Say that the local lottery system has decided to innovate. Lottery tickets can now be used as money. A ticket with a face value of $x can be used to buy $x worth of stuff at any checkout counter in the country. Or they can be held in digital form and transferred instantaneously across the lottery's new payments system to friends, the utility company, or the government tax department.
With the payments infrastructure in place, will people actually use lottery tickets to pay their bills, transact with friends, or settle their taxes? Can lottery tickets become money-like?
I'm skeptical. Here's my thinking. Say that Jane has just bought $10 worth of digital lottery tickets. At the same time she's chosen to leave $10 in her bank account (she likes the fact that they aren't risky). She spies a coffee stand and suddenly has an urge to buy a $2 coffee. When she arrives at the till, how will she decide to pay? With lottery tickets or deposits?
By paying for the $2 coffee with a bit of both—$1 in lottery tickets and $1 worth of bank deposits—she could end up with $9 of each, re-attaining her pre-coffee 50/50 allocation. But let's assume that every transaction is a bit costly to make, both in terms of time to completion and the small fixed fee associated with each payments network. So paying with both will be too expensive. She'll have to choose one or the other.
A lottery ticket is more than just a bet. Jane is investing in a fantasy in which she is fabulously rich. So from Jane's perspective, swapping her lottery ticket for a mere cup of coffee would be silly. Once she owns it, her ticket is worth more than hundreds of cups of coffee. A form of Gresham's law kicks in. Given that the coffee seller accepts both lottery tickets and deposits at their face value, Jane will only spend her deposits, which she perceives as being overvalued, while hoarding the lottery ticket, which she thinks are being undervalued by the coffee seller. If every lottery player is like Jane, than 'undervalued' lottery tickets will never circulate as money.
Jane could of course consider buying the coffee with lottery tickets only to purchase replacement tickets in time for the draw. But there's always a risk that she'll forget, or not have enough time because something unforeseen suddenly intervenes. By paying with a boring deposit, she doesn't have to fear missing out on a jackpot.
If it seems unlikely that Jane will want to purchase the coffee with a lottery ticket, what about Jim, who owns the coffee stand? Would he prefer to receive lottery tickets or bank deposits?
Again, a mix of the two instruments would be costly for him to accept given a doubling up of payments processing fees. In the unlikely event that Jim is also a lottery player and hasn't yet bought his tickets yet, then he may prefer that Jane buys a coffee with lottery tickets.
Consider that Jim has a constant stream of business expenses ahead of him, but rarely knows precisely when he'll have to make a purchase. Because the lottery tickets will most likely expire worthless in the future, they don't provide him with a suitable means of solving for his future uncertainty. Deposits, on the other hand, will always retain their value. As long as he keeps them on hand, he knows that he can meet his bills. So I think that Jim will probably prefer that Jane pays with deposits. (See more here).
In the unlikely event that Jane insists on paying with lottery tickets, Jim will probably acquiesce—the customer is always right. Since he doesn't want to be exposed to the uncertainty of lottery tickets, he will probably try to exchange them as quickly as possible for deposits, but this will be subject to a conversion fee. Anticipating this expense, Jim could very well decide at the outset to incentivize Jane to pay with deposits. He might place a small surcharge on lottery ticket payments, or offer a small discount if customers pay with deposits. Jim might even pretend that his lottery payments terminal is broken.
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The combination of Jane's reticence to pay with lottery tickets, a form of Gresham's law, and Jim's preference to avoid them will doom lottery tickets as money. Even though the infrastructure is in place for lottery tickets to be transported instantaneously from one person to the other, the incentives just aren't present. Investing in the infrastructure turned out to be a waste of money.
