What Bitcoin is

Graham,

Trust me, I’ve been through these arguments many many times. I sense, however, that you have no dog in this race and want to know what’s what. [Malachi, look away at this point, please].

I’ve summarized all I have to say on bitcoin in this article on my humble blog: http://smilingdavesblog.wordpress.com/2012/08/03/bitcoin-all-in-one-place/ The comments on the articles are also informative for the most part.

Since I’m feeling generous, I’ll respond to the gist of your post. You say that as we speak bitcoin is being used, by some people at least, as a medium of exchange. No. There is not a person on this planet who uses bitcoin for even 1% of his daily transactions. Nobody goes to the grocery store, or any other store, with a shopping list and a fistful fo bitcoins. Nobody will agree to be paid his salary in bitcoins. Nobody can look in his fridge, or any other largish area of his house, and see it filled with things bitcoins have bought him. In other words, even to the trivial amount of people who have had any interaction whatsoever with bitcoin, it was not as a medium of exchange, meaning something he knows he will go shopping with for most of what he needs.

It all depends on the definitions of those economics terms, but the point of this example was to show that no “thing” needs to be exchanged (not even at base). That is, there doesn’t need to be any backing, at least in the usual sense of “the dollar is backed by gold.” People’s willingness to transact in the system comes not from housecoins being backed by anything, but by their expectations that the system will continue working. You could say they’re backed by the system, like bitcoins are backed by the Bitcoin protocol. This is technically an entirely different kind of backing, but it seems to serve the same purposes as any other type of backing.

In particular, there seems to be little worry that additional bitcoins will ever be created beyond the initial limit of 21 million. The reason is that more than 50% of users would have to support such a change. This is another example of how the structure of the system constitutes the “backing.” We expect that gold will be very hard to mine, and we expect that bitcoins will be very hard to inflate (because the systemic considerations ensure their scarcity).

Housecoins are fundamentally exactly the same as bitcoins; Bitcoin is the Housecoin system writ large, with computers - and cryptographic signing instead of handwritten signatures. There is a hard limit on the total number of housecoins, set by agreement of the users (though with Bitcoin this agreement is enforced far more effectively). Housecoins are just imaginary units in a ledger, and the same is true of bitcoins.

So what I am saying is this whole idea that some “thing” of value needs to be traded was never a foregone conclusion. The new possibility opened up by systems like Bitcoin is that there can simply be a system - a peer-to-peer public ledger - that keeps track of transactions in such an efficient way that it can be used for buying and selling. You still end up with “tokens” that feel in many ways like dollar bills or gold coins, but if you dig down you find that these “coins” are nothing more than agreements among people.

This difference may be trivial in everyday life, but when arguing the theoretical side it must be kept in mind to maintain clear thinking on the subject.

To address the larger flow of this thread, it seems obvious to me that Bitcoin is an entirely new animal and the old rules are showing how they are not worded precisely enough in the way they would need to be in order to address Bitcoin. It is not a commodity and not a money substitute. Moreover, the idea of "commonly accepted" has taken an unexpected turn in the Internet age. How can we privelege the statement, "Ithaca Hours are commonly accepted in the Ithaca community" over "Bitcoins are commonly accepted in the Bitcoin community"? (Note that many bitcoiners are willing to accept bitcoins as payment for anything they own or any service they can provide, so although it may be true that you can't buy everything you need from other bitcoiners, this seems to be a matter of trade infrastructure (ebay-style sites, etc.) having yet to mature in order to facilitate trade among the estimated tens of thousands of users.) Either way, I still must ask how we can privelege the statement "You can buy *any drug* with bitcoins" over "You can buy almost anything with Ithaca Hours *in Ithaca*"?

The Internet has simply taken the importance of physical location out of the picture for many transactions, especially for services. This seems to throw a monkey wrench into the analysis from a classical point of view.

Aside from that, if bitcoins are persistently useful for trading any class of goods and services, and they have been for a while now (drugs and international wire transfers), the only question seems to be how far they will spread. Those skeptical of p2p ledger systems like Bitcoin need to give reasons why they cannot later come to be useful for trading other goods and services. Why must they remain limited to drugs and wire transfers (and webhosting services, programming services, design services, etc...)?

But that’s only true by virtue of government interference! There is nothing stopping gold/cash/etc. from being wired anywhere in the world using exactly the same protocol as Bitcoin itself.

So why it is that it is not possible yet, while bitcoin is already now, all over the world?

You see the difference?

No, it really doesn’t. You can transfer digital token claims to the same physical backing without having to move the physical backing an angstrom. It just sits there while people exchange the digital token claim to it.

Those digital tokens you are speaking about must reside to some centralized entity that allow you to exchange them. Until it decides it will not for some reasons, like happened for example to wikileaks.

