities as houses were improving spontaneously at the same time. Such houses might sprout new rooms with no one building them, with new paint jobs appearing mysteriously overnight without any painters having visited.

In this way, quite unlike the case of an asset bubble, the more people “pile into” a medium of exchange, the more valuable it actually is in its function as a medium of exchange from the point of view of its users. This is a separate matter from its price, as a few astute observers out there have so far already been noting.

This type of value has been likened to the use-value of a language rising the more people there are who can speak it. Another analogy would be to the use-value, from the point of view of each user, of a given social networking site rising the more people join it and the more they use it.

These are called network effects. In this case, the exchange value of the unit for each holder is directly related to each holder’s expectations of being able to use the unit in future exchanges (much like the value of knowing a language relates to one’s expectation of being able to communicate with it). This is in turn related to how many people accept the unit, how readily, and for what. It is important here to note, due to long-standing and common economic misconceptions, that the “future” in this sense is any future time—from five seconds from now to however many vaguely numbered years into the future a particular acting person might happen to have in mind.

When it comes to network-effect growth, the more the merrier. An analogy can be made not only to the rising stock price of a growing social networking site, but also, and more importantly, to the number of users of that site and how much it is used.

Check this box for a perspective shift

Yesterday, I saw a tweet from the insightful Bitcoin watcher Jonathan Waller. He wrote (enthusiastically, I think) that, “The bitcoin all-time chart is not even slightly sensible,” and linked to a chart [showing logorithmic growth shown on a linear scale].

This tweet got me thinking (yes, this is also a possible function of tweets). How can we make sense of this trend? Might taking some other perspective help?

This chart struck me as looking quite similar to a hyperinflation. However, instead of the exchange value of a trading unit plummeting toward the abyss as in an archetypal fiat paper-money collapse, Bitcoin has been doing the opposite.

Checking the log-scale box on the bitcoin price chart reveals a different picture. It shows a (so far) intuitively ascertainable long-term historical course with a large bump or two and some curves in the road. In this longer-term view, the exchange rate has been growing, not so much from one to two to three to four, as on a linear scale, but from 0.1 to 1 to 10 to 100. It has grown by several orders of magnitude during these couple of years.

Of course, the usual caveats must be quickly noted. “If present trends continue” can and often is infamously followed by them not doing so. But what might nevertheless be observed about this trend?

If one were somehow witnessing a phase in the first “hyper-monetization” in history, is this not more or less what one would expect to see?

Mark my words

The value of a paper money at the tail end of a hyperinflationary event is mainly the direct value of the physical paper (burning, wall-paper, etc.), but there is a more gradual build-up before the final collapse. The following chart is the price of Goldmarks in terms of Papiermarks from 1918–1923 in the Weimar Republic. This includes a steady logarithmic trend from 1918 to mid-1922. The exchange rate also moves from roughly 1 to 100 during those few years.

After that, however, the 1923 portion looks incomprehensible even on a log scale. As monetary authorities run the presses full speed and add new zeroes to denominations, a point is reached toward the end when the primary objective of market participants is to rid themselves of paper as quickly as possible before the last shred of exchange value evaporates.

The USD/BTC trend shows the price of Bitcoin against (also steadily depreciating) US dollars. This bears a certain similarity to the pre-1923 phases of the Weimar Papiermark/Goldmark chart. One difference is that the trend for Bitcoin from autumn-2010 to spring 2013 is the inverse of the trend for the ill-fated Papiermark from 1918 to mid-1922. In other words, for the years in question, the rise of Bitcoin’s relative exchange value shows a statistical pattern with similarities to the decline of the exchange value of the paper mark. Of course, the specific factors behind these events are quite different. In one case, the destruction was driven by ever increasing, arbitrary production of more units. In the other, the growth appears to be driven by voluntary adoption (with all its various motivations) and network effects.

If we were now actually witnessing early stages of an unprecedented hyper-monetization event, what might the top of such an event look like eventually? This is a fantastic and entirely speculative question and certainly invites the ever risky “if present trends continue” types of thinking. Looking toward the future should never be confused with looking into the past.

That said, during such a singularity-like event, were such a thing to be occurring, one might at some fairly early stage expect to see an Epic Rap Battles of History installment called, “Bitcoin vs. Fiat Money.” The key question would then soon become:

“Who won? You decide.”


For additional articles on this topic, visit my Bitcoin Theory page on this site.

[UPDATE: Seven months later, a new article including revised highlights of this article along with new material appeared: Hyper-monetization reloaded: Another round of bubble talk (7 November 2013).]

