Bitcoin’s Future: Is There Any Value?

Any discussion on Bitcoin, and any Cryptocurrency in general, always boils down to two things: why Bitcoin is good and what determines Bitcoin’s value.

To put things in perspective, Bitcoin should first be understood forwhat it is: a token. Essentially, the Bitcoin platform allows participants to transfer money from one person to another, with the benefit of being faster than previously conventional ways. The token is used in a way that facilitates this transaction in a similar way that other currencies work, i.e. similar to handing a Euro or a Dollar to another person in everyday life. Like other currencies, this token does not have any intrinsic value.

However, what differentiates Bitcoin from the rest of the currencies is that it is not backed by a sovereign state and thus there is no indicator one can monitor in order to observe its value. While Retail Sales, GDP, interest rates, and a bunch of other indicators can help traders assess the state of the US or Japanese economy, this does not hold for Bitcoin. Furthermore, the credibility from the controller of the money supply (i.e. the Central Banks) is again irrelevant. The only thing which appears to bind Bitcoin is its supply of coins, which is limited at 21 million coins.

People often relate this to the scarcity of Gold, however, this is not quite accurate Gold reserves are by no means finite. Like Oil, suggesting that Gold reserves are 54,000 tons simply means “to the extent of our knowledge”. We don’t really know what is hid under the surface of the earth and new discoveries take place all the time, be it small such as in Iran and Australia this year, or huge such as in Ethiopia a few years back. Thus, similar to Oil, the supply of Gold is not fixed but only quasi-fixed. Thus, no other means of payment has as much embedded scarcity as Bitcoin.

One could argue that scarcity is good as it prevents inflation. However, scarcity needs to be relative to the demand for the currency and, whether we like it or not, we need to be able to change the supply. Back in the Great Depression, the state’s inability to provide more liquidity to the economy, as a result of the Dollar being pegged to the Gold Standard, allowed for a continuation of the status quo, pushing more people into poverty and unemployment. In general, scarcity is not a bad idea, however, the availability of the token of exchange (i.e. money) needs to be able to change when things inevitably go bad.

Furthermore, scarcity is a relevant term. What it essentially means is that existing supply is lower than existing demand. However, this is the case for any medium of exchange. How many people think they have enough money? Most people usually want more than they have; hence money will always be scarce, regardless of its form. In fact, inflation is really the mechanism which makes money scarce: while relative prices will mostly remain similar (we get one pen for two apples), the monetary price of a pen would increase if money increases, thus automatically adjusting the economy to any change in supply and preserving scarcity. The only time money loses its value is in periods of hyperinflation, which is usually associated with a loss in production activity and Central Bank credibility and not so much by money printing.

Turning to the demand side, Bitcoin’s appeal is the only demand driver. If people believe that this can be used as a means of payment then it would make it more popular, and perhaps more valuable. Value and popularity are interlinked, but, in the end, the lack of other demand drivers makes Bitcoin extremely volatile. For the case of Gold, uses such as Jewellery, Electronics, Other Industrial, and Dentistry take up approximately 70% of global demand, helping in the reduction its price fluctuations. If just 30% of the overall demand refers to investment purposes and this makes Gold as volatile as emerging market currencies (red line in the Figure below) which face many credibility and economic instability issues, then it is not a surprise that Bitcoin (blue line) is the most volatile of all other financial instruments. In contrast, the Euro-Dollar exchange rate is the least volatile asset, along with US Real Estate and US Stocks.

High volatility is a problem which will not allow for a wide acceptance of Bitcoin. Who would be willing to accept a near 50% decline in the value of what they have obtained in exchange for the provision of goods and services in just one month, especially as no other currency has moved as erratically? People have problem enough to deal with loans in foreign currencies which fluctuate much less, how easy would it be to enter into another round of these issues? Arguments of the kind that Bitcoin is new and innovative and thus the market will need to find a way to correctly price it, although partly true, ignore the fact that a currency whose demand depends mostly on the whims of investors and speculators, and only partly on demand for transactions, will inherently have more volatility than other types of assets.

Why is demand for transactions only a small part of Bitcoin’s demand? Simply put, because its potential benefits are not so clear. The speed of transaction argument, which would most likely emerge first, necessitates that in order to benefit from Bitcoin’s speed both parties would have to own Bitcoins. This is essentially the same as requiring people to have accounts in the same banking institution in order to be able to move money among themselves fast. Thus, the speed of transactions appears to be pointless as there is really no difference in transaction speed if we use Bitcoin or digital banking.

Furthermore, decentralization, the important blockchain innovation Bitcoin is based upon, essentially means that coins are able to move from one place to another without anyone interfering with the process and with no need for mediators. While this is certainly a benefit, the Forex market already exists and is decentralized and also, in the broader sense, so are stock exchanges. Nothing can stop someone from exchanging a stock or a currency with another person and, in fact, this is why these have grown to be so popular. But truth be told, there is a mediator in Bitcoin (as there also exist in many centralized exchanges): the digital wallet required to keep your Bitcoins is the same as having an intermediary bank keeping people’s money or going through a broker to exchange Euros for Dollars. Whether or not the transaction of value between two wallets takes place in the blockchain or not merely refers to the way the system works.

To be fair, blockchain is an interesting technology with possible extensions we may yet not fully comprehend. However, looking at the particular benefits of Bitcoin reveals that these are, retrospectively, not as important as once heralded. This has led Bitcoin far from its original purpose, i.e. a means of transactions, to become a tool for speculation. At this point, Bitcoin, or any other coin which aims to increase its value via scarcity (only done, of course, via an increase in popularity), appears to have lost at their own game.

What makes Bitcoin better or worse than Ethereum or Litecoin, or any other coin for that matter? If it was transaction speed then Bitcoin would be worth the least. But it is not; in fact it is the Crypto with the highest value. This can only be justified if factors other than transaction speed affect the price, and this is where speculation jumps in. Speculation is not necessarily bad, however, it is still uncertain as to how Bitcoin relates to other assets in order to be able to make a meaningful strategy. As the Figure below suggests, Bitcoin’s correlations with Gold (Blue), USD (Orange), and Stocks (USA30 – Beige) are really all over the place, moving from positive to negative depending on the period at hand. While this could somehow be used in an investment strategy, there is still no confirmation that institutional investors are involved in Crypto trading.

Overall, the conclusions to be drawn from all of the above can be summed up in just two points: firstly, while the blockchain technology can potentially have useful applications, Bitcoin appears to have no intrinsic value and all its proclaimed benefits are not asimportant as heralded. Second, as a result of the first point, Bitcoin is reduced to a speculative asset whose value is almost entirely dependent on the whims of the market and whose real, underlying value is dependent on how many people choose to use it over of an alternative (e.g. bank, other coin, etc.). We’ll leave it to the reader to guess where the value of Bitcoin will go if there is never a critical mass of economic agents that is interested in transferring money that way…

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Dr Nektarios Michail

Market Analyst

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