Michael S. Rozeff
March 31, 2014
The bottom line is that cryptocoins are not money. The Austrian analysis rules.
Money’s key property is that it is a numeraire for goods. Wikipedia puts it this way:
“Numéraire is a basic standard by which value is computed. Acting as the numéraire is one of the functions of money, to serve as a unit of account: to measure the worth of different goods and services relative to one another, i.e. in same units.”
Gold is still the world’s numeraire or unit of account, although this fact is hidden by the daily use of currencies like dollars, yen, rubles, francs and so on.
A numeraire like gold cannot arise unless people in markets are willing to exchange for it in the first place. Consider an unconventional example. Suppose that we are in ancient Egypt. The pharaoh requires a tax of 10 bushels of corn from each adult male. Call the 10 bushels a TEC. The people might conceivably start to quote prices of other objects in terms of TECs, because everyone has to pay taxes. A horse might exchange for 5 TECs, say. The Pharaoh might introduce a paper bill that he is willing to accept in lieu of 10 bushels, and it could become a paper TEC. He’d pay his soldiers with this paper. They’d spend it and others who have to pay taxes would accept it. When April 15 rolled around, some people would pay the Pharaoh in paper TECs. Others would deliver corn. The TEC could become a unit of account or numeraire. If the Pharaoh inflated his issues of paper TECs, the prices of goods quoted in TECs would rise. It would take more than 1 TEC to buy 10 bushels of corn.
Gold is a free market and international unit of account. It got that way without a Pharaoh. It got that way because of its properties as a good that was internationally valued and recognized, by its durability, divisibility, high value per unit of weight, relatively low variation in supply, and so on. Once it became a numeraire, paper certificates could be issued against it. It still remained the numeraire.
The proof that gold is still numeraire is that the price of gold has tended to rise, as quoted in units of each paper currency, to the corresponding extent that these paper currencies have been inflated. The two (gold prices and money supply) are linked, even if not perfectly and not in lockstep. Expectations of future money policy and temporary supply factors cause noise in the basic linkage. This means that the prices of goods quoted against gold have risen, with gold as numeraire. The paper currencies are not a numeraire. They got their prices against gold by being issued at first against gold and later, when delinked from gold, by bearing some relation to tax revenues of the government.
Gold at $35 an ounce means $1 buys 0.02857 ounces of gold. In other words, the price of a dollar (representing a general purchasing power over goods) is 0.02857 ounces of gold. Gold at $1,300 an ounce means that $1 buys only 0.0007692 ounces of gold. It takes 37.14 dollars to buy that same ounce of gold. This means that gold and all items quoted in terms of gold cost 37 times as many dollars, apart from particular changes in prices arising from changes in technology and tastes.
If a shave and a haircut was 2 bits ($0.25), it’s now 37 x $0.25 = $9.25. I choose this because there has been little productivity change in a haircut. But the point is that the fiat dollar is not the numeraire. Gold still has that function.
New computer-bytes, called “cryptocoins” and “cryptocurrencies”, are being devised such as the “auroracoin”. These are not metallic coins. They are groups of digits arranged in a certain way and under the control of some persons. Their transfer and supply properties vary from case to case. The term “crypto” refers to their generation using cryptography.
Whatever their value as goods, their prices are quoted in terms of paper currencies, which in turn have meaningful prices by being linked to prices of goods and gold in particular as numeraire.
If cryptocoins had been invented thousands of years ago when many items from gold to cattle to cowry were in use as numeraire and money at different times and places, would they have displaced these items? Would they have come to be the numeraire for prices? Would a single cryptocoin have emerged in terms of which all other prices would be quoted?
I think not, and therefore I do not think that one cryptocoin will emerge as a new numeraire in the future. There are two important free market reasons. First, any cryptocoin has no significant independent value as a good, other than its possible use to exchange for other goods. By contrast, gold’s value in terms of corn and vice versa were established in exchange because each was an independent item of value. Each had one or more uses independent of possible service as a numeraire or currency. If the cryptocoin has no other use but as something to exchange for other items, this bartering exchange value cannot be established.
Second, there is no limit on the supply of competing cryptocoins. There are already many of these. The number of competing cryptocoins is unlimited. In the limit, cryptocoins are like tokens that a person stamps out in his garage, or stamps that a person prints using his copier. Their value is almost nil even if each person manufacturing them limits their supply because they are all substitutes for their sole use, which is as an exchange medium. An individual coin may be limited in supply but the market supply is not.
There is a third non-free market reason, which is that governments are unlikely to allow cryptocoins to survive if their main uses are to evade detection of money flows or taxation. But this is not a core argument.
The fact that cryptocoins trade at a non-zero price doesn’t counter the arguments given above. Novelties and fads also trade at non-zero prices.
Here is another way to understand why cryptocoins are not money. Imagine that a circle of persons decides to have its own private currency in the form of a cryptocoin. Their task is to establish exchange rates for all the goods and services that they exchange in terms of their private coin. They need to develop a supply process for coins and they need to decide how the coins are to be allocated among the group. A group of even a moderate size will immediately encounter difficulties in this if they try to set prices themselves, because there are so many goods and services and so many dynamic contingencies. They cannot create a numeraire. The best they can do is to fashion a bidding process by which members bid for coins in terms of some other goods that they offer. Suppose the group overcomes the severe allocation problem by deciding to own all the coins jointly. It then auctions them off. How can the auctioneer decide what the highest bid is if people offer a variety of goods and services? They need a numeraire. They will have to choose some item, like a paper currency or a good. They can’t establish a price for their cryptocoin without such a numeraire. This shows that the cryptocoins are not the numeraire and not money. At best, they are a derivative money or a substitute money.
Cryptocoins might still survive and be useful in certain transactions, but, like air, be so plentiful that they cost very little. For example, suppose that a person in Russia wants secretly to exchange rubles held in Moscow for dollars held in London. Instead of using a foreign exchange desk, he buys a cryptocoin with rubles from an exchange located outside Russia. He then sells the cryptocoin for a dollar deposit in London. For this use to survive, the cryptocoin exchange is going to have to become a foreign exchange trading desk with dealers to manage currency inventories. It will also have to somehow keep itself secret, which will be extremely difficult if it is doing many transactions.
The argument for unlimited supply of cryptocoins says that cryptocoins are headed for low prices, even zero. If cryptocoins are really no more than coins one can stamp out of cheap metal on a cheap machine, they’ll be worth virtually nil.