I think this setup also explains why bitcoin has never been adopted as a form of money. Like Jane's lottery ticket, a bitcoin owner's bitcoins aren't just bitcoins, they are a dream, a lambo, a ticket out of drudgery. Spending them at a retailer at mere market value would be a waste given their 'destiny' is to hit the moon. Sure, a bitcoiner can always spend a few precious bitcoins on a coffee, only to replenish his stock later in the day. But this would be dangerous, since bitcoin's price could spike at any moment. Far safer to spend one's deposits and hoard one's bitcoins.
Even when they claim to be accepting bitcoins, retailers like Jim actually rely on intermediaries like BitPay to step in and purchase the bitcoins while relaying dollars to the retailer. For instance, see last month's post on Ohio tax payments.
I also wonder how well my story fits with other examples of volatile media being used as money. For instance, John Cochrane has blogged about a world where one might trade an "S&P500 index share for a candy bar." If lottery ticket buyers and bitcoin owners are consuming a dream, then perhaps an owner of an equity ETF is doing the same. In which case, no one would bother buying candy bars with stocks, and so building out the payments infrastructure necessary to facilitate this would be pointless.
Apart from becoming rich, what new or additional utility would the lottery ticket provide?
ReplyDeleteWhat Bitcoin brought that did not exist before is a high degree of immutability, which reduces the cost of trust. Double entry accounting also reduced dramatically the cost of trust, therefore allowing new business that were not possible before. This characteristic could be a driver for Bitcoin adoption despite its volatility (volatility is unavoidable in the process of monetization).
Also, in the event that Bitcoin fees fall dramatically, which could happen with Ligtning Networks or any other scaling development, it might allow for new kinds of payments that are not possible with other MoE (microtransactions, streaming money...)
In my view, Bitcoin adoption as MoE does not depend on its current or future value. Rather the opposite, as for any other economic good, the current and future value of Bitcoin depends on its utility.
Immutability, meaning? You're balances can't be erased from the system?
DeleteYes. And also meaning certainty of transactions occurrence (as of CEAVOP assertions), irreversibility of transactions (certainty on settlement), and also meaning that the owner of a balance can demonstrate on its own it is a real balance (very useful for very cheap escrows).
DeleteIf we agree that certainty is very valuable, then anything that reduces the cost of certainty is valuable.
In my post I've invoked a situation in which bank deposits and lottery tickets are available. If for some reason the bank is censoring Jane from making card payments, but the lottery system isn't, then she will of course try to use her lottery tickets to buy the coffee. (And Jim will probably accept them--albeit for a price--because the transaction benefits him). But none of this detracts from my main point that when both instruments are available, forces will inevitably push lottery tickets out of circulation.
Delete(Note: I wrote something on the niche role that bitcoin can play as a backup payments system here).
But one thing is availability, in the sense that both deposits and lottery tickets are digitally tranferable, and another different thing is the specific properties of each medium. Bitcoin is not just tranferable digital currency, Bitcoin´s transferability is in fact slower and clumsier than bank deposits at this stage.
DeleteAnyhow, I agree that the analogy could apply now and many people hold bitcoin because they expect much higher prices. Indeed, if Bitcoin is being monetized this is an unavoidable speculative stage.
The problem with focusing on speculation (lottery thinking) is whether if Bitcoin is useless or it is very useful, speculation will happen in both cases. If we assume that Bitcoin is just a speculative bubble, obviously there is speculation. And if we assume that Bitcoin has very good features to become a general MoE in the future, there is even many more reasons to speculate on Bitcoin and that the speculation stage is going to be even wilder and longer.
Therefore, in this case speculation is a sign that in my view leans slightly more to real future utility than to a worthless bubble, but it is not conclusive at all. So if we want to draw any significant conclusion we need to assess Bitcoin specific features and if those features are unique or not and to what extent would they be useful.
You seem to be drawing a line between two types of speculative motives for holding bitcoins, a noble one and one based on lottery thinking. I don't see how this changes any of the conclusions I drew in my post: if Jane holds x as a speculation, or gamble, she'd rather keep it then spend it, since in her head she has already classified it as being far more than its market value. And Jim won't want to accept x because he needs stable media in order to meet uncertain expenses.