With bitcoins there is no central authority and nobody in the world can stop you to make a transaction to someone else.

You see the difference?

Also, a central entity like goldmoney ask for tons of papers (it took two weeks for me to being enabled), while I can start using bitcoins in 0 seconds, withoud asking anyone for permission.

You see the difference?

Now, someone does have to pay for the secure storage of that physical backing. But that’s the whole point of backing a digital currency…

With gold I have to pay for the secure storage, with Bitcoin I do not.

You see the difference?

BTC could drop to $0.000000000000000001 overnight.

Yes it could, but why it should? As more and more people uses it, less likely that could happen [I’m sorry for my awful English, I’m not a native speaker, please forgive me]

Have you ever heard of a numbered bank account?

Yes, I have, they were in Switzerland and they are no more, AFICT.

And have you ever tried to open one of those account? Do you know how much time and money it costs to open and use it?

Again, compare it with opening an “account” with Bitcoin: zero time and zero cost.

You see the difference?

So, while the risk is there, there is also the fact that with Bitcoin I can do things that I can’t do in any other way, right now, in all over the world, so in the end it’s a balance between risk and features.

Bitcoin is a product of the free market because it fullfeeds strong needs, and those needs are becoming more and more stringent due to the more and more government interventions in the economics.

Since all government seems to be heading all in the same direction, I don’t see Bitcoin going away anytime soon, quite the contrary.

You are in error. Read Menger’s On The Origins of Money if you do not believe me. Menger describes much better than Mises what factors influence demand for a medium of exchange and how to detect whether goods are liquid (or “saleable”).

Once again, the “backing” plays no role once a medium of exchange has sufficient liquidity. The function of medium of exchange sustains itself through the network effect. The purpose of the regression theorem is to explain how it gets to the point where the network effect is self-sustainable (i.e. reaches critical mass).

Furthermore, your argument is exactly the opposite of the actual demand: the stronger the state interferes with markets, the higher the transaction costs of fiat will be. Cryptocurrencies are affected by regulation disproportionately less than fiat. So the difference in transaction costs of fiat and something like Bitcoin would rise, and people would be more, not less, motivated, to use Bitcoin.

Somali schillings have low value not because the government can’t enforce their use, but because they had a small value before in the first place, and after the legal tender laws were abolished, there was no way to prevent counterfeiting, so the supply rose. With Bitcoin, neither of those factors are present.

The regression theorem states no such thing.

Suitability for exchange = transaction costs. See Menger in Principles of Economics and On The Origin of Money.

Yet, the acceptance keeps growing, and is motivated by rational choice, since people can lower their transaction costs by using Bitcoin. I understand that your misrepresentation of Mises leads to to denial though. Are you going to deny that the use of Bitcoin can lower transaction costs too?

Poker chips are at best a wannabe money substitute, they are not money in the narrower sense, since they are pegged to another money and are not subject to a distinct appraisal process.

I wonder what you’ll do when the number of people using Bitcoin exceeds the number of inhabitants of small countries. Now it’s already estimated at 500k-1m and it’s growing. And the more it grows, the higher the liquidity and the better the opportunity to lower one’s transaction costs by using Bitcoin.

Can you narrow it down for me? I haven’t read it and have no idea what portion you’re referring to.

Unbacked currencies will die out in a free market for the simple reason that a backed currency is always preferable - it’s the same reason that the consumer will always choose higher quality goods over lower quality goods at the same price. A backed currency can do everything an unbacked currency can (except possibly greater anonymity) with the added advantage of much lower risk.

Clayton -

You are mistaken. If the transaction costs of monetary base (Bitcoin) are sufficiently low, a system with money substitutes cannot compete on transaction costs, as there are costs associated with management of the monetary base (storage and redemption), even in the absence of the state. As I wrote before, adding backing to Bitcoin would increase transaction costs thereof, and would lead to its collapse.

Yes, and while it’s sitting, it causing costs to the issuer. These need to be offset somehow. So Bitcoin wins again.

You admit yourself that there are costs associated with money substitutes. So what you propose cannot beat Bitcoin on transaction costs.

There is also one more bonus, without money substitues, credit expansion is impossible. With money substitutes, you’ll end up with credit expansion and the credit cycle. I’m not sure to what extent that plays a role in the decision making process of media of exchange directly, but it’s a nice thing to have.

Since Bitcoin has no meaningful competition (fiat/gold have too high technological transaction costs, and other cryptocurrencies have lower liquidity), there is no rational reason for BTC to collapse, as the users of Bitcoin do not have any alternative to switch to.

