Satoshi Nakamoto created Bitcoin in response to the 2008 financial crisis, when governments inflated the supply of fiat money on a massive scale to save the banking system. He feared this would result in currency devaluation, so he designed Bitcoin to be a form of money that could never be inflated, and thereby hoped Bitcoin could become a store of value as enduring as gold.
The problem is Nakamoto was more focused on preventing inflation in the style of central banks than on what ultimately matters for a store of value – preventing devaluation in general, and he was not able to replicate the properties in gold to do that.
This is why Bitcoin is failing, whether HODLers (Bitcoin holders) recognize it yet or not. To understand why Bitcoin could never be the “digital gold” envisioned, it’s important to discern the properties in gold he was unable to replicate.
GOLD VS. CRYPTOS
Gold has intrinsic value that creates natural demand — non-arbitrary beauty (see Trendpost below). Intrinsic value is critical for a store of value because it means that the price of gold always has a floor. Gold will always be preferable in jewelry to metals that rust and that preference results in demand, even amid market turmoil at sufficiently low prices. And this means that drops in the value of gold will always be mitigated, rather than fear-inspiring enough for people to lose confidence in its ability to retain value. A floor ensures no rush for the exits is ever permanent.
Second, gold has a truly limited supply. It cannot be recreated under a different name, and it’s historically only been mined at a rate matching population growth, resulting in purchasing power stability. Its only competitors are three other precious metals, which each share similar supply constraints.
To understand why Bitcoin’s demand and supply properties differ from gold’s, it’s important to know what Bitcoin is. Bitcoin is the name for 21 million digital tallies on a distributed ledger, called a Blockchain. A ledger is a record book intended to keep track of items, like an inventory book at a jewelry store. Each tally in the book refers to a piece of jewelry, and the tallies themselves can be drawn into the book.
THE TECHNOLOGY IS NOT VALUE
The jewelry is what matters—the tallies only refer to them. If the storekeeper drew an absolutely limited number of tallies, cut them each out of the ledger book, distributed them to people, and said they were to be money but no jewelry was attached, it would be clear how absurd this seems.
That technology evolves to allow them to be sent digitally through an intermediary confers no additional intrinsic value, nor if technology evolved once more to allow peer-to-peer transactions on a distributed ledger.
The mechanism to transfer ownership may have evolved but what’s sent remains the same—tallies that refer to nothing, just as fiat paper was originally receipts for gold that then referred to nothing. Bitcoins are such tallies, a digital equivalent of fiat paper.
Demand for Bitcoin is therefore unlike demand for gold. Bitcoin has no intrinsic value—no one wants it for itself. The value of Bitcoin is entirely socially-predicated, so there is no price floor, as no one will buy if he thinks no one else will.
Thus, any form of devaluation has the potential to create a rush for the exits as fear takes over that a decline will not bottom-out, a process that can collapse price to the point that any confidence it can be counted on to store value is lost completely.
The supply properties of Bitcoin are also very different. The supply of digital tallies with the Bitcoin name is fixed at 21 million. But the supply of Blockchains is unlimited, so the supply of digital tallies is, too. While gold cannot be recreated under a different name, Bitcoin can, which allows for the creation of direct competitors, a condition that gold does not have and that governments historically protected their fiat money from by outlawing them.
Thus, while Nakamoto protected Bitcoin against government-based devaluation, he did not protect Bitcoin against private free market competitors in the way governments protect their own fiat paper. And a money with no price floor, devalued through competition, is as much at risk of collapse as one devalued through inflation, as the prospect of any decline feared irrecoverable spurs people to sell in anticipation that others will.
If something with little to no intrinsic value is created in a free market, is marketed as money, and is priced beyond the value of producing it, the excess profit margin attracts competitors that drive it down.
Because the profit margin from creating Bitcoin is extravagant, incentives outside of HODLing have been twofold: creating competitors – alternative distributed ledgers with their own tallies (altcoins), and investing in them. By providing potentially higher risk-adjusted returns, competitors incentivize divestment and redirection of capital out of and away from Bitcoin, decreasing its price.
The result is devaluation. And while the process is not inflation, it’s inflationary in effect because it produces the same result that actual inflation would.
Competitive devaluation is already occurring but the effects have been masked because money has moved into and out of the sector largely together, hiding that much of the capital invested in altcoins would otherwise be in Bitcoin. That Bitcoin now only has 50 percent of cryptocurrency market share attests to this, along with the sheer number of altcoins, 2,000-plus, that exist.
Ultimately, the profit motive driving people to HODL is also driving them to divest out of Bitcoin and into competitors, for no network is secure if loyalty is predicated on the promise of riches.
The greater the price of Bitcoin, the greater its profit margin, attracting more competitors that are essentially the same thing, like generic drugs flooding the market after the name-brand version loses its patent.
The higher Bitcoin gets, the lower its potential return, and the greater that of altcoins, fueling further divestment into the latter until the point at which it becomes clear what’s happening. Bitcoin cannot continue to rise without moving the risk-adjusted return differential further in favor of alternatives. TJ
Bitcoin is stuck in quicksand, and the quicksand will win. Because while a name-brand drug can retain value in a market flooded with generics, Bitcoin is not intended to be a drug or a stock, but a store of value. And no store of value has any value if it can lose 5 percent or more per year of market share to competitors, because eventually, new money stops coming in to mask this dynamic.
The recognition that it cannot store value amid perpetual competitive debasement will eventually induce people to rush out in the way they have in every fiat money collapse, a process that is now well under way.
Nakamoto created Bitcoin to be free market money, without protection from free market com- petition. No store of value can survive unless it withstands devaluation of any kind, government- based or otherwise, and only precious metals like gold have done this.
While it’s less convenient than Bitcoin, convenience cannot replace value, no more than the relative convenience of paper fiat to gold did before.
As the market takes the price of Bitcoin and others masquerading as money down to their intrinsic worth, this reality should become clearer to even ardent HODLers.