If you are an investor (punter) in ‘deflationary’ crypto-currencies (like Bitcoin and its ilk), it is vital that you understand the philosophy of money… if you don’t want to be left wondering where your money went once stable crypto-currencies becomes available.
To understand what I mean by ‘stable crypto-currencies’, it is necessary to understand what ‘money’ is.
Money is not a ‘thing’ (like gold). It is just ‘information’.
Money simply provides a way to measure and record the value of goods or services sold and bought.
Like a ‘ruler’ is used to measure ‘dimension’. In this analogy, different currencies are like different measures of length (such as cm and inch). Just as you can convert an inch into centimeters, so you can convert, say, dollars into euros. The conversion in each case is not putting a value on the measure, it is just a conversion of one unit into another unit.
In any transaction involving the payment of money, the seller alone provides the only value (in terms of the goods and/or services).
The buyer gives no value to the seller.
The buyer simply gives the seller a record of the amount of value that they agree has been provided by the seller — using money (units of currency).
The sole purpose of this record (money) is to enable the seller to recover the value (he or she gave to the buyer) from other member(s) of the community.
On the other side, all members of the community must accept the money as a valid record of the value of any goods or services provided by one of their members.
Once the seller spends their money, they and society are square. The seller will have got back the value (in terms of goods and services from other members of the community) equal (in their view) to the value they provided to the original buyer.
It means that as people trade goods and services, receiving and paying money in turn, they each get to take out what they put in — not more or less.
For this to work, two requirements must be satisfied:
- the ‘record’ (unit of currency) that is used to measure ‘value’, should have no value itself.
- the ‘purchasing power’ of the money must be stable — otherwise the seller will get out more (in the case of deflation) or less (in the case of inflation) than they provided. This is unfair on both counts.
The only difference between an inch and a dollar as a unit of measure is that it is possible to fix the inch against a specific physical feature in the real world.
Value as we know, cannot be pinned down in this way.
Value is in the ‘eye of the beholder’.
And yet, there are physical features in the real world that provide a reference or ‘backing’ for each unit of currency, namely the underlying resources (natural, human, built, technological and organizational) of the communities that accept it.
Speculators may try to manipulate the relative value between currencies, but over time, each currency must reflect the worth of the resources that underlie it… as long as the amount of currency on issue remains in line with the capacity of the community to produce goods and services, so that its ‘purchasing power’ remains relatively stable over time.
While a seller holds onto their money, so long as the money retains its purchasing power, the money acts as a ‘record of the wealth they had created when they organized the production and/or distribution of the goods and/or services they sold’. More colloquially, it is seen as a ‘store of wealth’… but it is not ‘wealth’ itself that is stored. It is simply the record that enables the seller to access real wealth by spending it.
A ‘store’ is a place where you put a commodity, say ‘wheat’. When you come to open the store, you hope to find the same amount you put into it, not more or less.
For money to act as a ‘store’ it should not be subject to ‘inflation’ (which Satoshi acknowledged). But neither should it be subject to ‘deflation’.
Inflation is bad because it advantages the holders of assets over the holders of money. Over time, inflation means you get to take out less value than you put in.
But deflation is just as bad, only it advantages the holders of money over the holders of assets, so you get to take out more than you put in.
For the sake of ‘fairness’, currency must be relatively stable.
Bitcoin and its ilk fail this test of ‘money’ disastrously as they are designed to be deflationary.
Relative stability in the purchasing power of money is also crucial in order for sellers to account profit, which is vital to ensuring that the process of creating our goods and services adds value rather than consumes it. Loss making enterprises consume more value in terms of their inputs than they create as output. Inevitably, such enterprises go out of business. This is the redeeming feature of ‘the market’. It ensures (all else being equal, which it never is) that our resources are dedicated to delivering the goods and services we collectively value the most.
It works best when there are a large number of buyers and sellers competing to sell and buy similar goods and services, where there is ‘perfect knowledge’, ‘equal power’, and no fraud. In this case, the market clearing price can be accounted as the ‘fair measure of the value of any particular good or service within the community’. It means that no seller or buyer gets more or less than they deserve.
There is no possibility that Bitcoin and its ilk can be used to reliably account profit and loss on trade due to its deflationary and speculative nature.
The idea that ‘cryptocurrencies’ should or do have a value arises because Satoshi likened Bitcoin to ‘gold’ which is a commodity, which does have value independent of its role as ‘money’.
As a commodity it can be exchanged. But in such an exchange it is being treated as ‘barter’ (of one commodity for another) not as ‘money’. Gold becomes both a commodity and money when it is formed into coins with a ‘face value’ that states the number of ‘money units’ that the coin represents.
The face value is the ‘money’. It can as easily be represented by bits of paper, or an electronic record in a bank account.
The ‘gold’ is simply the material from which the token is made that carries the imprint of the ‘face value’.
History shows that whenever the commodity value of a coin exceeds the money ‘face’ value, the coins are either hoarded or melted down for the gold.
In the case of Bitcoin, there is no ‘commodity’… nothing to ‘melt down’. There is just a bit of code. This code is worthless unless it represents ‘money’… and since the preceding analysis shows it is useless as ‘money’… it has no intrinsic value at all. The fact that people buy it (spending real money) is due solely to the expectation that other fools will one day pay more, in the expectation of finding even greater fools who think there are still greater fools, and so on.
This is not to deny the real value of a stable crypto coin… but that is another matter entirely.
It may be that there will be further ups and downs in the price of deflationary cryptos… until most people wake up to the fraud. There is evidence that this is already happening as more resources are poured into developing a stable crypto.