Open access peer-reviewed chapter

# On the Origin of the Value of Cryptocurrencies

By Er'el Granot

Submitted: February 15th 2018Reviewed: June 12th 2018Published: November 5th 2018

DOI: 10.5772/intechopen.79451

## Abstract

Bitcoin and other cryptocurrencies received a lot of criticism during the last 9 years. It is not surprising that this criticism came from organizations that are threatened by the crypto revolution (banks, government, central banks, finance companies, etc.). Nevertheless, it is very surprising to hear criticism from economics schools, which oppose central banking and advocate free choice in currencies (such as the Austrian school of economics). Unlike the ordinary criticism (that Bitcoin is a scam, a bubble, etc.), which can easily be refuted, the criticism of part of the Austrian school economists is based on interesting arguments, which requires a different level of explanation. For example, it was claimed that Bitcoin should be worthless; otherwise, it contradicts Mises’ regression theorem. The object of the chapter is twofold: first to explain why the criticism is unfounded and second to analyze the origin of the value of Bitcoin and other cryptocoins from the perspective of the Austrian school of economics. In particular, it is explained that Bitcoin does not contradict the regression theorem for two reasons. First, the initial value estimation can be a random event, and second, the Bitcoin network (even now) has a nonmonetary value.

### Keywords

• cryptocurrencies
• Bitcoin
• blockchain
• regression theorem
• Mises
• Austrian school of economics
• the value of money

## 1. Introduction

Bitcoin is based on three technologies: the Internet, encryption methods, and the new blockchain technology. Unlike these technologies, the Bitcoin revolution was both a technological revolution and a monetary one. It completely changed the monetary world, and it seems that its invention opened a Pandora box, whose effect cannot be underestimated or predicted. Since its inception in 2009, the Bitcoin project had many opponents, and like any successful project, their number increases gradually.

It is not very surprising to hear criticism from the industries and organization, which feel intimidated by the new invention. One would expect to find criticism from leaders in the banking industries, the insurance, and investment industries and, of course, from politicians. It is not even surprising to find criticism in the academic world, since, after all, one of the main tasks of the academic world is to instill past knowledge into the future generation and to be skeptical of new ideas.

On the other hand, since Bitcoin is a decentralized technology, it was warmly adopted by anarchist organizations worldwide [1, 2, 3], but for similar reasons, it was attacked by many others [4, 5, 6, 7, 8, 9]. Some attacked the Bitcoin from the fear of shaking the current centers of powers, but most attacked it out of ignorance. Strangely enough, even in the libertarian community, which in general embraced the new currency, there are some that used allegedly Austrian economics arguments to debunk the foundation of the Bitcoin economy [10, 11, 12, 13, 14].

In general, we encounter two strategies to attack Bitcoin: (1) presenting multiple minor or even clearly erroneous arguments. Consequently, the arguments keep reappearing, despite the fact that they are constantly refuted. And (2) using fundamental economic laws to allegedly demonstrate that Bitcoin does not possess the essential properties of money.

The object of the chapter is twofold: (1) to present and refute all the main arguments in a single chapter and (2) to utilize these arguments to reinvestigate the origin of the source of money in general and cryptocurrency in particular.

So, let us begin with the simple arguments:

## 2. Is Bitcoin a Ponzi scheme?

The most common criticism against Bitcoin is that Bitcoin is actually a Ponzi scheme [7, 10]. Clearly, there is no resemblance between the two. A Ponzi scheme is a fraudulent investment operation. The investors are made to believe that they gain from the investment operation, while in fact, the money comes from new investment, that is, a Ponzi scheme is a pyramid fraud.

While some cryptocurrencies or tokens do seem to be a Ponzi scheme, Bitcoin is definitely not. Everything about Bitcoin: its algorithm, its network, and its development projects are completely transparent. The network, the mining process, and the entire project are all decentralized. There are no managers, no organizers, and no control. Therefore, there could be no fraud.

Bitcoin does not even have a pyramid structure. An investor in Bitcoin can make a profit by selling it at a higher price, just like in any other trade. Unlike pyramid structures, the owner of Bitcoins does not have to convince multiple people to invest in order to make a profit.

It is true that in both cases, the first investors gain more than the last ones, and that their profit rises with the number of traders. However, by the law of demand, it is clear that the price rises with the increase in demand, that is, the price increases with the number of buyers. This is valid for any commodity, and Bitcoin is no exception. This is definitely not a pyramid structure’s fingerprint. Moreover, the whole network structure is different. A pyramid is a centralized structure, where there is a clear asymmetry between investors and all profits eventually dissipate toward the founders of the pyramid (this is a “top-down” business model). Bitcoin is a decentralized network, where all the Bitcoins’ owners have the same status. Moreover, the founders of a crypto network may not even own a share in this network, or they can sell their share, if they have one (like Charlie Lee, the founder of the Litecoin network, who recently sold all his Litecoins).

