JPMorgan CEO Jamie Dimon pooh-poohed bitcoin, calling it a “fraud, and Credit Suisse boss Tidjane Thiam said the speculation around the cryptocurrency is the “very definition of a bubble.” Lloyd Blankfein, CEO of Goldman Sachs, said he is still thinking about what it is, and speculated that in 100-200 years it may turn out to be similar to gold – a currency backed by “social convention.”

Blankfein may be closer to what may happen – though he omits one critical condition, namely: that historically, social convention must be combined with scarcity for a new monetary yardstick to emerge.  To see why, recall the famous example of the “stone money” among the relatively isolated tribe of the Yaps.  Milton Friedman discussed it is his Money Mischief, but reached an erroneous conclusion: his mistake, though, sheds light on what bitcoin needs to become a monetary yardstick.

At the end of the nineteenth century, the Yap used stone wheels as both a monetary yardstick for prices and as collateral. In order to function as a monetary yardstick, the stones had to be in limited and relatively fixed supply. Indeed, the stones were no simple rocks found on the island’s natural landscape. The Yap brought limestones to their island from distant islands, then carved them into disks and ensured that the number of such disks was limited.

The German colonial regime accepted them for paying taxes. But when the colonial government wanted to employ the locals and pay them in German currency, the tribe refused: As far as they were concerned, the German currency was not “money.”

The German authorities then painted black crosses on these stone wheels, which indicated their confiscation. The tribe could no longer use them either to pay taxes or as collateral. This impoverishment induced the locals to work harder and build the roads – “infrastructure” – that the Germans wanted. The German authorities compensated them by erasing the black crosses and giving back the rights to the stones to the natives. The stones became “currency” and yardsticks again.

Friedman concluded that this sequence of events shows how important illusion – myth – can become in monetary matters. He was mistaken. These events have nothing to do with myths and illusions. They show that the tribe understood money far better than today’s economists, central bankers and governments.

In many societies, drastic devaluations, inflation and confiscations have brought about significant political upheavals and violence

The loss and the destabilization of the monetary yardstick and the collateral made the tribe poorer, threatened to unravel traditions and customs that enforced oral contracts, and also brought about chaotic pricing behavior. The Yap worked harder for a while to restore the traditional yardstick and the value of collateral upon which their exchanges were built for centuries or more.  The Yap reacted peacefully. In many societies, drastic devaluations, inflation and confiscations have brought about significant political upheavals and violence rather than placid willingness to build roads, which this tribe had no interest in at all.

Jump from the Yap to the sequence of events that made gold into a yardstick, to illustrate the combination of scarcity and social convention necessary for its emergence. Once societies stumbled on the relative scarcity of gold and silver, goldsmiths realized that they could lend some of the gold left on deposit with them to borrowers who paid interest for the loans. The goldsmiths, who both owned gold and protected others’ gold for safekeeping, quickly learned that they could lend without facing the risk of immediate withdrawals from all depositors at once.

As evidence of the deposits, the goldsmith issued receipts. (The British currency is still called pound “sterling”; the term’s origin referred to the certificate backed by a pound of silver.) As the goldsmiths established credibility, they no longer had to give borrowers gold to be used by the borrowers to buy commodities and services. Rather, their paper certificates, backed by gold in their inventory and the perceived quality of the loans they made expanded credit and commerce: A relatively small amount of – scarce – physical gold, combined with the use of double-entry accounting, supported an increasing number of certificates.  As commercial activities spread and the magnitude of loans overshadowed the value of any precious metals held in goldsmiths’ inventories, the reputation and selection of good credits sustained the value of the receipts. Of course, when too many bad loans, wars, or natural disasters prevented borrowers from repaying loans, people holding deposits could not be fully reimbursed, and goldsmiths (banks) went bankrupt.

Why is a standardized, scarce item serving as a unit of account so important?

Say there are 1,000 rights to goods and services to be transferred now and in the future. In the absence of a monetary yardstick, there would be 499,500 possible prices, as each commodity, service or right would be priced in relation to every other. With one common yardstick, there would be only 999 prices.

This numerical illustration shows why, since time immemorial, every society promptly invented an item to serve as a monetary yardstick. In prisons, these were cigarettes. In that prison-land once known as the Soviet Union, cigarettes and Levi’s jeans were the yardsticks when rubles meant little except when used for centralized accounting. The next case, a rare “almost” laboratory experiment, shows how cigarettes as yardsticks actually got established – and destroyed when scarcities come into question.

Richard Radford was a British soldier, captured in 1942, who spent the remaining war years in prisoner of war camps. In 1945, he reported that the relative values of all commodities and services were quickly expressed not in terms of one another, but in terms of cigarettes. The prices formed within a month of the creation of the camp. Exchanges rapidly emerged, establishing one price for each commodity.

What the Yap tribe’s stones and the cigarettes in the POW camps had in common is that they were in relatively fixed supply, and as such these items functioned with reasonable utility as a yardstick.

Indeed, until June 1944 prices in the camps were stable. They were stable enough that expectations of random, short-term declines in the supply of cigarettes led to the creation of a “shop” (the goldsmith’s equivalent) that issued paper certificates worth “one cigarette” which were accepted at par instead of a real cigarette.

When the supplies of both cigarettes and parcels of food were unexpectedly halved in August 1944, the prisoners quickly got rid of the paper money, and cigarettes became the sole yardstick and medium of exchange. The paper money could still be exchanged, but only for types of food that prisoners did not want and whose inventories accumulated in “the shop” – a familiar pattern to anyone who has lived under Communism – paper money thus becoming a mere accounting fiction.

A black market quickly emerged and the paper money lost all its value in the camp, became a subject of jokes, and disappeared from circulation. As with the Yap, when the yardstick was destroyed, there was chaos.  With the unreliable supply, cigarettes ceased to be a yardstick, too. The shop and exchanges – institutions that were based upon the cigarette yardsticks and sustained the value of collateral in the camp – disappeared. The organized economy of the camp dissolved into obscure bilateral trades, depending on the negotiating powers of the parties.  Of course, hyperinflations displayed similar sequence of events.

The lessons for bitcoin are sharp and clear: Yes, money is, in part, a “social convention.” But the technology of “producing money” – whether navigating dangerous waters to bring stones to the island, or relying on the supply of cigarettes – must be such as to guarantee scarcity.  This appears to be at present the weak link of bitcoin.

Brenner holds the Repap Chair at McGill University’s Desautels Faculty of Management.  The article draws on his Force of Finance (2002) and “Towards a New Bretton Woods Agreement, “ American Affairs, May 2017