When Mises Met Szabo — A Discussion of the value of Bitcoin

Bitcoin and mises regression theorem

There is a large misconception among Austrian school advocates that Bitcoin somehow contradicts a supposed theorem by Mises nicknamed Mises Regression Theorem. Let’s not delve on the point that nowhere in Mises’ The Theory of money and credit can you even find the word regression. What the supporters of this argument say is the following:

Mises claims that a commodity can’t start as a medium of exchange. In order to establish itself as a medium of exchange, there first needs to be an exchange of this commodity. Thus, to be valuable, bitcoin needs to have some value outside of it being a medium of exchange. Gold has such value — it can serve as Jewellery and in different industries. Bitcoin doesn’t, so it has no value.

To say this has nothing with what Mises actually wrote is an understatement.

The argument Mises suggested does indeed say that to become a medium of exchange, a commodity must at some point in time have an exchange-value, based on which people will trade on it in the future until it becomes money. First, let’s agree Bitcoin is a commodity -

“We may give the name of commodity money to that sort of money that is at the same time a commercial commodity; and that of fiat money to money that comprises things with a special legal qualification. A third category may be called credit money, this being that sort of money which constitutes a claim against any physical or legal person”

Surely Bitcoin is not fiat money — it’s not a legal tender of any state or government. It’s not credit money — it doesn’t constitute a claim against any physical or legal person. We thus arrive to the understanding that it’s a commodity — but does it have any value ?

“Before an economic good begins to function as money it must already possess exchange-value based on some other cause than its monetary function. But money that already functions as such may remain valuable even when the original source of its exchange-value has ceased to exist. Its value then is based entirely on its function as common medium of exchange”

It’s a famous anecdote that the first bitcoin exchange-value was 10000 bitcoins for two Papa Joe’s pizzas. Once this exchange-value was established, Mises says clearly nothing matters anymore. The Subjective value of 10000 bitcoin to the guy owning two pizzas was greater than the two pizzas, and so he established an exchange-value. From this point onwards, all that matters for the valuation of bitcoin is the series of exchange-values. That’s it. That’s why the Austrians believe in subjective value — it doesn’t matter if the first transaction made sense. Was the guy exchanging 2 pizzas for 10000 bitcoin gullible ? Maybe, but the fact was that in his subjective valuation the deal was worth it is enough to establish an exchange-value, which is all Mises “Regression theorem” requires.

But what about Gold ? Isn’t Gold better than bitcoin because it has real commodity use, and can serve as Jewellery and in the chip industry ?

I would say that:

• Serving as Jewellry is not commodity use — It stems from the same source as being a widely accepted medium of exchange. If at some point people wouldn’t want it as a medium of exchange, they wouldn’t want it as Jewellery just as well. Quoting Szabo on this one, “‘Jewelry is money’ is how Sebag summarizes his observations of the modern Asian jewelry market.”. And Mises: “One and the same piece of metal can even fulfil both purposes simultaneously, as will be seen if we think of ornaments that are used as money or of a coin that is worn by its owner as jewellery until he parts with it again”.

Think about it — Aren’t precious-metals Jewellery actually wearable money ? Why do people prefer them so much over the cheaper imitations existing in the market ?

• When you buy gold, you already have its commodity use-value incorporated in the price. So saying that ‘even if it loses value as a medium of exchange, it still has its commodity use-value’ could be answered with ‘sure, but you’re paying for it already when you buy it’. Quoting Mises, “It is certain that nowadays the value of gold is largely supported by its monetary employment, and that its demonetization would affect its price in an overwhelming fashion”.
• If gold’s use-value is its uses in the chip industry, and every money needs to originate from its commodity use-value, does that mean Gold started being considered as money only after the chip industry started using it ..?

Let’s finish this section with another great Mises quote:

“Arguments from authority are invalid; the proof of a theory is in its reasoning, not in its sponsorship; and with all due respect for the master, it must be said that they have not justified their position very thoroughly in this matter”.

For anyone wishing to find more for themselves, simply read the first ~120 pages of Mises’ The Theory of money and credit And Menger’s 50 page long On the origins of money. I assure you it will not take too much of your time and you would be able to determine yourself whether this “most fundamental” argument against bitcoin serving as a medium of exchange is valid or not.

That being said, I wish to delve a bit more into why — and why not — bitcoin attained its monetary value.

Bitcoin is not the best store of value.

Gold is a better store of value for the following reasons:

• It’s truly decentralized — Never mind how much you pump the decentralized buzzword, a blockchain protocol depending on internet connectivity and software updates is not as decentralized as real life physical assets. The idea circling of confiscating Satoshi’s 1M bitcoins is an example where creative individuals can innovate arguments on how to take your money away from you. And through software updates they can do that, as hapenned in Ethereum’s DAO case.
• It has >5000 years of reputation, which is more than 10 years — A lot about currencies is being battle-tested, and being able to store value across eco-political occasions and times. Gold has proven it, while Bitcoin may always come up with some obscure bug that allows people to create 194 Billion bitcoins.

