The Scarcity Problem: Why Cryptocurrencies are so Divisive
In arguments between crypto-believers and crypto-sceptics, a theme that always arises is about cryptocurrency’s intrinsic value and how this is related to the its scarcity. The steep learning curve required to understand cryptocurrencies does not help in this debate as it usually boils down to “if you don’t get it, you don’t deserve to reap the rewards of this revolution” or “why should I help someone who is spreading what seems like FUD(Fear, Uncertainty and Doubt) to me”.
Granted, a lot of the cryptocurrencies now are way overvalued having raised billions of dollars without so much as a working product but the technology behind it deserves more scrutiny and understanding from both sides. This relationship between intrinsic value and scarcity is an important one as simplified arguments tend to push people into two opposing factions:
- The blind believer: Those who praise cryptocurrencies without getting a more nuanced understanding of the limitations of the technology. This belief is built upon vague ideas of how cryptocurrencies will get rid of the middlemen and empower individuals via transferring trust to a decentralized network. In the best case, they have greatly underestimated the difficulty in transforming the theory into real working products.
Mantra: Cryptos will save the world and there is nothing organisations can do about it. You can easily get rich in the process because the middlemen industry is worth XXX billions.
- The unyielding sceptic: Those who see cryptocurrencies as nothing more than a pyramid/ponzi scheme or a speculation mania similar to the tulip crash. This is based on the belief that cryptocurrencies do not have any added value and its valuations are only driven by manufactured scarcity.
Mantra: Cryptocurrencies are get-rich-quick schemes driven by FOMO (fear-of-missing-out). Even if the technology is useful, there is no point investing in it now cause a better one will come along in the process.
Lost in translation
First and foremost, the word ‘cryptocurrency’ tends to have different connotations depending on an individual’s knowledge of the industry. A quick search will provide the following definition:
“ a digital currency in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds, operating independently of a central bank.”
This does provide an explanation of what a ‘cryptocurrency’ is but for people unfamiliar, the only way they can ground it in reality is in relating it to the mainstream media’s coverage of Bitcoin’s crazy price rally. Those who would have dug a little deeper would eventually find out that ‘cryptocurrencies’ encompass a whole suit of digital currencies, each with a different design and purpose. As such, this discrepancy causes a communication breakdown right off the bat.
This is an important distinction to be made as the intrinsic value and scarcity argument is dependent on the specific implementation of the cryptocurrency. This lack of distinction can be likened to thinking of stationery as only consisting of a pen, sure it is the thing that most people will think of but there are so many types of pens and even other tools which serve different purposes.
In general (and for simplicity sake), cryptocurrencies fall into 3 categories:
- A store of value: Think of this as the digital version of gold
- A medium of exchange: The digital version of cash
- Special tokens: Tokens which are unique to the specific network and allows the holder to participate in the network
These categories are non-exclusive but every cryptocurrency will have a different degree of each depending on their design.
Digital Gold
Bitcoin (BTC) as it is implemented now tends to lean towards being a store of value (low transaction throughput, high transaction fees, slow settlement times). As such, this is the reason why the scarcity argument is always linked to it and why many sceptics scoff at the idea of Bitcoin being a global digital currency.
If you think of physical gold, people largely ‘invest’ in it because history has proven that society as a whole places some value in owning a set amount of gold. As such, they are assured that there will be a buyer for their gold in the future. Gold has a few key characteristics which makes it valuable in the eyes of society:
- Limited utility: There are minimal other ways gold can be used therefore ensuring that it’s “value” is largely determined by society
- Scarcity: There is a limited supply and mining for gold takes up a lot of work. The amount mined is also tiny compared to existing stock ensuring price stability
- Relatively fungible: One ounce of gold is indistinguishable from another ounce enabling privacy, anonymity and divisibility
- Durable: A gold bar will outlast many lifetimes
In this sense, Bitcoin shares a lot of characteristics with physical gold and goes one step further as digital gold. In essence, Bitcoin makes access to this ‘store of value’ asset much more democratic:
- Irrelevant logistic costs as movement of asset happens digitally
- Minimal maintenance costs as no physical storage is required save for a device to access the network
- Increased access point to the market as only a device and internet is required
In both cases, the ‘value’ is in the people’s trust in the network itself hence it is a case of a society redefining what is a ‘safe’ store of value which everyone can agree on. This is a great article if you are interested.
