Bitcoin is a digital currency, and, with a total market cap at over 100 million USD, the most widely used alternative to state-issued money. Importantly, it does not rely on a central authority for its creation, but is instead administered through a decentralized peer-to-peer network and produced through a process referred to as ‘Bitcoin mining’. Bitcoin has become popular amongst those who see the harmful effects of the current fiat money regimes and who see Bitcoin as a possible escape from the centrally controlled and continuously debased state currencies. It is possible that if something like Bitcoin was able to grow in popularity to such an extent that it rivalled the fiat currencies of the world, great pressure would be put on central banks’ money creation activities, as people would have in Bitcoin an easy to use and anonymous medium of exchange to escape to, and which does not suffer the same inflationary flaws as the state’s monopoly money. Bitcoin, therefore, could be a means to strike a major blow for liberty. Despite that, it has its sceptics even within the libertarian community.
Some, such as Smiling Dave (who operates a blog and posts on the Ludwig von Mises Institute Forums), say that the idea that Bitcoin could emerge as true money is contradictory with a part of economic theory known as the Regression Theorem of Money, and, due to that contradiction, it could never be considered money and is in fact doomed to failure. In that view, it is merely a bubble inflated by speculation and Bitcoin fanboys, and ripe for bursting. In response to the view that Bitcoin violates this Regression Theorem and that it therefore should not be taken seriously, some proponents of Bitcoin have gone to the length of rejecting the Regression Theorem altogether. Is such a step warranted? Or could there be a third view, which demonstrates a harmony between the demand for Bitcoin and the Regression Theorem, and allows for the possibility of Bitcoin becoming more widely accepted as money in the future? In this article I will attempt to make that very case.
Before we turn to the Regression Theorem of Money and how it relates to Bitcoin, we first have to understand the definition of money. By talking about money, we are not referring to any particular kind of currency such as gold or dollars, but rather to any generally accepted medium of exchange. A medium of exchange is any commodity that is used not for its direct use, but instead is obtained with a view to trade it in turn for another good. We also have to realise that the definition of money as a generally or commonly accepted medium of exchange does not give us a clear-cut understanding of what should be considered money and what should not be considered money. There is not a point at which we can distinguish a good as transforming from a medium of exchange not generally accepted into a true form of money. We can nevertheless identify where certain media of exchange clearly exist as generally accepted ones, e.g. the USD within the USA and the AUD within Australia.
Now I have already referred to the Regression Theorem of Money and its crucial place in a debate about the question of Bitcoin as money. Before getting onto that latter question, I will explain the Regression Theorem and its purpose. The Regression Theorem, as developed by the economist Ludwig von Mises, solves a particular problem in understanding the emergence of money. Because the demand for money comes from one’s ability to use it in trade for other goods, i.e. from its exchange value, and because this exchange value is in turn based on people’s willingness to accept it in exchange for goods, i.e. on its demand, we are met with an infinite regress if we simply attribute demand to exchange value, and exchange value to demand. Now, we can see in real life that these two things are based on one another in an economy where money operates, but the question is: how could this relationship come into existence? Why would someone demand a commodity for use in future exchange when no commodity is generally accepted as a medium of exchange? If a generally accepted medium of exchange is not already existence, one cannot be sure that he can eventually offload a good which he does not desire for his own employment. Only the barter of directly desired goods would exist as a common transaction. How then, did money come about?
The answer given by the Regression Theorem is that the goods that eventually become demanded as money, i.e. for their exchange value, are initially in high demand for their non-exchange value, e.g. for their value in direct use. Because such commodities are the most marketable goods vs. all others, they become more readily accepted in barter, since those who receive them know that, due to the high demand for their direct uses, such goods will be easy to exchange for goods that the recipient desires in the future. From this process of the most marketable goods being accepted due to the demand for their direct uses, such goods become generally accepted as money due to their common use as exchange goods. Here the Regression Theorem explains, purely through logic, how money could arise from an environment lacking a generally accepted medium of exchange. The most important thing to take from the Regression Theorem for our purposes, however, is the fact that in order for goods to become money – generally accepted media of exchange – they must have been demanded for their non-exchange value, whatever that might be. That non-exchange value does not have to be direct consumption use, but might for example be a good’s ability to facilitate the exchange of true money, as in the case of the use of gold certificates that represent gold but are only paper, and from which we can explain the origin of modern fiat currency.
