Bitcoin and the Store of Value Narrative


Manuel writes at juandemariana.org, is a perpetual student of monetary theory, and is a Bitcoin quasi-maximalist (he is almost there).

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Since Bitcoin’s inception, there has been an endless debate about the explanation of its value. What backs bitcoin? Does bitcoin have intrinsic value? Why is bitcoin demanded? To answer these questions many Bitcoin advocates refer to the principles established by the Austrian School of Economics concluding that bitcoin’s main source of value is being a store of value. I believe this conclusion is the result of the toxic block size debate by which both sides of the debate wrongly narrowed the concept of a medium of exchange to money (cash).

To make my position clear about the block size, I absolutely advocate for small blocks. I believe that running a Bitcoin full node should be as easy and affordable as possible so the system is not only decentralized but fully distributed where final users have full sovereignty over their bitcoin.

Going back to the principles of the Austrian school, the most widely followed monetary theorist of this school, Ludwig Von Mises, developed the Regression Theorem in his book titled “The Theory of Money and Credit”. The theorem states that for an economic good to be money it must primarily have other non-monetary uses before it can become money. Bitcoin does not fit this description. Some economists like Block and Davidson have tried to reinterpret this theorem in order to shoehorn Bitcoin into it by claiming that the Regression Theorem applies only to barter economies and does not apply when there are already monetary prices. I don’t think that interpretation is correct and it is also incoherent in and of itself (see Juan Ramón Rallo rebuttal).

Mises’ Regression Theorem is based on the observations made by Carl Menger in his seminal work “On the Origins of Money” where he describes the process of how money arose from commodities. But, what Menger did was make a historical observation, not a theoretical explanation. It was Mises who wrongly took those observations into theory with his unfortunate Regression Theorem.

In an attempt to dodge the Regression Theorem debate others have retorted with Nick Szabo’s views in his remarkable essay “Shelling out: The Origins of Money”, using the collectible and store of value arguments. Szabo’s excellent work is also a historical explanation like Menger, but more detailed and precise from an anthropological point of view.

I shall not spend much time rebutting the claim that bitcoin’s source of value at the very beginning was being a collectible in the literal meaning of the term. That was not what Szabo meant and it is not credible at all to say that the first bitcoin owners demanded it because it was a whimsy, rather than demanding it because they thought it could potentially become a medium of exchange. Bitcoin’s first owners knew well why Bitcoin was invented and for what purpose it was intended.

A popular narrative amongst Bitcoin supporters that apply Szabo’s views claim that money always evolves through the following stages:

  1. Collectible
  2. Store of Value
  3. Medium of exchange
  4. Unit of account

In my view, the above narrative is scientifically inconsistent and as such, it could be easily utilized against Bitcoin by academia and governments to spread negative propaganda like accusing Bitcoin of being a reckless speculative bubble and that there is no scientific support of its value other than “It’s valuable because people value it”. It’s not that I fear too much that they can stop anything - I believe Bitcoin will thrive or not regardless of what haters and supporters claim - though, they might be able to slow down the adoption process a bit.

The narrative is scientifically inconsistent because it deviates from the Subjective Theory of Value as it puts value in front of utility. I don’t want to claim that this theory is set in stone but, if it has to be amended, it has to be very well justified. In my view, there are absolutely no grounds for amendment within the above narrative. As I fully reject the collectible whimsy argument to explain Bitcoin bootstrapping, the only argument left is that the collectible is valuable because it is a store of value, which is obviously circular and therefore explains nothing. Game theory does not resolve that circularity either. Moreover, it is also confusing that the narrative assigns to store of value the properties which belong to medium of exchange (portable, fungible, divisible, quickly verifiable, etc).

Here I will explain how Bitcoin fits very well within the Subjective Theory of Value and also within the historical stages of exchange described by Carl Menger. Leaving apart deferred exchanges (i.e. credit), the basic first three stages of spot exchange are the following:

  1. Direct exchange: Barter.

  2. Indirect exchange: When exchange is done in two steps using an intermediate good. Szabo’s concept of “collectible” is a particular case within this category, which is using goods for long term indirect exchange.

  3. Money: When a good used for indirect exchange is widely accepted.

We would deal separately with the concept of Unit of Account because this function fulfills the need for economic calculus which is an extremely important need, but different than fulfilling the need for exchange. Regarding the store of value function, it is not exclusive to money or proto-money, as all economic goods are by definition a better or worse store of value.

