– September 16, 2019
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Two weeks ago, I had the good fortune of giving a series of talks on different subjects in Reykjavik, Iceland. Among the topics were Neutral Moresnet, the apparent coming of the age of negative interest rates as a policy option for central bankers, and cryptocurrencies.

In my talk about cryptocurrencies, I raised the possibility that where for years many have viewed the relationship between gold and Bitcoin as essentially substitute goods, in my view, they are evolving as complementary goods: gold the superior store of value, Bitcoin an easier-to-use medium of exchange. (As part of that analysis, I view the superior unit of account as U.S. dollars, but that is a discussion for another time.)

I noted that for roughly the last three months Bitcoin and spot gold have seen an over 80 percent daily price correlation, where — by comparison — close substitutes Coca-Cola versus Pepsi and Home Depot versus Lowes have been less than 30 percent correlated over the same time period. Clearly the market is assessing the two alternative assets as approximations of one another, driven no doubt by mounting worries about the state of the U.S. economy and the evolution of a stalemate in the U.S.–China trade war.

After my talk, a student asked me if I thought it was interesting that gold came to prominence as a widely accepted form of money as a result of many centuries of market processes whereas Bitcoin was simply invented, becoming within a few short years the center of gravity of the entire cryptocurrency complex. I’d previously heard, as a criticism of Bitcoin, that both the white paper and shortly thereafter the actual technology appeared essentially out of nowhere. A group of developers, the story goes, dropped Bitcoin into the market, whereafter it gained an insurmountable lead in usage and popularity.

This argument has been employed by fiat-currency enthusiasts and anti-crypto goldbugs as a reason why Bitcoin will never (or can’t) become a form of money, and by a number of Modern Monetary Theory proponents in support of their foundational State Theory of Money. In the lattermost case: Bitcoin was invented out of thin air, but no matter what happens to its fundamental attributes it will only become money when a government accepts it as payment for taxes.

I agreed with the student that the circumstances that have led to Bitcoin being considered an increasingly close substitute for gold involve many contrary elements: physical versus digital; price stability versus volatility; spontaneously ordered versus invented.

But on this last point, both the student and I were wrong.

In precisely the same manner as humans have used (and eventually abandoned) shells, beads, large stone discs, and ultimately different kinds of metal (copper, silver, gold, etc.) for money, Bitcoin is at the creative nexus of several long trains of experimentation and invention. Both the rise of gold and the development of Bitcoin occurred via a series of iterative, uncoordinated processes: in the case of gold, in the marketplace for money; in the case of Bitcoin, as the product arising from numerous originally unrelated innovations in several markets, each of those, in turn, coming from different minds and institutions with wholly unrelated objectives at the outset.

For example: the history of cryptography, which is the cornerstone of Bitcoin’s security, goes back to ancient history; modern crypto history arguably begins in 1976, with the Diffie and Hellman paper on public-key cryptography. The proof-of-work protocol used to confirm new transactions and add new blocks to the blockchain finds at least some of its early inspiration in 1992 and 2002 papers (the latter after being proposed in 1997). Napster may have been the first popular firm employing a peer-to-peer architecture, but it certainly wasn’t the first. IRC and Usenet preceded it, and firms like Limewire, Gnutella, and Kazaa followed, each adding improved functionality along the way.

And innovation in money has a history spanning eons — but directly related to the development of Bitcoin are private-company, community, and stamp scrip schemes going back over a century; local currencies; Chaum’s 1983 paper on digital currencies and the 1990 introduction of DigiCash; a number of dot-com-era entrants including Beenz, Flooz, CyberCash, and Confinity —  later known as PayPal. I would be remiss not to mention projects that tried explicitly to replicate gold in digital form, including e-gold, e-Bullion, and Liberty Reserve.

Interestingly, while gold is essentially established as the winner of the long-term process of monetary assessment and selection, Bitcoin is only the current champion. It may, over the long term, prove as insurmountable as gold, but at the present time, there are countless firms, teams, and individuals diligently innovating in the crypto space, each tinkering and tweaking to knock the top cryptocurrency off its perch.

Bitcoin is as much a product of spontaneous order as gold. The view that it merely appeared when developers created it, taking their cues from an apocryphal white paper, erroneously casts aside a century of technological progress and, more directly, several decades of monetary innovation. What will remain interesting — the trillion-dollar question, perhaps literally — is whether it remains so, or becomes another incremental step (however noteworthy) to the next development in money.

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Peter C. Earle

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Peter C. Earle is an economist and writer who joined AIER in 2018 and prior to that spent over 20 years as a trader and analyst in global financial markets on Wall Street. His research focuses on financial markets, monetary issues, and economic history. He has been quoted in the Wall Street Journal, Reuters, NPR, and in numerous other publications. Pete holds an MA in Applied Economics from American University, an MBA (Finance), and a BS in Engineering from the United States Military Academy at West Point. Follow him on Twitter. 

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