Introduction
Bitcoin promoters have been using the “digital gold” meme to illustrate its function as a store of value on its journey to full monetization. Being a store of value is one of the three generally accepted functions of money; the others are medium of exchange and unit of account. A money, the third thing used for indirect exchange, fully achieves each of these functions at correspondingly named stages with the addition of one at the beginning. These stages of monetization are collectible, store of value, medium of exchange, and unit of account.
It can be somewhat confusing, but these stages do not happen discretely but instead interact with and provide feedback for each other in a complicated monetization process.
For example, while Bitcoin will not be used widely as a unit of account until it reaches monetization, that will not stop some businesses from listing their products for sale only in Bitcoin (for both payment and denomination of price) even during the very early stages of Bitcoin. In this case, before Bitcoin is a reliable store of value, it is being used both as a medium of exchange and unit of account, but only for the isolated occasions when this business owner and his customers interact. It is only when each of these functions are universally adopted (by a society whether it is an isolated village in a jungle or the entire global economy) that we can say that an asset can be called money.
As shown in Murad Mahmudov’s famous Market Cap vs Lindy Effect chart, there is still a general linear flow of progression through these four stages of monetization despite the tendencies of the stages to overlap. Bitcoin is clearly past its stage as a collectible for cypherpunks and libertarians. It is widely known by almost everyone and is regularly discussed on various news programs. With Bitcoiners routinely promoting the idea of “hodling,” it must be the case that it is in the stage of becoming a store of value. Despite its sometimes huge peaks and valleys, we can see the price of Bitcoin denominated in fiat over a long time horizon appreciating in price, so it must be the case that it is doing a good job of storing value despite the fact that more bitcoins are being emitted into the network through the mining process. Because of its superior properties that make it very useful as serving the three functions of money, the hodlers are speculating that the price today is well below (even in orders of magnitude) its future price when the rest of society comes to congregate to use Bitcoin as money.
If the hodlers are correct, they stand to be economically rewarded very well. If they are missing something and are unaware of some fatal flaw that makes Bitcoin fail in its mission to become money, then they will lose their investment.
Carl Menger’s Store of Value as an Accidental Nature
While many Bitcoiners use Austrian economics to justify their bullishness on Bitcoin, some are pointing to Carl Menger’s writing on money to show a blind spot for Bitcoiners. In his book, Principles of Economics, Menger writes:
[I]t appears to me to be just as certain that the functions of being a “measure of value” and a “store of value” must not be attributed to money as such, since these functions are of a merely accidental nature and are not an essential part of the concept of money.
At first glance, it appears that Menger contradicts the Mahmudov’s and every other Bitcoiner’s argument that Bitcoin must generally be used as a store of value before becoming a medium of exchange. However, this quote from Menger and the arguments of Bitcoiners need context and further exploration.
Money is the Best Medium of Exchange Available
The first point to be made is that Menger is speaking very generally. Since money removes us from the barter system of coincidence of wants and direct exchange to a system of indirect exchange, if an asset cannot function as a medium of exchange, i.e. the third thing with high saleability and liquidity, then it would obviously never have the chance of being money. But this is a very basic filter for what qualifies something to have the potential to be money but not why one asset would beat out others to claim that role.
Interestingly enough, Menger provides some insight into this just a few sentences before the above quote:
If we summarize what has been said, we come to the conclusion that the commodity that has become money is also the commodity in which valuations answering the practical purposes of economizing men and in which accumulations of funds for exchange purposes can most appropriately be made provided that no impediments founded upon its properties stand in the way.
He further elucidates this point in On the Origins of Money:
With the extension of traffic in space and with the expansion over ever longer intervals of time of prevision for satisfying material needs, each individual would learn, from his own economic interests, to take good heed that he bartered his less saleable goods for those special commodities which displayed, beside the attraction of being highly saleable in the particular locality, a wide range of saleableness both in time and place. These wares would be qualified by their costliness, easy transportability, and fitness for preservation (in connection with the circumstance of their corresponding to a steady and widely distributed demand), to ensure to the possessor the power, not only “here” and “now” but as nearly as possible unlimited in space and time generally, over all other market-goods at economic prices.
This means that only the assets with the best monetary properties available would become money since people would look to exchange their goods and services for the asset that they believe would provide the highest saleability. This also helps to explain why what is used as money changes over time as technological advancements helped largely by the benefits of the existing money lead to the developments of even better moneys. Menger explains this using the example of how a cattle monetary standard was eventually replaced:
But rising civilization, and above all the division of labor and its natural consequence, the gradual formation of cities inhabited by a population devoted primarily to industry, must everywhere have had the result of simultaneously diminishing the marketability of cattle and increasing the marketability of many other commodities, especially the metals then in use. The artisan who began to trade with the farmer was seldom in a position to accept cattle as money; for a city dweller, the temporary possession of cattle necessarily involved, not only discomforts, but also considerable economic sacrifices; and the keeping and feeding of cattle imposed no significant economic sacrifice upon the farmer only as long as he had unlimited pasture and was accustomed to keep his cattle in an open field. With the progress of civilization, therefore, cattle lost to a great extent the broad range of marketability they had previously had with respect to the number of persons to whom, and with respect to the time period within which, they could be sold economically. At the same time, they receded more and more into the background relative to other goods with respect to the spatial and quantitative limits of their marketability. They ceased to be the most saleable of commodities, the economic form of money, and finally ceased to be money at all.
