This is PART 4 of my series where I examine Bitcoin through the lens of Austrian economics. In his part, I explore The Emergence of Bitcoin. Read other parts here:
While many Austrian economists disagree on various topics regarding the origin of money, the most notable and agreed-upon theory on the origin of money is Menger’s theory of salability. Bitcoin arose in a world that was long past the barter phase. Since bitcoin was never used for barter, there was also no problem that barter economies had, namely the problem of double coincidence of wants. While it might not be helpful to compare the emergence of bitcoin to the emergence of money in a barter economy, the same market dynamics described by Carl Menger dictate how new money emerges. These market dynamics, which also apply to bitcoin, are explained by the theory of salability:
Salability (liquidity) is how much economic sacrifice is required for disposing of or acquiring a good, i.e., how easy it is to sell a good at a market at any time and at any economic price. The sacrifice usually comes in the form of a discount on the price or in the cost of delaying the exchange resulting in the seller having to wait until the exchange can occur. The theory of salability describes how goods compete with each other to become money based on the difference in their relative salability. The more salable a good is, the easier it is for the owner to exchange it for other goods for a reasonable economic price, i.e., prices corresponding to the general economic situation. Another way of thinking about salability is the narrowness of the gap in which an individual can immediately buy and sell a good.
The early days: an illiquid good
In the early days of bitcoin, it had no price, no purchasing power, and no salability. On October 31st, 2008, the pseudonymous creator Satoshi Nakamoto publishes his whitepaper on the cryptography mailing list. At this point, bitcoin can’t be considered a good as it does not exist yet. On January 3rd of 2009, the first block was produced on the network, and thus the bitcoin blockchain was born, which resulted in the first bitcoin coming into existence. On October 5th of 2009, after the Bitcoin network went live, the first known bitcoin price offer was posted. The price for this bitcoin was calculated based on its mining cost, i.e., production cost.
According to Mises’ definition, bitcoin was considered a good even before it had a price: something that provides means toward an end. This can be observed by the fact that before bitcoin units had prices, they were still used on the network by early users. Whether this usage was an ideologically driven contribution to the network or speculation regarding future adoption is not essential. However, what is essential is that bitcoin was a good that provided some utility to its users. If it did not provide any utility, bitcoin would not have been used in the first place.
It would make sense to think that bitcoin was originally demanded for its potential of becoming money. This potential and the speculation derived from it would benefit early adopters, i.e., it would satisfy a need they had. Since bitcoin units can only exist in the context of the Bitcoin network, it would make sense that supporting the network in several ways would make its native units (bitcoin) more valuable.
The bootstrapping: liquidity via speculation
The first Bitcoin exchange, “Bitcoin Market,” was introduced in January 2010, and since then, somewhat liquid markets with sell and buy order books, price information, and other exchange mechanisms have enabled users to dispose of their bitcoin faster and for better economic prices making bitcoin more liquid (salable). In a later forum comment, the exchange founder explained that he wanted to create a marketplace where people could trade bitcoin for USD and speculate on the value, establishing a real-time BTC/USD exchange rate.
As a new and unknown good, bitcoin did not have effective markets to establish accurate prices and was not very liquid. Thus, the only logical development at this point was for bitcoin to be traded against the most liquid goods: the largest fiat monies such as USD and EUR. It would be unlikely that a bitcoin owner could have found someone willing to part with their consumption goods. This is because the receiver of this new asset, without valuing it as collectible or wanting to speculate on its price or future, would struggle to exchange bitcoin further for the things they want. This is because bitcoin was new and illiquid.
As established above, before bitcoin was used in indirect exchange, they were used in direct exchange with USD and EUR for speculation purposes. This can happen when a monetary good emerges in an economy that already has money. This use provided initial liquidity, making it possible for bitcoin to transition into a medium of exchange slowly. Even before bitcoin started developing prices and salability, individuals were willing to spend money or expend other valuable resources (early miners produced bitcoin when it was “worthless”) on bitcoin because this proved to be valuable to them, i.e., they derived some utility from “using” bitcoin.
Some primitive monies were hoarded as collectibles for speculation for future value appreciation, i.e., to anticipate an increase in purchasing power. This can be interpreted as speculation and an attempt at storing value. In this sense, a parallel between early proto monies and early bitcoin can be made. See PART 5 where I examine proto money.
The bitcoin whitepaper states that bitcoin was designed to function as money. It seems to be the case that ideologically driven early adopters were expending resources to acquire bitcoin to speculate and bootstrap the system into broader adoption. They inevitably increased bitcoin's liquidity by valuing, supporting, and speculating on bitcoin’s future. This might have given that initial push for the first price to emerge. People started buying it because they anticipated that other people, too, might value bitcoin for all the characteristics they valued it for (or other characteristics).
What is different today from when collectibles and proto monies were used as money is that today humans can foresee monetary demand since the concept of a medium of exchange is already well known. This can be contrasted with ancient people not being able to imagine such a thing.
Early adopters gave away Bitcoin simply by completing a captcha. A bitcoin developer at that time, Gavin Andresen, set up a service to give away free bitcoin because he wanted the Bitcoin project to succeed. It is more likely to succeed if people have some bitcoin to try using it. This shows many early adopters’ motivations: to distribute and increase interest and awareness of this new phenomenon. Like most achievements in life, this was done by having “skin in the game” and incurring some monetary, reputational, emotional, or any other type of risk.
