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Dec 3, 2013 (3 years and 9 months ago)

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8
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T
h
e Economics of Bitcoin
8
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by Robert P. Murphy, PhD
The Economics of
Bi
T
coin
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o
ne of the major !nancial stories this month
1-5."5/,-.#(!5) 5."5**,(.5/&5#(5
^#.)#(_5*,#-85#.)#(65),#(!5.)5#.-5)Ń
-
#&51-#.65#-55^*,7.)7*,50#,./&5/,,(38_5
/**),.,-5&#'5.".5#.)#(5#-5."5/&.#'.5
,7',%.5')(35) 5."5)'*/.,5!65
-
cause its scarcity is mathematically guaranteed
(5#-50#,./&&35#'*,0#)/-5.)5!)0,('(.5
counterfeiting e"orts.
.,.),-5,!/5.".5#.5#-55 65(5.".5)(&35
5*"3-#&5)'')#.35(5&-.5-55.,/5')(385
(5*,.#/&,65'(35,#.#-5#.5."51),%5) 5/
-
1#!50)(5 #--5-5^*,)) _5.".5#.)#(51#&&5(0,5
)'55!(/#(5')(385 (5."5*,-(.5,.#&5
I’ll summarize what Bitcoin
is,
then I’ll com
-
'(.5 )(5#.-5 /./,5 *,)-*.-5 -5 5 (15 ),'5 ) 5
money.
The Basic Mechanics of Bitcoin
(5."#-5)*(#(!5-.#)(65 ]&&5,15"0#&35)(55
1-#.5 ,.#&5 5 )7/."),5 1#."5 #&-5 ,.5
(who understands the mathematical details be
-
"#(5#.)#(5'/"5..,5."(5 5)C8
g
I refer in
-
terested readers to our article (see the endnote
&)15 ),5."5C5 ),55'),5)'*,"(-#05
2*&(.#)(65 -5 1&&5 -5 &#(%-5.)5.,/&35."(#&5
#-/--#)(-5#(0)&0#(!5(,3*.#)(5(5."5.#&-5
) 5^'#(#(!_5(15#.)#(-85/.5 ),5)/,5*/,*)--5
in the
LMR,
5&.5'5!#05$/-.55+/#%5)0,0#19
Ļ5ŀ,-.5."#(!5.)5-.,--5#-5.".5&&5) 5#.)#(]-5
^))%%*#(!_5#-5 )(5#(5 /&&5 */&#5 0#185 ,5
,)'5#(!5(,3*.650,35#.)#(5.,(-.#)(5
T
h
e Economics of Bitcoin
Supporters claim that Bitcoin is the ultimate free-market money of
the computer age, because its scarcity is mathematically guaranteed
and is virtually impervious to government counterfeiting efforts.
10
L M R
A P R I L 2 0 1 3
T
h
e Economics of Bitcoin
#-5)/.5#(5."5)*(65-/$.5.)5#(*((.5/#.
-
ing by anyone who downloads the software. In
fact, that’s the very
strength
of Bitcoin, and why
#.-5 *,)*)((.-5 -35.".5#.5,&#-5 )(5 ()5 (.,&5
/."),#.395,#-&35/-5()5-#(!&5),!(#4
-
tion is “in charge” of Bitcoin, it will be extremely
#Ń/&.5.)5 -.'*5#.5 )/.5 ) 5 2#-.(5# 5 #.)#(5
-")/&50,5)'55)'')(&35*.5/,
-
rency.
