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Why is Bitcoin considered store of value?

Introduction 

When you think of a safe-haven asset, you probably think of precious metals like gold or silver. They are investments that individuals flock to to hedge against the chaos in traditional markets. The debate over whether Bitcoin will follow in the footsteps of these assets. In this article, we will look at some of the key arguments for and against Bitcoin as a store of value.

Why is Bitcoin considered store of value? foxcbt.com
Why is Bitcoin considered store of value?

What is a store of value?

A store of value is an asset that has the ability to store value over time. If you bought a good value store today, you can be reasonably certain that its value will not decrease in value over time. In the future, you would expect the property to be of equal (if not more) value.

When you think of such a “safe haven” asset, you probably think of gold or silver. There are several reasons why they have traditional value, which we will explain shortly.

What makes a good store of value?

To understand what makes a good store of value, let’s first explore what makes a bad store of value. If we want something to be preserved for a long time, there is a reason that it needs to be durable.

Consider food. Apples and bananas have some intrinsic value, as humans need nutrition to live. When food is scarce, these items are bound to have a high value. But that doesn’t make them a good store of value. They will be worth a lot less if you keep them in the safe for a few years as they will obviously degrade.

But what about what is intrinsically valuable but also durable? Say, dry pasta? That’s better in the long run, but there’s still no guarantee it’s worth it. Pasta is cheaply produced from readily available sources. Anyone can flood the market with more pasta, so pasta in circulation will depreciate in value when supply exceeds demand. So, for something to maintain value, it must also be scarce.

Some consider fiat currencies (dollars, euros, yen) to be a good way to store wealth because they retain value over the long term. But they are actually less valuable stores because purchasing power decreases dramatically as more units are created (like pasta). You can withdraw your life savings and store them under a mattress for twenty years, but they won’t have the same purchasing power when you finally decide to spend them.

In 2000, $100,000 could buy you a lot more than it does today. The main cause is inflation, i.e. an increase in the prices of services and goods. In many cases, inflation is caused by an oversupply of fiat currency due to the printing of more money by the government.

To illustrate, let’s say that you hold 25% of the total supply of $100 billion – that’s $25 billion. Time passed, and the government decided to print another $800 billion to stimulate the economy. Your slice of cake has suddenly dropped to ~3%. There’s more money in circulation, so there’s a reason your stock doesn’t hold as much purchasing power as it used to.

Like our pasta mentioned earlier, producing dollars is not expensive. The above can happen in a few days. With a good store of value, flooding the market with new units will be a challenge. In other words, your pie will thin out very slowly, if at all.

For example, gold, we know that its supply is limited. We also know that it is very difficult to exploit. So even if the demand for gold suddenly spikes, burning a printer to make more won’t be a problem. It must be mined from the ground, as always. Although demand is growing, supply cannot physically increase to cater for that demand.

The case of Bitcoin as a store of value

From the early days of Bitcoin, proponents have argued that the cryptocurrency is more like “digital gold” than simple digital money. In recent years, this story has been echoed by many Bitcoin enthusiasts.

The Value Argument for Bitcoin argues that it is one of the best assets known to man. Proponents of the thesis believe that Bitcoin is the best way to store wealth so that it does not depreciate over time.

As we know, Bitcoin is subject to intense volatility. It seems unintuitive that an asset that can lose 20% of its value in a day is considered by many to be a store of value. But even with factoring down many times, it is still the best performing asset class by far.

So why is Bitcoin being hailed as a store of value?

Scarcity

Perhaps one of the most compelling arguments for the store of value argument is that Bitcoin has a finite supply. As you know, there can’t be more than 21 million bitcoins. The protocol ensures this with a hard-coded rule.

The only way that new coins can be generated is through mining, which is similar to how gold is mined. But instead of drilling into the Earth, Bitcoin miners must solve a cryptographic puzzle using computing power. Doing so will earn them new coins.

Over time, rewards dwindle due to events known as halvings. If you guessed that this halves the reward, you are absolutely right. In the early days of Bitcoin, the system rewarded 50 BTC to any miner who produced a valid block. During the first halving, this was reduced to 25 BTC. The next halving will cut it in half to 12.5 BTC, and the next will reduce the miners’ reward to 6.25 bitcoins per block. This process will continue for more than 100 years until the last part of the coin is put into circulation.

Let’s model this similarly to our fiat currency example earlier. Let’s say you bought 25% of the Bitcoin supply (i.e. 5,250,000 coins) years ago. Once you acquire these coins, you know that your percentage will stay the same as there is no entity capable of adding more coins to the system. There’s no government here – well, not in the traditional sense (more on this shortly). So if you bought (and HODLed ) 25% of the max supply in 2010, you still own 25% of that supply today.

Decentralization

It’s open source software, you might be thinking. I can copy the code and make my own version with 100 million extra coins.

You can really do that. Let’s say you clone software, make changes, and run a node. Everything looks good. There’s only one problem: there’s no other button to connect to. You see, as soon as you change the parameters of the software, members on the Bitcoin network start ignoring you. You have forked and the program you are running is no longer as globally accepted as Bitcoin.

