Saturday 7 December 2013

"I, Broken Economist": An Analysis of Gary North's economics of Bitcoin

Conceited arrogance

There is one thing that becomes apparent when reading Gary North's articles. He knows a lot. But there is also another thing that becomes apparent sometimes, in particular in his latest article on Bitcoin. He thinks he knows more than he actually knows. I can't address his article in full detail now as I'm at the Latin American Bitcoin Conference, but I thought I'd mention some core issues with his article.

Heterogeneity of a monetary system

He writes that money enables economic calculation, and thus division of labour. He writes that Bitcoin couldn't exist if money did not already exist. He writes that you cannot buy everything with Bitcoin (yet). He writes that without goods being priced in Bitcoin, it can't be money.

I agree with all of this (or let's just assume I do). I also claim that it's irrelevant. Because North does not have a general theory of liquidity, and a general theory of transaction costs. Which is very sad, because Menger was very eloquent on explaining both of these categories and made profound discoveries. People who claim that their arguments are based on Menger, yet do not have either a theory of liquidity or a theory of transaction costs do not really understand Menger.

North only has a partial theory of liquidity (a theory of stable prices) and a partial theory of transaction costs (division of labour). But Menger was very elaborate on explaining why both liquidity and transaction costs are heterogenous and cannot be summed up to a particular activity. The implied error of the homogeneity of a monetary system is visible when North writes:
"You cannot have a monetary system that does not apply across the board, yet still defend the concept of the division of labour through competitive pricing".
It is visible also in other partial implications of the alleged homogeneity, for example assuming that liquidity is a final means of payment. This already has been erroneously claimed by Smiling Dave. Final means of payment is merely one of the factors that influence liquidity. Liquidity is also not a unit of account. Unit of account and liquidity influence each other, but again are merely one of the factors.

In other words, North's critique of Bitcoin misses that there are components of liquidity and transaction costs other than those he mentions. The total mix of all these influences the choice of a medium of exchange. The weight of the result is not only different based on the evolutionary stage of Bitcoin, but also on the particular circumstances of a particular user. This is why some people in some situations will find Bitcoin more advantageous, and other people or even the same people in a different situation disadvantageous. It is also why it cannot be apriori concluded what the future of Bitcoin will be, we can only make educated guesses. The only thing we can do as praxeologists is to conclude that Bitcoin might expand in those areas where its advantages are assessed as subjectively the most important with respect to other media of exchange. It might never develop into "money", but it would be erroneous to conclude that that's the only relevant issue (the good old "money or nothing" fallacy).

Heterogeneity of social interaction

The problem that North thinks he knows more than he actually does is exacerbated by his misapplication of the system of property rights and social frameworks to Bitcoin (or the lack thereof). North does not understand that Bitcoin is a social framework. It is a more efficient social framework. Contractual relationships that are currently expensive or impossible (have high transaction costs) are now profitable and/or possible with Bitcoin. Payments are merely the first, easiest, type of a contract, on which Bitcoin demonstrates its advantages. Rather than being an "implicit denial" of contracts, Bitcoin provides a more efficient framework for them. I think that we can all agree that Bitcoin is not perfect. But there are no perfect goods. There is always the subjective assessment, imperfect information, and opportunity costs.

Bitcoin is at a very early stage, and the basis for the framework is still expecting human actors to fill it with their own activities. Contrary to North's claim that Bitcoin "put the cart before the horse", it's the opposite. Bitcoin first created a framework, and then this was incrementally use for payments.

This is also, paradoxically, why North is clueless. He understands how social institutions evolve in theory, yet he cannot connect empirical data (when it happens right under his nose) with the theory.


North complains that people who criticise his position of Bitcoin do not understand the Austrian school. Well, I know for sure that North does not understand certain aspects of it (in particular Menger's approach to liquidity and transaction costs), and on other aspects he can't connect the theory with empirical data. He's also lazy (because he did not read Austrian literature on Bitcoin and he did not gather empirical data on Bitcoin), and conceited (because he thinks his credentials give him immunity from errors).

As I wrote before, the future of Bitcoin does not depend on the understanding of economists. It depends on human action. I don't care about North's opinion. But as a researcher I see it as important that I address errors. Others than can read both, make up their own mind, and build on top of it. The Austrian school did not end with Menger, it began with him.

Wednesday 4 December 2013

Gary North is clueless about Bitcoin


In the last couple of days, Gary North has made posts about Bitcoin on his blog:

My major irritation is that North makes two fundamental mistakes that a researcher shouldn't do. He did not review existing Austrian literature on Bitcoin, and he did not collect empirical data. Instead, he repeated long refuted fallacies, and he made up his own fictional history of Bitcoin. This is why I have said in the past that the people associated with the Ludwig von Mises Institute have become lazy and stupid. There has been progress in the meantime, however. Mark Thornton, for example, has become a fan, and the LvMI actually started accepting both donations and payments for their webshop in Bitcoin. But then Gary North pops up.

To a small extent, I am familiar with North's work. I quote him in my master's thesis, and I read his chapter from the Theory of Money and Fiduciary Media (more on that later, when I quote North based on the notes I made when I read it).

Inability to classify Bitcoin

North repeatedly argued that Bitcoin is not used in market exchanges. This is empirically false. I buy goods with Bitcoin all the time. And I was told that even Walter Block (whom I argued earlier to be clueless about Bitcoin) sold his book for bitcoins once. I don't know why North makes claims to the contrary. However, this allows him to perform a methodological trick: because he denies that Bitcoin is used in exchanges, he can avoid having to classify it within the Misesian framework for classification of goods (into consumer goods, producer goods, and media of exchange).

Instead of classifying Bitcoin as a good then, North classifies it as a ponzi scheme.

Ponzi scheme

North provides his own definition of a Ponzi scheme and a reason why it causes problems. I submit my own definition, which is in my opinion more economically useful.

A ponzi scheme is a hierarchical system of fractionally backed claims. By putting an amount of money into the system, the participant gains a claim for a larger amount of money than he put in. In order for the settlement of claims to work at the beginning, the system is built hierarchically, so that earlier participants can get money from later participants. The reason why a system like this collapses is that as the amount of debt increases, so does the risk of triggering a settlement of claims. A full settlement at any particular time is impossible: the system is insolvent. Once there are too many triggered claims, this causes a cascading wave of defaults, and the claims thus become unclaimable and worthless. In a ponzi scheme, the trigger typically happens when not enough new people enter the system on time as the old claims mature, but this is merely a special case of trigger. All kinds of other triggers can hypothetically cause the cascade.

Bitcoin is not a system of claims. Bitcoin is a pseudo-commodity, not a claim. People who purchase Bitcoins do not have a claim on anybody, nor does anybody have a claim on them. There is no debt to settle, and no default that makes Bitcoin unclaimable. The mechanism that makes a ponzi scheme to collapse is absent with Bitcoin. Whatever reasons are there for Bitcoin to succeed or to fail, the analogy to ponzi schemes is invalid.

The necessity to classify Bitcoin as a claim, in the absence of the ability to classify it as a good, follows directly from the Misesian framework for classification of goods. The difference between a good and a claim is explained by Mises several times as relevant for determinant of their price: the price of claims is derived from the price of the underlying good. Sometimes, there are other factors influencing the price of a claim, but the price of the underlying good is a necessary component at least at the beginning.

The connection between the price of a good and a claim has been expanded upon by Malavika Nair, who also has a chapter in Theory of Money and Fiduciary Media, actually precisely about this topic. I exchanged some emails with professor Nair and this is what she wrote in respect to the classification of Bitcoin:
"I agree that Bitcoin is not a money substitute [i.e. not a claim, ed.], I think of it as closer to commodity money, just not a kind of commodity most people are used to. I know Selgin has come up with the term “synthetic money” but I’m not sure if that helps clear things up or confuses them. If anything, it’s a quasi-money or secondary money, which benefits greatly from its liquidity and the ease with which it can be sold for dollars".
In other words, Bitcoin is not a claim, but a good. It is priced for its own sake, not based on a price of another good it refers to. And since it is held in order to buy goods, it is a medium of exchange.

