The debate over whether Bitcoin is a money or not has cooled down quite a bit. But it’s still worth understanding what all the fuss was about. To do that, we first need to understand what constitutes a money.

Aristotle and Money’s History

To begin, money is a medium of exchange and must be widely accepted as such. More than 2000 years ago, the Greek philosopher Aristotle tried to define what made a good money. He stated four essentials:

1. It must be durable. That is, it must hold up to the test of time. Money must be able to stand up to constant transactions as it is a medium of exchange and store of wealth. A money that breaks down after being weathered due to constant handling doesn’t constitute a good money. In times past money had taken many forms. Some examples were sea shells, tobacco, gems, stones and even cigarettes.

2. It must be portable. A money that is too large, such as gold bricks, would be a poor choice for money. Thus, gold was coined as to make it portable. Paper money also falls into this category. More on paper money later.

3. It must be divisible and consistent. Economists refer to this as “fungible.” That is, every piece of the the divided money must be the same size, weight and value as all the other pieces. A one ounce gold bullion coin must be exactly the same as all other coins of the same denomination. A U.S. quarter is exactly like all other quarters and so on. Here again, paper money satisfies this rule as every denomination or bank note is exactly like all the others of the same.

4. Money must have intrinsic value.  The word “intrinsic” implies that the object would have value in and of itself. As the Austrians have taught us, nothing has intrinsic value. Gold, for example, is money because it has alternative uses that are of value to the owner. Understand the term “value” is in itself a loaded term. Value is subjective to the individual. Paper money of today, or better known as fiat currency does not meet Aristotle’s rule. Fiat currency derives it’s “value” from government fiat or decree. That is, because of legal tender laws, fiat currencies have worth only in the sense that if the individual were to transact in another form of money or refuse payment in the fiat money, they would suffer a penalty. Thus, it is “worth” it to the individual, or “valuable” to stay out of trouble with the government and accept its fiat currency. Government’s “value” comes from its “intrinsic” coercive qualities. But, I digress.

The Essence of Scarcity

Worth noting is the fact that money is a scarce resource. It is chiefly due to this scarcity that money derives its value. Fiat currencies fail the test, at least in regards to retaining their value when used as money, because governments can “print” them at will. Although governments today rarely actually print new money, central banks create money by simply entering account information with a few hits on a computer keyboard. This new money creation dilutes the already existing supply of money available and thus reduces the purchasing power of the fiat currency. Fractional reserve banking also inflates the supply of money by loaning out money that never existed in the bank’s accounts. By only holding a fraction of deposits on reserve, banks inflate the money supply with every loan or credit card charge made. I’ll get more in depth on the nuances of fractional reserve banking in a later article.

In the past, precious metals have fulfilled the role of money quite well. Gold, silver and copper were commonly used as money because they have nicely met the requirement as stated above. Most importantly, precious metals are scarce and very hard for governments to inflate away. The amounts of these metals are limited and require a lot of labor and capital to get them out of the ground. Paper and ink, on the other hand, are readily available and only require a printing press and a few laws to easily create new fiat currency. But, printing pieces of paper doesn’t add to a nation’s wealth. It only dilutes the wealth created by real economic activity in the producing sectors. It is production of goods that adds wealth. Capital in the form of money is merely a means to greater production and wealth. The measure of wealth a nation has is not in how much paper it can print.

Bitcoin and the Regression Theorem

Some years ago, an electronic encrypted currency protocol known as Bitcoin entered the realm of mediums of exchange. It went widely unnoticed until one day when its price shot through the roof. At one point the price for one bitcoin (BTC) hit over $260 in just a week. This would go on to happen again, stopping at over $1100 (it is currently less than half of that). Many speculated that the national banking crisis in Cyprus had much to do with the first up-tick. The “value” in BTC is its anonymity and inability for governments to regulate it. Thus, a holder of BTC can go on with his life without worry of government harassment or confiscation. Some claim that these very attributes is what led to its popularity with drug dealers and money launderers. The supply of BTC is also limited and known. Only 21 million units of bitcoin will ever be issued. According to Wikipedia,

The creation of new bitcoins is automated and may be accomplished by servers, called Bitcoin miners that run on an internet-based network and confirm Bitcoin transactions by adding codes to a decentralized log, which is updated and archived periodically.

