Bitcoins aren’t actually money

First let’s get one thing out of the way.  Language is a social convention and hence Bitcoins are money in at least one sense—they are considered money in ordinary conversation.  Thus when Bill Gates owns $50 billion in Microsoft stock, people say he has “a lot of money.”

But it is certainly not money in the sense that economists use the term.  Nor do monetary models apply to Bitcoins.  Here are three famous uses of monetary models:

1.  Inflation:  A change in the supply or demand for money will impact its value. Because the nominal price of money is fixed by definition, its value can only change through a change in the price level.  In contrast, a change in the supply or demand for Bitcoins will simply result in a change in the nominal price of Bitcoins.

2.  Interest rates:  Because prices are sticky in the short run, a change in the supply or demand for money will lead to a change in interest rates large enough to equilibrate the supply and demand for money after the market disturbance.  This is called the liquidity effect.  There is no liquidity effect for Bitcoins because their nominal price is not sticky, and hence interest rates do not need to adjust to equilibrate the supply and demand for Bitcoins.

3.  Business cycles:  Because wages are sticky in the short run, a change in the supply or demand for money that impacts NGDP will also impact employment and output.  Again, with Bitcoins the nominal price adjusts, and there is no impact on business cycles.

Bitcoins can be used as a media of exchange and a store of value.  They can be bartered for some other goods and services.  But it’s not a media of account, the sine qua non of being “money.”

PS.  And there is no Bitcoin bubble, because bubbles don’t exist.

PPS.  Here is my first Econlog post.


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21 Responses to “Bitcoins aren’t actually money”

  1. Gravatar of Dan W. Dan W.
    1. January 2014 at 08:28

    Scott,

    Bubbles may not exist but erroneous beliefs about financial markets do.

    For example, there is no such thing as perfect liquidity. The ’87 crash, LTCM and even the 2008 panic that created the political need for TARP each resulted from the false hope in perfectly liquid markets. Yet despite ample evidence that markets are filled with potholes economists, bureaucrats and financiers persist in promoting models that assume otherwise.

    So you may say that bubbles do not exist but financial ignorance does and it is never in short supply.

  2. Gravatar of TGGP TGGP
    1. January 2014 at 10:15

    Currencies trade against each other, so each has a price. The “price level” is just the price of a set of goods in terms of some currency.

  3. Gravatar of Alek Alek
    1. January 2014 at 10:30

    Bitcoin is money because it has all of these properties against a basket of illicit goods as well as against at least the fundamental service of mining more bitcoin.

    In particular it has a very high liquidity premium over the dollar for importing illegal substances.

  4. Gravatar of ssumner ssumner
    1. January 2014 at 11:13

    Dan, Yes erroneous beliefs exist, but the market is smarter than any individual.

    TGGP. No the price level is not the price of goods in terms of some other currency. Otherwise America had hyperinflation in 2007, as US prices soared in terms of the Zimbabwe dollar. The price level is the price of goods in terms of the medium of account used in that economy.

    Alek, Your comment does not address my post at all.

  5. Gravatar of Lorenzo from Oz Lorenzo from Oz
    1. January 2014 at 14:25

    But they have a high level of “moneyness”. As in, from Friedman & Schwarz:

    One alternative that we did not consider nonetheless seems to us a promising line of approach. It involves regarding assets as joint products with different degrees of “moneyness” and defining the quantity of money as the weighted sum of the aggregate value of all assets, the weights varying with the degree of “moneyness”.

    Perhaps they are not macro-economically money–because not a medium of account–but they are micro-economically money–because are a medium of exchange. (Which then makes me wonder about macro-analysis of countries with a high level of use of other currencies.)

  6. Gravatar of TallDave TallDave
    1. January 2014 at 14:32

    If you haven’t read the Bitcoin paper, it’s fascinating.

    http://bitcoin.org/bitcoin.pdf

    Could bitcoins or another cryptocurrency become the MOA? I think the answer depends entirely on the relative reliability of sovereign money vs networked digital money. Seems unlikely (mainly because sovereigns have lots of guns) but not impossible.

    I started downloading the blockchain and a bitcoin miner the other day, just for fun (seemed apropos while reading Crypotonomicon). Sadly my crossfired GPUs were just one series out of date for the common language the miner uses.

