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Why is Bitcoin Valuable?

Why is Bitcoin Valuable

The surge of cryptocurrencies has garnished an array of opinions on the matter. While some people hold a positive outlook, others see cryptocurrency as a dangerous and unstable innovation. Misconceptions largely drive the opinions of these skeptics. They fail to appreciate the true nature of cryptocurrencies, in particular Bitcoin and the positive change it will deliver.

Thomas Jeegers, a cryptocurrency expert, addressed these misconceptions through a robust analysis of the fundamentals of Bitcoin, the most popular and valuable cryptocurrency. Author of Understanding Crypto Fundamentals, he holds two master’s degrees in economics, an MBA from INSEAD and various advanced financial certifications, including Chartered Financial Analyst (CFA), Financial Risk Manager (FRM), and certifications in blockchain technology.

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Bitcoin: A Decentralized Currency

In light of Bitcoin’s incredible growth, Jeegers suggested we must take a step back and consider why Bitcoin has value in the first place. Beyond serving as an investment, Bitcoin holds great value as money. It possesses many positive features that distinguish it from fiat currencies. For instance, Bitcoin enables “peer-to-peer transaction”, in which value moves “digitally without requiring a third party”, such as a bank or government. This decentralization from third parties frees Bitcoin from various political agendas and censorship.

Bitcoin’s decentralized nature allows it to serve as an “ESG Asset” which can be employed to positively benefit the environment, society, and governance structures. For example, Jeegers cited the use of Bitcoin in Taliban-occupied Afghanistan to undermine the government’s attempts at suppressing education for young girls. In funding initiatives that support female education, activists are unable to trade using traditional currencies, as these transactions are tracked and censored. Bitcoin enables activists to finance positive programs without restrictions from the Taliban. Bitcoin removes “the hands of the government from their grasp on money”, incentivizing voluntary transactions free from central coercion.

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Strong and Stable Scarcity

Jeegers identified Bitcoin as both a network and an asset. As a network, Bitcoin is “available to all without any barriers to entry.” It is a “public payment infrastructure” that allows anyone around the world to transact value, regardless of wealth or status. As a monetary asset “without a central bank behind it”, it offers unique and absolute scarcity. Fiat currencies, such as the US Dollar and the Euro, only possess artificial scarcity, as a central power maintains their relative scarcity. This scarcity can be reduced by a central power increasing the money supply. Bitcoin, on the other hand, has a natural scarcity as no power can manipulate its supply. Like gold, it takes much time and energy from private entrepreneurs to mine. Thus, Bitcoin has a more stable and predictable supply than any fiat currency, whose supply can change at the whim of central bankers or governments.

To value Bitcoin, Jeegers put forth the Stock-to-Flow (S2F) Model, which values the scarcity of a commodity. By taking the current total amount of a commodity divided by the amount introduced each year, S2F finds the number of years it would take for the supply to double, assuming the mining rate stays constant. Gold has an S2F rate of roughly 60 years, implying a high level of scarcity. Throughout history, gold has always been the asset with the highest level of scarcity (as per the S2F), by far. Jeegers showed that the S2F ratio of Bitcoin in the last 12 months is almost identical, at “59.93”. Furthermore, the incoming flow of Bitcoin over the next year will be cut in half as a result of the recent halving of the supply, bringing the S2F ratio to “120.86” a year from now. This will make Bitcoin twice as scarce as gold. For the first time in the history of humanity, gold will no longer be the scarcest commodity in existence, making 2024 a pivotal year.

