Bitcoin is a service commodity whose intrinsic value depends on its ability to create a trusted network based on mathematics. It will eventually function as a store of value and as a means of payment, even though that might not be the case today.
The UK’s financial services watchdog, the Financial Conduct Authority (FCA), has issued a warning against Bitcoin, saying it has “no intrinsic value.” The FCA is not the first to bring this up, it’s a popular argument made by crypto skeptics across the board.
Scarcity and utility determine the economic value of goods
In economics, something has value if it checks the boxes scarcity and utility. Scarcity just means there is a finite supply. In the case of Bitcoin, there is a set cap of 21 million bitcoins – Checkbox ticked.
Bitcoin’s set cap makes it more reliable than other scarce assets. Gold supply, for example, is not fixed at all. There are potentially millions of tones more gold underground than has been extracted to date. Today, we are mining gold at four times the rate that we did 100 years ago. There is the risk that a gold rush could drastically increase supply and cut down prices – that can’t happen with Bitcoin.
The utility value of a currency depends on its function as a medium of exchange and store of value
Bitcoin-skeptics argue Bitcoin neither works as a medium of exchange, because of its high volatility, nor as a store of value, because it doesn’t have any real-world use and is not stable against future purchasing power. This argument is partially correct, at least for now.
Today, Bitcoin is practically useless as means of exchange. Price volatility is too high, making it an unreliable currency. But money is an evolutionary process. It doesn’t suddenly come into existence as a functioning store of value, medium of exchange, and unit of account simultaneously. Instead, those functions are developed in stages.
At this point, the inherent deflationary nature of Bitcoin leads to hoarding and speculation, driving price volatility. But once Bitcoin has finished accumulating value, when it has become a large and liquid asset, it will be much more stable than it is today. This trend is already visible. Since the inception of the genesis block, Bitcoin volatility has been decreasing.
Some argue fiat currencies are a better medium of exchange because they are based on the power and authority of political and economic institutions – like governments and central banks – and therefore more stable. That might be correct today, but it could change in the future.
Politically motivated institutions are not necessarily more trustworthy than distributed and decentralized networks. The latter might be more abstract and no single entity can be held accountable, but it is not necessarily less reliable. Readers from Greece will likely agree with this statement. It’s also somewhat ironical that the British FCA warns of currencies with no intrinsic value at a time when the Pound Sterling is trending towards an all-time low.
The stability of fiat currencies relies on trust in political institutions, and this trust has been declining over recent years, especially among the younger and more tech-savvy generation. Participation in democratic elections, for example, is significantly lower among younger age groups. As the younger generation takes over, the trust gap between fiat and cryptocurrencies will diminish further. At one point, people might prefer trusting a decentralized peer-to-peer network instead of a centralized political institution.
Bitcoin provides access to a trusted network based on mathematics
Gold can be turned into jewelry or used in medical devices; real estate can be used as accommodation, and US dollars are a globally accepted means of payment. The fact that these assets have an allegedly reliable real-world use case gives them their function as a store of value. Asset owners can save, retrieve and exchange them at a later time.
However, much of traditional assets’ utility is more perceived utility than actual real-world utility. According to the World Gold Council, industries use only 15 percent of all gold available. The majority goes toward making jewelry, gold bars, and coins — gold has value mainly because people perceive it as valuable, not because of its real-world use case.
Unlike a traditional commodity that can be turned into something that provides utility, Bitcoin’s intrinsic value is in the way how mathematics is used to provide a trusted network. Bitcoin does this in a unique way, that no other commodity has done before. Saying Bitcoin does not have any intrinsic value because it is not a raw material would be like saying a human brain has no value because it consists mostly of carbon and water.
Bitcoin is a new type of commodity, a “service commodity,” that gives direct access to a service, not a raw material. It offers access to an automated ledger service that was previously only available as a service offered by banks. And banks are highly profitable, so there must be some value in the service they provide.