  7. Gravatar of Alek Alek
    1. January 2014 at 15:53

    Sorry,

    I was pretty sure i was addressing the post. Prices for the goods and services i mentioned are posted in bitcoin often exclusively, so how is it not a medium of account? And one bitcoin is always worth one bitcoin just as a dollar is always worth a dollar.

    The sticker price reward for mining (which is in bitcoin) often stays fixed regardless of the fluctuations of demand for bitcoin on other markets that day…so that seems like price stickiness. That should generate some sort of “interest rate ” effects.

    The bitcoin prices on gambling sites are even stickier.

    The liquidity premia on bitcoin over dollars just shows how interest rates are coming hugely into play depending on which markets we are talking about.

  8. Gravatar of Kevin A Kevin A
    1. January 2014 at 18:38

    “Prices for the goods and services i mentioned are posted in bitcoin often exclusively, so how is it not a medium of account?”

    This is not true. Prices are almost always posted in dollars. This is true even of silk road, the largest bitcoin black market.

  9. Gravatar of lxdr1f7 lxdr1f7
    1. January 2014 at 19:10

    “They can be bartered for some other goods and services. But it’s not a media of account, the sine qua non of being “money.””

    So as soon as you cross the border into Canada with a million USD’s you dont have money? If you cross back over to the US you have money again. The sina qua non of being money is from acceptance as a medium of exchange and store of value. The unit of account in terms of bitcoin can be derived anyway without bitcoin being the primary unit of account.

  10. Gravatar of Geoff Geoff
    1. January 2014 at 19:24

    A lot of confusions in this blogpost. Some have been corrected before (e.g. “no such thing as bubbles”, “money is a medium of account”, etc) and yet continue to be repeated, while new ones have cropped up.

    1. Inflation: A change in the supply or demand for money will impact its value. Because the nominal price of money is fixed by definition, its value can only change through a change in the price level. In contrast, a change in the supply or demand for Bitcoins will simply result in a change in the nominal price of Bitcoins.

    This is an argument based on definitions, not objective facts. When one argues “a change in the supply or demand for Bitcoins will simply result in a change in the nominal price of Bitcoins“, one would be implicitly “pricing Bitcoins in terms of dollars”, which of course assumes that the definition of money is the dollar, not Bitcoins. But the question is whether or not Bitcoins are money. This cannot be answered by assuming dollars are money.

    Instead, one has to postulate for the sake of argument that Bitcoins are money, and then ask if the inflation question has an answer that makes sense.

    Thus, if we stipulate for the sake of argument that Bitcoins are money, then the nominal price of Bitcoins are indeed fixed. One Bitcoin is priced as one Bitcoin. Inflation of Bitcoins would affect their exchange value vis a vis goods (and dollars!). If the supply and demand for Bitcoins changes, then Bitcoin valuations would certainly change.

    2. Interest rates: Because prices are sticky in the short run, a change in the supply or demand for money will lead to a change in interest rates large enough to equilibrate the supply and demand for money after the market disturbance. This is called the liquidity effect. There is no liquidity effect for Bitcoins because their nominal price is not sticky, and hence interest rates do not need to adjust to equilibrate the supply and demand for Bitcoins.

    This again is defining the argument away. If we instead stipulate for the sake of argument that Bitcoins are money, then a change to people’s time preferences will indeed affect the borrowing/lending rates of Bitcoins. The liquidity effect would also not be excluded.

    (Note: The description of the liquidity effect Sumner gives is wrong. It is not true that supply and demand for money changes interest rates which then change…supply and demand for money. The liquidity effect arises when interest rates are lowered due to inflation, not a rise in the rate of saving and investment relative to total spending.)

    (Note 2: Notice that we’re told a change to the supply and demand for money is labelled as a “market disturbance”. First, the supply of money is set by the central bank, not the market. Second, if we now restrict our attention to demand, saying “market disturbance” suggests that a market action of earning money, which of course implies a holding of money, is undesirable, that it should be stopped by a non-market action, i.e. violence against innocent people.)

    3. Business cycles: Because wages are sticky in the short run, a change in the supply or demand for money that impacts NGDP will also impact employment and output. Again, with Bitcoins the nominal price adjusts, and there is no impact on business cycles.