## 3. Bitcoin is a bubble

Another common criticism is that Bitcoin and the other cryptocurrencies are a bubble [4, 6, 8]. This claim is not a very informative one. What does it mean? Does it mean that the Bitcoin price is too high? In a free market, the price is always right. If there is something “wrong” with the price, then it means that the market is not really free. When there is a housing bubble, it does not mean that there is something wrong with the houses, or that the sellers are greedier than they usually are, but it does mean that the government manipulates the interest rate and subsidizes bad mortgages, etc.

Therefore, any “bubble” claim is actually not a criticism against Bitcoin, but a claim against something external to its network—probably against governments. If everyone buys cryptocurrencies, it is probably because the public has no other investment channels. The banking interest is practically zero; the stock market is too high after 10 consecutive years of rising prices; and the housing market is recovering from the latest collapse. The fact that Bitcoin is in a state of a bubble, whatever that means, cannot be used as evidence to the argument that Bitcoin is worthless.

As Ludwig Wittgenstein wrote, “For whenever we test anything, we are already presupposing something that is not tested.” Similarly, when one believes the price of Bitcoin is too high, he presupposes that Bitcoin has somevalue.

## 4. Bitcoin yields no return

Another repeating argument is that Bitcoin is not a real asset in the sense that it does not yield any return. Unlike stocks or real estates, which yield dividends and rents, Bitcoin does not “yield” anything. People purchase Bitcoin only to sell it later.

## 21. Too costly to mine

A similar reasoning appears in a different argument against Bitcoin: the Bitcoin mining costs are extremely high, and even now, its electricity consumption is equal to that of a small country (like Ireland). Within several years, the costs would be gigantic, and it would be unprofitable to mine additional coins.

Again, this is a complete misunderstanding of the mining process. As was explained above, unlike gold mining, there is no given external cost for mining Bitcoin. The causality between cost and prices works in the opposite direction—Bitcoin prices determine the cost of mining. Therefore, at any given time, the users of the Bitcoin network are the ones who determine the amount of money they are willing to invest in the network security. That is, first, the mining cost cannot increase beyond the amount the users are willing to pay, and second, the electricity cost is not a wasted investment; it is a measure of the network security. The more people trust the Bitcoin network, the more they are willing to invest in it. Consequently, the Bitcoin price increases, and so does, as a byproduct, the mining cost, which measures the network computation power. That is, the more secure the network is, the more trustworthy it becomes in practice via the price mechanism. This is a positive feedback, which strengthens the network. However, there is a limit to the cost of security, which people are willing to pay in any financial transaction. This limit determines the mining cost.

It is interesting that a similar argument was put against the gold standard. Followers of the monetary school of economics argued that unlike fiat money, gold mining is a waste of useful resources, which can be directed to other useful industrial sectors. The answer of the Austrian school was that it is a small price to pay to prevent the government from inflating the amount of money [31]. The Austrian economists have a nice analogy: why so many resources are invested in steel locks? Wouldn’t it be smarter had we replaced them with paper locks and allocate the steel to better uses? This is clearly a rhetorical question. Security is a costly business. We pay for security and safety.

This is an important point. In a stationary economy, or, in the Austrian school terminology, the Evenly Rotating Economy (ERE), the future is already known, and there are neither surprises nor risks. Consequently, there is no need for money. In the ERE, money has no function. People need money only in states of uncertainty. Money helps relieve the sense of uncertainty. However, counterfeiting is a source of concern. Fiat money is susceptible to the whims of the government. Governments can (and do) inflate the money supply indefinitely.

The supply of gold, on the other hand, is regulated by the market, since gold counterfeiting is extremely difficult. Only when the market price exceeds the mining cost, new gold is generated by mining.

The same reasoning applies to Bitcoin. However, there are some very important differences: as was explained above, it is more difficult to counterfeit Bitcoin than gold, let alone fiat currency. Moreover, the ability to counterfeit fiat currency and gold is independent of their value. Therefore, as their value rises, additional counterfeiting attempts are made.

The opposite is true for Bitcoin. The difficulty to attack the Bitcoin network is proportional to the Hash power of the Bitcoin mining; however, the cost of this power is proportional to the price of Bitcoin (since most of the Bitcoins have already been mined). Therefore, unlike fiat money and unlike gold, as the price of Bitcoin rises, it becomes more difficult to attack the network (Bitcoin’s equivalent of counterfeiting).

To summarize this point, the high mining cost is not a waste—it is a security investment.

## 22. Scarcity and value

Another misconception about the origin of the value of Bitcoin is that unlike fiat money, which is created “out of thin air,” the number of Bitcoins is fixed and cannot be changed, and this inherent scarcity is the source of its value.