Wrong again, Clayton. Liquidity can outperform the lack of “backing”, and as long as there is a demand for money substitues (i.e. as long as the transaction costs of the “backing” are too high), they prevent the emergence of a commodity money if fiat already exists.

Again, people choose their media of exchange based on transaction costs, not on “backing”.

Wha? I guess this is another gem supposedly buried in Menger somewhere…

Clayton -

A backed currency can do everything an unbacked currency can (except possibly greater anonymity)

Except that storage is expensive for traditional backed currencies.

Except that confiscation is possible for traditional backed currencies.

Except that transaction between people requires a third party that may have political reasons for not allowing it for traditional backed currencies.

Except that opening an account it’s a tedious work, and this too is subject to the will of others for traditional backed currencies.

Except that a currency backed by gold, due to great technological advance, maybe in a distant future could be synthesized.

Except that for traditional backed currencies having to rely on third parties for storing and transacting opens the door to fractional banking and we have to trust them not to (or trust the auditors)

Except that unlike traditional backed currencies a new business can start and sell good and/or services without requiring approval from anyone.

You don’t have a clue what Bitcoin is all about, isn’t?

I suppose that when you realise that with Bitcoin you can do a lot of things impossible to do in any other way you could begin to accept the fact that more and more people are beginning to use it.

It’s a relatively short book. Unfortunately I don’t have good quotes from it, you might need to read Principles of Economics as well.

As I already explained, this is neither supported by the Austrian school, nor by empirical evidence, nor by Bitcoin. Backing is merely one of the factors influencing the transaction costs (trust of money substitutes). But it’s not the only one. Normally, liquidity beats all other factors.

The reason for the apparent confusion of choosing “worse” goods is the network effect (of what liquidity is an example). Network effect affects the value of goods, so it influences the choice. That’s why gold can’t outcompete fiat as a medium of exchange even after legal tender laws are abolished, the network effect poses a high obstacle. That’s also why people don’t switch to, say, esperanto even though linguistically it might be superiour than english.

But the network effect is also not the only factor. Hyperinflation can cause a switch. Technological progress can cause a switch.

And network effect also works for Bitcoin. Network effect gives the first mover a competitive advantage, so other cryptocurrencies have a difficulty of catching up.

Completely wrong. You are conflating the terms ‘medium of exchange’ and ‘money’. They do not mean the same thing. A medium of exchange is any commodity obtained for use in exchange for another good. The term money refers to a generally used medium of exchange. A commodity can be called a medium of exchange even if it is only used as such once.

Rothbard demonstrates the difference in this passage (MES pp. 192-193):

‘A commodity that comes into general use as a medium of exchange
is defined as being a money. It is evident that, whereas
the concept of a “medium of exchange” is a precise one, and
indirect exchange can be distinctly separated from direct exchange,
the concept of “money” is a less precise one. The point at which a medium of exchange comes into “common” or “general” use is not strictly definable, and whether or not a medium
is a money can be decided only by historical inquiry and the
judgment of the historian.’

It is clear from this passage that the term ‘medium of exchange’ has nothing whatsoever to do with the extent it is used, since it would be ridiculous for Rothbard to talk about a medium of exchange coming into common or general use if it had to be such by definition. Bitcoin, therefore, is undoubtedly a medium of exchange.

Actually I think this one is Mises or Rothbard or Salerno, when they analyse the money supply, but I can’t find the quote now.

And by the way, the best refutation of the “if people are free to choose, they choose commodity money” mistake is international trade. In international trade, people are free to choose what to use as a medium of exchange. And what do they use? They do not use commodity money. They use fiat money, with heavy leaning towards those that are the most liquid (e.g. the dollar, euro, pound sterling). Even though changing, say, the Czech crown to Thai baht directly is only one step and changing the crown to usd and used to baht are two, since the liquidity of usd is much stronger, the overall transaction costs are lower with the roundabout exchange.

I might get crucified for mentioning it, but Paul Krugman wrote two papers about the choice of media of exchange in international trade. He uses the term “friction” instead of transaction costs, but he gets right that in normal circumstances, liquidity beats all other factors. He wrote it in the 80s, before he switched to faking alien landings.

  1. Ithaca Hours have been discussed here: https://forum.freecapitalists.org/t/does-the-ithaca-hour-disprove-the-regression-theorem/19489/56

That link is of historical interest, as it shows that Smiling Dave is just like the rest of us, meaning not born knowing everything straight out of the box. He, too, had to learn. He, too, at one time did not grasp the finer points of Mises’ Regression Theorem.

  1. The bitcoin is an entirely new animal fallacy has been addresed many times. I’ll paraphrase what I wrote here:

Let us think back to high school. What was the most difficult course there? Even those who are adept at math might say they had the hardest time with high school geometry.

