Bitcoin's Paradox of Scarcity

For a medium of exchange scarcity is essential: There have to be meaningful limits on its supply (or on the growth in its supply) and it has to be impossible to spend one and the same unit of the medium of exchange in more than one place simultaneously.

In the case of a commodity money such as gold these requirements are satisfied as a result of the physical nature of the commodity: the potential supply of gold is limited by the total amount of mined or mineable gold in existence and by the cost of mining gold; moreover, if you give a gold coin to one person you cannot simultaneously give it to another person.

In the case of fiat money governments typically have a monopoly on its creation (although in the exercise of this monopoly they partner with and/or can delegate some of this creative power to central banks and commercial banks) so that everybody else can't go around creating new units of the fiat money at will.

And the problem of double spending is taken care of by either banks (if you use your bank account to pay somebody the bank makes sure that you don't spend the same money somewhere else at the same time) or the physical good itself (you can't give a coin or a bank note to one person and to another person at the same time).

Bitcoins, on the other hand, are wholly virtual and immaterial. Moreover, the bitcoin network is maintained in a decentralized way. So how can bitcoins still be scarce and rivalrous goods?

Bitcoin's First Use as a Medium of Exchange?

Every May 22 bitcoin enthusiasts celebrate Bitcoin Pizza Day. In 2010, back when hardly anyone had heard of bitcoin, Laszlo Hanyecz used his bitcoins to buy two Papa John's pizzas. Hanyecz sent 10,000 BTC to a fellow BitcoinTalk forum user, jercos [sic], who bought the two pizzas from Papa John's using his credit card and had them delivered to Hanyecz's house. 

This Bitcoins-for-Pizzas transaction is often regarded as the first real-world bitcoin transaction or purchase, the first transaction in which bitcoin was actually used as a medium of exchange. Wired wrote:

Laszlo Hanyecz, a Florida programmer, conducted what bitcoiners think of as the first real-world bitcoin transaction

 And economic researcher Peter Surda had this to say:

This example of a trade of Bitcoins for a pizza is indirect exchange and therefore, from that time on, Bitcoin has been a medium of exchange.

The odd thing, however, is that even though bitcoin is currently a medium of exchange and even though the Bitcoins-for-Pizzas transaction was an example of indirect exchange, in the transaction bitcoin was not actually used as the medium of exchange.

Bitcoin, Culture and Value

What good are bitcoins if you can’t show them off? I can’t wear a bitcoin chain around my neck or a bitcoin watch on my wrist. Nor can I hang a bitcoin on the wall. And because bitcoins are highly divisible and fungible they make for poor collectibles. I can’t possibly complete my bitcoin collection or impress people with the story of a specific bitcoin’s particular place in history or what makes it different from the other bitcoins out there.

These limitations are one reason why bitcoin is a peculiar store of value.

We typically think gold is expensive because people value it as jewelry, that original works of art are valued for their beauty and their place in history or the oeuvre of an artist. People collect old coins because they find them beautiful or fascinating and because they are driven by the human instinct to collect things that are rare and meaningful in some way.

It seems to be the aesthetic, historical, cultural features of these kinds of objects, together with their rarity and the human drive to collect that give them their value. But bitcoin doesn’t seem to have such qualities. Nor are bitcoins backed by governments or central banks who can create a demand for them the way they do with regular money. Bitcoins also don't provide returns in the way stocks do.

So if not through these properties, institutions or returns, how could bitcoins have become so valuable? Is bitcoin just in a big bubble that will inevitably pop?

In this article I first argue - much in agreement with Moldbug's Bubble Theory of Money - that while it is true that bitcoin is in a big speculative bubble, it is a sustainable one.

And secondly, contrary to how we usually think about them, most of the value of the objects I mentioned above - gold, fine wines, works of art etc - is also bubbly. 

Bitcoin is special only in that it is an extreme case of the same bubble mechanism. While much of the price of original works of art, fine wines and gold can be explained by this bubble-blowing mechanism these objects do also have some consumption value. Bitcoin's value on the other hand is nothing but bubble. The same principle holds for other cryptocurrencies such as Ethereum.