Matters of Money

I have some questions about how money works.

I’ll start by talking about Bitcoin, though my questions are more general than that.

As you are probably aware, Bitcoin is a cryptocurrency that is currently trading for US Dollars at the rate of (depending on the exact moment when you’re reading this) somewhere between $15,000 and $20,000 per Bitcoin.

As you are somewhat less likely to be aware, Bitcoin Cash is another cryptocurrency that is currently trading for US dollars at the rate of something less than $2000 per Bitcoin Cash token. Despite the similar name, Bitcoin Cash is (now) entirely separate from Bitcoin. It originated in a “hard fork”, where each holder of Bitcoin was given an equal amount of Bitcoin Cash for free (so if you were holding, say 50 Bitcoins, you got 50 Bitcoin Cash tokens). After the fork, the two currencies have evolved, and will continue to evolve, separately.

The technology of Bitcoin Cash is very similar to the technology of Bitcoin. It offers the same sorts of anonymity, security, and so forth. There are some reasons to believe that in the future, Bitcoin Cash will be a bit easier to trade than Bitcoin (though that is not true in the present), and there are some other technological differences between them, but I’d be surprised to learn that those differences are accounting for any substantial fraction of the price differential.

The total supplies of Bitcoins and of Bitcoin Cash are currently about equal (because of the way that Bitcoin Cash originated). In each case, the supply will gradually grow to 21 million and then stop.

Question 1: Given the near identical properties of these two currencies, how can one sell for ten times the price of the other? Perhaps the answer involves the word “bubble”, but I’d be more interested in answers that assume (at least for the sake of argument) that the price of Bitcoin fairly reflects its properties as a store of value. Given that assumption, is the price differential entirely driven by the fact that Bitcoin came first? Is there that much of a first-mover advantage in this kind of game?

Question 2: Given the existence of other precious metals (e.g. platinum) what accounts for the dominance of gold as a physical store of value? (I note, for example, that when people buy gold as a store of value, they don’t often hesitate out of fear that gold will be displaced by platinum in the foreseeable future.) Is this entirely driven by the fact that gold happened to come first?

Question 3: Are Questions 1 and 2 the same question? Are the dominance of Bitcoin in the digital store-of-value market and the dominance of gold in the physical store-of-value market two sides of the same coin, so to speak? Or do they require fundamentally different explanations?

Again—I’d prefer to talk specifically about first-mover advantages and to avoid debates about whether what we’re seeing in the Bitcoin market is a bubble. Those are interesting debates but they’re already taking place all over the web, and I don’t think we need to rehash them here. If you find it impossible to adopt the assumption, even for the sake of argument, that Bitcoin is a genuine store of value, then this might not be the discussion for you.


36 Responses to “Matters of Money”

  1. 1 1 James Pinkerton

    “and there are some other technological differences between them, but I’d be surprised to learn that those differences are accounting for any substantial fraction of the price differential.”

    Bitcoin, like our constitution, derives much of its value from an assurance that the rules of the network (the original contract) are resistant to change.

    Bitcoin cash derives its value from the fact that it is a technology improvement over bitcoin. If bitcoin cash offered no technology improvement, my guess is it would be worth ~$0.

    The market is currently pricing the former above the latter, but that doesn’t imply that your statement is true. It just implies the technology improvement isn’t sufficient to overcome the desire for stability.

  2. 2 2 Roger

    There are other clones of Bitcoin that are nearly identical. They are not as valuable because they are not as popular. It is not just that Bitcoin came first, but that it is more popular.

    Investors in gold do sometimes buy silver or something else if they think that gold is overpriced.

    Gold is popular because of tradition as well as various technical advantages over other metals. Anyone can create a coin with the same technical advantages of Bitcoin, except that it won’t have the popularity or supporting infrastructure.

  3. 3 3 Advo

    Bitcoin has been a mystery to me since its inception. As its primary value proposition appears to be the facilitation of black market transactions, money laundering, blackmail and tax evasion, I’m not clear why it’s still legal (particularly in the EU).

    As to Question 2:
    Gold is more popular than other precious metals because it looks really nice, much nicer than platinum. That is ultimately the reason why it became and has been the metal of kings and currencies.

    As to Question 1:
    >>>I’d be more interested in answers that assume (at least for the sake of argument) that the price of Bitcoin fairly reflects its properties as a store of value.<<<

    Not sure how you can make that assumption given the enormous day-to-day volatility of the value of a Bitcoin. If one Bitcoin will buy you 50% more goods and services on Wednesday than on Monday (or vice-versa), how can its price reflect its properties as a store of value?

