This blog will be devoted to deconstructing and refuting the following argument, variations of which I hear far too often among cryptocurrency critics:
“Cryptocurrencies are a bubble because they have no intrinsic value. They aren’t backed by anything other than the faith of the fools who buy it and of the greater fools who buy it from these lesser fools. It’s all virtual, an illusion, mass hysteria. It’s just like the tulip bubble…” etc etc
Implied by this argument, either explicitly or implicitly, is the associated belief that older, more traditional forms of money such as gold and the dollar do have intrinsic value, aren’t virtual but are in some sense “real”, and therefore not bubbles.
I’ll start by taking a closer look at the idea of intrinsic value, a slippery notion which can be defined in many different ways, none of which are consistent with the above statement. I’ll then argue that the concept of intrinsic value that these critics are alluding to is an illusion derived from their misunderstanding of the difference between money, which I’ll argue is a technology, and wealth which is the fundamental thing represented by money.
Once this illusion is dispelled, we realise that gold, the dollar and cryptocurrencies are all merely technologies of wealth and none of them have intrinsic value. Given this, the important question to answer is not whether or one form of money has intrinsic value or not but rather which is the best technology — which best fulfils the intended purposes of money. I’ll then make a case that cryptocurrencies are better technology than both gold and the dollar — the two most dominant forms of money that currently exist.
What is intrinsic value?
Now, there are a few different ways to define intrinsic value. I don’t think the critics are referring to the financial definition of intrinsic value, namely that of an asset generating cashflows, because these same critics are likely to believe that something like gold — an asset which doesn’t produce cashflows — does have intrinsic value.
I also don’t think these people are referring to the Wikipedia definition of intrinsic value which looks at the processes and costs involved in producing an item as a measure of its intrinsic value. Indeed, cryptocurrencies themselves also have production costs in the form of the electricity required to mine them. Moreover, many of the cryptocurrency’s critics have extensive and expensive collections of rare art and other collectibles — items with very low production costs which nevertheless possess huge market value.
So what is this mythical notion of “intrinsic value”? I believe what the critics are getting at with intrinsic value is the somewhat vague idea of absolute or objective value, a kind of grounding or backing by something “real” out there in the world. While undoubtedly an attractive and comforting notion, I believe it cannot exist in any form of money. Indeed, belief in the intrinsic value of money is caused by a fundamental misunderstanding of two separate notions: money and wealth.
The difference between money and wealth
As Paul Graham tells us in his characteristically lucid blog, money is not wealth:
“Wealth is not the same thing as money. Wealth is as old as human history. Far older, in fact; ants have wealth. Money is a comparatively recent invention.
Wealth is the fundamental thing. Wealth is stuff we want: food, clothes, houses, cars, gadgets, travel to interesting places, and so on. You can have wealth without having money. If you had a magic machine that could on command make you a car or cook you dinner or do your laundry, or do anything else you wanted, you wouldn’t need money. Whereas if you were in the middle of Antarctica, where there is nothing to buy, it wouldn’t matter how much money you had.”
So what is money then? Money is a technology, in the sense of “technique” or the way we do things. Specifically, it is the way we render the idea of wealth usable in the real world; it is the technology of wealth.
In order to fulfil this role, money must serve three purposes: (1) a medium of exchange — eliminating the inefficiencies of barter (2) a unit of account — facilitating valuation and calculation and (3) a store of value — allowing economic transactions to be conducted over long periods as well as geographical distances. Basically, money is the technology we use to move wealth around, record how much wealth we have and store it over time.
To perform all these functions optimally, money has to be scarce, available, affordable, durable, fungible, portable and reliable. Throughout history there have been many different forms of this technology: shells used by Native American tribes, stone discs used on the islands of Yap, inscribed clay tokens used in Mesopotania, precious metals used all over the world, paper dollars backed by gold, paper dollars unbacked by gold, digital bank accounts, credit cards and now cryptocurrencies.
