While many Austrian economists disagree on various topics regarding the origin of money, the most notable and agreed-upon theory on the origin of money is Carl Menger’s theory of salability.
Bitcoin arose in a world that was long past the barter phase. Since bitcoin was never used for barter, it did not face the problems that barter economies had, namely the problem of double coincidence of wants. While it might not be helpful to compare the emergence of bitcoin to the emergence of money in a barter economy, it is still the same market dynamics described by Carl Menger that dictate how new money emerges. These market dynamics, which also apply to bitcoin, are explained by the theory of salability:
Salability (liquidity) is the extent of how much economic sacrifice is required for disposing of or acquiring a good, i.e., how easy it is to sell a good at a market at any time, and at any economic price. The sacrifice usually comes in the form of a discount on the price, or in the cost of delaying the exchange resulting in the seller having to wait until the exchange can take place. The more salable a good is, the easier it is for the owner to exchange it for other goods for a reasonable economic price, i.e., prices corresponding to the general economic situation. Another way of thinking about salability is that it is the narrowness of the gap in which an individual can immediately buy and sell a good. The theory of salability describes how goods compete with each other for becoming money based on the difference in their relative salability.
The Early Days: An Illiquid Good
In the early days of bitcoin, it had no price, no purchasing power and no salability. On October 31, 2008, the pseudonymous creator Satoshi Nakamoto published the Bitcoin white paper on the cryptography mailing list. At this point, bitcoin can’t be considered a good as it does not exist yet.
On January 3, 2009, the first block was produced on the network and thus the Bitcoin blockchain was born, which resulted in the first bitcoin coming into existence. On October 5, 2009, after the Bitcoin network went live, the first known bitcoin price offer was posted. The price for this bitcoin was calculated based on its mining cost, i.e., production cost.
According to Mises’ definition, bitcoin was considered a good even before it had a price: something that provides means toward an end. This can be observed by the fact that before bitcoin units had prices, they were still used on the network by early users. Whether this usage was an ideologically-driven contribution to the network or speculation regarding future adoption is not essential. What is essential, however, is the fact that bitcoin was a good that provided some kind of utility to its users. If it did not provide any utility, bitcoin would have not been used in the first place.
It would make sense to think that bitcoin was originally demanded for its potential of becoming money. This potential and the speculation that was derived from it would benefit early adopters, i.e., it would satisfy a need that they had. Since bitcoin units can only exist in the context of the Bitcoin network, it would make sense that supporting the network in several ways would make its native units (bitcoin) more valuable.
The Bootstrapping: Liquidity Via Speculation
The first bitcoin exchange, “Bitcoin Market,” was introduced in January 2010, and since then, somewhat liquid markets with sell and buy order books, price information and other exchange mechanisms enabled users to dispose of their bitcoin faster and for better economic prices, making bitcoin more liquid (salable). The exchange founder in a later forum comment explained that they wanted to create a marketplace where people could trade bitcoin for USD and speculate on the value, which would establish a real-time BTC/USD exchange rate.
As a new and unknown good, bitcoin did not have effective markets to establish proper prices and was not very liquid. Thus, the only logical development to happen at this point was for bitcoin to be traded against the most liquid goods: the largest fiat monies such as USD and EUR. It would be unlikely that a bitcoin owner could have found someone willing to part with their consumption goods. This is because the receiver of this new asset, without valuing it as collectible or having the desire to speculate on its price or future, would struggle to exchange bitcoin further for the things they want. This is because bitcoin was new and illiquid.
As established above, before bitcoin was used in indirect exchange, they were used in direct exchange with USD and EUR for speculation purposes. This is what can happen when a monetary good emerges in an economy that already has money. This use provided initial liquidity, which then made it possible for bitcoin to slowly transition into a medium of exchange. Even before bitcoin started developing prices and salability, individuals were willing to spend money or expend other valuable resources (early miners produced bitcoin when it was “worthless”) on bitcoin because this proved to be valuable to them, i.e., they derived some kind of utility from “using” bitcoin. Some primitive monies were hoarded as collectibles for speculation for future value appreciation, i.e., for the anticipation of an increase in purchasing power. This can be interpreted as speculation, but also as an attempt at storing value. A parallel between early proto monies and early bitcoin can be made in this sense.