DeleteWell, the lottery thinking (becoming rich) might very well be present in both types of speculation.
DeleteAs I said, I agree on your conclusions that Bitcoin is not working as MoE because holders are not willing to exchange it because they expect higher prices.
But my point is that by comparing bitcoin to lottery tickets you are somehow implying that Bitcoin is useless and the only reason to hold it is because someday it will be very valuable. There is a reason that the lottery ticket might become very valuble, but what would be the reason for Bitcoin? just because? or because it is useful (has good properties) as MoE? If the latter is true, then the lottery case is only comparable to Bitcoin in circumstantial basis during the monetization stage, but is not comparable on general basis.
Regarding the niche role of Bitcoin, I think you are dismissing a hidden cost in fiat currency payments which is subsidized by the state (legal infrastructure) and the bank´s lending business. Bitcoin is money (not anyone else´s liability). Fiat currencies are credit, and as such need a backing to have value, so direct costs are all banking infrastructure, and indirect coss is the need to make use of a legal system to enforce the assets backing their currency. Backing a currency is not an easy nor simple task at all (i.e. US recent QE policies, Argentinan Peso, Bolivars, Yuan, Swiss Franc in 2015, UK Pound in the 90s, dollar in the 70s, etc).
Delete"But my point is that by comparing bitcoin to lottery tickets you are somehow implying that Bitcoin is useless and the only reason to hold it is because someday it will be very valuable."
DeleteMaybe I should be more specific. In my post, I've put lottery tickets in the same category as bitcoin, because in both cases their owners (for whatever reason) tend to ascribe to them a mental value that *far* exceeds their market value. And this is what prevents them from being used in payments. Doesn't seem controversial to me, and it seems like we agree. I'm not sure why you want to keep on arguing. :)
I do agree in the sense that Bitcoin is not working as MoE today because much higher prices are expected. But from my point of view the analogy with the lottery ticket is kind of contemptuous towards Bitcoin because the lottery ticket without a prize would be useless, and Bitcoin does not have a prize. So although I fully understand it is not the point of your post, you are implying (correct me if I am wrong) that Bitcoin is as useless as a lottery ticket without prize.
DeleteIn any case, not arguing, just exchanging ideas with someone I respect. I sincerely like your posts (even when I disagree) and I really appreciate the time you take writing them, and also the time you take answering comments.
I didn't intent to be contemptuous. Bitcoin doesn't have an explicit payoff like the lottery, it's payoff comes in the form of potentially rising to $100,000.
DeleteI don't think the bitcoin-lottery comparison is very fortunate.
ReplyDeleteA lottery ticket is objectively worth less than its cost. If we rationally calculate the odds of winning, it becomes clear the buyer paid a big fee in order to change a 100% probability of owning a small amount of money for a small probability of owning a huge amount of money.
That big fee prevents any rational investor from playing lottery. Then, why do people buy lottery? Well, for some people the fantasy in which they become fabulously rich is worth that price.
But this is not an economic decision, so most people just buy a small amount of lottery. You write:
"So from Jane's perspective, swapping her lottery ticket for a mere cup of coffee would be silly. Once she owns it, her ticket is worth more than hundreds of cups of coffee". If that was unconditionally true she would have spent her $20 in lottery. I.e. the marginal value of additional lottery tickets decreases very quickly.
This has nothing to do with bitcoin. Unlike lottery tickets, bitcoin is a liquid asset. You can buy and sell huge amounts of bitcoin at any time for a negligible fee. So buying bitcoin is an economically rational bet on its price.
Unlike lottery, bitcoin has many advantages versus fiat as a long term store of value. It cannot be inflated by government, it's difficult to confiscate or censor, etc. The fact that many people appreciate these features is driving an hypermonetization process with nice profits for those who migrate from fiat earlier. This represents an additional incentive to hold bitcoin. Lottery is a zero-sum game, bitcoin hypermonetization is the greatest value generation process in human history.
https://twitter.com/fnietom/status/1057354295732039680
S&P500 index shares would be a better currency than lottery tickets. But a currency backed by corporate equity shares most of the issues of current debt backed fiat currencies.