While money is an incredibly useful technology which allows for trade and forms the basis of our economic system, its danger is that it tends to obfuscate the concept of wealth that actually lies behind it. As Paul Graham tells us:
“People think that what a business does is make money. But money is just the intermediate stage — just a shorthand — for whatever people want. What most businesses really do is make wealth. They do something people want.”
Even governments often fail to understand this distinction between money and wealth. An increase in the supply of money will not make a society richer — it will merely lead to inflation (though it may enrich the government if it monopolises the production of money). In “Wealth of Nations”, Adam Smith mentions several countries that tried to preserve their wealth by forbidding the export of gold or silver. But having more of the medium of exchange would not make a country richer; if you have more money chasing the same amount of wealth, the only result is inflation.
On the other hand, an increase in wealth will make society richer. To quote Paul Graham once again:
Suppose you own a beat-up old car. Instead of sitting on your butt next summer, you could spend the time restoring your car to pristine condition. In doing so you create wealth. The world is — and you specifically are — one pristine old car the richer. And not just in some metaphorical way. If you sell your car, you’ll get more for it.
The role of trust
It is conventional to argue that money is a social construct which depends entirely on our collective belief or trust in it. While this is certainly true, it doesn’t explain why we end up collectively trusting certain forms of money over others. The reason is because money needs to fulfil the purposes outlined above and our trust in it is contingent on it doing so.
We collectively trust gold because it is scarce, fungible, doesn’t corrode and thus can be stored without losing value over time and easy to transfer as it can be moulded at relatively low temperatures. Similarly, we collectively trust the dollar because it is scarce (its scarcity being guaranteed by the federal bank), fungible, doesn’t corrode and can be easily transferred. To quote Niall Fergurson:
“Money is a matter of belief, even faith: belief in the person paying us; belief in the person issuing the money he uses or the institution that honours his cheques or transfers. Money is not metal. It is trust inscribed. And it does not seem to matter much where it is inscribed: on silver, on clay, on paper, on a liquid crystal display. Anything can serve as money, from the cowrie shells of the Maldives to the huge stone discs used on the Pacific islands of Yap. And now, it seems, in this electronic age nothing can serve as money too.” (Emphasis mine)
Gold and the dollar are outdated technologies
We’ve now established that the dollar and gold do not have intrinsic value as they are merely one of many technologies which we’ve used to move wealth around, record how much we have of it and store it over time. Their dominance comes not from any intrinsic value they have but rather from their effectiveness in fulfilling the aforementioned purposes of money.
If this is the case, then the important question we must answer about cryptocurrencies is not whether they have intrinsic value but rather whether they are better technology. I’ll now argue that they are.
For most of history precious metals and specifically gold have been the dominant form of money. Indeed, no other technology has been so closely associated to the idea of wealth and intrinsic value.
Initially, gold served all the purposes of money as it was moulded into golden coins of different weights and corresponding denominations, thus acting as a medium of exchange, unit of account and store of value. In the 18th century paper currencies were introduced whose value was guaranteed in gold in what was called the “Gold Standard”. The government pegged the gold to paper currency exchange rate and you could go to any bank in the world and exchange your paper money for gold.
As Mark C Taylor said, gold, like God, acted as a “sign that denies its status as a sign in order to ground the value of other signs”. And just as Nietzsche announced the death of God in 1896, in 1973 Nixon announced what should’ve been the death of gold by abandoning the gold standard and allowing currencies to float freely, their prices relative only to each other. Intuitively, one would expect the price of gold to have crashed, but actually it went up nearly three times in price.
Why did this happen? Firstly, because the price was no longer fixed by the government, it was free to fluctuate according to supply and demand. Secondly, the demand for gold increased because people even then did not have full faith in a government issued currency backed by nothing but the government itself. While the government issued bills’ value relied on the country not going bankrupt or the central bank not printing too much money, gold’s value was guaranteed by its natural scarcity and other economic properties as well as by its millennia-long history as the dominant form of money.
Thus, while gold had began by fulfilling all the purposes of money, it ended up acting primarily as our global, decentralised and independent store of value, one which people believed would hold its value even if these new government backed currencies were to fail. Its value derives from our collective belief in it as a technology which is our collective belief in its economic properties and its consequent ability to fulfil its purpose as a store of value. How valuable is it? Many estimates pin the gold investment market at ~$4 trillion.
