What's Bitcoin's Value?

sorin.cristescu (71)in #bitcoin • 6 years ago (edited)

It might seem surprising but almost 10 years after the first bitcoins have been minted, the question of bitcoin's value is still not settled.

Does bitcoin (BTC) have value?

^{Franck Miltgen, Candy Gradient V & VII, picture taken by myself}

In the short term, the answer is unambiguously "yes", as anyone can easily verify: try to get a bitcoin and you'll be hard pressed to succeed without paying a price (about 3650€ at the time of this article).

However, whether BTC has value in the long term, and what that value might be, is still hotly debated. Famous economists such as Nouriel Roubini and Joseph Stieglitz seem convinced that BTC's long-term value is zero.

In this article, I'll look into some of the purported sources of value for BTC, among which some I consider substantial, and some less so.

1. Bitcoin as a new God (or a new ideology)

More than a year ago, not long after discovering Steemit, I wrote a post called "The Church of Bitcoin", in which I was saying:

Bitcoin is something of value because people think it has value – and the more people agree, the higher its value.

But what pushes some people in the first place to believe BTC has value and then look out to connect with other people sharing the same belief?

^source
Ideological value: people want to make a statement, to send a message, to protest against a system - the current financial system - seen as deeply flawed, unfair and exploitative.

In a sense, it has been said that bitcoin embodies yet another aspect of the "revolt against the global (financial) elites" - the one which led to the "Brexit" outcome and the election of Donald Trump as POTUS, among others.

As such, bitcoin provides a useful "safety valve" for a part of the discontent. The "defensive" narrative of "Bitcoin as the 'knight in shining armor', defending the victims of the 'banksters' from their oppressors" is quite strong and people believing in it justify a significant part of BTC's worth.

2. Gateway to the cryptoverse

At the other end of the spectrum, the whole "crypto phenomenon" - the ICOs and dApps and projects - comes with a positive, optimistic outlook. Some people (disclosure: I'm one of them) believe blockchain is a radical vector of desirable change for our societies.

Which projects will succeed though, it's hard to say. Therefore, "diversification" seems a reasonable strategy.

But if one wants to contribute to these projects by acquiring their "cryptocurrencies" or "tokens", chances are it won't be easy to buy them with classical money ("fiat currency", i.e. dollars or euros). One first needs to exchange the euros or dollars in a "pivot" cryptocurrency, before then trading this "pivot" into other cryptos and tokens.

The question of the "pivot" is the classical "Schelling point" problem from Game Theory

^{If I have no idea what "pivot" currency I should choose, I'll choose BTC (i.e. the red square)}

Pierre Rochard, a "Top Writer in Bitcoin" according to Medium, and many others, mention bitcoin's value as the "Schelling point" of the cryptoverse (when in doubt, choose BTC), which value, somewhat paradoxically, increases as the size (and complexity and induced confusion) of the cryptoverse increase.

In practical terms, alongside Ethereum (ETH) for "tokens", the "BTC - crypto X" pair is often the most liquid and hence cheaper pair for almost every "crypto X" out there on the exchanges.

3. Speculative, uncorrelated asset, used for trading and hedging

Finally, BTC's extreme volatility make it desirable to another category of people: those looking for a liquid, uncorrelated asset, which they can trade speculatively and use for hedging.

^source

Moreover, as knowledge about it increases and more people seek to acquire some (even if only out of curiosity), demand for BTC is expected to increase overall. Limited supply in turn means that long term, one can reasonably count with a bullish trend.

Being (up to now at least) uncorrelated with other classes of financial assets, bitcoin can indeed play a hedging role for large portfolios. I have mentioned in the past a tendency of large asset managers to "get off zero" and investigate an objective of 0.1% of total assets.

I believe the above three features account for most of bitcoin's intrinsic desirability and value.

However, we have heard a number of other arguments which, while not completely without merit, I consider somewhat overblown and not as important as their proponents think.

I'll discuss three of them here.

4. Ultimate store of value

From these events (rather marginal for the time being), some people have started contemplating bitcoin as the ultimate store of value in case of a systemic crash. They believe that the true value of bitcoin will become apparent in the next crash, when the classical financial system will again teeter on the brink of collapse. Money will then seek refuge and a significant amount of them will chase BTC.

I believe that, as long as we are talking about the next financial crisis (which most people reckon is less than a decade ahead), that idea is fanciful.

During financial crises, money takes shelter in assets which inspire trust to the people controlling the movements of money. Most money movements are controlled by rather old people with a background in finance. In the past, they have shown trust toward government bonds and gold. Bitcoin is an abstract and complex mathematical and computer construct entirely reliant on a good quality internet infrastructure.

In a rather mild crisis, it is a stretch to imagine rather old people, not particularly computer literate, ever preferring bitcoin over good old cash and Treasuries.

In a more severe crisis, it is just as unlikely they will prefer BTC over gold.

^{Getty Images via The Economist}

And in a catastrophic crisis, there is a risk the internet infrastructure, on which bitcoin relies to be of any use, will become unreliable. Indeed, if a systemic crash is sufficiently deep to threaten the credibility of cash and gold, it is quite unlikely that the internet will continue chugging along and allowing bitcoin node synchronization.

5. Digital collectible

Michel Rausch, a young and bright researcher leading the Cambridge University Centre for Alternative Finance and avid Twitter user has suggested that the ultimate floor for the BTC's price is its value as a "digital collectible".

