The other day on Fox News there were three panellists discussing the record value of Bitcoin. One confessed that she had known nothing about Bitcoin until she read up about it as preparation for appearing on this panel. While she conveniently confessed her ignorance, that of her fellow panellists could be quickly and easily discerned from their comments. Here’s a short cut. Whenever you hear or read someone whose criticism of Bitcoin is based on it having “no intrinsic value” or not being “based on anything”, the safest thing you can do is to tune out or click on to something else.
All economic value is subjective. If I just drank a litre of water and I have a room full of water bottles, consider how much value one more water bottle would have to me. What would I be willing to give up (pay) for one more bottle of water? Now consider what I would pay for a bottle of water if I were out in the sun all day with nothing to drink and no other prospects for getting a drink other than to buy a bottle of water from you. The fact that our needs and wants change over time and differ from those of others is the fact that makes economic transactions possible.
If I go to a store and see a bottle of water priced at $1.99 does that mean that the value of the bottle is $1.99? Do you realize that if it did, no one would ever buy the bottle? If the $1.99 in my pocket was exactly the same value of the water bottle, why would I ever exchange one for the other? I’m not gaining any value so where’s my motivation? It’s only if, to me, the water is more valuable than $1.99 that I will buy it. I will be motivated to give up something of lesser value for something of greater value.
This is true of anything including traditional money, dollar bills, etc. “But these are backed by gold,” someone exclaims. Nonsense. Fifty years ago you you were theoretically (not practically) able to exchange money for gold but that’s long gone. Now it isn’t “backed” by anything. We value this money issued by the state, this fiat currency, because we have faith that other people also value it. I offer my $1.99 to the clerk and I know he will give me the water. Why? Because there’s a sticker price of $1.99 right on the bottle. That’s really an advertisement that the clerk, on behalf of the store owner, will accept an offer of $1.99 in trade for the bottle. He values the $1.99 more than the bottle (usually because he was able to purchase it for less than that and so he can earn a profit). I value the bottle more than the $1.99. So we agree to make the exchange because neither of us hold the value of the bottle to be $1.99 to us. The sales price is actually an arbitrary compromise that does not ever reflect the actual value of the item to either party.
So why do almost all of us almost always assign at least some value to fiat currency? Because it is a convenient way to facilitate other transactions. If I went shopping and all I had was a bottle of water I would need to find someone willing to trade something they had that I wanted to me in exchange for my bottle of water. Good luck, right? But if I had $1.99 I could buy something I wanted from anyone who was selling something for $1.99 or less. Many more possible transactions are open to me because of how widely accepted fiat currency is. Its value is as a convenient medium of exchange, as a facilitator of economic transactions.
That’s all equally true of Bitcoin and other crypto currencies. Bitcoin is what those who make Bitcoin transactions possible get paid for their work. They are called “miners” because with each transaction that their huge computer systems make possible, a tiny bit of new Bitcoin is created and they get it as a reward for making the transaction possible.
That’s how fiat currency works too. The state prints fiat currency and releases it into the economy through the banking system, debt repayments, etc. But it also uses some of the currency it prints to repay its own debts. So Just like the Bitcoin miner gets paid for facilitating the Bitcoin medium of exchange, the state gets paid something for facilitating the fiat currency medium of exchange.
But there’s a huge difference too. The state can print as much fiat currency as it wants. Tomorrow the state could print $100 trillion dollars and use the extra to pay off all its debts with “cheap money”. The only thing preventing the state from doing that is the political pressure not to let everyone’s money suddenly be worth almost nothing which is what would happen if there were so much of it in circulation.
That can’t happen with Bitcoin because there is a built-in mathematical formula that dictates how much new Bitcoin gets mined. In fact, it is an ever-decreasing amount because there is an absolute limit of 21 million Bitcoins. It is the decreasing supply coupled with an increasing demand that is fuelling the increase in the price of Bitcoin. The creation of Bitcoin is based on the objective criteria of actual work done to facilitate the medium of exchange (the blockchain). Whereas the creation of the state currency is at the whim of its central bank managers and politicians. They try to guess the right balance between printing too much and printing too little. Too much and we get inflation. Too little and we get depression. They can’t know all they need to know to make truly informed decisions about this and so we always teeter on the verge of economic dislocation (serious changes in the economy).
My wife quipped that rather than backed by gold, fiat currency is backed by debt, and she’s right. The decision about how much fiat currency to print is driven by the state’s interest in printing enough so that it can repay its massive debts with devalued money, tempered by its interest in avoiding the political consequences of inflation. The value you place in fiat currency represents your faith in the state’s ability to continue to perform this balancing act and avoid severe economic dislocations.
The value of Bitcoin requires no such faith in crystal ball gazing central planners. It is based on your own assessment of the value of a private, secure, anonymous, decentralized medium of exchange in the context of how likely it is that others will share your assessment of value. Sounds like the free market to me. So where do you place your trust? In the state, or in free people trading in a free market?
Free markets maximally employ knowledge disbursed among all individuals whereas central planners can only work with a fraction of that knowledge. The value you assign to fiat currency is a measure of your faith in the whim of the state’s central planners. The value you assign to Bitcoin is a measure of your trust in the free market. Whether it goes up or down, the value of Bitcoin represents something a lot more “real”.
Edit: This post was inspired by this discussion.