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Why Gresham’s Law is Important For You

Bitcoin’s legal status as commodity money brings to light Gresham’s Law, an economic principle stating “bad money drives out good.” We explore how to apply Gresham’s Law to the Bitcoin Standard.

Mickey Koss
Mickey Koss
Mar 21, 2024March 21, 202414 min read14 minutes read

Money makes the world go 'round. But what happens when there are different forms of money circulate side by side? 

This phenomenon is explained by Gresham’s Law, a centuries-old economic principle stating that "bad money drives out good." As Bitcoin continues its meteoric rise as a digital currency and store of value, the implications of Gresham’s Law are more relevant than ever.

Will Bitcoin be able to take hold as the new medium of exchange of the future?

Or will it be relegated to a nascent store of value as the bad money’s inflationary policy continues incentivizing spending?

Understanding Gresham’s Law

Historical Background and Definition

While often attributed to British financier Thomas Gresham, ancient Greeks and Romans knew the observation behind Gresham’s Law. They noticed that when coins of varying gold and silver content circulated together, the "bad" coins with lower precious metal content drove the "good" coins out of circulation. People hoard coins with higher gold or silver purity while spending money on "bad" coins of lesser value.

Properties of Money

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The principle was formalized in the 1500s by Gresham, who shared his observation that "bad money drives out good" in a letter to Queen Elizabeth I. At the time, the forced circulation of debased currency by King Henry VIII was draining England of its store of quality coins.

As the King forced an artificially debased exchange rate, silver gradually moved overseas to be used more favorably. Gresham’s Law explained the phenomenon and became a keystone of currency policy.

The rise of digital currencies presents a new scenario where the law applies. Bitcoin, the new “good money,” is predominately leveraged as a nascent store of value. Many people are reluctant to spend it throughout this translation period as it appreciates significantly in longer timeframes.

On the other hand, they freely spend traditional fiat currencies, which are considered "bad" money. This behavior aligns with Gresham’s Law in the realm of digital currencies.

Mechanisms and Examples in Traditional Finance

Gresham’s Law applies when different forms of commodity money coexist but have different intrinsic values.

Typically, one form is commodity money with physical worth value, like precious metals.

The other is a currency without commodity value, like fiat money, which gets its value from government decrees. When both are in circulation, the "bad" fiat money drives the "good" commodity money out of circulation.

Several mechanisms cause this:

Hoarding — People recognize commodity currencies have more long-term value and hoard them, while spending the "bad" fiat currency.

Melting down — The physical commodity coins get melted down and sold for their raw metallic value.

Account settling — When settling accounts, debtors pay in the debased currency since it’s still legal tender.

The end result — Only the inferior money circulates in the economy. This continues the devaluation cycle overall and can add to inflation.

Gresham’s Law in the Age of Digital Assets

The Rise of Digital Currencies

The rise of cryptocurrencies like Bitcoin represents a new chapter for Gresham’s Law. As a decentralized digital currency, Bitcoin differs significantly from traditional physical money. Backed by cryptography rather than commodities, it has a programmed supply and derives value from the network effect.

So, how does Gresham’s Law apply in this digital era? Can this age-old economic principle provide insight into Bitcoin’s future trajectory and impact on monetary systems?

Applying Gresham’s Law to Bitcoin

On the surface, critical aspects of Gresham’s Law appear relevant to Bitcoin:

  • Bitcoin has an inherent value and limited supply that contrasts with the unlimited supply of fiat currencies.

  • Bitcoin and fiat currencies have coexisted for over a decade and are both utilized as payment methods.

However, there are also key differences:

  • Bitcoin has no physical manifestation to be "driven out" of circulation. As a digital asset, it resides on the blockchain. 

  • Bitcoin provides utility as a payment network, uncorrelated asset, and monetary system outside government control. This utility affects its value.

When analyzing Bitcoin through the lens of Gresham’s Law, aspects of human psychology still apply. Just like precious metals, people leverage Bitcoin as a savings vehicle due to its limited supply and potential to appreciate. And when Bitcoin is more widely accepted, people may be more likely to spend fiat and save Bitcoin.

But Bitcoin also provides a unique utility that shifts incentives away from merely hoarding forever. It enjoys a first-mover advantage and a growing network effect. And its digital nature provides some insulation from the dynamics that drive physical metals out of circulation.

Economic Implications and the Future

If Bitcoin continues gaining traction, it could appreciate significantly in value against fiat currencies, which have an unlimited supply and inflation pressures. This could lead more people to hold their Bitcoin rather than spend it, as it represents "good" money compared to "bad" fiat, which is subject to devaluation.

In this digital age, "driving out of circulation" may not apply literally but could manifest in people abandoning fiat in favor of better-performing cryptocurrency. This could have profound implications for the legacy financial system.

But Bitcoin may also face challenges in achieving such dominance. Governments declare fiat legal tender and require taxes in fiat, creating built-in demand. 

While Bitcoin has existed outside the traditional purview of Gresham’s Law, its growing adoption and valuation against fiat currencies means the age-old economic principle is highly relevant. Understanding these long-term monetary dynamics will be critical as more institutions and individuals allocate to Bitcoin.

