“If I can’t find a reindeer, I’ll make one instead”! – Dr.Seuss, How The Grinch Stole Christmas
Last week in The Case Against Bitcoin I examined some of the flaws with Bitcoin that may prevent it from becoming a mainstream currency. I received some very intelligent comments and had a series of thoughtful conversations with many Bitcoin advocates who promoted Bitcoin’s value and efficacy as a currency. While I believe there is value in peer to peer financial transaction systems, I remain, however, unconvinced that Bitcoin will be a widely used digital currency of the future.
Greater Adoption Should Mean Lower, Not Higher Prices
If Bitcoin’s advantages lie in using a crypto currency system one would think that the cost of using it would decrease over time, not increase exponentially. The argument that more people will be using crypto currencies and more convenience and security features will be added to the Bitcoin system to justify higher Bitcoin prices runs counter to market principles. With competition, prices should drop.
The price of cars did not go up exponentially as more roads and bridges were built, motels and restaurants were added to the sides of the highways and more people used automobiles as a mode of transportation. Competition ensured that Fords would not be the only cars on the road and that prices for cars would remain affordable. Similarly, there will be additional competing crypto currencies, many superior to Bitcoin, that will keep a lid on the price of Bitcoin.
The peer to peer aspect of Bitcoin is superior to traditional electronic payment systems. Unfortunately, in order to access the system increasingly higher prices have to be paid to use it. This is a self defeating proposition. The Bitcoin system is substantially the same one of three months ago, but today Bitcoins cost four times more. Technology advances should make use cheaper not more expensive. To encourage adoption, prices need to be lower not higher. For example, Tesla will not increase the price of its cars ten fold as it adds more charging stations around the country to increase the utility of its battery powered vehicles. If it did they would see their sales plummet. If the price per Bitcoin remains high, competing lower priced crypto currencies will become more attractive and displace Bitcoin;especially since there are no barriers to entry in the crypto currency market.
If the value of Bitcoin is in the features of the system, not the value of the Bitcoin itself, the logical solution would be to charge to use the Bitcoin system. This is not possible with Bitcoin as no one owns the system, therefore the price of Bitcoins must necessarily rise as demand increases as more people wish to use it. This dynamic however, contains the seeds of the destruction of the price of Bitcoin as higher Bitcoin prices will inhibit widespread use and competing, less expensive crypto currencies will emerge that will undercut the price of Bitcoin. Also competing centralized commodity backed currencies will emerge that will allow payments to be made using proprietary currencies.
The high Bitcoin valuation is what is attracting people to it, not its utility as a currency. That increasing valuation, is also leading people not to use Bitcoins in transactions and rather to hoard the coins in the hope that they may be worth more in the future.
A viable currency can not be so expensive that its price deters buyers from buying it and sellers from using it for fear it might go higher.
Bitcoin – A Peer to- Peer Currency
Artificial Mining Scarcity
The computer mining of Bitcoins, the trading component of the Bitcoin system, is an artificial construct. Mining for real commodities like silver or drilling for oil has real costs and real returns. Silver is needed to power the electronics (without silver Bitcoin doesn’t work!) and solar industries and oil is needed, among many things, to heat millions of homes, for gasoline to power millions of cars and to create countless plastic products. Thus, the costs of mining for silver and oil are justified in that they lead to the extraction of silver and oil and the prices of these commodities can be valued based on their need and demand. In contrast, the mining costs of Bitcoins can only be justified if demand can be created for the Bitcoins themselves.
The underlying value of the Bitcoin itself is based on a Bitcoin computer mining game that wastes electricity to solve math problems that don’t need to be solved, and therefore is not a meaningful measure of value. Bitcoin mining is in effect, the solving of riddles for riddles’ sake. How can a value be placed on Bitcoins if they have no intrinsic value or unique properties? If Bitcoin’s value is in its use as a crypto currency, why wouldn’t any crypto currency do?