,]-5(5(&)!35 5'5/*51#."65.)5"&*5."5
(1)',5/(,-.(5."5^#!5*#./,_5) 5")15
Bitcoin works. Imagine a community where the
*)*&5 )(].5/-5.(!#&5')(395.",5 ,5 ()5
gold coins, but not any green dollar bills, ei
-
ther. Instead, the money in this community is
-5 )(5."5 hg5'#&&#)(5#(.!,-5,/((#(!5 ,)'5
g65 h65 i65 V65 hf6ooo6ooo65 (5 ŀ(&&35/*5.",)/!"5
hg6fff6fff85 .5 (35!#0(5.#'65 )(5 *,-)(5
^)1(-_5."5 (/',5 n65 1"#&5 -)')35 &-5
“owns” the number
34,323,
and so on. By saying
*)*&5^)1(_55(/',65&&5 5'(5#-5.".51"(5
commercial transactions occur, the medium of
exchange is the community’s notion of “owner
-
-"#*_5 ),5^--#!('(._5 ) 5."-5 hg5'#&&#)(5#(.
-
!,-5.)5-*#ŀ5#(#0#/&-8
),5 2'*&65 -/**)-5 #&&5 1(.-5.)5 /35 5 ,5
,)'5&&365(5."5*,#5-.#%,5)(5."5,5,-65
^1)5(/',-8_5#&&5"**(-5.)55#(5*)----#)(5
of the numbers
18
and
112.
5)5#&&5.,-5."5.1)5
(/',-A
18
and
112
A)0,5.)5&&365(5&&35
!#0-5#&&5."5,85Ļ5)''/(#.35,)!(#4-5.".5
."5.#.&5.)5."5,5"-5.,(- ,,5 ,)'5&&35.)5
#&&65(5#.5&-)5,)!(#4-5.".5&&35#-5()15."5
owner of the numbers
18
and
112.
)15 15 )'5.)5."5,&&35#(.,-.#(!5 *,.85
#."5."5,65."5.#.&51-55*#5) 5**,:51"(5
-"5-&&-5."5,65&&35"-5.)5-#!(5)0,5."5.#.&5
.)5 #&&85 (5 *,#(#*&5."#-5 *#5 ) 5 **,5 )/&5
be destroyed, stolen and altered, or fraudulent
-
&35 *,)/85 /.5 1#."5."5 (/',-65."#(!-5 ,5
#Ŀ,(.:5."5'"(#-'5.",)/!"5 1"#"5 #&&5
.,(- ,-5"#-5)1(,-"#*5) 5
18
and
112
5.)5&&35#-5
)'*&285".5"**(-5#-5.".5."5)''/(#.35
%*-5.,%5) 5)1(,-"#*5.",)/!"5(5#(/-.,35) 5
.")/-(-5) 5)/(.(.-85Ļ35"5%*5(),
-
')/-5 &!,-5 B#(5 2&5 ŀ&-5 ),5!#(.5 *#-5 ) 5
**,5# 53)/5&#%C651#."5hg5'#&&#)(5)&/'(-5,/(
-
The first thing to stress
is that all of Bitcoin’s
“bookkeeping” is done in full
public view.
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(#(!5,)--5."5.)*5 ,)'5& .5.)5,#!".A)(5 ),5
each number.
)5."5
columns
5,/(5,)--5."5.)*65 ,)'5g5.)5
hg5'#&&#)(85 .5."5 -'5.#'65."5
rows
of the
&!,-5,),5 0,35.,(- ,5 ) 5 5 *,.#/&,5
(/',85),52'*&651"(5#&&5)/!".5."5,5
,)'5&&365."5)/(.(.-51")51,5#(5,-").5
the of the deal wrote down (or entered into their
2&5ŀ&C65^)15#(5*)----#)(5) 5&&3_5#(5."5
next available row, in the column for
18
and
also the column for
112.
In these ledgers, if we
looked one row above, we would see, “Now in
."5 *)----#)(5 ) 5 #&&_5 ),5."-5.1)5 (/',-65
because they were originally owned by Bill be
-
),5"5.,(- ,,5."'5.)5&&38
Besides documenting any transactions that
"**(5.)5 5#(5 ,-").65."5 )/(.(.-5 &-)5
*,#)#&&35 "%5."#,5 )1(5 &!,-5 !#(-.5
those of their neighbors. If they ever discover
that their neighbors have recorded transactions
for
other
numbers (regarding deals for which
."5)/(.(.5#(5+/-.#)(51-5
not
5#(5,-").C65
then the accountant !lls in those missing row
entries in the column for that number.