Impact on Traditional Financial Systems

The Interplay Between Bitcoin, Fiat Currencies, and Gresham’s Law: Impact on Traditional Banking and Monetary Policies

The interplay between Bitcoin, fiat currencies, and Gresham’s Law is a complex dance of money, technology, and economic theory. Let’s explore two routes this interplay could take and how they could affect traditional banking and monetary policies.

Route 1: Bitcoin Accepted as a Means of Payment

Picture this: a country where Bitcoin is embraced as a legitimate form of payment alongside traditional fiat currencies. Gresham’s Law could come into play in this scenario but with a twist. Instead of "bad" money drives out "good" money, we might witness a shift where Bitcoin becomes the preferred form of payment, thanks to its advantages over fiat currencies:

  1. Currency competition and innovation: The acceptance of Bitcoin as a means of payment could create healthy competition between Bitcoin and fiat currencies. Governments and traditional banking systems may need to adapt to this new reality by introducing innovative financial products and services to stay relevant and attract users.

  2. Enhanced financial inclusivity: Bitcoin’s decentralized nature can provide financial access to those underserved by traditional banking systems. It could empower individuals in areas with limited banking infrastructure, allowing them to participate in the global economy.

  3. Altered monetary policies: With Bitcoin entering the mix, governments may need to reassess their monetary policies. The fixed supply of 21 million bitcoins could challenge central banks' ability to control money supply and ensure price stability.

  4. Vendor incentives: Since Bitcoin does not rely on layers of intermediaries to process transactions and move value, businesses are incentivized to adopt the technology as a cost-savings mechanism. As more businesses begin to accept Bitcoin, the public may very well follow suit, especially if those businesses pass their cost savings on to their customers as well.

Route 2: Hostility and Capital Flight

Now, let’s take a turn down a different path—one where governments continue their hostility towards Bitcoin, leading to the outflow of Bitcoin-denominated wealth from the country, as alluded to in the book "Sovereign Individual“:

  1. Government crackdowns and restrictions: In this scenario, governments perceive Bitcoin as a threat to threatening their control over monetary systems and attempt to suppress it through strict regulations or bans. This hostility might only drive the use of Bitcoin underground and limit its potential benefits.

  2. Capital flight and currency devaluation: Faced with government resistance, individuals may opt to move their wealth out of the country by converting it into Bitcoin, a portable bearer asset that can easily cross borders. This capital flight could pressure fiat currencies, leading to currency devaluation and economic instability.

  3. Impact on traditional banking: As individuals embrace Bitcoin to protect their wealth, traditional banking systems in hostile countries could experience a decline in deposits and face challenges in managing capital flows. Banks may need to adapt their services to cater to the changing financial landscape or risk becoming obsolete.

Remember, these two routes present contrasting possibilities and would have varied implications for traditional banking and monetary policies.

The acceptance or hostility towards Bitcoin depends on how governments and financial institutions perceive and adapt to this technological disruption.

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The Future of Money and Digital Currencies

The Potential for Bitcoin as "Good" or "Bad" Money: A Gresham’s Law Perspective

In the wild world of money, where Bitcoin roams alongside traditional fiat currencies, how does it fare in the eyes of Gresham’s Law?

Could it be considered "good" or "bad" money?

Let’s dive in and find out!

Bitcoin as "Good" Money

When we say Bitcoin could be seen as "good" money, we mean it’s the preferred choice for transactions and store of value. Here’s why Bitcoin might earn that shiny "good" money title:

  • Transcending boundaries: Bitcoin operates globally and is accessible to anyone with an internet connection. It’s not tied to any particular country or central authority. This borderless nature allows for seamless and secure cross-border transactions, making it a convenient option.

  • Security and privacy: Bitcoin offers a high level of security, as cryptographic technology protects transactions. It also allows for anonymous transactions, giving individuals control over their financial information.

  • Limited supply: Unlike fiat currencies that can be printed to no end, there will only ever be 21 million Bitcoin. This scarcity, combined with growing demand, could lead to price appreciation. It’s like owning a limited edition, except instead of Beanie Babies, it’s digital gold!

Bitcoin as "Bad" Money

On the flip side, Bitcoin might get labeled as "bad" money if it falls short in certain areas. Here are a few aspects that could contribute to this less flattering designation:

  • Volatility: Bitcoin’s price can resemble a roller coaster ride on a bumpy road. The value can fluctuate wildly, which might deter some from using it as a stable medium of exchange, at least during the monetization phase of adoption. 

  • Limited acceptance: While increasing in popularity, Bitcoin has yet to achieve widespread adoption as a payment method. You can’t exactly pay for your morning coffee or groceries with it everywhere you go, unless you stumble upon a Bitcoin-savvy vendor or cafe. If businesses remain intransigent in their acceptance, then it might be difficult to gain traction as an everyday-use currency. 

  • Learning curve: Bitcoin is a different beast from traditional money. It requires a degree of technical understanding to set up wallets, manage private keys, and navigate the ecosystem. This learning curve could act as a barrier to widespread adoption.