A short Bitcoin commentary on "Deflation and Liberty"

I just finished reading the monograph Deflation and Liberty (published 2008, but originally produced more than five years earlier) by Jörg Guido Hülsmann. I am a big fan of Hülsmann’s 2008 work The Ethics of Money Production (not to mention just about everything else he has written). However, I had understood the shorter work to have been a mere precursor to The Ethics of Money Production. Now that I have finally read it, though, my impression is that it is quite different in content and certainly warrants its own reading. Besides, I had to catch up with the indefatigable Mises Circle at UT group, which read and discussed Deflation and Liberty a few weeks ago.

Deflation and Liberty was written years before Bitcoin appeared, and even more years before Bitcoin began to rise to superstar status in recent weeks. My collection of quotations below read in a different light now that Bitcoin has risen as a “third way” in the exchange space.

Bitcoin is not technically deflationary under one definition because its supply is set to grow gradually up to a terminal limit (inflation and deflation in this sense refer to quantity of units rather than relative exchange value). The important point is that the Bitcoin supply is set to grow at a specific, pre-defined, and gradually declining rate that no particular person or group can manipulate. Its growth rate is fundamentally knowable and predictable by all market participants, and presumably less variable than even the total market supply of a given precious metal in any given year.

After the Bitcoin supply growth trend ends in about 2140, I understand new production ceases and its supply is to remain stable and then decline ever so slightly based on incidental micro events such as individual password misplacements. I therefore believe it is even now “deflationary,” not in the letter, but in much of the spirit in which Hülsmann used the term in this monograph. At any rate, it provides a diametric contrast with the familiar inflationary policies that take the form of arbitrary fiat increases in the money supply conducted for special-interest political ends.

In another sense of the word deflation, however, Bitcoin does qualify, for the moment at least. The general exchange rates of Bitcoin against all other goods and services will of course tend to decline so long as Bitcoin is gaining in exchange value; Bitcoin-denominated prices will tend to fall so long as its exchange value grows.

With this context in mind, let us see how Bitcoin stacks up in light of the following quotations, keeping in mind that no such thing as Bitcoin existed at the time this monograph was written. I will add some minimal commentary in brackets with emphasis in bold.

Selected quotations from Deflation and Liberty with commentary

p. 16 fn 8: Speaking of “an economy” we mean the group of persons using the same money.

[Bitcoin, though not yet technically a “money” by many definitions, is not geographically defined, but rather defined by the community of its actual users and producers on a global basis. Use and production is entirely voluntary and entry open. To join this community, one need merely aquire a free “wallet.”]

p. 30: In a truly free society, the production of money is a matter of private initiative. Money is produced and sold just as any other commodity or service. And this means in particular that in a free society the production of money is competitive. It is a matter of mining precious metals and of minting coins [and of mining Bitcoins], and both mining and minting are subject to the competition emanating from all other market participants.

[Bitcoin “miners” cobble together or buy their “rigs,” connect to the network, and set work in motion, all of their own volition.]

p. 31: The production of money in a free society is a matter of free association. Everybody from the miners to the owners of the mines, to the minters, and up to the customers who buy the minted coins, all of them benefit from the production of money. None of them violates the property rights of anybody else, because everybody is free to enter the mining and minting business, and nobody is obliged to buy the product.

[Bitcoin mining, exchanges, wallet services, users, etc. would all appear to qualify under this criterion of free association. No one is obliged to buy Bitcoins. Indeed, in perfect contrast, many people are currently scrambling to figure out how to acquire them.]

No game.p. 32: The producer of fiat money (in our days typically: paper money) sells a product that cannot withstand the competition of free-market monies such as gold and silver coins, and which the market participants only use because the use of all other monies is severely restricted or even outlawed. The most eloquent illustration of this fact is that paper money in all countries has been protected through legal tender laws. Paper money is inherently fiat money; it cannot thrive but when it is imposed by the state.

[Bitcoin is by no means imposed by the state. In diametric contrast, all that can be said of it on this count is that a few state agents are slowly starting to ascertain (and only roughly) what it is several years after its launch]

p. 35: It would not be uncharitable to characterize inflation as a large-scale rip-off, in favor of the politically well-connected few, and to the detriment of the politically destitute masses. [Fiat inflation] always goes in hand with the concentration of political power in the hands of those who are privileged to own a banking license and of those who control the production of the monopoly paper money. It promotes endless debts, puts society at the mercy of “monetary authorities” such as central banks, and to that extent entails moral corruption of society.

p. 39: That leaves barter as the only legal alternative to using paper money, and barter is so much less beneficial than monetary exchange that market participants typically prefer using even very inflationary monies rather than turning to barter.