    Again, this defines the argument away. The correct approach is to stipulate that Bitcoins are money, and then ask what would happen to “output” and “employment” if there is a change in the supply and demand of Bitcoins that affects NGDP.

  11. Gravatar of Geoff Geoff
    1. January 2014 at 19:25

    Bitcoins can be used as a media of exchange and a store of value. They can be bartered for some other goods and services. But it’s not a media of account, the sine qua non of being “money.”

    This is getting closer to the answer (let us put aside for the moment that the sine qua non of money is medium of exchange, not medium of account).

    Right now, Bitcoins are not a universal media of account. To be sure, there are some individuals who are pricing their gains and losses in terms of Bitcoins, so these folks are using Bitcoins as a medium of account.

    But the sine qua non of money is its medium of exchange use. Right now, Bitcoins are not a universal medium of exchange. They are not generally accepted in commerce. I don’t know anyone who are paid wages in Bitcoins. Yes, they are being used as “a” medium of exchange, but in order for it to be a money qua money, that medium of exchange has to be the case for everyone, or almost everyone. Because it isn’t, that’s why Bitcoins are not a money.

    What I suspect is happening is that Sumner’s confusion over money allegedly being primarily a medium of account is compelling him to make the half-truth inference that Bitcoins are a medium of exchange, which of course falsely suggests that they are a generally accepted medium of exchange, so that he can swat that down, and thus present the medium of account use as the primary characteristic of money.

    But we don’t have to make that mistake. We can retain the correct knowledge that money is primarily a medium of exchange, and argue, also correctly, that Bitcoins are not a generally accepted medium of exchange, and are hence not a money.

    The concept of “medium of exchange” without the “universally/generally accepted” criteria is not what money is about. I once used an old car as a “medium of exchange”, because I traded for it not because I wanted it, but because I knew someone else did, and they had something I did want. In this case, the car is a medium of exchange, but it’s not a money because used cars are not a generally accepted medium of exchange.

    PS. And there is no Bitcoin bubble, because bubbles don’t exist.

    Bubbles do exist. Bubbles however are not composed of nominal statistics or objects. They are “real”. Bubbles occur when too many real resources get devoted to long term, capital intensive projects, which might boost aggregate output for a time relative to the alternative, but are unsustainable in physical terms because the started projects cannot be physically completed/repeated as the requisite resources do not and cannot exist, given current and future savings/investment rates.

    Now, this is, in our economy, almost always caused by nominal factors, such as inflation, credit expansion and artificially low interest rates. So we observe bubbles associated with rising prices and then falling prices. But the bubbles are not the price trends. The bubbles are the real trends.

    If during 2007-2010 Bernanke inflated the money supply much more than he did, such that spending and prices, particularly in housing, did not fall up until today, then would that mean there would have been no housing bubble after all? Quite the contrary. It would still have been the case that too many long term, capital intensive projects like housing were started, but Bernanke just kicked the can down the road by further misleading investors into believing that there was sufficient resources freed up vis savings/investment to complete those projects.

  12. Gravatar of Bob Murphy Bob Murphy
    1. January 2014 at 19:37

    A change in the supply or demand for money will impact its value. Because the nominal price of money is fixed by definition, its value can only change through a change in the price level. In contrast, a change in the supply or demand for Bitcoins will simply result in a change in the nominal price of Bitcoins.

    But Scott, doesn’t the above merely prove that Bitcoins aren’t money, if people are using something else as money?

    I mean, I can do the same thing to prove that the Mexican peso isn’t money: When the supply or demand for it changes, it makes the USD/peso exchange rate move.

    BTW I *agree* with you that Bitcoins aren’t money (yet), but I’m just pointing out that it seems your argument above assumes the conclusion.

  13. Gravatar of Alek Alek
    1. January 2014 at 20:14

    Kevin a,

    Almost always isn’t always.

    Neither of these change the fact that it is possible to find goods and services, including the purchase of other crypto currencies denominated exclusively in bitcoin. And thus meeting even Sumner’s definition of money.

  14. Gravatar of Scott Freeland Scott Freeland
    1. January 2014 at 21:36

    Scott,

    I’m curious. Have you thought much or done much research regarding possible “bubbles” in Cabbage Patch dolls in the 80s, Beanie Babies in the 90s, or Pokemon cards?