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Energy Efficient

Bitcoin is known as being “energy-intensive” as it requires much energy to mine. Although this concerns many skeptics on the first glance, the reality of Bitcoin’s energy usage should be looked at in more details. Indeed, the energy used to mine Bitcoin is exceptionally cheap energy, i.e. energy that cannot be used for any other purpose, stranded energy that would otherwise be lost. Only such cheap energy makes sense to mine Bitcoin, because a miner would be better off finding alternative use for that energy (selling it for a higher price) if it was possible. Therefore, only otherwise-unusable energy is used for Bitcoin mining. Such energy is found, for example, on renewable power plants (such as hydropower plants or windfarms) at night, when there is no demand on the electricity grid, but the plant is still producing electricity. In the night, these plants still produce electricity, meaning owners must pay to dispose of this energy. By mining Bitcoin when there is no demand on the electricity grid, these plants become profitable 24/7. The existence of Bitcoin mining therefore provides a unique opportunity to monetize stranded energy. This opportunity is a strong incentive for producing more renewable power plants and therefore improving the electricity mix used around the world. It explains why the large majority of the energy used to mine Bitcoin is coming from renewable sources (much more than for any major country in the world) and why this trend keeps improving. In conclusion, not only is Bitcoin NOT wasting energy, but Bitcoin is actually the best technology available today to incentivize the development and usage of renewable infrastructure. Any person concerned with the environment should therefore be a strong supporter of Bitcoin mining.

Do historical trends indicate the future success of Bitcoin?

Through an S-Curve, Jeegers showed that it takes all innovations, such as the cell phone or internet, roughly the same amount of time to get from 0% to 10% adoption as it does 10% to 90%. It took Bitcoin 13 years, from its inception in 2009 to 2022, to reach 10% adoption. Thus, this model suggests that Bitcoin will reach 90% adoption by the year 2035!

Why should Bitcoin grow as much as other successful innovations, such as social media or Uber? Jeegers argued that Metcalfe’s law helps explain the growth of these successful platforms, as well as the future growth of Bitcoin. This law asserts that a network, such as a telephone service, grows in value as more users join. The first-ever telephone had no value as there were no other phones to dial. As more telephones came into existence, the telephone service grew in value as there were more people to call. This same concept applies to Bitcoin. Bitcoin holds little value as a currency if few people accept it. However, the utility enjoyed by existing and new users grows exponentially as more accept it. As the Bitcoin network grows in value, so does the incentive for non-users to join.

Methods for Valuation

In addition to Jeegers’s presentation, Hubertus Hofkirchner from Bitcredit derived an estimated value of Bitcoin as a medium of exchange from Mises’s reported base-to-credit ratio during gold standard times of one to ten.

In 2021, global central bank assets totalled 44 Trillion USD. Applying Mises’s ratio to this total, Hofkirchner calculated a total base money requirement of 4.4 Trillion USD or 10% of the previous number. Assuming that Bitcoin can become the global medium of exchange at that ratio, Hofkirchner calculates that Bitcoin needs to be roughly valued at $210,000 per coin, more than three times the price at the time of writing but far below some of the more outrageous valuations in the community. This translates to a probability of 33% for Bitcoin to achieve this feat.

Hofkirchner then compared this to the value of central bank gold holdings, 17% of 17.5 Trillion USD value of gold in May 2024, which would translate to a Bitcoin price of about $150,000 per coin. This implies a 50/50 chance for Bitcoin to become the future global money. Private gold holdings could increase this number but might be just held due to doubts about the fiat system’s stability and thus be no more relevant in a Bitcoin system. All these valuations reflect the predicted likelihood of Bitcoin to become a global medium of exchange.

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What’s Next?

The positive, unique characteristics of Bitcoin have undoubtedly furthered its potential as a medium of exchange. Firms such as Coinbase and Crypto.com, which allow users to pay in cryptocurrency, are pioneering the future of Bitcoin. As government policies continue to undermine the value and stability of fiat currencies, Bitcoin will grow as a hedge against these government-created, monetary inefficiencies.

The growth of Bitcoin as money will lead to a freer and more stable market, placing the economy in the hands of producers and consumers, rather than the government. It is no surprise governments and central banking systems initially feared cryptocurrencies as they strip governments and central banks of their manipulative, self-enriching power. Faced with the inability to stop the growth of Bitcoin, governments across the world are now progressively embracing Bitcoin (e.g. it is now becoming a political topic for the upcoming US presidential election) in order to benefit from this transformational innovation.

Author

Die Meinungen, die hier auf hayek-institut.at veröffentlicht wurden, entsprechen nicht notwendigerweise jenen des Hayek Instituts.

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