    That last question sounds really weird. Is it actually in any way meaningful?

  4. 4 4 Advo

    Meaning my last question.

  5. 5 5 Uncle Maury

    While Bitcoin’s predating Bitcoin Cash may be a portion of the effect, I suggest that the price differences reflect two more substantive differences between the cryptocurrencies.

    First, the different reputations of the founders. The one person who actually _could_ pilfer from, tamper with, or otherwise mess with Bitcoin or its blockchain is Satoshi Nakamoto. Whether you think he’s a real though secretive individual or someone well-known using a pseudonym, that one person holds the key to the original block; and he could, in priniciple, mess with the chain in a way that would be impossible to undo, or even, in principle, hard to detect or, at this point, even convince the technically savvy of. Instead, Nakamoto has built up a long history and a solid reputation for never having abused the unique power he has to tamper with Bitcoin.

    Regarding Bitcoin Cash, the founders, though more transparent as individuals, nevertheless have a long row to hoe before they are equally trustworthy. The holder(s) of the original key do have special powers, as well as the power to change the rules. No matter how transparent they appear to be, there is going to be a long period of demonstrating the reliability of their reputations to not tamper behind the scenes and to not keep changing the rules to accommodate their separatist goals. They may never be as convincing as the individual Nakamoto.

    Reputation may be another way of saying there is a first-mover advantage. However, I think reputation is a clear economic concept that is in fact independent of being the first mover. I don’t, though, know offhand of a way to distinguish between the two hypotheses empirically, or a way to come up with a measure that would work when a product such as Bitcoin Cash starts up.

    My second argument is that there are some actual structural differences between Bitcoin and Bitcoin Cash, and those structural differences are substantive. Bitcoin Cash was intentionally created to be more friendly to making transactions. The specific changes focus on making the speed of the electronic processing of transactions faster. If successful, that means Bitcoin Cash will appeal to a different set of consumers who are perhaps more interested in speed–say, because it suggests greater liquidity in fast-changing markets.

    However, faster transaction processing amount even more substantively to a great boon for miners. (That’s the supply side of the Bitcoin/BitcoinCash.) The producer of a newly-mined bitcoin or bitcoin-cash-coin gets to own it officially precisely because he’s first to transact in a speed race while mining and submitting claims to the blockchain. Faster transaction processing means faster-growing bitcoin supply (incidentally benefiting the owners of the fastest processing equipment). A faster-growing supply of bitcoins would lead to lower prices relative to a bitcoin product with slower-growing supply. And probably to a reduced demand by asset-oriented consumers, to the extent they are buying for a longer haul. I suppose a possible empirical test of this would be whether Bitcoin Cash quantities grow faster than Bitcoin quantities.

    I don’t know if I’ve fleshed this out fully, but them’s my thoughts. You posed a nice question.

  6. 6 6 Rob Rawlings

    Here is my attempt to answer q1:

    I think that many people see bitcoin as a great way to carry out anonymous transactions but have no interest in holding it. When they want to make a payment they convert dollars to bitcoin and upon receipt the buyer converts the bitcoin back to dollars (or other traditional currency). The required “bitcoin exchange services” are provided by bitcoin brokers who make money from the spread between buy and sell prices. These brokers hold bitcoin not for speculative purposes but as capital for their business needs.

    This drives a real demand to hold bitcoin that is a function of the volume of transactions. The value of bitcoin could be greater than bitcoin cash just because it has a greater volume of transactions. It doesn’t matter if this is because of different attributes or just that bitcoin has “first mover” advantages.

    In parallel to the real demand to hold a crypto-currency it is highly likely that there will be some speculative demand – based either on pure gambling or on some attempt to estimate future volumes of trade in the various currencies.

  7. 7 7 Steve Landsburg

    Uncle Maury: thanks for this exceptionally thoughtful and informative answer — but see corrections from DanC and Thomas below re the powers of Satoshi Nakamoto.

  8. 8 8 Steve Fritzinger

    Planet Money did an episode entitled Why Gold? several years ago. They asked a chemist to go through the Periodic Table and rate each element’s stability as a currency. Only the precious metals met all the requirements.

    Of the precious metals, gold was the best. It’s rare but not too rare, like platinum historically was.. Also platinum is harder to work than gold and its melting point is much higher. That made it less practical.

