Sunday, March 24, 2013

A Critique of Patrik Korda's 'Bitcoin Bubble 2.0'

By Peter Šurda
Economics of Bitcoin
Wednesday, March 6, 2013

Patrik Korda recently published a critique of Bitcoin: I get agitated when I disagree with others, so I wrote a rebuttal.

Competition under the network effect

Korda's first argument is that because it is easy to create a new cryptocurency, they will compete each other out of the market, kinda "race to the bottom", ending up with a hyperinflation and a collapse. However, he does not seem to understand the network effect, one of the most important aspects of money. The network effect both allows that money actually exists in the first place, as well as creates switching costs. As JP Koning said, "liquidity is sticky".

The problem with Korda's argument becomes more apparent because he himself shows a counterexample. He quotes Mises in explaining that silver has been replaced by gold and this demonetised silver. This explains how competition works under the presence of a strong network effect: the expected long term state is where a small number (maybe even one) media of exchange are the dominant ones, and other market players are far less liquid. For the same reason, a situation where there is a large number of competing cryptocurrencies without clear dominant players is not a stable state, rather a small number of dominant players will emerge.

The network effect is recognisable in particular with immaterial goods: there are a small dominant number of general purpose operating systems (Windows, iOS, Linux), a small dominant number of languages (Mandarin and English dominate, then Spanish and Hindi follow after a gap, and those four account for about half of the world population (I'm approximating, as people can speak more than one language)), there is only one dominant general purpose communication protocol (what we commonly call "the internet"), and so on. Surely, the composition of the dominant players can change, but it is a relatively slow process that does not magically happen overnight. Surely, there are a myriad of minor players, but there always tend to be a low number of dominant players.

If I said that everyone can create their own language, therefore without barriers to entry, everyone would end up with their own language and the ability to communicate would collapse, you'd surely think that I'm a moron.

Another important factor related to the network effect is path dependence. This means that the order in which choices are made influences the end result. This can mean, for example, the first mover advantage. Bitcoin is the first practically usable cryptocurrency, so it has a head start against others. And surely, JP Koning has a useful infographic showing that the market capitalisation of Bitcoin, the first mover, far outstrips the market capitalisation of others (by a factor of 100, at the time of making the graphic). This is also consistent with my claim from above that there typically is a small number of dominant players. Even though there is government interference in the choice of media of exchange (what we call fiat monies), international trade is affected significantly less than national, and we still have a small amount of major players (the USD and Euro).

I'm not arguing here that Bitcoin can't be replaced by something else, but that the scenario described by Korda makes no sense.


Korda makes the argument that Bitcoin is only usable with electricity and smart phone, but this is incorrect. Bitcoin is the first form-invariant medium of exchange, and can be used in almost any imaginable form, without having to rely on a middleman. Something like this never existed before in the history. People that criticise Bitcoin from this point of view tend to confuse implementation with the fundamentals.

Mises' Regression theorem

Korda, unfortunately, missed the core point of Graf's article. Even if there appears to be a wide disagreement on what the regression theorem actually says, we can be pretty sure about what it doesn't say. It doesn't say what happens to a medium of exchange after it becomes medium of exchange (and Robert Murphy concurs). It only talks about what happens before it becomes a medium of exchange. It does not say what happens between a medium of exchange becoming a medium of exchange and it becoming money, and it does not say what happens after it becomes money. It also does not talk about the scope of usage as a medium of exchange, how many people use it for something else than a medium of exchange, which media of exchange are sustainable, or any such invention that is frequently ascribed to it in particular by critics of Bitcoin. So unless Korda decides to mimick Smiling Dave and claim that Bitcoin is not a medium of exchange (and neither are gold, blue chip stocks or US bonds), the objection with respect to regression theorem is methodologically flawed.

Can Bitcoin become money?

Similarly as in the section about the regression theorem, Korda conflates medium of exchange (whatever is used in indirect exchange) and money (the most liquid good, and thus by implication, the most liquid medium of exchange). I consider the question of Bitcoin becoming money irrelevant for the near future. I have the same opinion as Vijay Boyapati, I think that if Bitcoin becomes money, that would be an unprecedented success. It would be the end of fiat money, and possibly also the state. But the implied criticism of Korda is a false dichotomy: either Bitcoin is money, or it's useless. I dub this fallacy money or nothing (and chicks for free). Contrary to this dichotomy, there is a wide range on the liquidity scale which is called "secondary media of exchange" (Mises) or "quasi monies" (Rothbard), that do provide, through liquidity, useful services. Bitcoin's further advantage is the decrease of transaction costs, which can be practically utilised as long as some level of liquidity persists. It already can be utilised now. There already are plenty of situations where the switch to Bitcoin improves utility. The criticism is like saying that unless everyone learns English, it makes no sense to learn it. Or even better, that it makes no sense to get an email address unless everyone uses email already.