Perhaps the earliest adopter after Satoshi himself, Hal Finney, was thinking about how to value bitcoin and how it could get a price when virtually no one would initially accept it. Then he speculated in a thought experiment about the risk-return asymmetry in acquiring very cheap bitcoin with only a few cents of computing energy and waiting for bitcoin to become a valuable global asset. Satoshi foresaw the price increase as a bootstrapping mechanism. They predicted that as the number of users would grow, the price per bitcoin unit would also grow, attracting more users and resulting in a positive feedback loop. This is what Menger described: speculation, exacerbated by speculation markets, increases the salability of a good. People might be correct in their speculation, which makes their action beneficial as they expedite price discovery for bitcoin.
Praxeology does not concern itself with why individuals speculated on bitcoin. What is important is the fact that it happened because the act of speculation satisfied potentially various subjective needs. It could have been likely a mix of desire for ideologically driven individuals to speculate on the success of the Bitcoin protocol and network and speculation for pure price appreciation. This gave the initial push for bitcoin to begin its journey to becoming a liquid medium of exchange.
Bitcoin as a medium of exchange
On May 22nd, 2010, the first purchase with bitcoin was made to buy two pizzas. Although this trade happened, this can barely be considered a quasi-indirect exchange. This can be counted as the first publicly known use of bitcoin in indirect exchange, which made it a medium of exchange per the definition. This exchange happened because bitcoin already had a price and liquidity. A trade would not have been possible if bitcoin were illiquid and had no price on the market.
The moment a good is used indirectly with more than one exchange and happens between more than two parties, it has served as a medium of exchange. This is where bitcoin entered the elimination-type market process where salable goods compete. As we have established before, only a limited number of individuals recognize the salability of a good. This knowledge spreads with increasing knowledge of the good’s salability (liquidity). The individuals involved in the pizza purchase recognized that bitcoin is a salable good, and thus it gave them the knowledge to use as a medium of exchange. Although extremely limited, bitcoin became used to purchasing consumption goods instead of being only speculated on and traded against fiat monies such as USD.
What separates winners from losers is precisely the difference in goods’ salability. The increased use of a particular medium of exchange is logically followed by it gaining even more momentum and being used more widely. The market recognizes this disadvantageous dynamic: vendors of less salable goods will generally trade for more salable goods before they trade for the goods they ultimately want.
Salability is not static nor a binary characteristic. Since salability can be viewed as a proxy for how much demand there is for a good, the salability of a good increases as demand increases, creating an upward spiral; a good’s high salability draws more demand, which increases its salability further. This again draws more demand, and so on. This process continues until a few goods are regarded as “media of exchange.” This means that in different types of economies and historical periods, different goods possessed different levels of salability based on the kind of society and the technological capabilities present in this society. Like gold was not used before smelting technology became widespread, Bitcoin would not have been possible to invent in 1960 because the technologies that bitcoin leverages today did not exist back then.
Hanyecz, who made the infamous pizza purchase, later said that Bitcoin was an “interesting system,” but it would not have any value if nobody except him were using it. Indeed, money is a good with little value as a standalone good. Many economists use Robinson Crusoe, the man stuck on an uninhabited island alone, as an example to explain economic phenomena. In the case of money, we can imagine that it would have no value to Crusoe since he would not be able to trade it with anyone, and he could not consume it either. Being a social phenomenon, the acceptability of money is an important characteristic.
The battle for the status of money
The selection process does not stop until a good becomes money. As individuals are incentivized to trade their goods for the most salable of the media of exchange, markets converge on a few monetary media. This process benefits only those media, while other less salable media of exchange continue their downside spiral until they drop out of the competition entirely. In Mengerian theory, one can think of the money market as a process of elimination where less salable goods are not demanded for their monetary value anymore. The only goods left after this process of elimination start being regarded as money.
This process of elimination creates a positive feedback loop which results in people emulating this behavior, furthering the monetization process of this good. According to the Austrian definition, this results in one dominant medium becoming generally used: money. Today, people are learning about the benefits of holding bitcoin long-term, which causes other bystanders to rush to acquire bitcoin.
Individuals holding less salable goods will be punished economically as the opportunity cost of holding less salable goods manifests in fewer exchange opportunities and higher costs related to exchange. Thus, using inferior media of exchange, as opposed to commonly used superior media of exchange, has opportunity costs not only to the individual giving it away but also to the individual receiving it.
There is a tendency for less salable goods to be used as media of exchange to be one by one rejected until the last good remains. While it might not seem evident to outside observers, we are observing this phenomenon with the growth of bitcoin. It could be the case that holding other monies, as opposed to holding bitcoin, might have high opportunity costs that manifest in higher exchange costs.
Individuals who go to the marketplace with more salable media of exchange will have a higher probability of being able to exchange it for the goods they want for consumption, as opposed to individuals who go there with less saleable goods, precisely because of this difference. As such, money can be described as the most salable good. However, two goods can be regarded as commonly used media of exchange.
One historical example would be that of gold and silver, which were used as money simultaneously. Although possible, the outcome of this involves disadvantages. It complicates the exchange process, reinforcing the belief that bitcoin, as superior money, will turn out victorious in the market for facilitating exchange.
It is unclear at what point bitcoin could be considered money. It is hard to define “money” because the moment a medium of exchange becomes commonly used is ambiguous and thus, cannot be strictly defined. The broader definition of a medium of exchange is hard to differentiate from the narrower definition of money, making the transition from former to latter not sharp but relatively gradual, which is why agreement on the definitions cannot be reached. Whether or not a medium of exchange is money is left to the judgment of the historian and other observers. Many bitcoin enthusiasts quickly declare bitcoin as money already, while others are more reserved and do not see it as such as today.
At 11 years old, bitcoin is still a very young monetary phenomenon. But as more people start recognizing its liquidity and the possibility that it could one day become money, its liquidity will grow even further. While bitcoin has global liquidity already, it is too early to declare it a winner in the competition for becoming money in its purest sense.
In PART 5, I will examine the paradox between Mises’s regression theorem and proto money.