  9. 9 9 DanC

    Uncle Maury’s answer needs clarification. Satoshi has absolutely no special powers regarding bitcoin. Having the key to the first block makes no difference. For smaller crypt-currencies, it may be the case that the founders have stronger influence, but in general it is ultimately miners who enforce the rules and keep transactions secure.

    And that brings us to a fundamental reason why first-mover advantage is so important. Currently, every other currency besides bitcoin is insecure because it doesn’t have a large enough portion of the world-wide mining power behind it. Right now, a large mining pool could switch to mining a currency with a smaller amount of hash power and double-spend that currency, including transactions that make deposits to exchanges. For a crypto-currency to be secure, it needs to have the majority of miners supporting it. I am surprised that this point hasn’t been demonstrated in practice…

  10. 10 10 Thomas

    Uncle Maury, you are mistaken about Satoshi Nakamoto having any kind of special powers or privileges over the Bitcoin protocol. He does NOT have any ability to pilfer coins or unilaterally change the rules or the historical blockchain. The Bitcoin protocol is open source with nowhere to hide any back doors.

    Satoshi’s only “power” over Bitcoin comes from the fact he almost certainly mined a large amount of coins in the early days. He may also become a bit of a figurehead should he choose to resume a visible role in the community, but any change in the protocol would still require consensus among the stakeholders OR a hard fork. The most disruptive thing he could do would be to dump or threaten to dump a large quantity of his coins on an exchange, and he has that power with both Bitcoin, Bitcoin Cash, and any other hard fork of Bitcoin.

    Also, the number of Bitcoin Cash coins will NOT grow faster than the supply of Bitcoin coins. Both are currently generating 12.5 new coins approximately every ten minutes and that rate halves every four years (next halving in 2020).

    One of the “smart” criticisms of cryptocurrency is that it’s too easy to make additional cryptocurrencies which will make the supply of coins infinite and eventually drive all prices to zero. So far the empirical evidence refutes that.

    I don’t really have any good answers to the questions in the post. All I can do is mumble something about Schelling Points and keep watching with fascination.

  11. 11 11 James Kahn

    Maybe this is obvious, but the emphasis on “store of value” seems misplaced. Any value bitcoin or bitcoin cash has is from its utility as a medium of exchange, as an alternative to conventional currency. If it proves to be a store of value it’s only from that. The fact that its value fluctuates so wildly is due to all the uncertainty about what that utility is: Whether competing crypto-currencies will arise, whether there will be security breaches, and ultimately how much demand for it there will be. Unlike gold or platinum, bitcoin has no utility other than as a medium of exchange. That makes it more like paper money. Gold’s alternative uses make its value more transparent and stable. As it becomes clearer how widely acceptable and useful bitcoin is, and exactly what its niche is as a medium of exchange, I would think its value would stabilize somewhat, but it would still be vulnerable to new entrants that could make it almost worthless very quickly.

  12. 12 12 Ken B

    I think DanC has made a really important point. Money has value only because people think money has value. That’s not a tautology, it matters a lot which people and how many of them. Because of the spread and depth of commitment to Bitcoin it has a more solid base of believers.
    At this point I want to mention Betamax vs VCR, and narrow vs wide gauge railroads.

  13. 13 13 Ken B

    Advo 4
    I think it’s a meaningful question. I will flout the rule by stating unequivocally that Bitcoin is not a store of value. It is a store of belief in value. (So are 100 dollar bills.) And therein lies your answer. Belief can fluctuate wildly. (Just spend some time watching Nate Silver beclown himself during an election if you doubt me.)

