Does Bitcoin have any value? The History of Money

This is an interesting one and its often questioned by everyone. Before I share my thoughts on the value of Bitcoin, or if there is even one, its good to watch this video to get a rough idea of what value means to different people.

Before gold came into existent during the barter trade, it was worth nothing and no one was interested. People want things of value that can be used, consumed, worn etc. Lets trace back to history and understand what is money and where did currency came from.

Problems with the Barter Trade Sysem

In the early civilisations, we know that barter trade is used to exchange goods and services before currency was invented. The concept of money does not exist and both parties would simply negotiate on what products to trade for in what quantities. This became a huge problem known as the “Double coincidence of wants”. It means if i want something, I have to find a specific seller who has exactly what I want and at the same time, I MUST also have something that the seller wants in return. You can imagine how ineffective, inefficient and inconvenient this is before modern transportation was invented.

The second problem is a lack of a standard unit of account to measure goods. Even if a buyer and seller eventually meets each other and both have what each parties wants, how do we define what is the fair value of a transaction or trade? There is no common yardstick to price goods and there is inefficiency in pricing goods.

The third problem is divisibility. If I want 5 kg of rice but i only have 1 cow, I can’t divide the cow into half and trade for 5 kg of rice. Either i overpay for the deal, or i don’t eat rice for the week.

The fourth problem is storage of value. Perishable item or live stocks can’t serve as a store of value over time as there is a limited lifespan for its utility. This makes it hard for those who are specialised in producing agricultural commodities to save for the long-term.

Metal Money

So how do we solve all these problems as mentioned in the barter trade system? Yes. Precious metals or metallic money made from bronze, silver and gold. These metals can be minted into copper coins, silver coins and their value can be easily derived from the weight and calibre of metal. It solves the problem of double coincidence of wants, lack of common unit of measure, divisibility and storage of value. We can now price them to say 1 cow = 10 silver coins, 1 kg of rice = 5 copper coins etc. This is the time when gold was first introduced as “money”.

Paper Money

Then the next problem came, as trade and commerce flourishes, transactions between merchants increase significantly. People started complaining that its too heavy and dangerous to carry these bulk of metals around especially during long arduous journeys. This is where paper money was introduced. It was a business originally started by the goldsmith, where you deposit gold with them and they issue you a receipt proof of ownership that can be used for making transactions. Central banks soon took power over goldsmith and they created official money notes that represents the amount of gold stored in their reserves. The value of money is pegged to the price of gold and the country can only print as much money as the value of gold stored in their vaults.

Fiat Money

But in 1971, the gold standard was removed by President Nixon and now that same paper money is not backed by any assets anymore. It becomes fiat money, a legal tender that is backed by the TRUST of government.


Inflationary impact of printing money

Ever since the gold standard is removed, US treasury is allowed to print as much fiat as they want leading to devaluation of currency. The purchasing value of a dollar has declined significantly since 1913 and US debt has ballooned tremendously to $21 trillion. Every dollar of savings in our bank is eroding in value. That’s the reason why there is a common saying among economists: “Inflation is a tax on savings”. Government is imposing a tax on our savings to pay off their debt burdens. Every dollar saved in the bank is actually devaluing if inflation rate is higher than interest rates bank paid us.

So coming back to the question of value? Does paper money have any value? As we are born in a developed country, you might think obviously yes. But the truth is value of fiat money comes from the trust and faith of government’s competency in running the economy. If you ask a Zimbabwe or Venezuela citizen if paper money have any value? They will say no immediately. Their inflation rate is above 10,000% and Zimbabwe has a hundred trillion dollar bill that is worth only US $0.40.

US Debt Clock

Now comes the next question, do you trust the economy of US? US has amassed $21 trillion dollars in debt as they are spending more than what they earn. The economic term for this is called deficit spending. To make up for the deficit difference, US has to borrow money through bonds from foreign countries, institutions and investors and pays an interest to them.

Just as in any business, if your debt leverage is too high, the interest expense can wipe out your business in times of economic downturns. The reason why US is still able to sustain this level of debt is because federal fund rates are at an all time low for a long period of time. But interest rates can’t stay for so long, eventually it has to rise when the economy is heating up. You can imagine the magnitude of interest expense for every % rise in interest rates.