Given this arrangement, at any given time
T
h
e Economics of Bitcoin
there are thousands of accoun
-
tants, each of whom has a virtu
-
&&35)'*&.5"#-.),35) 5&&5hg5'#&
-
lion numbers, from the !rst owner
/*5.",)/!"5."5*,-(.5)1(,85Ļ5
only reason the ledgers might di"er
from one accountant to another, is
if one of them had recorded a rela
-
tively recent exchange, which had
().5"5.#'5.)5*,)*!.5B.",)/!"5
."5 )*3#(!5 *,)--C5.",)/!")/.5
the entire community. But any
commercial transaction that is at
&-.55 15")/,-5)&5B&.]-5-3C65"-5
"5.#'5.)55)*#5350,35
-
countant, and so all of the ledgers in
the community will have a record of
the sale.
)15#(5."#-5"3*).".#&51),&65# 5
-)')(5-%-65^")5%*-5.,%5) 5
the money?” the answer would be,
^Ļ5)/(.(.-8_5/.5# 50(5"& 5
of the accountants and their ledgers
Many critics cite the work of Ludwig von Mises as “proof” that
Bitcoin will never become a genuine money.
12
L M R
A P R I L 2 0 1 3
1,5 %#&&5#(5 5!#(.5 2*&)-#)(65."5 ŀ((#&5
system would remain intact, because all of those
,),-5 1,5'--#0&35 /*&#.5 ,)--5."5
1")&5#(/-.,35) 5)/(.(.-85Ļ5)(&35."#(!-5
that might be lost would be sales that had oc
-
/,,5 )(&35 (5")/,5 ),5.1)5  ),5."5 2*&)
-
sion, because these might not have had time to
*,)*!.5)0,5.)5."5)/(.(.-51")5(5/*5
-/,0#0#(!5."52*&)-#)(8
.]-5 */-5#(5 )/,5 (&)!35.)5'%5 -/,5
the reader understands why we’ve construct
-
ed it this way. When all of the Bitcoins have
(5 ^'#(_A1"#"5 1#&&5"**(5#(5."5 3,5
hgjfA.",5 1#&&5 5 hg5'#&&#)(5 ) 5."'5#(5 2
-
#-.(85 Ļ.5#-5 5'."'.#&&35!/,(.65
ŀ25+/(.#.35) 5."'85
In our analogy above, we aren’t dealing with
."5)'*&#.5#--/5) 5^'#(#(!_5#.)#(-85 (
-
stead, we are focusing on the steady-state where
&&5) 5."5hg5'#&&#)(5#.)#(-5"05(5'#(65
and the community functions economically just
35.,(- ,,#(!5 )1(,-"#*5 ) 5."5 ),0,7ŀ25
+/(.#.35) 5."-5'."'.#&5)$.-8
)5#(5."5,&51),&65*)*&5.,(- ,5."#,5)1(
-
,-"#*5 ) 5 5 ,.#(5 ')/(.5 ) 5 #.)#(5.)5 ).",5
*)*&65#(52"(!5 ),5!))-5(5-,0#-85Ļ#-5
.,(- ,5#-5Ŀ.535."5(.1),%5) 5)'*/.,-5
*, ),'#(!5)'*/..#)(-5(5.",35"(!#(!5
."5^*/&#5%3_5.)51"#"5."5^-)&_5#.)#(-5,5
assigned.
(5 )/,5 (&)!365 15 *./,5."#-5 -*.5 ) 5
things by saying the accountants entered the
(15)1(,5) 55*,.#/&,5(/',5#(5."5(2.7
available row in that number’s column. In the
real world, the entire Bitcoin network
also
has
an entire history of each Bitcoin’s “life cycle,”
from the moment it was mined, through every
owner it ever had, down to the current owner. In
)/,5 (&)!365 15 *./,5."#-5 -*.5 35 -3#(!5
that you could look at the number
18,
for exam
-
*&65(5-5#.-5
first
owner in row 2, its
second
owner
5#(5,)15i65.85B5--/'5."5ŀ,-.5,)15#-5
,-,05 ),5&#-.#(!5."5#(.!,-5."'-&0-8C
Where Does Encryption
c
ome
i
n?
