Bitcoin’s zero-sum game

by John Quiggin on January 23, 2018

That’s the title of my latest piece in Inside Story. Nothing that will surprise anyone who’s been paying attention to what I’ve written on this, so I’ll just cite the conclusion

Since bitcoins are not useful as a medium of exchange, or desirable in themselves, their true value is zero. The highest price at which bitcoins have traded is around $20,000. At the time of writing, the market price is halfway between that level and zero. Pay your money (or not) and take your chances.

{ 65 comments }

1

Chet Murthy 01.23.18 at 7:53 am

John, isn’t USD (and other fiat currencies) already a “blockchain currency”? My understanding is, vanishingly little of the actual money supply consists in paper bills. Most of it is “balances at the Federal Reserve” and at banks. So in fact, it’s rows in a collection of tables in databases run by the FRB and financial institutions. Sure, those databases aren’t blockchains, but (a) as a distributed systems guy, I can make cogent arguments for why that difference isn’t germane, and in fact the FRB -could- use a “blockchain-like” system (Google Spanner) and almost nothing would change, and (b) if they’re (the blockchain currency folks) are really going to hang their hats on such a -technical- detail, uh … geez, I guess I’ll be shocked.

I guess what I’m saying is, it’s actually worse than what you said: if a government wanted to switch to a digital currency, they wouldn’t need to introduce a new one: they could just fully-digitize the one they already have.

2

Emma Goldman 01.23.18 at 10:44 am

Bitcoin has distinct properties which some people perceive to be of value, namely, it’s a currency with relative anonymity that stands outside of mainstream state and financial institutions, and that can be accessed and traded anywhere in the world with internet access with a simple key. I’m not saying that that outweighs it’s volatility, electricity usage, or the negatives of standing beyond the reach of the state, but some people think it does. Bitcoin comes out of the late-90s cypher-punks. A lot of its dedicated followers are libertarians, or at least anti-statist and of a very low opinion of Wall Street.

3

Coinlove 01.23.18 at 10:53 am

You really think the value of gold as an asset class derives primarily from its industrial uses or the desirability of shiny yellow jewellery? Is gold only valuable because it’s desirable, or does it’s desirability have something to do with the fact that it’s valuable? Is this question even meaningful? In any case it’s certainly much more useless than bitcoin as a means of exchange.

4

Foster Boondoggle 01.23.18 at 3:11 pm

Bit of a math error here:

If this were to happen, the value of the total stock of bitcoins would be equal to the value of US currency now in circulation, a bit over US$1 trillion. Since the stock of bitcoins is limited to twenty-one million, each coin would be worth around US$50 million. At a current price of US$10,000, this would be a bet worth taking at odds of 5000 to one.

10^12 / (2*10^6) = 5*10^5, which is 50 times the current level, not 5000 times. But that just makes the argument stronger.

5

Foster Boondoggle 01.23.18 at 3:12 pm

Sorry, my own math error! Should have been 2*10^7 in the denominator, and 50,000 as the result.

6

Jerry Vinokurov 01.23.18 at 4:24 pm

I think the easiest way to understand Bitcoin and various other cryptocurrencies is by looking at it as, essentially, a fandom. Bitcoins allow their holders to pretend like they’re brave resistors against the evil central banks; it’s a libertarian fantasy that you can actually enact, because it’s relatively easy to do so (much easier than actually living outside the existing economic system). Crypto is obviously parasitic on the existing economy and money system (were it not, what would even be the point of citing conversion rates?) but it gives you this nice illusion of sticking it to the man. Nevermind that the vast bulk of the coins are held by the early adopters who got in when the mining was easy and that the rest of the mining is now helping to generate environmental catastrophes worldwide. But hey, it gives you the opportunity to cosplay the brave libertarian without getting off your couch.

7

sapaterson 01.23.18 at 4:35 pm

Dear John Quiggin,
Thanks so much for that great article on bitcoins. I come to Crooked Timber to read discussions on classic literature and forgot that you are an economist – most of that has to do with your smooth style. And thanks for those two nuggets: seigniorage and fiat money; the difference in value of a currency and the cost of its manifestation, and the intrinsic value of a currency not exchanged for gold based on the ability to tax as well as to demand these taxes be paid in that legal tender. Anyone who thinks of bitcoions with these two notions in mind will certainly avoid them as they plunge into the depths of valuelessness.

