In response to my recent blog post about BitCoins, several commenters offered responses to my objections. Today I will address these considerations as well as others I came across during my research. Objection: My refutation was circular or my refutation was just an assertion that BitCoins are worthless. This isn't the case. I suspect many people interested in BitCoins may have some training in computer science, so I'll use an analogy from that field to briefly restate my argument. If you aren't familiar with computer science, feel free to skip ahead to the next paragraph. The value of a currency can be thought of as the result of a recursive algorithm, where the value on day n depends on the value on day n-1, with some adjustments. The problem with BitCoins is that there is no base case because BitCoins have no use outside of being traded around. This means that existing BitCoin "prices" are essentially arbitrary numbers with no grounding in anything real, mentally or physically. I am not asserting that BitCoins are "worth nothing." It would be more accurate to say that BitCoins are nothing. Government fiat monies can get away with this for reasons I describe below, but none of these considerations apply to the case of BitCoin for the very same reasons that BitCoin is intriguing, i.e. that it is without a central managing authority, that people don't have to use it if they don't want to, etc. More on this below. Objection: Some people do accept BitCoins, so they can't be a poor currency. There are several possible explanations for this. One possibility is that they are simply making an entrepreneurial error. This could happen for any number of reasons; for example, some people think (wrongly) that BitCoins are backed by processor cycles. Another possible explanation is that people are speculating that they will be able to sell the BitCoins later at a higher price. This could push the price up temporarily but would not mean BitCoins were a viable currency. Another reason people might accept BitCoins is because they value them due to the undeniable "cool" factor that BitCoins have. I, for example, ordered some "worthless" money from Zimbabwe because I thought it was neat and because I have an interest in hyper-inflated currencies. In this case, the problem is that there is only a niche appeal, not the widespread appeal that is necessary for a commodity to gain substantial exchange value and become a money. Some people collect Pogs or Pez Dispensers and will exchange goods for them. Some people buy pet rocks. That doesn't make any of those things good monies. Objection: Subjective value theory means that value only exists in the minds of people, therefore there is no reason BitCoins couldn't be as valuable as gold or any other commodity. This objection misses the point of my argument. It is true that value does not exist within things but rather in the minds of valuing agents. What the use value/exchange value distinction deals with why people make those valuations. In the case of use value, people value an item because they believe it will directly satisfy some desire of theirs. In the case of exchange value, people value an item because they believe that other people are likely to accept it in a trade. Moreover, the issue isn't that BitCoins aren't as "valuable" in some abstract sense as gold or any other commodity. The issue is that BitCoins have no broadly-held use value and therefore cannot gain the necessary status for becoming a money, namely that of being widely accepted in trade. This means the item in question must first be widely desired for its use value. Only then can it's exchange value begin to snowball. The unbridgeable gap here is the transition from being used by a small group of hobbyists in barter to being used by financial institutions and the man on the street as a proper money. Objection: Fiat currencies, like Federal Reserve Notes (US Dollars) aren't backed by anything, either, so what's the problem? The problem is that BitCoins aren't issued by a government and therefore lack the legal protections needed to make paper monies work. The following quote from The Ethics of Money Production by Jörg Guido Hülsmann (p. 159) describes how paper monies come into existence:
We have already mentioned that paper money never spontaneously emerged on the free market. It was always a pet child of the government and protected by special legal privileges. We have moreover pointed out the typical sequence of events through which it is established: In a first step, the government establishes a monopoly specie system, either directly by outlawing the monetary use of the other precious metals, or indirectly through the imposition of a bimetallist system. Then it grants a monopoly legal-tender status to the notes of a privileged fractional-reserve bank. Finally, when the privileged notes have driven the other remaining means of exchange out of the market, the government allows its pet bank to decline the (contractually agreed-upon) redemption of these notes. This suspension of payments then turns the former banknotes into paper money. This scheme fits the sequence of events in all major western countries.To summarize and elaborate, the only way to establish a paper money is to start with a commodity money so that exchange rates become established (through the process described by the regression theorem), and then to sever the connection between the paper certificates and the commodity through two legal tools: legal tender laws and legalized suspension of payments. Legal tender laws dictate that if A owes B some number of, for example, potatoes, B must accept either potatoes or whatever the government has designated as legal tender in payment of the debt. Typically a court will determine what cash amount is appropriate by referencing prevailing market prices. The implication is that immediately after the transition from a commodity money to a paper money, people are required by law to accept the paper money as though it were still backed by the commodity. Absent such a requirement, the paper money would be like any other slips of paper: or, more pertinently, it would be like BitCoins are now. No one can just declare something money. The way has to first be paved by establishing a monopoly commodity currency. It would be a boon if a decentralized currency similar to BitCoin but backed by some commodity could get off the ground, although it is likely that any attempt to establish such a currency would be met with a government crackdown. Regardless, BitCoin simply doesn't fit the bill. We'll have to wait a while longer to wrest control of our money from the state.