But even if we disregard the methodological nonsense and stick with North's own empirical description of the beginnings of Bitcoin:
"The money was siphoned off from the beginning. Somebody owned a good percentage of the original digits. Then, by telling his story, this individual created demand for all of the digits. The dollar-value of his share of the Bitcoins appreciates with the other digits."
even then the description is false. Almost all of Satoshi's Bitcoin are unspent, still where they were mined. As Bitcoin didn't even have a price for almost nine months, if Satoshi had attempted to sell his coins, he would have made a revenue of ... nothing. If he had tried to sell them when the price first formed on the market, he would have earned ...  932.68 USD. There's no typo, the value of all Bitcoin in existence at the time when the price emerged was less than a grand. If he waited until Mt. Gox started operating, he would have earned ... 171,517.5 USD (assuming he actually had all of the bitcoins himself). These sums are not even profit, only revenue, as they don't consider costs. Sounds like a real opportunity, doesn't it?

The theoretical explanation of the purchasing power of Bitcoin is missing, and the empirical one is contradicted by the empirical data. Now I'll proceed to explain why North cannot provide a valid theoretical explanation of Bitcoin.

Lack of a theory of liquidity

North refers to the chapter "The Regression Theorem As Conjectural History". Luckily, I made some notes when I read the book. North quotes Menger as writing:
"The theory of money necessarily presupposes a theory of the saleableness [nowadays we use the term liquidity, ed.] of goods. If we grasp this, we shall be able to understand how the almost unlimited saleableness of money is only a special case, - presenting only a difference of degree - of a generic phenomenon of economic life - namely, the difference in the saleableness of commodities in general."
This is precisely where and why North fails. He does not have a theory of liquidity. He has a theory of "stability of prices" instead. While Menger did claim that precious metals have a higher price stability than other goods, he argued that this is not a prerequisite for how the market participants treat it. In fact, with respect to the unit of account function, in Principles of Economics, Menger actually wrote this:
"The function of serving as a measure of price is therefore not necessarily an attribute of commodities that have attained money character. And if it is not a necessary consequence of the fact that a commodity has become money, it is still less a prerequisite or cause of a commodity becoming money." [emphasis added]
If the unit of account function is not a prerequisite for a commodity to become money, then it shouldn't matter how stable it is. Liquidity is not price stability. Liquidity is, in Menger's own words:
"A commodity is more or less saleable according as we are able, with more or less prospect of success, to dispose of it at prices corresponding to the general economic situation, at economic prices."
Apples have a relatively stable price. Yet apples are illiquid: they cannot be sold easily at the market price. Bitcoin does not have a stable price, yet Bitcoin is liquid. It's not as liquid as money, and it's probably not as liquid as gold. But it it is liquid and this satisfies the prerequisite for it acting as a medium of exchange. North's grasp of Menger's insights fails.

Speculation with Bitcoin

North argues that Bitcoin is used for speculation. The issue with this argument is that it does not contradict Bitcoin being used as a medium of exchange. The motivations of human actors in this respect are not mutually exclusive. If people hold a good in the expectation of dispensing with it in order to buy something else when they need that something else, it means they are using it as a medium of exchange. If they hold a good with the expectation of dispensing with it at a higher price when the time and place are opportune, they are speculating. But speculation is a normal part of life. A retailer buys, say, clothes wholesale, with the expectation of selling them at a higher price throughout the operating hours of his business, waiting for an opportunity. He speculates on the price of clothes. But that does not mean that clothes are a ponzi scheme or that there's something wrong about it. It does not refute the validity of other reasons for buying clothes.

People in countries with a high rate of inflation tend to increase the proportion of more foreign fiat monies in their liquidity portfolio. They simultaneously hold the foreign money because it is liquid (and can be used for its purchasing power), and because they expect the purchasing power to be higher than when holding their national, faster inflating, money. This proves that the motivations are not mutually exclusive.

The regression theorem

Regrettably, it turned out that a lot of Austrians do not comprehend the regression theorem. I suspect that this is because of the difference in the approaches of Mises and Menger. Mises spends the majority of his Theory of Money and Credit by analysing the mechanism by which prices form, and the factors influencing this. Based on this, he presents a threefold classification system of goods: consumer goods, producer goods and media of exchange. Mises himself did not invent this classification, he got it from an earlier economists but unfortunately I don't have my notes on this in a searchable form so I'll update this post with the proper reference later. Media of exchange, according to Mises, differ from other goods, because they are held for their purchasing power. He then goes on to explain how purchasing power (or "exchange value", another term he uses) emerges from use value through market exchange due to differences in marketability of goods (nowadays we use the term liquidity rather than marketability). He finishes with the conclusion that there is no other way for the exchange value to emerge than through a former use value and market exchange (catallactics), and theories that do not explain the exchange value of goods, "acatallactic monetary doctrines", cannot explain the exchange value of media of exchange.

While Mises viewed exchange value and use value as two components of the final price, Menger viewed the concept of liquidity as orthogonal to the concept of price. Their goals were different. Mises' approach is helpful for the analysis of the economic calculation, and for macroeconomics (business cycle, money supply and so on). Menger's approach on the other hand is helpful of understanding the microeconomic foundations of media of exchange.

Both Menger and Mises argued that the difference between money and a medium of exchange is quantitative rather than qualitative ("presenting only a difference of degree", in fact North himself has the same Menger's quote in his "The Regression Theorem As Conjectural History"). This is why we cannot make praxeological arguments about the origin of money that also do not apply to the origin of a medium of exchange. And this is why it's evident that some Austrians still don't understand the regression theorem.

The Mengerian approach to the origin of media of exchange is that media of exchange emerge out of liquid commodities. People recognise that some commodities are liquid (it is possible to"dispose of it at prices corresponding to the general economic situation, at economic prices"), and assisted by this knowledge, they start to hold them for this purpose (to dispose of them at economic prices). This is the moment when the function of a medium of exchange emerges. The Misesian approach is similar, but he uses the term "exchange value" to explain the liquidity premium of liquid goods (which is a more complex issue). This is why the Misesian approach is more helpful when examining prices, but less helpful when examining the motivations of market participants.

As Bitcoin is a medium of exchange (people hold it in order to purchase goods in the future), it must logically adhere to the regression theorem. It must have been a liquid good before it was used as a medium of exchange. And indeed, empirical analysis shows that this is correct. Before people used Bitcoin as a medium of exchange, it was possible to trade it against the US dollars on bitcoin exchanges, which featured visible order books. This made it easier to sell Bitcoin at economic prices. The fact that the exchanges were founded deliberately does not invalidate their economic function. Menger realised that specialised services that help with sales have a beneficiary effect on liquidity:
"The institution of an organized market for an article makes it possible for the producers, or other economizing individuals trading in it, to sell their commodities at any time at economic prices."
If we go even further chronologically, before Bitcoin exchanges existed, Bitcoin already had a price and was traded sporadically (i.e. was a good). The very early prices appear to have formed based on the variable production costs of Bitcoin at that time. And even further in the past, Bitcoin did not have a price, and while there were signs of using the blockchain, it probably didn't qualify as a good.

I document the process both in my thesis, and in an earlier blog post Professor Walter Block is clueless about Bitcoin. The origin of the function of a medium of exchange for Bitcoin is right out of the book. Menger's book, that is. Not North's book. North needs to deny the purchasing power of Bitcoin, because if he admitted it exists, he'd be left without the ability to explain it, having no catallactic theory of the origin of Bitcoin.

The network effect

North is equally clueless on the network effect (which was brought up by one of his critics). He goes even further:
"I can assure you that Carl Menger, the founder of Austrian school economics, did not use language like this: "money itself replaced non-money as a market network effect good." No Austrian school economist ever has. Austrian school economists do their best to communicate in something other than programmers' professional jargon."
North is wrong yet again. One economist familiar with the Austrian tradition, Mikael Stenukla, wrote a paper Carl Menger and the network theory of money. Many more Austrians are familiar with the network effect and understand that liquidity is a subset of the more generic concept of the network effect. The article was actually pointed out to me by Peter G. Klein, the executive director of the LvMI, who also did research the network effect.

Once you comprehend the network effect, you'll realise that the issue with respect to media of exchange is the empirical question of the critical mass of liquidity: the threshold below which a potential medium of exchange needs other utility in order for the system to be self-sustaining. Economists (including Austrians), who did not comprehend the concept of liquidity, implied that this threshold can only happen at a very high level of demand (or other auxiliary criteria, such as "price stability" proposed by North). But demand is not the same thing as liquidity. Bitcoin simply shows that liquidity can emerge at a lower level of demand than previously thought.