Bitcoins were fascinating as a concept as was the world of cryptocurrencies. What’s more amazing is the willingness and ability of society to engage in experimenting with economic concepts that are new or at least previously undefined.

I’ve been invading websites with my lengthy comments for a couple of weeks now to sound the clarion call of the consequences of the widening gap between the haves and have nots as teased out by Thomas Pikkety in Capital in the Twenty-First Century . The concentration of wealth is accelerating, when measured in national income, and historically has only been this bad just before the Bell Epoch, WW I, and WW II. How will we fare this time?

The reason for today’s invasion is brief(er). People need to embrace economic solutions to inequality and bitcoins has all the worst characteristics of Capitalism whose ultimate motive is to promote and glorify inequality. May I suggest as an alternative approach to Capitalism itself is the worker’s co-op model as espoused by Richard Wolff and others?

Think of this: a house is built in a cooperative model. Ten workers organized by complementary skills and abilities pool their borrowing power to finance the construction of a house. They agree to a prearranged structure of pay so that creditors are rewarded and those devoting specialty work or longer hours are commensurately compensated. When the house is sold on the open market they, presumably receive a larger share of the profit and are given higher credit ratings to boot. That means wealth where it is needed most to prevent the conflagration associated with unequal economic growth pointed out by Piketty.

So here’s the fun part. Co-ops support co-ops, giving them better deals and top priority; with the understanding that they coordinate like a political party with open primary votes where Co-op candidates stack up against the others. If they appear to give strength to a Republican or another whose politics are intolerable and the Socialist candidate is in the minority they drop out. But if they garner more votes than does the Democratic candidate we urge them to drop out. This game of Primary Chicken gives the Party the opportunity to articulate the advantages of the co-op structure which is the real purpose of the party.

‘Cause here’s the thing: The Republican Party is dead man walking – the Russia-gate scandal as well as the willingness of the Party to represent the interests of the .01% at the expense of the rest of us (think about the winners and losers in the proliferation of fossil fuels). The Dems run on the “I’m not Trump” campaign and continue to obstruct Progressive Democratic Socialist candidates with celebrity candidates or worse, almost without opposition they slip back into those easy habits of big donor campaign contributions which makes them the defacto Republican Party, talking about change while delivering to their donor class.

That’s when the Co-op Party will shine. It’s four, maybe eight years away, but the opportunity to end economic disparity awaits for those who are prepared and organized.

8

MisterMr 01.23.18 at 5:16 pm

“Since bitcoins are not useful as a medium of exchange […] their true value is zero”

My understanding is that the value of a “medium of exchange” is also zero.

For example if the USA has a NDP of 100$, with a “money base” of 10 circulating $, the total value of NDP is still 100$, not 110$.
One doesn’t count again the “money base” as value.

9

L2P 01.23.18 at 5:25 pm

“In any case it’s [Gold’s] certainly much more useless than bitcoin as a means of exchange.”

This seems like a curious statement, since it was literally the standard currency for most of civilization. It still would be if we wanted a deflationary currency like bitcoin. What’s your thinking here?

In any event, John’s not saying that ALL of gold’s value comes from its inherent usefulness. He’s saying that because it has SOME inherent usefulness it has SOME value regardless of how much people like it for “desirability.” This is different from all fiat currency, which literally is valued only by its “desirability.” A dollar, like a bitcoin, is only worth what people think it’s worth. It has no inherent usefulness except for negligible material costs.

But dollars, unlike Bitcoin, also have an “inherent usefulness.” Dollars (in total) are worth, at a minimum, the collective tax liabilities of all taxpayers. The US Government will always accept dollars for tax debts. This is different from Bitcoins, which aren’t backed by any usefulness. They can only be used if somebody else wants one, and have no floor they can’t fall through.

10

Philip Mole 01.23.18 at 7:01 pm

“Is gold only valuable because it’s desirable, or does it’s desirability have something to do with the fact that it’s valuable? Is this question even meaningful? In any case it’s certainly much more useless than bitcoin as a means of exchange.”

Except that thousands of years of gold being used as both a means of exchange and a store of value kind of contradict that point.

11

MPAVictoria 01.23.18 at 7:46 pm

” In any case it’s certainly much more useless than bitcoin as a means of exchange.”

