The Commodity Money Myth

Frank Shostak wrote an article about The Bitcoin Money Myth. For an Austrian economist with “over 35 years of experience as a market economist, central bank analyst, and builder of large scale macro-econometric models”[AAS profile], I’m not wholly surprised that he frames his arguments using the commodity theory of money.

Although Shostak does not do so in his article about bitcoin, many economists of the Austrian persuasion often hail back to Aristotle’s attributes of a useful money:

Money must stand the test of time and the elements. It must not fade, corrode, or change through time.
Money holds a high amount of ‘worth’ relative to its weight and size.
Money should be relatively easy to separate and re-combine without affecting its fundamental characteristics. An extension of this idea is that the item should be ‘fungible’. describes fungible as: “(esp. of goods) being of such nature or kind as to be freely exchangeable or replaceable, in whole or in part, for another of like nature or kind.”
Intrinsic Value.
This value of money should be independent of any other object and contained in the money itself.

[Taken from The Market Oracle]

Bitcoin handily satisfies everything in that list, even better than gold, except for the Intrinsic Value attribute. Some have argued that the conversion of electricity to proof-of-work that commoditizes the bits through a process known as mining, giving them an intrinsic value. I’m not convinced, for I think that bitcoins have no “intrinsic value”, they possess only network value as an exchange medium.

To prove my case that bitcoin has no intrinsic value, consider a hypothetical scenario. Suppose that I invest heavily in mining, but that, for whatever reason, bitcoin does not become widely used, and eventually becomes abandoned. The value of bitcoin relative to other goods/services/currencies drops to zero and my investment looks foolish in retrospect. In this case, bitcoin is worse than holding a hyper-inflated cash, because at least that I could use for stacking, wallpapering, or heating.

Yet, historically we have seen items such as paper certificates with negligible intrinsic value appear as money. Usually this proceeds in two steps, and Shostak acknowledges so in his article. First, an institution such as a government or bank issues certificates redeemable to the previously chosen commodity money. These are adopted because they rank higher on Aristotle’s portability attribute. Second, the institution severs the redeemability link. The money continues in circulation, partially because market participants may be reluctant to switch away from the customarily used unit of account and also often because of a legal tender law or keep-out-of-jail token during tax collection. Austrians like to refer to the resulting situation as “pure fiat” or “paper currency” to distinguish it from commodity money. But, as the issued certificates continue to circulate they satisfy the “medium of exchange” definition of money.

Because the intrinsic value of bitcoin is actually less than that of a piece of paper, I think bitcoin makes for a better money! I mean better in the sense that, when bitcoin can be traded for other goods/services, it does so purely because of its value as an exchange medium. That is, the price of a bitcoin is more purely function of its exchange prospects, than for any other currency in history. For econometricians, bitcoin operates as a better measuring tool:

  • The total supply is public knowledge.
  • The rate of mining (expansion of money supply) is public knowledge.
  • The entire transaction history is public knowledge and provides a wealth of computable information about velocity, network connectivity, etc.

If Shostak seriously believes that “money emerges out of barter conditions that permit more complex forms of trade and economic calculation” then he should be in love with fully digital currencies.

Although bitcoin fails on the Intrinsic Value aspect of Aristotle’s attributes, it does possess what I’ll refer to as Extrinsic Value, giving it a mechanism for adoption. That is, in the same way that taxation and legal tender laws coerce the use of fiat currency, the desire to escape that same coercion motivates the use of crypto-currency. Bitcoin has secured a niche market in delivery of goods that government’s dislike, but which a laissez-faire market happily trades. By enabling this market, bitcoin simultaneously gains foothold for expansion and a lesser likelihood of abandonment. Indeed, many vocal proponents tout bitcoin as a possible escape from government managed money. Except for the blockchain growth issues, it may end up bitcoin succeeds in displacing government paper, analogous to why VHS succeeded over Betamax.