Digital Gold versus Medium of Exchange versus Unit of Account
By Jeff Paul
The original promise of Bitcoin was to be both digital gold and a peer-to-peer payment network with the aim of becoming better “money” for the world. Yet it now appears that the tradeoffs of focusing too much on either use while ignoring another crucial function could prevent it from reaching its full potential.
The digital gold crowd imagines that if Bitcoin could become a world reserve asset, it will disrupt central banks and eventually force more honest money. In turn, it will free civilization from the tyranny of fiat debt money controlled by a small group of bankers.
This is a valid approach, but it completely sacrifices the use of Bitcoin as a peer-to-peer cash system that primarily empowers individuals against custodial middlemen (commercial banks and governments).
The peer-to-peer cash crowd imagines mass adoption of Bitcoin in commerce is the correct approach for it to become money.
These competing visions for the direction of Bitcoin led to a split in the community in 2017 when it forked into two networks – Bitcoin (BTC) focused on becoming digital gold, and Bitcoin Cash (BCH) focused on becoming an efficient P2P payment network.
At this time, Bitcoin (BTC) as digital gold is winning in the market as it reaches new highs in price and dominance in the cryptocurrency ecosystem. It’s no wonder why this meme is winning as everyone likes to get richer. But is that enough to make Bitcoin money?
The Case For Digital Gold
Bitcoin (BTC) focused on becoming digital gold following the Ludwig von Mises Theory of Money and Credit which implies that a “demand-to-hold” commodity can become a medium of exchange and then eventually a “universally employed” or “commonly used” medium of exchange – which Mises says is the definition of money.
This theory of valuable-commodity-first-then-money was popularized in the Bitcoin community by Saifedean Ammous in his book The Bitcoin Standard. Ammous cites the “Gold Standard” where government paper money was once tied to gold to control supply and thus preserve its value. He projects that Bitcoin could provide the same standard for money in the digital age.
The path begins with Bitcoin becoming a world reserve asset held by financial institutions, central banks and governments much like they hold gold. This phase is well underway. The Bitcoin (BTC) network will act a settlement layer for these institutions which, despite its high transaction costs and slow confirmations, is much more efficient than moving tons of gold between vaults to settle large debts. Thus, it will be treated like a unit of account by those institutions and a derivative tied to Bitcoin will eventually become money for the people.
In order for this strategy to work, Bitcoin must be viewed as the best digital store of value. This theory spawned a faithful community often referred to as “Bitcoin Maximalists” who fiercely defend Bitcoin against all other competing projects. They preach holding Bitcoin instead of spending it in order to manifest its demand-to-hold commodity status. They claim its network effect, highest market value, and strongest computing network makes it superior to the competition. Indeed, it is superior in those regards.
However, there are technical tradeoffs to bricking Bitcoin development into a lump of gold. These tradeoffs make Bitcoin (BTC) less useful as a peer-to-peer payment network and only suitable as a settlement layer for large custodians of bitcoin. So if this theory proves to be wrong and institutions don’t treat bitcoin as a reserve asset that leads to money, Bitcoin (BTC) is little more than a Ponzi scheme for an inefficient payment network that is getting lapped by better technology.
The Bitcoin (BTC) network has a limited transaction capacity which results in high network fees and inconsistent settlement times when its capacity is exceeded. Bitcoin’s transaction fees reached as high as $50 and transactions took days to confirm during its historic price rise in 2017. Today, Bitcoin fees are regularly $5-$10 during volume spikes.
In a world where in-network transactions on custodial payment apps like Venmo and Cash App are free and nearly free on other Bitcoin forks, Bitcoin (BTC) is woefully uncompetitive.
This limitation can be fixed with very simple software upgrades, but it requires all parties involved (developers, miners, exchanges and users) to adopt the change. So far this has proven to be impossible, especially because those who believe “store of value” is the primary (first) objective for money simply don’t care that it is less usable as a medium of exchange. They are content as long as bitcoin’s price continues to increase.
The Case For Medium of Exchange
Proponents of peer-to-peer cash, like Sal Mayweather, claim the digital gold crowd misinterprets Mises’ Regression Theorem of money because Mises also stated that “store of value” is a secondary use of money after medium of exchange. That only the most portable or saleable good will become money. And if Bitcoin’s fees are orders of magnitude higher than similar alternatives, it is less portable or saleable. Thus it won’t become money.
This vision for getting to better money involves optimizing Bitcoin as a medium of exchange and getting mass adoption in commerce and trade. It has been Roger Ver’s strategy using his platform Bitcoin.com to promote Bitcoin Cash (BCH) for everyday payments because it is easier, faster and cheaper to transact than Bitcoin (BTC). Its low fees also empower everyone, including the poor and disadvantaged, to use the network.
Despite being just as scarce and more portable and accessible than Bitcoin (BTC), so far Bitcoin Cash (BCH) has failed to gain ground in use volume or price. This doesn’t mean that medium of exchange is less important than store of value toward making bitcoin money. It merely reflects the current environment.
The Case for Unit of Account
“Ledger money” precedes commodity money. In his book Debt, The First 5000 Years, author David Graeber makes a strong case that early tribes used ledgers with arbitrary units of account as money well before gold became an inter-tribal medium of exchange. Sometimes these were informal ledgers of barter and favors. That is where we got sayings like “much obliged” or “I’m indebted to you” that are still with us today. Sometimes these units of account were shells, or marks on rocks or tally sticks. Some were even based on labor, where the trading of human beings was not viewed as slavery but rather as the only mechanism to settle debts.
Critically, the unit of account function of money is mostly psychological. Money is an imaginary good whose value is subjective in the minds of its users. As such, the arbitrary nature of these early units worked just fine for a period of time until people stopped believing in them or found something better to use.
Unit of account is used to measure the value of any other good and service in the marketplace and to settle contracts. For example, when asked the value of an apple, an hour of unskilled labor, or even bitcoin, your mind will instantly calculate the value using “money” – aka the unit of account and medium of exchange most used by your tribe. Today, unit of account is also a legal distinction. Governments enforce their currency as the dominant unit of account with the threat of violence. It’s very difficult to alter a common unit of account under these conditions without dramatic collapse in belief.
As such, the unit-of-account function of money may be most important of all. If bitcoin, or something tied to bitcoin, doesn’t become the universally imagined unit of account to price all other goods, it can’t perform as “money.”
This is why USD stablecoins have become the killer app for Bitcoin networks. It performs the unit-of-account function using the blockchain to exchange those units.
Advancing the Definition of Money
In light of the invention of cryptocurrency, Howard University philosophy grad and Bitcoin developer, Vin Armani, has advanced the definition of money as a tool for interledger communication. In other words, VISA, PayPal and MasterCard each have separate unique ledgers that use dollars and other government currencies to settle balances between them.
Bitcoin is not "money."
I am no longer going to use the word "money" to describe Bitcoin.
Money is a tool for interledger communication. An economy based on Bitcoin has a single, universal, public ledger so interledger communication simply doesn't exist.
— Ⓥin Ⓐrmani (@vinarmani) July 22, 2019
Armani adds “Money is a means of reconciling separate ledgers with one another. Changing values in a single ledger does not require money.”
If I settle a debt I have to you in a Bitcoin-based economy, I don't settle it with money. I settle it with a change to a shared ledger.
Human interledger settlement existed hundreds of thousands of years before money. Not all interledger settlement is done with money.
— Ⓥin Ⓐrmani (@vinarmani) July 23, 2019
The idea of money is complicated and nobody truly knows what will make the best money. All we can do is study history and observe how this new ledger technology is being used to advance the discussion in hopes that we move toward more honest money.