WAY more places I can exchange gold for cash than BitCoin.

12

Cian 01.23.18 at 10:35 pm

Coinlove: Even in societies where gold has been relatively common it’s been valued for it’s decorative purposes. People think it’s pretty.

If I have gold I can make and sell jewelry from it in pretty much any society. This gives it a base value as a commodity. Bitcoin has zero value as a commodity. There is literally nothing that I can make from it.

13

Peter T 01.23.18 at 11:47 pm

Money is a system of transferable debt. How it is recorded (clay tablet, metal, paper, computer) is immaterial. What counts is who owes it. The entire US community owes debts created by the issue of US notes or coins. It is not clear to me that the owners of Bitcoin debt have any substantial backing.

14

Coinlove 01.24.18 at 12:59 am

Gold is useful as a means of exchange if you’re able to hand a piece of gold to somebody in the same physical location as yourself; this is how it worked for thousands of years.

Now if gold could be physically teleported by somebody sitting at a computer to anyone else on earth with a computer, then its usefulness as a means of exchange would more closely resemble that of bitcoin. (This doesn’t mean bitcoin is a terrific means of exchange, just vastly better than gold. Also “means of exchange” doesn’t mean “number of places you can sell for cash”, but in any case I can sell bitcoin for cash without leaving my computer.)

As for people desiring gold because they know they can turn it into jewelry… you can turn a lot of things into jewelry. What makes gold a significant asset class for investors? Not its convertibility into jewelry. Or electronic circuits.

15

Coinlove 01.24.18 at 1:16 am

Also… to argue that bitcoin is inherently worthless because it’s only worth something if someone else wants one is circular and meaningless. When the price falls to zero it will be because nobody wants one. And then it will be worthless.

16

John Quiggin 01.24.18 at 1:45 am

@4 It’s so embarrassing. I actually checked and convinced myself I had the right order of magnitude. It’s fixed now, fortunately.

17

Moz of Yarramulla 01.24.18 at 2:04 am

Not to mention that bitcoin is incredibly fragile as a “store of value”, between the fluctuations in exchange rate and the ease with which it can be damaged or lost, it’s more like using artwork or IOU’s. Estimates for the number of lost bitcoins vary, but there’s solid proof that the number is at least 1000, and suspicions that it’s between 1 and 2 million (largely depending on your belief about Nakamoto’s million+ unspent coins).

18

derrida derider 01.24.18 at 4:38 am

“This [that gold is useless as a medium of exchange] seems like a curious statement, since it was literally the standard currency for most of civilization” – L2P @9

A quibble, but silver was always – right up to the C19 – more common as base money than gold. The shift to gold came with proper central banking and hence effective money multipliers – silver’s relative bulk was an inconvenience for central banks to hold in their vaults.

Plus of course many other commodities have been tried as a base to secure banknotes or equivalent against. The French tried assignats in the revolution – property claims on land (aided by Madam La Guillotine disposing of rival claims). And as JK Galbraith pointed out, tobacco had a longer run in the southern US as a monetary base than either silver or gold – the main problem was that it was hard to control the money supply as it was easy to pass other weeds off as tobacco.

As John points out, though, what they all had in common was that the base had some intrinsic use and hence demand, which both fiat currencies don’t need but which bitcoin lack.

19

Peter T 01.24.18 at 5:41 am

The base money for well over a thousand years before coins were invented was the IOU, mostly but not always denoted in some common unit. And this continues to be the usual form of money. The medieval villager had a tab at the mill and a tally-stick for the royal taxes. We have Visa. The medieval merchant settled accounts at the great fairs by netting out debts, then accepting an IOU or coin for the balance depending on his assessment of creditworthiness. We do it with a letter of credit and a set of accounts at central banks.

20

tomsk 01.24.18 at 1:04 pm

My own sense is that the (final?) great bitcoin crash won’t be long . It’s next to unusable as a payment mechanism now due to lag and ridiculous transaction fees, so the fundamental use case of buying drugs looks pretty much dead in the water. Can bitcoins be worth thousands when you can’t buy/sell anything with them in a remotely economical way? We’ll see.

21

tomsk 01.24.18 at 1:08 pm

Jerry Vinokurov @ 6

“…essentially, a fandom. Bitcoins allow their holders to pretend like they’re brave resistors against the evil central banks.”