  14. 14 14 Uncle Maury

    I want to respond to the commenters DanC’s and Thomas’s excellent remarks. My using words like “tamper” or “pilfer” was rather strong, so let me be clearer. I’m not talking about hacking the underlying code. I’m talking about the ability of a residual owner or founder of a fiat currency to take advantage of the power entrusted to him by others when they use–i.e., transact in, store value in, or otherwise circulate–a fiat currency.
    What I’m talking about is the reputational effects of the founder of a fiat currency such as Bitcoin or BitcoinCash. So, should the founder unexpectedly move large numbers of previously unused bitcoins or bitcoincash coins from uncirculated to circulated–so, coins held by the founder as a form of reserves originally created so as to reassure others–in a manner which could be very sudden or very slowly trickling–and then spend them at their high value, only to cause the value to fall for others as others realize there is now more cash chasing the same number of other items, and begin to bid the price of those goods up. With ordinary monies, that value-reaping effect by the reserve holder–usually the originator–is called seignorage.
    One estimate presented pretty carefully ( is that the to-date unmoved Nakamoto-held coins amount to 980,000 bitcoins. That would be nearly 5% of the total final number of 21 million bitcoins. Say, 5% of the bitcoins mined to date. That’s a lot. Certainly enough to qualify as reserves intentionally held for the purpose of reassuring bitcoin purchasers.
    Bitcoins that are unusable or unused either because the owners have lost their keys or because of technicalities in the underlying code are out of circulation in the same way money is out of circulation when it is held by the Federal Reserve. Money that is taken out of circulation does not get involved in transactions, and hence does not contribute to the price level. (You can think of it simplistically as if half the printed U.S. dollar bills were burnt up in a massive fire. Price levels would double because people literally have fewer dollars to spend, plus no way to convince the Fed to replace the exact number of dollar bills they themselves lost in the fire. Maybe the Federal Reserve would print more money, but that would take a while. That analogy is even stronger in the case of bitcoins, because there are not yet a lot of financial instruments such as loans that are denominated in bitcoin–which complicates the problem of figuring out the price level in a world with various kinds of money such as M1, M2, M3, …. Lost or unusable bitcoins have a relatively large effect on the price level–that is, the price of bitcoins relative to, say, U.S. dollars or to goods and service.)
    Bitcoins that have never been moved–i.e., used–may also include a lot of bitcoins that are not used by choice of the owner–ie., they are hard to spend or move or cash out, or they are simply intended as a long-term store of value not to be touched. Or as reserves held as part of a founder’s ownership to reassure others that he has put his money where his mouth is.
    To get back to Bitcoin versus Bitcoin Cash:
    Nakamoto’s large number of owned, held, unused, so-termed “unmoved” bitcoins is completely reasonable. That the owner or starter of a fiat currency himself puts a lot of his personal assets demonimated in that currency unit is the primary way to convince others he’s confident that it has value. Binding himself to holding that much of the fiat currency is hard to do. Nakamoto has in various ways either technical, by behavior, or accidental demonstrated that he’s not going to spend or move the bitcoins associated with him. Despite many ups and downs in the Bitcoin market, Nakamoto has not touched his bitcoins. Could be he’s dead. Could be he even lost his own keycode. Could be he brilliantly has forsight or unflagging confidence in Bitcoin. Could partially be technicalities. Could be he just doesn’t want to reveal himself. No one knows. But all the mystery or speculation aside, the reality is that a minimum of 5% of the bitcoins have been reliably out of circulation and appear likely to remain out of circulation.
    With Bitcoin Cash, what happens is not equally clear. First, the founders presumably have also themselves invested in large quantities of bitcoincash. Believing in themselves and putting their personal investments where their mouths are is surely something they’ve done. That also creates a reserve that helps back the value and reliability of their new currency, bitcoincash.
    But first question, will they spend down their private balances and reap seignorage when the market for Bitcoin Cash hits its first glitch–as asset markets are prone to do?
    And second question, could they change the rules of the game? There are arguments out there for removing bitcoins deemed to be permanently lost, including bitcoins attributed to, say, Nakamoto which have gone unused for various reasons. What will a breakaway group do?
    I deeply apologise for my overly long comments.

  15. 15 15 Steve Landsburg

    Uncle Maury:

    I deeply apologise for my overly long comments.

    Thank you for taking the time to write it.

  16. 16 16 Advo

    I don’t want to divert the thread, but… in what way is Bitcoin a better medium of exchange than the US dollar? Other than the potential for anonymity (and crime), I mean.
    At the moment it appears to be a more cumbersome, very expensive alternative to Paypal?

  17. 17 17 DenA

    Maybe I am missing something, but these do not seem like complicated questions.

    1)I don’t know about about bitcoin cash but compared to other cryptocurrencies or real currencies, bitcoin’s (relative) value will be determined based on whether it beats all other currencies to be the medium of exchange of the future.

    2)The value of gold (aside from its small value in industrial production) is derived from its reliability as a medium of exchange over thousands of years. There were historical as to why gold came to dominate. Suppose you are roaming the countryside. To facilitate barter it helps to have something that everyone demands, preferably something non-perishable and easy to carry. Gold did the trick at the time. But, there is nothing special about gold.