And what was so hard about it? For one thing, you could not toss together a string of buzzwords and get a passing grade. Faced with a proposition, you had to actually prove it, step by step, justifying each step with support.

The proof had to obey the strict rules of logic, too. You could not say Pythagoras was wrong because he is long dead, hopelessly outdated, a member of the bourgeoisie, did not have an internet connection, or is an entirely new animal. That didn’t cut it. You had to address the idea, not the man.

And when you addressed the idea, you had to show exactly why the idea is wrong. At what line of a proof is there a mistake, and what is the mistake, exactly?

Many people had no clue in high school geometry. They, of course, will also have no clue about AE and bitcoin arguments, because the structure of AE and of a bitcoin argument is similar to that of geometry. It is composed of statements backed up by step by step logical proofs.

Even those who excelled in geometry often found that the kind of thinking that went on in geometry class was never used in the real world, as seen on TV. No politician, for example, ever discusses an issue using logic. Instead they use every kind of argument that would have guaranteed them an F in geometry class. I imagine many college courses work the same way. One learns that tossing together buzzwords will earn one respect, and that actually thinking things through earns one failure, if one reaches conclusions disliked by the teacher.

Thus, the role model of proper thinking, seen only in geometry class, was drowned out by a flood of role models that did not use logical thinking. Pretty sad, pretty pathetic, but pretty common.

So guys, I welcome all comments. But don’t be surprised if my reply will be that you please show me exactly where the flaw lies in my thinking, and why it is a flaw. No more of this “Mises is dead and did not have an internet connection, so he must be wrong” stuff. Get used to logical thinking. Be liberated.

Summing it all up, if you want to show why Mises Regression Theorem does not apply to bitcoin becasue it is a “new animal”, do the adult thing. Summarize your understanding of the theorem. This is an important step, universally used in serious discussions. If you get it right, we can then take the rest of your argument seriously. If you get it wrong, we can mock you.

Next, summarize the proof of the theorem. Number the steps of the theorem, so we can grasp what you will do in the final step, to wit;

Show which line exactly of the proof is wrong because “bitcoin is a new animal”. Also, explain clearly why that line is wrong.

Guys, this is basic rational thinking. It is the gift of the Western World to humanity. It goes on every day in serious dicussions.

One example. Note that every single time, without exception, when Mises in HA or any of his other writings dismisses a competing theory, he always states it, sums up all the arguments in its favor, and then shows why it is wrong.

It is clear from this passage that the term ‘medium of exchange’ has nothing whatsoever to do with the extent it is used,…

Technically, I stand corrected. Indeed, the way Rothbard uses the term, if even one transaction is made where A wants butter, say, not to eat it, but to trade further with it, then butter is a medium of exchange in that one transaction.

But with that use of the phrase, then of course bitcoin being a medium of exchange proves nothing whatsoever about its chances of becoming money.

After all, if Tony the Dunce and Charlie the Retard once used soiled facial tissue that Tony blew his nose into as a medium of exchange, that places soiled paper tissue on an equal footing with bitcoin.Both are media of exchange. But I doubt that the bitcoin lovers will come out so passionately in favor of soiled paper tissue as being the wave of the future as they do for bitcoins, waving about the fact that it is a medium of exchange between Tony and Charlie.

What’s important is what Rothbard mentions a little before the bit you quoted, a medium of exchange in common use, which is what I meant. As it gets commoner and commoner, it may slide into being considered in general use. If it is not even of common use, it has no chance of ever being money.

Here’s are some quotes from Mises that may be of interest.

Money is the universally used
medium of exchange, nothing else. Only because money is the com-
mon medium of exchange, because most goods and services can be
sold and bought on the market against money…

A medium of exchange which is commonly used as such is called
money. T h e notion of money is vague, as its definition refers to the
vague term “commonly used.” There are borderline cases in which
it cannot be decided whether a medium of exchange is or is not "com-
monly-" used and should be called money. But this vagueness in the
denotation of money in no way affects the exactitude and precision
required by praxeological theory. For all that is to be predicated of
money is valid for every medium of exchange. I t is therefore im-
material whether one prescrves the traditional term theory of money
or substitutes for it another term. The theory of money was and is
always the theory of indirect exchangc and of the media of exchange…

History may tell us where and when for the first time media of exchange
came into use and how, subsequently, the range of goods employed for this
purpose was more and more restricted. As the differentiation between the
broader notion of a medium of exchange and the narrower notion of
money is not sharp, but gradual, no agreement can be reached about the
historical transition from simple media of exchange to money. This is a
matter of historical understanding. But, as has been mentioned, the distinc-
tion between direct exchange and indirect exchange is sharp and every-
thing that catallactics establishes with regard to media of exchange refers
categorially to all goods which are demanded and acquired as such media.