But how does this apply to Bitcoin? We see that Bitcoin is being employed as a medium of exchanged which demonstrates that it is in demand as such, but how could that come about in light of the Regression Theorem? Is there some non-exchange demand that initially drives this, as the Regression Theorem requires, or should we, as some have done, abandon the Regression Theorem with the realisation that Bitcoin proves it unnecessary? As I have said above, it seems to me that there is in fact no contradiction with the current demand for Bitcoin and the Regression Theorem. All we need to do in order to explain this fact is to understand the reasons for this demand.
One theory attempting to explain this argues that it is the demand created by speculation on the future price of Bitcoin which allows for Bitcoin’s exchange demand. According to this theory, speculators, believing that the advantages of Bitcoin are such that its price would greatly rise were it to come into wider use, are effectively demanding Bitcoins without the aim of directly offloading them. Thus the demand created by their activities has resulted in an environment of reliable exchange between Bitcoins and national fiat currencies, e.g. USD. This demand acts like the initial demand for direct use in the Regression Theorem, which allows a reliable exchange between the most marketable good and all other goods. In the same way, the speculators’ non-exchange demand has allowed for Bitcoin to gain an exchange demand by facilitating the use of fiat currencies which already exist as money in certain contexts.
This is quite like the way in which gold certificates could be used in the 19th century: though they were only made of paper, they facilitated the transfer of gold (since they were redeemable for gold) by being easier to transport, and so came into wide use. In the same way, Bitcoin has established a reliable transfer with fiat currencies (akin to redeeming gold certificates for gold), and can ease the use of those currencies. This is what makes Bitcoin different from any traditional kind of private fiat currency. The high degree of anonymity that Bitcoin provides is probably the chief factor in its ability to facilitate the use of already existing money, but we can also point to Bitcoin’s low inflation rate and security as advantages over trading directly in fiat money. Indeed, Bitcoin has been employed for its anonymity to ease the purchase of prohibited items such as drugs (on, for example, the black market site Silk Road). Bitcoin, therefore, due to its nature as a decentralized, encrypted, digital currency with a high degree of anonymity, has definite advantages in co-existing in a market with state fiat currencies. What makes the speculation theory even more attractive is the fact that the rate of Bitcoin mining is set up to benefit early adopters. Thus there is an even greater incentive for people who favour Bitcoin to build up their stock early, which in turn creates exchange between Bitcoin and fiat moneys.
The speculation theory gives only one possible reason for the initial demand for Bitcoin, in line with the Regression Theorem. It could be that the non-exchange demand for Bitcoin is a result of some other cause altogether, which has eluded this writer. The fact of the matter, however, is that there is indeed demand for Bitcoin, and, furthermore, that we needn’t throw out the logic of the Regression Theorem of Money as a consequence of that fact. Although it cannot be foreseen whether Bitcoin will rise in popularity and become an even more generally accepted medium of exchange, or on the other hand collapse and disappear from use, there is nothing in theory that prevents either of those outcomes from occurring. That is an empirical matter and cannot be known from theory alone.
Well written. There are a couple of additional points, first being that Bitcoin is the result of a combination; it is not an atomic commodity. Being composed of accounting, cryptography, and networking technologies, there are multiple areas from which the system could be said to draw its originating value from. Perhaps discovery of its value needs to begin further upstream.
Next is the potential for substitution, wherein one item is replaced by another, and in doing so assumes the associated value. Pattern similarity would allow for an established structure to pass value on to even an incrementally improved variation. If the underlying structure is substantially different, but the functional similarity is sufficient, the barriers to adoption may be very low.
Finally, there is incentive structure. A unique commodity may have no other value, but that uniqueness might be the very reason for its value, so long as there is a demand for rarity. The item’s other properties would then determine whether being unique is enough of an incentive to overcome them.
Thanks for the response. On the first point, I have heard it suggested that some cryptographic feature of Bitcoin was the initial reason for its use, but I haven’t seen any further elaboration on that. Would you happen to know anything more about that?
