Bitcoin’s Flawed Premise

Bitcoin is based on a fundamentally flawed premise. That flawed premise makes Bitcoin fool’s gold.

Don’t want to be a fool? Good. Read on.

The problem with Bitcoin is not the risk of a 51% attack. Nor is it the fact that Bitcoin, like all things digital, will never be secure, despite the near-supersonic hand-waving of zealots. And nope, it’s not that Bitcoin is being treated by government authorities not as a currency, but as a commodity, with all the tax consequences and headaches that go with this treatment. (Seriously, are you going to keep track of capital gains and losses when making small purchases with bitcoins? In other words, are you willing to become a tax evader — a felon — just to be hip?)

No, the problem with Bitcoin is far deeper than the above pesky details.

The fundamentally flawed premise undermining the entire Bitcoin concept is that Bitcoin is based on the assumption that the Quantity Theory of Money (QTM) is true. The harsh reality is that QTM is not true; it is but a clever-sounding, emotionally-potent oversimplification masquerading as a scientific theory. QTM is an optical illusion of the mind. It is a mental mirage.

QTM, which is nothing more than supply-and-demand in drag — lipstick on a pig — claims that the more of something there is, the less it’s worth, and conversely, the less of something there is, the more it’s worth.

From the perspective of QTM, gold is valuable because it is scarce. And, similarly, from the perspective of QTM, bitcoins are valuable because the number of them has a cap, an upper limit, thereby creating an artificial scarcity, hence making bitcoins valuable. Read about Bitcoin in the blizzard of articles causing whiteout conditions on the internet, and you are certain to come across the idea that Bitcoin is the equivalent of “digital gold”, exactly because the number of bitcoins is restricted. Buried in the deep drifts of this line of thinking is the implicit assumption that QTM is true.

That’s the part that renders Bitcoin fool’s gold.

QTM is an absurd misnomer because it does not hold for the monetary metals — gold and silver. Gold is not valuable because it is scarce. In fact, the opposite is true! Gold is valuable because it is the most marketable commodity on earth. Gold is so marketable that it has, for all practical purposes, constant marginal utility. This means that the marginal utility of gold declines more slowly than that of any other commodity on this blue marble, as ever more of that commodity is brought to market.

All commodities other than gold and silver have declining marginal utility. Their declining marginal utility is a natural obstruction to hoarding. As a consequence, the stock-to-flow ratio (the ratio of the total above-ground or finished stock to the total amount produced annually) of all commodities other than gold and silver is a fraction much smaller than one. (Agricultural commodities such as wheat, at harvest time, can temporarily have a stock-to-flow ratio approaching one.) So, for a commodity like copper for example, there might be a few weeks’ supply of copper above ground, making the stock-to-flow ratio far less than one. Increase the above-ground supply of copper by a small amount and its price would plunge as copper’s declining marginal utility manifested itself.

Not so with gold! The stock-to-flow ratio of gold is close to 100, several orders of magnitude greater than that of any other commodity!! From this perspective, gold is not scarce; gold is the world’s most abundant commodity. And increasing the above-ground supply of gold would increase it’s value, not decrease it, because the increased stock would serve to reconfirm that gold is the world’s most marketable commodity. So much for QTM. And so much for Bitcoin.

Incidentally, if gold has constant marginal utility, what prevents the hoarding of gold from going to infinity? The answer is profound: the phenomenon of gold interest spontaneously emerges as an obstruction — as a positive opportunity cost — to infinite gold hoarding. Gold and interest are inseparable concepts, two sides of the same coin as it were. But this topic is beyond the scope of this article. This article is simply trying to help you not be a bit-brain.

So I repeat, gold is not valuable because it is scarce. Gold is valuable because it is the most marketable commodity in the world, as empirically demonstrated by its unparalleled stock-to-flow ratio, or, in other words, its constant marginal utility. And the most marketable commodity is and will always be destined to be money … unless of course self-aggrandizing governments attempt to lock it up in Goldtanamo, so that it does not compete with their noncompetitive fiat money, with its fast-declining marginal utility.

Bitcoin will never be money. It will never be “digital gold”, its artificial scarcity notwithstanding. Why? Because the entire premise of Bitcoin is based on QTM, and QTM is but a nonapplicable abstraction — a wishful fantasy — a linear model that does not pertain to the highly nonlinear world of human action and that action’s expression through monetary dynamics. Bitcoin will never ever be the most marketable commodity, but will instead always be plagued by declining marginal utility.

Not even the touch of Midas will change that fact.



The Janus-Face of Marketability, by Prof. Antal E. Fekete