However, while gold has served us fine so far, all technologies eventually become outdated and vulnerable to being replaced, especially if they have not and cannot be updated and improved. The reality is, compared to digital gold offered by cryptocurrencies, gold is a pretty terrible store of value. Gold bars are big and heavy and extremely expensive to store and keep safe. They’re also costly and difficult to move around and vulnerable to being stolen. It’s also very difficult and expensive to verify if someone has gold and what purity it is. While its supply is scarce, it’s also unpredictable, and finding new stores of gold has historically had serious inflationary effects on its price. Also, no one knows exactly how much gold there is in the world, both in circulation and under the earth. Furthermore, in order to trade gold you need access to functioning gold markets, something which not everyone has access to and that are especially difficult to access in the places that really need them, such as Venezuela and Zimbabwe.
Cryptocurrencies solve these issues. They are infinitely divisible at no additional cost. They are cheap to store safely and you can store them yourself without relying on a third party (a €70 Ledger wallet is all you need to securely store an unlimited number of bitcoins). You can transfer them around anywhere in the world quickly, securely and cheaply (this will only become cheaper over time as scaling measures such as Lightning network for Bitcoin and PoS/Casper/Sharding for Ethereum are introduced). You can’t lie about having cryptocurrencies or about their purity as they cannot be falsified, forged or counterfeit since there is a public ledger with records of who owns each and every bitcoin (by public ID) and every transaction ever made on the network. Like Gold, supply is scarce but unlike Gold it is fixed and predictable. For instance, there will only ever be 21,000,000 bitcoins and its supply is a probabilistic geometrically declining supply function such that we know how many bitcoins will be mined each and every single day until the last bitcoin is mined in 2140. As a result, we know exactly how many bitcoins are in circulation today and how many there will be at a specific point in the future. Also, unlike gold which requires functioning gold markets, Bitcoins can be acquired and traded from anywhere with an internet connection, making it an ideal solution for countries like Zimbabwe and Venezuela.
Finally, while gold is desirable because of its independence from other asset classes (expressed as its low correlation with other asset classes) which makes it a stable store of value even in a global financial crisis or during harmful geopolitical events , Bitcoin has been shown to be even more independent from other asset classes as it is completely uncorrelated to any other asset class. Indeed, there is a growing body of empirical evidence that Bitcoin is already serving as a hedge against harmful global economic/geopolitical events with its price spiking in response to both Brexit and Donald Trump’s win.
Some may say cryptocurrencies are too volatile to act as a global store of value. While this is currently true, as Haseeb Qureshi tells us, Bitcoin does not need to immediately replace gold, for now it just needs to complement it. Furthermore, Bitcoin’s volatility has been going down every year and it is already just as volatile as oil, and less volatile than many SP500 Equities. While it’s still 5–6 times more volatile than gold, the gap is narrowing every year.
Given all this, I argue that cryptocurrencies provide better store of value technology than gold. As people realise this I suspect we’ll see gold markets beginning to fall with gold eventually becoming valuable primarily as either jewellery (although even gold’s desirability as jewellery is inextricably tied to its cultural symbolism as a store of value - would people still want to wear gold if it was no longer used as a store of value?) or as a hedge against a global crisis scenario which leads to the internet going down. In fact, many gold buyers already buy it for this very reason.
Digital payments network
If gold is the dominant store of value technology, then the dollar has become the dominant medium of exchange and unit of account technology. Interestingly, the dollar is, in many ways, as virtual as cryptocurrencies are. Just like cryptocurrencies, the dollar doesn’t physically exist out there in nature, it is created by the federal government. As Maria Bustillos tells us:
“The U.S. dollar is what is known as a “fiat” currency. Fiat is Latin for “let there be,” as in fiat lux, let there be light; hence, fiat denarii, let there be lire, bolivars, dollars, and rubles.”