Bitcoin satisfies the regression theorum. Once upon a time it was worthless tokens with the intrinsic and valueless property of being able to be retitled and not counterfieted. Then someone decided to use some to buy a pizza. And thus it became money.
My reply: https://smilingdavesblog.wordpress.com/2012/12/08/bitcoin-yet-again/
And my response to that article: https://voluntaryistreader.wordpress.com/2012/12/08/continuation-of-the-bitcoin-debate/
My argument is that the initial demand was due to geeks and libertarians wanting to get their hands on some bitcoins as a novelty for their personal pleasure similar like gold jewelery drove the initial demand for gold. Sure, bitcoins are digital and incorporeal but who’s to say people can’t “wear” them if they want to do so? Isn’t this exactly what happens with other digital items in computer games all the time nowadays?
So it might have not even been that the initial demand came from people thinking these bitcoins could be worth a fortune some day but merely by people who thought they “looked shinny” and wanted to “wear” them.
Thanks for the comment. Yeah, I definitely think that some ‘hobby’ demand played a factor in it too.
There is a more direct route to understanding Bitcoin’s path through the Regression Theorem. Bitcoins, much like any other good, can be bartered for; the reason for the valuation, although interesting, is irrelevant for the purposes of the Regression Theorem. Once a sufficiently developed barter system is developed, then Bitcoin can further develop as a medium of exchange, and then can eventually become a money.
What good was gold thousands of years ago? You can’t eat gold. Gold is too soft to use in tools. You don’t know about gold’s uses in advanced industry, such as being a corrosion-resistant conductor, since technology isn’t sufficiently developed yet. Gold had one significant use: making pretty things.
Bitcoin is very much like gold. Gold has the properties desired for money: divisibility, recognizably, and scarcity, among others. Bitcoin was designed to also have these properties. The only significant original direct use of gold was making pretty things. The original adopters of Bitcoin were the type of people (as as result of being interested in crypto-currencies) to see Bitcoin as something beautiful. As a result, Bitcoins had a small intrinsic value to them, and so it had its place on the value scales of those individuals. A system of barter was then able to emerge as people with different valuations traded Bitcoins for other goods.
After the initial system of barter was formed, Bitcoin’s value and community grew through speculative actions. Today Bitcoin’s intrinsic value has been completely overtaken by its value in barter & exchange, and its community has grown far beyond just those that find it beautiful; as a result many commentators can have a difficult time in recognizing this intrinsic value of Bitcoin.
Some great points there, thanks for sharing them.
[…] response to my recently posted article on Bitcoin and the Regression Theorem of Money, Smiling Dave has written what he believes is a rebuttal of the points contained in that article. […]
Excellent essay. If I may add, the narrow definitions of money that are used by the Smilin Daves of the world have always proven to have little application in the real world. People will use whatever means they need to use in order to form exchange networks with each other if other means become too restrictive:
[…] Bitcoin and the Regression Theorem of Money (voluntaryistreader.wordpress.com) […]
Wouldn’t the regression theorem apply to bitcoins in the same way that it applies to paper dollars? (Ie, they are valued because of some arbitrary decision made by enough people who were involved in its development, and that the evaluation of its price is traceable through its history all the way back to initial evaluations against the dollar, based on what certain nerds believed it would be worth at the time.)
[…] value. An example of a recent attempt that started off nearer to the approach below was “Bitcoin and the Regression Theorem of Money” (7 December 2012). However, this explanation still mainly referenced speculative demand […]
[…] does not disprove Mises’ Regression Theorem has been discussed to some lengths, even right here (1 or 2) at our humble blog. My own position on the issue is quite close to Aristippus’: Bitcoin […]
[…] about how something could ever become money. A good explanation of this paradox can be found here. I quote the relevant passage […]
Most interesting article.
However, regarding the origin of a currency, think of what the common means of exchange was in Ancient Pharaontic Egypt: nòt gold but barley! Talk about “generally or commonly accepted medium of exchange” based upon trust.
And remember that our word “salary” comes from the Latin word “salarium” or “salt allowance.” Sweat is salty and we need it to survive because salt retains fluid in the body without which we dehydrate and die.
(Although soldiers were paid in ‘solidi,” solde, which is the latin for hard or “solid” (currency) – gold.)