“Bubbleology” and faith in purchasing power of BTC
What would happen if Bitcoin was money? It would disappear.
Apendix 1.: “Bubbleology” and faith in purchasing power of BTC
As you could read in the article “What would happen if BC was money? It would disappear.”, Bitcoin unlike gold cannot get its purchasing power as such. On the basis of the given article it is clear that BTC cannot be money. However, today some economists are convinced that purchasing power of money is derived from the faith that economic good could be, is or was money. Moreover, money is considered as a bubble that will finally burst. I call this theory “bubbleology”, or “economic charlatanism” with respect to the argument of faith in money.
It deals of application of objectivism when explaining purchasing power of money[1]. Money as an asset as such should have purchasing power. Any other economic good is demanded for the so called use value it brings to us and its value is derived from what we subjectively think about the economic good in terms of satisfaction of our needs. However, in bubbleology we demand money because we want to exchange it and this is what everybody wants as well. Money does not have any so-called use value. It cannot be consumed. We have it only for exchange. Everybody believes in its exchangeability. If we lose faith, money loses its purchasing power. According to this theory money objectively has purchasing power. We believe in it. We need faith in exchangeability of money in order to be able to explain where the origin of exchangeability comes from[2].
Within this reasoning assigning purchasing power of money is based on estimate of its purchasing power towards the future, which is what purchasing power is derived from today. It means that if we believe that money will have purchasing power in the future (i.e. we believe that we would be able to buy something for money), this is what its purchasing power is derived from today. If we thought that money would not have purchasing power in the future, we would not want it today. Faith would get lost.
In this theory purchasing power is dependent on two basic variables. The first variable is demand for keeping money balance and the second is estimate of dilution of purchasing power of money dependent on the number of newly increased monetary units in the economic system. Basically, both variables are derived from the presupposition that we believe that money can be exchanged for something in the future. If we lose faith, there is neither demand for keeping money balance, nor anticipation of purchasing power on the basis of the number of monetary units in circulation. If we do not believe in purchasing power, particular good considered as money is lost. That is why these authors claim that the bubble concerning money will burst. This is also the origin of my term “bubbleology”.
The first variable should influence purchasing power in the following way: The higher demand for keeping money balance from the side of people is, the more intensively purchasing power grows. We can imagine that in following way. If we have total of 1000 units of any money and if somebody keeps 500 units at home under his pillow, then the remaining 500 circulating units increase total purchasing power of all money; holder increases also purchasing power of the 500 units kept under the pillow. The reason behind is that all others use only 500 units in circulation. However, growing purchasing power means decrease in prices of other economic goods from the opposite perspective. This theory claims that the decrease in prices of economic goods causes that higher demand for money balances from the holder side should be automatically balanced. Lower prices of economic goods as a matter of fact will motivate our holder to decrease keeping money and to purchase goods, i.e. to satisfy his further needs by means of newly purchased goods. This results consequently in change of purchasing power of money because it will be more units in circulation what will cause consequently higher prices of economic goods and the market is brought by this mechanism into the balance.
The second variable influencing purchasing power of money in this theory should be linked with the number of new monetary units. A simple premise try to be as true: if we add new monetary units into the circulation, purchasing power of all monetary units decreases. If we have 1000 units in economy, if somebody keeps 500 of them and if the total number of units is increased to 2000 units, while somebody keeps 500 of them, total purchasing power of money increases proportionally to the given increase. The process is not even, but is goes on finally. It is not even because new owners get to new money gradually and they allocate it to the economic system later on. So, the effect of new money and higher prices occurs gradually.
If this theory applies[3], then the reasoning about BTC as money is simple: the more people start to use BTC as a means of exchange, even though its value is derived from USD today, and the more use of BTC is expanded, the higher potential of becoming money it has. At a single point in time (later in the future) people will “forget” older money, e.g. USD, or circumstances will motivate people to leave USD (fiat money will fail) and they will start to use what has become the most expanded among people, i.e. BTC. All prices (of inputs or outputs) will be determined only and only in BTC. BTC will become hypothetical money — meaning people will believe that BTC will be possible to exchange in the future and therefore they will use it as money that day.