[Bitcoin has now landed out of the cyber ether as a sort of “third alternative” to this scenario]

The considerable social advantages of deflation

p. 40: Deflation…abolishes the advantage that inflation-based debt finance enjoys, at the margin, over savings-based equity finance. And it therefore decentralizes financial decision-making and makes banks, firms, and individuals more prudent and self-reliant than they would have been under inflation. Most importantly, deflation eradicates the re-channeling of incomes that result from the monopoly privileges of central banks. It thus destroys the economic basis of the false elites and obliges them to become true elites rather quickly, or abdicate and make way for new entrepreneurs and other social leaders.

p. 41: Deflation is at least potentially a great liberating force. It not only brings the inflated monetary system back to rock bottom, it brings the entire society back in touch with the real world, because it destroys the economic basis of the social engineers, spin doctors, and brain washers.

p. 43: The dangers of deflation are chimerical, but its charms are very real. There is absolutely no reason to be concerned about the economic effects of deflation—unless one equates the welfare of the nation with the welfare of its false elites.

[In conclusion], pp. 43–44: The purpose of these pages is not to appeal to the reason of our monetary authorities. There is absolutely no hope that the Federal Reserve or any other fiat money producer of the world will change their policies any time soon. But it is time that the friends of liberty change their minds on the crucial issue of deflation. False thinking on this point has given our governments undue leeway, of which they have made ample and bad use. Ultimately, we need to take control over the money supply out of the hands of our governments and make the production of money again subject to the principle of free association. The first step to endorsing and promoting this strategy is to realize that governments do not—indeed cannot—fulfill any positive role whatever through the control of our money.


For additional articles on this topic, visit my Bitcoin Theory page on this site.


REVIEW | The Ethics of Money Production by Jörg Guido Hülsmann

Business ethics, or at least violating them, if the media is to be believed, is all the rage. The Ethics of Money Production is the first in-depth look (well, the second; the first, as Hülsmann points out, was written 700 years ago by a French Bishop) at the ethics of making money. Not the business of earning money, but the business of producing it.

Money production has been monopolized by the state for so long that it is difficult for us to even conceive of it is a business. The very idea sounds like science fiction. But might this not be in the good sense of science fiction, the sense in which it invites us to question fundamentals and consider what else is possible?

Money production is a business, one that happens to be a state monopoly, generating massive financial gain for the state in multiple layers. Like any business, even a state monopoly, money production ought to be viewable from the perspective of business ethics.

Is the monopolization of money production by the state really necessary, wise, or ethical, or is it simply a practice of long standing that needs to be called into serious question? The Ethics of Money Production takes on just this challenge from both ethical and economic perspectives.

For me, this book came at the end of a concentrated series of readings I did on money and banking issues. Years earlier, I had read several works in the free banking literature from Larry White, George Selgin, and Kevin Dowd, but this time my readings included The Case Against the Fed, The Mystery of Banking, Money, Bank Credit, and Economic Cycles and a series of more recent back-and-forth academic articles on the fractional reserve vs. 100% reserve debate. Even after all this, Hülsmann's volume had a number of unique and important perspectives and insights to offer.

While it is simply stated, it covers a tremendous breadth, touching on all the key issues at just the right level of detail to make it accessible without oversimplifying. It squarely addresses the issues from both ethical and utilitarian angles while clearly distinguishing which is which. It gives priority to the ethical. If something is just plain wrong, there is no basis for excusing it on some set of utilitarian grounds. Nevertheless, the author is also in thorough command of all the utilitarian arguments made in favor of what he identifies as unethical money production, and he examines them all, finding each to also be flawed or self-contradictory on purely economic grounds.

He finds that there has been no real attempt to defend conventional statist monetary practices on ethical grounds at all, and indeed, he can uncover no non-utilitarian ethical grounds in support of such practices to even address. Moreover, he finds substantial grounds for condemning these practices as fraudulent and socially destructive on many levels, from both ethical and purely economic standpoints.

He summarizes the forms that this destruction takes. The continuous loss of value of everyone's money discourages saving, responsibility, and long-term planning and thereby even assists in the break-down of family bonds and other institutions of civil society. The sole beneficiary is the state itself and its closest friends, the banks that help finance its activities beyond what the citizens would be willing to pay in visible taxes.

Inflationary financing is essential to state power, to its wars, to its expansion, to the consolidation of its domination of its subjects. Control of money is a central, if not the central, strategic issue in the strength of the state, providing the state with a nearly limitless means of financing itself at the expense of its subjects in a way that is hidden from, and quite mysterious to, most of them.