Also just as cryptocurrencies, dollars consist primarily of numbers out there in cyberspace. Indeed, while dollars are sometimes stored in paper or coins, these only account for about 10% of dollars in circulation. As James Surowiecki reported in 2012:
“only about 10 percent of the U.S. money supply — about $1 trillion of the roughly $10 trillion total — exists in the form of paper cash and coins”.
Despite their similarities however, I will argue that cryptocurrencies are a superior medium of exchange and unit of account technology than the dollar.
Firstly, the dollar relies on trust in the U.S. government which creates and backs it. The dollar’s scarcity and therefore its value relies on the federal government not printing too much of it. The federal government has complete discretion in when and how many dollars they can print. To quote Maria Bustillos once again:
“There is nothing stopping them from creating more dollars whenever the mood strikes. Of the $13.7 trillion in the M2 money supply as of October 2017, $13.5 trillion was created after 1959 — or, to put it another way, M2 has expanded by almost 50 times.”
Many argue the dollar’s value is also “backed by the full faith and credit of the United States government.”. But what does this mean?
“It means that if you take one dollar to the U.S. Treasury and ask them to redeem it, they will: They’ll give you…one dollar. Or four quarters, if you want, probably.”
As Bustillos illustrates so clearly, since the abolition of the gold standard, currency has become a circular system in which the dollar is backed by the US Government in dollars. This works fine, until suddenly it doesn’t, as many European nations have discovered in the last few years.
Monetary crises in unstable governments like Portugal, Italy, Greece, Spain and Cyprus have made people realise just how virtual paper currencies are and have consequently precipitated a number of spikes in the crypto markets. In 2013, the Eurogroup ruled that bank shareholders would be first in line for assuming losses of failed banks, followed by bondholders and then depositors with more than €100,000. As a result, bank failures all across Europe cost these “wealthy” depositors billions. As if this wasn’t enough, as a condition imposed for Germany’s €12 billion bailout loan, the Cypriot government was forced to raise an additional €7.5 billion by effectively looting its citizens’ bank accounts, taking a 6.75% haircut from insured deposits of €100,000 or less as well as 9.9% from accounts above €100,000.
Can paper currencies such as the dollar really act as a medium of exchange technology when they’re so reliant on the financial health of the countries that issue and use them? While it’s arguably unlikely that something like this will happen to the dollar (although some disagree), the reality is that there is a nonzero % chance that it could happen and if it does, the consequences would be devastating. Why should a medium of exchange technology be controlled by any one country or tied to its fate?
Cryptocurrencies solve these issues by providing a decentralised medium of exchange and unit of account technology which is uncorrelated to the performance of any nation state or asset class. Rather than relying on the authority of banks or governments to verify transactions and record how much each person has, bitcoin transactions are verified by thousands of people around the world in a distributed computer network (which anyone can join) and recorded in an immutable, unfalsifiable public ledger which is also accessible to anyone. As a result, no government can, as the Cypriot government did, take money from your bank account, no failed bank can wipe out your savings and no central bank can devalue your money by printing too much of it. Moreover, unlike the law which is apt to be rewritten or even suspended in times of emergency, bitcoin code can only be changed if a majority of users (miners) vote to change it.
While this alone is a technological improvement over the dollar by rendering our medium of exchange truly independent, cryptocurrencies also provide some significant technological advantages in both international payments and micropayments.
Right now, if I want to send $10,000 to China, my best option is to bank transfer it. This requires, first of all, that I have a bank account, which requires credit reports, identification and pre-permissions. Then, it will cost me €30 in fees in addition to the 1–3% exchange rate spread commission that the bank will charge me and it will take 3–5 working days to process.
On the other hand, using cryptocurrencies I can send money without having a bank account, without exposing my identity or knowing the identity of the person I’m sending to (a public key is all that is necessary). This will take 10 minutes to process and cost less than €1. Clearly the user experience of setting up wallets and sending money needs to be simplified and improved if cryptocurrencies are to see mass adoption, however, in terms of speed, simplicity and cost, cryptocurrencies a far superior technology for processing international payments.
