After reading several articles which sell hopes as facts and FOMO as investment strategy, I felt it was the right time to share some critical thoughts on what Bitcoin really is and what it isn’t. Note that I’m not opposed to Bitcoin or cryptocurrencies in general. I simply think that some important points are frequently being missed, and that a lot of people focus on specific aspects while being blind to the bigger picture.
Bitcoin is often referred to as digital gold, so let’s have a look at gold first. Why is gold valuable? Sure, it has some nice applications in electronics (connectors immune to corrosion) and research (coatings for mirrors, sample preparation for electron microscopy). But gold was valued by mankind thousands of years before these things were invented. I think it’s pretty safe to say that the value of gold boils down to two qualities:
1. It’s shiny.
2. It’s rare.
The shininess is what initially sparked the interest in gold, and together with the rareness it leads to demand being much larger than supply, hence the value of gold is high. Since the high demand and low supply have accompanied us for millennia, gold is widely accepted as a means of value storage.
Now, what about Bitcoin? Does it have the same qualities? Bitcoin is shiny in a sense because the idea it is based on has the potential to revolutionize the financial system. That is certainly enough to spark the interest of a lot of people. And Bitcoin is rare by design. The maximum amount of Bitcoin to ever exist is algorithmically limited to 21 million, most of which have already been mined. Whether Bitcoin or other cryptocurrencies are a good option for value storage remains to be seen. Sure, the price development over the past couple of years clearly shows an upward trend, but nobody can predict with any reasonable certainty what’s going to happen within the next 10, 30, or 100 years.
Apparently, leaving aside value storage, the gold comparison is not so far-fetched. But there is one more important commonality that gold and Bitcoin share: their value is not intrinsic. What do I mean by that? I’ll give you some examples. A piece of bread has an intrinsic value because you can eat it and you must eat to survive. A house has an intrinsic value because you need a place to live. But what do you do with a piece of gold? Sure, you can sell it for good money, but only because people agree that gold represents a high value. If no one would care about gold jewelry anymore, and if it were replaced by other materials in its technical applications, guess what would happen to its value.
It’s even worse with Bitcoin. While gold, valuable by agreement or not, can at least be used as raw material in the production of certain items, Bitcoin is just a bunch of zeros and ones on a digital storage medium. It has absolutely no intrinsic value whatsoever.
As I said, the maximum amount of Bitcoin that can ever exist is limited, so Bitcoin is deflationary by design. This fact is often used to support the claim that Bitcoin is superior to fiat currencies because it can’t suffer from the problems arising from the printing of money out of thin air — something we’ve been seeing a lot lately. While this may indeed be a major advantage, the conclusion that because of this Bitcoin’s value must increase as time goes by, is flawed. This reasoning is based on fiat currencies, whose purchasing power increases during a deflation. But with fiat currencies you can buy anything, whereas the acceptance of Bitcoin is still low. And all the deflation in the world won’t increase your purchasing power if only three shops accept your currency, and neither of them sells what you are looking for.
It is true that today one Bitcoin costs a lot more Dollars, Euros, Yuan, etc. than it did a year ago. But the driving factor for this price increase is not Bitcoin’s built-in deflation. It’s simply the fact that a lot more people want to own Bitcoin than a year ago. The reasons for this are diverse. Some honestly believe that our financial system needs to change and that cryptocurrencies are a step in the right direction. Some have a pragmatic view on this subject matter and consider cryptocurrencies a high-risk high-gain asset class which makes sense in their portfolio, as long as most of their money is in other asset classes. And then there are a whole lot of poorly informed, greedy hotheads who — blinded by the price development or the promises of self-proclaimed crypto-messiahs — put all their money into Bitcoin. There’s a word for that, which starts with an I. No, it’s not investor.
Another frequent argument in favor of Bitcoin and other cryptocurrencies is independence. A decentralized network immune to manipulation (because of the Blockchain technology) sounds like a good protection from the despotism of financial institutions and governments, right? Indeed. But there is an important limitation: this holds true only for a cryptocurrency that has de facto managed to replace a major fiat currency. So long as most transactions are carried out using fiat currencies, cryptocurrencies can’t live up to this promise, simply because they are not necessary to keep the economy running. Nations can impose drastic regulations (as recently done by China) or completely ban Bitcoin without jeopardizing their economy. And what good is a manipulation-safe currency if you can’t use it?
On top of that, Bitcoin is highly susceptible to another kind of manipulation that has nothing to do with the Blockchain but with psychology. As we have recently learned, one social media fart from Elon Musk is enough to make the Bitcoin price drop by a double-digit percentage. I would not exactly speak of independence if one individual can have such a strong influence on a currency. To be fair, I should mention that this problem would probably subside if Bitcoin was embraced by a large enough number of companies and nations.
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