Why Bitcoin´s Own Success Will Kill It

Not a day passes without the mentioning of Bitcoin or BTC. At work, in the subway, at grandmas 80s birthday or the local insurance guy; just about everybody talks BTC these days. Discussions, however, almost always circle around the fact how BTC has risen over 1000% within a year and all the money one has/could have made by buying BTC. Rarely I observe critical questioning and thinking of where the real value of this freshman financial asset lies. Should these discussions ever come up the bull case centres around these two arguments; “BTC is the better gold” and “BTC is a currency everyone is going to use”. Let me briefly talk about that.

Will BTC be a world currency?
Picture the financial system relying on BTC. It would look something like this: While limiting the amount of coins issued to 21mm is one of BTCs biggest selling arguments it is at the same time its achilles heel. Not being able to increase the number of coins or currency in circulation would mean ,given the wide acceptance of BTC, that more and more coins are demanded. Basic economics says if demand exceeds supply the price of any asset will increase to a point where a new, higher, equilibrium is reached. While this seems rather bullish for the value of BTC it might very well be the opposite. In expectation of an ever increasing coin value companies and individuals would curtail spending and investment to a minimum, completely choking the economy. The following severe depressions would likely send coin values decreasing because of falling demand for the cryptocurrency. Once inflation abates the economic activity would increase again and demand for the currency would channel into a new round of deflation. Cycles of boom and bust with unseen severity would be the new normal.

It is not a coincidence that the first creation of a central bank in the US was an answer to cater to the seasonal increase in demand for money caused by the harvesting season. Only with a dynamic money supply the yearly cycles could be smoothed. In a BTC world central banks would be greatly missed.

Further, businesses and individuals carry debt. Be it the mechanic who purchases a new man-lift to expand his car shop or the family that wants to move into their own house. Usually such investments are funded with the help of credit without which e.g. the father could only purchase the family-house in his 60s, long after his children have moved out. Let´s think of buying a car via a BTC loan. You go to your local bank ask for a one year loan of 1 BTC or around USD 16.000. Neglecting interest rates odds are that BTC has risen another 500% in one year, which would require you to return USD 28.000 to your local BTC bank. You are short BTC, a highly volatile asset that if you believe in its success will increase in value rapidly. For a company buying a machine with same 1 year BTC loan this would require the company to earn a return of 500% on the investment only to payback the funds at expiration. Imagine now taking out a 30 year loan to buy a house. Not only you couldn´t repay the mortgage, but also your BTC bank would know that you couldn´t and would choose not to lend to you in the first place.

Summing it up as a currency replacing the Dollar BTC is outright useless. Its success will kill it. There go the price targets of >1.000.000 USD.

Bitcoin as a payment system
Thinking of BTC as a payment system is an enticing idea. BTC can theoretically be transferred to another individual (without an intermediary aka bank) at light speed and zero cost. Unfortunately, the underlying BTC blockchain, cannot handle a lot of transactions at the same time. To cope with the multiple transfers of BTC in parallel it has in place a convenient system to prioritise transactions. When a fee is is paid to the BTC miner, who also records the transfer of BTC, the paying transaction is prioritised over the non-paying. Hence what happens is that the transfer of BTC becomes expensive and slow, creating an inferior user experience when compared to the today´s wire transfer with banks.

But what about BTC being the new gold?
Only 21mm BTC can be mined with exponentially increasing difficulty. Isn´t this enough to justify a value per BTC that at least matches the market cap of all mined gold? By the way as of today this would equate to a value of around USD 387.000 per BTC. I am arguing no. Scarcity alone doesn´t equal to a high value. By no means I am a defender of gold, which is a piece of metal that produces nothing else than storage costs. To profit from it we require someone else to pay a higher price. However, unlike BTC, gold has proven to be the ultimate currency during crises accepted by people all over the world. Reasons for it are its beautiful appeal and historical association as means of payment (after all Bitcoin is usually presented as a gold coin) which is embedded in our thinking. Therefore, a likely buyer for gold is always around the corner. BTC as initially argued will stumble over its own success and will keep itself from reaching widspread acceptance. Thus odds are that you will be left without a buyer for BTC when you need it the most.

Since BTC can neither be efficiently used as currency, payment system or store of value it should trade closer to its lower bound. However, Cryptocurrencies addressing the mentioned shortcomings, might be decent competitors to our current monies and might prove successful.

 

 

 

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