The debate over BTC on the web has been surrounding the definition of the product. Some claim it is merely a peer-to-peer electronic payment system. Some say it is the new money. Others, scoff at this idea and argue it doesn’t meet Mises’ regression theorem of money. Ludwig von Mises, built upon the work of Carl Menger who determined that, when followed back through history, all current money has at one time began as a commodity. Menger went on to explain that at some point in history certain goods were more “saleable” than others. Today we would say more “liquid” or “convertible.” He pointed out that certain goods were used more than others because they were in higher demand and were easier to exchange for other goods. These saleable goods eventually led people further and further away from barter where they began engaging in indirect exchange with each other. As time progressed, these goods were increasingly narrowed down to precious metals. Mises continued to show that money is in fact a commodity. Through his regression theorem he showed that people today expect money to have a certain purchasing power tomorrow, because of their memory of its purchasing power yesterday. People yesterday expected their money to have a certain purchasing power than it did days ago and so on and so on.

Because of Menger’s work on the origins of money, Mises’ regression theorem doesn’t go on ad infinitum. At some historical point we can trace money back to when it emerged from a barter system. We can see that commodity money was valued like any other commodity. Gold was valued as a commodity in its own right before it became money explaining how today’s market value for gold became established.

This is were the controversy comes in for those who follow the Austrian economic tradition. The claim is made that BTC is not a commodity money because it never had a use before it became a medium of exchange. Unlike gold or silver, it has no alternative uses. Therefore it is not money nor ever will be. Again, the contra is that since it is traded on the market, it is in fact a commodity and money. It satisfies all the above stated criteria for money except, some would argue, it’s intangibility — alternative uses or not. Moreover, they argue that if you begin with BTC and then going back, consider the currency used in its purchase, you could use the regression theorem just as with fiat dollars, yen, pound sterling and so on, in relation to gold. Meanwhile, it is still purchased and exchanged for goods as any other currency — bubble or not.

The Possibilities

Most recently, commentators are saying that the Austrian economic scholars who deny BTC as money are not doing their proper due diligence in economic theory. As students of the Austrian school we are taught to always think as an economist and to use good theory. We are not to rely on historical evidence as the old discredited German historical school taught or empirical evidence as do the monetarists.

Austrians have shown that economics is none of these, but rather it is human action. People making choices in how to apply their scarce means to their preferred ends. If people are widely accepting Bitcoin and exchanging with it, then it must be a type of evolution in the progression of money. After all, how could Carl Menger or Ludwig von Mises or even F. A. Hayek have known about electronic encrypted currencies to include them in their theories? Not to mention the world’s largest market of exchange, namely the internet? At the time Mises was working out his regression theorem no one had ever logged into their Amazon account or bid on Ebay. Could BTC be the next leap in money? Will there be a scholarly paper published explaining this evolution?

Conclusion

To argue that Bitcoin can never be money is missing the point. Nobody in a prisoner of war camp ever complained that their cigarettes didn’t perfectly satisfy the regression theorem while they traded them off for more coffee. It is doubtful that those who are satisfied with their preferred choice in Bitcoin will much care either. One thing is certain, if it hadn’t been for the onslaught of fiat currencies BTC would never have been invented. There wouldn’t have been a need for encrypted electronic currency had we been on a sound money policy. Not to beat a dead horse, but if there is anything to blame for the public desire to encrypt and hide their transactions from government, look no further than intervention. The government’s intervention in the economy is what led to the development of Bitcoin. Maybe BTC is a only a fad. Maybe someone else will develop yet another form of money that world governments and central banks cannot control. Possibly we will witness a currency collapse of international proportions and see the re-emergence of commodity-backed money. Regardless, buckle up and hang on, this could be a bumpy ride. At least it won’t be boring.

[Image credit: http://www.wired.com]