What you just did is functionally equivalent to taking a picture of the Mona Lisa and asserting that there are now two Mona Lisas. You can convince yourself that’s the case, but luckily convince anyone else.

We said that there is a kind of government in Bitcoin. That government is made up of every user running the software. The only way that the protocol can be changed is if the majority of users agree on the changes.

Convincing the majority to add more money will not be an easy task – after all, you are asking them to reduce the amount of money they hold. As it is today, even seemingly unimportant features take years to reach consensus across the network.

As the size gets bigger, it will only become harder to push changes. Therefore, holders can be reasonably confident that the supply will not be inflated. While the software is man-made, the decentralization of the network means that Bitcoin acts more like a natural resource than code that can be changed arbitrarily.

Attributes of good money

Those who believe in the value argument also point to the characteristics of Bitcoin that make it a lot of money. Not only is it a scarce digital resource, but it shares characteristics that have been used in currency for centuries.

Since the advent of gold, it has been used as money across civilizations. There are several explanations for this. We talked about durability and scarcity. These can create good fortune, but are not necessarily good forms of money. So you want replaceability, portability, and divisibility.

Fungibility

Fungibility means indistinguishable units. With gold, you can take any two ounces, and they will be of equal value. The same is true for things like stocks and cash. It doesn’t matter what particular unit you’re holding – it will have the same value as any other unit of the same type.

Bitcoin’s fungibility is a complicated topic. It doesn’t really matter which coin you are holding. In most cases, 1 BTC = 1 BTC. Where it gets complicated is when considering that each unit can be linked back to previous transactions. There are cases of businesses blacklisting funds that they believe have engaged in criminal activities, even if the owners subsequently received them.

Should it be important? It’s hard to understand why. When you are paying for something with a dollar bill, neither you nor the seller know where it has been spent in the previous three transactions. There is no concept of transaction history – new invoices are no more valuable than used ones.

However, in the worst case, it is possible that older bitcoins (with more history) are sold for less than newer bitcoins. Depending on who you ask, this scenario could be the biggest threat to Bitcoin or nothing to worry about. For now, though, Bitcoin is still functionally interchangeable. There have only been a few isolated incidents of coins being frozen due to dubious history.

Portability

Portability indicates the ease of transporting an asset. $10,000 in a $100 bill? Easy enough to move around. $10,000 worth of oil? Not much.

Good coins need to have a small form factor. It needs to be easy to implement so that individuals can pay each other for goods and services.

Gold has a very good tradition in this area. At the time of this writing, a standard gold coin is worth almost $1,500. It is unlikely that you will buy a full amount of gold, so smaller denominations will take up less space.

Bitcoin really outperforms precious metals when it comes to transportability. It has no physical footprint. You can amass trillions of dollars worth of assets on a piece of hardware that fits in the palm of your hand.

Moving a billion dollars worth of gold (currently over 20 tons) requires tremendous effort and expense. Even with cash, you’ll need to carry a few pallets of $100 bills. Bitcoin makes it possible to send the same amount anywhere in the world for less than a dollar.

Divisibility

Another important quality of money is divisibility – that is, the ability to break it down into smaller units. With gold, you can take a one-ounce coin and cut it down the middle to make two half-ounce units. You may lose your insurance premium if you destroy the beautiful drawing of an eagle or a buffalo on it, but the gold value remains the same. You can cut your half-ounce unit multiple times to create a smaller denomination.

Divisibility is another area of ​​Bitcoin. There are only twenty-one million coins, but each coin is made up of one hundred million smaller units (satoshi). This gives users a lot of control over their transactions, as they can specify an amount to deposit up to eight decimal places. Bitcoin’s divisibility also makes it easier for small investors to buy small pieces of BTC.

Store of Value, Medium of Exchange and Units of Account

Sentiment is divided on Bitcoin’s current role. Many people believe that Bitcoin is simply a currency – a tool for moving money from point A to point B. We will delve into this in the next section, but this view is in contrast to other What many advocates of the store of value protect.

SoV proponents argue that before Bitcoin becomes the ultimate currency, there are stages. It started as a collection (arguably where we are now): it has proven itself to be functional and secure but has only recently been adopted by a small market. Its core audience mainly consists of hobbyists and speculators.

Only with better education, the infrastructure for organizations, and more confidence in our ability to maintain value can we move on to the next stage: the store of value. Some believe it has reached this point.

At this time, Bitcoin is not widely spent due to Gresham law which states that bad money creates good money. This means that, when there are two currencies, individuals will tend to spend the lower one and hoard the higher one. Bitcoin users prefer to spend with fiat currencies because they have little confidence in their long-term survival. They hold (or HODL) their bitcoins, because they believe they will hold value.

If the Bitcoin network continues to grow, more users will adopt it, liquidity will increase, and prices will become more stable. Because the stability is stronger, there is not much incentive to hold it in the hope of achieving higher returns in the future. So we can expect it to be used more in daily commerce and payments, as a powerful medium of exchange.