Let’s accept this reasoning and the fact that purchasing power of money depends on faith in money as such. It is a wrong theory but for the sake of the argument let’s assume that it is correct. Miracle will happen and BTC will become money. Bang! That’s it. What will happen then? The article will show that as a result mining of BTC will collapse, i.e. one of the basic pillars of Bitcoin network. There will be nobody to secure network, i.e. miners will lose economic motivation to mine. The question is why?
While in the article “What would happen if Bitcoin was not money? It would disappear.” I explained that BTC as such will not have purchasing power because it cannot mediate debt exchange, in this appendix we presuppose that purchasing power of BTC exists. It is not derived from debt mediation. We believe in it. That’s it. If purchasing power of BTC exists, miners do not have any difficulty determining their costs. However, you will see that this would not help the miners.
Preconditions of Reasoning about BTC Disappearance in case that BTC had Purchasing Power Based on Faith
1. First of all let’s suppose that we do not use USD and other currencies. We use BTC as money. USD does not exist.
2. As you could see in terms of bubbleology purchasing power is estimated on the basis of adding new monetary units in circulation. In case of BTC this variable starts to be irrelevant in 2140 and we would be able to accommodate to it till 2140 because we know exactly the new supply. However, after 2140 the number is unambiguously given and unchanging[4].
3. Change in purchasing power will be directly affected by demand for keeping money balance and with respect to assumption no.1 it is only demand for keeping BTC. The higher interest rate is, the less are holders motivated to keep BTC and vice versa. Interest rate as well as purchasing power should be relatively stabilized in the context of bubbleology. The total number of BTC units in the economic system would not change after 2140 and till that time it is quite predictable; the only variable is the number of lost private keys and the number of BTC which they control. Only demand for BTC balances changes. However, it is “controlled” via interest rate and via price level change which are counter-forces to balance purchasing power. BTC purchasing power is possible to consider within this theory as very stable variable.
4. From this perspective demand and supply of economic goods are the primary reason for change in relative prices in the economic system. In other words, the prices of electricity, data centres, overheads and all other assets change only depending on supply and demand for given goods themselves and not depending on changes in purchasing power of BTC. Price movements are caused only by an entrepreneurial activity and consumable costs reflected in development of economy depending on whether it expands, decreases or stagnates. As a result BTC miners will search for areas with relatively low costs of mining where mining will be transferred to. A variable in the form of searching for lower input costs is a neutral variable in the context of our reasoning. It does not impact whether mining will be performed or not. Entrepreneurs will mine in areas which ensure the lowest costs possible.
5. The character of economy is also neutral for our discussion. It does not matter whether economy is expanding, decreasing or stagnating. In terms of mining BTC (money) a type of economy has no effect. First, purchasing power of BTC does not have to grow if economy is expanding, it does not have to decrease if economy is decreasing and it does not have to stagnate if economy is stagnating. Money does not have purchasing power expressed in total amount of assets in the economic community. There are more assets in economy than expressed by money. Money mediates only exchange, i.e. only exchange of smaller part of all existing assets for money. In this theory money has purchasing power derived from the number of its units and demand for keeping it. Second, the type of economy is identical for every participant of the market. Prices decrease to every participant of the market in expanding economy with identical monetary stock, they grow in decreasing economy and they are identical in stagnating economy. From this perspective the type of economy is a neutral variable. It applies also from the miner’s point of view. Assumption no. 2 applies. The miner gets only already existing monetary units after 2140, which will be only redistributed as fees for securing network and the prices would reflect changes of purchasing power and type of economy till 2140 due to the precise knowledge about new coins creation. Distortion price effects linked with who gets a new monetary unit as the first do not apply due to the fact that we exactly know how many units will be till 2140 and who gets them as first. Assumptions no. 3 and 4 apply as well. Changes in purchasing power would be quite balanced. It means that purchasing power grows only relatively in expanding economy, it decreases only relatively in decreasing economy and it is identical for everyone in stagnating economy. It is relative since not everybody prefers e.g. higher consumption of assets in expanding economy vis-a-vis decrease in prices and vice versa in decreasing economy. Entrepreneurs would keep reacting to every decline or increase in prices exclusively caused by others entrepreneurial activity. BTC miners would do as well.