    Cigarettes work just as well in prison. They are small, non-perishable and a lot of people like to smoke. Cigarettes have significantly higher value in prison then outside, because their value as a medium of exchange is higher than their consumption value. This is true eventhough it’s their consumption value that has lead to them being used as a medium of exchange. It’s not hard to imagine cigarettes to remain the dominant source of exchange for historical reasons even if the number of smokers falls substantially.

    Btw, this is true not only for currencies but also for financial assets, which for all purposes one can consider as money. See for instance, this article:

    3) I think they are the same question.

  18. 18 18 Thomas

    Ready to take a stab at question 1 now. I think the prices of various cryptocurrencies come from BOTH their technical details and their quality as Schelling points. If technical details were all that mattered, identical clones of Bitcoin would have long since driven the value to zero. If their quality as Schelling points were all that mattered, Bitcoin never would have been able to differentiate itself from monopoly money.

    Instead of assuming Bitcoin IS a store of value, it would probably be better to assume that Bitcoin and other cryptocurrencies are immature stores of value that MIGHT one day become genuine stores of value. Their prices as they journey from zero to maturity are the realm of speculation. What is the likelyhood that cryptocurrencies as an asset class will be a stable store of value someday? How long will that take? Might they also become a unit of account/means of exchange? How big will the cryptocurrency asset class be? Is there reason to believe only a few cryptocurrencies will dominate, perhaps for the security issues mentioned by DanC? If so, which ones have an edge? Will there be niches that can support non-dominant members? What will those be and what size?

    Cryptocurrencies as a whole are priced as speculative complements/rivals/replacements for the dominant legacy stores of value and means of exchange. Individual cryptocurrencies are priced as speculative complements/rivals/replacements for the dominant cryptocurrencies.

    In the specific case of Bitcoin Cash, its current value probably comes from a belief that it still has a chance to become the dominant fork of Bitcoin. Its advantage over other coins also claiming to scale better than Bitcoin is that it is forked from the dominant cryptocurrency. At this time, a transition to Bitcoin Cash dominance could still be spun as a case of delayed consensus rather than a far more damaging sign that even the most well established of these “stores of value” can suddenly become obsolete. Also, since so many holders of Bitcoin hold equal amounts of Bitcoin Cash, user opposition to (and motivations to attempt to derail) a transition would be much lower than if a non-Bitcoin-forked cryptocurrency were threatening Bitcoin’s dominance. If I’m right, it suggests that in the absence of any optimistic new information, the value of Bitcoin Cash will steadily go down compared to Bitcoin since its friendly narrative becomes a harder sell as time goes on.

  19. 19 19 Steve Landsburg

    Advo (#16):

    in what way is Bitcoin a better medium of exchange than the US dollar?

    I think there are many possible answers to this, including the fact that the future supply of Bitcoin is known with certainty, whereas the future supply of US dollars will be in the hands of authorities who might be arbitrary, capricious, or otherwise unpredictable. I do not have to worry that the supply of Bitcoins will suddenly double overnight. I do have to worry (at least a little) that the supply of US dollars will suddenly double overnight.

    Another answer, which does not apply to Bitcoin but does apply to Ethereum: Ethereum, unlike the US dollar, allows us to write contingent contracts in unambiguous computer code as opposed to possibly ambiguous legalese. Using Ethereum, I can send you a token on August 18, 2034 provided some long and complicated set of logical conditions is satisfied, the blockchain will verify that set of conditions, and the payment will or won’t be made accordingly. With dollars, we can spend years in court arguing over whether the conditions were really met or not, due to ambiguities in the English language.

    (And yes, we could in principle write a contract in dollars and delegate the arbitrarion to a computer program — but that computer program would have no way of enforcing its decision, whereas the Ethereum blockchain does.)

    There’s a lot more, but I think the above is plenty already.

  20. 20 20 Advo

    Thank you, Steve:

    I do have to worry (at least a little) that the supply of US dollars will suddenly double overnight.

    While the future quantity of bitcoins is known, it is quite unclear whether it will remain a viable medium of exchange in any given country.
    If the US and the EU were to decide that bitcoins should be illegal (as China has done) or greatly restricted, that would largely eliminate the value of bitcoin as a medium of exchange for the citizens of those countries, and greatly diminish it for the rest of the world.

    I believe that such a devaluation of bitcoin by government fiat is way more likely than a sudden by-fiat devaluation of the dollar (even though in the age of Trump NOTHING seems impossible anymore).

