The Price of Bitcoin: Erroneous Beliefs

The price of Bitcoin is silly, and it probably will get a lot sillier. I want to set out my views on Bitcoin’s price as clearly as I can. Hence, I am writing this post.

If you’re sitting at your computer right now thinking, “Well this guy clearly just doesn’t understand Bitcoin!” then please stop reading. Why? Because you’ve read three sentences and you’ve already decided I don’t understand something. You’re an idiot. Stop reading.

Also, if at the end of this you’re very angry with me, you need to sit back, relax, and ask yourself why. Why do you care so much? Someone could write a blog saying Python is horrible and I wouldn’t care. I can still use Python even if someone thinks it sucks, and you can still buy Bitcoin even if I think you shouldn’t. In short, don’t @ me.

With that out of the way, let’s get started. There are five justifications for the price of Bitcoin: it’s a great safe store of value, it’s a great payment system, it’s great for international money transfers, it’s great for anonymous transactions, and it’s a great speculative asset. Only the last one holds true, but only because enough people erroneously believe in the first four. That, in my opinion, is going to be a major problem.

A Safe Store of Value

The idea that Bitcoin is a safe store of value is often justified with reference to Bitcoin’s properties as a speculative asset. The purchasing power of the US dollar has gone down over the last 50 years, whereas Bitcoin has gone up 300% in the last month or two. However, that 300% gain is irrelevant to Bitcoin’s status as a safe store of value. To be a safe store of value, it needs to, err, store value safely.

If you want to store value safely, an important question is “What is the chance I lose everything?” That answer should be very close to 0%. And with Bitcoin, that’d be very hard to argue. There’s nothing intrinsically valuable about Bitcoin, as evident from all the worthless alt-coin clones. There’s nothing stopping it from ending up at zero, and it only has a ten-year track record to point to. I don’t think this is at all controversial.

On top of that, the idea that Bitcoin is safe from any government interference is very uncertain. I think there’s a big question of what happens if a government, e.g. China, decides to truly crash Bitcoin. The government nationalizes the large mining operations, buys a bunch of mining hardware, and takes over 50% of the network. It then stops confirming some or all transactions. The price of Bitcoin almost certainly crashes. That price crash might incentivize miners to move over to some other coin, giving the government a larger percentage of the network, and so on. I don’t think it ends well. There are potential solutions, and I am not saying this is fatal. What I am saying is that this is a source of uncertainty that really detracts from Bitcoin’s claim to be a safe store of value.

Payments (Online, Cross-Border, etc.)

Bitcoin isn’t a great payment system. There are obvious scalability issues (in terms of transactions per second), although I think those can be overcome. There’s also the issue of transaction fees. The transaction fees include what you pay to transact, but we should also include what every holder of Bitcoin pays for the network to operate. By that measure, Bitcoin isn’t cheap.

It’s not surprising that Bitcoin isn’t especially cheap. Trustless consensus is achieved through proof of work, which isn’t exactly efficient. In fact, the inefficiency is a feature, not a bug. There’s nothing necessarily wrong with that. However, Bitcoin isn’t an efficiency improvement on, say, Visa. The cost of a less efficient system cannot magically be lower.

There are also plenty of types of transactions where Bitcoin is clearly worse than using a credit card. For example, you wouldn’t want to use Bitcoin to buy some goods online from a seller in a different country. Many Bitcoin supporters tout the lack of chargebacks as a feature, but chargebacks are kind of useful when you paid money for goods you never received. This isn’t earth-shattering news. Even Satoshi recognized this in the first page of his whitepaper, referring to “non-reversible payments for non-reversible services”. Yes, multisig transactions could be used, but then we’re really just reinventing a less efficient wheel.

International Money Transfers and Criminal Transactions

Bitcoin isn’t a horrible way to transfer money to someone in another country. I am not especially familiar with the market for transferring money abroad, but I can see how it works with Bitcoin and it’s not horrible. I set up a wallet and buy BTC on an exchange then transfer the money to the recipient’s Bitcoin wallet. The recipient then sells BTC on an exchange, and receives local currency. Great.

