One thing the bitcoin enthusiasts have forgotten about is Gresham’s Law. For those who need reminding, it basically states that as long as the dollar is legal tender, meaning you are forced to accept it in payments, then people will spend their dollars and hoard whatever money they perceive as superior. This will go on until the better money disappears from circulation.

Which is exactly what is happening now to bitcoins. The tiny amount of people who know bitcoins exist overwhelmingly do not spend them at all. They are so positive bitcoin is superior to dollars, [especially since bitcoins will go up in price forever, they think] that the moment they get their hands on a bitcoin, they hoard it. 97% of all bitcoins have not ever been used to buy anything.

So that bitcoin has no chance whatsoever. If the bitcoiners bang the drums about how great bitcoin is, then people will hoard it, but never use it as money. If they try the reverse, and tell everyone what garbage bitcoin is, then, since no legal tender laws protect bitcoin, nobody will bother with it in the first place.

What about the small amount of people today who do buy things in bitcoin? They have not thought things through. They have not figured out that whether bitcoin is better than their local currency, or whether it is worse, they are better off not using it to buy things. If you think it’s better, hoard it. If you think it is worse, don’t touch it in the first place.

The bitcoin crowd hopes that bitcoin use will expand in an ever increasing circle. A friend will bring in a friend, or something. They talk about network effects, and kickstarts.

But we have shown that it is just plain shooting oneself in the foot  to buy things with bitcoin, whether you think it better or worse than dollars. Is there a network effect for poor thinking? Can stupidity be kickstarted? You know what Abe Lincoln said, and the bitcoin mania proves yet again. You can fool some naive people all the time, and everyone, maybe, in the short term, but long term, there is no network effect for these things.

So what does this mean for the ultimate future of bitcoin? Very simple. Some people will not touch it. The hoarders will hoard. But then what?

When Gresham’s Law took effect in the past, the better money that people hoarded was gold or silver. It had intrinsic value. Gold and silver do not depend on being money for their very existence.

But bitcoin is different. Say you have a huge hoard of bitcoins. You don’t intend to spend it, ever. So of what use it to you? Only to sell to someone else who wants to hoard it. So we have a world sprinkled with bitcoin hoarders, who just have their bitcoins sitting in their laptops, like some dead weight. And they paid $266 for every last one of them. What will be the end of such a situation?

We are not examining something unique in the history of man. It has happened over and over. People paid a lot of money for something that brings them nothing, be it stocks that give no returns, tulips that are way overpriced, gold and silver mines that have no gold or silver. So what did they finally wise up and do? They sold it for a pittance, which was all they could get. Or else they were unable to sell it, and got nothing.

UH OH. Here comes Devil’s Advocate again. I see he’s been scanning reddit.com.

DA: Got you this time, Dave. Gresham’s Law only refers to what happens when there is a fixed legal exchange ratio between two currencies. There is no fixed legal exchange ratio between bitcoins and dollars.

SD: You know that, and I know that, but let’s distinguish carefully between Gresham’s Law and the underlying logic of Gresham’s Law.

DA: What do you mean, underlying logic?

SD: Why will bad money drive out good money? And why only where there is a fixed legal exchange rate? Did the Good Lord decree that it must happen?

DA: Of course not, Dave. The reasoning is simple. If I can force the vendor to take inferior money, and I can keep the superior money, I’ll do it. Thus, the superior money will be hoarded, and he inferior money will be what people spend.

SD: So why does there have to be a legal exchange rate?

DA: That’s just a mechanism for forcing people to take the inferior money when everyone wants the good money. The market rate is, say, 40 ounces of silver for an ounce of gold. But there are laws forcing people to accept an ounce of silver as if it were worth an ounce of gold. Instantly, that makes silver inferior [=overpriced] and also forces the vendors to accept the inferior money.

But once one money is superior and the other inferior, for whatever reason, and there is also a law forcing acceptance of the inferior money, it’s game over. Of course people will stash the good stuff and pass on the bad stuff, since they can force the vendor to accept the bad stuff.

SD: OK, so does bitcoin need some legal fixed exchange rate to be superior to dollars?

DA: Oh, no, Dave. Bitcoins are by their very nature superior to dollars. They are secure, infinitely divisible, cryptographic, money of the future, and the whole world loves them so much more than dollars. Didn’t you ever read the many praises of bitcoin, and why it is so much better than mere old fashioned, outdated, clunky dollars?

SD: Are there legal tender laws forcing someone to accept dollars in the US?

DA: Of course.

SD: So what would you rather keep, a wrinkly grimy clunky dollar, or a brand new shiny, destined to constantly increase in value [due to network effects and kickstarting] bitcoin?

DA: You’re darn right I’m hanging on to my bitcoins. I’m going to pass my dollars on to the next sucker, who is legally obligated to accept them, poor fellow.

SD: Thank you Mr Gresham.

DA: I see what you did there.

[LATER] The redditors came out in droves attacking this article. The most salient point they made, at least to the superficial glance, is that I don’t know what I’m talking about.

Make sure you look at this follow up article where Dave replies to seemingly devastating attacks: http://smilingdavesblog.wordpress.com/2013/10/23/redditors-save-bitcoin-from-greshams-law-or-did-they/

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