Increased usage further stabilized prices. In the final stage, Bitcoin will become a unit of account – it will be used to value other assets. Just as you might value a gallon of oil at $4, a world where Bitcoin reigns as money would help you measure its value in bitcoins.

If these three monetary milestones are reached, advocates see a future where Bitcoin has become a new standard replacing the currencies used today.

The Case Against Bitcoin as a Store of Value

The arguments presented in the previous section sound perfectly reasonable to some and like crazy arguments to others. There is some criticism of the idea of ​​Bitcoin being “digital gold,” coming from both Bitcoiners and crypto skeptics.

Bitcoin as Digital Cash

Many are quick to point to the Bitcoin white paper when disagreements arise on the subject. To them, it was clear that Satoshi intended to use Bitcoin in the first place. In fact, it’s in the very title of the article: Bitcoin: A Peer-to-Peer Electronic Cash System.

The argument is that Bitcoin can only have value if users spend their money. By hoarding them, you’re not supporting the adoption – you’re harming it. If Bitcoin is not appreciated as a digital currency, its core proposition is not utility but speculation.

In 2017, these ideological differences led to a significant fork. The minority of Bitcoiners want a system with larger blocks, which means cheaper transaction fees. Due to the increasing usage of the native network, the cost of a transaction can increase significantly and cause many users to forgo lower value transactions. If there’s an average fee of $10, there’s very little you’ll spend on a $3 purchase.

The fork network is now known as Bitcoin Cash. The original network rolled out its own upgrade around that time, called SegWit. Nominally, SegWit has increased the capacity of blocks, but that is not its main goal. It also lays the groundwork for the Lightning Network, which seeks to facilitate low-fee transactions by pushing them off-chain.

However, in reality, the Lightning Network is still far from perfect. Regular Bitcoin transactions are significantly easier to understand, while the management of Lightning Network channels and capacity comes with a steep learning curve. It remains to be seen whether it can be streamlined, or whether the design of the solution is fundamentally too complex to be abstracted away.

Due to the increasing demand for block space, on-chain transactions are not as cheap as they used to be in busy times. Thus, one could make the argument that not increasing the block size would damage Bitcoin’s usability as a currency.

No intrinsic value

For many people, the comparison between gold and Bitcoin is absurd. Basically, the history of gold is the history of civilization. Precious metals have been an important part of society for thousands of years. Admittedly it has lost some of its dominance since the gold standard was wiped out but nonetheless remains the quintessential safe-haven asset.

Indeed, it seems like a stretch to compare the network effects of the king of assets with an eleven-year-old protocol. Gold has been revered as a status symbol and an industrial metal for millennia.

In contrast, Bitcoin is not used outside of its network. You can’t use it as a conductor in electronics, nor can you make it into a big shiny chain when you decide to start a hip-hop career. It can simulate gold (mining, finite supply, etc.), but that doesn’t change the fact that it is a digital asset.

To some extent, all money is a common belief – the dollar has value only because the government says so and society accepts it. Gold has value only because everyone agrees it has. Bitcoin is no different, but what gives it value is still a small group in the grand scheme of things. You may have had many conversations in your personal life where you have to explain what it is because most people don’t know about it.

Volatility, correlation and a store of value

Those who got into Bitcoin early have certainly enjoyed their wealth growing to a large extent. For them, it’s really worth being stored – and then a number. But those who bought their first coins at all-time highs had no such experience. Many companies have made big losses when they sell any time later.

Bitcoin is extremely volatile and its market unpredictable. Metals such as gold and silver have negligible fluctuations in comparison. You can make the case that it’s too soon and the price will eventually stabilize. But that in itself may indicate that Bitcoin is not currently a store of value.

There is also Bitcoin’s relationship with traditional markets to consider. Since the birth of Bitcoin, they have been on a steady uptrend. Cryptocurrencies have not really been tested as a safe-haven asset if all other asset classes also perform well. Bitcoin enthusiasts may consider it “unrelated” to other assets, but there is no way to know that until other assets are affected while Bitcoin remains stable.

Tulip Mania and Beanie Babies

It would not be an adequate criticism of Bitcoin’s store of value assets if we did not draw comparisons with Tulip Mania and Beanie Babies. These are waning spells at the best of times, but they serve to illustrate the dangers of bursting bubbles.

In both cases, investors rush to buy items they consider rare in the hope of reselling them for a profit. On their own, those items have no such value – they are relatively easy to manufacture. The bubble appeared when investors realized they had massively overvalued their investments, and the tulip and Beanie baby market subsequently collapsed.

Again, these are attenuated types. Bitcoin’s value comes from users’ trust in it, but unlike tulips, cannot grow more to meet demand. That said, there is no guarantee that investors won’t see Bitcoin overvalued in the future, causing its own bubble to burst.

Closing thoughts

Bitcoin certainly guarantees most of the features of a store of value like gold. The number of units is finite, the network is decentralized enough to provide security to the owner, and it can be used to hold and transfer value.

Ultimately, it still has to prove its worth as a safe-haven asset – it’s too early to say for sure. Things could go both ways – the world could switch to Bitcoin in times of economic uncertainty, or it could continue to be used by a minority.

Time will answer.

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