Aug 27, 2013

The Benefit of Specialization – Bitcoin as an Invented Currency

Posted by in categories: bitcoin, economics, engineering, finance

Originally posted as Part II of a four-part introductory series on Bitcoin on May 7, 2013 in the American Daily Herald. See the Bitcoin blog for all four articles.

The emergence of money and its importance in enabling trade between people has been well researched and documented in the literature of the Austrian School of economics – Theory of Money and Credit by Ludwig von Mises and Man, Economy and State by Murray N. Rothbard being prime examples. The contribution of the Austrian greats to the understanding of money and its origin made clear exactly what money is (e.g. the most marketable commodity), the different types of media that are employed in exchange between people (e.g. commodity money, credit money, fiat money and money substitutes) and a theoretical explanation for their origin (the Regression Theorem). The Austrian School has also given arguably the most convincing analysis of the relationship between the money type in use, the manner by which it is controlled and the business cycle – emphasizing the importance of sound money. But except for a few sparse outliers, what the Austrian School has yet to do is fully recognize Bitcoin as a valid scholarly and academic topic. With this article, I hope to contribute to its recognition.

Money’s characteristics

Money enabled people in early stages of civilization to go from direct exchange, with difficulties such as the double-coincidence of wants, to indirect exchange. This improved mechanism paved the way for facilitating man’s specialization in his tasks, thereby enabling division of labor within society since each specialized laborer was able to trade his goods for others indirectly with the use of a medium of exchange. Money has taken many forms but there are certain characteristics all forms should have. Aristotle, for instance provided the following four:

  1. Durable – The item must remain usable and retain its characteristics, for which it is valued, over long periods of time (e.g. shouldn’t fade, corrode, rot, etc).
  2. Portable – One should be able to carry it upon their person. A related point is that it would be desirable to have a high value per unit weight, making large quantities portable too.
  3. Divisible – By having uniformity of quality or homogeneity, the item should retain its characteristics when divided into smaller parts or when recombined to a larger unit. Thus, a similar point is the fungibility of the item, meaning that the units can be substituted for one another.
  4. Intrinsically Valuable – The intended meaning is that it should have value as a commodity regardless of its property as money, although as I argued in a previous article, value is subjective and therefore extrinsic to the item, so it cannot in itself be intrinsically valuable. A related point is that the item, ideally, would be rare and certainly not subject to unlimited reproducibility – meaning it should be scarce.

Though Aristotle did not specifically mention fungibility, scarcity or other points such as recognizability, stability of supply, malleability etc., these points generally cover the qualities of good money. The fact that there are monies out there (e.g. fiat money) that so blatantly lack an important characteristic (e.g. not being subject to infinite reproducibility) makes the Mises Regression Theorem so interesting, in that it explains how such a money came about.

Man’s desire for convenience

Mises defined money, in its narrower sense, as taking three forms: commodity money; credit money; and fiat money. In its broader sense, money substitutes like fiduciary media are also used. Of all these forms of money, the most convenient are fiat money, credit money and money substitutes. These forms can be represented by pieces of paper (e.g. banknotes or contract) and therefore, as long as there is trust in the issuing entity or in the counterparty, these monetary forms will be accepted ‘as good as’ the money that backs them or the money that is promised in the contract. Banknotes, token money and the like stemmed from the fact that the common man did not want to store large amounts of precious commodities in his home nor carry it on his person. Banks stored the commodities and issued redeemable notes instead. Let’s face it, humans choose the path of least resistance and so convenience is desirable.

The unfortunate situation that arose is that when banks (or their ‘money warehouse’ predecessors) realized that not everyone wants all of their stored gold at once, they started issuing multiple banknotes backed by the same unit of money stored. This fraud has become pervasive and eventually legally licensed by the state. So while ‘hard currencies’ are good, their lack of convenience has led, as a matter of historical fact, to fractional reserve banking. This practice and the expansion of the monetary base introduce anomalies into the economy and bring about the business cycle.

Another aspect that is inherent to commodity money (and most all other money types) is that the payment system has always been separate from money. Whether carrying a bag of coins in one’s pocket or arranging for an armored van, payment requires delivery of money. Banks and clearing houses took on the role to perform this service, charging lucrative transaction fees in the process. Here, too, it became more convenient to use credit money or internet banking, where one just transfers the information about the transaction and where it is just as convenient regardless of the sum involved. No physical asset can be transferred instantaneously and without effort.

As desirable as physical commodities such as gold and silver are, the fact that they become increasingly less convenient the more you have of them has turned out to be their Achilles’ heel.

Division of labor and specialization of tools

As we can see from the above arguments, while commodity money has been the soundest of options, it is not without its flaws. But, remember, this is not an unusual phenomenon. Being self-sufficient and growing one’s own food is also prudent, yet most will concur it has its disadvantages. Humans have discovered that division of labor and specialization makes everyone better off. Specialization, though, is most effective when the tools one uses are also custom-made for the task at hand. Imagine using a gardening trowel as a ladle for your soup, or a battle axe as a butcher knife… This is a facetious comment, to be sure, but why then must we ‘make do’ with an ornamental commodity or a block of highly conductive metal as money? Humans once used flint to start fires because that is what nature provided. Surely, we agree a lighter is much better. Why should we not seek to invent a tool to facilitate monetary transactions, call it money, which would cover the characteristics noted above (Aristotelian or others) as ideally as can be? Then just set it free and see if it acquires value through a catallactic process, much like gold and silver did in the past. As Rothbard said in relation to gold: “If gold, after being established as money, were suddenly to lose its value in ornaments or industrial uses, it would not necessarily lose its character as a money”. If one invents money and it establishes itself, who cares if it has no other purpose?