The Bitcoin white paper states that bitcoin was designed to function as money. It seems to be the case that ideologically-driven early adopters were expending resources to acquire bitcoin to speculate and bootstrap the system into wider adoption. By valuing, supporting and speculating on bitcoin’s future, they inevitably increased bitcoin’s liquidity. This might have given that initial push for the first price to emerge, after which people started buying it because they anticipated that other people too might value bitcoin for all of the characteristics they valued it for (or other characteristics for that matter). What is different today from the days where collectibles and proto monies were used as money, however, is that today, humans can foresee monetary demand since the concept of a medium of exchange is already well known. This can be contrasted with ancient people not being able to imagine such a thing.
Bitcoin was given away by early adopters simply by completing a captcha. A bitcoin developer at that time, Gavin Andresen, set up a service to give away free bitcoin because he wanted the Bitcoin project to succeed and it is more likely to succeed if people have some bitcoin to try using it. This shows what many early adopters’ motivations were: to distribute, increase interest and spread awareness of this new phenomenon. Just as with most achievements in life, this was done by having “skin in the game” and incurring some risk, whether monetary, reputational, emotional or any other type of risk, for that matter.
Perhaps the earliest adopter after Nakamoto themself, Hal Finney was thinking about how to value bitcoin and how it could get a price when virtually no one would accept it at first. Then he went on to speculate in a thought experiment about the risk-return asymmetry in acquiring very cheap bitcoin with only a few cents of computing energy and waiting for bitcoin to become a valuable global asset.
Nakamoto foresaw the price increase as a bootstrapping mechanism. They predicted that, as the number of users grew, the price per bitcoin unit would also grow, which in turn would attract more users resulting in a positive feedback loop. This is what Menger described: speculation, exacerbated by speculation markets is what increases the salability of a good. People might be correct in their speculation, which makes their action beneficial as they expedite price discovery for bitcoin.
Praxeology does not concern itself with why individuals speculated on bitcoin. What is important is the fact that it happened, because the act of speculation satisfied potentially various subjective needs. It could have been likely a mix of desire for ideologically driven individuals to speculate on the success of the Bitcoin protocol and network, and speculation for pure price appreciation. As discussed before, this gave the initial push for Bitcoin to begin its journey to becoming a liquid medium of exchange.
Bitcoin As A Medium Of Exchange
On May 22, 2010, the first purchase made with bitcoin was conducted to buy two pizzas. Although this trade happened, this can barely be considered even a quasi-indirect exchange. This can be counted as the first publicly-known use of bitcoin in indirect exchange, which made it a medium of exchange as per the definition. This exchange happened because bitcoin already had a price and liquidity to some degree. A trade would not have been possible if bitcoin were illiquid and had no price on the market.
The moment a good is used in more than one exchange, and between more than two parties, it has served as a medium of exchange. This is where bitcoin entered the elimination-type market process where salable goods compete. As we have established before, only a limited number of individuals recognize the salability of a good. The individuals that were involved in the pizza purchase recognized that bitcoin is a salable good, and thus it gave them the knowledge to use it as a medium of exchange. This knowledge spreads out with the increase in knowledge of the good’s salability (liquidity). Although extremely limited, bitcoin started to become used to purchase consumption goods, as opposed to being only speculated on and traded against fiat monies such as USD.
The increased use of a certain medium of exchange is logically followed by it gaining even more momentum and being used more widely. What separates winners from losers is exactly the difference in goods’ salability. This disadvantageous dynamic is recognized by the market: vendors of less salable goods will generally trade for more salable goods before they trade for the goods they ultimately want.
