Bitcoin, the Greater Fool’s Gold

In a recent blog post, Bob Murphy succinctly asks a question that seems to get at the heart of the disagreements between Bitcoin proponents, and Bitcoin haters like me:

There are people claiming that Bitcoin’s non-monetary price is zero, and hence if it’s trading for anything at all, it is in a bubble. But by that logic, gold’s non-monetary price might be (say) $250, and so if it’s trading right now for $1,250, then $1,000 of that is clearly just due to a self-fulfilling prophecy, where people are willing to pay $1,250 for gold because they think that’s how much (at least) it will be worth in the future. If something were to shatter that expectation, then the price of gold would plummet back down to its fundamental value of $250

He similarly quotes a hypothetical proponent’s position, which I believe captures my point of view quite fairly. I would recommend reading his whole post, it’s not very long. I’ve touched on this particular argument before, but I think I should expound on it, given the opportunity to respond directly to Dr. Murphy’s careful layout of the proponent’s position. Murphy, at least for the purposes of this article, accepts the premise that bitcoin has no value as a consumer good, whereas gold has some. I will counter-argue with that premise as well. He also makes some of the same distinctions in categories of valuation that I like to make: consumption, store of value, and speculation. However, I think that Greater Fool speculation is a separate entity. But let’s start with the beginning.

He gives $250 as a hypothetical market value for gold in a pure consumer market today, and of course $0 for bitcoin. For simplicity, let’s suppose that this hypothetical $250 market price is absent any major lapses in knowledge on the part of vendors, so we can safely take as a given that there is no bubble in this market. In reality, a price of $250 doesn’t mean that all consumers are willing to buy at exactly $250, there will be a range of prices at which potential consumers are willing to buy. Suppose this range is between $100 and $1000. We arrive at the price of $250 because anybody only willing to spend $249 is out-bid by people willing to spend $250 or more. The number of people willing to pay $250 or more roughly matches the amount vendors are willing to sell at the same price (basic supply and demand).

Supposing then, that people start deciding to buy gold as a store of value. Many of them are willing to spend more than $250 an ounce, thus they outbid many of the potential consumers in the market, bringing the price up to, say, $300. In buying for a store of value, they expect the price to stay roughly the same, at worst. As such they are speculating on price stability (as Mises said, all action is speculative). Is this a bubble? Not necessarily, because we said that there are potential consumers going up all the way to the $1000 range. It might be a bubble, since these holders may be overestimating the demand at those higher prices, but not necessarily, because they might be right. In contrast, if the same is done with bitcoin (again, taking the $0 pure-consumer market assumption) they can’t possibly be right, so it must be a bubble.

Okay, so what brings gold all the way to $1200 today? It is probably the result of speculation, but the sort of longer-term speculation on effects of inflation of the dollar, in which the gold is priced. Is this a bubble? Again, not necessarily. If the feared outcome of inflation comes to fruition, consumer goods will skyrocket in price, and gold is a consumer good. The hypothetical pure-consumer market, may rise, say, to $1100. If we then account for the store-of-value speculators of that future date, those who speculate on price stability, perhaps the stable price post-inflation will be $1500. Now, the long-term speculators could be wrong that impending inflationary effects will increase the consumer + store-of-value price of gold to that degree, in which case this mentality and the resulting price would be a bubble. But in doing the same with bitcoin, taking the opening assumptions of no consumer market, they are surely wrong.

I’d like to note here that store-of-value speculation on price stability, alone, can increase the price of gold, but it cannot (without being a bubble) rise above the hypothetical price that the highest bidding consumer is willing to pay. That is, this cannot raise it above $1000 in the initial example. But speculating on price increase, as in the case of inflation speculators, the price can be well above today’s entire consumer market, without (necessarily) being a bubble. That said, this is not even the case today; gold-tipped RCA cables are still on the market. I like to point to this example because even jewelry can be a convenient store of value, whereas it seems implausible for RCA cables.

