Bitcoin What Is Bitcoin’s Elusive Intrinsic Value?
As the market value of a single Bitcoin comes down off its lofty all-time maximum of over $2,800 to a still-bubbly $2,500 or so, aficionados and skeptics alike wonder whether the Bitcoin speculative bubble is finally popping, or whether the recent downturn is simply a profit-taking opportunity on the road to even loftier heights.
And speculative bubble it certainly is, as a non-negotiable, software-constrained supply runs headlong into greater-fool demand. As even greater fools displace the ones before, all participants, foolish or not, increase their focus on the central question of Bitcoin:
Why does Bitcoin have any value at all?
Adam Smith’s invisible hand of supply and demand explain the market value of Bitcoin to be sure – as market value is simply what someone is willing to pay, and plenty of fools are so willing.
Strip away the drivers of extrinsic value, namely its greater-fool demand and its constrained supply, however, and what remains? The asset’s intrinsic value.
Just as gold would retain its luster, malleability, and resistance to tarnishing, thus making it useful for numerous manufacturing and jewelry purposes regardless of its scarcity, one wonders what intrinsic value Bitcoin holds.
You would think the answer would be obvious, but instead it is remarkably elusive. Never before in the history of commerce has a speculative bubble developed around an asset that had no clear intrinsic value. Even tulips – the very symbol of a speculative bubble – are flowers of remarkable beauty.
Where, then, lies the intrinsic value of Bitcoin?
Bitcoin’s Mysterious Missing Intrinsic Value
Plenty of people – both aficionados as well as skeptics – question whether Bitcoin has any intrinsic value whatsoever. “The question is I do not understand where the backing of bitcoin is coming from,” says Alan Greenspan, former chairman of the Federal Reserve. “You have to really stretch your imagination to infer what the intrinsic value of bitcoin is. I haven’t been able to do it.”
Such consternation appears on all sides of the political spectrum. “There is no intrinsic value,” states Henry Blodget, founder, CEO and editor of Business Insider, on CNBC’s Squawk Alley. “If anybody is persuading you that it should somehow be related to some GDP or gold…put down the Kool-Aid and back away.”
And then there’s Paul Krugman, writing for the New York Times NYT -1.70%: “To be successful, money must be both a medium of exchange and a reasonably stable store of value. And it remains completely unclear why Bitcoin should be a stable store of value,” Krugman writes. “I have had and am continuing to have a dialogue with smart technologists who are very high on Bitcoin – but when I try to get them to explain to me why Bitcoin is a reliable store of value, they always seem to come back with explanations about how it’s a terrific medium of exchange. Even if I buy this (which I don’t, entirely), it doesn’t solve my problem.”
What About Bitcoin’s Utility?
In fact, many people consider Bitcoin’s utility to be the source of its intrinsic value – a reasonable conclusion on first glance, as many assets’ intrinsic value depends upon the asset’s utility, including gold.
Some writers even go so far as to say Bitcoin’s only intrinsic value is its utility. “Bitcoin’s utility as a store of value is dependent on its utility as a medium of exchange,” writes John Kelleher, a freelance web developer, in Investopedia. “We base this in turn on the assumption that for something to be used as a store of value it needs to have some intrinsic value, and if bitcoin does not achieve success as a medium of exchange, it will have no practical utility and thus no intrinsic value and won’t be appealing as a store of value.”
Muddying these waters is the fact that many people confuse Bitcoin’s utility with its political value. Mark Rees, Sr Systems Engineer at Intermountain Healthcare writing for Bitcoin Magazine, for example, listed Bitcoin’s transparency, programmability, use of multiple signatures, and a number of other features of Bitcoin that make it usable. In addition, Rees lists characteristics that may offer political value, like its transcendence of borders, independence of banking laws, and its ability to “upend centuries-old money monopolies.”
This radical Libertarian context for Bitcoin, in fact, has led many of the cryptocurrency’s fans down a rathole of confusion. The reason: The Libertarian belief that money requires a physical basis of value, which is why so many Libertarians want to dissolve the Federal Reserve and return to the gold standard.
Should we Ask the Libertarians?
Jack G. Shorebird, writing for ToughNickel, begins by quoting Ayn Rand: “‘Money cannot function as money, i.e., as a medium of exchange, unless it is backed by actual, unconsumed goods.’”
He continues: “Cryptocurrencies do not require an intrinsic value. They are not gold in the rough. What is important is that the cryptocurrency, like a check, is backed by an ‘unconsumed good.’”
The conclusion to this questionable line of reasoning is that Bitcoin cannot function as money. “Given this definition, cryptocurrency, with few exceptions, is not functional money, yet,” Shorebird continues. “But neither are dollar bills or euros. Dollars, for example, are backed by nothing.”
