In the “crypto” world, there are theorists mistakenly applying Irving Fisher’s equation of exchange without knowledge of Austrian critiques of the idea. Understanding why Austrian economists are critical of MV = PT might help these theorists avoid these errors in reasoning. (These theorists include Kyle Samani, Chris Burniske, and Vitalik Buterin among others, hereafter referred to as “crypto velocity theorists.”)
Quick Overview of Terms in the Fisher Equation of Exchange
In the equation, M = the money supply, V = the velocity of money, or the average number of times a currency unit changes hands per year, P = the average price level of goods during the year, and T = an index of the real value of aggregate transactions. In the MV = PQ formulation, Q = an index of real expenditures and P × Q = nominal GDP.
How Are Crypto Velocity Theorists Misapplying the Theory?
Crypto velocity theorists seem to believe that the current structure of crypto tokens (non-bitcoin ones) has a velocity that is too high. They assert that somehow by using the protocol to force holding or “lock up” periods the velocity of the token can be slowed down, enabling more sustainable value capture for a crypto protocol. There are various “tokenomics” ideas being proposed to achieve this slowdown in velocity, such as profit share mechanisms, staking functions to lock up the token, or gamification to encourage holding.
But are these mechanisms sustainable in the longer term? Distinguished against these ideas is the simple concept of bitcoin, a token and monetary network created to replace fiat money. Bitcoin can justifiably hold a place in a person’s cash balance under a theory of speculative demand based on its monetary characteristics. In this case, the more relevant reference is Carl Menger and the argument around marketability or saleableness, not the quantity theory of money and associated equation of exchange.
How Do Prominent Austrian Economists Critique the Quantity Theory of Money?
Austrian economists reject the quantity theory of money, which is too mechanistically focused on the nominal quantity and not on real subjective valuations by individuals. Murray Rothbard and Joseph Salerno point out many problems.
In Man, Economy, and State, Rothbard points out a serious conceptual flaw:
At any one time there is a given total stock of the money commodity. This stock will, at any time, be owned by someone. It is therefore dangerously misleading to adopt the custom of American economists since Irving Fisher’s day of treating money as somehow “circulating,”…There is, actually, no such thing as “circulation,” and there is no mysterious arena where money “moves.” At any one time all the money is owned by someone, i.e., rests in someone’s cash balance.
In other words, Rothbard shows that velocity is a rather meaningless idea. Further, he points out that different goods cannot be meaningfully added together, demonstrating the absurdity of doing so:
How can 10 pounds of sugar be added to one hat or to one pound of butter, to arrive at T? Obviously, no such addition can be performed, and therefore Fisher’s holistic T, the total physical quantity of all goods exchanged, is a meaningless concept and cannot be used in scientific analysis.
Joseph Salerno levels his own critique against the idea of the quantity theory of money also, identifying where it is vacuous in his article “A Simple Model of The Theory of Money Prices“:
Let’s begin with the Quantity Equation as conventionally stated: MV = PQ. Our simple model above reveals that the real action is on the right side of the equation.…The mechanical passing of a specific sum of money from one hand to the next in exchange, that is, “spending,” is completely governed by the money price that has been antecedently established by the exchanging parties. Thus the money spent is merely an outcome of the pricing process and in no sense a causal factor. In other words, the aggregate flow of money spending is determined by the value of money and not the other way around.
Salerno demonstrates that individuals’ subjective valuations drive prices all along, not the quantity of money in a mechanistic sense.
So, in the end, “Tokenomics” and attempting to “game” token velocity downward to satisfy an erroneous Fisher equation of exchange is misguided. We should aim to understand bitcoin and cryptocurrencies from an Austrian monetary theory standpoint. Menger’s On The Origins of Money and Ammous Saifedean’s The Bitcoin Standard are more relevant places to begin. Saleableness is more important than velocity.
