Tag Archives: François R. Velde

What backs Bitcoin?

12 Nov

In several earlier posts, I implied that the Imperial Government of the United States might be actively hostile to Bitcoin, which could certainly tend to complicate its widespread adoption. In this, I believe I was in line with the conventional wisdom (a position I have seldom fitted into comfortably). However, in the interim, several indications have arisen which suggest that the IGUS is maintaining a neutral stance vis-a-vis Bitcoin. Most notably; last month’s Federal bust of Silk Road was not accompanied by a frenzied government call for the abolition (as if that were even possible) of Bitcoin, and last week, François R. Velde, senior economist at the Federal Reserve Bank of Chicago, published Bitcoin: a primer in the Chicago Fed Letter. This is a balanced piece which includes a good technical explanation of Bitcoin. It concludes with the statement that, “[Bitcoin] represents a remarkable conceptual and technical achievement, which may well be used by existing financial institutions (which could issue their own bitcoins) or even by governments themselves.” I have long believed that the most rational response of the state to Bitcoin would be to embrace and profit from it along with rest of us, and this paper suggests that at least one of the court intellectuals agrees.

However, Dr. Velde makes a common mistake when he states “Fiduciary currencies” (including Bitcoin) “—in contrast with commodity-based currencies (such as gold coins or bank notes redeemable in gold)—have no intrinsic value…”. This touches directly on a criticism I answered briefly in a previous post, which is that “Bitcoins are backed by … well … nothing. It’s fiat money issued by ‘the market’…”. In that post I addressed the mischaracterization of Bitcoin as fiat money, since this designation requires the imposition of a state fiat or decree to support the value of the currency. Dr Velde correctly points out that fiat money, including the US Dollar and all other major national currencies, is also a fiduciary currency, and has no “intrinsic value” derived from its status as a commodity.

So what is the error that Dr Velde has made? You might expect that I would argue that Bitcoin has some sort of “intrinsic” value, perhaps deriving from the fact that it requires an input of energy to create new Bitcoins. I have seen this argument before, in Bitcoin forums and articles. Dr Velde alludes to this when he remarks that “The term ‘mining’ may lead one to think that bitcoin is not fiduciary.” However, this is nothing more than the Marxist labor theory of value, and holds no water in a serious economic discussion.

My argument is not that Bitcoin has intrinsic value. It is quite the opposite – I maintain that no form of money, fiduciary or commodity-based, has intrinsic value. In fact the term “intrinsic value” is an oxymoron. Things have intrinsic characteristics; gold is dense and malleable, Bitcoin is decentralized and cryptograpic, water is wet, etc. One of the intrinsic characteristics of the concept of value is that it always and everywhere is a subjective ranking reflecting the goals of a human actor and the options available to him for achieving those goals. To argue that gold has intrinsic value is to assert that there is some minimum level in the rankings assigned by every living human to every option available below which gold (in some specified quantity) can never sink. This is clearly ludicrous. A drowning man in possession of a kilogram of gold will be more likely to find positive value in letting it sink to the bottom of the sea than in maintaining his hold on it.

What is really being said by incorrectly applying the adjective “intrinsic” to the value of gold is that gold has a long established history of being relatively highly valued by many if not most people. In fact, it is so highly valued that its market price cannot be even remotely accounted for by its utility as anything other than as (primarily) a store of value and (secondarily) a medium of exchange. This explains why the vast majority of the gold currently in the hands of humanity consists of bullion bars or coins, or chains, rings and amulets that may also be used for exchange in a pinch. Only a tiny fraction is employed in such uses as decorative gold leaf or as an electrical conductor.

To quote Dr. Velde again, “a currency that has value only because of the belief that it will have value may have no value at all (for instance, if I believe that no one will accept it, I will not accept it either)”. Quite true, and applicable to gold as much as to any other thing on earth. What is at issue here is not some intrinsic value that gold can never lose, but rather the strength of the belief that gives gold as well as Bitcoin its value. I am certainly not suggesting that the strength of the general belief in the exchange value of gold is likely to be diminished anytime soon. I am merely asserting that the fact that Bitcoin is not “commodity-based” or “gold-backed” has no rational bearing on its value whatsoever.

The only difference between Bitcoin and gold, or any other currency, is that the demand for Bitcoin is 100% derived from its utility as money (that is, a medium of exchange, a store of value and a unit of account), whereas there does exist some modest demand for non-monetary gold. Gold has a history of demand spanning 5 millennia, Bitcoin has a history of demand spanning 5 years. But based on that brief history, there is no reason to think that the belief in the value of Bitcoin is in danger of vanishing.