Gresham's Law and Bitcoin: A Flawed Association. Irrelevant.
Gresham’s law, observation in economics that “bad money drives out good.” More exactly, if coins containing metal of different value have the same value as legal tender...
What is Gresham's Law?
Britannica states: “Gresham’s law, observation in economics that “bad money drives out good.” More exactly, if coins containing metal of different value have the same value as legal tender, the coins composed of the cheaper metal will be used for payment, while those made of more expensive metal will be hoarded or exported and thus tend to disappear from circulation.”
Historical Example of Gresham’s Law
Great Britain accidentally adopted a de facto gold standard in 1717 when Sir Isaac Newton, then-master of the Royal Mint, set the exchange rate of silver to gold too low, thus causing silver coins to go out of circulation. As a result of this devaluation of silver, it was more profitable for people to export silver to other countries such as France, Germany, and other European Countries, as well as the colonies of the New World, where silver was in high demand for trade and commerce. This led to a shortage of silver in circulation in Britain and an influx of gold.
The Flawed Association
Gresham's Law states that "bad money drives out good money" when there is a fixed exchange rate between two types of currency or assets. This is because people will tend to hoard or use the "good money" for savings or other purposes while using the "bad money" for transactions since it can be exchanged at a fixed rate for the more valuable currency. This leads to a scarcity of the "good money" and an oversupply of the "bad money." However, when there is a floating exchange rate, the relative value of the currencies will adjust based on supply and demand, so the law does not apply.
Gresham's Law and Bitcoin are often associated because both involve the concept of "good" and "bad" money. However, the association is flawed because Gresham's Law is based on the legal tender status of a currency and the relative value of that currency compared to others. Bitcoin has a floating exchange rate with the USD, the relative value of the currencies will adjust based on supply and demand, so the law does not apply.
Irrelevant
With the ability to do Cross-Chain Atomic Swaps with a floating exchange rate, Gresham's Law has been made irrelevant. Governments will have to accept the market rate like everyone else.
Additional Resources
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Poll:
— Erik Voorhees (@ErikVoorhees) April 14, 2022
At the Roundtable a couple months ago, I got into very heated debate with @nvk about Gresham's Law.
His definition: Bad money drives out good *generally.*
My definition: Bad money drives out good *specifically under the condition of a fixed exchange rate.*