6. Money does not serve only for purchasing things (i.e. I can buy ice-cream, a tractor, a scooter, right here, right now) but also for exchange in time (I get principal today and I pay off principal and interest later). So money is also a unit of account. If BTC has purchasing power, i.e. if we believe in it and if we use money also for mediating debt, then we must use BTC also for debt exchange. If BTC would be money, we simply cannot avoid it! Under this assumption and within this (wrong) theory, it still holds that BTC must express interest rate. We cannot omit the phenomenon of interest even if we assume faith in money. What is different in this theory is approach to what interest rate actually is. In this case interest rate is dependent only on time preference, i.e. we prefer 1 BTC today over 1 BTC in the future, or we ask for interest for postponement of consumption in the future. Such a defined concept of interest contains several mistakes, however it is possible to use it within this theory[5]. Another article describes criticism of this concept[6]. For our purposes it is sufficient to realize that more complicated production needs somebody else’s funding and that it needs paying off principal and interest. BTC mining would be a more complicated and specialized production structure.
7. Another assumption we must count on is the character of BTC. The character of BTC is absolutely different from all other assets. In the event that coconuts, salt, leather or other assets (in fact these goods were used as money[7]) were money on the basis of faith and if they were already produced and if it is applied that by some miracle their new units would be added into the economic community by some given mechanism and one day could not be added into the economic community at all, their manufacturers would disappear one by one and there will be no one who produce it by definition at the end. No one would produce them because it would not be possible. The given goods (coconuts, salt, leather or other) as money would just exist. However, unlike these assets BTC is different. We need economic activity for existence of BTC. BTC cannot only exist as other tangible assets do. BTC must be mined, if it wants to exist. Otherwise it does not make any sense.
8. Another point is that we must realize that in principle all relevant BTC units will be mined one day. There will be no new ones[8]. Profit of miners will be based only on (!) redistribution of existing BTC units one day. On the basis of fees. The pie is not growing, it is just being divided.
9. Since after mining the last relevant number of BTC the miners can “live” only on fees and since the assumption no. 1 applies, BTC transaction capacity will be used at maximum. This assumption results from the fact that the number of transactions will always be limited from the perspective of the decentralised character of BTC and maximum exploitation implying using BTC as money.
10. Nominal level of BTC fee and associated decision of people about the height of fees in BTC must be considered as neutral, or irrelevant for our reasoning. BTC as money would serve only in the sense of settlement layer. There must be an LN level (lightning network) above BTC in principle with unlimited amount of transactions where fees would be relatively low for consumers; the reason behind is that in the LN layer people would club together to collect fees for BTC settlement layer. The prices of fees in the LN layer could be affected also by decision-making of clients to implement settlement in various times, the result of which is that transactions with more frequent settlement would be more expensive and vice versa. It means that transaction for a final client of the network does not have to be too expensive in the nominal level of BTC. Firstly, more people would club together to collect fees from LN layer to pay fees for basic settlement transaction in the BTC layer, secondly, people could freely choose temporal aspect when settlement per hour would be a little bit more expensive than e.g. once per month. The nominal level of fees from the perspective of clients using BTC or any LN layer token is simply not crucial for our reasoning.
11. The last assumption is the following. The given assumption is quite known in the bitcoin community and it was conceived by the author of “Bitcoin Standard[9]” book. To paraphrase: the more people demand BTC as store of value due to its limited amount, the more its price (in USD) increases. The more its price increases, the more its mining gets profitable (in USD) and the more people strive to mine it. However, this does not create more BTC, but higher hashrate, which means higher security of the network and higher demand for BTC as better store of value[10].
Why would BTC Disappear also in case that BTC had Purchasing Power Based on Faith?
In the event of BTC mining the same as described in case of money mining = gold applies. If interest rate is 5% and the miner mines a commodity in which the interest is expressed, then for 1 BTC in cost he must gain more than 1.05 BTC in fees after the year 2140, in practical life much earlier. However, fees could not increase its value in USD, since we would have only BTC determining all other prices. It means that very particular amount of BTC would exists in circulation and it would need to be redistributed also among miners for securing network, so the network’s hashrate would be relevant. At the same time it applies that an additional unit of invested BTC would not bring an additional unit in the form of higher profit. Only hashrate increases, which does basically the opposite, i.e. a relatively lower average yield per a BTC unit additionally invested in mining.