    Perhaps examples like the above support some of Shiller’s musings about bubble psychology, even if he’s wrong when it applies them to stocks or housing. I’d be interested in contrary viewpoints.

  15. Gravatar of ssumner ssumner
    2. January 2014 at 06:36

    Lorenzo, Yes, But I’d say the macro aspect of money is what really matters, at the margin. Water is really important in a micro sense, but the water market is not macroeconomically important.

    Talldave, It might become a MOA, but I’m skeptical.

    Alek, I misunderstood your comment. In my view there aren’t enough prices measured in Bitcoin to make it an important MOA, but I’m open to changing my mind. The fact that Bitcoin mining returns are sticky in bitcoin terms is not an issue, as far as I can see. Isn’t that true of commodities?

    lxdr, If you cross into the US with Zimbabwe money you still have Zimbabwe money. But it isn’t the “M” in macro models of the US economy. That was my point. We don’t have hyperinflation here.

    Bob, You asked:

    “But Scott, doesn’t the above merely prove that Bitcoins aren’t money, if people are using something else as money?”

    Yes.

    Scott, No, I haven’t given it much thought. But I do know that many collectables go up in price and then go up even more (baseball cards, etc), so the fact that something went up and then down tells us nothing about whether it is a bubble.

  16. Gravatar of Alek Alek
    2. January 2014 at 09:44

    Sumner,

    I think I see now where your post is coming from. Bitcoin monetary policy is pretty much useless in a traditional sense since it would be so dominated by other factors. Particularly because it is not the majority MOA, even where it is accepted.

    So what really would be the good in thinking about Bitcoin as a currency the way we think of the dollar? I think you are saying there is none at least not yet.

    I still see the Bitcoin mining as different from commodities because for commodities a monetary authority doesn’t promise to pay an amount of a commodity for your mining…under a gold standard they might and I would view that as seignorage.

  17. Gravatar of Doug M Doug M
    2. January 2014 at 11:00

    I know very little about bit coins but…

    From what I understand:

    Inflation: When we talk about inflation, we are talking about what a goods and services a bitcoin buys. The fluctuations of the US dollar value of a bitcoin says nothing about bitcoin inflation. From what I understand there is little price fluctuation in bitcoin denominated goods despite large fluctuations in the USD / bitcoin exchange rate.

    Interest rates: I was unaware that there was much lending in bitcoins. What is the current Prime rate (or equivaltent) how about long-term rates?

    Business cycles: I don’t know how many people are paid a bitcoin denominated wage… Who is tracking the economic statistics (wages, employment, output) for the bitcoin currency zone?

  18. Gravatar of Bob Bob
    2. January 2014 at 19:43

    The prices of Illegal substances change in bitcoin terms, so it’s not really a medium of account. The one reason you see the price only in bitcoins is because it’s the preferred method of exchange by some people.

    It’s the way it has to be too, or the arbitrage opportunities available would be ridiculous.

  19. Gravatar of Scott Freeland Scott Freeland
    3. January 2014 at 00:13

    Scott,

    But with respect to Beanie Babies, for example, little stuffed toys selling for $5-$7 retail had prices bid up to the thousands in some cases, but then prices crashed suddenly after a few years of apparent mania. Similar things happened with Pokemon cards and Cabbage Patch dolls.

    And in the case of Beanie Babies, prices crashed soon after the manufacturer stopped manufacturing them. So, less supply was associated with lower prices?

    I’m not saying this means these are examples of bubbles, but rather that it may be phenomena worthy of study nonetheless.

  20. Gravatar of ssumner ssumner
    3. January 2014 at 08:49

    Alek, I’m a bit confused by the mining thing, maybe someone can help me out. So if you mine one bitcoin, you are paid one bitcoin? Or you mine something else and am paid one bitcoin?

    Doug, You said;

    “From what I understand there is little price fluctuation in bitcoin denominated goods despite large fluctuations in the USD / bitcoin exchange rate.”

    Given that bitcoins rose from $1 to $1000, that seems weird.

    Scott, Certainly interesting, and given it’s a product that one cannot short, it’s probably less efficient than other markets.

  21. Gravatar of Daniel Daniel
    3. January 2014 at 08:51

    Scott,

    re: bitcoin mining

    https://www.youtube.com/watch?v=GmOzih6I1zs

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