Bitcoin – Currency or Bubble?

Bitcoin, the first crypto currency of the world, has come a long way. When I first heard about it, I thought it was a joke. A purely digital currency, really? Since bits are almost free these days, it seemed obvious that the value of such a currency would have to be zero.

It took me a while to understand that bitcoin was actually based on a genius new technology called the blockchain. This technology limits the amounts of bitcoins with mathematical certainty. More than that, it appears to be entirely libertarian. The whole purpose of bitcoin is to create a currency, that is as scarce as gold, and cannot be controlled by governments. But unlike gold, it also comes with a whole integrated, anarchic banking infrastructure. What an amazing idea.

Bitcoin could really be a great form of money. It has almost all the characteristics that we know money needs to have. Firstly, it is durable. So far, the software seems secure, and the bitcoins cannot be destroyed. Secondly, it is divisible. There are many bitcoins, which in itself can be divided into many subunits. Thirdly, it is fungible, meaning all bitcoins are interchangeable. It does not matter which bitcoin you own. And finally, bitcoin is convenient. It is easy to use. In fact it is probably more easy to use than anything else out there that tries to be money. All it needs is an internet connection and a very simple computer, and it can be transferred anywhere instantaneously.

There is however one problem with bitcoin. Unfortunately, it is lacking a characteristic that, according to the Austrian School of Economics, a potential currency needs to have. And that is an intrinsic value. For something to be money, it first needs to be used for something else but being money. Only then will enough people trust to keep their savings in that new currency, because only then they will have a guarantee that they can never fully lose their savings. The intrinsic value puts a floor into how far the currency can fall. It also spreads the usage of the commodity, and therefore establishes a market, before it is used as money. This is, so the argument, essential to give it the necessary trust, and acceptability to function as a currency.

Gold, for example, has been used as money for thousands of years. But it is also an extremely useful metal for other purposes. Even at current prices, it has a limited usage in the industry. If prices were to fall, it would immediately become attractive for all kinds of purposes. That puts an effective floor into the value of gold. It is this what we can call an intrinsic value.

Bitcoin however, does not seem to have an intrinsic value. It tries to jump this important first stage, and wants to be money straight away. The question is, is this possible? Or at least, is this possible on a free market. Sure, it is probably possible if a state forced people to use it. We have seen this happening with fiat currencies like the Euro. But will people voluntarily adopt something as money, that does not have an intrinsic value. With crypto currencies, we are currently in the process of finding out.

So far, one could make a strong argument that bitcoin proofs the austrians wrong. When I discovered bitcoin, the price was already around $30. Not bad for something without an intrinsic value. Ever since, the price has hugely fluctuated, but the tendency has been clearly up. As I am writing this, a single bitcoin sells for way north of $2000. It has more than doubled within a few month, and the chart seems to have turned parabolic.

But is this enough to proof that the Austrians were wrong? I thought about this a lot in the last few years. Since bitcoin already seemed to have a dollar price when I discovered it, I originally tended towards thinking that it indeed can be money without having an intrinsic value. However, I have since more and more changed my mind about this. I now think that bitcoin, or any other crypto currency, will not become a widely accepted currency. The idea that high bitcoin prices in dollars proof the opposite, seemed to have been a bit premature. It was literally wishful thinking on my part. I wanted it to be true.

I am sorry to say this, but I think what we are currently seeing is a classic speculative bubble. And far from being encouraging, this is going to kill crypto currencies in the end. That is because, as long as it is in a bubble, people are going to hoard it. This prevents it from being used in daily business transactions. And once the bubble pops, lots of people will get burned. For good reasons, humans don’t tend to forget painful experiences like that quickly. That means that when this is over, they will have likely learned to mistrust crypto currencies.

From very early on I realized that people who own Bitcoins were not all idealists. Yes, they kept telling me about the great technical functions this new currency had, and how it would create big problems for governments. But a scarily high number of people also told me, that they expected the price to skyrocket and consequently for bitcoin to make them rich.

These two things are not really compatible with each other. Sure there are currently a lot of traders in all kinds of established currencies. That means, the idea of making money on a currency is not unique to Bitcoin. What is unique however, is the scale of upwards volatility that people predicted in the crypto currencies, and also the high percentage of speculators.