But does it really matter that it’s Bitcoin? No. Any crypto-currency with non-zero value works equally well provided we both have access to an exchange that supports it. That is, if I can trade USD for BTCrap and my friend can trade BTCrap for NOK, then that’s just as good as BTC. In other words, BTC isn’t special.

That is also true of using Bitcoin for criminal (or otherwise anonymous) transactions. It doesn’t really have to be Bitcoin. Sure, maybe right now it’s a bit more convenient, but is that really Bitcoin’s claim to value? I get that people like to point to “network effects” but really, it wouldn’t be too hard to create an application that allows vendors to transact conveniently in any crypto-currency. That might already exist, actually.

On top of that, if you need a high level of anonymity, I can see the argument for using an alt-coin. There are already Bitcoin analytics companies that help law enforcement (and others) monitor Bitcoin’s blockchain; being on a different chain doesn’t seem like a horrible idea.

The point I’m making is that insofar as Bitcoin does offer something of value, it isn’t unique. Facebook has network effects: we’re all on Facebook, whereas if I used Google+ I’d be left talking to that one weird kid I went to school with. Bitcoin doesn’t have network effects. As a user, I don’t really care that more people are using BTC than BTCrap. BTCrap serves my purpose just the same. And if it is an issue, a fairly simple app can handle exchange to make it so that a vendor is indifferent between receiving BTC and BTCrap.

Speculative Asset

Bitcoin is a great speculative asset. Ho-boy is it good at going up in price. A few months ago BTC traded around $3,500, and now it’s at $10,000. Can’t beat that!

This is where the idea of “digital gold” comes in. It’s trite, but I’m not sure it’s totally wrong. Anything, even a (nearly) useless gold rock can have value if we all agree it does. There are some differences: gold does have some value as a commodity, and also has a history of providing the basis for the monetary system. Nonetheless, I’m not sure “thing has arbitrary value because we’ve all agreed” is totally wrong. So why not Bitcoin? And “why not” is right. It’s possible that this belief network, the collective belief that Bitcoin has value “just because”, can persist.

However, I don’t think it will. Anything can be a speculative asset that we assign arbitrary value to, it seems, but there’s a reason why Bitcoin has achieved this meteoric rise while the numbers I wrote on the paper next to me remain valueless. The reason is that Bitcoin has a good story: there’s some hope or promise that it’s a great store of value, that it’s a great payment system, that it’s great for international transfers, and that it’s safe from government interference. These stories are what gave Bitcoin its momentum. This is how it gained traction, and as people saw the price go up, they jumped on board. They ate these stories up, and to the moon they went.

But none of these things are true. As I’ve explained in this post, Bitcoin’s not great at anything, at least not uniquely so. And when people start to realize these things aren’t true, the game is going to end.

Conclusion: Bitcoin’s Future

Or maybe it won’t end. Maybe Bitcoin can make a seamless transition from people telling stories that aren’t true to “we’ve all agreed this has value for no good reason”. It’s not impossible, it just hasn’t happened yet (source: my Twitter mentions).

In the short-to-medium term maybe none of this matters. Everyone I meet asks me about Bitcoin. They don’t know anything about it, but they’re interested. I don’t think the game ends tomorrow. If institutional investors are able to legally and easily invest in Bitcoin for the first time, we’ll probably see a lot of money flowing in. For smart bullish analysis of crypto-currencies, follow @toptickcrypto.

But I think it matters in the long term (like, some time in the next 10 years). Bitcoin’s value is built on stories that aren’t true. It’s not a great safe store of value. It’s not a great payment system. It’s not uniquely great for international money transfers or even for criminal transactions. Bitcoin’s only feature that is relevant to its value is that the price is going up, and I think that will cease to be true when people realize that to be the case.

But, err, maybe I’m wrong.