The Problem of Anonymous
o
wners
Now in our !ctitious world, there is one glar
-
#(!5 *,)&'5.".5 15 #(].5 ,--95 )15 )5
the accountants
verify the identity
5) 5."5*)*&5
who try to buy things with numbers? In our ex
-
'*&65 #&&5 1(.5.)5 -&&5
18
and
112
5.)5 &&35
for her car.
Now Bill really is the owner of the numbers
18
and
112;
5"5 (5 Ŀ),5 &&3]-5 ,65 /-5
-"]-5-%#(!5^1)5(/',-_5 ),5#.85Ļ5)/(
-
tants will verify, if asked, that Bill is the owner
) 5.")-5 (/',-:5#.5 -3-5^#&&_5#(5."5 &-.5,)15
which has an entry in it, under the
“18”
column
and the
“112”
column in all of their ledgers.
/.5",]-5."5*,)&'95"(5."5(,35
-
countants see Bill trying to buy the car from
&&365")15 )5."35 %()15
that that human be
-
ing actually IS the “Bill” listed in their ledgers?
Ļ,5(-5.)55-)'5135.".5."5,&5#&&5(5
demonstrate to all of the accountants that he is
in fact the same guy referred to in their ledgers.
)5*,0(.5 ,//&(.5-*(#(!5) 5)(]-5')(35
35(5/(/."),#45*,.365."#-5'"(#-'5'/-.5
be such that
only the real Bill
will be able to
convince the accountants that he’s the guy.
,5#-51",5."5^*/&#I*,#0.5%3_5(,3*
-
.#)(5#--/-5 )'5#(.)5 *&385 (5'35 ,.#&5 1#."5
,.65 15 0&)*5."5 (&)!35 /,.",5.)5
"(&5."#-5 -*.5 ) 5."#(!-85 ),5'35 ,0#
-
.5.,.'(.5",65-/Ń5#.5.)5-395Ļ,5#-55
way that the legitimate owner of a Bitcoin can
*/&#&35')(-.,.5.)5."5).",5*)*&5#(5."5
network that he or she really
is
5."5 *,-)(5.)5
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whom that Bitcoin belongs. Only someone with
."5 *)----#)(5 ) 5."5^*,#0.5 %3_5 1#&&5 5 &5
.)5*,)/550&#5^-#!(./,_5.".5)(0#(-5."5
).",5*)*&5#(5."5(.1),%5.)5.,(- ,5)1(,
-
-"#*5) 5."5#.)#(5.)5().",5*,.385Ļ#-5#-5")15
5 #.)#(5#-5 ^-*(.6_5  .,5 &&A#.5#-5.,(- ,,5
,)'5 )(5 *,-)(5.)5 ().",65#(5 2"(!5 ),5
goods or services.
Bitcoin: The Benefits
Within the Austrian community, there are
.")-51")5&)05(5.")-51")5".5#.)#(85Ļ5
-/**),.,-5&)05."5 .5.".5#.)#(5#-50#,./&&35
#''/(5.)5 )/(., #.#(!85 Ļ,5#-5 ()5 -#(!&5
agency “in charge” of Bitcoin, but instead its
*,).))&5#-5-)'."#(!5.".5."51")&5(.1),%5) 5
)'*/.,-5#'*&'(.-85Ļ,5#-5."/-5()5(!,5
) 50(55*,#0.5!,)/*5-//'#(!5.)5."5.'*
-
..#)(5.)5#(ł.85Ļ#-5#-5&#.,&&35'."'.#&&35
#'*)--#&95."5(/',5) 5#.)#(-5#(52#-.(5
1#&&5#(,-5),#(!5.)55*,.,'#(5 ),
-
'/&65'2#(!5 )/.5#(5."5 3,5 hgjf85 BĻ5 (15
Bitcoins are “mined” into existence along the
1365 (5 1,5.)5."5 )1(,-5 ) 5 )'*/.,-5
.".5*, ),'5."5(--,35)'*/..#)(-8C
Ļ#-5#(7/#&.5-,#.35#-5."5-/*,'50#,./5) 5
Bitcoin in its intended role as a new, digital mon
-
3850(5)'')#.35')(35-/"5-5!)&5)/&5
*).(.#&&35*,)05/(.(&5# 65*,"*-5-5
from now, scientists invent a machine that can
easily rearrange the building blocks of matter.
