Why So Many Smart People Have Been Wrong About Bitcoin

Everyday I hear brilliant people argue that bitcoin will eventually collapse to zero because it has no intrinsic value. So, it's a "bubble" or a "Ponzi", they say. Regrettably, many of these people are Chartered Financial Analysts (CFAs) or otherwise have strong financial or economic backgrounds. Consequently, one might be forgiven for assuming that they know about which they speak.

Except they don't. In fact, there's an inverse correlation between the extent one's financial and economic training and the ability to see intrinsic the obvious value in bitcoin. The more of the former, the less of the latter. By contrast, those with strong technology backgrounds have no difficult perceiving the intrinsic value of bitcoin.

Why such disagreement?

Respectfully, financial types almost invariably approach the question of bitcoin's value from the wrong starting point. Thus they reason from the wrong premise. When the premise is wrong, the conclusion will be too.

Specifically, financial types suppose that each bitcoin is a discrete thing. They view them in isolation. Because (in bitcoin's case) that thing is not useful for anything by itself, and because (unlike a share of stock) it doesn't represent a claim to anything that is useful or profitable, they assign it zero intrinsic value.

This ignores the fact things without intrinsic value often nonetheless have great worth as part of a system or network. Oil, for example, was largely worthless until the combustion engine was invented. But combine refined oil with a combustion engine and...presto...suddenly you can make, do and drive things that you couldn't before. And that's pretty darn useful! And since supplies of oil are limited, oil has tremendous and enduring value.

Fiat currencies are similar. The pieces of paper upon which our dollars are printed have no intrinsic value. As paper, they are essentially worthless. And yet because those discrete papers are uniquely capable of liquidating certain types of debts, namely tax liabilities, they have incredible purchasing power. Combine greenbacks with our tax system that is denominated in dollars, and...presto...enduring value suddenly appears.

An engine is a mechanical device that produces work by burning oil. The Bitcoin network (as opposed to each bitcoin unit of currency) is a program (digital machine) that produces an unchangeable record of transactions (something that was impossible before Bitcoin was invented in 2008). Each of those transactions is represented by the exchange of the bitcoin "currency" between "accounts" maintained by a decentralized network of computers. While the significance of a decentralized, immutable transaction record is beyond the scope of this writing, suffice it to say for now that nobody in tech today doubts its usefulness or importance. Furthermore, because the supply of the bitcoin currency is limited, bitcoin's have value (currently about $4,000 per coin, though coins are nearly infinitely sub-divisible).

People in finance fail to grasp bitcoin's value because they simply don't understand how the technology works. Consequently, they commonly recite the fallacy that the the immutable transaction record (commonly called the "blockchain") is valuable, but the individual bitcoins transacted on it are not. This is tantamount to arguing that combustion engines are valuable but the fuel that burns in them is not. A combustion engine without fuel is not an engine. Likewise, a blockchain without without an underlying cryptocurrency is not a blockchain. Combustion engines produce work only when they burn fuel. Blockchains produce an immutable transaction record only when cryptocurrency is exchanged between users. How and why this is so is beyond the scope of this writing, but suffice it to say for now that nobody with any degree of technical competence doubts this fact. The financial types who seek to distinguish between the value of blockchain and the value of bitcoins just don't understand the technology.

Just like paying taxes can't be done without first acquiring dollars, making an entry in Bitcoin's immutable ledger can't be done without first acquiring at least some fraction of a bitcoin. Because making such an entry is useful for a variety of purposes (just like burning oil in a combustion engine is useful for a variety of purposes), and because the number of bitcoins is limited, bitcoins have value (currently about $4,000 per bitcoin).

Because bitcoin is software and its always possible to copy software, financial types also frequently fall prey to the "we'll make more" fallacy. In other words, they will frequently argue that bitcoins can't have value because the supply is not really limited. The supply of bitcoins is unlimited, they argue, because unlike gold or oil, anyone can just create a "fork", or a copy, of bitcoin. Indeed, such copies or forks have already happened on multiple occasions over the last nine years.