Despite the fact that there are traders in all major currencies, the main function of these currencies is to facilitate everyday business activities. Most people use them that way. For that reason the volatility in these currencies is relatively low. It would be a major problem for any currency, if people started to abandon it for their everyday business. That is what we are seeing in a hyperinflation, which usually marks the end of a currency.

Despite the hype that we are witnessing at the moment, bitcoin currently is not used often as an actual currency. In fact, percentage wise, the number of people who use it as such seems to decrease rather than increase, as more and more speculators enter the market. So why are prices going up? Instead of seeing solid demand from real businesses for these currencies, the demand appears to come from people, who are betting on higher prices instead. I currently see a lot of media attention for bitcoin, hardly any of which is praising it as a currency. Pretty much all are promising new investors big fortunes. And that is even true for articles coming from the hardcore bitcoin community itself. But where exactly are these fortunes going to come from, if bitcoin is not used for real business?

And to my knowledge, there really is currently no major business out there that accepts bitcoins. I know, people will tell me that that is not true. Bitcoin can be spend in many shops. Yes, you can pay with them, but that does not mean that the business accepts bitcoin. I still have a euro account in Germany, with an attached VISA card. I can buy stuff with that card in pretty much any shop in the UK. That does not mean that euros are widely accepted in this country. The prices and all the accounting are still done in pounds. My euros are simply immediately exchanged into pounds at the time of the purchase. So what is really happening is that I have to sell my euros for pounds, and then pay the business in pounds. The technology simply enables me, to do all these things in only one step.

The same is happening when someone pays with bitcoins. However, at least for euros, there are many businesses outside of the UK which account in the European currency. But how many businesses are pricing and accounting in bitcoin at the moment? Hardly any, or maybe even none. For a legal business this is indeed close to impossible. Everyone has to pay their taxes in the local fiat currency. But also, it is impossible, because bitcoin is extremely volatile. This volatility makes business calculation and planing impossible.

A lot of people will argue that yes, currently the volatility is high and therefore bitcoin is not yet a currency. But the more people have it, the more it is going to be used as one. That way, over time, the volatility will go down and bitcoin will become a real currency.

There are two problems with this. Firstly, for the volatility to go down, people need to stop using it as a speculative asset. The speculators are driving volatility up, not down. First, they are driving prices up very quickly, which is what we are seeing at the moment. And then, when the time comes that enough people want to take their profits, they will drive down prices even more quickly. If bitcoin wants to become money, the speculators will have to go.

The problem is, they currently appear to be the only people who give the crypto currencies value and liquidity. That is because of bitcoin’s lack of an intrinsic value. At the moment, it is essentially just a Ponzi scheme. In other words, it is a zero sum game. For every winner there must be a loser. Winners are usually the early adopters, if they manage to get out in time. This puts a big incentive on these people to cash in their bitcoins for a more accepted currency. And as mostly in investing, the losers are the ones that come late to the party, which is often the majority of people. Those people will get burned.

That creates the second problem. Once these people got burned, the crypto currencies will gain a very negative reputation. While before anyone new about them, the reputation was at least neutral, after a major crash, the reputation will be bad. And that of course is not helping on the way to establish these currencies as trustworthy for business and savings.

So what we are seeing right now does not look like the breakthrough of crypto currencies. It looks more like the beginning of the end. It is a classic speculative bubble, in which people enter for no other reason but prices going up.

If you don’t believe that this is indeed the main reason for the current strong interest, then explain to me why are all of the crypto currencies going up simultaneously? If we were witnessing the breakthrough of a crypto currency, we would need to see one or two market leaders going up, but not all. The others would need to go down to zero. We cannot have all of these currencies establish themselves. That defeats the purpose of a currency, which needs to be as widely accepted as possible. The fact that there are so many appreciating crypto currencies out there, also proofs the critics right, who argue that, despite the blockchain technology, these currencies are not really scarce. Yes the internal number of units is limited, but there is no limit to the number of currencies itself. Anyone can easily create one.

I am sorry, but what we are seeing right now very much looks like a speculative bubble, a Ponzi scheme. Some people will make a fortune, while the majority will get burned. I am therefore fairly convinced that, although we are still in the middle of the party, the bitcoin experiment has failed. That is not to say that this party will necessarily end soon. But it does mean that bitcoin, or another crypto currency, will not become an actual currency. Before a crypto currency can take off, it will have to have a use in some other wide spread application.

