Published on 14 February 2018

For all its fragile highs and lows, bitcoin has been in the headlines for months. But, some observers warn, bitcoin has no intrinsic value, and virtual currencies are not credit or debt. What does this statement mean? To find out, you must first understand why currency is debt.

The first credits, a goldsmith’s affair

In the first half of the seventeenth century, goldsmiths were one of the few trades able to guard against crooks; the nature of their business meant they had vaults. Wealthy merchants were particularly vulnerable and soon thought of asking goldsmiths to keep their precious metals safe.

Obviously, this was not a free deal: the gold or silver was stored in exchange for a promissory note, or receipt, with the depositor’s name on it, and of course fair compensation for the service rendered. On presentation of this promissory note, all or some of the precious metals could be withdrawn.

As things evolved, these receipts become anonymous, mentioning only the amount of gold payable in return. As the receipts were much easier to handle than gold, they were soon preferred for trading in goods or services. These notes, which could be exchanged for the weight of gold written on them, constituted a credit for the holder.

Goldsmiths had gold reserves sitting permanently in their vaults. Meanwhile, traders wanted to borrow funds to develop their business. The two parties quickly found common ground on the basis of receipts identical to those of the depositors. These receipts were ephemeral: they were destroyed as soon as the debt was discharged.

Establishment of the money creation mechanism

It wasn’t long before the goldsmiths realized that while gold came in and went out, the amount of gold in their vaults did not fall below a certain threshold. Statistically, not all borrowers would ask for their receipt to be redeemed at the same time. Hence the idea of offering more receipts than there was gold. The sum of the amounts written on the receipts was higher than the weight of gold required to guarantee it. Though there was a risk of being unable to cope with an influx of receipt holders wanting to withdraw gold, it was obviously moderate because the system grew. Having said that, as John Law discovered in 1720 with his disastrous strategy to replenish French coffers post-Louis XIV, all asset holders trying to cash out at the same time is not just a theoretical possibility!

The mechanism of money creation was born. When a merchant borrowed, the goldsmith printed him paper receipts. The sum was recorded in the ledgers. Receipts were issued and the amount of gold in the vault didn’t change. The merchant used these notes to pay his suppliers, who would use them in turn to pay employees, who could themselves use them to buy bread and so on. The currency circulated, and the starting point for all these exchanges was a simple record in a ledger.

The story doesn’t end there: when the merchant repaid his debt, the goldsmith destroyed the receipt. Money creation and destruction followed each other with a non-zero-sum result: the merchant’s business activity grew and the goldsmith earned interest. Aristotle’s three properties of money were there: acceptability, divisibility and durability. Acceptability, because the currency was guaranteed by trust in the gold reserve. Divisibility, because it meant labor could be exchanged for bread, since everything was measured in common units of account. Durability, because the currency’s reference to gold gave it a certain stability. The amount of currency needed to buy bread was the same—adjusting for inflation—whether one purchased it at a given time or a year later.

Government currency, central banks and commercial banks

This mechanism is now used by governments. However, while currency was based at first on an equal value of gold, the shift to the government arbitrarily decreeing its value has become customary. Such currency is called fiat money because it is based on trust in the government, which arbitrarily decrees its value. The euro, for example, is the equivalent of gold for goldsmiths. The goldsmith’s role is now held by the European Central Bank, which issues the banknotes and coins in circulation. Governments, for their part, enforce two rules: it is illegal to refuse the national currency in settlement of a debt, and it is illegal to pay taxes with another currency. These rules make the currency a lot easier to accept.

Conventionally, in a state, the central bank issues the national currency and applies the government’s monetary policy. Commercial banks distribute the central bank’s currency and manage services such as loans using bank money, that is, funds held in accounts, the transactions of which are recorded. A bank transfer of one hundred euros does not mean that there are one hundred euros in cash in a box; it’s only an accounting entry. Another entry will debit the account following a payment by bankcard.

Overall, 95% of the money supply is created by commercial banks and 5% by central banks. A commercial bank is legally required to hold a reserve of 1% of its amounts outstanding in government currency at the central bank. Note that the money supply created by obtaining credit, and destroyed when the debt is repaid, covers the principal but not the interest. This has to be financed elsewhere, typically through new loans.

And virtual currencies?

Whereas bank money allows you to withdraw the recorded sums from your bank in cash at any time, nothing of the sort is offered with virtual currency. Virtual currency only exists in the ledgers. The way it’s constructed, only the written record of the currency persists in the process—any transaction is indelibly recorded—but its total independence from other currencies prevents it from being based on any value or currency. It can be said to have no intrinsic value. In fact, the expression “virtual currency” borders on the oxymoron.

Without intrinsic value, none of the 1,300 virtual currencies meets the Aristotelian definition of money. Virtual currencies are certainly gaining acceptance, and you can’t deny that they are divisible: they make it possible to measure the value of goods and to make comparisons. But they are not durable. Currency makes it possible to defer a purchase for “later”, at a better time. That is, as long as the purchasing power of that currency is still the same “later”. Yet by definition, virtual currency is not based on any element that might ensure its stability. That being said, to deny Aristotle and say that “bitcoin is a currency” largely simplifies the debate.

Where could the intrinsic value of the volatile bitcoin lie if it had one? For my part, I see two possibilities: fast fund transfers and ICOs (initial coin offerings), which consist in contributing to financing a project, not by investing capital or lending funds, but by pre-purchasing services that the project will propose. For example, Ethereum offered ether, Uber could have offered rides, and Air France could have offered air miles. The investments, which are very attractive in the initial phase, can be exchanged later on the market; these financial products are known as tokens.

A value dependent on emotionalism

Ultimately, the price of bitcoin is driven entirely by supply and demand. A purchase is made by betting on the fact that “someone” will be willing to buy at a higher price. Might it be a kind of stock? Not exactly. A stock is a certificate of ownership with voting rights, defining a value that virtual currency does not have. A type of bond? Not that either, because a bond is a loan.

In the end, a virtual currency has no reference. It has no “reasonably” high or low value. Price fluctuations follow the mood and emotions of the moment, from craze to disappointment in unexpected if not surprising movements. Its price is unpredictable. Just because it’s high doesn’t mean it won’t get higher. But it can also fall.

Saying that it is a bubble is all very convenient, but at eight thousand dollars in mid-November, we might have predicted a burst. Alas, it then took off again, the price doubling in a fortnight. The unpredictable bitcoin is a perfect product for fans of heady emotions and gambles. All because a virtual currency is not a debt.


Jacques Baudron, teaching fellow in virtual technologies, MRT bachelor’s program, Université Paris Sud – Université Paris-Saclay

The original version (in french) of this article was published on The Conversation.