I hadn’t thought about it in quite these terms before but this seems dead on.

22

Z 01.24.18 at 1:40 pm

I think the easiest way to understand Bitcoin and various other cryptocurrencies is by looking at it as, essentially, a fandom

I think that’s precisely right.

23

TM 01.24.18 at 2:54 pm

If Bitcoin is useful for cheap, efficient and secure money transfer, as most advocates seem to claim, I wonder if they couldn’t just have created a network for cheap, efficient and secure money transfer, based on the Blockchain, that uses an already existing currency, let’s say … the dollar? That way the whole volatility and speculation issue could have been avoided. Does anyone have an explanation why they chose this route, unless volatility and speculation were intended by design? The claim that this makes Bitcoin “independent” of states and banks and so on is of course nonsense.

24

Cian 01.24.18 at 2:54 pm

Also… to argue that bitcoin is inherently worthless because it’s only worth something if someone else wants one is circular and meaningless. When the price falls to zero it will be because nobody wants one. And then it will be worthless.

If people stop believing that bitcoins are valuable then it’s value will be zero as you can’t make anything with a bitcoin.

If people decide that gold is no longer a ‘valuable’ metal it will still have a value above zero, as it has uses as a commodity.

25

MPAVictoria 01.24.18 at 3:53 pm

“This doesn’t mean bitcoin is a terrific means of exchange, just vastly better than gold”

But… it isn’t though. You keep saying this but it isn’t true. I can buy and sell gold online at WAY more places than bitcoin. If I have physical gold I can take it to WAY more places again.

26

Whirrlaway 01.24.18 at 3:54 pm

Maybe someday botcoins of some sort will have the social construction behind them that gold does, but gold is so much easier for a human to grasp (as it were). Dollars are a social construction that owns an army and a navy and so will have legs for now.

27

hix 01.24.18 at 4:34 pm

Wouldnt the right headline be negative sum game?
Theres also a sentence repetition: Unfortunately for Bitcoin fans, the chances of this happening are a lot less than five to one.

Unfortunately for bitcoin fans, the chances of this happening are a lot less than that.

28

SamChevre 01.24.18 at 4:44 pm

I wonder if they couldn’t just have created a network for cheap, efficient and secure money transfer, based on the Blockchain, that uses an already existing currency, let’s say … the dollar?

Because if you use dollars, you have to comply with US law (including all the know-your-customer reporting that bitcoin is designed to avoid): that’s why the US could prosecute a Swiss citizen for taking bribes in Qatar while working for a Swiss organization–they were paid in dollars, so US anti-bribery law applied even though nothing about the transaction had anything to do with the US

29

Scott P. 01.24.18 at 5:21 pm

“As for people desiring gold because they know they can turn it into jewelry… you can turn a lot of things into jewelry. What makes gold a significant asset class for investors?”

And those things — such as Spondylus shells on the Peruvian coast, or cowrie shells/coral in West Africa — were also used as money in much the same way that gold was in other regions.

30

al 01.24.18 at 6:44 pm

@8 – “100$” = ?R

31

Sandwichman 01.24.18 at 6:49 pm

Good one, Whirrlaway @25: “botcoins”

This “medium of exchange” business is apparently unshakable. Yes, bitcoins can function as a medium of exchange. That’s trivial. So can coconuts.

The important function of a monetary unit is as a stable counter for credit transactions. A volatile “medium of exchange” can play almost no role in credit transactions except perhaps a minor one as collateral for loans denominated in a stable currency.

Who wants to borrow in bitcoins worth $10,000 and repay in bitcoins worth $20,000? Who wants to lend in bitcoins worth $20,000 and get repaid in $10,000 bitcoins?

32

Coinlove 01.24.18 at 7:40 pm

You can sell many things online whether it be gold, used laptops, furniture etc. what you cannot do is transport these things over the internet at the point of sale. Bitcoin you can. That’s the difference.

33

Coinlove 01.24.18 at 7:45 pm

MPAVictoria please explain how I can use a piece of gold that I have in my house to buy something from someone on the other side of the world without leaving my house.

34

Coinlove 01.24.18 at 7:49 pm

Cian, so what? Is the argument then that the “inherent value” of gold is what it would have if it were not a “valuable” metal but instead just a mere “commodity”? Is any difference in the price of gold between above what it would be if it were not “valuable” just an illusory bubble?

