Platt Perspective on Business and Technology

Considering the nature and qualities of money 7: bitcoin and peer-to-peer currencies from a broader monetary economic perspective

Posted in macroeconomics by Timothy Platt on February 9, 2014

This is my seventh posting to a series on money and on what monetary value functionally means (see Macroeconomics and Business, postings 142 and loosely following for Parts 1-6.)

I have been writing in this series about several approaches for establishing and benchmarking the value of money whether backed by a benchmarked valuation commodity such as gold, or whether it is a fiat money that is offered to the marketplace without that type of material goods backing. And in the course of that I have discussed scrip and other cash alternatives as well, with all of that directed towards elucidating the valuation of peer-to-peer currency as an emerging phenomenon, with bitcoin simply a best known and most publicized example of that currency formulation. And in that, this entire series has been a discussion of monetary economics as a specific branch of macroeconomics, even if I have been pursuing this discussion without always explicitly making that connection.

My goal for this series installment is to step back from the currency-type details that I have been pursuing up to here, as I discuss what peer-to-peer money is and how its valuation is established. My goal here is to at least begin a discussion of monetary valuation per se as that is being challenged and reshaped by the emergence of peer-to-peer currencies as a monetary alternative that is coming to be accepted and used in active marketplaces and by businesses and consumers – even if we are still in the early stages of that happening, at least as of this writing. And I begin here by going back to a question that I began addressing from the beginning of this series: what is monetary value built upon as its supporting foundation? Ultimately, any valid answer to that has to be grounded in and correlated with overall marketplace and economy-wide wealth and wealth creating capacity. And the emergence of peer-to-peer money turns what that means in what up to now has been a largely unexamined direction. More specifically, my goal for this series installment is to at least begin exploring what that direction is, and I begin that by discussing more standard monetary systems based on nationally backed money supplies as a starting point.

• Traditionally, a money supply and the valuation of its units of currency can be thought of as representing overall levels of production and of goods and services available in the marketplace. More productive societies produce and hold correspondingly more valuable currency, simply assuming that the volume of units of money produced do not exceed the rate of productivity achieved and maintained.
• Peer-to-peer currencies such as bitcoin turn this around, shifting monetary value from a production and productivity foundation to a consumption, and a consumer-based foundation. Ultimately, the peers in a peer-to-peer valuation system are the consumers in its valuation-setting marketplaces. And valuation becomes demand-driven.

This, ultimately, is what makes peer-to-peer moneys such as bitcoin so disruptively novel. These currencies diverge from a more traditionally understood monetary valuation base at a very fundamental level, and one that cuts to the core of basic economic theory and practice. And their valuation would be grounded in what can be seen as a new and emerging form of abstraction.

• When a currency is backed by some agreed to measure of a mutually accepted underlying commodity, its valuation is stabilized by the marketplace availability of that commodity, and whether that commodity takes the form of some specific chemical element (e.g. gold or silver) or some manufactured product (e.g. large stone coins or alcohol.) See Part 1 and Part 3 for brief discussions of some of the currency backing commodities that have historically been used.
• When a standard nationally backed currency is switched from a commodity based standard to a fiat money model, its valuation becomes more abstracted insofar as it is no longer backed by some single tangible commodity, but it is still backed by the production and productivity-backed strength of the economy and the marketplaces of the country that produces and maintains it – or for a currency such as the Euro, by the group of nations that collectively play that role.
• When a currency switches to a peer-to-peer model, it drops that stabilizing standard too, and gains its valuation strictly from the consensus valuation of its holders.

As history readily verifies, standard commodity backed and fiat moneys also depend for their valuation stability on public trust and confidence. Bank runs as more local phenomena and larger scale losses of confidence in entire currency systems, with the hyperinflation that this leads to, have recurringly validated that point, showing that when a government claims to back its (fiat, for example) money with its full faith and credit, it is also counting on its citizens and the people of its marketplaces accepting it with their full faith too.

• For true peer-to-peer money, its entire valuation foundation is based in its level of shared supporting public trust.
• So when for example, bitcoin valuation goes up in synch with the increased standard monetary cost and the increased effort required to successfully mine new bitcoin units that comes entirely from public perception and the levels of valuation that bitcoin trading markets are willing to bid this valuation up to.

So I come back to a fundamental question that I raised earlier, in Part 4 and Part 5. How can the valuation of a currency such as bitcoin be stabilized to limit and control the ephemeral vagaries of fad? That I contend, is still an open question and one that critically requires addressing if bitcoin or any of its peer-to-peer counterparts are to gain the traction and stability of their more traditional monetary counterparts.

I am tentatively planning on ending this series here with that question, though I am also thinking of coming back to it again, to discuss the due diligence and risk management issues of bitcoin wealth and how they might be addressed. Meanwhile, you can find this and related postings at Macroeconomics and Business.

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