Knut Svanholm

@knut.svanholm

On Gresham’s law

Gresham’s law states that bad money drives out good money. It describes a phenomenon seen as well in school yards as in developing countries. In any market, people will hoard the good stuff and spend the bad. Discounted products in a store is an example of how this works. If a store has too much of a certain good it will lower the price of that good to free up space in its warehouse. Many goods are popular for very limited amounts of time. The fidget spinner for instance, has suffered from something very much like hyperinflation and therefore merchants try to rid themselves of their fidget spinners faster and faster. Currencies behave in a very similar manner. Take the recent case of the biggest denominations of the Indian Rupee for instance. The two largest Rupee banknotes, 500 and 1000, were demonetized by the Indian government on the 8th of November last year. The official excuse they had for doing so was to fight corruption and money laundry. Curiously enough though, the bills didn’t stop circulating. Instead circulation increased while the value of the bill started to decline, as predicted by Gresham’s law.

So what is Bitcoin, bad money or good money? In the case of Bitcoin some interesting contradictions arise. The better Bitcoin works as a unit of account, in other words the less volatile the price is, the less it will be traded as a speculative asset. The more transactions there are on the market, the higher the transaction fees will be. The higher the transaction fees, the fewer the incentives to use Bitcoin as money (although layer two scaling solutions will at least partially fix this). Fewer transactions is a sign of bad usability, right? Not necessarily. It could also be a sign of Gresham’s law in action. People are funneling bad money (dollars) into good money (Bitcoin). Good money doesn’t circulate as much as bad money does. In the case of Bitcoin, people who see its true potential will not sell their Bitcoin at all except if their lives depended on it.

For some time now, the crypto markets have been showing red figures. You might have noticed that two digit reds are more common in alts than in Bitcoin. This is nothing new. What you’re seeing is Gresham’s law being played out in real time. Fear, uncertainty and doubt scares people away from cryptocurrencies from time to time. Digital assets are sold off and converted into dollars and euros. People are selling what they fear and buying what they trust. If you still believe in the concept of cryptocurrency that usually means converting your whatever-coin back into Bitcoin. If you lost all your faith you’ll probably want dollars or euros but in order to convert your whatever-coin you most likely have to convert it to Bitcoin first. This is how the lifecycle goes. As the crypto pie grows bigger, it grows in all directions. As it shrinks, Bitcoin shrinks a little less than the others.

The world has never seen an invention like Bitcoin before. It is truly unique and it has already changed the world. Every year there’s a new bunch of fools trying to find the next Bitcoin, refusing to believe that this rocket has barely left the ground yet because of its jaw dropping price movements. Every year there’s a pullback, some years a big one. People panic sell because they forget the fundamentals and how solid this is in the long run. Long term hodlers always win. No matter when you bought, wait at least five years before even considering selling and you’re guaranteed to do better than 99% of the day traders out there. Forget about chart analysis and price predictions, get to know the fundamentals and you make yourself immune to snake-oil salesmen, scams and propaganda. Knowledge is a vaccine and no, it won’t give you autism.

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