In order to deduce a conclusive and irrefutable answer, we first need to examine why the markets give any value to crypto-currencies. Let’s first look at Bitcoin, the first of it’s kind, and work our way through the methods that could help determine the value of other alt-coins.
Every entity that is traded on an exchange, regardless of whether it is a stock, bond, currency, commodity, crypto-coin, or derivative are assigned a value, a price in dollar or other government issued currencies, by the markets. The value given to Bitcoin is the notion that one day it will replace money, as we know it today, in a better way.
That leads to an interesting question - What is money? I thought I knew the answer to it all these years until I stumbled upon Mike Maloney's YouTube videos. According to Maloney, money is defined as “something" that should have all the following properties:
- Medium of Exchange
- A Unit of Account
- Portable
- Durable
- Divisible
- Fungible (Interchangeable)
- Store of Value
We all know (or knew) that government issued currencies like US Dollar, British Pound, Euro etc fits very well within his definition. Well… Not Really!! US Dollar, the most important of all, as it is the global reserve currency, has lost 98% of it’s purchasing power since the creation of Federal Reserve in 1913 (Ref: Buy Gold Save Gold - Gary Christenson). So even though it has most of the properties of money mentioned above, it is not a store of value. This is because government has the power to create money a.k.a. inflate the currency supply in the economy through various techniques known as printing, quantitative easing and debt issuance through fractional reserve banking.
That effectively means, if I saved in a government issued currency for my retirement, I would have lost some, if not a lot, of that purchasing power I enjoy today by the time I retire. On my savings I will have to earn an interest rate matching the inflation so as to retain the purchasing power. But unfortunately, due to the near zero interest rates that we have since the 2008 financial crisis, that is not possible.
Looking at the history of human civilisation, we can see that Gold/Silver naturally evolved as money because both precious metals fulfil all the properties of money including “Store of Value”. That is because, nobody can easily “print" gold/silver. One ounce of gold minted in Canada has more or less the same value as a one ounce gold minted in Australia. These metals are rare and so is Bitcoin. Nobody can inflate the supply of Bitcoin into the economy. The number of Bitcoins that can be "mined" is finite. And the process of mining is decentralised across thousands of computers across the world. Hence, no single entity, including the developers of the now famous blockchain algorithm, can create a bunch of Bitcoins from thin air and add them into their wallet.
So ideally, just like Gold/Silver, if I store my savings in Bitcoin, it should retain it’s purchasing power, shouldn’t it? Not exactly!! There are a few caveats to that argument. We need to examine the following two arguments that I often see on the commentaries.
- There is nothing backing bitcoin; the intrinsic value of bitcoin is zero.
- Bitcoin might be rare, but there is nothing that stops anyone from creating similar blockchains and thus dilute the value of Bitcoin
The Intrinsic Value of Bitcoin
Some people including investor Peter Schiff, who famously predicted the 2008 financial crisis, call Bitcoin a "digital fiat currency” (Ep. 251 Podcast). I disagree because, fiat money is a currency established as money by government regulation or law (Wikipedia). Basically what that means is, government hands you a piece of paper and says it is worth $5 and you simply put your trust on it. What you are not told is that it may not be able to buy you a meal in 10 years time as it can today. Bitcoin’s value as money is determined by the free markets.
Assuming that there are no market manipulations, I would argue that the intrinsic value of any money/currency, regardless of whether it is fiat, precious metals or crypto-coins, is determined by market confidence. What gives US Dollar any value? It’s the confidence that when you receive that pay-check, you have enough to buy groceries or to pay your rent. The confidence wouldn’t be the same if United States was a war torn country like Afghanistan, Libya or Syria. The groceries would suddenly become much more expensive if you had to pay in US Dollars. The underlying truth is that the price of groceries didn’t go up but the value of dollar has fallen because the market has lost confidence in it’s value.
What gives gold any value? To a dog it’s just a harmless piece of metal that sits in a corner. But as a human being, you know that a 500 year old gold coin that your found in a shipwreck can still buy you something today (words of Ron Paul, US Politician). If gold was available in plenty just like copper it wouldn’t have had the same value. But unlike copper, gold was rare 5000 years ago as it is now. And so is Bitcoin!!! It is rare.
Copies of Bitcoin a.k.a Alt-coins
Apart from Bitcoin, there are at least seven hundred crypto-coins out there at the time of this writing. Bitcoin cannot be replaced but is being replicated using the same/similar blockchain open-source code to create alternative coins. This should have definitely affected the value of Bitcoin but unfortunately it hasn’t.
The strength of a blockchain is the community of core developers and supporters behind it. The developers help in maintaining the integrity of the blockchain and the supporters help the general public to the blockchain through education, working at changing law/regulations, introducing supporting softwares etc.
If I announced the creation of a new blockchain in my name today, nobody is going to pay any attention. It will be worthless just like a large set of crypto-coins out there. Bitcoin so far has had that support and has eventually established as a major brand name in the crypto-currency world. The integrity of the blockchain is well maintained and this helps in maintaining the market confidence pretty high.
As an analogy of why alt-coins didn’t devalue Bitcoin, consider this - when Robert Mugabe, the president of Zimbabwe, decided to print dollars into oblivion, the price of US Dollars didn’t fall. Because Zimbabwean dollars are not same as US Dollars.
Conclusion
Now that we have introspected both the statements in favour of Bitcoin, it should definitely be worth investing in, isn’t it? Nope!!! We still need to carefully consider the following "What If?-s” before buying Bitcoins.
What if the integrity of the blockchain itself is compromised? Some of the possibilities I could think about are given below, although I might be wrong on some of them.
- A new vulnerability is found in “finding new blocks” on the blockchain that may give an unfair advantage to a single or group of miners.
- A bug is found in the blockchain code that cannot be immediately fixed by the core developers
- The blockchain itself gets hacked. It’s a piece of software and a fool-proof software is only a myth.
- A breakthrough advance in technology, say an invention of massive computing power, that makes finding the new blocks by solving the crypto-algorithms much quicker.
- If you lose your private key/password, you lose all your Bitcoins forever.
Unlike physical Gold/Silver or fiat currencies, Bitcoin allows users to transact on the Internet without a third party like a bank being involved. Your Bitcoins can always be with you. You can avoid the hassle of carrying a bag full of gold coins and a sword to protect them. Also, you don’t have to have an account with any financial institution who may then gamble with your savings in the derivatives market and go belly-up during a financial crisis.
But all investments come with some risks. If you decide to buy some cryptos, here are a few points worth keeping in mind.
- Bitcoin or any crypto-coin is worth something only if there is a strong community backing it.
- Blockchain as a technology is evolving very fast. Better alternatives in future could push out existing ones. As an example, Ethereum seems to have a lot more potential benefits than Bitcoin.
- I wouldn’t be emotionally attached to any blockchain. Once, I was emotionally attached to a wind energy company and held on to their stocks. They don’t trade anymore.
- Keep minimal, if possible no, investments in a crypto-coin blockchain run by any financial institutions. The whole point of Bitcoin is a decentralised monetary system that gives no advantage to anyone including the governments.
- Only invest the money that you could afford to lose COMPLETELY. It is very tempting to buy more Bitcoins in the recent bull run but only god can predict tomorrow’s price.
- The value of Bitcoin can go to zero but physical gold/silver that you can touch will always have some value.
I hope that helps… Good Luck Investing!!
What so many don't get is bitcoin isn't as good as many other crytos , the head start will not mean anything.