This is why it also cannot be concluded that Bitcoin cannot become money (the same non-sequitur that already was presented by Patrik Korda earlier this year). Of course it can. It just needs to outcompete other media of exchange. And this can't be determined apriori: it's an empirical issue. As I argued in my thesis, transaction costs play a major role in influencing the choice, and Bitcoin has lower transaction costs than anything that existed before that. Even though Austrians typically do not use the term "transaction costs" (I've heard Salerno use the term "transactions costs" once though), Menger used the term "economic sacrifices" and it was evident that it's the same phenomenon. It is also evident from Menger's writing that transaction costs are heterogeneous, with many influencing factors, and that:
"Economic development tends to reduce these economic sacrifices, with the result that even between the most distant lands more and more economic exchanges become possible which previously could not have taken place."
Bitcoin is just such an economic development as Menger mentions. It allows a more efficient conduct of market operations. This is why the claim of North that Bitcoin has no utility is absurd.

The utility of Bitcoin

North's denial of utility is filled with nonsense and lacks fundamental economic analysis. It has been repeated too often by others, but it's strange that reputable researchers like North come up with this too. In order to understand the utility of Bitcoin, I recommend the recent video by Stephan Molyneux. If you don't have the time to watch, I'll just provide some points which I consider important or interesting.

The True Value of Bitcoin by Stephan Molyneux:

Bitcoin can partially or fully replace the following services by more efficient ones:
  1. Proof of ownership (obsoletes notaries)
  2. Dispute resolution (obsoletes mediators)
  3. Record auditing (obsoletes accountants)
  4. Smart property (obsoletes the police)
  5. Decentralised stock exchange (obsoletes centralised stock exchanges)
  6. Highly efficient payments (obsoletes banks, debit cards, money transmitters)
  7. Full control over your money (obsoletes central banks and banking regulators)
  8. Conditional payments (obsoletes lawyers)
  9. No inflation
  10. No business cycle
And now, here's the kicker: points 1-5 does not require that Bitcoin is a medium of exchange (because they do not require Bitcoin to have purchasing power) and points 6-8 do not require that Bitcoin is money (because they do not require that Bitcoin is used as a unit of account). Only points 9 and 10 require that Bitcoin is a unit of account. If that ever happens, that's just the cherry on the top. Some, for example Michael Suede, even come to the conclusion that without the ability to steal money, states couldn't exist.

The claim that Bitcoin has no utility is ridiculous. North really should have done some research.


It looks like I still have a lot of work to do. I thought that the research that Austrians (and semi-Austrians) did with respect to Bitcoin (in particular John Paul Koning, Konrad S. Graf, Daniel Krawisz, and of course me) would be sufficient for the other Austrians to move on and continue contributing more new interesting things. Sadly, this didn't happen yet. There are still many Austrians that are lazy, ignorant, or sadly, outright fraudulent, as they fabricate a fictional history and present it as facts. This is in particular saddening as North is a historian.

I'm not an expert in North's writings. I did find his "Mises on Money" helpful and informative (I highlighted 35 passages into my research catalogue), while his "The Regression Theorem as Conjectural History" somewhat weak. I know he has something against George Selgin, but I don't care about that. However, his attempts to address Bicoin are just annoying. I attempted to address several core problems of his articles. I hope this helps people to understand Bitcoin, and Austrian economists to finally move on beyond long refuted nonsense, and produce something new and helpful.

Sunday 29 September 2013

Research update #2

I haven't posted a while, but that was because I have been reading, doing research for the book and writing it. I thought I'd post a quick update.

I do have several partially written posts that I plan to finish and gradually release. Mostly they will provide topics related to Bitcoin in a more looser way, such as hypothetical changes in the future or effects of Bitcoin, or critiques of some non-core critiques of Bitcoin.

In August, I started working part time at Megion Research & Development, which you might know under the name mycelium, the makers of the mycelium bitcoin wallet and the Bitcoincard. Once I finish the book I plant to work there full time. My role is business development.

I would like to thank a generous donor who bought me 13 books out of my Bitcoin Research wishlist on amazon. Also to people who donate Bitcoins (see in the right column for link). Thank you. I exchanged some of the donations for cash to offset the costs of my server and books. I used bitcoins from the donation wallet directly to pay for the renewal of the domain.

Earlier this week I attended the Future of money 2.0 conference in Bratislava, organised by the F. A. Hayek foundation. It was a conference about the risks of our financial system and possible consequences and outcomes, and how to protect one's assets. I was introducing the mostly Slovak and Czech audience into Bitcoin. I hope it helped people to understand the potential of it. You can download my slides (in English), the talk was in Slovak and it should be available soon (I'll update this post and the publication subpage once that's ready). I met with Jim Rickards (keynote speaker) and Philipp Bagus (he was on my panel). I was lucky because I had read both Currency Wars and The Tragedy of the Euro so I was familiar with both of their backgrounds. I had asked professor Bagus to read my thesis prior to the conference and he told me that it shows deep knowledge of Austrian economics. I actually promised him back in 2011 when I asked him some questions about Bitcoin that I'll post a review of his book on the German Amazon site, which I didn't do yet because I'm lazy. So go and buy his book, it's good. Jim Rickards liked my talk (I guess the translators did a good job too then) and asked if he can forward journalists to me because they keep asking him about Bitcoin and he's not a specialist on it. He also told me that his debate with Micky Malka about Bitcoin from earlier this year has been misinterpreted. He's not anti-bitcoin, he was just taking the anti- side of the debate because that's how a debate is supposed to work. I attempted to explain to him that some of the points he brought up are being addressed, and that it differs from country to country. I mentioned the taxation guide prepared by Trace Mayer and Bill Rounds, among other things. Jim seems like a smart and pragmatic guy. At a pre-conference dinner I also met Ivan Svejna, a libertarian-leaning member of the Slovak parliament. He was skeptical about Bitcoin, but luckily I had Bitbills and Casascius coins with me to "show" bitcoin, so he took a picture of them (Rickards also saw the coins and bills).

Now I'm in a hostel in Amsterdam where I was at European Bitcoin Conference 2013. I had a presentation about economic myths and Bitcoin. The slides (in English) are available for download, the recording will be put up by the organisers later. Today Eli Sklar couldn't make it for his presentation so Moe arranged an impromptu economics panel, where I was with Tuur Demeester (Macrotrends newsletter), Johann Gevers (Monetas/OpenTransactions) and Vitalik Buterin (Bitcoin Magazine). Both were a very enjoyable experience with participation of the audience and I thank you for your feedback.

During the conference, I met some old friends, like molecular and Dominik, Jorge Timon from the Freicoin project (we were actually able to clarify some of our positions better to each other after having a sort of flamewar in August at the linkedin Bitcoin group), Hakim Mamoni, slush, Tamas Blummer from Bits of Proof, Patrick van Zuijlen, Meni Rosenfeld, Gary Rowe, Dmitry and many others (if I forgot to mention you, complain and I'll add you to the list). There were also some which I either met for the first time or spoke to for the first time even though we saw each other at previous conferences. I spoke with Tony Gallippi of BitPay, Charlie Lee (Litecoin/Coinbase), Ron Gross from Bitblu, Tomer Kantor's (he's making a documentary), Jörg Platzer (ROOM77) and many others. Thank you Moe, Dmitry and the rest of the organisers, thank to all the panelists and of course all attendees. I always look forward to yet another Bitcoin conference.

I had the very pleasant surprise of meeting Konrad S. Graf in person, a fellow Austrian researcher interested in Bitcoin and we spoke at length about many of the facets of the Austrian School and praxeology. There was a funny scene where Konrad and n8rwJeTt8TrrLKPa55eU (I always forget his real name, sorry) were talking about the Austrian school and Konrad asked me if I read The Ethics of Money Production. I said that I read it twice, he laughed and said he read it twice too and told n8rwJeTt8TrrLKPa55eU that he should "witness this historical moment" and it's unlikely to ever happen that people like this are at the same place.

