Can cryptocurrencies perdure solely as payment networks?
Or, can Bitcoin exist solely as a store of value?
This is the fourth of a five-part series. Read here the first, second, and third parts.
The conflicting views of Bitcoin as primarily a SoV or a payment mechanism have existed since the beginning. Although one is entirely free to use Bitcoin just for payments and nothing else, someone still needs to provide the demand to hold it. As already argued above, if no one is willing to hold, then its value cannot be sustained. For this same reason, any cryptocurrency designed with the sole purpose of functioning as a MoE — without regard for its programmed scarcity — is unsustainable over the long term. It will likely have an inflationary policy or a hesitant and uncertain one, neither of which is enticing for potential holders.
There are other factors at play preventing a “MoE-only crypto” from prevailing over a longer horizon. First, the idea of having one asset for storing value and another to effect payments negates the foundational concept of money. If money is an intermediate good for realizing exchanges, then why introduce a second intermediate good (i.e., the MoE-only crypto) that adds friction to a transaction?
Would it not be more sensible to use the same asset for storing and transferring value instead of using two assets, one for SoV and another for paying, in a kind of semi-barter exchange? A brand new and different asset involves price discovery and liquidity hurdles, exchange rate volatility, and incipient network effects all of which result in higher overall transaction costs. While a cryptocurrency may display low fees and high capacity, the reduced transaction costs in the narrower sense alone are incapable of sustaining long-term value for a currency.
To further illustrate this assertion, let us review the case of international payments. Assuming Bitcoin is a preferred MoE for cross-border transfers, and remitters and recipients are not demanding it to hold as cash balances, but only as a vehicle currency, then other people must step in and be willing to hold it. These people will perform this role because they perceive Bitcoin as a good (at least prospectively) SoV.
However, if this value proposition is absent, then why would anyone hold it? Will other people eventually need it as a bridge currency? Would someone risk holding an asset for no reason other than allowing third parties to someday use it briefly to move value across the planet? Why would anyone risk holding such an asset instead of using any other payment system where there is no need for another currency?
With all these open questions, it is precisely why XRP (Ripple’s currency) is essentially nonsensical. It inverts the economic rationale for why a good is desired and held as cash balances. Ripple expects its currency will be demanded exclusively because it can be used as a vehicle for international transfers when the cause and effect relationship is effectively backward. Bitcoin can be used as a vehicle for international transfers because individuals demand it as a valuable asset to hold.
This all suggests that if Bitcoin is to gain in relevance and adoption, then it needs to stand out as a SoV and not just a payment mechanism, a vehicle currency or as a transitory MoE (narrowly understood here as a good which is used to transact but which individuals are reluctant to hold for much longer than a specific transaction). That said, any other cryptocurrency competing against Bitcoin will succeed if it beats it as a SoV and not as a payment network.
Technologists, such as Kyle Samani, the managing partner of Multicoin Capital, are biased to believe the SoV utility maximized by Bitcoin is not essential; other features or “utilities” are more important, which is expressed as Samani’s “utility hypothesis.” I do not belittle these features, but I argue it is senseless to program them into a new cryptocurrency instead of on top of another more liquid or established currency. Again, if detached from a SoV design, then these utilities alone are unlikely to confer a cryptocurrency long-term value.
Similarly, Chris Pacia, the OpenBazaar developer and proponent of BCH, suggests “the primary innovation of Bitcoin is P2P value transfer, not ‘limited supply.’” While there is truth to this statement, it overlooks a key element: what is the source of this value? At its core, Bitcoin is simply a P2P UTXO transfer system. Value resides not inside the protocol, but subjectively in each individual, and limited supply is an integral part of the equation. Without scarcity, there is no value to transfer and Bitcoin could not even have bootstrapped in existence. So, you cannot separate one from the other.
Now, Chris disputes the idea of Bitcoin as “sound base money.” In his view, if you price out on-chain transactions due to high fees, then layer two payment networks will be “too easy to control and manipulate” and will cause the downfall of Nakamoto’s invention just like the gold standard. “My goal is censorship-resistant unregulatable money,” he adds. “Rehashing the failed gold standard experiment, this time in digital form isn’t going to produce a different outcome.” There is also some truth to this statement. But, once again, he seems to neglect crucial differences. The gold standard did not fail only “because of corruptible middlemen.” In fact, gold needed to be severed from the monetary order precisely because it was sound money and acted as a barrier to inflationary policies. Governments were only able to accomplish this feat because gold was not resistant to censorship. Herein lies all the differences: Bitcoin is not only sound money but also uncensorable digital sound money.
