Gresham's Law

Gresham’s law states that “bad money drives out good”. In other words, in an economy where two currencies are in use, individuals will spend the bad money, which is constantly devaluing, and hold the good money, which retains its value. Thus, the bad money will dominate in terms of circulation and use in daily transactions, while good money will dominate in terms of savings and long term investment.

For example, in the case of Bitcoin, imagine an individual who holds both bitcoin and U.S. dollars. If they spend money to buy goods, they should rather spend their dollars as dollars are constantly losing value. If they were to spend their bitcoin, they would lose out on bitcoin’s potential future rise in valuation. This is one of the reasons Bitcoin has grown faster as a store of value than as a method of payment.

Gresham’s Law is most visible when a government or central bank legislates the value of money through legal tender laws or a currency peg. For example, in 1965, the United States government reduced the silver content of half-dollar coins from 90% to 40%. Both 90% silver coins and 40% silver coins were legislated to have the same value. This led to most 90% coins being melted down, exported, or otherwise removed from circulation.

— Sir Thomas Gresham explaining the consequences of debasement to Queen Elizabeth, 1558

Gresham’s law explains how government interference in the supply and valuation of money can harm an economy. When Henry VIII of England debased England’s silver coins and enforced an inaccurate peg between gold and silver coins, the more valuable gold coins were sold abroad, where their price was not legally suppressed, leaving England impoverished by low quality money.