Tag Archives: Silk Road

Gresham’s Law and Bitcoin

14 Nov

“The course our city runs is the same towards men and money.
She has true and worthy sons.
She has fine new gold and ancient silver,
Coins untouched with alloys, gold or silver,
Each well minted, tested each and ringing clear.
Yet we never use them!
Others pass from hand to hand,
Sorry brass just struck last week and branded with a wretched brand.
So with men we know for upright, blameless lives and noble names.
These we spurn for men of brass…”

Aristophanes, “The Frogs”, circa 405 B.C.E.

Gresham’s Law states that “bad money drives out good”. When the price of a currency is artificially constrained, for example by a legal tender law, then the constrained price may be higher, the same, or lower, than what its price would be on a free market. If the currency’s constrained price is lower than it would be on a free market, it will tend to be exported to be resold where the constraint does not operate, and thus will disappear from circulation. If there are competing currencies in the constrained market, the currencies that are relatively undervalued will also disappear from circulation. This will be true, even if the constrained price of the most undervalued currency is still greater than or equal to its true free market price. If creditors are compelled under legal tender laws to accept one or more currencies at a fixed price, debtors will always tend to pay with the cheapest currency available, that is the currency whose constrained price has the greatest positive (or smallest negative) spread from the free market price. The currencies with a narrower spread, even if they cannot be resold on a foreign market at a profit, will tend to be retained as savings.

What does this have to do with Bitcoin? Bitcoin actually does trade on a truly free and global market. Thus its spread is, by definition, zero. No national fiat currency can make this claim, at least in its home country. Thus, by applying Gresham’s law, we can see that given a choice, debtors will tend to pay their debts with their national currency, and retain any Bitcoin that they acquire as savings. They will exchange their Bitcoins for other currencies only if they have no other means of paying a debt or purchasing a necessity.

This means that the adoption of Bitcoin for commerce directly will be slow, or in other words, even if Bitcoin becomes commonly used as a payment system by merchants, prices for consumer goods and interest rates on loans will continue to be denominated in the national currency, and will be quoted in Bitcoin at the prevailing free market exchange rate at the time of payment. During the current phase of Bitcoin’s adoption, as it becomes increasingly clear that demand continues to rise steadily, I would actually expect that Bitcoin prices will be quoted at a discount to the instantaneous exchange rate.

So, as a unit of account, Bitcoin will not become the standard anytime soon, although it probably will at some point in the future, when demand for Bitcoin reaches equilibrium with other currencies, and in particular, gold and silver bullion, which also trade globally on a fairly free market. However, as a store of value, I believe that it is already the standard.

In my next post I will explain at what price I expect that equilibrium to occur.


The reply continued….

5 Apr

The Post article laid out most of the arguments offered by the critics of Bitcoin. I will address each of these objections in a series of posts. The first objection is always “It’s a bubble”. In the 1990’s and early 2000’s when the real bubbles were frothing up, few people outside the economics fraternity had even heard the word used in the financial context. Today of course, every literate person knows that a bubble is when something goes up in price fast, and then collapses in price even faster. People still tend not to know why bubbles occur, as evidenced by the quote from the Washington Post in my first posting. People who have given it any thought tend to fall into two camps; those who believe bubbles are due to a failure of the capitalist system of free markets, which is true to an extent, and those who believe they are due to the unwarranted and harmful interference of the state apparatus in the operation of the capitalist system of free markets, which is absolutely true.

People with no clear understanding of the economic forces that inflate and then collapse financial bubbles see the price of an asset class rising fast, or at least in a sustained rise, and label it as a bubble. Naturally, watching the dollar price of 1 BTC rise from $12.50 to $147.00 in three months, they would suspect a bubble. But they should consider another paradigm for synthesizing bitcoin into their worldview. Bitcoin has gone from an idea to a property valued by the market at over $1.500,000,000 in about 4.5 years.

This property is in the hands of a corporation, but a corporation the likes of which this old earth has never seen before. Rather than a top down, command and control, bank-ridden mechanism for regulatory capture and the funneling of cash into the maw of the state, this is a bottoms-up, voluntary, self-financed association of independent business men and technicians, working together to produce a product with a proven market, in fact by definition the largest and most proven market on earth, the market for money. The product they produce is easy to produce with the right equipment, and anyone is freely licensed to download the entire software suite which stitches the equipment into the cooperative network and begins production of the product. Thus, an investment in computer hardware and electricity purchases a share of this corporation, one that pays a regular dividend, literally like clockwork, as there is no board of directors or shareholder election to decide on the size or timing of the dividend. The size of the dividend has been announced until the year 2140 (131 AB). Thereafter, the dividend will reflect the market valuation of the speed at which transactions within the network are processed.

The dividend is paid in the product itself. The product performs exactly as advertised, at a cost far lower than competing products. The only consumable production input is electrical energy, and the only maintenance cost is the depreciation of solid-state semiconductor technology. Innovators within the corporation, acting independently of any hierarchy of management or authority (since none exists) have already achieved orders of magnitude reductions in the energy input requirements. So long as a few shareholders participate in production the production rate is guaranteed. Once produced, the product cannot be destroyed, and will continue to function with no maintenance, no wear, no degradation.

So the only difficulty in estimating the value of the current and future stock of the product is to estimate the market share that the product will eventually command. In the United States alone, this market was valued in 2011 at between 2.15 and 9.61 Teradollars, depending on which components of the U. S. money supply are considered to be in competition with Bitcoin. Let’s take the lower figure (the U. S. monetary base) as the target market and assume a ridiculously conservative estimate of 1% of this market captured by Bitcoin. Divide this by the 21 million BTC that will be produced, and you get a lower bound for bitcoin’s worth in 120 to 130 years on the order of $100,000 per bitcoin. And that is just the U. S. market.

To me, the notion that such a blatantly superior product would capture only one percent of its target market is ludicrous beyond belief. My personal lowest estimate would be 50%, giving a value of $5,000,000 per bitcoin. And my estimate of when it will reach that level is based on its behavior this year, of doubling in market share each month, and actually almost doubling twice in March. I will be very conservative and guess that the doubling rate will slow to an average rate of once per quarter. At that rate, bitcoin would be approaching the 5 million dollar mark in the first quarter of 2017, a mere 4 years from now.

So no, bitcoin is not in a bubble, and will not be for years, if ever. In my next post I will address the critics who warn of hackers.