This is the first part of a five-part series.
At present, it is misguided to focus on the act of “spending Bitcoin.” Instead, we must strive to encourage people to “earn Bitcoin” and “be paid in Bitcoin.” These are just the opposite sides of the same coin, and it may seem I am playing with semantics. However, I contend that the economic and technical consequences of stressing one viewpoint (to spend) over the other (to earn) are profound and irreconcilable.
The scalability controversy surrounding Bitcoin has given rise to many subordinate and parallel discussions, which is precisely how the topic of the present article emerged. Since the Bitcoin Cash hardfork, the debate has intensified. Although each faction now works on separate blockchains, cryptotwitter remains replete with tweets and threads from both sides.
Bitcoin Cash (BCH) proponents argue Bitcoin is electronic cash and must be used and spent. Money is defined as a commonly accepted medium of exchange. Thus, if a cryptocurrency aims to be money, it must be used in exchange. So, states their rationale.
First, it is indisputable that money’s essential function is being a medium of exchange. But, as argued below, there exist evolutionary steps following a logical path a good or service must traverse to be used for indirect exchange. By ignoring this dynamic, BCHers fall prey to using language and economic reasoning echoing more of Keynes than Mises. They fail to see it is only a matter of when Bitcoin shall be used as a medium of exchange than ifit should be used as such.
Second, the understanding of Bitcoin primarily as a “good to be spent” leads to an entirely different vision for its protocol development, which, by the way, could not be more pronounced when we contrast Bitcoin Core and Bitcoin ABC. So, from a technological perspective, BCHers fail to see it is only a matter of how Bitcoin shall be used as a medium of exchange than if it should be used as such.
This is the first article of a five-part series in which the case for Bitcoin as a “store of value first, medium of exchange later” will be made. In this first installment, the foundation is laid: economics.
Economic theory and money
Mainstream economists tend to either define money very broadly or refrain from defining it at all. Greg Mankiw, whose economics textbook is the standard at universities across the globe, describes money as “the stock of assets that can be readily used to make transactions.” In no order or degree of importance, as is the usual practice among economists, the authos lists the functions of money as MoE (“medium of exchange”), SoV (“store of value”), and UoA (“unit of account”).
Austrian economist Ludwig von Mises, on the other hand, argued money’s defining function is that of being a “medium of exchange,” whereas every other commonly cited function, namely “store of value” and “unit of account” (Mises uses “common denominator” and Carl Menger’s phrase “price-index”), are secondary and can be traced back to the term medium of exchange.
Money’s essence is being traded in exchange for that which one wishes to consume. This generalization is undeniable. Nevertheless, for something to become money, or a universally accepted medium of exchange, it must first follow evolutionary stages.
A good is initially recognized and hoarded as a SoV for deferred exchanges. Then, because of its hoarding, is used as a MoE through a process in which other individuals also recognize its utility and wish to hoard the items for future exchange. Once a good becomes widely accepted and used as a SoV and MoE, ratios of exchanges tend to be priced in terms of the good. In other words, it is employed as the common denominator in the market ultimately growing into a UoA.
Certainly, SoV and MoE reinforce each other until the point at which a good becomes highly liquid (or the most liquid), which enables it to become a UoA. But, if a good is not recognized as an adequate SoV (or has little to no prospects of ever becoming one), then its chances of being accepted in exchange are dim. This is why SoV tends to prevail over MoE at the dawn of a good’s monetization.
How the predominance of each function differs as a commodity gains liquidity may be argued. First, comes the SoV, second, the MoE, and third, the UoA. While MoE is the most important function of “moneyness,” UoA is the defining mark for understanding what things we can call money. While a good is not employed as a UoA, but solely as a SoV and MoE, it can be analyzed in terms of its moneyness or, in other words, its liquidity (Menger’s “saleability”). Colloquially, we will just call it money. From a scientific approach, if a good is not a UoA, then it should not be called money. As this is a digression from the point of this article, the discussion on the vagueness of the word money will be left for another time.
Through the passage of time and increased liquidity, the function of SoV might lose weight on everyone’s demand for cash balance. So, as the economy develops and division of labor intensifies, the proportion of ready cash for overall investments diminishes as one can better anticipate its future in- and outflows of money.
Now, Menger and Mises did not dwell upon the functions of money, nor did they attempt to arrange each in a temporal ordering. For Mises, money’s essential role is facilitating indirect exchange, and everything else that may be theorized about monetary phenomena is inextricably linked to media of exchange. Their indifference to any temporal ranking of functions may be explained by the fact that, during their times, money was already established. Gold and silver were the primary commodity monies with (usually) redeemable paper currencies. Money had emerged and was chosen by the market, so it was no longer a concern to conjecture how a new good could arise to be adopted as a common MoE.
But since Nakamoto’s invention, economists returned to theorizing about money and how it comes into existence. If Bitcoin does become money, then what we are witnessing today is precisely “the birth of money,” which, by the way, was the title of my first article covering Bitcoin (in Portuguese).
The monetization of a good, be it seashells, salt, copper, gold or irredeemable paper currency, occurs over an extended period, such as decades or perhaps centuries. If we are now amid an inflection point of monetary history, then it is paramount we understand what factors are relevant and how matters can play out.
Store of Value takes precedence
Various assets that can be used to store value over time would be considered mediocre media of exchange (i.e., real estate). For goods aspiring to be money, though, the ability to transfer the respective good in an exchange increases its usefulness as a SoV. In this sense, SoV and MoE are interwoven in more ways than economists like to admit.
In practice, then, there is no sharp distinction between the functions of SoV and MoE when we examine monetary phenomena. This makes it essential to understand the nuances of the evolutionary process through which a good becomes money.