Finally, none of what I’ve described thus far is actually what I would consider “Greater Fool” speculation. All of the above forms of speculation, as I have described them, are based on the expectation, correct or not, of certain consumer prices at a certain point in the future. Greater Fool speculation, on the other hand, is speculation based on the assumption that another trader will always be around to keep the price afloat, in spite of the fact that there is no expectation of consumers. I don’t believe that it is correct to describe every price above the consumer price of gold to be a Greater Fool price. I’d gladly concede that some of gold’s price is due to it, maybe a whole lot of it, like in any market. But to say that everything holding gold so high above the hypothetical pure consumer market price is Greater Fool pricing is incorrect. A lot of speculation is quite legitimate, and as such, it is not necessarily a bubble (again, there could still be bad data). However if we assume that bitcoin has no potential for a consumer market, we must conclude that it is purely a bubble, either via bad data by those who believe bitcoin does have a consumer market, or of the Greater Fool variety for those who do not.

Original content by Dan, CC0 (attribution appreciated), tips welcome

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9 Responses to “Bitcoin, the Greater Fool’s Gold”

  1. ectoendomezo January 4, 2014 at 9:26 am #

    Chris Pacia made an additional “accidental point” regarding bitcoin vs. gold:

    In an EMERGENCY or any serious “crisis” especially the emerging horrifying reality of global warming related environmental crisis’ like Katrina or Sandy…well..Bitcoin is literally, Unequivocally..even irrefutably:


    No Power? No “Digital Currency”!

    No “Network”? No “BTC”!


    Whereas most probably are aware that Gold is now the “Gold standard” for “End Times Paranoia” or even realistic and quite prudent “Preparedness” regimens.

    But “Storing Bitcoins For Use In A Crisis” is a literal “Joke” (am I the first to tell it?).

    Frankly as anyone who’s survived real crisis may tell too is a sort of poor thing to store…you are literally better off storing Food, Water, Tylenol, Toilet Paper, Batteries and Tampons.. as they have a much higher “ROI” in a Crisis than “Precious Metals”..but “Digital Currency” has literally “Zero Value” sans the entire (And quite complicated) network that is Required for it to function at all.

    Just sayin…

  2. Matt G December 30, 2013 at 6:27 pm #

    Greetings. I came upon this post from Murphy’s blog and had to think on it a long while.

    Do I understand correctly that you believe the price of a store of value is capped by its commodity “use-value” to the highest bidder? And if it exceeds this price, it is a bubble?

    If so, why? Why can’t people value some commodity primarily as a store of value, and have its value for preserving wealth drive the price higher than anyone would be willing to pay for a non-monetary use? It seems that by your definition, this would be a bubble. But why is value derived from desirable monetary properties less “legitimate” than commodity use?

    Very wealthy people who need a way to store their wealth can value some things highly just because those things are valuable.

    • Dan January 12, 2014 at 10:51 am #

      Hello Matt,

      I’m sorry I’m responding so late, my inbox got crowded. I hope you get an email notification so you can get a chance to respond to me if you want.

      “Why can’t people value some commodity primarily as a store of value, and have its value for preserving wealth drive the price higher than anyone would be willing to pay for a non-monetary use?”

      I think part of the issue is that a lot of people hand-wave the concept of a “store of value”. Let’s think carefully about what that phrase might mean. Value is not an intrinsic property of the item (as Bitcoin proponents often point out). It is a phenomenon of reaction to the item by an individual. Does storing somebody’s reaction to an item, within the item, have any sort of coherent meaning? No; to say “this object stores value” is shorthand for “I expect somebody to value this object a certain amount, at a certain later time”. So it requires a certain amount of expected future demand. “Valuing something for its ability to store of value” is pure speculation, though it may not be obvious from the way it’s phrased. So you must now ask what one is speculating on. If you’re speculating on selling at a price in the future that will be above the future highest consumer bid, you’re in a bubble. (and if you *know* it’ll be above the highest consumer bid and expect it to work anyway, you’re in a Greater Fool bubble)

      Now, all that said, since I’ve been lazy about actually responding until now, I’ve had a while to ponder what you asked. And I have come up with one interesting counterexample to my claim, which sortof fits your description. The assumption I make for this article, which is not a good general assumption, is that when people value something its ability to store value, they expect to be able to sell at the same price. In reality, people may hold onto Gold with the expectation that it will drop in price, because they feel that every other alternative is worse. I may value Gold today at $1100/oz today because I hope and expect to sell it in 5 years for $1000. If, over those 5 years, the highest bidding consumer is $1000, I am bidding the price of Gold above the highest consumer bid because of its ability to store value, and yet I would say this is *not* a bubble, because nothing will break my expectations, I fully expect to take a loss.