Since salability can be viewed as a proxy for how much demand there is for a good, the salability of a good increases as demand increases, creating an upward spiral; a good’s high salability draws more demand, which in turn increases its salability further. This again draws more demand, and so on. This process continues until a few goods are regarded as “media of exchange.” Salability is not static nor a binary characteristic. This means that in different types of economies and different historical periods, different goods possessed different levels of salability based on the type of society and the technological capabilities present in this society. Just like gold was not used before smelting technology became widespread, Bitcoin would have not been possible to invent in 1960 due to the fact that the technologies that bitcoin leverages today simply did not exist back then.
Hanyecz, who made the infamous pizza purchase, said later that Bitcoin was an “interesting system,” but it would not have any value if nobody except him was using it. Indeed, money is a good that has little value as a standalone good. Many economists use Robinson Crusoe, the man stuck on an uninhabited island alone, as an example to explain economic phenomena. In the case of money, we can imagine that it would have no value to Crusoe, since he would not be able to trade it with anyone, and he cannot consume it either. Being a social phenomenon, the acceptability of money is an important characteristic.
The Battle For The Status Of Money
The selection process does not stop until a good becomes money. As individuals are incentivized to trade their goods for the most salable of the media of exchange, markets converge on a few monetary media. This process benefits only those media, while other, less salable media of exchange continue their downside spiral until they drop out of the competition entirely.
In Mengerian theory, one can think of the money market as a process of elimination where less salable goods are not demanded for their monetary value anymore, and the only goods left after this process of elimination start being regarded as money. This results in one dominant medium becoming generally used, which according to the Austrian definition, is money. This process of elimination creates a positive feedback loop which results in people emulating this behavior, furthering the monetization process of this good. As it stands today, people are learning about the benefits of holding bitcoin long term, which causes other bystanders to rush to acquire bitcoin too.
Individuals holding less salable goods will be punished economically as the opportunity cost of holding less salable goods manifests in fewer exchange opportunities and higher costs related to exchange. Thus, using inferior media of exchange, as opposed to commonly used superior media of exchange, has opportunity costs not only to the individual giving it away but also to the individual receiving it. There is a tendency for less salable goods to be used as media of exchange to be one by one rejected until the last good remains. While it might not seem obvious to outside observers, we are observing this phenomenon with the growth of bitcoin. It could be the case that holding other monies, as opposed to holding bitcoin, might have high opportunity costs that can manifest in the higher costs of exchange.
Individuals who go to the marketplace with a more salable medium of exchange will have a higher probability of being able to exchange it for the goods that they want for consumption, as opposed to individuals who go there with less saleable goods, exactly because of this difference. As such, money can be described as the most salable good. It is not, however, impossible for two goods to be regarded as commonly used media of exchange. One historical example would be that of gold and silver, which were used as money simultaneously. Although possible, the outcome of this involves disadvantages and complicates the process of exchange, which reinforces the belief that bitcoin, as superior money, will turn out victorious in the market for facilitating exchange.
It is unclear at what point bitcoin could be considered money. It is hard to define “money” because the moment a medium of exchange becomes commonly used is ambiguous, and thus, cannot be strictly defined. The broader definition of a medium of exchange is hard to differentiate from the narrower definition of money making the transition from former to latter not sharp, but rather gradual, which is why agreement on the definitions cannot be reached. Whether or not a medium of exchange is money is left to the judgment of the historian and other observers. Many bitcoiners are quick to declare bitcoin as money already, while others are more reserved and do not see it as such today.
At 11 years old, bitcoin is still a very young monetary phenomenon. But as more people start recognizing its liquidity and the possibility that it could one day become money, its liquidity will grow even further. While bitcoin has global liquidity already, it is too early to declare it a winner in the competition for becoming money in its purest sense.
This is a guest post by Satoshi Baggins. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.