None of this however means that the blockchain won’t be successful. We will almost certainly see this technology transforming the world in many, non money applications. And maybe one of these applications will get widely used, and eventually becomes a form of money. But as for bitcoin, it seems the austrian’s will be proven right again. At least on a free market, we will not see anything being adopted as money that does not have an intrinsic value first.

Money matters

Recent developments in the Republican Presidential platform debates in the US have been most encouraging to proponents of sound, commodity-based money. Regardless of whether anything substantial materialises from them in the short-term, the mere fact that gold standards and central bank audits are being discussed openly and seriously at the heart of a major political party is a positive sign that the debate is heading in the right direction for those of a libertarian or conservative persuasion.

With this American narrative in mind, it is perhaps a good time to re-consider the arguments in favour of a return to a commodity standard of money (be it backed by governments or produced privately on the free market) and why a commodity standard is essential for a sound economy, more stable prices and for keeping the growth of government firmly in check.

To those visiting the site for the first time and who are perhaps new to free market economics, I hope this article will form a useful introduction to the question of money from an Austrian school perspective.  For others, it is merely intended as a starting point for further discussion on an issue which is sometimes thought of as an interesting aside (albeit never on Libertarian Home, whose focus on Hayek and currency competition is laudable ).

Commodity v Paper

© Tax Credits

Whilst there are various reasons why printing more money can be politically expedient in the short-term, its longer term consequences usually result in some economic or currency disaster or just the plain old expansion of government.

Thus the three major problems with the paper standard and a “flexible” paper money supply in general are:

1) Distortions in economic calculation, causing the boom and bust cycle;

2) Price inflation (and in extreme cases, hyperinflation), causing hardship;

3) The inevitable growth of government.

Taking each of these points in turn.

Booms and Busts

The logic of the Austrian Theory of the Business Cycle (ATBC), as this theory is also known, is beautiful in its simplicity. In short,  ATBC teaches that any artificial expansion of the money supply (whether by governments or by its central bank proxy) causes the market price of interest to be lower than it would be otherwise on the free market, in turn sending misleading  economic signals to producers who consequently invest and cause a boom in all sorts of interest-rate sensitive industries such as housing and construction. As the real savings and resources in the economy needed to sustain such projects do not really exist, the projects must inevitably be unwound, at which point can it be said the “bust” part of the cycle has kicked in.

Thus can it be said that the responsibility for the devastating booms and busts witnessed in the Wall Street crash stock of 1929, the “tech wreck” of the early 2000s, and the housing market collapse of 2007/2008 rests squarely at the feet of the central bank and the paper standard.

Needless to say, a return to a commodity standard would take the printing presses firmly away and thus remove the ability of central planners to foster such malinvestment and havoc.

Price Inflation

An inevitable consequence of continuously increasing the money supply, a paper money standard reduces the purchasing power of people’s savings over time and erodes their standard of living. Indeed, since the establishment of a universal paper standard in the twentieth century the value of national currencies relative to the goods and services they can buy has suffered an inexorable decline.  In the bygone days where gold or silver were in official use as currencies, people saved for retirement knowing that the purchasing power of their currency medium would be preserved. Not so today, where people who would stuff their hard-earned paper notes under the mattress would right be viewed with genuine human concern.

Whilst a return to a commodity standard would not abolish year to year fluctuations in the price of goods and services, there is little doubt the purchasing power of the circulating medium would be much better retained over the long-term.  James Turk, founder of the precious metals bank GoldMoney, often uses the example of how 2 silver dimes are able to buy the same amount of petrol at the station today as when a child his parents would fill up the family car.

Growth of Government

Perhaps most insidious of all, paper standards facilitate the sort of government expansion that would simply not be possible under a commodity standard. For with a licence to print, resting with the government itself or its central bank proxy, the political class is no longer forced to make the difficult case for raising taxes or increasing borrowing but can instead turn to this imaginative and more invisible third way of funding itself.

Under such an arrangement all sense of financial reality is abolished, that critical impediment to the inexorable growth of government. The secret darling of socialist ideologues and power-hungry political elites, a paper standard means there is no longer any real requirement to deliberate on the affordability of going to war, increasing state benefits or creating a new government agency to run some bold new initiative.  Money, it appears, does grow on trees after all.

