A brief economic critique of Bitcoin from an action logic perspective

Published on February 6, 2023 by Die Marktradikalen. Written and translated by scalatheagorist.

Disclaimer, on which a praxeological view of this critique is based: Praxeology - as a deductive method discipline - does not claim absoluteness but rather asserts a truth claim about human cognitive abilities. This means that praxeology, similar to mathematics or logic, also aims for an apriori deductive schema, but in contrast to the two disciplines mentioned (knowledge that no human has perceived so far), it is only meaningful in terms of human thinking capabilities (only what is cognitively perceived by humans). [1] All subsequent considerations encompass the perspective of a temporal, "short-term" character!

According to Friedrich August Hayek's business cycle theory, which asserts that economic freedom and the free market are the best means to promote prosperity and growth, Bitcoin as money could have both strengths and weaknesses; weaknesses that play a significant role in today's system. It is not uncommon for the importance of hedging against financial risks – including currency, price, and credit default risks – to be overlooked. However, such risks are real threats that can impact the prosperity and economic autonomy of a society.

Price risks, plus some practical considerations

(1) Unclear regulation of Bitcoin and unclear effects on further adoption can influence the demand for Bitcoin due to market participants' uncertainties, leading to price fluctuations compared to existing state monopoly currencies of the fiat money system. This can be particularly noticeable during the transition phase to a hard money standard.

(2) Errors in technology, hacks, security risks, attacks on DNS nodes, political infiltration at DNS providers, etc., can lead investors to sell their Bitcoin. This can result in price crashes and undermine trust.

The government could deliberately set wrong incentives (3), a policy that turns initially accepted adoption into an inverse situation. This can be achieved through tax measures, regulations, or restrictions on trading options, which could have an increasingly negative effect on Bitcoin's acceptance and, consequently, influence its price. In other words, the government can undoubtedly use the threat of violence to prohibit specific groups from conducting Bitcoin transactions (regardless of technical enforceability). Partial bans, territorial or crossing national borders, are also conceivable. Interventionism has an impact on price development and the acceptance of Bitcoin as a free medium of exchange.

According to Ludwig von Mises, the most important function of money is to serve as a general medium of exchange, enabling economic calculation. Without money, people would have to directly exchange goods or services, which would be a very cumbersome and inefficient practice (the problem of double coincidence). Money facilitates this process by providing a unified "measure" of the value of goods and services, allowing for easier evaluation and comparability of alternatives. Moreover, money facilitates the exchange of goods and services across time and space, as it represents a standardized form of exchange not influenced by local conditions. [2][3]

Credit default risks

The volatility of the exchange rate (1) between Bitcoin and fiat currency can lead to loan defaults, as borrowers may struggle to meet their repayments when the value of their collateral, in this case, Bitcoin, decreases (which may be related to the previous point).

Unclear regulation and legal uncertainty (2) surrounding the use of Bitcoin can result in borrowers either not obtaining loans or being unable to repay their debts. For instance, lenders may have concerns about extending loans to individuals who own Bitcoin, as they are unsure about how to enforce their claims if borrowers fail to repay their debts. It remains uncertain whether banks are required to accept or transact payments with Bitcoin; therefore, if financial institutions are reluctant to engage in Bitcoin transactions, it can make it challenging for borrowers to access loans.

In comparison to traditional currencies, the liquidity (3) of Bitcoin may be lower, potentially causing difficulties for borrowers in repaying their debts.

Currency and price risk

Das Währungs- und Preisrisiko möchte ich an dieser Stelle handlungslogisch fortführen, welches ich mithilfe meines Artikels «Folgen einer Einführung eines Bitcoin gedeckten US-Dollars» näher erläutere:

Deflation:

"Due to the significant increase in the price of Bitcoin measured against the US dollar, goods and services would experience corresponding increases in prices. More specifically, Bitcoin hodlers [...] - especially the whales [...] - would consequently feel a significant increase in purchasing power. This surge in purchasing power creates pressure to diversify a portion of their wealth. As a result, investments are made in assets such as stocks, real estate, etc. - to preserve purchasing power - to build production structures or to buy consumer goods in general. This redistribution into different assets and goods leads to a further increase in purchasing power, which, in turn, causes the prices of goods to rise across the board over time. The overall purchasing power of Americans will thus increase significantly. [...] Certainly, the timeframe for such a scenario is not foreseeable, as the extreme increase in purchasing power that initially occurred diminishes when the price-driving effect of being tied to Bitcoin fully reaches the broader population. Institutions, primarily banks, as intermediaries for covered assets - also for redeemability in Bitcoin - will now need to take action by acquiring additional assets from exchanges or private capital providers or exchanging them for other tangible assets. Over time, a price-deflationary situation would set in, which will be discussed later." [4]

A disadvantage (1) is that this redistribution of purchasing power can lead to an 'unequal' distribution of wealth. A counterargument could be that redistribution effects are always unequal on a free market, and the free market aims for equilibrium, although it is never achieved. However, the argument for the mentioned disadvantage is based on the notion that the 'unequal' distribution of Bitcoin holdings could temporarily increase before reaching saturation over time.