Few people outside of the community of radical Libertarians would claim that fiat currencies like dollars or euros aren’t money. In fact, such currencies are backed by the ‘full faith and credit’ of the countries that issue them – backing that Bitcoin lacks by design.
Without such backing, we’re left once again with the question of Bitcoin’s intrinsic value. “It’s not simple. The dollar has intrinsic value because you need dollars to pay taxes in the United States,” explains Joe Weisenthal, writing for Business Insider. “Gold has real value because it’s shiny and can be used for jewelry…. But what about Bitcoin? If you ask Bitcoin believers why a bitcoin is worth anything at all, they will tell you about how amazing the technology is, and how it’s ‘programmable’ and how cryptography and pseudoanonymity are so great. But none of these are very satisfying answers.”
Beyond Bitcoin’s Utility
The reason Bitcoin’s utility as a cryptocurrency is an unsatisfying explanation of its intrinsic value is because for all other types of assets, intrinsic value goes beyond the asset’s use as a medium of exchange.
After all, the reason gold has served so well as money throughout history is the combination of both its scarcity as well as its intrinsic value outside of its use as money. Bitcoin lacks such utility.
While some people theorize that cryptocurrencies like Bitcoin don’t actually require intrinsic value, others are more realistic. “The supply of Bitcoin is fixed and there is no other use for it besides as a currency,” explains Sean Lynch, site reliability manager at Google GOOGL -1.42%, writing for the Underground Economist. “Merchants will go from taking one coin for a year of porn to not taking Bitcoin at all, and a bunch of people will be left with worthless Bitcoin.”
The notion that cryptocurrency doesn’t need intrinsic value is nonsense, because market value always depends in part upon intrinsic value. “Currencies to be exchangeable have to be backed by something,” Greenspan points out. Without intrinsic value, nobody would have assigned Bitcoin a value in the first place.
The Missing Piece of the Puzzle
The missing piece of this puzzle – the piece that both Bitcoin fans as well as detractors have missed – is the ability to mine Bitcoin. Because in theory anyone can put in the effort to create new Bitcoin by processing Bitcoin transactions, it is possible to profit on Bitcoin outside of its use as a medium of exchange. This fact, combined with its enforced scarcity, enable Bitcoin to become such a medium, and thus have value.
In fact, the Bitcoin infrastructure is intentionally set up to reward miners: if more miners attempt to create Bitcoin then it automatically becomes more difficult to profit from the process. Likewise, if fewer miners make the attempt, then it becomes easier to make money this way.
A Bitcoin’s intrinsic value, therefore, is the representation of the effort it takes to mine it.
However, figuring out this value is a complex task. There’s the straightforward cost/benefit analysis: how much will it cost you to set up your mining gear, pay for electricity, etc.
Many people seek to make money this way – but you could crunch all the numbers to ensure that you’ll mine enough Bitcoin to more than cover your costs and yet still not make any money mining.
The problem: by design, as more Bitcoins are mined, the harder it becomes to mine them. “Only those with specialised, high-powered machinery are able to profitably extract bitcoins nowadays,” explains Jordan Tuwiner, Founder & CEO at Buy Bitcoin Worldwide. “While mining is still technically possible for anyone, those with underpowered setups will find more money is spent on electricity than is generated through mining.”
Over time, therefore, the pool of successful miners will continue to shrink, leaving only large, industrial operators with unusually low costs, typically due to government subsidies.
The Problem with Bitcoin’s Intrinsic Value
As this pool shrinks, furthermore, another problem arises: the ‘51% problem.’ The 51% problem derives from Bitcoin’s essential decentralization. If one party (say, Chinese government-subsidized and government-controlled miners acting in concert) controls 51% of mining capacity, they can change Bitcoin’s rules as they like.
The risk inherent in this situation goes well beyond simply the collapse of Bitcoin. Since Bitcoin’s intrinsic value is tied to the ability to mine it, any party in control of Bitcoin can also change Bitcoin’s intrinsic value however they like.
Never before in the history of civilization has this happened – where cornering the market on a commodity means gaining the power over its intrinsic value.
Before such time as the 51% event occurs, all we have to worry about is the popping of a speculative bubble. Long term, however, the risks underlying Bitcoin are far greater and more difficult to understand.
In the final analysis, we may find the ‘mining’ metaphor to comforting, but in reality, it is dangerously misleading. Gold miners cannot fundamentally change the nature of gold itself, but Bitcoin miners potentially can do just that – and it’s just a matter of time until they will.