I also had a great experience meeting the inventor of hashcash, Adam Back (also, one of the few people who were in contact with Satoshi before he published his paper). Among other interesting things he told me his experience with DigiCash. DigiCash was a predecessor of Bitcoin in the early 90s. It was also a cryptographic currency that from economic point of view was a pseudo-commodity, like Bitcoin. And people did start to use it in trades, such as for t-shirts. There were no fiat-exchanges and no real time price. Adam said he just mimicked the approximate ratios that others were using, and traded t-shirts for DigiCash. The experiment however was shut down by the Dutch regulators and since then, cryptocash enthusiasts knew that you can't have a centralised server. Based on his description, I'm hesitant to classify DigiCash as "medium of exchange" or "liquid", but it appears to have become a good even though it was a completely virtual "thing" without non-monetary uses. So Bitcoin wasn't even the first wannabe-money to overcome the first step. Rather, Bitcoin was the first one to manage to overcome all the obstacles to become a medium of exchange, and to resist the regulators' attempt to shut it down for a significant amount of time. One thing Adam recollected that I found funny was that after Bitcoin launched, Satoshi emailed him again and Adam wasn't able to get excited because "we already know that it can work". Adam also doesn't want to own any Bitcoins and got "angry" when people used the bitcointip reddit bot to send him Bitcoins anyway (maybe he was joking, I'm not sure).

Next week I'm in Atlanta at the Crypto-Currency Con 2013, I have a presentation about sound money. I try to create a new presentation for each conference I go to, so look forward to it. See you there.

Sunday 22 September 2013

Professor Walter Block is clueless about Bitcoin

This is a second article in a series (the first being Mises Institute is clueless about Bitcoin). Sadly, one of my favourite Austrian economists, Walter Block, seems to be making the same blunders as some of the other economists associated with the institute. The purpose of the post is to address some of the fallacies he produced and explain where exactly the error is.

Some of the arguments were not actually made by professor Block but by people talking with him and he did not subscribe to them. However, they are common fallacies and show cluelessness of their proponents, so I decide to pool all of them together

The source

The primary source of my complaint is the following video, published about a week ago couple of days ago on youtube. The relevant part starts at 4:21 (transcript on the right side):

  • 4:21 - Caller: We also seem to agree that it only exist because they've suppressed gold. And my question I guess is this is the biggest one, doesn't that make it by definition malinvestment?
  • 4:35 - Block: Doesn't it make Bitcoin malinvestment?
  • 4:39 - Caller: Yes. If it only exists because of the fiat, and the artificially lowered interest rates, and the counterfeiting and all the rest, isn't that by definition malinvestment?
  • 4:53 - Block: Yes, I think it's malinvesment and it's contrary to Menger's theory.

Now to the individual issues.

Bitcoin shows that Austrians do not really understand Menger

I am still baffled how an Austrian economist, in particular one who researched money, can invoke Menger as a method of "disproving" Bitcoin. Research in this area has been done and published by Konrad S. GrafDaniel Krawisz, and of course me. One might argue that I'm a nobody and can be ignored. However, Graf had a paper published in Libertarian Papers and met with professor Block. Daniel Krawisz had articles published on

What happened with Bitcoin and how does it match what Menger wrote

One of the most irritating things is the sheer ignorance of "Mengerian critics" of Bitcoin. They do not take the time to collect historical data, yet proclaim certain judgement about what did or didn't happen. The information is public and reachable with not much more than a search engine (not to mention that in my master's thesis I already did a lot of the work and summarised the findings for the lazier ones). Another summary for the lazy ones is the "History" page on the Bitcoin wiki site. Let's take it step by step and iterate through what actually happened with Bitcoin, and how that matches the writings of Menger and Mises.

On October 31st 2008, "Satoshi Nakamoto" published his paper. At that time, Bitcoin as a "thing" did not exist yet. There was only an idea of Bitcoin. Ideas are not catallactic phenomena, so it's not really important, it just is a milestone that helps us in our understanding.

On January 3rd 2009, the "Genesis Block" of Bitcoin was created by Nakamoto. From that moment on, bitcoins have existed as "things". However, a bitcoin was not a good at that time yet, it did not fulfil the four Mengerian requirements for goods. People did not know how to use bitcoins to satisfy their needs. One of the early adopters, Mike Hearn, reminisces (at 4:27):
"I found it very early on, when noone was using it, so noone, no exchanges, had no exchange rate at all, so they were just completely floating in an abstract space. You know, what was one coin? Well, nothing really." [emphasis added]
On October 5th 2009, one of the early miners, "NewLibertyStandard", published the exchange rates he was using to sell bitcoins. How did he know how much to charge? This is what he writes:
"During 2009 my exchange rate was calculated by dividing $1.00 by the average amount of electricity required to run a computer with high CPU for a year, 1331.5 kWh, multiplied by the the average residential cost of electricity in the United States for the previous year, $0.1136, divided by 12 months divided by the number of bitcoins generated by my computer over the past 30 days."
In other words, he was using his own variable production costs as his asking price. "Theymos", who was also one of the early adopters, did not like the price and three years later, wrote:
"His pricing methodology will seem very strange nowadays... At the time, I performed similar calculations and thought he was charging too much."
Theymos' objection exposes the fundamental problem with the critiques of Bitcoin (Theymos himself isn't a critic, he just exposes the problem). It does not matter what Theymos, Block, Korda, Smiling Dave and a whole bunch of other clueless critics think or thought. The fact is, sales occurred. That is the only relevant factor for an economist. There is no other way for prices to emerge than through catallactic processes. They cannot emerge by a critic liking it and disappear by a critic disliking it. That we do not like it or do not understand the reasons behind it is completely irrelevant. In Antifragile, Nassim Nicholas Taleb scolds theoreticians who imply that our understanding can influence whether something happens or not. Empirically, it did happen. I don't know if "NewLibertyStandard" was the first seller ever, but he probably is very close to being the first one. What we can safely say however is that from then on, Bitcoin was a good, which is demonstrated by people exchanging it for the US dollars.

On February 6th 2010, the first traditional Bitcoin exchange launched. Its founder, "dwdollar", announced:
"I am trying to create a market where Bitcoins are treated as a commodity.  People will be able to trade Bitcoins for dollars and speculate on the value.  In theory, this will establish a real-time exchange rate so we will all have a clue what the current value of a Bitcoin is, compared to a dollar.  I have an early version up at
This is only a small demonstration of what I have in mind and to show everyone I'm actively working on it.  Feel free to register and try it out.  You will get 10 phoney dollars and 10,000 phoney bitcoins to trade.  ONLY the limit orders work.  Market orders will come later. [emphasis added]
The reason why this was an important milestone is the emergence of bid and order books for Bitcoin, and an easy mechanism for trading. The exchanges are what Menger refers to as "organised markets", places where people trading congregate, and allow for a qualitatively more efficient way to obtain price information and execute trades. The bid and ask order books, together with a trading mechanism, make, in Menger's terms, it easier to sell at "economic prices" and make a good more saleable:
"A commodity is more or less saleable according as we are able, with more or less prospect of success, to dispose of it at prices corresponding to the general economic situation, at economic prices." [emphasis added]
Unlike Block, Menger recognised the connection between specialised markets and liquidity:
"Some commodities, in consequence of the development of markets and speculation, are able at any time to find a sale in practically any quantity at economic, approximately economic, prices." [emphasis added]
From the time Bitcoin exchanges with orderbooks existed, Bitcoin was not merely a good, but a liquid, or in Mengerian terms, saleable, good. And exactly as Menger predicted, specialised services that help buyers and sellers to coordinates their plans, played a significant role in the process. Many of the people attempting to determine the early motivations (e.g. Robert Murphy, who, unlike Block, definitely is not clueless about Bitcoin) theorise that speculation was one of the factors. And indeed, again exactly as Menger predicted.

On May 22nd 2010, Laszlo Henyecz, or just "laszlo", managed to purchase two pizzas for 10,000 bitcoins. The purchase was facilitated by a Bitcoin buyer "jercos", who used a credit card to order two pizzas, to be delivered to Laszlo. This example of a trade of Bitcoins for a pizza is indirect exchange and therefore, from that time on, Bitcoin has been a medium of exchangeThis trade was only logically possible because at that time, Bitcoin not only had a price but also was liquid (or saleable, as the Austrians say). It would have been logically impossible to do this otherwise. A good without a price cannot be a medium of exchange, and as Menger brilliantly figured out, an illiquid good cannot be a medium of exchange either. Furthermore, as Mises elaborates, liquidity must emerge as a catallactic phenomenon and cannot be made up.

