Bitcoin and the theory of money in the tradition of Carl Menger

Economics Economics Questions
21

Nobody is actually buying anything with bitcoins…Nobody is actually reading your blog.

A medium of exchange is something you use to buy stuff, not something to sleep on. If nobody is buying anything with bitcoins, then it is not acting as a medium of exchange. If over 99% of the world has never owned a bitcoin, and if over 99% of those who owned one never bought anything with it, that is a strong refutation of the claim that bitcoin is, as we speak, a medium of exchange.

A blog, on the other hand, is a personal experience, independent of what anyone else does. Even if only one person reads the blog, he has gained by it.

BTW, plenty of people are reading my blog. You read it regularly Pete, and grace it with your comments, at least the bitcoin articles.

22

This does not match the definition of direct and indirect exchange as provided by Mises. Both the situations you describe are an example of indirect exchange, an obtaining of a medium of exchange in order to sell it in the future for another good. You’re taking off the shackles of Mises and building your own theory.

It does not even explain all the possible options. In Somalia, the old schillings continue to circulate, even tough there is no real taxation and no direct use for the bank notes. Most of the gold, similarly, is used for monetary purposes and not consumed.

You also ascribe to the state the powers that it does not have or at least do not typically use. The only thing it needs to introduce fiat money is the existence of money substitutes and the power to fix exchange ratios. Gresham’s Law will take care of the rest, no need to ban anything. Indeed, bans of use of foreign monies are only characteristic in closed and centralised economies (such as during communism). Furthermore, if your argument was correct, then international trade would be impossible, since at leat one party needs by definition to use the currency other than the local fiat one.

Now, I admit that both your categories can explain a part of the demand for a particular medium of exchange. But that’s not the reasoning behind the Misesian classification system of money. The reasoning behind the Misesian classification was to explain the price of money. You only explain demand, and for that matter only a part of it.

23

/Sorry, nothing of educational value to add as of yet. Essentially bookmarking for later.

24

Smiling Dave,

I’ll just repeat that based on both my own calculations as well as the ones from the article you link on your blog, the velocity of circulation of Bitcoin is greater than M2 velocity of either USD or Euro, and that the argument from “hoarding” is decidedly anti-austrian, rather it is keynesian and gesellian.

Your “definition” of a medium of exchange (which took me over a year to pull out from you) is something you invented yourself, with no references to the Austrian school. I thorougly debunked your definitions on blog posts and exposted how you contradict yourself.

Yes, I read your blog, but I arbitrarily decided that there is a limit of five people for it to matter, and until then it can be arbitrarily ignored. Same as you aribrarily decide that whatever amount of Bitcoin users, it’s irrelevant.

25

Could you give an example of a multi-step indirect exchange?

26

Conza,

Hurts to see that. The great Magic Johnson.

27

Your theory that bitcoin provides the value of low transaction costs of other currencies (like USD) relies on there being steady demand for bitcoin in the first place. Where does this steady demand come from? There is no steady demand, as there is nothing steady in the future (such as direct use) to tie its price to. Low transaction cost cannot be the theory of value of Bitcoin.

You also say: “well, if you do the transaction really quickly, then you don’t risk it changing its price very much”. So Bitcoin only works well for indirect exchange if after you get it you have to immediately buy something else with it? That seems like the worst possible indirect exchange good.

FYI: For my purposes indirect exchange and money are interchangeable. No good ever reaches the state of universally accepted, and the mechanism remains the same for the two. Money thus is simply a widely used good in indirect exchange.

28

I sell a loaf of bread for a bag of beans. I buy a fish with the bag of beans. The fish-seller buys milk with the bag of beans. The milk-farmer who accepted the bag of beans as means of payment eats the beans.

Or: you work for dollars. You buy a fish with your dollars. The fish-seller pays property taxes with those dollars and receives the good of not going to jail and keeping his house.

29

I see three single-step exchanges there, not a single three-step exchange.

Same here.

30

secure durable pseudonymous cryptographic communications.

