September 8, 2013 2 Comments

“Why would anyone outside of a lunatic asylum want to hold money? What an insane use to put it! For it is a recognized characteristic of money as a store of wealth that it is barren; whereas practically every other form of storing wealth yields some interest or profit. “

John Maynard Keynes

This is how Keynes understood the functions of money because he believe that as individuals we should be self-interested enough to want to maximize the utility of money. Keynes believe that the public holds money for three purposes: to have on hand for ordinary transactions, to keep as a precaution against extraordinary expenses, and to use for speculative purposes.

This is called liquid preference. and it is more or less the idea that we would rather have a dollar that can purchase anything now, in our hands (as it IS the mode of exchange), than to have a bar of gold that is subject to storage fees, a house that is deteriorating or food that is rotting. That is because these are physical items subject to physical notions, and cannot be immediately exchangedthey are illiquid, and the more illiquid something is, the more risk that is taken on, hence the need for a higher dividend yield, or ROI on investment. This preference for money is due to the special properties of liquidity that money has.

Before I explain how bitcoin is different, it is very important to understand how the government sees money from the standpoint of liquidity preference. Because of this feature of money, the government likes to smudge the numbers on the money supplybiasing it with inflation. Their logic is that of Keynes: money is a stupid store of value, and we should punish those that horde their money through a hidden tax called inflation. This is done by slowly increasing the supply of money which more or less forces people to invest their money today when their is less total number of dollars in the economy, than in 5 years, when there are many more dollars in the economy, thus force the value of your money down. This is simply how fiat currencies work because they are based off of a fractional reserve banking system.

Now how is bitcoin different? Well, Bitcoin is not money as we know it

Bitcoin is a commodity.    It has all of the features that make it act like money, and is superior to money in many ways but it is a commodity money similar to gold.

When we understand bitcoin from this perspective, it causes for Keynes ideas of what money is to break down in its entirety when talking about Bitcoin and its functions as money.  Bitcoin destroys the concept of liquidity preference by imbuing finance into the internet itself, thus making everything and anything liquidmore so than cash itself. The proof of wealth itself exists in cyberspace, any sort of property can instantly become liquid by being able to be traded instantly on cyberspace exchange for that value in bitcoin.[1]

But more importantly, because bitcoin is commodity money it must be backed by the commodity value. I cannot just make up a bitcoin as the government can make up a dollar. My bitcoin must be backed by the very real work and energy that my computer expended to get that bitcoinor someone has to sell it to me. There is no other way to get bitcoins. Period.

This is very important in understanding the whole functions of an economy. By having a money that must be backed by some sort of real energy outputin this case the energy expended miningand it cannot be forged, and thus can be subject to true economic conditions, not the whims of governments. The value of each bitcoin come from that the work done to create it ensures that no more than 21 million can ever exist, and so by fixing the supply you give this form of currency value. This means that as people, we can make economic choices for ourselves, without the meddling hands of an overarching State whos actions within the economy and money supply continuously prove to be disastrous. That is why people flee to gold in times of crisisyou cant make up gold, and the commodity value (the resources needed to extract that gold today) of gold cannot collapse.

Finally, because bitcoin has the properties of a commodity, there is less rent seeking behavior which is healthier for the economy on a whole. I dont have to invest my bitcoins because my bitcoins in and of themselves are an investment. I know that with a fixed, steady supply that, generally overtime, my bitcoins should gain against fiat currencies. This means that I am not out desperately rent-seeking with my moneyI dont have to make stupid, risky investments, as one MUST do with fiat currencies to create value. I do however have the choice of making investments, which some are doing with the securities marketsjust like with gold. Through having a currency that has intrinsic value from how it is used, unlike fiat currencies, there is less rent seeking behavior, which helps create a more stable and healthy economy on a whole.

Bitcoin flips the idea of liquidity preference on its head because its not technically moneyits a commodity. Even though it is a commodity, it has all of the features of sound money. with the extra twist of living on the internet, which inherently makes it superior to money. So this means that holding fiat money, and being subject to the States abuse of liquidity preference will soon be an anachronism of the past.

[1] Aspects of this technology are still being developed with colored coins and other digital currency systems, but it is clear that being able to exchange and sign contracts via the internet, in a decentralized, peer-to-peer fashion will be available very soon.