Ļ#(%5) 5."5^,*&#.),_5'"#(-5)(5."5(1,5
versions of the
Star Trek
television series. On
."5-")165*)*&5-35.)5."5)'*/.,65^ %5'5
5/*5) 5,&5,36_5(5."5-.'#(!50,!5
**,-85/.5# 5*)*&5(65#(5,&5&# 65)(535
o
nly someone with the possession of the “private key” will be able
to produce a valid “signature” that convinces the other people in the
network to transfer ownership of the Bitcoin to another party.
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say, “Make me a bar of gold,” then it would seem
#'*)--#&5.)5"055-.&5/(#.5) 5)/(.65# 5#.5
1,5-5)(5*"3-#&5)'')#.#-8
In such a world, however, a mathematically-
ŀ(5')(.,35/(#.A-/"5 -5 #.)#(A
1)/&5 -.#&&5 5#''/(5.)5 )/(., #.#(!85 0(5
if we had a machine that could transform lead
into gold, it still couldn’t increase the number
) 5#(.!,-5 .1(5 f5 (5 hg5'#&&#)(85 /"5 5
,+/-.5)-(].50(5'%5-(-8
Bitcoin: The Problem
On the other hand, it is Bitcoin’s lack of a
*"3-#&5')#'(.5.".51),,#-5'(35) 5.)
-
day’s Austrian enthusiasts. After all, Ludwig
von Mises in his famous “regression theorem”
2*&#(5."5 */,"-#(!5 *)1,5 ) 5 ŀ.5')(35
by the historical fact that it was once redeem
-
&5#(5!)&5 ),5 -#&0,85 Ļ5 */,"-#(!5 *)1,5
of these commodity monies, in turn, could be
traced back to the days of barter, when gold and
silver were valued because of their non-mone
-
tary functions.
#(5 #.)#(5 (].5 5.,5 %5.)5."5 3-5
when it was either redeemable in other forms of
money, or was itself used as a non-monetary com
-
modity, many critics argue that either Bitcoin
withers and dies,
or
Mises must have been wrong.
Now, I am not going to go out on a limb and
*,#.5.".5 #.)#(5 1#&&5 )(5 35 5/-5 -5 5
genuine money around the world. However, I
1(.5.)51,(5 (-5) 5."5/-.,#(5"))&5.".5
if
this
is their argument, then Mises has already
&)-.85 5."#-5&)!#5#-5,#!".A('&365.".5#.)#(5
can never become a genuine money, because
all money must ultimately have originated as a
,!/&,5)'')#.3A."(5#.5-")/&5&-)5^*,)0_5
that Bitcoin could never become even a medium
of exchange.
.]-5*/-5 ),55+/#%5, ,-",5)(5/-.,#(5
')(.,35 )(*.-85 5
medium of exchange
is
Even commodity
money such
as gold could
potentially prove
untenable if,
perhaps decades
from now,
scientists invent a
machine that can
easily rearrange
the building
blocks of matter.
