Bitcoin’s value beyond hype

A product or a service creates value when it solves a human need. When Amazon was founded, it was a lifesaver for book lovers in remote places where they didn’t have good bookstores. People of the world allowed Jeff Bezos to become rich because he made their life simpler. We happily exchange money for services when it enables us to make our lives better. Librarians help others but scientists help themselves. Guess who makes more money?.

Just like Amazon solves a real-world need, so does Bitcoin. (Of course, like Amazon stock, people speculate on Bitcoin’s price as well.) What needs does bitcoin solve for? The answer to that is long-winded. The network effects and feedback loops in bitcoin ecosystem make teasing out the value question really difficult, but I’ll try doing that here.

My current interpretation of bitcoin’s real-world value takes three different views. In practice, it provides a mix of all three but the degree to which it performs this function is hard to say (and that’s what makes this space so exciting).

Bitcoin as gold

Many people work hard today so they or their children can enjoy a better life tomorrow. To enjoy benefits of their labor in future, people seek storage mechanisms that durably store value for a long time. Storing your savings in cash is a bad idea because inflation makes them decrease in value over a period of time (For example, if INR 10 gets me one cup of coffee today, it may require INR 500 in 10 years). Storing value in stock comes with risk – what if the company didn’t exist in future? You could store it in government bonds (which is a popular choice) but that’s also risky – what if the government defaults?

Gold makes an excellent choice for a store of value because it’s scarce and expensive to mine. One key property that’s desired out of a store of value is resistance to inflation and minimal risk of losing value. Gold has performed these two jobs really well throughout history and it has an advantage over bitcoin that humans cannot simply create more gold, while with bitcoins humans can simply fork and start a new cryptocurrency. However, Bitcoin has an advantage over gold because you are not required to physically store and protect it, unlike gold. Plus, you can buy really small units of bitcoin which may not be possible with gold.

If you believe Bitcoin is a store of value, you should NOT expect to make money from it because you’re using it to store money earned into it. People do not usually buy gold to make money, they buy it to store money. The only people who make money buying or selling is jewelers but they make money by selling their trust that it’s pure or their designer work. Gold, in itself, is a commodity.

Bitcoin as payments network

Another way to look at bitcoin is to focus on its network which allows permissionless, cross-border transfers of money. Through this lens, bitcoin’s direct competitors will be illegal money laundering services and indirect competitors will be Visa / international banks.

Bitcoin as a payments network should give you returns because it’s used to give a service to a human whose other options were either costly, worse or unavailable. As more people get attracted to bitcoin over money laundering services or Visa, they will be willing to offer a similar commission to what competitors charge (2-3% for credit cards or up to 10% for money laundering). And that’s how bitcoin network will make profits. If you hold a bitcoin, you are essentially a shareholder in payments network as the usage of bitcoin network increases the value of the bitcoin token and you benefit from that appreciation.

If you believe Bitcoin is a payments network, you are very much like a Visa shareholder, expecting bitcoin’s price appreciation in tune with how competitive bitcoin’s offering is as compared to its competitors.

Bitcoin as currency

I find it funny when people say they’ve invested in a currency. You get paid in a currency or you trade in a currency, but rarely do you invest in a currency. Currency is a unit of value. Sitting idle, it does no economically useful work and you shouldn’t expect to hold a currency to give you massive returns. Returns on a currency aren’t generated until someone purchases it from you at a premium.

Currencies do change rates against each other and one can make a case that by holding a currency, you’re betting on demand of that nation’s products (so people would want to purchase forex from you to pay for those products). If you were to go with this train of thought, by holding bitcoin as a currency, you’re essentially in a commodity business. When customers come to you to purchase bitcoins, a competitor can come along and offer them bitcoin at a cheaper rate. Making profits in a commodity business is hard – competition eats away all your margins.

So if you believe Bitcoin is a currency, do not expect returns from it. As a currency, it is a commodity and you will get commodity-like returns from it.

So, which lens is the right lens?

Now, that’s a billion-dollar question 🙂 If you have an opinion on this, please tweet to me. I’d love to learn from your experience.

Thanks Roby for reviewing an early draft of this post.

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