Bitcoin and Liquidity Preference

“Why would anyone outside of a lunatic asylum want to hold money? What an insane use to put it! For it is a recognized characteristic of money as a store of wealth that it is barren; whereas practically every other form of storing wealth yields some interest or profit. “ –John Maynard Keynes

This is how Keynes understood the functions of money. He believed that individuals should be self-interested enough to want to maximize the utility of money. Keynes believe that ‘the public’ held money for three purposes:

  • to have on hand for ordinary transactions
  • to keep as a precaution against extraordinary expenses
  • to use for speculative purposes.

This is called liquid preference, and it is the idea that we would rather have a dollar that can purchase anything now, in our hands (as it is the official mode of exchange and legal tender), than to have a bar of gold that is subject to storage fees, a house that is deteriorating, or food that is rotting. Because physical items that are subject to physical decay cannot be immediately exchanged as money can, everything become more illquid than money. The more illiquid something is, the more ‘risk’ that is taken on in holding it; which creates the need for a higher dividend yield, or ROI for holding that object when comparing it to money today. This preference for money today is due to the special properties of liquidity that money has. When two monies are compared side by side, Gresham’s law take effect, with the bad money driving out the good.

In order to understand how bitcoin operates as a payment system, we must first understand how governments created money. This is a very long and esoteric topic which I explain in some detail in bitcoin and the history of money. Essentially over the course of several centuries, governments have changed money (i.e legal tender) from being backed by commodities, like land, gold, or silver; to being backed by nothing except for their own legal force (which is why you cannot exchange your dollar for gold or bitcoin down at the bank). This allows for governments to augment the money supply to attempt to change the velocity of money–this is the equivalently of change exactly how much more ‘liquid’ legal tender is, then any other commodity.

So how is bitcoin different? Well, Bitcoin is not money

Bitcoin is a commodity money. 

Bitcoin’s intrinsic value is derived from its ability to act as money, while still having an independent commodity value.

So in reality, bitcoin is not a ‘money’ in the most traditional sense of the word–it is not recognized as being an official form of legal tender, nor is it created in the same way that money is created by the state. What this means is that if bitcoin is not created by any state entity as a legal tender, then it must be a classic form of money: commodity money. This is something like gold, silver, bushels of wheat, cigarettes–really anything you can imagine, it just has to be something that is of value to society, and is plentiful enough to be readily exchanged, while still being divisible, portable, and difficult to counterfeit.

What happens when we understand bitcoin from Keynes perspective (that money is a barren storage of value)? We can see that his statement is true–but then, why is bitcoin worth something? Because again, bitcoin is not money–it is a commodity that acts like money. This means that the whole payment network of bitcoin while still working, acting, and functioning like money, it distinctly is not money.

Bitcoin is a commodity which is used primarily as storage of value that is readily exchangeable–more so than any other form of legal tender, or commodity-money that has ever existed. What happens when we do a side-by-side comparison of bitcoin-as-money, against all other forms of money, is that bitcoin will always be a superior form of money. Always.

Bitcoin flips the idea of liquidity preference on its head because bitcoin not technically money–it is a commodity-money with a built in payment system. Bitcoin has all of the features of sound money, with the extra twist of living on the internet, which inherently makes it superior to all forms of legal money. Over time, as people come to know and understand, how and why bitcoin is a better form of money, people will start abandoning fiat money causing for both hyperinflation and hyperbitcoinization.

Next: Bitcoin’s Creative Destruction