Brad DeLong and Paul Krugman have joined in the bitcoin conversation:
- Watching Bitcoin, Dogecoin, Etc…
- Bitcoin is Evil:
DeLong starts his tirade with the following:
Underpinning the value of gold is that if all else fails you can use it to make pretty things.
Krugman goes on his rant with the following:
To be successful, money must be both a medium of exchange and a reasonably stable store of value. And it remains completely unclear why BitCoin should be a stable store of value.
What is DeLong talking about? Unclear.
DeLong states that gold’s value has to do with the fact it can make pretty things. What? The value of gold has everything to do with its scarcity and its ability to function as money, not because people can use it to make jewelry.
DeLong might be confused by the “Paradox of Value”, or confusing a good’s usefulness with its value. (e.g., Water is very useful and keeps us alive, but isn’t extremely pricey).
- http://en.wikipedia.org/wiki/Paradox_of_value
- A more detailed story of a marginal utilitity theory of prices and goods (starts page 21) http://mises.org/Books/mespm.pdf
Case in point: The Yapanese. http://www.npr.org/blogs/money/2011/02/15/131934618/the-island-of-stone-money
There’s a tiny island called Yap out in the Pacific Ocean. Economists love it because it helps answer this really basic question: What is money?
There’s no gold or silver on Yap. But hundreds of years ago, explorers from Yap found limestone deposits on an island hundreds of miles away. And they carved this limestone into huge stone discs, which they brought back across the sea on their small bamboo boats. It’s unclear if these stones started as money. But at some point the people on Yap realized what most societies realize. They needed something that everyone agrees you can use to pay for stuff. And like many societies, the people of Yap took the thing they had that was pretty — their version of gold — and decided that was money.
What is Krugman talking about? Clear, but arguable.
Krugman makes a more plausible argument related to the functions of money. Specifically, he states that BitCoin is unable to fulfill its role as a “store of value.” This is a valid claim, but it can also apply to other money in circulation–especially fiat currencies run by governments with serious incentives to drive inflation (in other words, ensure the currency doesn’t maintain a store of value). So the real question should be the following:
Which form of money serves the core functions of money most efficiently.
First, the textbook answer for what makes something function as “money.” http://en.wikipedia.org/wiki/Money
Medium of Exchange:
- Value common assets
- constant utility
- low cost of preservation
- transportability
- divisibility
- high market value in relation to volume/weight
- recognizably
- resistant to counterfeiting
Unit of Account:
Store of Value:
Measure of Value:
Bitcoin is an ideal currency in many respects, but its ability to serve as a store of value and a medium of exchange depends on the ability to use the currency in a variety of circumstances…and that depends on adoptability by the broader public.
Here is a nice writeup by William Luther on bitcoin that sums up the issues: http://mercatus.org/sites/default/files/Luther_CryptocurrenciesNetworkEffects_v1.pdf
Cryptocurrencies are digital alternatives to traditional government-issued paper monies. Given the current state of technology and skepticism regarding the future purchasing power of existing monies, why have cryptocurrencies failed to gain widespread acceptance? I offer an explanation based on network effects and switching costs. In order to articulate the problem that agents considering cryptocurrencies face, I employ a simple model developed by Dowd and Greenaway (1993). The model demonstrates that agents may fail to adopt an alternative currency when network effects and switching costs are present, even when all agents agree that the prevailing currency is inferior. The limited success of Bitcoin—almost certainly the most popular cryptocurrency to date—serves to illustrate. After briefly surveying episodes of successful monetary transition, I conclude that cryptocurrencies like Bitcoin are unlikely to generate widespread acceptance in the absence of either significant monetary instability or government support.
At a high level, a lot of things can serve as money–to include giant limestone rocks. Some are better than others. BitCoin has many favorable characteristics relative to other potential money. But the big problem for any money is getting the entire network to agree on its usage. And as Luther points out, “The model demonstrates that agents may fail to adopt an alternative currency when network effects and switching costs are present, even when all agents agree that the prevailing currency is inferior.”
About the Author: Wesley Gray, PhD
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