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-)'."#(!5.".55*,-)(5*.-5#(55.,65().5
because he wants to directly consume it or use
#.5#(5*,)/.#)(65/.5/-5"5#(.(-5.)5.,5
#.5135 ),5-)'."#(!5&-65#(5."5 /./,85)5 ),5
2'*&65# 55 ,',5!)-5.)5.)1(51#."5!!-65#(
-
tending to buy shoes, he might trade the eggs to
a !sherman in exchange for salmon. (Assume
he knows the cobbler in town hates eggs but
&#%-5ŀ-"8C5Ļ(5"5.%-5."5-&')(5.)5."5)
-
&,5(5/3-5-")-51#."5#.85 (5."#-52'*&65."5
salmon served as a medium of exchange.
Ļ5 )/(,5 ) 5."5 /-.,#(5 "))&65 ,&5
(!,65,!/5.".5$/-.5."#-5-),.5) 5*,)--5&5
.)5."5-*)(.()/-5',!(5) 5')(3651"(55
*)*/&,5'#/'5) 52"(!51-5!,/&&35
-
*.535'),5(5'),5*)*&5#(5."5)''/
-
(#.385 .5 -)'5 *)#(.65 1"(5 0#,./&&35
everybody
1-5 1#&&#(!5.)5 *.5#.65."(5.".5'#/'5 ) 5
exchange would cross the boundary to become
That makes Bitcoin a medium of exchange, which therefore has
already surpassed the qualitative hurdle, as far as the regression
theorem is concerned.
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References
g85),5 /,*"35(5,.]-5#(.,)/.),35,.#&5)(5#.)#(65-95"..*9II)(-/&.#(!3,*'8)'I&)!IhfgiIfjI#.)#(7 ,)'7(7/-.,)7
&#,.,#(7*,-*.#07*,.7#8".'&8
money.
After all, the de!nition of money is “a
!(,&&35*.5'#/'5) 52"(!8_
%5.)5#.)#(95 .5
already
has become a me
-
dium of exchange. In other words, there are
1-#.-51",5*)*&5.,5,&5!))-5B-/"5-5
-65 ))%-65 (A"'A#&&##.5 -/-.(-C5
#(5 2"(!5 ),5 #.)#(-85Ļ/-65#.]-5 ().5',&35
.".5 #.)#(5#-5 5 ŀ((#&5 --.65 1",5 *)*&5
(5.,5#.5 ),55)&&,-65/,)-653(65.85)'5
*)*&5 ,5 -&&#(!5."#,5!))-5
directly for Bit
-
coins
and then using those same Bitcoins to
+/#,5!))-5 ,)'5 ().",5 *,.385Ļ.5'%-5
Bitcoin a medium of exchange, which therefore
"-5 &,35 -/,*--5."5 +/&#..#05"/,&65 -5
far as the regression theorem is concerned. At
."#-5*)#(.65."5)(&35."#(!5-.)**#(!5#.)#(5 ,)'5
)'#(!55 /&&7&)1(5')(35#-5.".5#.-5*.
-
ability as a medium of exchange is currently
,-.,#.5.)55-'&&5 ,.#)(5) 5."5*)*/&.#)(85
Now maybe it will take o", and maybe it won’t,
but there is nothing
in principle
5.)5 *,0(.5#.5
,)'5)'#(!55')(365."5135'(35*)*&5
are arguing.
c
onclusion
5(].5*,#.5."5 /./,85 35#!#.&5/,
-
,(#-5 1#&&5 )(5 35,*&5 0(5 )'')#.#-5
-/"5 -5!)&5 (5 -#&0,85 Ļ,5#-5 ()5"/,&5.)5
Bitcoin’s emergence as a full-blown money, that
#.5"-(].5&,35)0,)'5#(5#.-5#(#.#&50&)*
-
ment as a mere medium of exchange.
However, until humans achieve the age-old
,'5) 5&"'365(5(5*,)/5!)&5)/.5) 5
-,5'.&-65 5-.#&&5*,#.5.".5!)&51#&&55."5
market’s ideal money of choice. If governments
would get out of the money and banking sec
-
.),-65 5."#(%5151)/&5-55+/#%5,7',!(5
of gold as the worldwide money.