So going back to Menger, we find that to overcome the problems of direct exchange (barter) humans began to use some goods for indirect exchange, that is, demanding or hoarding a good not for consumption but for exchanging it for other goods in the future. For example, if they had the possibility to decide on hoarding cereal or eggs, it is reasonable that they chose cereal as it is more durable and divisible. As the concept of a medium of exchange is still not imaginable for them, they wouldn’t be able to assess how cereal could be demanded by others to use it also for indirect exchange. They would just rely on others demanding it as food in the future (durable) while they could potentially use it for several different exchanges (divisible). Once this experience is repeated, the concept of medium of exchange clearly reveals itself and it is immediately picked up by human entrepreneurship to be further exploited.

Each individual might choose completely different goods for indirect exchange depending on what they have available and when they are expecting to need them for exchange, so a convergence between individuals to choose the same good for this purpose is initially not necessary. The convergence would come naturally afterward, once humans have discovered the concept of medium of exchange, and that’s when the most salable goods begin to compete for being a generalized medium of exchange (i.e. Money). The game theory concept of focal point kicks in at this stage reinforcing the demand for the most salable good.

A key concept in this debate is the term of the exchange. For a good to be money it is implicit that it serves well its purpose in the short term. This is also implicit in the words “most salable” within Menger’s definition of money “the most salable of commodities”, which Carlos Bondone has generalized to “the most salable present economic good”. If it only serves its purpose in longer terms it might not be money but, it would still be a medium of indirect exchange.

But, in this post, we are interested in the bootstrapping process to achieve that salability. Let’s refer back to the stage of goods being just a medium of indirect exchange. I stated above that humans would rely on cereal’s utility as food to foresee its future demand because the concept of medium of indirect exchange would still be an unknown abstraction for them. If we fast forward to a context where humans already conceptually grasp a medium of exchange, why should they not be able to foresee the monetary demand of any good, regardless if it has other uses or not– that is, its ease of transport, divisibility, durability, and unfalsifiability. This is clearly the case for Szabo’s “collectibles” and also Bitcoin’s case. From a historical point of view, I find it rather unlikely that humans used otherwise useless goods as a medium of exchange without first having discovered the medium of exchange concept through other consumptive goods, but it is certainly theoretically possible.

In the same way that discovering the concepts of adding and subtracting quantities is more natural through comparing physical quantities (i.e. beads, as in an abacus), that does not necessarily prevent humans to skip that step and directly invent written numerals and ledgers. Even though we once used the abacus and its sexagesimal numeral system, it does not mean that all other numeral systems must first be accounted through the sexagesimal system.. We must not confuse the supporting medium by which we historically experiment and discover a concept (i.e. beads or commodities) with the concept itself (arithmetics or Money).

If something arises (bitcoin) that can fulfill the sole use case of a medium of exchange better than the incumbents (barter, salt, gold, fiat etc.), then that is where the demand can be found. Can this demand can be speculative? Yes, it is speculation on the possibility of the good becoming money in the future.

Mises had the following concern regarding new monetary goods that have no other use than a medium of exchange: (Human Action – Chapter 17 section 4 – “The determination of purchasing power of money”)

“A value judgment is, with reference to money, only possible if it can be based on appraisement. The acceptance of a new kind of money presupposes that the thing in question already has previous exchange value on account of the services it can render directly to consumption or production. Neither a buyer nor a seller could judge the value of a monetary unit if he had no information about its exchange value–its purchasing power–in the immediate past.”

So, how is it that a completely new monetary good’s price is discovered? That is the least of the problems. The owner of bitcoin might arbitrarily ask for a price and buyers can accept it or bid at a lower price until they agree on the same price. At that point, the first exchange takes place. In the beginning, the price might be totally erratic, but as more market participants are interested, demand and supply builds and the price stabilizes. This continuous auction process is indeed how prices of goods have always been discovered and it is nothing special for money nor anything new that Bitcoin brought. The fact that many other speculators join in later just for the “lambos” without caring about Bitcoin’s monetary utility is completely irrelevant in relation to bitcoin’s primary source of value. A subject for another blog post is whether or not speculators and traders are beneficial for Bitcoin.

Conclusion

Bitcoin’s origin of value can be fully explained on the grounds of the subjective theory of value and Menger’s definition of money. Because the need for exchange is a basic human need, any good that has the qualities to satisfy that need, (even if it only satisfies that one need), is useful and therefore subject to being demanded.




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