Whether for the reason of making a more perfect money or just to make a digital form of it, an unknown hacker (or group of hackers) brilliantly devised a new money — Bitcoin. We see that it has already acquired some value and a quick search will show an ever increasing number of businesses willing to trade in Bitcoin. It is already a medium of exchange for a growing number of countercultures. Whether it continues to gather momentum is an empirical question, one for which only time has the answer. But let us not forget this is a free market phenomenon. Nothing about its ownership, mining or its use violates private property rights. As with any good on a truly free market – the only test it must withstand is the test of marketability and popularity within the confines of the non-aggression principle and private property rights.

But does it serve customers’ needs?

By far the best and most academically rigorous description of Bitcoin I’ve seen has been given by Peter Šurda in his Master’s thesis. Konrad Graf has also written extensively on the subject with clarity and insight. I will not do justice to arguments they put forward, but will share their opinion that Bitcoin has superior qualities as it relates to the characteristics of money.

  1. Durable – Bitcoin can exist in any number of forms, be it physical or intangible (yes, you can actually have a Bitcoin coin or card). It can be printed on paper or committed to memory. But at its core, it is abstract and can be made to be as secure as the network it depends upon. Its peer-to-peer nature makes it all but impossible for governments to shut down.
  2. Portable – If it exists in its intangible form, there is nothing more portable than 1s and 0s. A million bitcoins weigh as much as a millionth of one. It is also the most easily transportable good – no shipping costs, insurance, etc. It is, after all, its own payment system. In fact, it is so portable, you can carry backup copies with you or trusted parties, hidden in USB keys and on anonymous servers – this is the only form of money that could pose an insurmountable challenge to those wishing to confiscate your money.
  3. Divisible – Each coin is divisible into 100 million smaller units, meaning that even if each bitcoin rises to $1 million each, we would still have the equivalent of a penny. Likewise, Bitcoin is perfectly fungible.
  4. Scarce (Intrinsically Valuable) – Bitcoin is rare (total quantity will not exceed 21 million units) and is not subject to unlimited reproducibility. This is by design and due to its complete decentralization, there is no one entity that can override this characteristic.

Šurda additionally showed how it was superior in logistics, manipulation, authentication, transaction costs of property rights, counter-party risk, and others. Graf noted its superiority also in purchasing power and stability of supply, lending itself to become a catalyst for deflation (in the good way). And since Bitcoin isn’t a raw material in creating other products, premiums aren’t charged for industry use. Therefore, no other lower-order goods’ costs of production are affected by its potentially ever-increasing value in a deflationary environment.

Best of all, this is a commodity money that does not need money substitutes and it doubles as its own payment system. This leads to two very desirable outcomes. Banks would no longer be needed as ‘money warehouses’. Individuals could store their own bitcoins, much like they store their cat photos on their hard drives or online. Many libertarians wonder how to make fractional reserve banking illegal. You would not need to – it would come about naturally since this ‘service’ would no longer be required. Banks’ role in the business of transferring money would dwindle as well, since paying in Bitcoin is as easy as sending an email. Transaction fees and capital controls would become a thing of the past. Banks would therefore revert to providing useful services, such as pairing up those who want a loan with those who have money to lend. They would finally be forced to innovate, same as businesses across the spectrum have been doing since the dawn of civilization.


Bitcoin has the making of becoming money in its own right. As of now it is a medium of exchange for a limited group of individuals, but it has already acquired value and is already being purchased for its exchange value. Bitcoin is a free market phenomenon. The value it has was not forced upon anyone and its use is not protected by legal decree.

Professor Hoppe notes the following: “Economic theory has nothing to say as to what commodity will acquire the status of money. Historically, it happened to be gold. But if the physical make-up of our world would have been different or is to become different from what it is now, some other commodity would have become or might become money. The market will decide.”

What becomes money is indeed an empirical question that we can only analyze with hindsight. From the great work done by the economists quoted above, we can uncover another empirical fact – that money has arisen in a spontaneous manner, through the evolution of successive generations of human actors. But let us not conclude that money can only arise spontaneously – it can be purposefully invented and then left to the market to adopt or reject. What we are witnessing is the adoption of a new invented form of money. Money, after all, is a tool to facilitate economic transactions. We must accept – and build into our theories – the possibility of using a tool that is custom-built for this purpose. We must not merely denounce a form of money because its building blocks are not naturally provided or because it does not have other uses. If it meets and exceeds all of the characteristics of money, if it adheres to principles of economic scarcity and decentralization, and if actors on the free market see the value in it and freely exchange goods and services for it – we need to accept this, too, as having potential of being included in our books and scholarly articles alongside the time-honored alternatives. Let us have academic debates about its practical or economic merits and flaws. This is not a winner-take-all situation. Competition in currencies is just as valuable as competition in other areas. Let’s just remember that Bitcoin could well help us achieve a better and freer society with a sounder economy.

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