@Smiling Dave
As I understand it, the theory is that gold became used as money not only because it was valued for it’s use as jewelry, but because it had relatively high value compared to its weight and volume (it was easy to travel with for example) and also because the demand was common enough that it could be traded in far away places. (Gold also has many other intrinsic properties making it practical, but so does bitcoins.)
The critics of bitcoins say, since bitcoin only has a tiny initial demand, less than a dime, and it’s only traded by a tiny group of computer geeks, it can’t become money.
I think, perhaps, part of the disagreement then is because of some unique advantages that comes from using a digital and Internet based medium which might not be immediately apparent. It would certainly have sounded like science fiction 50 years ago.
First of all, even if bitcoins are worth less than a dime, bitcoins have no weight or volume. Both 0.00000001 BTC and 21 million BTC fits on a USB flash drive. Transferring the smallest fraction cost as much as transferring all bitcoins that exist. So even if bitcoins only have a tiny value, it makes it possible and practical to use them as a medium of exchange. Secondly, even if there is only a handful of fools that are willing to exchange bitcoins for money, thanks to the Internet, anyone can get in touch with them (for example at mtgox.com) in an instant and they can make the exchange in less than a few minutes. I think the Internet might have lowered some requirement physical money has that rules out, say beanie babies, as impractical.
Also, I think an important point is that there are other, more practical, alternatives to physical money than beanie babies, like USD or precious metals. Given no better alternative people might actually use beanie babies as money. Most people use some national fiat currency rather than, say precious metals, despite the disadvantages, probably because paper money is more practical than gold coins.
If we could use gold or other traditional forms of cash on line, most people would probably prefer to do so in favor of bitcoins, but currently the only alternative is credit cards or centralized services like paypal who a takes large fees. (Despite these fees, many people still prefer credit cards when they could have used cash, because digital transactions are more practical (and the fees are hidden.)) If people perceived bitcoin as more practical and safe (or at least beneficial enough) why wouldn’t they use them when paying on line?
My background is with computers so I might find the idea of bitcoins having some intrinsic coolness more believable than someone with a background in economics. Not so long ago I still believed most money was based on the gold standard, and I admit the theory behind currency is completely new to me. I will try to summarize the way I understand the regression theorem in order to rule out any misunderstanding. Based on the excerpts from Mises texts on your blog, I would summarize it as:
- An economic good initally has a value due to some demand (before it’s use as money).
- If a good becomes popular as a medium of exchange, it would create additional demand. If the supply is limited and the demand increases so does it’s value.
- “Now the extent of that part of the demand for a medium of exchange which is displayed on account of its service as a medium of exchange depends on its value in exchange”.
In other words, in order for the first trader to accept bitcoins in exchange for his goods he must be able to later trade the bitcoins for some good he wants. This can be done at exchanges such as mt. Gox where bitcoins can be traded for dollars, wich is something many people wants/need. So it’s possible, although risky perhaps, to use bitcoins as a medium of exchange.
Since there is a limited supply, if bitcoins where to become a popular medium of exchange it’s value would increase due to increasing demand. (And if popular enough it would eventually be considered money by most definitions).
This is what the bitcoin speculators are betting on. Some bitcoiners even seem to argue that the initial demand for bitcoin could come from speculating that the demand will increase when bitcoins are used as a money in the future. This seems paradoxical but I can’t think of a reason it’s wrong.
The main question is this though: what happens if the initial demand eventually disappear (because it’s a fad)? As far as I understand the regression theorem it doesn’t say anything about that. Or rather, it actually indicates that the money will retain its value due to the demand for its use in transactions. As far as I can see, the critics claim this would be the end of bitcoins but no one has explained why.
As bitbutter says somewhere, the key difference from gold is that there is some industrial demand for it:
“Unlike gold, the price of Bitcoin could fall to zero if there was a loss of confidence it its future tradeability. In the event of a loss of confidence in gold, gold holders could likely still sell their gold to certain buyers (for a fraction of its current price). It’s not clear why you, and others, apparently [claim] that this one marginal advantage enjoyed by gold (a better assurance of a minimum sale price) should be considered the dividing line between money and non-money.”
I agree there might be several reasons why the confidence in bitcoin as a transaction medium might disappear (if there is a flaw in the encryption scheme used for example). But if we say its usefulness as a transaction medium is constant and the number of bitcoins is constant, why would the demand (and consequently value) drop to zero within a few years?