I actually thought, based on his lecture (transcript right):
"You can’t have a piece of paper be money. Let’s suppose I wrote over on this piece of paper, I write "ten Blockheads". And I go around the room and I say, hey, Erin, will you give me your car I’ll give you ten Blockheads. You know she’s gonna look at me as if I'm a little weird. They don’t call me Walter Weird Block for nothing. That’s part and parcel of it. The point is that if somebody just printed up a piece of paper, noone would accept it, except in some sort of weird way. Murray Rothbard used to do this and he would say "Well, suppose I printed up ten Rothbards and tried to trade..." and I would raise my hand and say "I’ll accept them, I’ll give you my bicycle for one" and he would say "Shut up Block, I’m trying to make a point here". But the point is, you see, ten Rothbards, if I really had ten Rothbards, I could probably sell it for a lot of money. But it would not really be money, it would be more like, art or something like that, a unique kind of thing. But forget about that sort of thing. In any real case, if someone said "Here is ten Rothbards, give me your house, ..." Well, ten Blocks. Ten Rothbards I don’t know what you can do with it, if it was real ten Rothbards, but you get the point." [emphasis added]
that Block comprehends that liquidity makes goods into media of exchange. It was actually this lecture that made me comprehend the whole issue. We're now apparently in a weird situation where the teacher teaches a student something the teacher himself doesn't know.

While it was logically possible for "laszlo" and "jercos" to use Bitcoin as a medium of exchange, why did they actually do it? Let's just ask Menger:
"But the willing acceptance of the medium of exchange presupposes already a knowledge of these interest on the part of those economic subjects who are expected to accept in exchange for their wares a commodity which in and by itself is perhaps entirely useless to them. It is certain that this knowledge never arises in every part of a nation at the same time. It is only in the first instance a limited number of economic subjects who will recognize the advantage in such procedure, an advantage which, in and by itself, is independent of the general recognition of a commodity as a medium of exchange, inasmuch as such an exchange, always and under all circumstances, brings the economic unit a good deal nearer to his goal, to the acquisition of useful things of which he really stands in need." [emphasis added]
Because "laszlo" and "jercos" recognised that Bitcoin is a liquid good, this provided them with the knowledge to use it in indirect exchange. Just like this knowledge arises in some people first, it consequently arises in other (clueless) people late. The latter seem to be in a majority now, but that is not a fundamental issue for an economist.

What happens when a medium of exchange evolves into money?

Some of the "Mengerians" seem to think that the "regression" applies to the evolution of a medium of exchange to money. Regrettably, it is not always clear in either Menger's or Mises' writings whether the theorem is supposed to explain the origin of media of exchange as such, or only that of money. They both arbitrarily change between "medium of exchange" and "money", add and remove "general acceptance" and that money is, and isn't, praxeologically different from other media of exchange. However, we can produce the following quotes by Menger:
"If we grasp this, we shall be able to understand how the almost unlimited saleableness of money is only a special case,—presenting only a difference of degree—of a generic phenomenon of economic life—namely, the difference in the saleableness of commodities in general." [emphasis added]
If there is only a difference in degree (i.e. what nowadays would be called a quantitative difference), then we cannot make praxeological distinctions between a medium of exchange and money. If the regression theorem is a praxeological insight, it either applies to both a medium of exchange and money or neither. Another relevant quote by Menger is the following:
"The reason why the precious metals have become the generally current medium of exchange among here and there a nation prior to its appearance in history, and in the sequel among all peoples of advanced economic civilization, is because their saleableness is far and away superior to that of all other commodities, and at the same time because they are found to be specially qualified for the concomitant and subsidiary functions of money." [emphasis added]
Let me translate this into a more digestible form. Once a good becomes a medium of exchange (and we thus know it is saleable/liquid), then it competes with other media of exchange not on the basis of its origin, but on criteria unique to media of exchange, such as liquidity and transaction costs. The question of its origin becomes irrelevant. The Austrian critics of the origin of Bitcoin are too late. Their objection would only have been relevant in the narrow timeframe between October 2008 and May 2010. Since then, the criteria determining the future of Bitcoin, as Menger explains, have changed. Sadly, the Austrian critics didn't shift their attention accordingly, and remain silent on the issues of liquidity and transaction costs. This problem is emphasised in another video where Block comments on Bitcoin and the theorem:

37:47: Will it work? No, I don't think it will work either.
38:07: If you compare it to gold or silver, where you have some intrinsic value, not intrinsic, but market value, Bitcoin won't work. On the other hand, if you compare Bitcoin not to market money, but to fiat currency, well now it's a bit of a horse race. Now I'm not sure, that's an empirical issue. Bitcoin is not based on the Mengerian theory of the creation of money. But on the other hand, if you compare it to theft, which is fiat currency, maybe not so bad. So I don't know about that.

I fully agree that the issue "Bitcoin vs. fiat" is an empirical issue. What Block does not recognise however is that "gold vs. Bitcoin" is also an empirical issue. Not only is Bitcoin based on the Mengerian theory, it also already works. As I just said, Block's objection comes too late (in addition to, regrettably getting confused on the "market value" question and being silent on the issue of liquidity).

Is it possible to "violate" the regression theorem?

As Daniel Krawisz points out, if we interpret the regression theorem as a praxeological insight, then it must not be possible to violate it. If there is a disconnect between empirical data and a theory, then either we do not understand it or we do not correctly interpret the empirical data. Daniel Sanchez explains this in one of his articles:
"Yet the most history can do for an economist is to provide either an example with which to illustrate (but not prove) an economic theorem to help students grasp the concept by giving them a concrete manifestation of it, or a clue that perhaps he has performed fallacious reasoning in deriving the economic theorems he has been operating with. But even in the latter case, he must use discursive reasoning to catch the fallacy, and then to adjust his theory according to the corrected reasoning." [emphasis added]
The claim that Bitcoin can "violate" or "be contrary to" the regression theorem is methodologically absurd. Sadly, Sanchez himself allegedly is clueless about Bitcoin, and professor Block appears to commit all three offences (not understanding the theorem, not interpreting the empirical data, and claiming that you can "violate" praxeological fundamentals) togehter.

One could also argue, as Gary North in The Regression Theory as Conjectural History (was published in The Theory of Money and Fidicuary Media (ed. Jörg Guido Hülsmann), that the theorem is merely a probabilistic conjecture rather than an aprioristic argument. I do not agree with this, and I also do not think that Menger and Mises viewed their arguments regarding the theorem from the Northean point of view. Mises in particular wrote:
"And all these statements implied in the regression theorem are enounced apodictically as implied in the apriorism of praxeology. It must happen this way. Nobody can ever succeed in construction a hypothetical case in which things were to occur in a different way." [emphasis added]
And he also denied that there can be exceptions in other forms of money:
"This link with a preexisting exchange value is necessary not only for commodity money, but equally for credit money and fiat money. No fiat money could ever come to existence if it did not satisfy this condition."
Professor Block, and other Austrians clueless about Bitcoin should really spend some time on actually reading Menger and Mises. And of course, their own writings and lectures.

Conclusion regarding the regression theorem

As a medium of exchange, Bitcoin emerged exactly as Menger predicted. He and Mises also explained that it would not have been logically possible otherwise. It is regrettable, that people who proclaim to adhere to Menger's teachings do not recognise it when it happens right under their noses. It also is something which already happened over three years ago and cannot unhappen. My recommendation is that the "Mengerians" need to shut up and move on.

Is Bitcoin a "token" because it traded against the dollar first?

(presented by the caller rather than Block himself) This fallacious idea seems to have been popularised by Patrik Korda. I already posted several rebuttals to that argument, the most specific one is the second one, where I quote several Austrians, including Mises and Rothbard, in that token money must be a par value claim on the underlying base money. Bitcoin never was a claim on, or even had a peg to, any underlying base money, and its price was not derived from the price of the US dollar. However, that is not important here. Here another issue arose: the fact that it trades against money, seems to invoke in some observers the impression that that this somehow makes it suspicious.