And just like in any business, the way to resolve this is to think of ways to increase revenue and cut spending. In the context of government, it would be to increase taxes for future generations to pay OR to cut down on government expenditures such as healthcare and social security. However, doing either of them is unpopular among voters and the government risks losing popularity and power in the next election.

Alternatively, they can print money to pay off debt which is what happens during the 2008 economic crisis. As more money is pumped into the economy, our value of money decreases due to inflation. There is more supply of money chasing the same amount of goods and services, UNLESS the injection of money stimulate higher demand of goods and services.

The US Debt seems like a house of card that is going to collapse anytime. This reminds me of the sub-prime mortgage crisis that happened in 2008.

Sub-prime Mortgage Crisis 2008

Families applied for houses and paid mortgage payments. Investment banks in wall streets wanted a share, so they bought the mortgage payments from banks, package them into collaterized debt obligations with different risk levels and sold it off to investors. It doesn’t end there, wall street wanted MORE. But there was simply not enough home buyers due to stringent credit requirements of buying a house. So they decided okay, let’s do away with down-payment and there is no need for you to proof if you have a stable income from a job. Hence, the term “sub-prime” because these are subprime mortgages. They believed that even if these families defaulted, I still have the house which can be sold off to the market.

Since getting a house is so easy, everyone started getting nice big houses, even the low-income families. Everyone started to look rich and investors were happy with their investments as monthly cash flow from mortgage payments kept coming in. But as we know, this is just a ticking time bomb similar to US current debt levels. Slowly, families started to default and houses increased in supply. Investors received lesser cash flow from mortgage payments and housing prices plummeted. This cycle went on and wall street ends up having a huge supply of houses with no interested buyers. Investors started walking away from these collateralized debt obligations investment as mortgage payments ceased. This spiral ended up in the economic crisis as we have seen in 2008. On 3rd Jan 2009, The title of The Times wrote ‘Chancellor On Brink of Second Bailout for Banks’.


The Birth of Bitcoin – Digital Money

Interestingly, on the same date of 3rd Jan 2009, the first Bitcoin genesis block was mined. It was the very first block; the mother of bitcoin blockchain. And in that first block, a message was embedded by
Satoshi Nakamoto with the exact same title to serve as a reminder that we can’t trust the government. The initial group of people who bought bitcoins were cypherpunks and libertarians. They believed in cryptographic codes to rule society and they are mostly people who are anti-government, anti-banks.

Bitcoin just celebrated its 10th anniversary on 3rd Jan 2019 and a lot has changed since. Back to the topic of whether bitcoin has any value… it’s a highly debatable subject. I came across this blog recently and find it to be quite interesting. The author came up with different valuation methods in an attempt to quantify the value bitcoin. In a recent article, Tom Lee also came up with methods such as using active wallet addresses to value bitcoin and some use cost of bitcoin mining as an approximate. But I am not going to evaluate which valuation methods gives the most accurate fair value or what.

Perceived Value vs Practical Value

Instead, my focus here is on how a value of something is actually determined by society. Instead of immediately debunking it as a worthless asset class. we should think of it as perceived value rather than practical value.

If you think about it from a practical perspective like the red skin seller in the video above, gold actually has no value. Its just a piece of metal that’s gold color. You can’t do anything with it. Value is given by people because we perceive it to have value, merchants and banks perceive the same value and would accept it because they know gold could be sold to someone else.

Warren buffet does not invest in gold because it serves no practical value. He mentions people from mars are going to scratch their head and wonder why we value gold. But yet we know that gold has a very strong perceived value that is highly demanded anywhere in the world. The market cap of gold is standing at $8 trillion.

Similarly, bitcoin itself has no value too. All it is is just some script codes that proves ownership of an asset and it solves the problem of double spending (allowing $ to be sent through internet without central intermediary). The even more difficult part to grasp about bitcoin is that its intangible. At least gold can still be seen and touched, but bitcoin is just codes on a blockchain network and you can’t physically touch it.