35

Coinlove 01.24.18 at 7:53 pm

Scott P; again, so what? Gold is not (today) money. It is still a significant asset class. Is this because investors are attracted to its shiny yellow lustre? Or because they choose investments on the basis of jewellery-convertibility?

36

Coinlove 01.24.18 at 7:57 pm

“Maybe someday botcoins of some sort will have the social construction behind them that gold does, but gold is so much easier for a human to grasp (as it were).”

Indeed the change in the value of crypto currencies since Prof Quiggin first predicted a bitcoin price of zero is the manifestation of this evolving social construction.

37

alexh 01.24.18 at 8:05 pm

> If people stop believing that bitcoins are valuable then it’s value will be zero

Hackers launching a successful ransom-ware attacks requesting bitcoin necessarily don’t need to think it’s that valuable to them. Demanding bitcoin an entirely safe (to them) way of making their victims squirm; is it not possible that some would do this more or less for (sick) fun? (Or something else. Wikipedia says about 2017 Ukraine ‘Petya’ attack that
‘ The attack has been seen to be more likely aimed at crippling the Ukrainian state rather than for monetary reasons’ – even though, perhaps to obsfucate this purpose, it did ask the victims to provide bitcoins.)

And then, voila, bitcoin suddenly has real value – to ransomware victims; ‘disbelieving’ doesn’t unlock their computers. And (reportedly) many banks today feel it prudent to actually stockpile bitcoin because one day they _might_ be victims of such ransomware. So now there’s even more true demand. Hence yet more incentive for hackers to launch bitcoin based ransomware attacks…. I doubt the equilibrium of this is truly zero value.

38

Chip Daniels 01.24.18 at 11:35 pm

@9:
“Dollars (in total) are worth, at a minimum, the collective tax liabilities of all taxpayers. “

This is what I have been thinking, but since I’m not an economist, I can stand to be corrected.
I hear a lot of claims about how fiat currencies are just a collective illusion, that they have no intrinsic value, but don’t they have the value of the government’s ability to extract very real tangible wealth from the areas it controls?

In other words, couldn’t the US government demand tax payment in the form of commodities and goods like wheat or oil or machinery, the way ancient government took hides and such? Wildly impractical, but theoretically possible?

Or to put it in yet another way, isn’t it correct to say that governments hold a tax lien, a legal claim upon some portion of every bit of wealth produced within their borders, plus the will and ability to foreclose on that lien?

39

Whirrlaway 01.25.18 at 2:53 am

alexh, Totally analogous to the foundation of the dollar et all in the tax requirements of some state. @Coinlove, so colorably the equivalent of acquiring an army.

40

TM 01.25.18 at 8:28 am

28: “Because if you use dollars, you have to comply with US law “

Is that so? My understanding is that financial regulators treat Bitcoin no different from “conventional” money. I can’t claim much expertise in this area but it doesn’t seem plausible that the mere fact of calling something Bitcoin instead of Dollar has those huge legal – and practical – ramifications the advocates claim. Or to put it differently, if a dollar-denoted cryptocurrency can be policed by the state then I don’t see how any cryptocurrency can evade control by the state, once state interest is strong enough.

41

alexh 01.25.18 at 8:40 am

> alexh, Totally analogous to the foundation of the dollar et all in the tax requirements of some state

I wouldn’t be confident that extortion (resp, taxes) is “the” foundation of bitcoin (resp, dollar) value, but we can clearly see that it (paying the extorters) is _a_ source of genuine bitcoin demand. Demand as in ‘some people will pay real money to acquire bitcoin’ (to pay blackmail), and major financial institutions will pay real money for bitcoin even to get insurance for possible future blackmail. This really happens.

So to say of bitcoin that “their the value is zero”, or to suggest that what value they have is solely due to some sort of collective delusion, is at best exaggerating and at worse plain wrong. (Or, to be fair, requires a very different definition of ‘value’ to what I have mind;
e.g. perhaps a definition more aesthetic or morality-based than economic)

42

TM 01.25.18 at 9:02 am

Or to put it differently, they could call it whatever they want but specify in advance a fixed exchange rate with an existing currency, or (hwy not) with gold. This should have no implications for its legal status.