On the contrary. There is nothing unusual about a new good to trade against money if we already live in a monetary economy. We do not have barter now anymore, and most exchanges occur with a medium of exchange. Indeed, from Mengerian and Misesian perspective it would be suspicious if Bitcoin did not at first trade against money, but against consumer and producers goods. As a new good, Bitcoin barely had a price and wasn't liquid. Such a good cannot act as a medium of exchange. What would such a good trade against in a monetary economy? Against consumer/producer goods rather than media of exchange? There would have been little motivation to use Bitcoin in barter (direct exchange). And as Menger explains, only as a good gains liquidity, do people start accepting it in a trade as indirect exchange. The fact that Bitcoin at first traded against fiat money (the most liquid one, the US dollar), is exactly what, according to Menger, happens at the beginning of the emergence of a good in a monetary economy. The other alternatives would have been either implausible or logically impossible.

That Bitcoin could "piggyback" on the US dollar is nothing strange. Different types of goods emerge in a monetary economy than in a barter economy. A barter economy has higher transaction costs, a lower specialisation of labour and does not allow for complex investment projects. A computer, for example, would not have likely been produced in a barter economy, and has to "piggyback" on a preexisting monetary system. Does that make computers suspicious?

Furthermore, even as it gains liquidity, there is still nothing unusual about a medium of exchange to trade against other media of exchange. Quite the opposite. The world forex market is the most liquid market that exists. According to wikipedia, the daily world forex volume was about four trillion USD in 2010. The article also lists the following characteristics that distinguish forex markets from others:
  1. its geographical dispersion;
  2. its continuous operation: 24 hours a day except weekends, i.e., trading from 20:15 GMT on Sunday until 22:00 GMT Friday;
  3. the variety of factors that affect exchange rates;
  4. the low margins of relative profit compared with other markets of fixed income; and
  5. the use of leverage to enhance profit and loss margins and with respect to account size.
Someone who spent at least five minutes researching the history and performance of Bitcoin exchanges can immediately recognise the first four points, and if you remember the now defunct Bitcoinica, you'll recognise the last one as well.

The critique that there is something suspicious about Bitcoin because it trades against other media of exchange has no basis in the Mengerian/Misesian approach to emergence of liquidity. It contradicts it, and is to be classified, using the same arguments as Mises in his own critique, as an acatallactic monetary doctrine, right next to the one which says that the opinion of an economist, rather than actual trades, determine prices and liquidity.

Can Bitcoin be used to discredit the Austrian school?

The caller submitted the hypothesis that Bitcoin can be used to discredit the Austrian school by associating it with illegal things (such as drug dealing). Well, gold-based payment systems have already been shut down (E-gold or Liberty_dollar) for exactly the same reasons, i.e. the Four Horsemen of the InfocalypseGoldMoney has been neutered, they probably choose to not actually provide a competing system in order to prevent being shut down. I don't see how Bitcoin can be used to discredit the Austrians more than the gold based systems.

Gold, not Bitcoin, is a malinvestment

Professor Block made the argument that Bitcoin is a malinvestment (i.e. he agreed with the caller). They are not the first ones making this argument, it has been made by Patrik Korda before, and some other guy in a youtube interview (which I did not save and can't find it anymore, I thought it was Chris Duane but it looks like it wasn't). I will take the opposite side and make the argument that gold, rather than Bitcoin, is the malinvestment.

The concept of malinvestment is popular in particular with the Austrian Business Cycle Theory. The argument is that artificially lowered interest rates make it appear to be profitable to invest into projects farther removed from the consumption, even thought the availability of capital and the time preference of consumers do not make such a project possible at such a price structure. Eventually, either the project will run out of actual resources, or the prices adjust in a way unpredictable by the investors making the project unprofitable (the latter is more likely to happen in a market economy, only if the price adjustment is prevented you'll actually run out of all resources). The investment into the projects farther removed from consumption is called malinvestment, because the structure of available capital does not allow it to satisfy the needs of the consumers. The project will fail and the investment has to be liquidated at a loss. If the interest rate wasn't disturbed by an increase of the money supply through lending to investors, this would have been recognisable in advance and wouldn't have happened.

Media of exchange are not producer goods. Furthermore, I don't know how about gold, but there appears to be little or no evidence that the purchasing of Bitcoins is fuelled by loans made at an artificially low interest rate. Certainly there is little reason to believe it is happening at a higher proportion with Bitcoin than with gold. So what other type of malinvestment can there be?

Media of exchange serve in indirect exchange. They allow it to mitigate the uncertainty by having liquid goods and thus the ability to make unpredictable purchases in the future easier than doing so with illiquid goods. We can therefore posit that for media of exchange, whether obtaining them is a malinvestment depends on their future liquidity.

Let us now compare the possible future liquidity of gold and Bitcoin.

Is gold evolving into money?

Many of the Austrians think or argue that the impeding fiat system collapse will make gold (or another "real" commodity) into money. There appears to make sense, doesn't it? Once fiat hyperinflates or actually stops working (banks go bankrupt), what will people use? The most liquid good that still works, i.e. gold.

Not so fast. First of all, the majority of transactions nowadays happen electronically, in particular in "western" countries. These transactions will need to find a replacement, not the physical exchange of a good. There would be a huge logistical issue of how to make gold, both in the physical sense as well as a clearing mechanism, work. Banks might have support for gold as a unit, but how will they gain gold-backed reserves? By people depositing their gold into the banks, right after a massive bank collapse? A more likely scenario is an increased role of gold in the assets of central banks, combined with a confiscation of physical gold from the populace, i.e. something like the gold exchange standard, where a normal guy never actually sees a gold in a transaction or has the ability to redeem his fiat for gold. GoldMoney would probably be one of the first stashes to be confiscated, accompanied by the statist propaganda how it is necessary to "fix" the economy.

One also needs to remember that normally, it is liquidity, rather than the use value or even the question of fraud, that determines the use of a medium of exchange. Even more strongly it is phrased by Hans-Hermann Hoppe:
"Driven by no more than narrow self-interest, man will always prefer a more general, and if possible, a universal medium of exchange to a less general or non-universal one."
If a fiat money collapses, it is thus replaced by a more liquid fiat money, because fiat money, whether we like it or not, is more liquid than gold. We've seen this empirically occur many times. The event is also called Dollarisation rather than "Goldisation". Collapsing fiat systems are spontaneously replaced by the US dollar, not by gold. In other words, for gold to gain liquidity, it is the US dollar that needs to collapse, not just any fiat currency.

Of course, it could actually get so bad that there is a global collapse of the supply chain, something that David Korowicz or Karen Hudes warn us about. Gold is not going to fix that, because what is needed to prevent it is a replacement for the financial system, not a replacement of the unit. Merely liquidating unsustainable debt, while a necessary step, is completely inadequate to address this issue.

The only possible scenario which is advantageous for gold is that the financial system collapses without having a replacement, while at the same time the economy still having a sufficient amount of division of labour, and at the same time finding out some way of permanently preventing the possibility of fiduciary media or fiat money. Unless this prevention can be put into place, the "reign of gold" will be short, and will be replaced by fiduciary media and/or fiat money, it would just take longer than in a case of an "orderly" reform of the financial system.

I am not the only one skeptical about gold being able to fulfill the requirements of the Austrian critics of our monetary system. Michael Suede, asked what the point of a gold standard is if we already know if failed. It is not money anymore, it is merely a highly liquid good. Did gold gain new features that make it more likely to resist substitution and confiscation? I haven't noticed any. Comparing gold to Bitcoin is indeed, as professor Block argues, silly. To be fair, there have been technological advancements in helping gold be a medium of exchange:
However, all of these are inadequate from the broader perspective. None of them allow gold to be sent electronically and none of them make it easier to transport, control, and with the exception of small change, resist substitution. And unless you find out how to violate the fundamental physics and chemistry laws, gold won't be able to overcome these obstacles (additionaly, if you find out how to violate these laws, then gold would become useless as money anyway). The situation is exactly the opposite as the caller and Block submit. Gold is amedium of exchange that does not solve any of the real issues (i.e. it does not work), while Bitcoin, so far, has been working. We don't know for sure how well it will be able to handle the issues in the future, however it has shown a path of how it is possible so solve them.

In summary, irrespective of a collapse of fiat money, the outlook for gold to gain more liquidity looks bleak.

Is Bitcoin evolving into money?