    As to the Ethereum question, as a lawyer, I cannot see any significant application for that kind of thing, as the percentage of contracts truly hinging on such hard, unambiguous logical statements seems to me to be essentially zero (outside perhaps of forward contracts on currencies and the like, but there we already have satisfactory arrangements).

    Perhaps there are some situations I’m not thinking of right now.
    But any “installment payment plan” for example which renders payment purely as a matter of the passage of time would require the payor to have all the Ethereum at the outset of the transaction, and that money would be bound up for the duration of the contract.

    In addition, where the payee is providing goods or services in consideration, due performance of such obligations certainly cannot be included in the blockchain code as a condition.

  21. 21 21 Advo

    To give an example of the regulatory dangers to Bitcoin – what happens if the EU submits it to the full force of its anti-money laundering regulations?
    In the worst case, that would require full identifiability of all participants in a transaction.
    EU citizens wishing to transact with Bitcoins would be able to do so (legally) only via institutions with the requisite know-your-customer policies and procedures (i.e. large banks) and only with counterparties at similar institutions.

    Bitcoin would then just be an overly complicated and expensive way of wiring money from one bank account to the other.

  22. 22 22 Roger

    “the future supply of Bitcoin is known with certainty”

    I don’t agree with this. Bitcoin is controlled by a fairly small number of miners, and they could easily increase the supply if most of them agree to do it. So far it has been profitable for them to maintain the scheduled limits, but if it becomes more profitable for them to increase the supply in the future, then I would expect them to do it.

    “write contingent contracts in unambiguous computer code”

    Maybe this could happen decades in the future, but nobody has figured out a way to make it work today.

  23. 23 23 RichD

    SL: “Are Questions 1 and 2 the same question? Are the dominance of Bitcoin in the digital store-of-value market and the dominance of
    gold in the physical store-of-value market two sides of the same coin?”

    “Why is this object money?” Hasn’t this question vexed economists for
    centuries? Apparently, it’s irrational, the ‘bigger fool’ theory, as KenB
    noted in #12; confidence breeds confidence. I doubt Bitcoin is any
    different, or that we’ll suddenly resolve it here.

    Re your use of “store of value” – are you intentionally distinguishing that, from money and currency? A point of some nuance -

  24. 24 24 Capt. J Parker

    Dr. Landsberg said in Question 1: ” but I’d be more interested in answers that assume (at least for the sake of argument) that the price of Bitcoin fairly reflects its properties as a store of value.”

    The price of a Bitcoin is a function of the supply of Bitcoin and the demand for Bitcoin. If the supply of Bitcoin is identical to the supply of Bitcoin Cash then the difference in price has to reflect a difference only in demand. The difference in demand between Bitcoin and Bitcoin Cash could have something to do with differences in how well each stores value but it could just as well have something to do with a bunch of other attributes that affect demand for currency and other commodities. Branding can increase the demand for a branded commodity over a non branded one or over one with a less well recognized brand. Being the first to establish a Brand makes it more likely that that brand will be the most widely recognized but a brand owner can do things like advertising to affect brand recognition.

    It’s getting increasingly difficult not to have heard of Bitcoin. I’m now getting spam and seeing clickbait from other crypto currency wannabes. But, this was the first time I’ve heard of Bitcoin Cash so the demand difference between Bitcoin and Bitcoin Cash is likely due in part to the fact that the Bitcoin Cash brand is much less well known. This has something to do with Bitcoin being first but is also a function of poor (or nonexistent) brand management of Bitcoin Cash.

    On question 2
    Was gold the first? The first coins were not pure gold. They were made of electrum, a naturally occurring gold-silver-copper alloy. I agree with the other folks that replied that differences between gold and other precious metals are significant and enough to explain golds dominance regardless of it being first or not.

    Question 3 is a great question and is probably applicable to many things, not just currency. Is the dominance of X due primarily to it being first? A big reason for saying yes is because if X is currently dominant and along comes Y which is identical to X, the identical nature of Y alone would not be enough for Y to be adopted in place of X. Everyone selling in a competitive market knows that equivalency is not enough. You need to give the customer a reason to switch.

  25. 25 25 Alan Wexelblat

    People have said a lot about the Bitcoin side. I’m very much in the “tulip bulb” camp on that, and you said you didn’t want to hear that answer, so I’ll leave off and go on to “Given the existence of other precious metals (e.g. platinum) what accounts for the dominance of gold as a physical store of value?”