Once you own Bitcoins you must necessarily believe that they are valuable and try and convince others that they are as well. Its hard to ascribe value to a currency that is not backed by anything. The common rejoinder is that government currencies are not backed by anything either and that Bitcoin has superior properties (ease of transfer,lower costs of transfer,anonymity) and therefore Bitcoin’s $1200 per coin price is justified. This is the repugnant ‘lesser of two evils’ argument – “Bitcoin isn’t backed by anything but the dollar isn’t either”.
While the dollar is not backed by anything other than the “full faith and credit” of the issuer, legal tender laws ensure its use.
In contrast, an attractive feature of Bitcoin is its use is voluntary and people are free to believe in it and ascribe value to it. The flip side, however, is people are also free NOT to believe in it and ascribe value to it. Bitcoin can not be propped up by force of law. It’s value is based on collective belief of value and usefulness. If collective faith is lost in Bitcoin, its value diminishes or vanishes.
Legal tender laws may be repugnant, but so is unbacked money.
The artificial construct of Bitcoin computer mining is at the heart of the lack of intrinsic value argument. The Bitcoin creators did not find a gold mine, they created one. Indeed, no one would have gone looking for Bitcoins ten years ago because they did not exist. The “invented” characteristic of Bitcoins is what will prevent them from retaining value. Basing a currency’s value on a non productive arbitrary activity (actually wasteful) like mining for Bitcoins, is as inane as basing a currency on how many times a group of people can run around the block-no matter how limited the number of coins you issue as a result of that pointless endeavor.
Mining of natural resources has a purpose and the extraction of them is limited by nature not by self serving computer design.
The concept of arbitrarily creating scarcity to create the perception of value by inventing a computer game that requires people to waste electricity to solve math problems to extract Bitcoins seems like a pretty easy concept to replicate. It also seems like a concept that if repeated would highlight why value should not be ascribed to such arbitrary and unproductive activity.
As of this writing, the price of Bitcoin is over $1000. The recent vertical price move of Bitcoin over the past month or so is based on a simple premise – more people want Bitcoins because the price is going up, not because they have any use for them. Bitcoin’s stratospheric price level is not based on any comparable benchmarks and will eventually collapse as competing and lower priced digital currencies gain traction and provide some basis of price comparison. Anything that rises as fast and as high as Bitcoin has recently, inevitably crashes. Bitcoin may, however, continue to soar along with the entire crypto currency sector.
Bitcoin is being valued as if it is a unique invincible currency. That perception and reality will not last. Bitcoiners cite the ability of Bitcoin holders to send payment directly to an individual in China or to take their Bitcoins cross border without raising the suspicion of customs officials as justification for its lofty valuation. While these are useful features, the vast majority of people will never have use for cross border transactions or the evasion of capital controls.
Bitcoiners also justify the value of Bitcoin by noting that it is outside of the system and therefore not subject to manipulation. Any item with a price that is traded can be manipulated. There are already plans for a Bitcoin ETF. ETFs provide Wall Street with any number of potential manipulative devices, including lending, short selling and hypothecation. If someone or some entity wished to manipulate the price of Bitcoin it could be done.
The price of Bitcoin is clearly in a bubble as its price has not been driven by any identifiable fundamentals or meaningful comparables. A stable Bitcoin price is extremely important in determining its future as a viable currency. A crash in Bitcoin’s price would make it further unsuited for use as an everyday currency and damage Bitcoin’s long term ability to continue as a viable currency. If that happens Bitcoin will have failed the market test. If, however, despite the flaws pointed out here, Bitcoin’s price stabilizes and its adoption as a currency increases, it will have passed the market test. My bet is that it won’t but markets are smarter than me or any of us.
*even if security prevents the stolen Bitcoins from ever being used, hacker/thieves can shut down the Bitcoin system by stealing large amounts of Bitcoins to intentionally disrupt the 21 million limited supply. Government confiscation of Bitcoin can achieve the same result. The 21 million Bitcoin limit is a dual edged sword which means there can be no further discovery of Bitcoin even if most of them have gone missing. The inability to create more Bitcoins in the event that most of them have been stolen or lost would render the currency useless. The 21 million limit is a built in kill switch.
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