Jake Zeller (@jake_zeller) Entrepreneur and Investor Why Bitcoin is Valuable When people think of “value” or “money” they imagine things that can be physically held. A brick of gold feels heavy. A dollar bill feels crisp. And while consumers have grown accustomed to online banking and digital balances, it’s still understood that digital balances can be exchanged for physical cash (not considering fractional reserve banking, of course). Bitcoin, on the other hand, is entirely digital. A bitcoin is simply a digital token without a physical analog or representation. This trips people up because society has been conditioned to believe that only physical items (like gold or cash) can be valuable. The focus of this post is to address why Bitcoin is valuable. Simply put, Bitcoin is valuable because it serves two important functions: (i) store of value and (ii) medium of exchange. Definitionally, a store of value is any type of commodity, asset, or money that has value and can be predictably stored and retrieved over time. A common use of value stores is to hedge against inflation. For example, if Michael lives in Thailand and fears that the Baht will depreciate on political instability, it would be wise for him to put his savings in gold (a reliable value store). I argue that in time, bitcoin will become a reliable store of value, just like gold. There are four key properties a store of value must have. Scarcity—Any value store must be scarce. Gold is scarce and takes a lot of work to mine. In the same vein, bitcoin is scarce since only 21 million will ever be created. Divisibility—A value store must be divisible so both large and small amounts can be easily denominated. Gold is physically divisible (down to the atomic level) in that one can continuously divide a brick of gold into successive halves. Similarly, bitcoin is (for all intensive purposes) infinitely divisible. Fungibility—Any two pieces of gold (assuming equal weight and purity) will command an equal value on the open market. This is the essence of fungibility, the necessary property that individual and equal units of a value store be capable of mutual substitution. Based on construction, bitcoin is fungible, as evidenced by the fact that any two bitcoin will command the same price on the same exchange. Consensus—For something to contend as a store of value, people must agree that it’s valuable. Contrary to public belief, gold isn’t valuable because it has intrinsic value. Rather, gold is valuable because it’s scarce, divisible, fungible, and people agree it’s valuable. In fact, gold has very little intrinsic value. The value of all gold ever mined is approximately $8T. Yet the the value of all gold ever used in industry (the “intrinsic value”) is only a fraction of this. If demand for gold were to fall out over night, the value of gold would plummet substantially. Just like gold, bitcoin will eventually reach mainstream consensus as a value store. There’s currently $8.5B in market capitalization behind bitcoin in addition to the brightest minds evangelizing adoption. And as adoption increases, volatility will subside. At this point, bitcoin will function as a reliable value store. In fact, bitcoin will be a superior value store to gold since it has added properties of anonymity, durability, portability, resistance to counterfeiting, and ease of storage. In addition to all the above, Bitcoin is also valuable as a medium of exchange. Strictly speaking, a medium of exchange is an intermediary instrument used in trade to avoid the inconveniences of pure barter. In modern economies the medium of exchange is fiat currency. Bitcoin confers multiple benefits over traditional fiat currency. Lower cost international remittance—Over $500B is remitted overseas each year through services like Western Union, MoneyGram, and Xoom at an average fee of around 9%. Remittance companies typically make money through transaction fees, currency conversion fees, and currency spreads. This fee structure is largely mitigated by using bitcoin as the underlying medium of exchange. Within the next few years, bitcoin will make it possible to remit money to anyone, anywhere, instantly, with less than 1% in total fees. Faster transaction speed—The correspondent banking system is notoriously opaque and slow. International B2B transactions can sometimes take weeks to settle, creating liquidity and cash flow management concerns for many participants in the supply chain. Bitcoin offers a superior solution in that transactions can settle in under 10 minutes. Greater interoperability—The current financial system is ill equipped to communicate. For example, it’s unlikely that a small bank in the U.S. can transact overseas without relying on a relationship with a correspondent bank. Bitcoin easily solves this problem and brings greater flexibility to financial transactions. Bitcoin is an open source protocol that sits on top of legacy systems allowing seamless interoperability. Trustless transactions—Transacting in fiat currency requires trusting a central authority, like PayPal or a local bank. Bitcoin is decentralized and trustless, requiring no threads of trust in any transaction. Moreover, complicated transaction logic (like escrow) is included in the Bitcoin protocol so that commerce can take place without using a trusted third party service (like escrow). No central governance—National governments can enforce rules and regulations on fiat currency transactions. For example, it’s illegal for U.S. payment processors to do business with gambling websites. While this may seem reasonable, it’s often difficult to determine where to draw the line. Should U.S. payment processors be allowed to facilitate donations to Edward Snowden? While some Americans consider him a traitor, many consider him a hero. A similar example is when PayPal discontinued processing payments for WikiLeaks and froze all of their accounts. It’s my belief that the ability to make/receive payments should be a universal right. Bitcoin is entirely open source, decentralized, and outside the authority of any government. Accordingly, it’s impossible for anyone or anything to interfere with one’s ability to receive bitcoin payments. Written by Jake Zeller (@jake_zeller)
Posted on: Sat, 13 Sep 2014 18:41:23 +0000
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