Classification according to ToMC

As I wrote in my thesis, as Bitcoin is not money (yet), merely a medium of exchange, it is impossible to use the classification system of Mises to classify Bitcoin. If it becomes money, then we would have a classification problem. How to solve it I leave open in this post, as I consider it merely a theoretical question with no practical relevance. In my thesis I present options for solving it.

Now, Korda claims that Bitcoin is token money. However, going upwards from the bottom of the graphic in Mises' ToMC Appendix B, Bitcoins are not token money, because they are not fiduciary media, because they are not money substitutes. The Austrians use two definitions of money substitutes (I explain the difference between the two in my thesis):
  • absolutely secure and immediately payable claims to money (in the narrower sense)
  • things that act as full substitutes to money (in the narrower sense) from economic point of view
Irrespective of which of these definitions is correct, Bitcoins, clearly, are neither, as there is no underlying "money in the narrower sense". So the attempt of Korda to provide a classification of Bitcoin failed.


This is a complicated question, I just want to dissolve some unclarities. While some information about Bitcoin transactions is recorded in the blockchain, and publicly available, this information does not include any references to the identity of the parties involved in the transaction. While a vector analysis can reveal some relationships hidden upon first look, there are on the other hand many other things that can be done to obfuscate this. Examples are mixers (either explicit ones or ones that can do that function indirectly, e.g. Satoshi Dice), and some features that have not been fully implemented yet, e.g. transaction rewriting, or proposals for new opcodes.

From economic point of view, the "perfectness" of Bitcoin's anonymity is not the relevant question. The relevant question is whether this is significantly (from the point of view of users) better than the alternatives, and if it presents a significant cost increase for the attacker (e.g. the state). I'll leave this one open too, I'll just add that for transactions that do not involve a physical meeting of the trading parties, anything else than cryptocurrencies is highly unlikely to provide a comparative advantage over Bitcoin from the perspective of anonymity.


Korda seems to think that the question of the Bitcoin price being a bubble is important. I on the other hand consider it completely irrelevant. The relevant question is if Bitcoin decreases transaction costs, and the answer is that it does. Whether the price changes are a bubble or not does not change the answer to the question whether it has a comparative advantage against other media of exchange. The price is irrelevant (thanks for the slogan, Tony). Emphasising the bubble is kind of like saying that when the dot com bubble burst, this must mean that the internet is unsustainable and must collapse.

Almost all critiques of Bitcoin entirely ignore transaction costs. It's like arguing that there's no point in internet if we already have the library, the post office and the TV. According to the logic of these critiques, the businesses will decide to forego a highly profitable opportunity of providing services that increase the efficiency of social interaction and their potential customers are going to forego a reduction of costs of these interactions. Instead, the arbitrary judgement of these critics concludes that the target market is somewhere entirely elsewhere (in barter in a village, for example), and at the same time that arbitrary target market is not a good match for Bitcoin. It baffles me all the time. But I hear it all the time too. People have fixed ideas about what they think money should do, and when Bitcoin doesn't fit into that scope, they don't understand it. It is difficult to recognise a paradigm shift while it's happening, but it is always obvious after it already has taken place. I guess some people just have to endure having their brains in an ignorant state while the market structure changes around them and those with more foresight are able to increase the efficiency of their business operations (and increase their profit).

My recommendation for serious economic analysis of Bitcoin is to ignore the price as much as possible, as long as there is one (i.e. the price is higher than zero). It's simply not relevant.


Regrettably, Korda's criticism contains many flaws. Hopefully I manged to address them. My most important argument is that one should be careful to avoid mixing theoretical and empirical issues. To summarise my counterarguments:
  • Due to network effect, the market structure will move towards a small number of dominant cryptocurrencies, so there's no hyperinflation
  • Whether Bitcoin can become money is not important, as using it is already advantageous now, as a medium of exchange. If it ever becomes money, that would really rock though.
  • Non-economists do not understand the regression theorem and invent their own versions of it which are nonsensical
  • Bitcoin is not token money as it never was a money substitute
  • Bitcoin is pseudonymous, and has a comparative advantage against competitors from this point of view
  • The price of Bitcoin is irrelevant
Reprinted with permission.

Read part 2 of the critique: "The classification and the future of Bitcoin"
Read part 3 of the critique: "Is Bitcoin a money substitute?"
Read part 4 of the critique: "Response to Korda's article"


  1. Please see excellent comment section following Peter's original blog post.

  2. This is excellent analysis, thanks, Jon

  3. Round 3: