Gresham’s law: Is Bitcoin good money or bad money?
As he states in the whitepaper, Satoshi Nakamoto envisioned Bitcoin as a peer-to-peer electronic cash system for online payments. However, under the “HODL” warcry, the community seems to have given it a better use as a store of value. That’s not a bad thing, though. Quite the contrary, it means that Bitcoin has proven to be what we call “good money.”
Thomas Gresham, the merchant ahead of his time
Thomas Gresham was a merchant and financier that worked for the Crown of England during the 16th century. England’s currency was already the British pound sterling, but its face value was so high that there were three different units: the pound, which was equivalent to 12 shillings, which in turn were worth 240 pennies each. Each one consisted of a small, silver coin. Back then, all currency was backed by precious metals, which provided their value.
However, the Crown changed the composition of the shilling, replacing a good amount of the silver with regular metals. The people quickly became aware and started separating those coins — let’s call them “bad shillings” — from the original, full-silver ones — the “good shillings” — based on their minting date.
These coins were still worth the same by law, but merchants, obliged to accept them, received less silver for their products. The face value fixed by the government didn’t change, but the real value of bad shillings, measured in the silver they contained, was lower. In other words, those coins were overvalued.
Gresham’s law
Being forced to accept both “good” and “bad” shillings, merchants’ only alternative was to raise prices. So, for example, instead of charging one shilling for their product, they now asked for one and a quarter. That way, they’d ensure to receive the same amount of silver as before.
But now, another problem arises. If merchants are charging one and a quarter of a shilling — whether a “good” or “bad” shilling — people using good shillings would be taking a loss. They could just use bad shillings worth the same and melt the good ones down for the silver, which would be worth more than their face value.
This is essentially what Gresham’s law is all about. Essentially, it states that legally overvalued currency will tend to drive legally undervalued currency out of the market. In other words: bad money displaces good money out of circulation whenever there are two or more legal currencies in a market. For “bad money,” we understand the one whose face value is higher than its real value — in other words, it’s overvalued. In this case, the bad shillings are worth more than the silver they’re made of. On the other hand, “good money” would be the one with greater real value or more potential for greater value than its face value — or undervalued money — . That said, the silver used to mint good shillings was worth more than the shilling itself, hence “good money.”
Modern applications of Gresham’s law: Bitcoin and fiat
You may be thinking how a 500-year-old principle for a completely different economy from ours may apply to our current system. The truth is, Gresham’s law is still valid today.
Since the abandonment of the gold standard and the transition to fiat, the theory has moved from currencies’ intrinsic value to its fundamentals, stability, and strength on international markets. “Bad money” no longer refers to being overvalued, but to currencies which undergo constant and progressive loss of their purchasing power (devaluation). Contrarily, we use “good money” to describe currencies that maintain stability over time, keeping their purchasing power and appreciating against those that don’t.
Bitcoin’s fundamentals of security, agility, scarcity, and controlled emission make it the best money we have. Yes, it’s volatile, but it only takes a glance at the charts to see how Bitcoin appreciates against fiat currencies in the long term, not only keeping its purchasing power but acquiring more and more over time. Additionally, anyone using Bitcoin knows precisely how much available supply there is and how much there will be at any point in time.
On that note, fiat currency is today’s “bad money.” It is centralized, devaluatory, and inflationary. It doesn’t even have clear rules. Their respective issuing institutions can change them unilaterally in the blink of an eye, making it immensely unstable and unpredictable.
Therefore, Gresham’s law: bad money drives good money out of circulation. We as a community have decided to use Bitcoin as a store of value rather than Satoshi’s original plan for it to become a common means of payment because we are logical, rational beings. We’d rather get rid of our bad money — fiat — to acquire goods and services and keep our good money — Bitcoin — for ourselves. Just like people five centuries ago saved their silver shillings and used bad shillings for commerce.
Bitcoin is good money
If we’re discussing good and bad money, it’s hard to find a reason not to categorize Bitcoin as the best currency that ever existed. It is the most secure, accessible, and agile to use, and its laws — its “monetary policy” — written in its code, are crystal clear, immutable, and equal to everyone and anyone.
Consequently, it’s pretty reasonable that people choose to store it in their cold wallets and don’t touch it for years. This doesn’t mean they can’t or shouldn’t use Bitcoin to pay for something. It just explains why most of them don’t want to. And that is not a bad thing at all. It shows how strong Bitcoin is as a currency, and simultaneously, how “bad money” fiat currency really is.
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