The result would be the following: The miners’ competition will inevitably cause that yield of mining equals zero. This is not a theoretical assumption about perfect competition model. We should realize that any other economic industry is able to secure its higher profitability with new investments in more productive production methods by means of higher productivity, lower prices and thus higher sale of number of goods. We should realize that in any other economic industry the entrepreneur can discover this higher rate of productivity. In case of BTC a higher efficiency rate in the form of e.g. better hardware, lower price of electricity, a better way of cooling, decreasing margin, change in the code, etc., does not cause higher nominal yield in BTC in the mining industry as a whole. In the field of BTC mining, even if any entrepreneurial discoveries occur, nothing changes the fact that all BTC would be exhausted after a certain period of time. In other words, in any other industry the pie that is redistributed among more entrepreneurs can grow. But not in the field of BTC mining. The pie would remain the same. Miners could not also refuse transactions with lower fees in BTC. Their sales would depend first mostly and then exclusively only on fees. They would be inevitably pushed by overheads in such a functioning system where the level of fees is determined in BTC (not in USD). It would inevitably lead to the situation that the level of fees will equal the level of interest rate, or it could be below it. Why? Because of: A) competition, B) decreasing yield per an invested unit of capital, C) impossibility to add an additional unit, D) the principle of getting yield only on the basis of redistribution after 2140 (in practical life much earlier) and E) the need to pay minimum overheads, which implies that the miner must accept any fee. Situation which would cause bankruptcy of miners who finance their project based on debt, or the opportunity costs would make them go bankrupt if they fund their projects from own resources.
Decision in favour of BTC as money would have also other undesirable impacts. If yield in the mining industry would always be zero or negative, it would result in bankruptcy of the miners and subsequent absolute concentration and centralisation of mining. However, if a single miner remained, it would not help BTC as money. Whereas every BTC additionally invested in the mining industry causes incessant lower yield, interest rate would grow higher in this sector compared to other economical industries. Inevitability of risk surcharge associated with decreasing yield of a unit of invested capital is the reason. This would cause that on the one hand the mining industry would attract new and new investment, which would go bankrupt, on the other hand this would happen to the detriment of other economical sectors. This way investment in BTC mining would cause decomposition of the production structure in other economical sectors, i.e. in sectors where all other entrepreneurs do business. They would certainly try to gain capital resources. However, use of BTC would mean to them existence of incessant pressure to increase interest rate from the side of creditors (due to the fact that mining industry would have higher interest rate), which would make no sense to them. That is why they would quit BTC as money, which collides with our basic assumption that people freely choose BTC as money.
The miners could not mine even if we presuppose that purchasing power of money would constantly increase. This shows that we would omit assumptions no. 3 and 4 and we would have constantly growing purchasing power of money. At that time we could speculate whether in case of zero or negative nominal yield in the mining industry the miners could rely on growth of purchasing power of money. This would cause that yield from mining could be profitable with respect to relative decrease in costs linked with growth of purchasing power of BTC. However, this is a problem again. Such a growth of purchasing power implies that 1 BTC today is worth less than e.g. 0.99 BTC tomorrow; BTC has increasing purchasing power in time, which is a problem again. Why to mine? It makes no economic sense to them and they would prefer to keep their BTC, which should get higher and higher purchasing power in time without the necessity to invest any economic resources and to get into risk linked with this business activity. Which would not happen because in the meantime BTC would disappear, since no one would want to mine and secure the network.
Reasoning through faith applies only if we claim that the miner would secure network voluntarily. Without economic motivation. This reflection is based on presumption that the miner invests economic resources for free in order to secure existence of BTC as money because he uses it as money too and otherwise he would depreciate his past investment. This alternative is associated with two options of supporting mining: by public subsidies or private subsidies of BTC mining. The case of public subsidies does not have to be analysed. BTC should be free money. If BTC mining was dependent on public subsidies so that mining of private money exists, it would be a significant paradox. Logical nonsense in principle. Voluntary private subsidies of BTC mining existed in the beginning of functioning of this system; due to the lower limit of network difficulty[11]. For sure it can work in a small collective of enthusiasts. However, the idea that people should abundantly and voluntarily support any economic activity just for existence of BTC (which is not money), while there were much simpler and cheaper alternatives of what should be selected as money, verges with a higher rate of charlatanism compared to the theory based on faith in money. It is pure economic nonsense. However, these are already only hypothetical reflections about another hypothetical reflections.