I believe bitcoin's value as a collectible is almost nil. Collectible value is ineffably linked with emotions - many of which go through the senses - humans collect mostly things they can see and especially touch. As bitcoin cannot be seen nor touched (nor heard, smelled or tasted), it's hard to imagine a significant number of people getting emotionally attached to it.

Moreover, one critical feature of a "candidate collectible" is its scarcity. Indeed, few people collect grains of sand. True, the number of "bitcoins" is limited, but to about 21 000 000, in itself a rather large number for a true collectible, for which the ideal quantity is 1.

In addition, it is hard to imagine someone collecting bitcoin while being ignorant about its true nature. As it happens, "bitcoin" is just an imaginary contraption, a "marketing name", a "brand" - the digital reality is a rather less glamorous UTXO (unspent transaction output) whose value can be almost arbitrary (hence the extreme divisibility of BTC, down to 10^-8, a satoshi

granddad+grandson.PNG
^{source Shutterstock}

In practice, "collecting bitcoin" can only be imagined as being able to show your grand-grand-grand kids ... possibly a flash memory (USB stick perhaps) with ... maybe an executable for a bitcoin node and a private key granting control over an UTXO ... but that balance need not be of 1 BTC and can be arbitrary, including 0, which would cost nothing and won't hold monetary value.

6. Sound money

Back in early 2017, some articles were explaining that "bitcoin is better money ... as it simplifies the exchange of goods and services"

Yet the reality is stubborn. There is hardly any evidence that more goods and services (excluding those related to the expansion of the cryptoverse) are paid for with bitcoin in 2018 than in 2011.

Despite failing to make any significant progress in its intended quality of "electronic cash" for the past 7 years, some people still insist that bitcoin is the future of money.

Many reasons have been quoted as an explanation for this failing, but the cognitive dissonance is stronger with the true believers. Their preferred explanation is that bitcoin is little used as "means of payment" because of the 10' confirmation time and the transaction fees.

To address that, a group of bitcoin believers have set out to build the Lightning Network, where confirmation times are much faster and transaction fees are negligible. The Lightning Network is still brittle, buggy and complicated. In addition, it introduces some troubling trade-offs, in terms of trust and control, that have yet to be sorted out.

Another group of followers of the "bitcoin as electronic cash" vision have on the other side decided to fork the blockchain and created "bitcoin cash" (BCH) which has recently split further into BCH and BSV.

But more to the point, the Lightning Network as well as the BCH and BSV forks address secondary problems while completely ignoring the primary problems preventing bitcoin (whether BTC, BCH, or BSV) from fulfilling the "Satoshi vision" of a "peer to peer electronic cash system".

The first of these major issues is that, in order for people to be ready to spend bitcoin, they need a convenient way to earn bitcoin.

"Earning bitcoin" was seemingly easy in the eyes of its inventor, the pseudonymous Satoshi Nakamoto. All one had to do was to download the bitcoin software and start mining on his computer. Little seems he to have imagined that the competitive spirit of humans was soon to transform bitcoin mining into an arms race which led to extreme specialization and concentration.

Today, no one but the most efficient industrial mining operations can mine bitcoin profitably. This has not escaped the followers of Satoshi's vision. Yet they retort that people could simply "buy bitcoin with fiat" (in order to then spend it as "electronic cash"). But if people have to earn fiat currency first, then buy bitcoin in order to spend it, why not spend the fiat currency straight away?

Especially when the authorities who control the fiat currency make spending it rather convenient while doing nothing to facilitate acquiring or spending bitcoin (or even actively hampering bitcoin transactions)?

Under these conditions, bitcoin remains an interesting alternative for international money transfers, but this use case is rather marginal and the competition in this area (with later and more sophisticated cryptocurrencies) is high.

A second powerful brake on bitcoin's suitability as "electronic cash" is precisely one of the reasons of its value, its limited supply (of about 21 000 000). Indeed, as more people start using it (for the thrills of being transgressive, for entering the cryptoverse, and for trading and hedging), demand for bitcoin is expected to outstrip supply.

As such, whoever acquires bitcoin would be rather well advised to hold it (or "hodl" it, in jargon), rather than spend it.

Conclusion

I have presented 6 possible reasons for ascribing value to bitcoin.

I believe the first 3 contribute substantially to give bitcoin value:
1. Ideological (quasi-religious) symbol
2. Gateway to the cryptoverse
3. Speculative, uncorrelated, volatile trading and hedging instrument.

I am somewhat skeptical with respect to the the next 3's contribution to bitcoin's value:
4. Ultimate store of value
5. Digital collectible
6. Electronic cash (its original intended purpose)

If you know what witnesses are and agree that people commited to keeping this blockchain ticking play an important role ...

(by simply clicking on the picture - thanks to SteemConnect)

What's Bitcoin's Value?

1. Bitcoin as a new God (or a new ideology)

2. Gateway to the cryptoverse

3. Speculative, uncorrelated asset, used for trading and hedging

4. Ultimate store of value

5. Digital collectible

6. Sound money

Conclusion

Other posts you might enjoy:

Blockchain and Europe

Steem ecosystem

Blockchain, Crypto and Society

What's Bitcoin's Value?steemCreated with Sketch.

1. Bitcoin as a new God (or a new ideology)

2. Gateway to the cryptoverse

3. Speculative, uncorrelated asset, used for trading and hedging

4. Ultimate store of value

5. Digital collectible

6. Sound money

Conclusion

Other posts you might enjoy:

Blockchain and Europe

Steem ecosystem

Blockchain, Crypto and Society

What's Bitcoin's Value?