PART 6: Bitcoin and The Regression Theorem
This is PART 6 of my series where I examine Bitcoin through the lens of Austrian economics. In his part, I explore how bitcoin fits into the regression theorem. I talked about the regression theorem in PART 5. Read other parts here:
There has been some discussion on whether bitcoin “violates” Mises’ regression theorem or not. Many have argued that it is not compatible with bitcoin, while others have come up with various explanations why there is no conflict between the Austrian theory and bitcoin. This part dives into what the theorem states and how bitcoin fits into it. An alternative viewpoint will also be presented where bitcoin is compared to proto money, a term used by Nick Szabo in his writings.
Before Mises applied the subjective theory of value to money, Austrian economists experienced circularity in their attempts to explain the value of money: money is valuable because you can exchange goods with it. You can exchange goods with it because it is valuable. Something is missing here.
Mises built upon the Mengerian theory of the most salable good and introduced his regression theorem. The theorem explains that the value of money can be explained by its future purchasing power. Individuals can speculate on its purchasing power because they observed it yesterday. The regression theorem describes how a good can gain original demand as a medium of exchange. According to the theorem, a good must have a prior value-generating direct use before amassing medium-of-exchange demand. In short, the theorem states that monetary good’s purchasing power regresses to direct-use demand.
The regression stops until the day when the good was valued for direct consumption, i.e., for its own sake. Economist Jörg Guido Hülsmann explains in his book, The Ethics of Money Production that the prices initially paid for a good’s non-monetary uses make it possible for buyers to estimate future prices at which these goods can be sold. It would be extremely risky to buy a good for indirect exchange without ever knowing its past prices, and thus a medium of exchange cannot emerge when this knowledge is lacking.
However, it is important to note that media of exchange do not become money because of their direct utility (consumption) but rather because of their salability (liquidity). Many goods served as money until they were demonetized because a new, more salable, and less costly (to transact) money emerged. The properties that can make a good salable are examined in PART 2.
Bitcoin and regression theorem
At first glance, the emergence of Bitcoin as a medium of exchange does not seem to adhere to Mises’ regression theorem since it seems that bitcoin has never had any direct use other than exchange use. The first attempt to try to fit bitcoin to the regression theorem was the common thesis that the regression theorem only applies to barter economies with no existing money prices.
Walter Block and Laura Davidson argue that bitcoin does not violate the theorem. According to them, there are two circumstances where a good can become a medium of exchange: (1) it needs to emerge from a pure barter economy where there are no prices for money (regressing to its direct use-value, or (2) it emerges in an economy where there are already prices for existing money. The latter describes the circumstance in which bitcoin emerged because of a sophisticated economy that had an existing price structure for money. In this case, the emergence of bitcoin does not violate Mises’ theorem. Konrad Graf also argues that bitcoin managed to bootstrap its purchasing power because advanced relative money prices existed already, which eased bitcoin evolutionary challenges.
Graf mentions some of the possible “direct uses” were mystique value, geek appeal, curiosity, challenges for enthusiasts, and social signaling. Following methodological individualism and subjective value theory, these direct uses do not need to be recognized by anyone else except the individual himself.
However, there have been attempts to point out logical inconsistencies regarding the regression theorem. Some of the pillars of Austrian economics are the theories of subjective value and marginal utility, which have been explained in PART 1. Eric Voskuil argues that the theorem violates the theory of subjective value, even though it relies on it; value is always subjective, and thus, can be based on practically anything, in the case of bitcoin, utility as a medium of exchange. Like all other goods, money is subjected to our valuations based on its utility to us. The law of marginal utility does not deal with “objective” use-value but with subjective use-value. This means that it does not concern itself with prices, physical or objective properties of a good, but rather its relevance in satisfying individuals’ self-perceived needs. The utility of goods is to satisfy needs. Thus anything that satisfies a need has utility, which in turn gives the good value in individuals' minds, resulting in the good having purchasing power. Some users perceived utility in holding bitcoin due to its properties and saw bitcoin and its properties as a means to satisfy their wants.
Since bitcoin was used before, it has a price or any liquidity to satisfy a need, it has utility. Whether this utility was direct or monetary is not important. This begs whether this distinction between direct use and monetary value is necessary. Money is a good that satisfies the need for liquidity, which is derived from the need for exchange. The reason for bitcoin gaining that initial liquidity was most likely speculation and the market that emerged to cater to that speculation. This made it possible to transition from being a good to becoming a medium of exchange. All that is needed for a good to transition from direct exchange to indirect exchange is more demand for this good, regardless of the reason for this demand. From this point, the number of potential indirect exchange opportunities grows.
Satoshi suggested that bitcoin could get initial value by people foreseeing its potential usefulness for exchange, even mentioning that collectors could initially spark the initial value. Szabo explains that this tendency for individuals to collect rare items can bootstrap the monetization process. Whether it is speculation or other use cases mentioned before, these are all direct uses since they were not used for indirect exchange. What needs these uses satisfied is an empirical question that can only be asked to the individuals who participated in these actions.
Historically speaking, the likely first media of exchange were wearable beads made from seashells from 120 000 years ago, which seemed to have no use-value other than being pretty collectibles. These beads were desired goods, nevertheless. While these peculiar ornamental proto monies/collectible possessed qualities that made them salable, no use value seemed required for these proto monies to emerge as monetary media successfully. They emerged because they had characteristics that made them good for monetary functions: trade between tribes to seal pacts, storing value for long periods, and transferring it to the next generations. Economics, and the axiom of human action, do not concern themselves with the rationality of actions, but only with how to best satisfy wants. Therefore, these previously mentioned bitcoin uses are not relevant; essential is that they existed.
The emergence of money is described in PART 2 as an organic market process where nobody instituted it. While bitcoin was not found but invented with a clear purpose, it still follows the theory. It was voluntarily adopted by individuals perceiving benefit in doing so: individuals were trying to satisfy their wants, whatever those may have been. Nobody was ever forced to use bitcoin. Bitcoin was offered to the market as a tool for a very old phenomenon: to facilitate exchange either now or in the future.
Bitcoin as proto money
See my discussion on proto money in PART 5.
Most media of exchange have some liquidity, which they attain at some point in their monetization process. However, in the previously mentioned ‘proto monies,’ they were seemingly illiquid: trades happened few and far between. While the times in which these proto monies arose were quite different from modern-day, it can be helpful to make a parallel between early proto monies and bitcoin. While the times were different, individuals' incentives and tendency to speculate seem to remain innate to humans. This is because, just like bitcoin, they seemed to have no other uses than being media of exchange in many cases.
If one views bitcoin in the beginning as proto-money, one can see how the early adopters might have had the same mission as early men did: to predict which things are going to be desired by other individuals. Individuals who speculated more successfully than their counterparts managed to acquire wealth by hoarding desirable objects. This can be contrasted to bitcoin. It can be seen how early users hoarded bitcoin because they, after evaluating its potential salability to be high enough, speculated about other people demanding it in the future. This speculation was exacerbated by emerging speculation markets such as an early bitcoin exchange MtGox. This process would naturally make individuals converge on a few dominant objects creating a feedback loop.
When viewed as proto money or “collectibles,” it makes sense for individuals to acquire bitcoin at early stages since users believed it could become money one day. Increased usage of bitcoin is what eventually made it transition past this proto money phase. Proto monies having these characteristics (wearability, hide ability), individuals innately perceived the benefit of exchanging “real goods” for these seemingly “useless” objects, possibly thinking that these pretty objects could also be demanded by other individuals that would also perceive the benefit of owning them. Bitcoin could have also been seen as “useless” since the benefits of owning it were not very observable. However, what is interesting is that the bitcoin exchange MtGox before being a place to trade bitcoin, was an exchange for trading other kinds of collectibles, namely “Magic: The Gathering Online” cards.
It can be said that during the first couple of years, when bitcoin had no price or purchasing power, it could have been described as collectible or proto money. Only a handful of people had insight and belief that bitcoin could potentially become a liquid monetary good. Like the bizarre proto monies, bitcoin satisfied someone’s need and later managed to accrue monetary value. It is up to debate if the separation between “use value” and “exchange value” is necessary. Buying into a medium of exchange is an implicit economic statement that this good (bitcoin) is demanded. As more people emulate this behavior, bitcoin can develop beyond being a “mere collectible.”
In PART 7 I will examine the salability of bitcoin more in-depth by focusing on three different dimensions.