I don’t know about the exact value of bitcoin just like how nobody can quantify the exact value of gold. It is all based on simple economics of supply and demand. But there is one thing i am absolutely sure and that is bitcoin’s perceived value is DEFINITELY not zero. If not it would not have even passed the $1 mark, what more $1,000 or $10,000. You might argue its a hype just like the tulip mania. But if something is worth zero, prices would crash down to $0 and not come back up. This is what happen to the Tulip craze which lasted for about 2 years. It crashed and the market never came back. But over the past 10 years, bitcoin has seen its rise and fall in cycles AND it keeps coming back up even higher after a crash.

Another reason why Bitcoin is definitely not worthless is to simply look around at what every government in every country is doing. Look at what institutions is doing. If bitcoin is worthless why would wall street banks like JP Morgan buy a huge load of BTC. Why would the parent of NYSE launch bitcoin futures? Fidelity launch custody services, Goldman Sachs launch crypto trading desk, Temasek invests in Binance, big hedge fund firms launch crypto index, BTC ETFs etc. These are billion dollar or even trillion dollar asset companies. Why would they invest in something if its worthless?

Therefore, if someone asks if bitcoin has value, the next question you should ask back is do you think gold has value? There is no right or wrong answer to this. It all boils down to individual investment philosophy. If you think in practical value terms like Warren Buffet’s style. You would have stayed away from gold, internet and bitcoin and your investment choices would be tangible, brick-and-mortar businesses. If you have a higher risk appetite, believer of future tech and exciting technologies, then crypto assets might be of value to you. All in all, the most important thing is still from the words of Warren Buffet: “Stay within your circle of competence”.

1 Comment

  1. Your analysis when comparing bitcoin to gold is very strange. Gold, unlike bitcoin cannot be copied. Bitcoin can be copied lock, stock and barrel into a new “cryptocurrency” that I could call anything I like. There is nothing that looks like gold that we have created yet. Maybe in the future there would be, and in that case I would fully expect gold prices to collapse.
    Your tulip mania point, in a similar way, is not very relevant. Tulip mania, was somewhat of a local phenomenon, and the number of human beings involved in the mania was much less than bitcoin. It should also be noted that many especially rare tulips remained prized for decades after the initial mania despite still not having any intrinsic value. Now gold has been valued for millennia and one reason is that you can make sparkly things with it that are pretty much impossible to replicate. Even today with heavy plating, fake gold jewellery is very easy to recognise. Of course you could say that is very limited value, but it is a unique thing that bitcoin just cannot have.
    As for why an exchange would create bitcoin futures, it would do so for the simple reason that there are exchange fees to be made. The same with trading bitcoin. Precisely because it has no real value, the thing trades utterly technically, and some simple algorithms can trade it very effectively and make people a lot of money. You don’t have to see value in something to trade it. Also, Investment banks have often started trading desks and then shut them if they made no money. I have seen many examples personally. So just because they are billion dollar companies doesn’t mean anything. Also, just in case you are wondering, the cost for the exchanges to set up these contracts is very small, such that they probably break even after a few months trading in reasonable volume. Therefore their barrier to entry is close to zero.
    The biggest problem however with both bitcoin and any altcoin, is the simple fact that it gives you no recourse. You don’t have any recourse to anything with a bitcoin. You don’t get transaction fees (the miners get those), so what do you get? the answer is nothing. You don’t own the network you don’t own anything. And because the code can be copied in a second, the entire thing is hyperfiat rather than anti-fiat.
    What natural asset can you buy with a bitcoin? If you have USD and the USD tanks, you can buy a house in the US, or buy the stock of a US company. What can you do with bitcoin?
    Bitcoin is unique amongst manias and scams in one sense though. And that is because it is the world’s first truly decentralised ponzi scheme. In some sense everyone who buys bitcoin with the exception of those who bought day 1 and those who bought at the highs are both Ponzi, and the victims of the scam at the same time. The extent to which you are one or the other depend on where you bought. The fact that so many people cannot see this, is not surprising, as the hype of blockchain is quite palpable, and also because human beings are very good at being deluded.

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