Bad Money

People frequently cite Gresham’s Law as a reason bitcoin will not succeed as a medium of exchange. I’ll let the Wall Street Journal make the argument:

Even if bitcoin worked better, it is in a Catch-22 because of Gresham’s law, the nostrum that bad money drives out good. Given the choice of spending inflationary government-issued money or something which holds its value, everyone would spend the bad paper stuff and hoard the bitcoin. You wouldn’t want to be the person who spent 10,000 bitcoins on two pizzas in 2010, when a bitcoin was worth a fraction of a cent. Those bitcoins are now worth $40 million. But if no one spends bitcoin, it will never get established as a currency.

(Article available without paywall here)

Aside from laughably arguing that Bitcoin will go to zero because it will be so valuable no one will spend it, this is also a common misapplication of Gresham’s Law.

I look to Venezuela today: Of course everyone would prefer to spend their bad money (Bolivar) and hoard their good money (bitcoin). But transactions require both parties’ consent. Your barista gets to determine how she is paid, and she has little interest in your worthless fiat.

Venezuela is the epicenter of Bad Money (2017), and simultaneously the most successful transactional example of mass market bitcoin usage. Bad money is most certainly not driving out good.

Why is Gresham’s Law apparently failing? It turns out, “bad money drives out good” is a false interpretation of Gresham’s Law. A clarification is offered by Nobel prize-winner Robert Mundell that Gresham’s Law could be more accurately rendered:

“Bad money drives out good if they exchange for the same price.”

A 1964 Kennedy Half Dollar coin was 90% silver, but 1965 minting of the same coin was changed to 40% silver. Because the US Government enforced them both to be accepted for $0.50 worth of goods, bad (40% silver) money drove out good (90% silver money). People hoarded the more valuable silver coins, melted them for their content, and spent the low-value coins. This has been true through the ages, as kings debased their coins to create extra money out of thin air.

However, Bitcoin only trades at a variable exchange rate.

Lambo dealer only accepts Bitcoin for your new car? No problem, go spend your fiat to buy some bitcoin at the prevailing rate.

Thinking Gresham’s law predicts “no one will spend BTC” is literally the opposite of what is predicted.

For those stuck thinking Gresham’s law will prevent bitcoin becoming currency, Thiers’ Law is a clear extrapolation of the impacts of good money in a bad economy without exchange controls:

In the absence of effective legal tender laws, Gresham’s Law works in reverse. If given the choice of what money to accept, people will transact with money they believe to be of highest long-term value. However, if not given the choice, and required to accept all money, good and bad, they will tend to keep the money of greater perceived value in their possession, and pass on the bad money to someone else. In short, in the absence of legal tender laws, the seller will not accept anything but money of certain value (good money), while the existence of legal tender laws will cause the buyer to offer only money with the lowest commodity value (bad money) as the creditor must accept such money at face value.

In a series of countries that faced a rapidly debasing fiat currency in the 20th century, the “best available money” (US Dollars) rapidly displaced the domestic fiat. In Venezuela, Zimbabwe, South Africa, etc: US Dollars were not hoarded — they became a common means of exchange. Bitcoin need not replace all transactions (say, taxes) — taking any meaningful share of the payments market would be a huge win.

In the absence of fixed exchange rates or an enforceable government mandate to accept bad money, instead of bad money driving out good, the presence of good money signals the death knell of the debased currency.