      Now, this scenario creates a twist – what if there are thousands of people like me, constantly doing the same thing? We could bid the “store-of-value” price of Gold to, say, $1300, and *keep* it there, if there’s a steady flow of us. So in 5 years, I could sell for $1290 and do better than I expected. There’s no bubble because if it dropped to $1000 I wouldn’t be disappointed. This is sophisticated to evaluate, and it’s probably left to a real economist. Time value of money I think is an important factor in examining this. The notion of price “stability” is an arbitrary construct, I think. Prices matter in time. (Really, you wouldn’t denominate such an investment in USD because I could just be better off holding onto the USD. It makes more sense to price it in some commodity that degrades over time. “I have 3000 apples now. I’d rather have 2500 apples in the future. I’ll trade it for gold in the mean time.”)

      But at any rate, I think that it’s reasonable to say that nobody would be interested in “storing a value” of zero. So, this doesn’t save Bitcoin. Even in the above scenario, I’m speculating that Gold will “store” *something*. If Bitcoin “stores” something, it’s purely because of other speculators, which makes it a bubble.

  3. Dan December 19, 2013 at 11:23 am #

    And here I said I was careful with my use of price and value, and I screwed them up in my second paragraph :P. Should be:

    Bob says, “If bitcoin is in a bubble for being above commodity price, so is all currency” and I’m saying, “No, Bitcoin is not in a bubble *just* for being above commodity price. It depends *why* it’s above commodity price.”

    • Dan December 19, 2013 at 11:24 am #

      And I also screwed up where the above comment was supposed to go, not my day apparently.

  4. Chris Pacia December 19, 2013 at 10:57 am #

    What I think your missing Dan, and Bob’s main point, is that your “Greater Fool” speculation cannot explain money. According to this theory money must be in a bubble since it trades well above it’s commodity value.

    But the reason it does so because of the convience it provides in trade. Using gold as a medium of exchange was clearly more convient than barter. Hence, gold historically derived a demand that exceeded it’s use value. Since gold doesn’t trade as money today it’s interesting to speculate about it’s current value but I think much of that is due to risks imposed by central banks and the potential that gold could once again trade as money in an emergency scenario.

    The value of bitcoin clearly is the result of speculation that its use as a medium of exchange will increase in the future. Therefore I don’t think the term bubble is appropriate anymore than it is appropriate to call dollars a bubble.

    • Chris Pacia December 19, 2013 at 10:58 am #

      *Edit- you’re

    • Dan December 19, 2013 at 11:21 am #

      So, it seems like you’re missing my main point. And Bob is much more succinct, he gets much more to the point than I do so it’s probably easier to miss my point than his.

      Bob says, “If bitcoin is in a bubble for being above commodity price, so is all currency” and I’m saying, “No, Bitcoin is not in a bubble *just* for being above commodity value. It depends *why* it’s above commodity price.”

      And I can explain it *in terms of* commodity value. Note my careful use of the word “price” and “value”. It doesn’t make sense to say that gold’s “commodity value” is $250. Valuation is a personal phenomenon, not a group phenomenon. All you can say is that its (hypothetical) “commodity price” is $250. Value, on the other hand, is an individual phenomenon. Value determines the price an individual *would be willing* to pay. The aggregate of individual valuations settles in a *price*.

      If, given the *exact* same valuations, the supply were to be disturbed by people removing items from the market, the *price* would increase. Only higher bidders would be able to buy. And my point is, if people buy *only* for the purpose of “preserving value”, that decreases the supply, and raises the price. That person can later sell directly to a consumer. There are no fools in that scenario.

      Similarly, a speculator could buy at a price *way* higher than the hypothetical consumer market. If the speculator is correct in their predictions, and dollars inflate, they can again sell *directly* to a consumer post-inflation, with a wide profit margin.


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