By Aristippus

Bitcoin is a digital currency, and, with a total market cap at over 100 million USD, the most widely used alternative to state-issued money. Importantly, it does not rely on a central authority for its creation, but is instead administered through a decentralized peer-to-peer network and produced through a process referred to as ‘Bitcoin mining’. Bitcoin has become popular amongst those who see the harmful effects of the current fiat money regimes and who see Bitcoin as a possible escape from the centrally controlled and continuously debased state currencies. It is possible that if something like Bitcoin was able to grow in popularity to such an extent that it rivalled the fiat currencies of the world, great pressure would be put on central banks’ money creation activities, as people would have in Bitcoin an easy to use and anonymous medium of exchange to escape to, and which does not suffer the same inflationary flaws as the state’s monopoly money. Bitcoin, therefore, could be a means to strike a major blow for liberty. Despite that, it has its sceptics even within the libertarian community.

Some, such as Smiling Dave (who operates a blog and posts on the Ludwig von Mises Institute Forums), say that the idea that Bitcoin could emerge as true money is contradictory with a part of economic theory known as the Regression Theorem of Money, and, due to that contradiction, it could never be considered money and is in fact doomed to failure. In that view, it is merely a bubble inflated by speculation and Bitcoin fanboys, and ripe for bursting. In response to the view that Bitcoin violates this Regression Theorem and that it therefore should not be taken seriously, some proponents of Bitcoin have gone to the length of rejecting the Regression Theorem altogether. Is such a step warranted? Or could there be a third view, which demonstrates a harmony between the demand for Bitcoin and the Regression Theorem, and allows for the possibility of Bitcoin becoming more widely accepted as money in the future? In this article I will attempt to make that very case.

Before we turn to the Regression Theorem of Money and how it relates to Bitcoin, we first have to understand the definition of money. By talking about money, we are not referring to any particular kind of currency such as gold or dollars, but rather to any generally accepted medium of exchange. A medium of exchange is any commodity that is used not for its direct use, but instead is obtained with a view to trade it in turn for another good. We also have to realise that the definition of money as a generally or commonly accepted medium of exchange does not give us a clear-cut understanding of what should be considered money and what should not be considered money. There is not a point at which we can distinguish a good as transforming from a medium of exchange not generally accepted into a true form of money. We can nevertheless identify where certain media of exchange clearly exist as generally accepted ones, e.g. the USD within the USA and the AUD within Australia.

Now I have already referred to the Regression Theorem of Money and its crucial place in a debate about the question of Bitcoin as money. Before getting onto that latter question, I will explain the Regression Theorem and its purpose. The Regression Theorem, as developed by the economist Ludwig von Mises, solves a particular problem in understanding the emergence of money. Because the demand for money comes from one’s ability to use it in trade for other goods, i.e. from its exchange value, and because this exchange value is in turn based on people’s willingness to accept it in exchange for goods, i.e. on its demand, we are met with an infinite regress if we simply attribute demand to exchange value, and exchange value to demand. Now, we can see in real life that these two things are based on one another in an economy where money operates, but the question is: how could this relationship come into existence? Why would someone demand a commodity for use in future exchange when no commodity is generally accepted as a medium of exchange? If a generally accepted medium of exchange is not already existence, one cannot be sure that he can eventually offload a good which he does not desire for his own employment. Only the barter of directly desired goods would exist as a common transaction. How then, did money come about?

The answer given by the Regression Theorem is that the goods that eventually become demanded as money, i.e. for their exchange value, are initially in high demand for their non-exchange value, e.g. for their value in direct use. Because such commodities are the most marketable goods vs. all others, they become more readily accepted in barter, since those who receive them know that, due to the high demand for their direct uses, such goods will be easy to exchange for goods that the recipient desires in the future. From this process of the most marketable goods being accepted due to the demand for their direct uses, such goods become generally accepted as money due to their common use as exchange goods. Here the Regression Theorem explains, purely through logic, how money could arise from an environment lacking a generally accepted medium of exchange. The most important thing to take from the Regression Theorem for our purposes, however, is the fact that in order for goods to become money – generally accepted media of exchange – they must have been demanded for their non-exchange value, whatever that might be. That non-exchange value does not have to be direct consumption use, but might for example be a good’s ability to facilitate the exchange of true money, as in the case of the use of gold certificates that represent gold but are only paper, and from which we can explain the origin of modern fiat currency.

But how does this apply to Bitcoin? We see that Bitcoin is being employed as a medium of exchanged which demonstrates that it is in demand as such, but how could that come about in light of the Regression Theorem? Is there some non-exchange demand that initially drives this, as the Regression Theorem requires, or should we, as some have done, abandon the Regression Theorem with the realisation that Bitcoin proves it unnecessary? As I have said above, it seems to me that there is in fact no contradiction with the current demand for Bitcoin and the Regression Theorem. All we need to do in order to explain this fact is to understand the reasons for this demand.

One theory attempting to explain this argues that it is the demand created by speculation on the future price of Bitcoin which allows for Bitcoin’s exchange demand. According to this theory, speculators, believing that the advantages of Bitcoin are such that its price would greatly rise were it to come into wider use, are effectively demanding Bitcoins without the aim of directly offloading them. Thus the demand created by their activities has resulted in an environment of reliable exchange between Bitcoins and national fiat currencies, e.g. USD. This demand acts like the initial demand for direct use in the Regression Theorem, which allows a reliable exchange between the most marketable good and all other goods. In the same way, the speculators’ non-exchange demand has allowed for Bitcoin to gain an exchange demand by facilitating the use of fiat currencies which already exist as money in certain contexts.

This is quite like the way in which gold certificates could be used in the 19th century: though they were only made of paper, they facilitated the transfer of gold (since they were redeemable for gold) by being easier to transport, and so came into wide use. In the same way, Bitcoin has established a reliable transfer with fiat currencies (akin to redeeming gold certificates for gold), and can ease the use of those currencies. This is what makes Bitcoin different from any traditional kind of private fiat currency. The high degree of anonymity that Bitcoin provides is probably the chief factor in its ability to facilitate the use of already existing money, but we can also point to Bitcoin’s low inflation rate and security as advantages over trading directly in fiat money. Indeed, Bitcoin has been employed for its anonymity to ease the purchase of prohibited items such as drugs (on, for example, the black market site Silk Road). Bitcoin, therefore, due to its nature as a decentralized, encrypted, digital currency with a high degree of anonymity, has definite advantages in co-existing in a market with state fiat currencies. What makes the speculation theory even more attractive is the fact that the rate of Bitcoin mining is set up to benefit early adopters. Thus there is an even greater incentive for people who favour Bitcoin to build up their stock early, which in turn creates exchange between Bitcoin and fiat moneys.

The speculation theory gives only one possible reason for the initial demand for Bitcoin, in line with the Regression Theorem. It could be that the non-exchange demand for Bitcoin is a result of some other cause altogether, which has eluded this writer. The fact of the matter, however, is that there is indeed demand for Bitcoin, and, furthermore, that we needn’t throw out the logic of the Regression Theorem of Money as a consequence of that fact. Although it cannot be foreseen whether Bitcoin will rise in popularity and become an even more generally accepted medium of exchange, or on the other hand collapse and disappear from use, there is nothing in theory that prevents either of those outcomes from occurring. That is an empirical matter and cannot be known from theory alone.