The rapid growth of Bitcoin’s popularity over the last decade has sparked an intense discussion among different stakeholders. The investment community is interested in Bitcoin as it represents a potentially lucrative speculative asset. Policymakers want to better understand the potential implications of the issuance of a central bank digital currency. Data scientists are fascinated by the innovative algorithm, the computing power, the proof-of-work mechanism, and the use of blockchain as a decentralized ledger in order to possibly become miners and make a profit.
In 2008, Satoshi Nakamoto, the founder of Bitcoin, defined Bitcoin as: “A purely peer-to-peer version of electronic cash [which] would allow online payments to be sent directly from one party to another without going through a financial institution.” Thus, Bitcoin is introduced by its creator as a virtual currency. However, the question remains: can Bitcoin be defined as a currency and ultimately substitute traditional money?
Firstly, the textbook definition of money is analyzed. Secondly, Mises money regression theorem is reported and discussed.
Money is defined as anything that is generally accepted in payment for goods, service, or in the repayment for debts. It has three main characteristics: (1) medium of exchange, (2) store of value, and (3) unit of account. Starting with the first characteristic of money, a medium of change (1) must be widely accepted, easily standardized, divisible and easy to carry, and doesn’t have to deteriorate quickly. Bitcoin is not widely accepted and it does deteriorate quickly. (2) A store of value is used to save purchasing power over time. Bitcoin is a very risky and thus a volatile asset which cannot be used as a store of value. Lastly, (3) money must be used to measure all the transactions within an economy (i.e.: it is used as a reference point of the price of all the goods and services offered). Given Bitcoin’s volatility, the latter cannot be done with Bitcoins. Thus, none of the textbook points of money definition is respected by Bitcoin (Investopedia, 2020).
In order to evaluate Bitcoin for its money-like functions and features, we can also apply Mises’ regression theorem and focus mainly on its function as a means of exchange. The latter states that: “It is true that he who considers acquiring or giving away money is, of course, first of all interested in its future purchasing power and the future structure of prices. But he can not form a judgment about the future purchasing power of money otherwise than by looking at its configuration in the immediate past.” (Mises, 1912). The world’s most successful currencies have entered the definition of money throughout a process that has lasted centuries. Indeed, by applying the theorem on these currencies, it is possible to trace back their original value in the barter system. Accordingly, in order to be able to evaluate Bitcoin’s demand through its monetary features (i.e.: mainly its function as a means of exchange), it is necessary to move back to its value as an asset. The value of Bitcoin as a cryptocurrency, and the main driver for its demand, is its network. In fact, “As the number of participants increases so does the number of possible exchanges among the participants and the value of the network services” (Pagnotta & Buraschi, 2018). In a peer-to-peer network, as in the case of Bitcoin, the confidence of one agent in the network justifies his use of Bitcoin as a currency. Indeed, the agent relies on others’ adoption of the currency and on his expectations on others’ adoption of the currency (Mises, 1912). Thus, we can deduct that the value of the crypto-currency depends on the value of its network of users. This notion is called Metcalfe’s Law: “The key measure of value for cryptocurrencies is the network of people who use them” (MIT, 2018). The latter is also mentioned in the article “Competition in the Age of Online Giant” as one of the three principles of digitalization and network theory of the emergence of economic hubs. Bitcoins are already accepted for house purchases in Spain and to pay taxes in Switzerland. The latter opens a promising root for Bitcoin.
To conclude and summarize, considering the state of art I believe Bitcoins cannot substitute our monetary system. Nevertheless, they display several characteristics of an emergent economic hub and in the near future have a high chance of being a real disrupter of our economic system as a whole.
Iansiti, M., & Lakhani, K. R. 2018. Managing our hub economy. Harvard Business Review, 96(1), 17-17.
Investopedia (2020). Money definition. Retrieved from https://www.investopedia.com/terms/m/money.asp
Pagnotta, E., & Buraschi, A. (2018). An equilibrium valuation of bitcoin and decentralized network assets. Available at SSRN 3142022.
Metcalfe, M. (2013). Metcalfe’s Law After 40 Years of Ethernet. Computer, 46(12):26–31.
Mises, L. (1912). Human Action, Theory of Money and Credit. Mises Institute. Retrieved from https://mises.org/library/human-action-0/html/p/605
MIT, (2018). How Network Theory Predicts the Value of Bitcoin. MIT Techonology Review. Retrieved from https://www.technologyreview.com/s/610614/hownetwork-theory-predicts-the-value-of-bitcoin/
Nakamoto, S. (2008). Bitcoin: A Peer-to-Peer Electronic Cash System.
Nakamoto, S. (2010). Bitcoin Does NOT Violate Mises’ Regression Theorem. Satoshi Nakamoto Institute. Retrieved from https://satoshi.nakamotoinstitute.org/posts/bitcointalk/428/#selection-9.4-9.54
