December 4, 2013

Bitcoins have real value

Filed under: Uncategorized — Tags: , , , , — admin @ 3:07 pm

I recently happened upon an interesting blog post from that claims the fair price of bitcoin is zero, and I think it behooves me to write a rebuttal. I’m interested in MMT and other economic perspectives, but at the same time I think it’s valid to point out that they’re shoehorning new types of currency into models that were designed to handle fiat money. The results obtained may very well be wrong due to the inapplicability of the model to this case.

I agree that bitcoins are commodity money, but I definitely don’t think their value is zero. Let me make another comparison of bitcoins to gold. In the subjective theory of value, the “value” of gold to anybody may vary depending on what they can do with it, and whether that benefits them. The market value of gold is what the gold will fetch on the “gold market”, accounting for all the various costs of transacting on that market. So let’s look at the value of bitcoins in this context.

If you read the whitepaper, you will see that bitcoins were designed to be the first method of payment online without trusting intermediaries. To pick one contrasting example, e-gold was backed by gold but had a single point of failure: the servers of “Gold & Silver Reserve Inc.” — in network theory, single point of failure is a risk that all communications are exposed to. If this central point went down — which it did — it killed the whole system. Now, the point does not have to be completely fail in order to jeopardize the system. Just a partial failure, or the risk that it can fail, introduces uncertainties. So the value of bitcoin is that sellers can accept payments without the uncertainty of:

  • chargebacks and other reversals
  • inflation and other fiat currency risks

as well as enjoying low transaction fees. This is REAL VALUE for real people, and in aggregate represents a tremendous market cap. Here is another way to look at it: before bitcoins, there was NO WAY that I could purchase things online without trusting an intermediary, such as a bunch of credit card processors, banks, and governments. The transaction fees in addition were high, and I paid them for the convenience of easily making the payment online. With a bitcoin wallet, I can save those transaction fees and pay only one fee: to the miners.

Think of bitcoin miners as full-reserve banks, which they will become roughly equivalent in the limit as the returns from mining are eclipsed by the fees. The fees are to cover running the system, they are in effect the cost of transacting, and instead of paying them to “your” bank you pay them to whatever bank happens to solve the block that includes your transaction. If that fee is too low, you’ll have to wait until some bank agrees to accept your transaction.

So bitcoins are a commodity which has real value — something that guys like Peter Schiff don’t seem to get or acknowledge when they hawk gold. Sure, gold has “intrinsic value” as a metal. But bitcoins have the value that comes from having in place:

  1. A powerful open source software client
  2. A presumably secure network protocol
  3. A growing network of merchants ready to accept the currency
  4. Not to mention future applications of the “timestamp server” such as proof of copyright, proof of signing contract, etc.

And by the way, #3 is the reason that new cryptocurrencies can’t just spring up and be worth the same amount as bitcoin. We have to consider here metcalfe’s law. Gresham’s law doesn’t really apply because no government is going to set the exchange rate between bitcoins and, say, litecoins.

In short — the value of bitcoins may be in a bubble, but underlying that is Metcalfe’s law. Even after the novelty wears off, there is real value in this commodity that is increasing, and the difference between bitcoins’ intrinsic properties and gold’s intrinsic properties are things like easy online payments anywhere in the world, low transaction fees, and lower exposure to various types of risks.