43

Collin Street 01.25.18 at 9:14 am

Scott P; again, so what? Gold is not (today) money. It is still a significant asset class. Is this because investors are attracted to its shiny yellow lustre? Or because they choose investments on the basis of jewellery-convertibility?

Basically the latter. But note, they don’t need to want to convert it into jewelry themselves; as long as they can sell it to somebody who does, or to somebody who thinks they can, then the price is stablised.

Or, more technically. If there’s an imperfect substitute [say brass] for an expensive product [say, gold], a fall in the price of the preferred-but-expensive alternative leads to people shifting their purchases from brass to gold; demand elasticity is extremely high, the demand curve is nearly vertical, and the clearance price doesn’t shift much. Just a tiny bit.

Individual buyers don’t need to be involved in jewelry themselves to take advantage of this; as long as enough people want gold for shiny to stablilise the price this way — and this shows no signs of changing — then the price is more-or-less stable and people can allow for this in planning their trades.

44

Coinlove 01.25.18 at 10:24 am

‘Crypto-currency’ is a term that misleads both proponent and detractors. Obviously bitcoin etc is not issued by any state and does not settle liabilities to any state. They lack this critical property that would make them resemble cash-money. ‘Crypto-asset’ is a less confusing term that better describes what these ‘mined’ blockchain tokens actually are; the original concept-design was named ‘bitgold’ and the relevant comparison is not to official currencies but to gold as an ‘valuable’ asset.

45

Coinlove 01.25.18 at 10:30 am

Collin Street without explaining *why* the demand curve is ‘nearly vertical’ then you haven’t really explained anything. Why is gold stored in bank vaults and not other things used to make jewelry?

46

Peter Erwin 01.25.18 at 11:02 am

Coinlove @14:
What makes gold a significant asset class for investors? Not its convertibility into jewelry. Or electronic circuits.

Going by figures for the past 5–10 years from the World Gold Council, slightly over 50% of the demand for gold is for jewelry and another 10% is for technological/industrial uses, with a little under 30% for coins, bars, and “ETFs” (exchange-traded funds) and 10% for central banks.

So it appears that about 60% of gold’s value comes from the combination of jewelry and industrial use.

47

Trader Joe 01.25.18 at 12:58 pm

Now a word from the trading desk.

While some of the reasons above are reasons people own gold, jewelry making and industrial uses don’t begin to explain more than about $200-300 of gold price (that would be a floor). To the greatest extent the value of gold is fixed by financial buyers and sellers who utilize it as an asset class that is uncorrelated to all other asset classes save the US dollar (it correlates to that because its priced in that, though it wouldn’t have to be).

Accordingly, some of the math majors around this might be able to explain in more detail, adding it to almost any portfolio reduces its volatility and can increase its expected risk adjusted return (though not necessarily its absolute return). This is despite gold being fundamentally a negative yielding asset (i.e. somewhere the financial instrument is backed by physical gold which must be insured, stored, secured etc.).

As such, gold is added to portfolios during periods of natural market volatility due to geo-political or economic-social crisis and is removed from portfolios when that volatility dampening effect isn’t useful.

There is no inherent reason Bitcoin or any other non-correlated asset couldn’t perform the same function except that as currently traded it doesn’t. Right now Bitcoin would add volatility to nearly any possible portfolio and adding volatility via a negative return asset reduces expected risk adjusted returns across nearly any portfolio – no one would want that, so for now, it remains an inferior asset.

(Bitcoin has a negative expected return since it has frictional cost to trade and doesn’t inherently produce cash flows, it avoids the holding costs of gold, which isn’t insignificant, but it doesn’t produce returns).

So, long story short – Bitcoin has some characteristics that COULD make it better than gold, but 2000 years of history and embedded infrastructure and massive current volatility are more than 100% neutralizing that advantage. Proponents will only be right if a decided majority agrees they are right (like a fandom)….till then, the naysayers by definition are correct.

48

Coinlove 01.25.18 at 3:45 pm

Peter Erwin, firstly those figures relate to newly mined gold not the overall stock of gold, secondly such a decomposition of the value of gold doesn’t follow logically unless you also believe that more than half of all movements in the price of gold can be attributed to corresponding changes in the quantities of gold utilised for non-investment purposes, which is obviously not the case.