What is new in The Ethics of Money Production?

Hülsmann goes even further than his predecessors in imagining the conditions of free market money production. A key weakness in previous formulations was a working assumption that only one type of metal would form a circulating monetary unit. However, it is quite possible that more than one could function in parallel for different purposes. There is no need to have an arbitrary, state-imposed "bimetalist" exchange rate between metals, which has historically driven one or another metal out of circulation whenever the market rate for it exceeded the official rate. In a truly free market for money, gold could end up being used for higher-end transactions and savings, and silver and/or copper coins for everyday transactions. He mentions historical precedent for such arrangements where, for brief periods, the state has not banned them. The metal rates would obviously have to float, as all state-manufactured bimetalist disasters and Gresham's Law-generated deflations in history have clearly demonstrated.

Multiple, freely floating monetary metal currencies are also defensive for the monetary order as a whole. If one metal begins to become corrupted or weakened for any reason, it is easy for consumers to switch to another at the margin. This helps preserve monetary stability, tending to mitigate and rebalance speculative value shifts, and preserves for consumers the ability to quickly and dynamically shift away from any potential problem areas. This is exactly the same consumer power that the state has always sought to take away in order to protect its sad parade of monopolistic funny-money schemes. The essential point is to have total monetary freedom, which means that people are never forced to accept money they do not wish to, and are free to use any money they do wish to.

The book also pointed out a subtle error in previous monetary standard formulations. Saying that "an ounce" of a certain grade of a metal is the monetary unit is not clear enough. Rather, it may be better for the unit to be a specified type of coin that contains this amount of metal.

It is costly to mint coins. If the monetary unit is not specified as a coin, a debt of 100 ounces could be paid, for example, with 100-oz. bar instead of 100 coins. However, the bar is quite likely to be less valuable than the coins because of liquidity differences and minting costs. The market solution would likely be to make a specified type of coin itself function as the contractual monetary unit. If someone wanted to pay in bullion, it would have to be discounted so that the value of the 100-oz. bar, for example, would be lower than the value of 100 of the minted coin units, and a balance would be due in addition to the bar.

Understanding this means taking yet another step toward the consistent application of the subjective theory of value in monetary theory. In this scenario, the bar, even though of the same metal, is not the money; it is just another commodity. This is because "money" is an economic rather than a physical concept. The coin, in this example, would be the "money," but not the bar.

As Hülsmann shows, all such problems, such as confusion as to the actual monetary unit, ultimately arise from the state arrogating to itself the right to set arbitrary "standards," which inevitably have some flaw in them that leads to problems that people operating in free markets could easily have solved and would not have generated.

But the state does this for a reason: it profits. That it profits at the expense of its subject population, should be the first point taught in any exposition of monetary theory. In state-run educational institutions, however, how much prominence is this point likely to be given?

As expected, it is hidden as well as it can be. The author shines light on it for all to see and shows a way forward that is at the same time more ethical, economically sounder, and truer.

Prices should be falling

The long-term price level should be falling due to productivity growth. The fiat money monopolists' grand concern about how far inflation is above zero is silly. Keeping the price level flat is still a massive form of theft out of the pockets of every net positive holder of the state-mandated currency (other than some of the first recipients of new infusions). This is because the price level not only should not be rising, it should not be flat either. Indeed, it should be falling, as it did in terms of gold before the replacement of real money with paper monopoly tickets issued by state cronies.

The creation and near universal spread of the image that as long as inflation is not too far above zero, everything is fine, is a massive delusion, which masks a truly mind-boggling embezzlement racket. Even if central banks did manage zero inflation, the fact that prices were not falling with ongoing economic progress would indicate the ongoing degree of currency depreciation relative to the progress of the real economy.

What is "currency depreciation?" In the case of fiat money systems, it is embezzlement of the savings of every single person all the time everywhere. Rather than steal particular pieces of money, treasuries, central banks, and their cronies steal portions of the value of all the money that exists (leaving it all where it is in cash and deposits), and divert it into their very own newly printed notes and newly infused magical deposit credits for Wall Street. No mere private bandit could ever dream of running and maintaining such a crime syndicate.

What's the defense? A couple of possibilities. Own tangible assets (buildings, metals) and minimize holdings of fiat currency. Another—commonly adopted in the US, but not necessarily recommended—is to be in debt. Currency depreciation harms those with positive net cash and benefits those with negative net cash (the devaluation of a negative creates a double-negative and therefore a positive). No wonder there are so many in debt. Saving in fiat money is punished.