"If that was unconditionally true she would have spent her $20 in lottery. I.e. the marginal value of additional lottery tickets decreases very quickly."
DeleteI don't think that's how a lottery player's thought process goes.
Here's my hypothesis. To begin with, a player makes a one-off choice between cash-in-hand and lottery tickets. Once they've chosen the optimal balance, say a $10/$10 split, the player's mental value of the lottery tickets is updated. The tickets have ceased to be $1 pieces of paper, but a gateway to an entirely new life. After the mental update, the player will not trade her $10 in tickets back for a mere $10. She needs much more than that. See this link, for instance, where people consistently refuse to part with their ticket for twice its value.
You seem to be suggesting that if lottery tickets were worth so much to someone, then the full $20 would have been allocated to them. Not so. Assuming that the original allocation between cash and lottery tickets was a one-off decision prior to their fantasy value kicking in, that explains why the remaining $10 is allocated to cash, and stays that way.
That link is certainly interesting. I may not share the mindset of lottery players, which may explain why I don't play myself. But the fact that most players spend only a very small fraction of their wealth in lottery endorses my argument: marginal value of additional lottery tickets decreases very quickly.
DeleteThis doesn't invalidate the key point of my argument anyway. Lottery tickets are illiquid hot potatoes. Even if they are worth more than their cost for their owners (after they bought them), the value for other people doesn't even reach their cost. And even those who might be willing to accept them wouldn't want to accumulate a big amount.
Their irrational/illiquid value makes lottery tickets a bad MoE and their perishable nature makes them a bad SoV.
The fact that some owners of bitcoin and promising companies assign lottery-like value to their holdings doesn't change their fundamental difference with lottery: liquidity.
"Lottery tickets are illiquid hot potatoes."
DeleteWhy so? Let us say the issuer sets up a website where it offers to buy back all $1 lottery tickets for $1 less a 0.5% fee. Now, anyone can liquidate any quantity of tickets in an instant. Voila, infinite liquidity (exactly like the liquidity offered by bitcoin exchanges). That doesn't change the fact that no one will want to spend lottery tickets at shops, nor will merchants want to accept them.
Well, you are moving the goal posts. Lottery operators take about 30% cut. Why would they buy back lottery tickets that were sold for $1 and worth $0.70?
DeleteIf that was the case and they were trustworthy enough, lottery tickets would behave like banknotes with an expiration date. All this represents costs. Merchants would be surely willing to accept them for the right premium, and if there wasn't a better alternative some people would start using them even if they don't like to play lottery. But we have much better alternatives thankfully, so I don't see how this exercise is productive.
DeleteIf the issuer obliges itself to accept tickets at a specific price then it becomes a liability. Now that’s a complete different case from Bitcoin which is not anyone else’s liability. Bitcoin exchanges do not have any obligation to buy bitcoins at any specific price.
If the issuer obligues to buy, you don’t even need the lottery example, you already have Tether.
Delete"Lottery operators take about 30% cut. Why would they buy back lottery tickets that were sold for $1 and worth $0.70?"
DeleteThe operator takes in a $1, issues a $1 ticket, and promises to return the $1 it keeps in reserve. Seems pretty simple to me. Look, in Ontario they allow lottery ticket refunds, as long as its before the draw. It's the same policy.
"Merchants would be surely willing to accept them for the right premium, and if there wasn't a better alternative some people would start using them even if they don't like to play lottery."
Yep, welcome to my post. ;)
Apparently, even the Ontario Lottery and Gaming Corporation only allows the purchaser of the ticket to seek a refund. Probably to prevent people having the temptation to use them as bearer instruments. Therefore they keep being "illiquid hot potatoes" in the hands of any merchant.
