Does bitcoin answer an economic need?

19/05/2022

“If you wait for bitcoin volatility to be much lower before investing, you will probably have to pay a much higher price” – Yves Choueifaty, President and Chief Investment Officer, TOBAM

In the end, what exactly is money?

Money finds its value in scarcity.

The economy is about the creation, exchange, storage and use of wealth, be it labour, goods, services, innovations, contracts. One should never confuse wealth creation with money issuance. It is often, in fact, the opposite: money issuance tends to imitate but ultimately delay and impede wealth creation. In his book “The denationalisation of money” (1975), Friedrich Hayek1 exposes a theory that whenever a group of people owns the monopoly of money supply, eventually they abuse it, and this results in cataclysmic crises that potentially cause millions of deaths and decades of delayed development. He suggests that to get rid of those crises, we need to get rid of the monopoly of money issuance.

Theory generally finds its motivation in the modelling of reality. Theory, an articulated discourse, is most often based on one or a set of tentative definitions.

One of the oldest definitions of money is Aristotle’s, which recommends that, for an object to be considered as money, it must have the following three functions: store of value, unit of account and medium of exchange. Aristotle does not invent money when saying this. Money preceded him by many thousands of years. There is little doubt that flint arrowheads served empirically as a store of value as early as the Palaeolithic.

Money and time: an organic bond

In the language of patents, the three functions of Aristotle’s definition are not “independent claims”. It is, in fact, because the object is a store of value that it becomes a unit of account and/or a medium of exchange. The independent claim is “store of value”. To put it simply, the fundamental function of money, the one that founds the others, is the transport of labour over time. We work for compensation, in the hope that this reward will give us access, in the future, to others’ labour. One of the most important contributions of money to the history of the economy is the possibility of saving labour, the possibility of transporting value over time. It can or should be distinguished from investment, which supposes risk.

If a “monetary” issuing institution sets itself an inflation target, say, of an official 2% per year, by definition it renounces on the transportation of value across time. One could speak of “melting” money to qualify this object, but in fact it is an object that no longer meets Aristotle’s definition of money. In this, the issuing institutions have given up issuing “money”. The case becomes even more difficult if we consider the real cost of living rather than only the Consumer Price Index (CPI). Apart from effective housing costs, one of the major costs of living components ignored by CPI is the increasing cost of government2-3. Public goods and services though a non-merchant good still have a cost to the consumer4 that is not limited to levies but also comprises huge deferred taxes and costs (public debt)5.

Money failing to transport value over time gives way to a vacuum, and “nature abhors a vacuum”. At least subconsciously, populations will try to store value somewhere other than in improperly managed or issued “money”. We will no longer “save” in “money”, but by acquiring a home, stocks, art… or new digital assets. We will even frequently borrow for this, putting ourselves “short” the currency, thus integrating, at least subconsciously, that the repayment will be in a devalued currency... We are in fact adopting the same strategy as the sovereign by borrowing now and paying back in devalued assets.

A “rational” investor in the sense of financial theory is an investor seeking profits. This investor is necessary to the existence of an “efficient” market. An efficient market can be described in brief as a market where prices are “justified” by fundamentals. When a price is higher than justified by fundamentals, the rational investor will sell the asset, thereby lowering the price until it converges towards the price justified by fundamentals, and vice versa in the case of an undervaluation.

What rational investor would be ready to lend an asset to be reimbursed in devalued assets several decades later? None, except when… constrained by some (funny?) regulations. This is why the main lender has become the central bank itself, which is not driven by the search for profit and therefore not a rational investor. The central bank will target other self-attributed “goals”. These new objectives come at the expense of the Aristotelian function of money. When a Central Bank sets itself the task of encouraging growth, saving a banking system, funding impecunious states, or financing the energy transition, the question is not whether these goals are good or bad, but whether they are being pursued at the expense of the fundamental function of money: to transport value over time.

Money finds its value in scarcity.

Bitcoin’s value proposal is “There are 21,000,000 of it”.

On bitcoin’s volatility

There is an obvious investment thesis for Bitcoin. And there is an anti-thesis…

Some see the 2025 price of Bitcoin lower than a single euro, and some see it North of half a million; this fight is driving Bitcoin’s extreme volatility. Bitcoin is an extremely risky asset. However, this is never a rational reason not to consider investing in an asset. For example, one drop of Chlorine could make a glass of water drinkable, while in excess it could poison it. It’s the same for Bitcoin. Risk is only relevant in the context of size. A $1 million investment in the S&P 500 is far riskier than an investment of $50,000 in Bitcoin…

The price and the volatility of Bitcoin will be intertwined with its adoption. The higher the adoption, the higher the price and the lower the volatility. If you wait for Bitcoin volatility to be much lower before investing, you will probably have to pay a much higher price.

1 Nobel prize economic science 1974
2Social security and social expenses Included

3The usual argument that taxes are not a cost as there is a counterpart to taxes does not hold, indeed there is also a counterpart to the price of a car: the car itself!

4 … or the taxpayer

5 In the same way that if you buy a car at a price of 100, paying 10 in cash and borrowing 90, the real cost of the car is still 100

Yves Choueifaty, President and Chief Investment Officer, TOBAM

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