31

Oh wow, I hadn’t realized this board supported a “hide signatures” option. It’s in the Edit->Site Options page by one’s name in the top-right of the page, BTW.

32

Nielsio provided one, I will provide others that are more relevant for our daily uses: using a credit card, using a debit card abroad, international wire transfers, western union, … They all go through multiple steps of exchanging one form of money into another, sometimes between two money substitutes of the same currency, sometimes involving a forex trade. We typically perceive it in a smooth fashion, but it’s a complicated mechanism of ugly hacks build on top of each other.

33

There is no such thing as “theory of value”, there is only catallactics. Demand for low transaction costs comes from both parties to the trade. A merchant can split his savings by offering a buyer a discount. Forex speculators establish bid and ask orders, providing a mechanism for the parties to the actual trade to use Bitcoin. As long as forex speculators think they can earn on fluctuations, there will be a full loop of demand and supply. But this is just one possible way a sustained economy can work. There are plenty of other motivations through exogenous factors (financial crisis, capital controls, …), or ideology, which add to demand. And due to the network effect, as long as the comparative advantage in transaction costs persists, we can expect the ecosystem to grow. Similarly to the internet: as long as it decreases transaction costs, people will move to it instead of the alternatives (such as the post office, the fax machine, the library, and so on).

You can hedge price fluctuations, in particular in an advanced monetary economy as we have now. Hedging is not free, but that still leaves a margin for a decrease in transction costs. Specialised services providers do this for a fee, or you can roll your own, the barriers to entry are very low.

But before something is money, it must be a medium of exchange. There is no way around it, and Mises affirms that money must be explained through catallactics. There is a transition phase when a medium of exchange is not money yet. That is where Bitcoin is now. Furthermore, there is nothing saying that if something remains a medium of exchange forever yet does not become money, that that is somehow bad.

BTW have you read my thesis yet? I explain a lot of things there, including references and so on.

34

You said:

“..one could easily assert that acceptance of bitcoin is based primarily upon usage. this is because bitcoin has industrial value.”

So people are accepting a bitcoin in exchange for their 260 USD even though there is an almost free competitor available in the form of PGP or OTR encryption? Do you have evidence that even a single person is using Bitcoin in ‘secure durable pseudonymous cryptographic communications’?

35

Bitcoin, more like Bitch-coin. Am I right?

36

Even those situations can be broken down into sequences of multiple single-step exchanges.

37

But what are they basing their speculation on? Again, you’re assuming a steady demand to exist for this to be able to occur. So what actually drives the price of Bitcoin?

If I have a photograph of a car, it will not be able to get me from A to B. If the government trains stop working, that does not suddenly make my photograph of a car more useful for transportation. Similarly, pointing to the financial crisis, capital controls, etc, are not things that actually give Bitcoin value.

Yep, that is what I am arguing. People believe Bitcoin is a good money alternative, but they do not understand how indirect exchange actually works. So what you get is something extremely volatile, the price of which is driven by Bitcoin enthusiasts, which precisely is not useful for indirect exchange.

I had skimmed through it before, but I just read through it properly (until page 49).

You’re basing your writing on Mises and Rothbard, who’s value theory (regression theory) I do not accept. You use the phrase ‘network effect’, but appear to leave it unexplained.

38

I believe this short article will help to further an understanding of Bitcoin. I’ve rewritten and reworked this from a previous post:

Bitcoin, Commerce, and Contracts

There has been a lot of discussion and debate about Bitcoin recently, but relatively little discussion about the merits of Bitcoin as a payment system. A better understanding of Bitcoin requires that we understand something about the original problem that Bitcoin was designed to solve.

Below this article I’ve pasted the first two introductory paragraphs written by Satoshi Nakamoto explaining the original intent of the Bitcoin payment system. I’ve bolded the phrases that refer to “trust” and “nonreversibility.” In his two opening paragraphs, Nakamoto refers to the idea of the “trusted third party” six times and to idea of “nonreversibility” four times. As is clear, Nakamoto’s intent was to design a payment system that eliminates the middleman in an exchange between two people, and that therefore prevents the possibility of the middleman reversing the transaction. Bitcoin was designed to solve some specific problems that arise in Internet commerce.

