by Alexandru Cojocaru
A good advice I once received was that if you have a book that really changes your life, you should read it again after ten years. Your changes of views as well as the changes in the world are very likely to bring new understandings, perhaps so much so to change your life a second time.
It is The Theory of Money and Credit by Ludwig von Mises which changed my life. I read it back in 2008 when I was convinced that money creation and monetary policy are the task of the government. After I finished the last page, I knew that the best thing that governments should do about money is to leave it alone.
So here I am, re-reading The Theory of Money and Credit in the context of a major relevant change in the world in the last ten years: the development of cryptocurrencies, and bitcoin in particular. This change raises questions that have to be answered to understand if the treatise includes and explains this development. If not, the science of economics must be extended to describe it:
Is bitcoin a new form of money, or does it classify under one of the kinds of money described by Mises?
Von Mises classified money in commodity, credit and fiat. He also classified money substitutes in money certificates and fiduciary media (token money, uncovered bank deposits and notes). We should look into each of these.
Commodities are goods having fulfilled some other needs before becoming a medium of exchange. They also have other uses while being a medium of exchange and they derive an intrinsic value from those other uses. Gold, oil, wood, tulips, cotton are all commodities.
Is bitcoin a commodity?
No. Bitcoin was designed to be money and has no practical use other that being a medium of exchange. The intrinsic value of bitcoin derived from other uses is zero.
Credit money are bills of credit/claims to something that should be returned to the creditor with a given interest and after a given time. The claims can be rolled over indefinitely if the creditor agrees and the interest can be renegotiated and may have whatever value. These claims are money if they circulate as a medium of exchange (goods and claims change hands meaning that the good and the requirement to pay the claim when its time is due, both pass from the seller to the buyer).
Is bitcoin credit money?
No. Of course, creditors can lend bitcoin to debtors issuing bills of credit/claims with whatever interest and maturity they agree; and these claims can further circulate as a medium of exchange. However, these claims are not bitcoin money, but credit money. If we call these claims “bitcoin titles” and we consider the example of a title of 100 bitcoins with 1% interest, we cannot say that the title has the same value as 101 bitcoins. There are considerations like the fungibility of the title versus that of 101 bitcoins and the questions on if and in what extent the title can be rolled over, also if the interest will be re-negociated. Those considerations make the valuation of the bitcoin title to be different that the valuation of 101 bitcoins. Even though both are used as a medium of exchange and no matter how small the difference in valuation is, they should be treated differently in the economic science.
Fiat money is an abstraction of the human mind with a relatively low cost of production that is designed to be a medium of exchange. Fiat money has an intrinsic value of zero and its quantity can be dictated by men.
Is bitcoin fiat?
Yes. It was conceived to be a medium of exchange, so it has an intrinsic value of zero derived from other uses. The cost of production is significantly lower than the price of some commodities. The gold/bitcoin exchange ratio now is about 1 bitcoin for a 250 gram pure gold bar. We must compare the energy consumption to “mine” the bitcoin with the energy consumption of discover a geological gold deposit, extracting several tons of mineral from a couple of miles below earth or excavating hundreds of tons of rock from the surface, the transportation, the refining. While the cost of producing the 250 gram pure gold bar is just a little lower than the price of the bar, the cost of producing a bitcoin is half the value of one bitcoin in the US and it may be way lower in countries like Venezuela.
Bitcoins can be destroyed with no possibility to recover them. One can only do that to an atom of gold if one places it on the border of a black hole or uses the total energy of a supernova to mute it into mercury. The blockchain is not immutable. Whatever the creators promise, it is subject to human manipulation. Men already reverted transactions on the blockchain for subjective reasons. There is absolutely no guarantee that in future men won’t hard-code transactions to increase the bitcoin quantity. An abstraction of the human mind can get corrupted. The U.S. Constitution, for instance, proved to be no guarantee for liberty either.
Can banking exist with bitcoin money?
Yes. What bitcoin banking is not, is to keep bitcoins in the online or offline (also called ‘cold’) wallets of banks. People may choose online or cold wallets to reduce the risk of having their money destroyed in their own personal wallets (because bitcoin is fiat, it can be destroyed: viruses, hard disk failure and so on). Storing bitcoin in cold wallets in banks is just a safe way to keep savings in bitcoin, same as having gold in a gold depository. Online wallets allow the use of bitcoin for exchanges, but the transfer of bitcoins is initiated by the owners of the wallets. The role of the bank here is only to provide a safe storage for the wallets in the cloud.
There is nothing inherently new to banking in both cold and online wallets. As Ludwig von Mises pointed out, the defining activity of banks is to lend other people’s money. This is possible only if clients transfer their bitcoins in the wallet of the bank and the bank gives to the clients whatever certificates in exchange (paper, electronic). The certificates are redeemable any time by any person, that meaning that the bank is obliged transfer bitcoins from its wallet to the wallet of the person who presents the certificate for redemption.
From that perspective, a bitcoin banking system resembles very much a gold banking system. The outcome is that the clients of the banks exchange money substitutes (certificates) and the real money (the bitcoin) is exchanged on the blockchain only between banks and for deposits and redemption.
Are inflation bubbles possible in a bitcoin banking system?
Yes. We established that the defining activity of banks is to lend other people’s money. Banks do this in two ways: by depriving themselves or by not depriving themselves of the money that they lend until they get it back with interest.
In the first case, we talk about banks lending bitcoin and depriving themselves of the quantity of the bitcoin lent, until they receive it from the borrower with interest. This activity has no influence on the subjective value of bitcoin, since the same quantity of bitcoin circulates in the market.
In the second scenario, the banks issue bitcoin certificates that they lend with interest, without depriving themselves of using the real bitcoins in the same time. They issue more fiduciary media (uncovered tokens, certificates) than the bitcoins they have in their wallet. They justify this behaviour on the classical fact that not all the clients will redeem their bitcoins in the same time.
Since there is no difference perceived on the market between the circulation of real bitcoins and that of bitcoin substitutes, the issuance of fiduciary media in excess of the bitcoin reserves causes an expansion in the quantity of money in the broader sense (real: narrow + substitutes: broad).
From this perspective also, bitcoin is closer to commodity money like gold rather than legal tender fiat money like dollars and euro.
A hasty conclusion may be that bitcoin is commodity money, like gold, but better: infinitely easier to store and to carry. But we should not let ourselves be fooled by this appearance. What makes bitcoin very easy to store and to carry is what makes it possible to create, to destroy and to be valued down to nothing. The economic science is indifferent to human motivations and probabilities to create, destroy and value down to nothing bitcoins, as all these are subjective. The mere possibility is enough to conclude that at present times, bitcoin is fiat. This doesn’t exclude the possibility for cryptocurrencies to evolve in the future.
Is bitcoin better than gold for peace, liberty and prosperity?
My intuition – and a look at history – tells me that fiat money would always get corrupted. The better bet, thus, would be commodity money like gold. But then again, another great lesson from the Austrian School of Economics is that in a complex situation, when logic can’t help me to answer questions such as what is better to do to achieve a certain goal, we should let the market decide. Perhaps the future has some surprises in store when it comes to cryptocurrencies.