Bitcoin is, I would say, less liquid than gold. It has less people using it, less mature organised markets, more problems with cooperating with the banking sector or the regulators. However, there is nothing either fundamental or problematic with this. Bitcoin does not need the banking sector to work. It already can be traded in over 3000 cities in 169 countries. It does not need to cooperate with the regulators, because there is no middleman.

For Bitcoin, the issue is exactly the opposite as with gold. The reason why it has a comparative advantage as a medium of exchange is not because of liquidity rank, but because it decreases the transaction costs. It provides a payment processing system that is a replacement for the more common systems like POS terminals for debit cards, ATMs, paypal and so on. Except you don't need a middleman to either provide the service or to entrust your money to. The early adopters of Bitcoin are niches that can benefit from this decrease of transaction costs the most: online gamblingblack markets, donations, charityonline products and so on. Event the emergence of altcoins proves that Bitcoin decreases transaction costs: they piggybacked not on the US dollar, but on Bitcoin, and with small exceptions, they don't even have markets where they can be traded against the US dollar.

Not only does Bitcoin decrease transaction costs from the narrow point of view of a medium of exchange, it also does it from the point of view of a financial system. It provides a replacement for the Wall Streetnotariescorporations, and in general anything that has to do with transfer and enforcement property rights. It is a framework that implements an enforcement of transfer of property rights, analogous to the title-transfer theory of contract, where the transfer itself is transparent and enforced automatically or semi-automatically. All the problems with statist provision of services that has to do with property rights now have a competition not because the state permits it, but because it is more efficient.

What would happen to Bitcoin if the fiat system collapses? First of all, already the "dollarisation" is being amended by "bitcoinisation", such as in Argentina or Iran, despite the maybe overhyped media portrayal. In Kenya, which already has a high mobile payment penetration, Kipochi provides an integration between M-PESA and Bitcoin. Bitcoin also allows them to overcome capital controls in a way that neither the dollar nor gold can. People in those countries are then increasingly more likely to migrate to Bitcoin rather than dollar or gold as their monetary system collapses. The USA might well be the last country where Bitcoin reaches sufficient liquidity to be called "money", and at the greatest cost. If the financial system collapses and is not reformed quickly (by the state), Bitcoin will still continue working, while there won't be a gold-based alternative for a while.

To be sure, there are many obstacles that Bitcoin has to overcome during its growth, such as scalability, user friendliness and so on. But there are no fundamental problems here. These are empirical issues that can be solved by entrepreneurship, and the development is happening right now as I write this. Can gold do any of that? I don't think so. That is why the liquidity of Bitcoin will most likely rise, and the liquidity of gold will most likely remain at approximately the level it is now. Maybe calling gold a malinvestment is an exaggeration, but I wanted to provoke the reader.

Concluding remarks

It is interesting that Austrians understood money 100 years ago better than their successors living now. We have been confused by the existence of all kinds of forms of money and media of exchange. It's long past to confront the confusion and improve clarity.

Empirically, it ultimately does not matter whether Block is or isn't clueless about Bitcoin. The opinion of an economist does not take precedence over catallactic phenomena.

Wednesday 26 June 2013

Research update #1


Late Monday I returned from the 2nd International Conference on Complementary Currency Systems (CCS) that took place in The Hague, Netherlands. I met with many researchers and practitioners, several of them I quote in my thesis (such as Thomas Greco or Hugo Godschalk). Almost everyone knew about Bitcoin and I took the opportunity to explain how it can be used benficially for the people normally involved in CCS. My impression was that most didn't like the inelastic money supply. They do not like that banks are privileged to create money and would prefer that everyone can create money, including credit forms. Some even didn't like that the control over the balance is with the end user, arguing that this promotes crime. Both during my panel and the rest of the time (the conference took five days) I tried my best to explain that Bitcoin is a voluntary system and the technology can be used to construct other monetary systems (indeed, my co-panelists were Marco Sachy from freecoin and Jorge Timón from freicoin) and even for other areas which have to do with property rights, such as finance, banking, legal and property rights enforcement. And, of course, that it makes it more difficult for the banks to create money.

One thing however that I must say that I was pleasantly surprised about was that there appeared to be a unanimous support for a easy regulation and displeasure with the treatment Bitcoin has received. The legal troubles that have affected Liberty Reserve, or before that Liberty Dollar, and the recent public announcements from the regulators are not specific to "libertarian" alternatives. Many of the complementary currencies have suffered from regulatory pressure too, one of them being Bangla Pesa, which was recently shut down in Kenya. The conference organised a petition for the ending of the prosecution of people involved with Bangla Pesa.

I also was able to attend the Utrecht Bitcoin meeting as it was nearby, and finally meet Koen Swinkels in person. Koen is similarly as me interested in deep fundamental economic questions related to Bitcoin and we discussed the topic online several times.


As I now conduct Bitcoin research full time, and am accepting donations for my research, I decided to make my research more open. First of all, I opened my research bibliography and notes. Zotero is a collaborative tool for helping in research, I've been using it since I started my research, now I just made the data public. It contains over 400 entries (books, articles, lectures, ...), notes I made for them, such as quotations that are interesting from the point of view of Bitcoin. You can directly export a Zotero library into bibtex, and plugins are available for MS Office or Libre Office.

Last but not least, I want to make the spending of the donations also publicly auditable. So far I haven't spent anything, but it's difficult to finance my research just from savings. So here is a list of intended uses for the donations:

  • Server hosting. I rent a dedicated server that gathers data from the blockchain (it runs a full node and I recently added several altcoins) and Mt Gox. I plan to add other data sources in the future. The server doesn't do anything else and costs 32 EUR per month
  • Zotero storage plan. I mentioned Zotero above, I have an extensive bibliography (now public) and the storage required exceeds the free hosting plan. I currently pay 20 USD per year.
  • Books and articles. I am not affiliated with any research institution and need to pay full price for any publication that I want to read. Of course I try to get them for free but this is sometimes difficult. I also created a separate Amazon wishlist which includes items I find relevant for my Bitcoin research, so you can "donate" also by directly gifting me a book from that wishlist. I prefer kindle editions to paper books but not all are available in electronic form.
  • Potentially also travel and accommodation costs for conferences. Even though I take part on conferences that I find relevant for Bitcoin, not always do the organisers cover my costs. The Bitcoin 2013: The Future of Payments in San Jose cost me about 1100 EUR for travel and accommodation and the CCS 2013 about 600 EUR. I'm not counting other costs associated with the conferences such as food as I eat regardless of whether I am at a conference or at home. These two conferences already happened so I am not going to use the donations to cover the cost for these two. The other two conferences that I've been invited this year (Cryptocurrencycon and Future of Money 2.0) will cover my costs so it's less of a problem there, but there could be other conferences in the future.
I'll publish the expenditures on a separate page once they occur.

Let me know what you think, and if you have any comments on the donation spending.

Thursday 16 May 2013

Status update, conference in San Jose and meeting professor Selgin

I thought I'd post an update. I haven't posted for a couple of weeks, but for a good reason. As some of you might know, last month I decided to concentrate on research of Bitcoin full time and I left my job. Now I'm a full blown "Bitcoin economist". What this means is that I read books all the time. Well, not entirely, I've also been spreading the word about Bitcoin among people, and trying to figure out how to earn money by doing research. I've also been working on my own book, which is an updated version of my master's thesis with some enhancements and fixes. I've been invited to present at two other conferences this autumn (I'm not sure they have been announced yet by the organisers, one is in the USA being organised by Jeff Tucker, and one will be in Slovakia, organised by the F. A. Hayek foundation). If you want economic research or consulting about Bitcoin, let me know, I'm sure we can work something out.

I'm now at the airport in Vienna, waiting for a flight and hope to eventually arrive in San Jose, just in time for the Future of Payments Bitcoin conference, where I'll be one of the panelists on the Economics panel on Saturday between 4pm and 5pm. Some of you might be at the conference too, so I'm looking forward to meeting you.