49

Collin Street 01.25.18 at 9:17 pm

Collin Street without explaining *why* the demand curve is ‘nearly vertical’ then you haven’t really explained anything.

I did, though. “A fall in the price of the preferred-but-expensive alternative leads to people shifting their purchases from brass to gold”. The existence of a cheaper imperfect substitute stabilises the price of the preferred-but-expensive option, and this effect is very big with gold.

Or you could just skip the technical/mathematical details and run on the first paragraph, which says basically the same thing in a straightforward easy-to-understand format. There’s no shame in that.

50

mpowell 01.25.18 at 10:39 pm

Trader Joe,

How do you conclude on how much value jewelry and industrial uses drive the price of gold? After all, people are using gold for these use cases at today’s prices. How do you assess what the volume of jewelry based demand would be at 70% of the current market price?

51

Coinlove 01.26.18 at 12:17 am

I read both your paragraphs and the closest you came to explaining the phenomenon you describe was “people like shiny”. But brass and gold are both shiny and the phenomenon you describe should have a stabilizing effect on both prices (at least relative to each other). People prefer gold because it’s valuable; it’s also valuable because they prefer it; an explanation that hinges on such preferences is tautological. And there are cheaper “imperfect substitutes” for almost anything used to make jewelry, so that doesn’t distinguish gold and isn’t an adequate explanation either. Are you saying that gold is a major investment asset, stored in bank vaults around the world, because it’s the only product used in jewelry with a cheaper substitute? Also if gold has a high own-price elasticity of demand I think you mean the demand curve is nearly horizontal not nearly vertical.

52

Whirrlaway 01.26.18 at 4:50 am

“botcoin” (I confess) was a retained typo, but the physical foundation of bitcoins is in fact in the ability of the internet to communicate and maintain the blockchain stuff [reliably, timely, securely, economically, etc], as a sort of VPN or botnet. I don’t know that it is obvious that that network can be carried indefinitely into the future as hardware and protocols evolve. Not forgetting the political difficulties in such migration. Rather less durable than dollar-like currency I would think, and useful or not gold will at least always be gold.

53

John Quiggin 01.26.18 at 7:06 am

Gold is not just shiny but highly malleable and ductile, which accounts for the eagerness with which it has traditionally been sought as a jewellery item. It’s true that the preference for gold over apparently close substitutes has an element of social convention, and this is true of a lot of rare items that aren’t used as money (diamonds vs zirconia for example). But these conventions aren’t totally arbitrary in the way that Bitcoin fans want, and they aren’t at all related to the success of fiat money, which reflects the states power to tax.

54

Coinlove 01.26.18 at 7:22 am

Nobody (here) is claiming that the preference for gold over other malleable, ductile metals is totally arbitrary, nor that it is related to the success of fiat money… the claim is that similar arguments made for bitcoin having an “intrinsic value” of zero could be made for gold having an “intrinsic value” that would be (much) lower than its actual price.

For an insight into what such arguments may be missing, it is informative to read Szabo’s ‘bit gold’ proposal, which was written several years before the invention of bitcoin:

http://unenumerated.blogspot.com.au/2005/12/bit-gold.html

55

Collin Street 01.26.18 at 1:34 pm

Also if gold has a high own-price elasticity of demand I think you mean the demand curve is nearly horizontal not nearly vertical.

If you understood that much then you should be able to work out the rest, and that being so some of understandings/confusions you claim to have look a bit disingenuous. Stimulated, as the soccer players call it.

Ultimately… it works. Gold price is stable. If you understand how, great. If you don’t… well, it’s still happening whether you understand or not, isn’t it? Nobody needs your understanding to keep things going.

56

Peter Erwin 01.26.18 at 3:33 pm

But brass and gold are both shiny

In addition to the points John made, there is the fact that brass tarnishes (and can even corrode) — and can sometimes leave a residue on your skin — while gold does not. So it’s not entirely a matter of “they’re both shiny and therefore equally useful”.

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Trader Joe 01.26.18 at 6:35 pm

@50mpowell
The biggest element in the price is the cost to mine. Obviously mines vary, but the big producers tend to have an average cost in the $800-900 range. Beyond that you have to look at it in reverse – don’t look at what the demand for Jewelry and industrial is because in the short-run that is relatively fixed, you have to look at Bar, Coin and ETF demand and where it inflects higher. In recent years that has been in the +$1300 range. That tells me by difference the price associated with industrial and jewelry usage.