First, as was explained above, Bitcoin is also inflationary. In fact, the important characteristic of the decentralized crypto coins is not that coins cannot be created “out of thin air,” but that their creation is fully determined by the well-known protocol and cannot be manipulated by a central entity (i.e., governments). Therefore, the users can take account of the inflation parameters into their future financial contracts. This property of cryptocurrencies is a clear advantage they have over fiat currencies. In fact, this is a major advantage even over commodities backed currencies, such as gold, since the future mining rate of gold is unknown, while cryptocurrencies are created in a predetermined manner.

Second, scarcity, by itself, cannot be the source of value. Using Bohm-Bawerk example, the fact that a certain mud pie cannot be reproduced is, in itself, an insufficient demand to make it valuable. Scarcity is a necessary but insufficient condition for value creation.

## 23. The regression theorem and the originof value

It was Karl Helfferich who formulated in 1903 the vicious circle of money [32]. The marginal value theory of Menger, the forefather of the Austrians school, can explain why a handful of diamond worth considerably more than the buckets of water, despite the fact that water is clearly more essential to human existence than diamonds are [33]; however, it could not explain why a seemingly worthless object like pieces of papers can have a high value. In other words, it cannot explain why people would be willing to exchange them with commodities, which have a clear intrinsic value. It was clear that if people, for some reason, attribute value to money, then it would be a logical behavior for the individual to attribute value for money, even if he does not find it useful to himself. However, how did money gain its value in the first place, or, in others word, it is a vicious circle to say that people want money simply because people want money [32].

Mises, apparently, solved this conundrum. He said that people want money today because they anticipate that other people would want it tomorrow since they wanted it yesterday, that is, money has value today because it has value yesterday. By introducing time schedule into the description of the process, Mises circumvented the vicious circle. But he did it with a cost. This logic leads to the unavoidable conclusion that any money had, prior to its use as a medium of exchange, an intrinsic value [34].

Thus, there is an argument that Bitcoin cannot be money since it never had an intrinsic value, that is, while the US fiat dollar is valuable today since it was based on the original value of the gold dollar, which was based for millennia on the currency value of gold, which was based somewhere in the past on the commodity value of gold, they claim that Bitcoin does not have such a chain of events. One cannot find any intrinsic value in the Bitcoin genesis. While gold has an extensive commodity use in its premonetary era, Bitcoin, according to them, had no nonmonetary history and therefore cannot evolve into money.

This claim has several flaws. First, they turn Mises’ argument on its head—Mises used his argument to explain how apparently worthless object can be used as a medium of exchange. Bitcoin is already a medium of exchange, which means that there are only two options, either Mises argument is erroneous or that they are missing something about Bitcoin. In fact, Mises was not entirely accurate and Bitcoin does have a nonmonetary value.

I would like to harness a physical analogy to explain this point—the laser.

When a laser is connected to a power supply, it emits coherent light almost instantaneously. Nowadays, lasers are very common and there is nothing special about this; however, a laser is not a light bulb, the origin of light in a laser can be regarded as a similar mystery. A laser consists of two basic elements: a light amplifier and a resonator, which is actually a feedback mechanism. Hence, a laser is a giant amplifying machine. Using the feedback, the laser keeps on amplifying the light. But wait! Where did the light originally come from? The laser has no element that generates the “original” light (i.e., the primordial photons), it only amplifies it. So where did the light originally come from? Well, actually, this is quite a mystery that nobody really knows. The source can be thermal noise, scattered light, or maybe the zero point energy. While academically it may be an interesting question, it is practically irrelevant to the laser operation. Moreover, it teaches us an important lesson—in the presence of a highly efficient amplifying process, the increase is exponential, and therefore the initial trigger is practically irrelevant. It doesn’t matter whether the process started from a single photon, ten photons or a hundred, the changes in the time till it reaches equilibrium (the time, in which it grows exponentially) is negligible.

The same goes for Bitcoin. It was proven to be a rapidly accelerating phenomenon. In fact, just like the laser intensity or any other phenomenon with an approximately constant rate increase, the value of Bitcoin grew exponentially: within about 4 years it increased by a factor of a million! The technology was proven so successful that the initial value, people attributed to Bitcoin, is unimportant.

The legendary pizza transaction, which allegedly determined its initial market value (in which a couple of pizzas were sold for 10,000 BTC), could be totally different. It could have been sold for 1000 or 100,000 BTCs, and the final outcome would be almost the same and it would be determined by the equilibrium value. In fact, the entire process can start from a whim of a handful of strange geeks (see, for example [35]). That is totally sufficient, exactly like the amplifying process in a laser, which can start, for all we know, from a single photon, which accidentally was present in the laser’s cavity.