Another disadvantage (2) would be that a rapid and substantial increase in the price of Bitcoin could lead to price inflation in other assets not held in Bitcoin. This could result in a decrease in wealth for those holding their assets in other forms.

In addition to the aforementioned disadvantages - it should be reiterated that these considerations refer to a closed period of time - another one (3) would emerge if the price-deflationary situation takes effect: A price-deflationary situation, as described in the above quote, could lead to a short-term reduction in demand and a slowdown in the economy. From the perspective of debtors, this results in higher real interest rates; debtors would thus be confronted with falling prices and rising interest rates, exacerbating their debt burden accordingly.

Nevertheless, it should be mentioned at this point that investors benefit from deflation, as deflation enhances the value of assets such as stocks and bonds and generally increases purchasing power. With more purchasing power, it is possible to buy more goods and services for assets, which, in turn, increases real wealth. Similarly, companies would benefit from the motivation to increase efficiency and reduce costs in a deflationary environment, leading to higher economic performance.

Natural interest rate (Urzins)

The natural interest rate, also known as the original interest rate, describes the level of interest that would establish itself in the market without government intervention or other influences. It represents the minimum return on capital needed to keep capital in circulation. The natural interest rate is determined by the supply and demand for capital and the productivity of capital and is appropriately related to time preference. [5]

When Bitcoin is used as the primary monetary system, a tendency towards lower interest rates and a lower natural interest rate may emerge. As Bitcoin has a limited supply, it can have a disciplining effect on monetary policy by preventing excessive money creation. The decentralized nature of Bitcoin may also lead to more stable interest rates due to its resilience to political influences.

One drawback of reducing the natural interest rate could be the impact on the traditional financial world. This shift may alter the business models of banks, insurance companies, and other financial institutions that rely on interest-dependent income sources. A reduction in the natural interest rate can slow down lending and, consequently, reduce investments and economic activity. Additionally, it may result in an asset distribution favoring those who already possess wealth, as they receive interest, while it becomes more challenging for those without wealth to obtain (backed) loans and improve their financial situation. There is also a risk that a lower natural interest rate could decrease the value of assets such as bonds and other investments, leading to losses for investors.

Conclusion

Bitcoin can be considered as a counterpart to state-controlled fiat currency. It enables individuals to act and react freely outside conventional systems to bypass government regulation and surveillance. Whether Bitcoin will ever gain widespread acceptance and state tolerance in the Western world is a matter of speculative and varied opinions. Depending on the speed of Bitcoin's advancing adoption, it can have significant impacts on economies and global monetary policy (following the Friedmanian ideal of monetary integration), which can be both positive and negative from a macroeconomic perspective.

Nevertheless, it must be fair to mention that today's financial system is fundamentally hostile, as it always operates at the expense and detriment of one or more groups (the deceived), in favor of those (the deceivers) who receive newly created fiat money first, such as the privileged group of political entrepreneurs. Furthermore, this group and its partners justify their political actions with the necessary spread of ideology. This means that the existing system manipulates interest rates, taxes market participants, etc., to steer economic cycles in their favor—at least in their belief—which inevitably leads to a downturn following an upturn. The consequences are recession, upheaval, and uprisings, seen as a corrective phase from the perspective of the deceived, exposing the deceptions of political entrepreneurs. [6]

Perhaps the mass adoption of Bitcoin is, at its core, a final rejection of the prevailing system in favor of a, at best, free and new system, representing a holistic recovery over time from an economic standpoint.

Sources:

• [1] Ludwig von Mises, Nationalökonomie, S. 17, 1940
• [2] Ludwig von Mises, Nationalökonomie, S. 131, 1940
• [3] Antony P. Mueller, Carl Menger Geld (Teil 6), (https://www.misesde.org/2021/09/carl-menger-geld-teil-6/), 2021
• [4] Folgen einer Einführung eines Bitcoin gedeckten US-Dollars
• [5] Ludwig von Mises, Nationalökonomie, S. 476-477, 1940
• [6] Andreas Tiedtke, Der Kompass zum lebendigen Leben, S. 260-261, 2021