Bitcoin, price denomination and fixed-rate fiat conversions

People are apparently still talking about the monetary regression theorem and its relationship to Bitcoin. There still seems to be a lot of confusion out there around both. Using a confused version of the regression theorem to criticize a confused version of what Bitcoin is does not seem like a promising recipe. I have been trying to focus on finishing up a longer work on Bitcoin and Austrian theory, but here for now are a few updated comments that came out of an online discussion today.

One newer point that has emerged in my work in progress is that the regression theorem is a theoretical explanation of how something that was at one time not money could ever become money in the first place. However, the theorem is not made to be a criterion of judgment for determining what is or is not money after the fact. Upon observing something actually functioning as a medium of exchange, the economist’s task is to explain how it came about. The role of the regression theorem was to explain specifically how something could have ever gotten started in a medium-of-exchange role to begin with. Judging and dismissing are unrelated to the function of the actual regression theorem. It is supposed to be explanatory and illuminating.

One area of confusion seems to surround the relationship between Bitcoin and fiat money, specifically the idea that Bitcoin has somehow emerged from fiat money, something like the way the euro got started on the backs or the various European national currencies. I addressed this briefly in my 27 February 2013 article, but here are some further observations.

Such transitional conversions are done with fixed exchange rates set by law. The new currency takes up its value from the old one in an administratively managed process. This applies to historical metallic coin monies giving rise to paper money certificates through a fixed conversion rate (later dropping the convertibility) and it applies to retiring paper monies being used to launch a new paper money, as in the case of the euro. However, the attempt to apply this translation/transition model to Bitcoin runs into serious trouble because no such transitional official fixed exchange rates have ever existed for Bitcoin. Quite the contrary. Governmental actors are only beginning to so much as roughly understand Bitcoin years after it already entered active use. It emerged on the market from scratch as its own good, certainly not from any official fiat.

It could be objected that regardless of origins, Bitcoin is only able to keep functioning through its relationship to fiat money and fiat money pricing. It is a mere strange shadow of the existing systems. Goods and services are priced in fiat money and a Bitcoin equivalent is paid. Bitcoins can be bought and sold referencing current market pricing on the most liquid exchange, Mt. Gox. In other words, this argument implies, Bitcoin could not function without these props.

This raises a number of interlocking issues. Bitcoin is now useful for many reasons, among them transferring value that may or may not have been obtained through the sale of fiat money and that might or might not end up being used to buy other fiat money in the future. On the other hand, while there are certainly active speculative traders on the exchanges, there are also folks buying Bitcoin with fiat money with no intention of selling it again into fiat money, but only of using it to buy goods and services in the more or less distant future. There are merchants using Bitpay so they never have to “touch” Bitcoin, but there are also merchants giving discounts for payment in Bitcoin, and accumulating the Bitcoin. There are consumers holding Bitcoin ready to use and other consumers that might only obtain specific amounts of Bitcoin for some specific purpose and then return to a zero balance. There could be some Bitcoin miners who mainly only ever sell Bitcoin for fiat money, but never buy any with fiat money. Everything is possible.

One point the Austrian school has long emphasized in monetary theory is that while money is special in certain ways, it is also a good itself, not a mere veiled marker or representation of other values. It is a type of good distinguished from other goods and services mainly by its higher marketability.

It is true that Bitcoin users have benefited greatly from the existence of market economies with functioning price structures. Pricing is still done for the most part in local fiat currencies and will probably continue to be unless and until Bitcoin becomes more stable in purchasing power than the fiat money that users are comparing it to, each in his own decision-making context. Automatic software price conversion makes it possible for the system to piggyback on existing and familiar price structures in each local area with immense convenience.

Yet I do not think there is any fundamental reason that Bitcoin-denominated pricing of goods and services could not evolve from scratch if it hypothetically had to. Fortunately, it does not have to. If no money existed at all, it would be necessary to get it going. We just have the convenience of already being able to rely on existing market prices for goods and services and the further convenience of being able to reference real-time market prices from organized exchanges. An argument could be made for just taking the easy road and using them. I think this is all just to the good of contextualized convenience and not so theoretically fundamental. Still, there are already Bitcoin-priced goods and services, particularly starting within the Bitcoin economy. For example, the Trezor Bitcoin hardware wallet is on pre-order for the price of 1 BTC.

The extent to which Bitcoin users reference fiat pricing in commerce is probably what has given rise to some  conflation with what I think is the quite different process by which one fiat money is converted into another by the official declaration of a fixed conversion price. Paper euros probably could never have taken off unless the official exchange rates with their predecessor currencies had been declared by law and the predecessor currencies had also been phased out by law. Without such official (“fiat”) declarations, printed euro notes would most likely either have been worthless or negatively valued due to the need to pay to store or dispose of them.

Bitcoin never had any official conversion price (or official anything), so how could it have gotten started? Bitcoin could never have begun to function in any other roles, such as transferring value derived from paper money over distance and converting into other paper money, if some initial users were not willing to trade any valuable goods or services for Bitcoin itself to begin with. After it began to be traded for other goods and services, one could observe it functioning in various, increasingly useful roles on that basis, some in interaction with existing monetary systems, but so long as its market price remained zero, it could not begin to serve in any such trading roles.

I think the initial-value question is probably much more narrow and technical than it is sometimes made out to be when the name of the regression theorem is invoked (the name; not necessarily the understanding). That question is how to explain a movement from a zero indirect-exchange value to non-zero indirect exchange value. Reaching non-zero from zero, especially in a digital computing context, is all that is needed for the rest to follow.

Anyone still talking about the regression theorem and Bitcoin might do well to focus on detailed historical research from the year 2009 and 2010 at the latest. After that, the deal was already done, leaving room only for efforts at explanation of what had happened. The rest was up to adoption, entrepreneurship and network-effect growth.