DeleteYou keep avoiding the main argument: liquidity. Bitcoin is a highly liquid asset, with other great monetary qualities, very different from a lottery ticket. If you provide liquidity to lottery tickets (which is not a very realistic scenario) you would still have a currency worse than the fiat currencies we have today. Bitcoin is much better than that, it removes trust in any third party. No inflation, confiscation resistant, censorship resistant, potential anonymity, instant digital payments for free...
"You keep avoiding the main argument: liquidity. Bitcoin is a highly liquid asset, with other great monetary qualities, very different from a lottery ticket."
DeleteReally? my whole post is about liquidity.
Bitcoin is a liquid asset because it can be quickly sold on an exchange. But in p2p and point-of-sale settings, it is illiquid, because of what I wrote about in my post. Same applies to the lottery ticket scenario that I set up.
In one of my replies to mpolavieja, I touched on censorship resistance and immutability.
Bitcoin cannot only be sold on an exchange, there are platforms where people trade them p2p (even with a premium). The fact it's not accepted at point-of-sale is irrelevant and only means it's not a very good MoE for most use-cases today.
DeleteAs Vijay Boyapati explains, it's important to understand that "cash" has been misinterpreted to mean "medium of exchange" rather than as the more appropriate meaning: "bearer instrument". Bitcoin, like gold, is a bearer instrument.
Lottery tickets cannot have genuine liquidity because they are worth much less than their face value. If one assumes your irreal lottery conditions, liquidity would be provided by the issuer. But in that case it doesn't matter if it is issuing lottery tickets or banknotes, the lottery component becomes irrelevant and it's only a burden because of its expiry.
I understand you wanted to remark that expectations of a higher price (I.e. price deflation in terms of bitcoin) represent an impediment for bitcoin to be used as a MoE. That is true, but the lottery comparison wasn't fortunate. There are many other impediments for bitcoin to become a generally accepted MoE, but even if this keeps being the case its monetary features (as a bearer instrument) are not diminished. In many countries the MoE keeps being the local currency even if the prevalent SoV and UoA is the USD.
JP,
ReplyDeleteLet me try to put it in a slightly different way, even though I'm not sure if I manage to say anything new:
The assets you talk about are held for either a transactional or a speculative purpose (if we leave the precautionary purpose aside). If you hold an asset for speculative reasons, you most likely don't want to trade it for a cup of coffee, unless your opinion on the future value of the asset happens to change simultaneously with an emerging need for caffeine.
One could of course assume that people might choose to hold S&P 500 shares for transactional purposes. But even then they are necessarily speculating, knowingly or not.
Holding deposits has very little to do with speculation, usually.
I think that's right. People have mental buckets. The transactional bucket only admits extremely stable assets, because they are being held in reserve for a range of unscheduled payments. Very few people would put shares in this bucket since they could crash, leaving the person unable to make these payments.
DeleteYes, it seems the (nominally) most stable forms of credits tend to be the most generally accepted, which makes sense.
DeleteDeposits/cash can be seen as a temporary step, after one has surrendered goods, services or what we could call 'risky credits' (eg, stocks), and before one decides to obtain (other) goods, services or risky credits. Without this temporary, nominally risk-free step, we run into the problem with "double coincidence of wants". In this case 'wants' are not restricted to want of goods or services, but include risk preferences, too.
To suggest that people generally would be indifferent between holding, say, S&P 500 ETF shares and holding deposits, or even prefer the former, is to ignore the inevitable realization of risk inherent in 'risky credits'. I doubt John Cochrane, for instance, will see as much moneyness in S&P 500 ETF shares if the price of those crashes 50-60 % during the next couple of years.
We people are lazy. Deposits offer a way of least (mental) resistance from selling our labor to buying goods and services. Yes, by holding deposits/cash one is to some small degree speculating, but one avoids a higher degree of speculation (risk-taking, really) which comes with any alternative assets.