Equally naive are also arguments such as “entrepreneurs will find out the way … they can cope with anything and BTC would be money. Entrepreneurs will deal with it. They are innovative.” The answer to this argument is very simple. Sure, they could deal with any situation. They would choose the easiest and the most feasible alternative. They would choose something else for money, not BTC. It is that simple.
Conclusion of the Appendix
It is necessary to highlight again that bubbleology itself or the theory based on faith in money is not correct. This appendix was elaborated in the context of presumption that if we believed in purchasing power of BTC. However, the consequence is the same. BTC as money would disappear sooner or later as well. People would choose something else for money.
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Matúš Pošvanc, the original version was published on August 18, 2018. The article was modified, complemented and finally edited on August 27, 2019. Translated into the English in November 2019.
[1] The given issue is described in detail in Pošvanc, M: Theory of Intersubjective Perception of Value of Money. WWW DOCUMENT <https://medium.com/@matus.posvanc/theory-of-intersubjective-perception-of-value-of-money-4f02c9dad61d>
[2] When you think about it the argument of faith is in principle “fair” solution to the problem of getting purchasing power. But it is wrong. It is the same as when people knew that day alternates with night and they thought it was because the Sun goes round the Earth. It was their faith. And it brought an answer to the given issue — why day alternates with night. Both the thinkers and people at that time were satisfied with the given answer. Even though the answer was wrong. It was faith that somehow gave answer to the problem. It is very similar in this case. People do not think much about the problem how money gains purchasing power. An argument of faith gives an answer which is sufficient for many people. Even though it is wrong.
[3] Criticism of this theory is in Pošvanc, M: Theory of Intersubjective Perception of Value of Money. WWW DOCUMENT <https://medium.com/@matus.posvanc/theory-of-intersubjective-perception-of-value-of-money-4f02c9dad61d> or in the brief summary of Pošvanc, M.: Why we need not (inevitably) Gold Standard but Free Banking.
[4] Let´s omit assumption that some private keys to BTC are lost and some can get lost. It does not affect the principle of the reasoning. At the same time it does not affect the principle of reasoning of theoretically implemented BTC hard-fork in the form of increase of the number of BTC, or implementation of some algorithm of increase.
[5] For criticism of concept of pure time preference interest see e.g. Murphy, R.: Unanticipated Intertemporal Change in Theories of Interest. WWW DOCUMENT <http://consultingbyrpm.com/uploads/Dissertation.pdf> or in Potužák, P. 2016. CAPITAL AND THE MONETARY BUSINESS CYCLE THEORY. WWW DOCUMENT <https://vskp.vse.cz/49157_capital_and_the_monetary_business_cycle_theory_essays_on_the_austrian_theory_of_capital_interest_and_business_cycle>
[6] Pošvanc, M. The Theory of Interest. Revision of the Austrian Approach. WWW DOCUMENT <https://medium.com/@matus.posvanc/the-theory-of-interest-revision-of-the-austrian-approach-b2bd0988aeb3>
[7] See e.g. Einzig, P. (1966, 2014). Primitive Money: In its Ethnological, Historical and Economic Aspects. Pergamon Publisher.
[8] Let´s omit the fact that the community could theoretically change the number of BTC units from 21 to XY millions. Nothing changes the fact that BTC would still remain rigid in the same way as it is.
[9] Saifedean, A.: Bitcoin Standard: The Decentralized Alternative to Central Banking. Wiley. 2018.
[10] BTC should allegedly replace current currencies and become the best money mankind has ever invented (according to the Saifedean point of view BTC is the best money). As the reader of previous article “What would happen if BTC was money? It would disappear.” can see, there is nothing so far from reality.
[11] It means that first BTC miners really subsidized the security of the network even though the price of BTC was given in USD and it was not economically reasonable to mine.