Then, what is or will be BCH? This is not a rhetorical question. Considering BCHers abhor transaction fees, they will have no option but to resort to inflation to incentivize mining. Ironically, BCHers like Chris, in the pursuit to avoid a new gold standard in digital form, may end up bringing about the same inflationary standard we currently have, this time in digital form.
In conclusion, I argue sound money is a prerequisite and that privately produced money must be sound to be bootstrapped, which will always outcompete a less sound or inflationary contender.
Will Bitcoin ever be used primarily in exchange?
What if Bitcoin is never used primarily as a MoE? What if it remains only as a SoV rarely used in everyday exchanges? What if it takes much longer for liquidity to increase and for it to be more widely accepted in transactions? Alternatively, what if governments impose severe restrictions for everyday commercial use? Could Bitcoin still retain any utility?
These are important questions that deserve serious consideration. Depending on your vision for Bitcoin, the answers may differ markedly.
If you view Bitcoin first and foremost as a MoE, e.g., a payment mechanism, as do BCHers, then it might be rendered useless if it cannot be used in exchanges in the future. Curiously, this point-of-view resembles the criticism Austrian economists used to raise a few years ago against Bitcoin, which argued that if it is not money, then it has no value whatsoever. Economist Peter Šurda dubbed this the “money or nothing fallacy.” For BCHers, the only difference is the time frame: if Bitcoin is not used as a MoE in the future, then it will have no value. Either Bitcoin becomes money (i.e., a general MoE) or it has no purpose at all.
On the other hand, if you ascribe to the SoV thesis, then you recognize that a purely digital asset itself has utility. The notion of digital scarcity is powerful and groundbreaking. Even if Bitcoin takes longer to gain liquidity and is not primarily used for exchanges, then a digital version of gold is still highly useful.
Obviously, a functional SoV is based on the premise it can be transferred without incurring prohibitive costs or unreasonable delays. But, it does not require instantaneous payment finality nor costless transactions. It does require, though, secure transfer and payment finality.
Therefore, like gold today, Bitcoin can exist as a SoV. This scenario may persist for much longer, perhaps decades, than enthusiasts would wish for. Sure, I would appreciate if it gained adoption sooner, boosted liquidity, stabilized price, and allowed for more usage as a MoE. Nonetheless, we cannot deny reality as confidence takes time and regulation may eventually hinder the “currency use case.”
Chris Pacia fiercely disagrees with this opinion by arguing gold is not held today because it is largely perceived as a SoV. Instead, the “excess demand comes from speculators who are speculating that gold will take on new use cases at some point in the future.” Speculators, like gold bugs, who expect the inevitable currency collapse will make the metal reemerge as the standard of a future monetary system. Pacia claims, however, that if these “new use cases” never materialize, then gold is set to a significant downtrend in demand.
It is indisputable that some gold bugs share this investment thesis. However, it is a gigantic leap to affirm this corresponds to gold’s main source of demand. Pacia appears to ignore other intrinsic properties that make gold stand out as a unique asset in the world. It is a millenary commodity, naturally scarce, irreproducible, and universally recognized as valuable. Gold cannot be inflated, counterfeited nor defaulted on. It is no one’s liability and has no counterparty risk.
These extraordinary attributes elevate gold’s position as the ultimate asset to be hoarded even by every relevant Central Bank around the globe. In the end, every national monetary authority distrusts its peers. Paper currency is a political convention, and despite all institutional and constitutional safeguards, a Central Bank will not risk backing its currency 100% on another national paper currency equally subject to unpredictable inflationary pressures.
We are now three years shy of the 50th anniversary since Bretton Woods broke down, and official gold reserves are a meager 8% down compared to 1971 (see sources here and here). This is a remarkable testament of confidence in gold as a SoV. To this end, there is a case for a purely digital SoV, and Bitcoin can serve this purpose even if it is used sporadically as a MoE.
Read the last part.
