Common among economic misunderstanding is the concept of “backing.” Somehow, the word “backing” signifies a final, and perplexingly, in my opinion, acceptable point.
Among all things that ever occurred in the history of the world during the entire existence of humans, the only thing which could ever be, or needed to be, backed, was a promise.
Somebody could accept a favor and “back” it with the promise to pay their debtor back in the future, in the form of something valuable to the lender. A coconut for a crab, or vice versa, perhaps.
Fiat currency is so pervasive today, that many people have little perspective on the concept of value. Historically, we are in uncharted territory. Never before have so many nations been so intricately tied together by a global monetary system. And yet, to the layman, the one who toils aways to make a living for a family, this seems normal.
It is not normal.
The main chink in the Keynsian armor is that monetarists ignore a central concept known as the subjective theory of value. If you read a modern macroeconomic textbook on the matter, you will encounter this term, but it tends to be buried and ignored. However, the implications are significant.
Why should anybody call for the “backing” of anything? The answer lies in a subtle observation of the subjective theory of value. For instance, if you make hats, you may very well be as excited about your 100th cap as you were about the first, for your own consumption, but you probably weren’t. In essence, the value to which you ascribe your 100th is light years behind the value that an undoffed individual might enjoy.
In such a world, where un-had things are better than many-had things, one might search for a more objective measure of value. After all, if the value of all things is subjective, how can we trade amongst one another without resorting to barter? When two individuals wish to trade, it helps to employ a medium of exchange which deviates as little as possible compared to the whims of their endeavors.
And what is the number one factor that determines objective value? There are many contenders, but the absolute winner in the equation is scarcity.
When the US was on a gold standard, the implication was that any individual could walk into a bank, proffer about $20 worth of paper currency, and receive gold in exchange. This was the gold-backed currency of yestercentury. But why was gold chosen?
Despite what many gold enthusiasts may claim today, it had nothing to do with gold’s industrial uses. In fact, the lack of industrial uses contributed to its status as a store of value. Sure, you can wear gold, but more people hid it away in safes than plastered it to their wrists.
Gold is scarce. However, even this term is often misunderstood. Because gold is highly divisible, scarcity isn’t really the best term to use. Gold is limited, or at least highly limited. What you know when you hold a gold coin in your hand is that is may indeed lose value, but not because somebody made more of it over the weekend. In you hand you hold a piece of hard work, labored over precisely because gold is limited.
So why is Bitcoin backed by gold? Admittedly, it isn’t. “Backing” requires a “backer,” somebody who will redeem a promise with a limited item, a token of posterity, an objective measure of value, or at least, as close as you can get to such a thing.
This is why those who claim that Bitcoin is backed by nothing are misunderstanding why backings occur in the first place. The only thing that can be backed is a promise, and the best backing possible is a universally accepted, limited, measure of value. Bitcoin is no such promise. It is gold unto itself. Bitcoin is the backing.
And for the adventurous mind, pairing gold to Bitcoin is quite easy. With a total valuation of about $8T of gold, and a total valuation of $7B of Bitcoin, Bitcoin comes out at about ~1,000x undervalued. That puts Bitcoin around ~$500,000 per coin if you equate 1 ounce of gold to the equivalent portion of outstanding bitcoins.
Of course, this valuation is crazy. After all, the world would never adopt a frictionless, honest, and limited store of value as their backing article of choice if it happened to be digital too… right?