Bitcoin is not the best payment system.

Centralized payment systems such as Paypal are a better payment system than Bitcoin for the following reasons:

• Bitcoin is inefficient by design — It can process smaller amounts of transactions, and could eventually have higher transaction fees than centralized payment systems once its use is more widespread.
• Paypal and Visa integrate seamlessly with fiat currencies — Bitcoin does not.
• Bitcoin has latency built in — While in Visa, you get a confirmation seconds after you commit your transaction — they just need to run their anti-fraud mechanisms, check that you have sufficient balances and then they can change the record and you’re done — Bitcoin’s convention is to wait 6 confirmation cycles — 1 hour before a transaction is approved — and that’s inherent to the protocol.

Bitcoin IS the best store of value integrated with a payment system.

That’s where I think the gold advocates are missing the point. Gold is a good store of value, but it’s not very good as a medium of exchange. In the physical level, it’s easier to carry paper money. If you want to make a large transfer, you will need a secure UBS truck with armed guards. Most of the times, you will take a counterparty risk and store Gold through an intermediary. Thus, bitcoin could be very advantageous as the world’s financial backbone.

If you’re having an issue with imagining how bits in the virtual space can have so much value, imagine the next scenario:

In 15th century Italy, while digging in the ground the Florentines discover a complicated network of tunnels leading to Genoa, Venice and Rome. The tunnel system comes built-in with iron carts, that are the only ones that can travel in the system. An iron cart can reach within an hour to every house in every city. They can’t carry any commodity, but you can assign them values and send them around, and the magic of the tunnel makes sure there is no hyperinflation in these values and they behave like sound money.

Does anyone really believe the florentine wouldn’t use this system to make safe financial transactions throughout Italy ? Wouldn’t the iron carts be valued at a high price ?

‘Bitcoin’s future is in being virtual gold’ is not good thinking

Quoting Mises,

“The Functions of money as a transmitter of value through time and space may also be directly traced back to its function as medium of exchange”

If something is not at least a reasonable medium of exchange, it can’t be a good store of value. That’s why, without siding either with the current Bitcoin or Bitcoin cash community on this one, I would say believing in a future where Bitcoin can have almost no transactions and just serve as a Store of value as a form of virtual gold is very wrong.

Store of values are like sharks. If they don’t move at all, they’re dead.

What about Alternative coins ? Can’t bitcoin be reproduced a million times ?

While in theory it can, a lot will need to happen for a new coin to emerge: It will need to have miners that want to participate in the system, merchants that are willing to accept it, and users that are willing to invest in it. Though it happened with Litecoin and Dogecoin, this is not an easily reproducible task.

When Bitcoin was first introduced, it had no competition. An altcoin that rises now, will need to have some significant useful new qualities in order to overthrow bitcoin or take a significant market cap. With large enough financial backing and a huge marketing budget, it might happen even without such significant improvement, but the network effect is very strong. That’s why just a few social networks and just a few messaging apps control these domains. Still, it’s good to emphasize I’m not a Bitcoin maximalist and am referring to Bitcoin throughout this blog post more for ease of terminology. It could and probably will be a set of cryptocurrencies to rule the helm, but issues such as liquidity and long-term price stability will induce people to stick to a few of them.

Bitcoin is best fit to be the world’s financial backbone

As an individual merchant, I wouldn’t care so much about Paypal defaulting. It would probably not be among my 20 first worries. I care more about getting customers, reducing my costs, and all I want is some payment system that works. I would probably not store too much funds there at a given time anyway. So though bitcoin at a phase of its growth is serving these SMB users, probably more so for tax evasion, illegal trafficking and speculation purposes, this is not where the future of the currency should be. Once the regulatory environment becomes clearer, bitcoin could become the world’s financial backbone, gradually replacing Swift. The off-chain solutions will offer cheap transactions that still incorporate counterparty risk for the Paypal type merchants, but for large transfers and Enterprises Bitcoin on-chain will be a great fit.

Suggesting a framework to investigate implications of Bitcoin replacing the swift system

I will now enter into the realms of speculation and analyze the effects and process of Bitcoin replacing the Swift system. This needs to be taken with a grain of salt, but here goes:

I will use the MV=PQ model advocated by the latest Cryptoassets book by Jack Tatar and Chris Burniske.

From here we learn that in the swift system, PQ = 1.25 Quadrillion dollar per year. Now let’s assume any bitcoin velocity, say 100, so a bitcoin changes 100 hands within a year. This gives us an ultimate bitcoin price of

12.5 Trillion Dollar / 21 Million coins in circulation == 600,000 dollars.

This sounds like a huge inflow of money into Bitcoin. How could this actually work ? And why would it be beneficial to financial institutions to buy bitcoins and compensate the early adapters so much ?

Let’s say a large financial institution has the same amount of inflow and outflow of money during a time period, as his customers are paying and getting paid about the same amounts in aggregate. This means that if its payment system is based on bitcoin, it will have just about the same amount of bitcoins over time. Let’s assume the institution have an outflow of 100B$ each month.