For those who may not be actively involved in running a business that depends on third-party payment processing, the problem that Nakamoto proposes to solve with Bitcoin is an important problem not only from the point of view of commerce, but also from the point of view of libertarian contract theory.

Third-party payment systems such as Visa, Mastercard, American Express, and PayPal, act as a middleman when a customer makes a purchase from a merchant. When a dispute arises, the payment processors may resolve the dispute using its own judgment, criteria, and procedures, in disregard of the contract that may have been agreed to by the customer and merchant. For example, the customer and merchant may agree that the current transaction is a “final sale” and that no returns will be allowed. The transaction occurs and the customer receives the good or service in question. Upon receiving the good or service, the customer then changes his mind and demands a refund. The merchant refuses to process a refund, so the customer appeals to Visa or PayPal asking for a reversal of the payment. In effect, the customer asks the third-party payment processor—who ultimately controls the debits and credits—to force the merchant to issue a refund. The payment processor (Nakamoto’s “trusted third party”) may in this case reverse the transaction and grant the customer a refund regardless of the contract that had been agreed upon by the merchant and customer.

Essentially, the “trust-based” or “third-party-based” payment processing systems (Visa, PayPal, etc.) are not bound to enforce contracts between trading parties. Since the third-party payment processor cannot be trusted to enforce a contract between trading partners, the parties to a trade must incur additional—and often high—costs, in an attempt to ensure that the trade is executed according to the terms of the contract. The parties must either meet face-to-face and conduct a physical exchange, or they may transact electronically and then seek to enforce the contract through the court system when one of the parties reneges on the contract . “Trust-based” payments effected by a middleman who is not bound to enforce the contract between trading partners are inherently risky and uncertain. The middleman may at any time and for any reason reverse the payment regardless of the contract between trading partners. This is the important commercial problem Nakamoto’s Bitcoin system addresses.

The Bitcoin payment system also drastically lowers the cost of payment processing (the amount merchants pay to Visa or PayPal). For example, a small merchant can expect to pay between 2.5% to 3.5% of sales in payment processing fees. If a small merchant has monthly sales of $50,000, a typical payment processing fee could be $1,400 per month or $16,800 per year. By contrast, Bitcoin transaction fees are negligible.

What if we were to conduct a survey of all merchants who depend on third-party payment processors and ask them whether they would be interested in a payment system with virtually no processing fees and no possibility of charge-backs (payment reversals)? Many of the academics and social theorizers who are debating the merits of Bitcoin likely have little experience with the costs, problems, and limitations associated with payment processing in Internet commerce. They don’t understand the very real and important commercial applications of Bitcoin and how Bitcoin radically reduces transaction costs thus furthering free trade.

Regardless whether the specific project Bitcoin ultimately succeeds or fails, we can be assured that demand for the services Bitcoin was designed to provide will remain. If Bitcoin fails, then other payment processing technologies along the same lines will be attempted, since the Bitcoin experiment has demonstrated the potential to radically reduced transaction costs for all merchants involved in Internet commerce. Market demand for a payment processing system that reduces transaction costs and enables irreversible payments constitutes market demand for the various components of such a system. Thus, it is easy to understand why individual Bitcoins, as components of a valued payment system, may themselves be individually valued.

In discussing and theorizing about individual Bitcoins, we should keep in mind the Bitcoin payment system of which they are a part, and the important advance in Internet commerce that Bitcoin represents.

Bitcoin: A Peer-to-Peer Electronic Cash System - Satoshi Nakamoto - http://bitcoin.org/bitcoin.pdf

  1. Introduction
    Commerce on the Internet has come to rely almost exclusively on financial institutions serving as
    trusted third parties to process electronic payments. While the system works well enough for
    most transactions, it still suffers from the inherent weaknesses of the trust based model.
    Completely non-reversible transactions are not really possible, since financial institutions cannot avoid mediating disputes. The cost of mediation increases transaction costs, limiting the
    minimum practical transaction size and cutting off the possibility for small casual transactions,
    and there is a broader cost in the loss of ability to make non-reversible payments for nonreversible services. With the possibility of reversal, the need for trust spreads. Merchants must be wary of their customers, hassling them for more information than they would otherwise need. A certain percentage of fraud is accepted as unavoidable. These costs and payment uncertainties can be avoided in person by using physical currency, but no mechanism exists to make payments over a communications channel without a trusted party.