    The answer is a combination of historical accident and physics. Gold has been used since pre-literate times as a measure of value and that long history helps even today. So, why gold?

    First, it’s visually distinctive. Roofs used to be covered in gold to denote and make more visible important buildings such as palaces and houses of worship.

    Second, it’s really resistant to environmental degradation in almost any climate. You just don’t lose gold to the weather the way you lose copper or iron. Even silver tarnishes much more easily even if unused. People commonly have polish for their silver (utensils, jewelry) but much less often need to polish their gold. If you don’t understand the mechanics of oxidation, it can appear that a tarnished object has lost value. If the gold appears never to lose value it’ll be more highly prized and used.

    Third, it’s incredibly malleable. Forming it into objects such as roofs, jewelry, etc. is something easy to do with relatively primitive hand tools. Ease of manufacture means that labor doesn’t add as much to the cost as the skilled labor needed to work with more difficult materials, among other benefits.

    Fourth, it’s surprisingly easy to find. In the US we had the California gold rush that started because people literally found nuggets of gold in shallow water. Many other sources of gold started out as simple surface-level finds. Most modern gold comes from complex deep mining, but that has a lot to do with economies of scale. If you have no machine technology it is much easier to find quantities of accessible gold than either platinum or silver. The total quantity in the world of platinum is many orders of magnitude less than the total quantity of gold. Silver is more plentiful in total but harder to acquire at an individual or pre-industrial scale.

    Combine visual appeal, durability, ease of access, relatively substantial quantities, ease of working, and you have a winner. Moving forward in time, gold became the backing value for the vast majority of currencies and that persisted well into the era of fiat currencies – famously including the US ‘gold standard’ that promised the ability to swap paper for metal even when the amount of paper money vastly exceeded the actual reserves of metal.

    This brings us to a comment made earlier about Bitcoin – value is based on trust and reputation. Gold had centuries of trust and reputation going into the paper money era and its use as a backing story continued that trajectory.

    Even after the last currencies became decoupled from metal exchanges and became more fully fiat, countries – particularly those with good reputations in large foreign commerce such as the US, UK, and USSR – maintained significant gold reserves. That practice only fell recently when the era of electronic money emerged and countries could realistically hold and exchange substantial amounts of foreign currency. Today in the 21st century, a non-major country’s currency stability is often directly related to its foreign-currency reserves and not at all to its gold reserves.

    There’s a whole other way to look at this story that talks about how gold became associated with important human emotional and social elements, of which the “gold wedding ring” is just the most obvious one. But I’m nohow enough of a sociologist to tell that story.

  26. 26 26 Harold compared gold and platinum.

    Store-of-value Potential

    Let’s turn our attention to their store-of-value potentials. Clearly a coin or bar made from platinum will be a better store of value – at current prices – than gold. Why? Simply because platinum is harder (won’t scratch), less reactive (won’t tarnish) and occupies a smaller volume (easier to store) than gold. [Nevertheless,] the market seems to think that these physical properties are deficient to something else. Perhaps it comes down to the possibility that:

    central banks simply can’t get enough platinum bullion (due to its rarity in the earth) to make it worth their while to replace their gold bullion or perhaps that
    platinum has been unable to (in its short existence) shake off gold as the true form of money.

    Not a great deal of help. I think Alan Wexelblat describes it well. Only gold and platinum have the right physical/chemical properties and gold is just rare enough to fit the bill nicely, whereas platinum is too rare.

    Platinum could in principle attain such a high value that you could replace tonnes of bullion with kgs of platinum, but then quantities would be too small and fiddly for more general exchanges, like coins.

  27. 27 27 Harold

    Uncle Maury describes the reputational aspects of Nakamoto based on his non dumping of his large stock. However, as bitcoin cash came from a hard fork from bitcoin, is it not the case that nobody else has a large stock of bitcoin cash, so this should be equally as dependable as bitcoin?

  28. 28 28 Ken B

    Good point.

  29. 29 29 Vic

    Hi all,
    I would like to make two claims here:
    1. BTC is not a store of value, and is not designed to be, because there is no negative feedback between price changes and future price changes. The feedback for the BTC is actually slightly positive.
    2. It is this positive feedback that currently gives the BTC first-mover advantage.

    Let me start with the obvious: usually commodities have a negative feedback between successive price changes: if an external shock increases price of gold, more miners come online, which increases production, which pushes the price back down.