The Interplay Continues

In the grand dance of Gresham’s Law, the stance on whether Bitcoin is "good" or "bad" money might vary depending on who you ask and under what circumstances. It’s worth noting that perceptions can evolve over time, influenced by technological advancements, regulatory changes, and societal attitudes. 

Many argue that Bitcoin is still in its earliest stages of adoption. As Bitcoin grows and matures, the volatility is expected to decline, making Bitcoin more suitable for everyday transactions. 

That being said, despite the current volatility, many are choosing to live on a Bitcoin standard regardless. This trend could continue to accelerate with fiat monetary debasement over time. 

Challenges and Controversies

Criticisms of Applying Gresham’s Law to Bitcoin

Addressing the Limitations of Applying Gresham’s Law to the Bitcoin Market

Ah, Gresham’s Law. It’s a nifty economic principle that helps us understand how "bad" money can squeeze out "good" money. However, when it comes to applying Gresham’s Law to the Bitcoin market, we need to consider its limitations and potential criticisms. So, let’s put on our thinking caps and dive into the complexities!

Technological Differences

Bitcoin is a whole different beast compared to traditional fiat currencies. Its underlying technology and features can challenge the application of Gresham’s Law in a couple of ways:

  1. Digital vs. physical: Bitcoin exists purely in the digital realm, unlike physical coins or paper bills. This digital nature can affect people’s perception of its value and utility, making it harder to compare directly to physical currencies.

  2. Uniqueness and scarcity: Bitcoin’s limited supply and uniqueness set it apart from fiat currencies. Unlike traditional money, Bitcoin cannot be easily replicated or printed at will. This scarcity factor introduces a whole new dynamic that may not neatly fit into Gresham’s Law’s framework.

Adoption Challenges

  1. Limited acceptance: Bitcoin’s acceptance as a means of payment is still in its early stages. While some businesses and individuals embrace it, it’s not yet universally accepted. This limited adoption could hinder the smooth operation of Gresham’s Law, as the battle between "good" and "bad" money requires widespread usage.

Volatility and Store of Value Concerns

Bitcoin’s notorious price volatility can make it a less desirable store of value or medium of exchange for the risk-averse. Others may be hesitant to spend their Bitcoin if they expect its value to skyrocket in the future, leading to higher savings rates and less circulation.

Utility Differences

  1. Transaction speed and scalability: Bitcoin’s underlying blockchain technology comes with speed and scalability limitations.

The time it takes to process transactions and the number of transactions the network can handle per second can impact its practicality as a medium of exchange.Though second-layer protocols alleviate these concerns, some argue that later adopters may be relegated to second-class citizen status with Bitcoin service providers rather than fully owning the Bitcoin themselves.

Privacy and Anonymity

Bitcoin offers a degree of privacy but is not entirely anonymous. Transactions can be traced on the public blockchain, which might deter some individuals from fully embracing it for everyday transactions.

Conclusion: The Dance Between Bitcoin and Gresham’s Law

And thus, our journey through the interplay of Bitcoin and Gresham’s Law comes to an end. We’ve explored the potential for Bitcoin to be considered "good" or "bad" money, and delved into the limitations and criticisms of applying Gresham’s Law to the Bitcoin market. But before we bid adieu, let’s summarize the key takeaways:

  • Bitcoin as "Good" money: Bitcoin has the potential to be preferred for transactions and as a store of value due to its borderless nature, security features, and limited supply. It’s like a globetrotting superhero with cryptographic armor and a limited-edition cape. Pretty impressive, right?

  • Bitcoin as "Bad" money: On the flip side, Bitcoin faces challenges that might hinder its acceptance as a stable medium of exchange. Volatility, limited adoption, and a steep learning curve can make it a little less dazzling in the eyes of Gresham’s Law. But fear not, for these challenges may fade away with time and adoption like a bad hair day.

  • Technological, adoption, and utility differences: Bitcoin’s digital nature, unique scarcity, limited acceptance, scalability concerns, and privacy features introduce complexities that may not neatly align with Gresham’s Law. It’s like trying to fit a square peg into a round hole, but the pieces might just come together with some wiggling and adjustment.

So, armed with knowledge and a sense of adventure, my intrepid Bitcoin explorer, you’re ready to navigate the twists and turns of the Bitcoin landscape.

Embrace the learning journey, make informed decisions, and remember that Gresham’s Law is just one piece of the puzzle. Bitcoin is a world of its own, filled with surprises, challenges, and the potential to change how we think about money.

Now, go forth, conquer the Bitcoin realm, and ride the waves of the digital revolution with confidence and a touch of humor with Swan Bitcoin today. Happy Bitcoin-ing!

Mickey Koss

Mickey Koss

Mickey Koss became a freelance writer in the Bitcoin space in an attempt to build a proof of work portfolio for when he left the Army. He graduated from West Point with a degree in Economics before serving in the Army for nearly a decade. He became orange pilled in graduate school and is now a regular contributor to Forbes, Bitcoin Magazine, and Bitcoin News. He’s been on popular podcasts such as BTC Sessions’ Why Are We Bullish, and is a regular on Café Bitcoin.

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