A commodity may be employed as a MoE despite being a relatively poor SoV. History is full of examples where commodities were widely used as media of exchange though they performed poorly in terms of value preservation, either because of being perishable or having a less scarce supply. To use Menger’s term, some commodities are more “fit for preservation” than others.
Even for those commodities historically adopted and subsequently discarded as a MoE, it was a precondition to preserve some value through time and space, at least for the period during which the goods were hoarded. As Mises noted in The Theory of Money and Credit, “Menger has pointed out that the special suitability of goods for hoarding, and their consequent widespread employment for this purpose, has been one of the most important causes of their increased marketability and therefore of their qualification as media of exchange” (emphasis mine). So, according to Mises (and Menger), hoarding does cause a good to be used as a MoE, among other reasons.
In this sense, if a commodity is incapable of minimally performing the monetary function of storing value, then this limitation would likely prevent it from being used in exchange provided there existed no law or edict mandating otherwise. Furthermore, a commodity may withstand the test of time by being merely a reasonable SoV and not a MoE (for technical or political reasons, which is covered below). Gold, in modern times, is a prime example.
Swiss National Bank gold reserves.
Several characteristics enhance a commodity’s liquidity in the marketplace, such as transportability, divisibility, and recognizability. However, ceteris paribus, men prefer a commodity that better preserves value over time and space than those that do not.
Now, both Menger and Mises approached the emergence of money and indirect exchange from a barter perspective: a MoE is an intermediate commodity that brings the economizing individual closer to his final goal, his desired commodity. It solves the double coincidence of wants. This intermediate commodity may be demanded for direct use in consumption. To Mises, money’s value can be traced back to when it had no monetary utility, and it was just another commodity being acquired for consumption. This is the thrust of Mises’ famous regression theorem.
Nick Szabo, on the other hand, addressed the theory of money using extensive archeological evidence that were not yet available during Menger’s lifespan. In Shelling Out: the Origins of Money, he identified artifacts historically used to preserve and transfer wealth within ancient tribes. These objects required “unforgeable costliness” in their manufacturing, were collected and valued by primitive societies and were used for transferring wealth (voluntarily or coerced) for inheritance, tributes to conquerors, reparations or even paying the price of a bride in marriage. Collectibles, the term coined by Szabo, can be considered a proto-money representing rare or scarce goods used to store wealth (SoW) and as a medium of wealth transfer (MoWT).
Beads made from shells of the pea-sized snail Nassarius kraussianus, that lived in a nearby estuary. Blombos Cave, South Africa, 75,000 B.P.
To Szabo, Menger’s theory “as an actual description of the origins of money is almost surely wrong — or alternatively, it is even more right than he could have known. This is because money, in the form of collectibles such as shells, predated low transaction cost commodity markets by tens of thousands of years.” Rather than offering conflicting theories, Szabo complements Menger’s writings suggesting that even goods serving no useful purpose or apparent utility, can display desired qualities as money. Therefore, through a careful reading of Menger’s and Mises’s monetary writings, Szabo’s theory on the origins of money and collectibles, the store of a value function can be considered predominant in the initial stages of a commodity’s monetization.
What gives money value
Another angle through which proponents of BCH attempt to make their case is that money must be used in exchange to have value and must be spent. Utility, according to BCHers, is evidenced in the act of spending.
This is where a more nuanced examination of money’s source of value is pertinent.
Money’s essential function is indeed being used in exchange. But, why does money have value in the first place? Because it has purchasing power (PP). Where does its PP come from? The demand for and supply of money. Its PP originates from the demand to hold money and the demand to hold cash balances.
Money’s utility lies in its ability to purchase goods and services, which is derived from individuals’ demand to hold cash balances. Many economists mischaracterize the holding of money as “idle hoards,” as if hoarding was any different from holding for its own sake. As Mises put it, “hoarding money is nothing but the custom of holding a greater stock of it than is usual with other economic agents, at other times, or in other places. The hoarded sums of money do not lie idle, whether they are regarded from the social or from the individual point of view. They serve to satisfy a demand for money just as much as any other money does.”
Along the same lines, Murray Rothbard in Man, Economy and State, added “that money in one’s cash balance is performing a service demonstrates the fallacy in the distinction that some writers make between ‘circulating’ money and money in ‘idle hoards.’ In the first place, all money is always in someone’s cash balance. It is never ‘moving’ in some mysterious ‘circulation.’”
If money were to be spent as soon as received in exchange, it would have no market (or very little) price. As Rothbard stated, “if no one is willing to keep a cash balance longer than instantaneously, there will be no money held and no use for a money stock. Money, in short, would either be useless or very nearly so in the world of certainty.”
The graveyard of cryptocurrencies is full of projects conceived with rules incentivizing users to spend their coins. Idealized in 2011, Freicoin attempted to introduce demurrage as a protocol specification to convince users to circulate coins by “using them” and provide “stable long-term value.” In other words, hoarding was discouraged, and spending encouraged.
Based on the Freigeld idea of German economist Silvio Gesell, “demurrage forces freicoins to circulate at deliberately high rates. Separation of money’s roles as store-of-value and medium-of-exchange allows money to flow when it is needed, in good times and bad. Our careful selection of governing parameters creates a currency whose value is stable with neither price inflation nor deflation… The properties of Bitcoin make it analogous to precious commodities like gold or silver, and it will always function as a useful store of value. Freicoin, on the other hand, is meant to be used as a medium of exchange only, kept on hand just long enough to provide a cash-flow buffer.”
This approach underlies the theory. But, humans have a way of proving economists’ theories wrong. If users were disincentivized to hold freicoins, then why would anyone accept them in the first place? BCHers may not appreciate this inconsistency, and would certainly dispute the following claim, for, in a sense, they have become present-day freicoiners.
Read the second part.