Say the swift commissions are about 0.8% per transaction while for bitcoin they are 0.1% per transaction, and each bitcoin is engaged in 10 outgoing transactions a month, so in average it goes in and out of the system 10 times a month.

Buying 10B$ worth of Bitcoins would satisfy their transaction needs, as it should be enough to make 100B$ worth of transactions with the bitcoin velocity we assumed.

The monthly commissions costs will then be 800M$ compared to 100M$. You can calculate that within ~14 months the investment in bitcoins will return itself. That’s a cool ROI.

What happens if bitcoin transaction costs go up to 0.7% per transaction ?

It will then take 100 months (~8 years) for ROI. Depending on the market interest rates, the process of moving money into the bitcoin system will stop at some point.

We can assume in a non-speculative market, bitcoin price should in general grow linearly with transaction per second rate, and so also with transaction costs. Thus, we learn that bitcoin price should in the medium term stabilize according to the ratio between swift transaction commissions and current bitcoin transaction commissions.

From here we learn Swift transfers around 30M transactions per day, so average transfer is 160K$, which currently means bitcoin transaction commissions would stand at ~0.02%. This means Bitcoin has a space to grow 0.8%/0.02% == x40, so it could arrive at 400K$ valuation. Let’s go harder on bitcoin though, and assume most of the transactions are smaller, say around 1000$, so bitcoin transaction commissions would currently stand at 0.2%, this will give us a more modest growth valuation of x4, so about a 40K$ valuation.

Wait, what about Nick Szabo ? You promised to present his ideas about the origins of money

Yeah I kind of did. The article got quite lengthy and Mises & Menger are actually not that much opposed to him, so there was no point in presenting the ideas in a form of a debate. You may read more about his very interesting and insightful ideas in the links I’ll add right at the end of the blog post.

I hope to dedicate a full blog post for Nick Szabo’s ideas, but for the time being I will be content knowing that the guy behind bitgold, who is known as one of Bitcoin’s founding fathers is a very thorough and thoughtful scholar and individual thinker.

Resources:

Nick Szabo on the origins of money -

https://unenumerated.blogspot.co.il/2006/06/menger-on-money-right-and-wrong.html

https://unenumerated.blogspot.co.il/2006/06/monetary-origins-pushed-back.html

https://unenumerated.blogspot.co.il/2006/06/selling-seashells-by-seashore.html

https://unenumerated.blogspot.co.il/2007/08/money-and-problem-of-cooperation.html

https://unenumerated.blogspot.co.il/2017/03/collecting-metal-inner-and-outer-worlds.html

https://unenumerated.blogspot.co.il/2017/02/conflict-and-collectibles-among-yurok_87.html

https://unenumerated.blogspot.co.il/2011/06/of-wages-and-money-cost-as-proxy.html

https://unenumerated.blogspot.co.il/2011/05/bitcoin-what-took-ye-so-long.html

https://unenumerated.blogspot.co.il/2008/03/logical-emergence-of-money-from-barter.html

https://unenumerated.blogspot.co.il/2008/06/commodities-currencies-and-st.html

https://unenumerated.blogspot.co.il/2005/11/flying-money-brief-overview.html

https://unenumerated.blogspot.co.il/2008/04/bit-gold-markets.html

https://unenumerated.blogspot.co.il/2009/04/money-and-efficiency-of-plunder.html

http://nakamotoinstitute.org/shelling-out/

https://unenumerated.blogspot.co.il/2016/07/artifacts-of-wealth-patterns-in_15.html

Peter Schiff debates against Bitcoin -

https://www.youtube.com/watch?v=Cuvpd0EwtHw

https://www.youtube.com/watch?v=fFuT-MEMu94

https://www.youtube.com/watch?v=MsL_8AazpsA

https://www.youtube.com/watch?v=7mUn-d8R98k

https://www.youtube.com/watch?v=mFcTJAQ7zc4

I would be happy to debate Peter myself. As a quite enthusiastic follower of his who listens to almost his every podcast, I hope I can change his mind on the subject using Szabo’s and Mises’ arguments themselves. I believe he’s very smart but uninformed when it comes to crypto, and also quite fortified in his beliefs and positions by this point. The Ivan on Tech debate was a quite good and informed debate though — 3rd link, if you wish to listen to it.

Discussions of Bitcoin and Mises regression theorem

https://mises.org/power-market/murphy-bitcoin-and-regression-theorem

https://tucker.liberty.me/bitcoin-and-misess-regression-theorem/

https://mises.org/library/cryptocurrencies-and-wider-regression-theorem

Nice Cryptoassets valuation articles -

https://medium.com/cryptolab/https-medium-com-kalichkin-rethinking-nvt-ratio-2cf810df0ab0

https://medium.com/blockchannel/on-value-velocity-and-monetary-theory-a-new-approach-to-cryptoasset-valuations-32c9b22e3b6f