It’s likely not what you think — because most people are asking the wrong question.
People often say: “bitcoin can’t be money, it isn’t backed by anything.” This is an old way of thinking that originated with paper money. Prior to paper money, people used precious metal coins (such as gold) because they maintained strong monetary properties: scarcity, durability, divisibility, portability, fungibility, and acceptability (the six monetary properties).
Paper became money because it was superior to gold in terms of divisibility and portability BUT it lacked scarcity. People reasoned that we could benefit from the greater divisibility/portability of paper money as long as it was redeemable in a form of money that was scarce. This is when money needed to be “backed” by something.
Since we changed money to paper money that wasn’t scarce, it needed to be backed by something that was.
Since the repeal of the gold standard, politicians have retarded the meaning of the word because our money is no longer backed by something scarce. Governments say money is backed by their “full faith and credit” as an attempt to allude populations into the belief that their horrendous credit is economically equivalent to one of the scarcest commodities in the world.
So, what is bitcoin backed by?
Nothing. Sound money, like gold, isn’t “backed.”
Only money that lacks inherent monetary properties must be backed by another money that maintains those properties. The idea that our base layer money needs to be backed by something is thinking from the era of paper money.
Bitcoin does not require backing, it has inherent monetary properties superior to any other form of money that has ever existed. It’s important because when people think money needs to be backed by something, they assume money requires backing from a government.
As we transition out of the fiat era back to sound money, it will be important for individuals to remove the narrative that money is something that needs to be backed.
But isn’t bitcoin backed by energy?
Isn’t bitcoin backed by proof of work?
Bitcoin is ENABLED by these things, and many others: electricity, software, incentives, algorithms, hardware, suppliers, customers, contracts, property rights, real estate, communities, etc.
When you say it is “backed” by these things you are implying that it is redeemable money and are retarding this definition just as fiat practitioners have. You wouldn’t say that gold is backed by mining infrastructure, international agreements, property rights, etc.
You would say that it’s supply is enabled by those things.
As an aside – don’t conflate market value with monetary value. Gold’s market value exists because it is used in electronics or as jewelry. Gold’s monetary value exists because it is used as money.
Gold’s market value in electronics/jewelry could go away tomorrow and it would still maintain monetary value (because it has strong monetary properties). Market value is not needed for something to have monetary value (as a unit, not at scale).
Lastly, the purpose of definitions is to communicate distinctions in meaning. By saying something is backed by energy you are inherently reducing the ability to distinguish bitcoin from everything else that is backed by energy (because energy backs everything). If I told somebody literate in economics this notion they would say: sure, so is everything, that isn’t a good answer.
Economics is a framework for assessing value to make decisions. Discussing what makes bitcoin superior money, needs to be understood through an economic framework. The good news is we already have an economic framework to use – monetary properties. So, here’s how to think about it: all of those things that ENABLE Bitcoin are really enabling it to have superior monetary properties.
Superior monetary properties are what make bitcoin inherently sound money and for that reason we don’t need to back it with anything. This distinction is important because:
(1) Anyone who understands monetary theory will think you are foolish saying bitcoin is “backed” by energy/algorithms or that you don’t understand the term.
(2) The world needs to realize that sound money does not need to be backed by anything, it needs to be inherently superior.
(3) If you think I’m stupid and still want to use the word “backed” for things that enable bitcoin then you need to be complete and list all of them (a challenging task) when defining it for people.
In conclusion: bitcoin isn’t backed by anything, it has inherent monetary properties which are enabled by the entire ecosystem of resources, capital, and labor that created it.
If you are curious to understand this better, the first three chapters of my book cover it in depth — you can find the link on my author page.
If you don’t want to immediately buy my book then check out this series based on my book that I wrote for Bitcoin Magazine which covers this concept.
This is a guest post by Eric Yakes. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.