Earlier this week, I had the opportunity to meet one of the leading proponents of free market money, professor George Selgin. I corresponded with him before about economic aspects of Bitcoin and I quote him in my thesis, and after I found out he was going to have a lecture not very far from where I live, I registered and attended. I also briefly spoke to him, and it was very fruitful and helped me to understand some of his positions better. For example, on several occasions in the past as well as during the lecture, he claimed to have objections against Bitcoin. It wasn't entirely clear to me, I though that he had both macroeconomic objections (the evolution of the money supply does not follow the ideal of the freebanking branch of the Austrian school) as well as objections to its future as a medium of exchange. It turns out that it was only the former. He now clarified that he does not know how Bitcoin will evolve as a medium of exchange (he made a joke that if he did, he wouldn't be lecturing but rather talking to his broker). Just like me (and Rothbard in The Case for Genuine Gold Dollar) he thinks that people do not choose a medium of exchange based on price stability (or macroeconomic criteria in general), and that the analysis of macroeconomic features of media of exchange and their acceptance by the market are two separate questions. He also replied to some other things I asked him, but I'm not going to post it here yet, rather I want to integrate it into my book.

I have several draft posts related to Bitcoin, some are boring and abstract, some are new and interesting, I'll update and post them as time progresses. Don't worry, I haven't forgot about the readers of my blog.

Wednesday 24 April 2013

Bitcoin at the 2nd International Conference on Complementary Currency Systems

I've been invited to the 2nd International Conference on Complementary Currency Systems (CCS), taking place between 19th and 23rd June 2013, in The Hague, Netherlands. I'm on a panel on the day 3, the strand of the conference specialised for local government officials and policy-makers. I'm looking forward to meeting the other participants, in particular Jorge Timón from the Freicoin project with whom I exchanged comments on the forum.

Wednesday 17 April 2013

The Mises Institute is clueless about Bitcoin

The Ludwig von Mises Institute (the one behind, located in Auburn, Alabama) posted several articles over the last week or so about Bitcoin:
Prior to that, they posted about it during June 2011, by Justin Ptak:
And one in October 2011, by Jeffrey Tucker:
In the meantime, Jeffrey Tucker became a Bitcoin enthusiast (disclaimer: I've been interviewed by Jeffrey and Laissez-Faire Books is publishing my book about Bitcoin, so I might be biased). Justin Ptak appears now to be friends (on Facebook) with Bitcoin fans. This may or may not imply his change of opinion, but it doesn't look like he published anything more about Bitcoin at least.

Now, there is nothing wrong with criticism. And Bitcoin can be criticised, there are many legitimate objections to it. But to criticise something merely because someone feels a pressure to criticise, and then rushes to hastily print something quickly is not scholarly work. It is symptomatic that the institute didn't publish anything in between. They are under pressure to publish something when there is a media interest in Bitcoin, and hence hastily rush to assemble something. But actual academic research appears to be absent.

The main issue appears to be the conflation of money, unit of account and a medium of exchange. Unit of account is not a necessary function of either money or a medium of exchange. It is merely a possible byproduct of it.

A further issue is the "self-reinforcing monetary spiral" (i.e. which mainstream economists call the network effect), in which one medium of exchange emerges victorious and beats all other media of exchange and that we call money. But this is merely a hypothetical model that is furthermore prone to misinterpretation. First of all, transaction costs can prevent this spiral to escalate to its final stage. Currently, we have hundred something currencies all over the world. Legal restrictions prevent this spiral from playing out. But this is merely an empirical factor, rather than a rule that gives legal restrictions magical powers. Even without legal restrictions, we can't be entirely sure that the transaction costs won't hinder a full monetisation.

The second issue is the neglect of other media of exchange, those that are not money. Mises calls them "secondary media of exchange", and Rothbard calls them "quasi-monies". These goods are liquid, and a part of their demand is due to their liquidity. They are not liquid enough to be money, but nevertheless they serve, not only through their other uses, but also through their liquidity, a valuable purpose. This is what Bitcoin is. This is what gold is too. And this is also the pool for potential candidates for money. Before something can be money, it must be a medium of exchange.

Bitcoin is somewhat liquid, and it has a very important advantage against extant money: it reduces transaction costs. It reduces transaction costs even further than existing payment mechanisms, so that even a fluctuating price is not enough to offset this reduction. We can therefore expect Bitcoin to be used as a payment mechanism in those areas where it can substitute for other payment mechanisms. This is also a type of network effect. Once they use it as a payment mechanism, people may decide that they do not actually need to fully convert it to/from fiat, and use Bitcoin as a store of value as well. Indeed, Tony Gallippi from BitPay reported (can't find the link now) that their customers are increasingly opting to keep a larger proportion of the payment in Bitcoin, whereas at the beginning they just converted the whole sum to fiat money.

Yet again I have to quote White in his brilliant insight, which has not yet been processed by other Austrians:
"Coinage reduces transaction costs compared to simple exchange, because of authentication and weighing. Bank liabilities also reduce transaction costs. But these are empirical factors, and not something inherent in all possible monetary systems."
Rather, other Austrians make empirical (!!!) statements like this (Salerno):
"With the use of clearing systems, money substitutes are virtually costless to transfer."
An adoption as a payment mechanism, and expansion into a store of value are the early stages of monetisation. This is the same mechanism as the Austrians hypothesised occurred during pre-monetary times, only we now already have a different money. But already existing money is not a showstopper for this mechanism to work. Liquidity is just not the only factor influencing the choice of media of exchange. The argument of Hoppe that
"Driven by no more than narrow self-interest, man will always prefer a more general, and if possible, a universal medium of exchange to a less general or non-universal one."
is therefore false. It is only apodictically true in a world without transaction costs. It still may happen in a world with transaction costs, we merely can't be sure about it. And Bitcoin is a hint that empirical factors can't be dismissed entirely. EDIT: If the statement of Hoppe was true, once money exists, it could never have been replaced by a new money, and we clearly know from history that that's not the case.

Will Bitcoin ever become money? That's an empirical issue and we can't know this in advance. But equally we cannot dismiss it, unless we find a competitor to Bitcoin based on fiat money (or precious metals like gold) that is able to mitigate the transaction cost advantage of Bitcoin. And that would be very difficult to pull off. One of the reasons is the transaction costs associated with the boundary between money in the narrower sense and money substitutes (such as redemption, settlement, and so on), which Bitcoin does not need. Bitcoin is form-invariant and can exist in practically any imaginable (and unimaginable) form. The second one is regulation (management of money and money substitutes is strictly regulated and burdened by many restrictions which have nothing to do with monetary policy, such as anti-money-laundering, capital controls, war on drugs and so on). Even if regulation affects Bitcoin, unless there is an alternative that isn't affected by regulation, there is still no reason for Bitcoin users to switch to something else.

But Bitcoin can do much more than become money. With algorithmic contracts, it can make large parts of the financial sector obsolete. With its ultra low transaction costs, it can make money substitutes redundant (and, obviously, without money substitutes there is no credit expansion and without credit expansion there is no business cycle). Again with its transaction costs and abstract base, anyone can make a payment to anyone, anytime, anyplace. Nothing that has existed so far in the history can do that. And even if we disregard it as a hypothetical, we just need to remember that gold already failed, because it was reduced from money to a secondary medium of exchange. This was only possible because money substitutes emerged. If nothing else, Bitcoin shows that money substitutes are merely an empirical quirk and not an inherent feature of monetary systems, and for that alone is it should change the landscape of the Austrian literature forever, and open a wide spectrum of possibilities for research and our understanding of money.

For more in depth analysis, I recommend my master's thesis, or if you wait a while you can get an updated version in a book format.

Wednesday 10 April 2013

The economic fundamental of money substitutes

Since Patrik Korda still criticises my approach to money substitutes, I thought I'd summarise here their fundamentals. This is not a definition of a money substitute, nor an exhaustive listing of all possible types of substitutes. Rather, it is to explain their essence in a way that is easily understandable and clarify why Bitcoin has nothing to do with them.

The fundamental of a money substitute is a causal link between money in the narrower sense and the substitute. This causal link is the main, necessary, factor explaining the price of the substitute. For argument's sake, I'll leave it open whether other, optional, factors exist. This is the essence of the point Mises was making, he was trying to explain the price of money substitutes. And he found the explanation in the causal link to the money in the narrower sense.

For Bitcoin, there is no such underlying causal link to a money in the narrower sense that explains the price of Bitcoin. The price of Bitcoin is determined by other factors.

Therefore Bitcoin is not a money substitute (or it wouldn't be if Bitcoin was money).