In the previous paragraphs, it was explained why one does not have to prove that Bitcoin currently has an intrinsic use value in order to show that its exchange value, that is, its value as a medium of exchange, does not contradict Mises’ regression theorem; nevertheless, Bitcoin had and still has an intrinsic use value.

Clearly, even prior to the Pizza transaction, the initial miner group attributed value to Bitcoin since they spent their time and the energy consumption of their computers to generate these Bitcoins.

Bitcoin is not the only thing that can be sent via the blockchain, in fact, almost any kind of information can be sent via the transactions, and this is an irreversible process, since any such information will remain in the blockchain for eternity, and everyone in the network will have an access to this information. Bitcoins are the cost of perpetuating the information. In other words, Bitcoins can be regarded as the “real estate” of the blockchain. The more Bitcoins a person has, the more information he can send on the blockchain. There are all kinds of data encapsulated on the blockchain: poems, prays, political statements, commercials, and even photos [36]. In fact, it is amazing how many kinds of information can be found there. It is not difficult to find many applications for this kind of information retention.

One of the special applications is the announcement of contracts. Such contracts will be confirmed by the blockchain. Or another important application is a decentralized registrar of real estate (or any other type of property). With the Bitcoin network, one can announce ownership of objects, the information will be available instantaneously, and since it is not centralized, then there is no fear of losing this information.

The important thing is to realize that there is no direct connection between this information and the value of Bitcoin. The relation is indirect. The value of these announcements is directly related to the number of nodes in the network. The more people are connected to the Bitcoin network, the more valuable this information is. Therefore, if the network is large enough, then people will like to use it by sending and announcing information. However, it is clear that when the network grows, sending information becomes more valuable, and therefore the value of the network’s coin, which controls it, increases as well. The more coins a person owns, the more he controls the network. Again we see that owning Bitcoin is like owning real estate on the blockchain.

Clearly, at its inception, when the Bitcoin network was small, the value of publishing data over it was low, but then the Bitcoin’s value was accordingly small. In fact, in its genesis, the Bitcoin’s value could have been only the subjective value of the first few geeks, who mined it (including Satoshi himself). When the network grows, the Bitcoin value increases exponentially, just like the laser power.

Nowadays, the fees of sending information over the blockchain are quite high, and therefore people seldom use the blockchain for broadcasting information. As a consequence, they tend to forget that the Bitcoin network has a clear nonmonetary use, and therefore it has a subjective use value. In any case, the fact that Bitcoin has a nonzero value does not and cannot contradict Mises’ regression theorem.

## 24. Conclusions

Bitcoin has many enemies, and, as a consequence, there are many arguments, which allegedly explains, why Bitcoin should be worthless or should be banned. The truth is that Bitcoin is extremely valuable and is here to stay because it cannot be banned. On the other hand, Bitcoin has many advocates, which use inaccurate arguments to justify the origin of its value.

The fact that these arguments were presented by renowned economists shows us that our understanding about the origin of money did not change much during the last century. The mysterious Satoshi Nakamoto gave us the opportunity to revive these century-old conundrums.

The main conclusions are:

• Bitcoin is not a scheme; it is a great monetary invention, which has a clear economic value.

• It cannot and should not be banned by governments. In fact, any government’s manipulation and regulation emphasize and increase the need for cryptocurrencies.

• Criminals are not the only ones who see the benefits in using cryptocurrencies. In the third world (e.g., Venezuela and Zimbabwe), cryptos are lifesavers. In general, cryptos are extremely valuable wherever censorship resistance is required, and in a global market economy, that fact creates value for everyone.

• Bitcoin does suffer from infancy problems (high volatility and high transaction costs); however, these issues are not fundamental and will be resolved eventually (we already see many signs for that). The fact that the crypto market exceeded 800B\$, despite these issues, only emphasizes the need of the markets in them.

• The energy which is spent in crypto mining is not a wasted energy. It is the source of the network’s security which increases the trust in the system, and in a market economy trust is a very valuable commodity.

• The easiness in the creation of new coins is not equivalent to fiat money inflation. Fiat inflation is a counterfeiting process, while the creation of new cryptos is equivalent to the creation of a new invention, which may be better, but it has to surmount the former coins’ network effect.

• Bitcoin does not contradict any economical law. In particular, it does not contradict Mises’ regression theorem for two grounds: first, Bitcoin was valuable for the first miners even before it was used as a medium of exchange, and the regression process can be kindled by any subjective whim; second, even now Bitcoin has a nonmonetary value (just like gold) as a “real-estate” on the Bitcoin network.

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Er'el Granot (November 5th 2018). On the Origin of the Value of Cryptocurrencies, Blockchain and Cryptocurrencies, Asma Salman and Muthanna G. Abdul Razzaq, IntechOpen, DOI: 10.5772/intechopen.79451. Available from:

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