    But BTC is not like gold for two reasons:
    - diversity effect: increase in number of miners makes the BTC more attractive for users.
    - fixed production: increase in number of miners does not increase production of coins.

    Diversity effect:
    To subvert the system, an attacker must have computational resources (such as a botnet) comparable to (at least a few percent of) the rest of the mining community.
    Thus, the more independent miners are there (or the smaller the largest miner is relative to the rest), the more credible the BTC is.

    Fixed production:
    The miners do not produce coins. The produce hash attempts. Successful hash attempts are rewarded by the system with coins.
    But: definition of success is adjusted regularly so that the production remains constant at 1 success per 10 minutes.
    Thus, even if number of miners doubles every quarter, the BTC users won’t notice: the coins will still be produced at 1 every 10 minutes.

    Combination of these two features creates the positive feedback for BTC prices:
    An external shock (such as an expression of interest from a major exchange) increases the prices
    –> more miners come, but they can’t change the aggregate production. They only make the BTC more credible.
    –> more credibility without change in production leads to even higher price.
    The production, as perceived by the users, may even decrease, if the miners, impressed by the recent price changes, choose to hoard the newly created coins.

    The same loop may work in reverse, of course:
    An external shock (such a change in legislation) outlaws BTC in a large country
    –> users in that country dump their coins
    –> price goes down
    –> many miners, especially small ones, quit
    –> one of the remaining miners is responsible for more that 20% of the whole production
    –> users worldwide realize that a successful hack attack now on any large miner will make the BTC not credible and dump their coins
    –> more miners quit, the largest miner now produces 50% of coins
    –> game over.

    Please shoot.

  30. 30 30 Harold

    Vic -very interesting analysis. I had not realised the production rate was fixed no matter how many miners.

  31. 31 31 Richard D.

    As there appears to be a few here with expertise on the innards of Bitcoin,
    a couple of questions:

    What encryption algorithm does it use, and what happens when quantum computers
    come on line?

    In days of yore, check kiting was a problem; one could write multiple checks,
    making multiple purchases, before the bank, or vendors, caught up.

    Now, Bitcoin has distributed ledgers, which are fast, but still, it’s a
    global network, with some update latency. So what’s to protect against
    a similar scheme, operating sequentially, at millisecond intervals?

  32. 32 32 Vic

    Re kiting:
    A merchant is supposed to wait for at least 6 blocks (i.e. 1 hour) after receiving a payment in BTC before shipping the product. By then the payment will either be reflected in the blockchain, or not. If the buyer attempts to double spend, only one of his payments will end up in the blockchain.
    Google “bitcoin double spending” for details.

  33. 33 33 Steve Landsburg

    vic (#29): Your points about feedback had not previously occurred to me. They sound right. Thanks for the enlightenment.

  34. 34 34 Vic

    Re gold vs platinum: it looks like a preference for liquidity. Here are the numbers I could find:

    Gold price: $1263 per oz today // source: apmex dot com
    Pt price: $924 per oz today // ibid
    Ratio: 1.36

    Gold production: 2500 tons per year worldwide // source: wikipedia
    Pt production: 161 tons per year worldwide
    Ratio: 15.5

    Product of these two ratios: 21.1

    Considering any large seller rushing to liquidate metal assets in a hurry would be competing with the metal miners, these numbers suggest it could sell 20+ as large value in gold than in platinum before markets get spooked.

    If I were a central bank ordered to keep some reserves in a metal, I know which metal I would choose.

  35. 35 35 Richard D.

    Vic: “… wait for at least 6 blocks (i.e. 1 hour) after receiving a
    payment in BTC before shipping the product.”

    So, Bitcoin is incapable of automated stock trading?

  36. 36 36 Vic

    re 35:
    To do automated stock trading you have to go through an exchange. There are no exchanges currently that trade BTC directly for stocks, so the question is moot.
    In the future if such an exchange opens, something must enforce that you don’t send the same coin to two sellers, so either everything will work as today: you fund a brokerage account, wait a few hours and trade from it – in this case the broker watches over your shoulder so you don’t overspend, or you register with the exchange, bypass a broker and send BTC directly to the sellers – in this case you won’t know if the transaction actually happened until a few blocks (10s on minutes) later. In the latter case, the blockchain will protect the seller from you overspending, and also protect you from the seller showing more shares than he actually has.
    Type bitcoin double spending into google, open the first 5 links – it’s all there.

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