I’ve noticed Peter Schiff is back on the financial talking head shows as the Austrian contrarian. As is so often the case, the bulls and the bears argue about price targets and speculation, but Schiff approaches all subjects from his usual principled position. Fundamentals. What is the ultimate source of value? If that source doesn’t exist, then the price is speculation.
He wrote a book on it. I remember reading it. I gave it to my friends. He explained how a fish commodity based economy would work, and how fish reserve notes could ruin it. He understands the implications of Mises Regression Theorem, and his application of that theorem to Bitcoin is admirable.
I remember back in 2011 arguing online with other Austrians about this. At that point we weren’t sure if Bitcoin was 100% over- or undervalued. It’s tempting to look at the current price and say to yourself in hindsight “Of course it was under valued”, but if Schiff is right about the use value of Bitcoin, then it’s not only possible that Bitcoin falls to zero… over a long enough time line, It’s likely.
Currencies have historically started as commodities and their value derived from their utility. These commodities fulfilled some role in achieving the goals of many different individuals. That wide utility, combined with scarcity, is where the ability to bootstrap itself into a currency comes from.
People tend to challenge this claim when it comes to Bitcoin, instead focusing on a probabilistic argument. The longer a price remains above a certain value, the likelihood of that price being over valued approaches zero. This merely skirts the argument, but worse, is a failure to see the decisive point which would undercut Schiff’s argument entirely.
To understand this point, you must first understand what a proof of work algorithm is. Bitcoin’s Proof of Work algorithm is based on a hashing algorithm known as SHA-256. This algorithm takes an input and returns an output such that it’s impossible to determine what the output is without randomly testing inputs.
Every time you test an input, you must use some energy to do the calculation. We know that there’s a certain probability of you finding the correct output from your guessed input, and can calculate how many times you tested different inputs to find that result. When you show us the input that matches the output miners are searching for, it amounts to proof that you and the other miners performed that number of calculations. The implication of this is that you’ve spent the equivalent amount of energy.
Who ever finds the correct input for the expected output first is the miner who receives the reward and all the fees for mining that block. Bitcoin amounts to proof that some quantity of electricity was spent. That is why Bitcoin is known as a Proof of Work system.
And that leaves us with one more concept needed for Bitcoin to have a fundamental value. Economic Signaling theory. When a person wishes to interact with another person, that comes with an implicit time cost to the other person. With so many people trying to gain your attention for their own benefit, it can be hard to stand out from the crowd. By signaling credibility, you can receive attention over others who aren’t signaling.
One of the methods of doing this is to take on an unnecessary cost. This is one of the reasons why people go to college. By giving up four years of income and taking on college loans, students signal to employers that they are serious candidates. This allows employers with no knowledge of students reputations to reduce employee search costs.
Bitcoin is a signaling method. This idea has even been implemented by Balaji S. Srinivasan when he created Earn.com. On that site you can send a message with Bitcoin attached, and you’ll only have to pay if they respond. The amount attached to the message boosts the signal your sending that the message is important. Think of this mechanism like spam filtering or Captcha. By forcing the client to do something that’s hard to automate, you ensure that the visitor to your site is a user. Likewise, by forcing a person to send you proof of work when they contact you, you ensure that they place a high value on interacting with you.
To some this equates to the “Labor Theory of Value”, but the value of Bitcoin isn’t the effort put into it. It helps to think of it like an electric speaker. The amount of electricity (work) determines the volume (strength) of the sound (signal). The value of the sound is determined not by the volume, but from others listening and responding to it. By increasing the electricity put into creating the sound, you’re increasing the volume. That separates your sound from the background noise and grabs people’s attention. Bitcoin is proof that you were willing to work to mint that token. Sending that token to another party excludes you from sending it to anybody else. By putting work exclusively into communicating with them, it shows the other party that you believe your communication will be worthwhile.
In summary, Bitcoin = Signal, Signal = Attention, Attention = Opportunity. It’s not a certificate which can be forged (a distinct possibility with college degrees). Nothing will ever stop a bitcoin from representing the effort put into it, and you can’t send it multiple times. Therefore a bitcoin will always have this intrinsic signaling utility. And just like gold it’s price will never go to zero, unless people no longer value the ends it’s capable of achieving.
Schiff’s last point is that the blockchain is forkable, and that these coins are infinite, but he doesn’t take into account that the total hash power of these forks is not infinite. Miners must choose which fork to work on, and that current hash power is equally important to how this value is derived. Because bitcoins are fungible, their value can decrease when the hash rate falls.
This does not affect how bitcoin fulfills Mises Regression theorem. If this wasn’t important to you, then Schiff’s arguments were never of concern. Austrian economists, however, can rest assured that even on Schiff’s own terms, Bitcoin still retains use value even if not used as a currency or speculative asset. It turns out that Bitcoin isn’t a new asset class. It’s an old one — a signal.