Under such an arrangement there is no limit to the growth of the state and its concomitant influence over the lives of its people.  The opposite is true for a commodity standard, which at the very least forces a degree of transparency from the central planners who, forced to rely on more traditional methods of self-funding, have to appeal to the people directly anytime they wish for more government largesse.


Assuming then the superiority of a commodity standard over a paper one, the tricky question comes over the process of implementation. Leaving aside the question of the political obstacles that would have to first of all be surmounted, what would the new system look like? Should governments introduce a new gold standard to back their national currency? Should they permit gold and silver to trade freely in the market place in competition with their national currency? Should they remove themselves from the business of money production altogether, turning it over to a free market system of currency competition, as advanced by Hayek?

Whilst many of us would like to see the Hayekian solution, a return to a government-backed gold standard would be a step in the right direction. Yes, governments cannot be relied upon to keep their promises (i.e. to stay on the gold standard once on it) but if such a change were to ever take place it would have to be a reflection of a radical change of thinking amongst the populace at large (either through education or as a result of a financial crisis) who might just help to keep the government in check.

Whilst a new gold standard might be far from perfect, any system that might restrict the government’s ability to cause harm through excessive money printing should be given due consideration.  Such a new gold standard could serve as the first step towards re-integrating the notion of commodity money into society at large and paving the way for the complete privatisation of money production. Most importantly, it would serve to debunk and deposit that failed notion of a paper standard into the ash heap of history, where so many actual paper currencies have wound up in the past, again and again.




Krugman’s unlikely reading of Rand

Paul Krugman writes:

… Ryan has said that his views on monetary policy are based on Francisco d’Anconia’s speech in Atlas Shrugged.

Aside from revealing just how much of a Rand fanboy Ryan is — urban legend, my foot — this is interesting because that 23 paragraph speech isn’t just a call for the gold standard; it’s a call for eliminating paper money and going back to gold coins.

That speech is the one known as the money speech, I’ve linked to it because Krugman doesn’t. Krugman is right to some extent, the speech does represent a call for the gold standard, but it is wrong to characterise it as a 23 paragraph speech in favour of a return to gold coins. Yes the characters in Atlas Shrugged do exchange gold coins for cigarrettes, for the use of a car, groceries etc, and there is one tiny sub-clause in 1100 pages about how slips of paper should be gold:

Those pieces of paper, which should have been gold, are a token of honor – your claim upon the energy of the men who produce. Your wallet is your statement of hope that somewhere in the world around you there are men who will not default on that moral principle which is the root of money. Is this what you consider evil?

When I read this, I considered it a simplification. You could argue that Rand’s portrayal of the characters using gold coins cannot be a simplification, or that could be a nod in the direction of plausibility. A bank note found in the hands of a worker, labelled “Bank of Midas Mulligan”, would be a bit of a giveaway to the authorities looking for missing industrialists; the coins marked US Dollars less so. But the best evidence that this is a simplification is twofold:

  • Rand’s aesthetic premises, which are well documented, advocate leaving out details and simplifying down to what is most important.
  • Its 0.19% of the money speech. Five words from 2617. Five words from 1100 pages of a book, does not make it a theme.

Krugman is just setting up a strawman for the purpose of poking holes. These five words are his protection from accusations of outright dishonesty. He knows the speech is about the moral status and cultural role of sound money. He knows it advocates money as a store or token of stored wealth given value by production, rather than a debt payable by the confiscation of wealth from future generations of the virtuous. He knows that only the most literal and bone headed reading of the speech would read it as a serious call for gold coinage, and that the real message in policy terms is that money should be backed by real wealth, and not confiscated future wealth.


Krugman read it closely enough to count the paragraphs and he was able to read its content at his leisure. He did not. Instead he is just trying to cast aspersions on Paul Ryan so that credulous democratic voters will be able to feel they have read something about Ryan’s beliefs and will be happy to vote Obama, and thus for Krugman’s favoured economonic theories. If he had chosen to discuss where the value of money should come from his readers would be lead in another direction that Krugman does not favour, so he offers up a tidbit about the history of coinage instead.

Dear Democrats if this is all you’ve read then you haven’t read a damn thing, but please vote Obama anyway because if this trash represents the level of discourse of our most honoured intellectuals then all that can come of a Republican victory is that Rand continues to get the blame for policies she would never endorse.