Clearly, the metals like copper and eventually gold and silver that replaced cattle as money were not immediately used as money or even media of exchange upon their discovery but had to undergo some sort of process by which people began to use them as such. It is laughable to think that the first person to pull a gold nugget out of the ground would say, “I’m going to use this to buy something from my neighbor!” People first used it for its collectability and enjoyed its ornamental functions and then industrial uses. However, its physical features such as durability, divisibility, and scarcity are what led to its monetization.
Bitcoin as a Medium of Exchange
Enter Bitcoin. What’s especially interesting about Bitcoin is that it provides digital scarcity and is thus not a physical commodity and therefore cannot be used in economic consumption. It was designed to become money but given its lack of a physical nature to be used for anything but money, it must only serve as a medium of exchange. You cannot eat it, you cannot build physical things with it, you cannot use it in electronics, etc. The only thing you can do is sign transactions to transfer the ownership of your bitcoins to someone else. It matters not if it is somewhat expensive to transfer that ownership; the magnitude of the transaction fee does not negate its primary function as a medium of exchange.
Because someone doesn’t immediately sell their gold or dollars upon receipt doesn’t render those currencies useless as media of exchange. We simply call the act of delaying of spending saving. Likewise, the “accidental nature” of the store of value function of Bitcoin comes when owners decide to delay spending them. The reason for the saving is that the owner speculates that in the future more people will demand Bitcoin as a medium of exchange for payment. With this and the ever-inflating fiat system in mind, it would be destructive to the Bitcoiner’s wealth to spend his bitcoins instead of his fiat. Any rational economic actor would save the thing he expects to be worth more in the future and spend the thing that will be worth less tomorrow than it is worth today. This is Thiers’ law in action.
Bitcoin has not reached it’s stage of medium of exchange yet because it is not universally used that way. Only a small fraction of the world’s population own Bitcoin at this present moment. The key nuance in understanding Menger is understanding the difference between medium of exchange as a function and medium of exchange as a stage in monetization.
Applying Menger to Gold
As few months before Satoshi Nakamoto mined the first Bitcoin block, Robert Blumen wrote a piece on Mises.org called “Is Gold Money?” He took on the above Menger quote regarding store of value as an “accidental nature” to address the reasons why gold, despite its demonetization through government forces, did not lose its store of value function despite many experts claiming it would. Although Blumen was not considering Bitcoin, you can easily insert it into his analysis, which makes Bitcoin an even more bullish proposition.
Blumen writes:
But why is gold a better store of value than most any of a vast number other nonmonetary goods? Why were Milton Friedman and the other economists wrong? Their error was the assumption that political institutions have the final say over what is and is not money. But this is not so: the market has final say. Looking at the process by which money originated from barter helps to understand why. According to Menger, money came into being through the efforts of individuals to expand the range of goods they could acquire through exchange beyond the possibilities available.[7] Some individuals in a barter economy begin by bartering their goods for a commodity that they do not need but is generally in demand throughout the market, with the intention of later exchanging that commodity for other goods. This strategy is called indirect exchange. These astute traders realize that “the acquisition by trade of the consumption goods that he needs … can proceed … much more quickly, more economically, and with a greatly enhanced probability of success.”[8]
He later continues:
The result of market competition is not necessarily permanent. Market competition is an ongoing process. Even when one commodity emerged as money, there continued to be competition from other nonmonetary commodities. Once the world’s money, even gold could have lost its place had a superior alternative emerged. But that is not the reason we no longer use it. Political money did not prove its superiority through a market process. What happened instead was a politically imposed change from a better system to a worse system.
Although the central bankers have used political means to replace gold with paper, they do not have the power to end the competition between their money and commodity money. The “demonetization” of gold by central banks has rigged the competition — but not ended it.
Gold is no longer used as money and there are perhaps several reasons for this. Fiat has saleability across space that is superior to gold’s but this doesn’t seem like it would be enough to overcome the value derived from its hardness. However, it was gold’s inability to provide security against the political means of control that ultimately caused its demonetization. So, as Blumen says, it was not a market process but a political process that caused the transition from gold to fiat. Those political forces, however, only elbowed gold offstage; the market forces (i.e. people trying to retain their wealth) keep it poised to remonetize as soon as the government’s fiat system collapses under its own weight.
But gold’s same flaws would still exist and while better technology today would stave off the centralization for perhaps a longer time than before, no technology exists for gold that would allow it to be inoculated from the clutches of government centralization. Alternatively, Bitcoin with its superior monetary qualities over gold and fiat, has the ability to not only crush the fiat system but also deal the final death blow to gold’s monetary standing. Gold losing its monetary value through competition is a good thing, because, as Blumen wrote above, it would mean that “a superior alternative emerged.”
Final Thoughts
We have the privilege to live in a time when a new market-driven monetary standard is emerging for the first time in thousands of years. It’s happening in sync with the way long-dead economists explained an asset monetizes. As Bitcoin proves these economists correct and vice versa, we have a positive feedback loop of assurances that both our Austrian economic principles and our speculation that Bitcoin will become global money are correct.