Who decides what your bitcoin is worth?
If you’re someone like me who recently took the plunge and bought some bitcoin — Congratulations! You are now the proud owner of the only asset that’s more harmful to your health and general well-being than Tesla stock. Yes you ‘researched’ it for years before you finally pulled the trigger. And yes you followed the Buffet rule — Be fearful when everyone is greedy and be greedy when everyone is fearful. You were able to buy ‘low’ by being prudent when everyone panicked and ran for the exit door. You are in it for the very long-term. You ‘ignore’ the short-term volatility. Good for you.
But just who decides what your bitcoin is worth at any point of time? A security like a corporate bond or a stock has a value that is ‘secured’ by all the money the company will generate in the future and by all the other assets owned by the company. Government bonds, treasury bills and fiat currencies are also ‘secured’ by all the tax dollars the government will collect in the future. But just what secures the value of a bitcoin? The answer is absolutely nothing. Bitcoin is not a security. It’s value is not backed or secured by anything. So yes — It’s value can absolutely go down to zero. It’s highly unlikely, but certainly possible. So the next time your friend Dave tells you it is impossible for the value of a bitcoin to drop below 2500$, run away from him. He’s not your friend. Not anymore!
So if it’s not a security, just what exactly is it? Almost everyone who owns bitcoin including me certainly treats it like a commodity. We hoard it like gold, hoping it’s value will go up in the future because the supply is limited and the demand is not. And that’s what fundamentally gives bitcoin value. Over the long run, the value of a bitcoin will be decided by what portion of their portfolio investors all over the world want to allocate to a digital asset that stores value for the same reason anything stores value — because it’s supply is limited whereas the demand for it is potentially unlimited.
In the short-term, the value of a bitcoin like any other asset traded on a public exchange will be controlled almost entirely by speculators. Volatility will reign free. Fear of missing out, greed, desperate attempts to limit losses, herd mentality and deliberate market manipulation using large trades dominate cryptocurrency exchanges today. Wild fluctuations in the value of bitcoin are all too common. Market manipulations by whales who pump and dump bitcoin are becoming increasingly frequent. In the short-term, all markets including and especially cryptocurrency exchanges are voting machines. But over the long run, markets are weighing machines.
Trouble is, just how exactly do you weigh bitcoin? If bitcoin’s history until now is any indication, it’s becoming increasingly difficult to make a case for it being used routinely (in meaningful volumes) for financial transactions or as a global currency reserve in the foreseeable future. If so, why do I need bitcoin in the first place? If it’s just a store of value, why is it better than gold to begin with? When was the last time you were on the way to the post office to mail a bar of gold to your aunt in New Jersey thinking “I wish there was a better way to send gold over the internet”?
On the other hand, almost anyone who has ever sent money to a loved one abroad, has at some point wished there was a faster, cheaper way to do international wire transfer. But if a mechanism for sending money anywhere in the world safely and cheaply is all we are after, the value of a bitcoin is largely irrelevant as long as it is sufficiently stable (at least over the long term, since miners will eventually have to be compensated entirely with fees for processing transactions). Stable coins like DAI fit the bill way better than bitcoin as long as they are able to achieve scale and widespread adoption.
As an instrument that stores value, bitcoin has certain fundamental advantages over cash as well as more familiar commodities. Governments can always print more cash, lowering it’s purchasing power over time. In the last ten years, the average supply increase for the Argentine peso has been a whopping 129% per year! Bitcoin is inflation proof (it’s supply inflation is steady and precisely predictable to be more rigorous). It’s total supply is fixed. Only 21 million bitcoins will ever be mined. The actual number of bitcoins in circulation over the long run will be lower, since the private keys corresponding to several (as many as 4 million according to some estimates) bitcoins have been permanently lost. The supply of bitcoin is not only fixed, it has a precise upper bound. While gold, platinum, diamond and oil are all scarce commodities, none of them have precise upper limits on their supply. Fracking fundamentally changed the supply side of the equation for oil. Laboratory-grown diamonds have the potential to similarly disrupt the long and complicated diamond supply chain.
However, a limited supply is no guarantee of value. Bitcoin’s real purchasing power will grow over time if and only if the demand for it continues to increase. Oil reserves are finite. But it’s value can and will decrease over time, as the world continues it’s slow but steady march towards a sustainable future. For a commodity to be a good store of value, it should have limited supply and have no superior alternatives to ensure that demand for it keeps rising. So far there is no indication that the demand for bitcoin is slowing down. The demand growth is in fact accelerating, especially in economically volatile regions such as Venezuela, Argentina and Hong Kong. But the demand for bitcoin can easily slow down, if a superior alternative for it becomes available.
So, how much will the bitcoin in my wallet be worth 10 years from now? Nobody and I mean nobody knows. A share in a company is fundamentally worth all the money the company will earn over it’s lifetime. But what is a bitcoin worth fundamentally? The demand for oil 10 years from now might be unpredictable, but at least the future global demand for energy is not. What will the future demand for bitcoin look like? What will the demand for cryptocurrencies in general look like 10 years from now?
If you are new to cryptocurrency investing, remember that you can own as little as 0.000001% of one bitcoin. If you want to have cryptocurrency in your portfolio, you can start by setting aside a very small portion of your savings for investing in bitcoin or another cryptocurrency of your choice. Remember — Cryptocurrencies like bitcoin will be extremely volatile assets for the foreseeable future. It is not for the faint-hearted. Frankly, it’s terrifying. And if you already own bitcoin, but haven’t told your partner about it yet because you think she is just going to freak out — What is wrong with you? Go tell her now. And please get help. And the next time your friend Dave tells you it is virtually certain at this point that bitcoin will cross the 100,000$ mark in 2022, remember — He is bat-shit crazy! And why are you still friends with him? You can do so much better.
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