The bitcoin phenomenon

I got my chops on economics learning from the Mises institute and more specifically from the mind of Murray Rothbard.  If you haven't read any of his stuff, I highly recommend downloading a bunch of his more popular works in audiobook format.  Once you read and digest the content from him, you'll have a good idea of what money really is and understand my skepticism around bitcoin.

Just to quickly summarize what money is and why it exists and how it came about we have to start at the beginning.  An economy first starts off as not an economy but as man as he was thousands of years ago where his standard of living was basically no different than that of animals.  It was a hand-to-mouth existence.  Property rights at its most raw form - you pick a berry, you eat a berry; you hunt game and you consume it.  However, at some point in our history, we discovered that we could directly exchange with each other.  I would venture a guess it happened when mankind learned to settle down and not be so nomadic in order to survive.  Probably when we discovered agriculture or something.  Either way, with more respect for property rights, people started to accumulate savings and then with those savings, we could begin bartering, or another word for direct exchange.  Barter quickly started to hit its limitations one of which is a 'double coincidences of wants.'  If I had corn and wanted blueberries, I would have to find a person who harvested blueberries who also wanted corn.  Otherwise the trade cannot occur.  So before money came on the scene, a person would need to find an alternate commodity in the market that they could have confidence in that would facilitate the trade.  So maybe if I knew the blueberry harvester wanted wheat, then I could confidently trade my corn for wheat and then trade the wheat for the blueberries I wanted.  It's very important to note at this point why wheat works.  It's not because I simply have confidence in it.  To simply stop there is to ignore a very important point regarding bitcoins.  You have to ask yourself where the confidence comes from.  The confidence comes from the fact that it has existing marketability due to the fact that it can already be exchanged for any other commodity in the market.  We'll be touching on this later regarding bitcoin.

The emergence of money came out of a market demand for indirect exchange to overcome this 'double-coincidence of wants' obstacle.  However, in both direct and indirect exchange, both parties create value in the marketplace and both walk away from the transaction having gained in their minds.  Now as we fast forward through the gold standard and then paper receipts for gold and then fractional reserve banking and then a pure fiat money standard, we have to remember that this erosion of the money took place very gradually where confidence was never broken insofar as the market perception within the economy.  Clearly if one day we're on a gold standard and the next day we're on a pure fiat standard, the transition would never work.  The free market wouldn't accept it.

So now let's examine bitcoin.  Basically bitcoin is a computer-generated 'coin' very much like a virtual coins you might collect playing some Facebook game.  They can be collected, used and handled very much like how you would handle real coins.  There were some other things to make this project work.  Unlike the Facebook coins, that could be created out of thin air by some hacker, there is a way to make it nearly impossible to make copies of bitcoins thus limiting their supply.  So basically, the creator of bitcoins made it possible to "discover" bitcoins by solving a problem that gets more difficult to solve with each new bitcoin discovered.  This is called mining....sort of like mining for gold.  A lot of labor has to be put into finding more.  Then the programmers decided to create a hard limit of 21 million possible bitcoins that could come into existence.

What these programmers were trying to do was create a competing currency and they almost did it.  They satisfied many criteria for what makes a good money: Limited quantity, divisibility (bitcoins can be divided up into smaller entities that retain its value; like gold will not lose any of its properties even if you cut it in half unlike say a shovel), and portability.  The one thing bitcoins didn't have that gold did was 'utility value' or 'intrinsic value.'  I know people out there will call out the whole 'There is no such thing as intrinsic value...blah blah blah" argument but that is just semantics, IMO.  I find that this group of people do not strictly adhere to the definition of 'value.'  Strict adherence to the definition would render the words 'utility' and 'intrinsic' redundant and so to correct 'adherence' for 'utility' makes no sense.  If you don't know what I mean, go look up 'value' in how Austrian economics defines it.  Value, according to this school of thought, exists simply in the mind of the exchanger.

So my main issue with bitcoins is it they have no value, period.  There is no regression to tie them to anything that had or has value.  From what I can tell, they spontaneously existed and due to the other properties of money, were valued.  So what could you get for a bitcoin way back when they were in their infancy?  How did the first bitcoin users use them?  How did they know the transactions back then were equitable?  I would contend that they didn't.  This early period of bitcoin has been described in a very muddled fashion.  No one has a very clear answer.  I read only things that go like, '...it's value was determined by the transactions it allowed..."  Huh?  What does that mean?

Some people tried to use the regression theorem saying they have value because bitcoins can be exchanged for dollars and dollars ultimately got their value to gold and so this chain maintains its continuity.  Not really.  If that was true, then the very first bitcoin would have been worth in the tens of trillions of dollars.  Then as the second bitcoin was minted, the value would have been cut in half, then into a third, into a fourth, etc.  But if you see a chart of bitcoin, the graph doesn't look like an asymptotic function showing extreme deflation going left to right as a function of time.

You have to remember that paper gold reciepts had a one-to-one mapping to gold for anyone who wanted to hold their gold in a goldsmith's vault.  That's what gave the paper its value and was the source of the confidence.  Bitcoins didn't have this from its origins.  There was no one-to-one mapping to anything!

The other thing some bitcoin advocates use to argue its valuation is the time and "labor" to mine bitcoins.  Fair enough.  You can have a computer use its CPU cycles and resources like RAM and whatnot to solve this math problem and voila..a bitcoin generated.  Unfortunately, this is also a economic fallacy.  This employs the concept of the Labor theory of value.  Funny, because I thought these were the same people who advocated Austrian economics and tout the Subjective theory of value.  Just because I spend hours on a Civilization game and then save that game on a file, that file doesn't necessarily have market value.  Could I trade it?  I don't know....maybe.  Does it instill confidence in me to trade it?  Obviously not.  So this argument fails.

The last argument I see is bitcoins have value because other people want bitcoins.  Okay, that's a fair argument since many people want gold for no other reason than other people want it.  However, like I said before there is a chain of value via monetary regression and history that show gold has value.  Bitcoins is still trying to make its case.  To spontaneously to gain confidence is extremely difficult and without a lot of guns like the government does for fiat, I have my doubts.  In order to do so, you have to demonstrate redeem ability to anything of value from the very beginning like the gold paper receipts   To already claim value due to network effects is no different than real-estate investing is good investment because someone else will buy it from you.  Bubbles burst in exactly this way.  Ponzi schemes unravel exactly this way.  Things running on confidence alone will never last.

Perception only appears like reality until reality sets in.  Feeling full alone will never keep you from ever needing to eat again.