What is needed is an electronic payment system based on cryptographic proof instead of trust,
allowing any two willing parties to transact directly with each other without the need for a trusted third party. Transactions that are computationally impractical to reverse would protect sellers from fraud, and routine escrow mechanisms could easily be implemented to protect buyers. In this paper, we propose a solution to the double-spending problem using a peer-to-peer distributed timestamp server to generate computational proof of the chronological order of transactions. The system is secure as long as honest nodes collectively control more CPU power than any cooperating group of attacker nodes.

39

I was merely attempting to provide one possibility to show that a steady system is possible. So I’ll do a story instead as I don’t think you understood the “model” I presented.

A guy G sells fiat on a Bitcoin exchange in order to buy bitcoins. The counterparty is a speculator S. The G buys goods/services from a merchant M. Merchant sells bitcoins on an exchange and gets fiat, his counterparty being a speculator S. G is able to purchase goods at a lower price. M is able to increas his profit margin due to lower fees and other costs associated with the payment processing. Speculator may or may not earn, but he thinks he can earn as long as someone is trading, because this creates fluctuations.

This is a minimalist closed loop, and the only thing it requires is that Bitcoin decreases transaction costs sufficiently for all parties to profit.

Of course, the whole reality is more complex, but that only creates more opportunities for profit.

Hmm. I’m not really sure how to respond to this, if you’re really that shortsighted. You can transport Bitcoins over the border undetected, you can’t do this with fiat. Your bank account can be expropriated (or deleveraged, whichever you prefer), but cash has high transction costs, so this creates a gap.

If you’re referring to the “virtuality”, you don’t get the network effect. Bitcoin already is a medium of exchange, so these things already work. It’s like wondering why languages exist. They are abstract concepts too, but if you were the first person who invented a language and tried to talk to someone unfamiliar with the concept of language, you’ll fail. But languages already have crossed the critical mass for the network effect, so you actually already can communicate with others.

I think that you don’t understand how indirect exchange works. In one of your early videos, you show a sequence which ends with a medium of exchange being consumed. But that’s not a necessity. That’s only a necessity until the network effect (liquidity) passes the critical mass. After critical mass, a medium of exchange can circulate without being consumed.

We may argue that if all the ideologists left Bitcoin, the leftovers would be below critical mass. That is a valid argument. But that’s an empirical argument and we can’t know for sure whether the criticial mass (absent ideology) has been crossed or not. If it has, then it’s no problem. If it hasn’t, it still can as long as ideology will keep fuelling demand for Bitcoin until entrepreneurs build the ecosystem to the extent that it passes the critical mass.

I must admit I don’t undestand what you’re talking about.

I thought this was obvious, but allow me to elaborate. I hope I will formulate it correctly, but reserve the option of fixing errors later. Network effect occurs when the utility of a good is increased if the number of its users increases. Since it is impossible in the physical sense of consumption, there is always an underlying immaterial good (for the purposes of this argument, I’ll count media of exchange as immaterial goods). Liquidity (salability/marketability if you prefer Megner/Mises) is a type of network effect. The concept of critical mass is more difficult, but the way I use it is that for all users, the utility derived from the good under network effect must exceed the costs. If someone needs to fuel it (maybe they expect future utility, but can’t derive the utility yet), then the critical mass hasn’t been reached yet.

Applied to a medium of exchange, the network effect occurs when liquidity emerges. Critical mass is crossed when demand for other types of utility than that for a medium of exchange is not necessary for the medium of exchange to work.

40

@Autolykos

I must be out of the loop, as I thought indirect exchange was meant to contrast with direct exchange. I was unaware that it had more than two steps.