Digital Currency
As for the medium of exchange argument, cryptocurrencies such as Bitcoin Cash (a branch of the original Bitcoin) is more suited for this role with its higher transaction speeds and lower transaction costs. Due to the design of Bitcoin Cash, transaction costs are significantly lowered and payments are relatively instantaneous. This enables micro transactions to take place, something which would not have made business sense in traditional banking.
For cryptocurrencies which are designed to be more of a digital currency, there is not much point investing in it in the hopes of turning a profit cause in appreciating in value, it effectively undermines its use as a currency. The scarcity argument does not apply here but there are people who invest in it now because it is still in the very early stages. Effectively, they want to invest in the currency before it finds a higher equilibrium after mass adoption. This is a possibility as the total market capitalization of these cryptocurrencies are insignificant compared to fiat currencies. An important caveat is that this relies on the currency having a small degree of ‘store of value’ characteristics.
Special Tokens
As for the special tokens, the scarcity argument applies here only in so far as shares apply to early stage venture capitalism. You can think of these tokens as purchasing discounted tickets upfront in order to fund the construction of a carnival (analogy not mine but I can’t remember where I saw it). People buy these tokens now in the hopes that they will be able to participate in the future network at a discounted price . These tokens are supposed to act as initial funding for the developers and a way for participants in the network to communicate value.
It must be noted that at the current moment, the majority of people are buying into these tokens with the view to sell it on the open market once the token appreciates in value. This defeats the whole purpose of it being a fund-raising tool as this speculative purpose introduces significant volatility into the network. Many scams are built upon selling the scarcity of their tokens and how much of a discount individuals can get if they bought the token now.
Will Bitcoin be replaced in the future?
Another argument against investing in cryptocurrencies now is that it is such an unproven technology that a version 2.0 will come out in the future hence there is no point investing in it now. This is definitely a possibility but with cryptocurrencies essentially being code, they can be upgraded much like the software on any computer. The main difference is that the majority of the network must be in agreement before such changes are made to the network. As mentioned before, the value of such cryptocurrencies is in the network and as such those with an established user base will likely undergo a code upgrade then adopt a totally new unproven cryptocurrency.
Conclusion
The scarcity argument is an over-generalization of how cryptocurrencies work as it effectively groups all cryptocurrencies into a single basket. The intrinsic value of a cryptocurrency is therefore also largely dependent on the goals of the cryptocurrency. It can be the ability to easily access a ‘store of value’ asset, it can be the ability to conduct microtransactions with ease or it can be in the value add that a particular cryptocurrency introduces into our lives.
Cryptocurrencies democratizes participation in value chains and evens out the asymmetrical power relationship between organisations and individuals. Crytocurrencies do not completely replace government or middlemen systems but rather provide an alternative to these centralized systems. It is definitely limited in applicability, but the implications of it being effectively rolled out is huge. With that being said, we need to look past the hype. When we stop trying to sell cryptocurrencies and blockhain as a magic bullet for all problems and instead concentrate on finding the right solution to the problem at hand, that is when crytocurrencies will truly add value to society.
For those more knowledgeable about cryptocurrencies, I confess that major oversimplifications especially with regards to 3 categorizations but this was in the interest of clarity.
Thanks for staying till the end. Would love to hear your thought/comments so do drop a comment. I’m active on twitter @AwKaiShin if you would like to receive more digestible tidbits of crypto-related info or visit my personal website if you would like my services :)