The "we'll make more" fallacy is again a consequence of viewing each bitcoin as a discrete thing rather than an integral component of a much larger system. Of course anyone can copy or "counterfeit" bitcoin, but unlike fiat or even gold, any such counterfeits are immediately recognizable as such. Suppose you created a $100 bill that was immediately recognizable by everyone as counterfeit. Would anyone accept it? Of course not. But...why not? Because accepting counterfeit currency is illegal? No, creating counterfeit currency is illegal but accepting it is not. People refuse to accept your $100 bill simply because they know that others, and especially the government (which demands dollars to liquidate tax debts), are unlikely to accept it. The social consensus of our monetary system determines what is (and is not) genuine and valuable.

Just as the US government will not accept anything other than US dollars in satisfaction of tax debts, nobody may transact on the bitcoin network without genuine bitcoins (of which there will ever only be 21 million). It's impossible to "con" the bitcoin network into accepting any other cryptocurrency, so counterfeits are completely useless when it comes to making an entry on Bitcoin's blockchain. Anyone wanting to transact on the Bitcoin blockchain must have genuine bitcoins, period.

Fair enough, the financial types say, but people can just make entries on other networks/blockchains instead. While this is technically true, it's practically irrelevant. For reasons that are beyond the scope of this writing, the "security" of any blockchain varies in direct proportion to the value of its underlying cryptocurrency. This is not doubted by anyone who understands the tech. Said another way, the value of the cryptocurrency over time is a proxy for the blockchain's security, and therefore its usefulness.

For important transactions, everyone wants to transact on the most secure/valuable blockchain, and that blockchain is currently Bitcoin. Furthermore, as bitcoin's value increases its security and usefulness likewise increase exponentially, creating more demand for bitcoins which in turn drives the bitcoin price higher. This virtuous cycle is known commonly in the technology world as the "network effect".

The network effect is evident in most any social-based technology. Consider Facebook, for example. Facebook, like Bitcoin, is just software. Consequently, anyone can copy it. You or I could start a Facebook competitor at a relatively trivial cost. But, what are the odds that people will choose to use our social network rather than Facebook's? In the absence of some incredible innovation that Facebook can't replicate, virtually nil. Google and Apple, both of which have nearly unlimited financial resources, have been unable to successfully launch a Facebook rival. Why? Because Facebook is simply more useful than any start-up social network ever could be. Why? Because more people are already on Facebook and the whole benefit of a social network is to be...well...social. To connect. Nothing connects today like Facebook, and the same was true three and five years ago.

Even though Bitcoin is far, far more than just a potential medium of exchange, there are few things more "social" in nature than currencies. Currencies are beneficiaries of incredible network effects resulting from social consensus (as my discussion above concerning counterfeits illustrated). As the world's first worldwide, Internet currency (among a great many other things) bitcoin has a tremendous first mover advantage (akin to that of Facebook's five years ago). In the absence of some catastrophic technological failure (which seems increasingly unlikely given that Bitcoin has run uninterrupted for nearly 9 years now) or the arrival of an innovative competitor with technologies that Bitcoin can't replicate (is Ethereum such?), Bitcoin's network effect lead seems nearly insurmountable.

In conclusion, bitcoins have use value because they are limited in supply and constitute the exclusive means of transacting business on the world's most secure blockchain network. For transactions of importance, people will generally prefer more secure blockchains over less secure ones, and Bitcoin is the most secure. As blockchain use cases increase exponentially over time, demand for bitcoins will increase exponentially. Given their strictly limited supply, this should lead to additional price increases which in turn make Bitcoin exponentially more secure and useful, driving further demand. Barring a catastrophic failure of the technology or the arrival of a competitor that is far, far better, Bitcoin's network effect advantage seems insurmountable.