My question is maybe naïve at this point, but when we talk of fiat currency, we trust in an entity; in the case of the U.S. dollar, it would be the Federal Reserve. As long as the sovereign exists. What is underpinning the trust in Bitcoin?
That is a great question that comes up a lot. At its core, it is the fundamental question of: “Where does money get its value?”
Quite honestly, I would challenge the idea that when you trust a currency, you are trusting an entity. I don’t think that most people who spend Swiss francs do so because they trust the Swiss central bank to offer good stewardship in managing the currency with a 2 – 2.5% inflation per annum, while simultaneously managing the unemployment rate, in a grand strategy of monetary policy.
Most people have no idea what the Swiss central bank is, and probably still think there is gold in the vaults. They have no idea how money works!
What they trust is, when they go to the store tomorrow, someone will give them a dozen eggs for what the eggs cost Yesterday.
That is where the value comes from, it is forward trust. It is the anticipation of future value, the expectation that not only will you believe in the illusion that pieces of plastic or paper have value,
but the next person tomorrow will also still believe in that illusion long enough to feed you.
That is where the value of the money comes from, not some central entity. The central entity provides a guarantee that the money hasn’t been forged, which was especially important when the money was precious metals. You wanted to be sure it wasn’t 30% zinc, but real silver or real gold, so the monarch would stamp it to tell you: “This is guaranteed.”
In fact, it was one of the highest forms of treason to forge, tamper with, or slice off pieces of the money.
The monarch provided a guarantee of unforgeability, of metal purity, when the value was intrinsic (tied to the material the coin was made of). or somewhat intrinsic in the coin.
What exactly does the central bank offer in terms of the value? It certainly isn’t a promise to not print more right? It is still a promise of unforgeability. They say: “Within this jurisdiction, you can give this, if nothing else, to the buyer of last resort (central bank).” You will be able to pay the government with this money, for any debts you owe.
That is the only guarantee you get, the only basis of trust you get. I would say, that it is a relatively weak promise.
So why do people trust in bitcoin or any digital currency that exists out there?
Fundamentally because they believe it will still have value tomorrow, and they could use it to buy goods and services. At least, that is how I use it. I am paid in bitcoin and then I use bitcoin to live. I trust that I will still be able to use bitcoin tomorrow to live. As long as that joint hallucination rolls forward, bitcoin will have value.
So the value is really in the community, the economic activity of all the participants, understanding that we are all using this to the trade.
The second part is, I trust that it can’t be forged. I have made the algorithms which create bitcoin,
so I know that it can’t be forged, faked, or diluted. You can just read it, no need to go through that pain of creating algorithms on your own.
So I have that level of trust. That is all it is. I believe that other people will find it useful in the future. That is the basis for all money and currency.
Behind that, there is also a very large amount of energy expenditure and computation to ensure it is also rare.
Where is bitcoin’s intrinsic value you may ask? A lot of people think they can still go to a national bank, give them some currency, and bank will give you some amount of silver or gold in return.
That was in the gold or silver standard times, not any more. But regardless, bitcoin is confusing to people, intriguing and ironic that the intrinsic value of bitcoin lies in its non physicality, in the mathematical properties which make it possible to have secure non-physical currency.
Rather than “intrinsic value,” I like to use the term “intrinsic utility.”
The truth is, systems of money which have intrinsic value do not make very good money, because the intrinsic value of a money dilutes the purpose. Money is meant to be an abstraction of value through which we communicate value, not value itself.
If you can eat the money, then some people will choose to eat the money, and cause deflation in the supply. If you chose bananas as your money, that doesn’t make a very good system of money.
Things that have intrinsic value may change abruptly due to circumstances. If you use water as your money, and suddenly have a monsoon or a drought, your money supply is now shit.
The best forms of money don’t have intrinsic value.
Intrinsic value is an illusion that we have created in order to explain money at a level to a five-year-old,
which is apparently the same explanation we give to everyone in our society forever.
Instead, I think intrinsic utility is a great concept. Bitcoin is useful, because it can do things that can’t be done by other forms of money.
Intrinsic utility isn’t forward-looking, it is practical.