Obviously a dynamic calculation to some extent and there is no rule that price can’t fall below cost. What happens however as the gold price rises is the supply that comes from recycled gold goes up. Recycled gold isn’t normally used for bars/coins so the excess supply created by price serves to limit the price effect from fabrication/usage (rather than financial) market.

We can also see it from gold surplus/deficit calculations. Since 2014 there has been a surplus and the price of gold has stayed largely between $1100-1300.

If you’re interested in this stuff gold.org (the world gold council) has enough data to choke even the biggest goldbug.

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Collin Street 01.27.18 at 12:11 am

the claim is that similar arguments made for bitcoin having an “intrinsic value” of zero could be made for gold having an “intrinsic value” that would be (much) lower than its actual price.

It does. The “underlying” price for gold has been discussed in reasonable detail in this very discussion, as Trader Joe has mentioned and as you’ve responded to: it’s a lot lower.

But because of the way “capital” works, losing almost all your money is an incalculable improvement on losing actually all your money; assets with small residual values are vastly preferred over assets with none. We can see this with other asset-classes as well, although I cfb digging up details for you for reasons, that strike me as adequate.

[also, of course, a collapse in gold price is modelled as an extremely unlikely event, but collapses in bitcoin to zero are modelled with odds on the ranges of “inevitable over the medium term” to “eh, definitely on the cards”; this also matters]

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alexh 01.27.18 at 12:47 am

Mr Quiggan, I don’t so much care if you scoff at me but it seems to be a fact that in June 2017 rather a lot of Ukrainian entities were scrambling to find bitcoin after the Russian cyber-attack. And another fact (based on the press) is that major banks are accumulating bitcoin without the slightest speculative motive, but as insurance.
What meaning of “value” do you have in mind to say that bitcoin has truly zero value in light of its usefulness in resolving extortion.

Unless I’m completely off base, this is a somewhat important question. If someone can create wealth using an entirely-‘safe’ extortion scheme, we have – not something to be ignored, not something to be blown off as a ‘bubble’ or ‘zero value’, but a societal threat. I have no bitcoin or cryptocoin, and no interest in such, but to the contrary am scared that neglect threatens society.

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alexh 01.27.18 at 12:53 am

(Continuing previous comment)

When attacking bitcoin (no interest, I think it should be actively destroyed) it’s satisfying and easy to address the gold-bugs and the bitcoin-is-like-gold fanatics. Except, you’ve got some pretty smart commenter on the ‘gold’ side, a tribute to your audience.

But resting your case on ‘here are reasons why bitcoin differs from cold” seems weak.

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Coinlove 01.27.18 at 12:53 am

In addition to the points John made, there is the fact that brass tarnishes (and can even corrode)…

we’re finally getting to the point.

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Collin Street 01.27.18 at 2:34 am

Seriously, there’s nothing impressive about the value of gold analysis, this is literally textbook stuff. I have literally the least amount of formal economics training it’s possible for a human to have (one year lower level high school elective) and this sort of content was covered.

And I don’t think anybody here thinks that specie money is a good idea. “Even worse than gold” is dismissal of bitcoin, not praise for metal.

(If you want post-collapse resources? Learn to make shoes)

@coinlove: thinking in terms of “the point” will blind you to your own conceptual errors.

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Coinlove 01.27.18 at 3:33 am

and missing the point leads you to irrelevancies and circular reasoning

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Coinlove 01.27.18 at 3:44 am

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Collin Street 01.27.18 at 6:14 am

When you say “the point”, coinlove, what you actually mean to say is “my point”. But calling it “the” rather than “my”… well, it blinds you to the points others are trying to make, doesn’t it. It’s an insistence that the thing you’ve recognised is the only thing anybody needs to pay attention to, that the observations and deductions of others are worthless.

Which, well, is great if you’re right… but also it means you’ll never be challenged, never see the mistakes you do make, and blocks you from learning from your misconceptions. Which means… well, the more you have a personality that insists on their correctness, the less likely you’ll actually be to be correct.

It’s making yourself stupid, coinlove. Allow yourself to learn from other people by allowing them the chance to show you your mistakes.

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