Micropayments are another area where cryptocurrencies have a technological advantage. As Haseeb Qureshi tells us:
“With traditional financial networks (taking Visa as the canonical example), any monetary transfer incurs fees of at least 20 cents. This means it’s infeasible to transact any amount less than 20 cents, and at 50 cents, a seller would be sacrificing 40% of their revenue to Visa.
This renders most micropayment schemes untenable on traditional payments networks. A lot of otherwise innovative business models are simply ruled out. What if you wanted to create a blogging service that charged 25c to read past the fold? Tough luck — after payment processing fees, it wouldn’t be worth the HTML it was printed on.”
Right now, businesses work around this by doing what Qureshi calls micro-accounting, which is basically just noting the micro-payment on a ledger and then settling up at the end of the month to minimise the impact of the fixed fee. However, true micropayments open up a whole host of business models that wouldn’t otherwise be possible.
While most cryptocurrency enthusiasts see the potential to disrupt the middlemen that are banks, they also have the potential to disrupt the middlemen that are the online advertising giants. Indeed, behind our everyday browsing there is an invisible ad marketplace in which advertisers pay publishers for our attention through the middle-men of Google, Facebook, Yahoo, etc. Whenever we visit a web-page, a micropayment is happening in the background between advertisers who pay money to get our attention, publishers who create content that we want to consume and the ad platforms who manage the relationship between the previous two. While each page view costs a microscopic amount of money, in total they add up to the multi-billion dollar businesses which form the lifeblood of the online economy. With cryptocurrencies, we could potentially eliminate the middlemen, allowing for a peer to peer attention exchange marketplace. This puts creators of all kinds back in the driver’s seat and enables a whole new range of business models based on content production and creation. As Jolpinski tells us:
“Think about investing in someone’s blog or even a comment. Being paid for sharing stuff that others find relevant or valuable. Becoming a shareholder in someone’s Instagram feed. Or even social network cooperatives where proceeds from ads are redistributed directly to the top contributors on the network. Possibilities are infinite here.”
Finally, since cryptocurrency can be thought of, among other things, as “programmable money”, it is much more versatile and adaptive as a technology of wealth than any of its predecessors. Whereas gold and the dollar’s features are inherent to it and pretty well fixed, cryptocurrencies can adapt and evolve according to the needs and desires of its users and enable a variety of different ways to exchange wealth, thus rendering the concept of wealth usable in new and different ways. Through smart contracts for instance, cryptocurrencies may allow a vastly greater range of parameters to be embedded into exchanges of value, as well as a huge array of different valuables to be exchanged such as time, contracts, expertise, goods, services and many more we are yet to imagine. As Nelson tells us:
By using Token’s programmable money platform, banks and their customers can hardwire T&Cs into their transactions, securing and verifying them using a combination of cryptography and tokenization technologies. Transactions can only ever be authorized when all the T&Cs are met. It makes the transaction virtually impossible to hack, since the data transmitted between the transacting parties is meaningless to everyone else. It also happens instantly and enables the parties to reduce — and usually eliminate — their dependence on third parties, such as clearing houses, which would traditionally charge a fee for verifying the authenticity of the transaction and those performing it.
By using programmable money, banks in particular have a massive opportunity to transform how they operate. Many of the transaction-based services banks provide, like inter and intra-bank transfers, cross border payments, direct debits and B2B payments all require third party validation. This external checking process costs the bank and slows everything down.
The potential applications for self-validating transactions conducted using programmable money are practically limitless. When used consistently across the world, they have the power to transform the way the world transacts.
Whenever someone next tells you that “Cryptocurrencies have no intrinsic value!” I hope you’re now able to confidently respond that although that’s true, it’s also true of gold, the dollar and all other forms of money. After all, money is merely the technology of wealth —the way we make wealth usable and transferrable in the real world — and many have come and gone throughout history. Given the technological advantages provided by cryptocurrencies, this author argues that in the distant future it’s possible that we may be looking back at gold and the dollar with the same amused curiosity that we now feel looking back at the sea shells of the Maldives or the stone discs of Mesopotania.