In December I wrote an article, Can Bitcoin Exist Only as a Store of Value?, in response to what I perceived to be an increasing belligerence among some people in the Bitcoin community who argue that Bitcoin doesn’t need any actual use cases because “store of value” is the use case. In that article I attempted to show that there is no such thing as an asset that has no utility except as a store of value. A sentiment recently echoed by Rick Falkvinge on Twitter:
7 Jun
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It's a bit unfair to paint a whole side with such a broad brush. Store of value and preserving immutability seems like a reasonable position
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Rick Falkvinge ✔ @Falkvinge
You cannot have something be a store of value, except as a secondary function, where a primary function generates ongoing demand.
5:47 PM - Jun 7, 2017
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Sadly, the recent run up in the Bitcoin price has caused people to double down on the store of value argument, seriously jeopardizing Bitcoin’s future in my opinion.
So let’s revisit the Store of Value. Maybe I’ll do a better job explaining it this time.
Why do people invest?
Let’s review some economic basics before moving on to discuss Bitcoin. First, all other things equal people prefer the satisfaction of their wants now, in the present, to satisfaction in the future. Economists call this time preference and it’s phenomenon underlying the time value of money.
As an illustration, suppose you have $3,000 in your hand and you’re just about to walk out the door and purchase a new TV. In other words, you’re about to spend the $3,000 on a consumption good. Let’s imagine at this point I stop you and ask to borrow the $3,000 from you. Further, to isolate the phenomenon here let’s suppose this loan has zero risk of default (no such loans exists in the real world but bear with me). Would you be willing to loan me money if I promise to pay you back the $3,000 in six months? Presumably you would answer, “No”! And the reason would be because I’m asking you to postpone the satisfaction of your wants for six months with nothing in it for you. The only way I could get you to agree to this deal would be to offer you enough interest, for example I will repay you $3,300 in six months, to compensate you for your loss of present satisfaction. If you value $3,300 six months from now more than you value $3,000 today, then we have a deal, otherwise I need to offer more interest. And, of course, in the real world where risk exists, I have to offer you additional interest to compensate you for the risk that I wont repay you.
So that’s time preference. So far so good.
Liquidity Preference
There’s a second reason people may be motivated to invest and this is closely related to the “store of value” concept. To illustrate, let’s change up our thought experiment a little bit. You still have $3,000 cash on hand, but you’re trying to figure out what you want to do with it. So you make a list of things you’d like to spend it on and rank each item in order of preference. Suppose your list looks like this:
Go snowboarding in Aspen
New computer
Liquor
The problem you have is it’s now the summer and there’s no snow in Aspen! So if you want to go snowboarding in Aspen you will need to wait six months. You now need to re-evaluate your list. Do wait the six months then go to Aspen or do you just spend the $3,000 on your number two choice of a new computer? Well, that depends on your preference, but let’s suppose you chose the vacation to Aspen. Your list now looks like:
Go snowboarding in Aspen six months from now
New computer
Liquor
So now that you’ve decided on Aspen, what do you do with your $3,000 for the next six months? Well, you need to store it, but in what asset? All other things equal you’d prefer to store it in the asset that has the lowest risk possible so that you don’t lose your principle. You’d also prefer that asset to be extremely liquid. The liquidity requirement might not seem obvious at first but we’ll discuss it in a second. But first, do we know of any assets that are extremely low risk and high liquidity? Sure, money! By definition, money is the most liquid asset in the economy. It’s also the least risky asset in the economy since other financial assets such as bonds, etc are denominated in it.
Now government meddling in the money supply does pervert our analysis a little bit since it can be relied on to debase the currency, but if you need to make sense of this thought experiment in the presence of inflation you could think of some other very low risk/highly liquid asset like T-bills.
So all other things equal, you’re going to store your value in money (or T-bill, etc if it helps with the thought experiment). Now suppose I know that you have no plans to spend that $3,000 over the next six month so once again I return and ask you to borrow the $3,000. Again assume this is a risk-free loan. Would you loan me the money? Why not? After all, you’re just going to sit on it for six months. If you loan it to me, you wont miss it at all.
The answer here is that while you don’t have any plans to spend the $3,000 over the next six months, your plans could change! You could, for example, have an unexpected medical bill that you need to pay and have to nix the Aspen trip. If you lent me the money, it would not be available to you in case of emergency. All you would be holding is an extremely illiquid loan contract from me.
So again, even assuming a risk free loan, you will not be willing to part with your $3,000 unless I offer you interest. And the amount of interest I offer you needs to be enough to compensate you for your loss of liquidity. And, just like before, once we drop the assumption of a risk-free loan, the interest will need to compensate you for your risk as well.
In this example we considered saving six months for a trip to Aspen, but we could just as easily imagine someone saving for 40 years for retirement.
Back to Bitcoin
Now that we’ve got the basics out of the way, let’s return to Bitcoin. In the second example, would you be willing to store your value in Bitcoin instead of cash (or T-Bills or whatever)? Not if you’re behaving rationally! Bitcoin is both extremely high risk and very illiquid comparably. In order to incentivize you to actually store your value in Bitcoin, it needs to offer enough of a potential return on investment to compensate you for both the dramatic increase in risk as well as the loss of liquidity.
Now let’s stop an consider what the “store of value only” bitcoiners are saying. They are saying that bitcoin does not need any use cases other than “store of value”. But as we’ve just seen, Bitcoin can only be used as a store of value if it has a sufficiently positive ROI to compensate for the additional risk and loss of liquidity.
But if it’s only used as a store of value, and nothing else, where will the demand that drives this ROI come from? Well, the only place it can come from is from a perpetually increasing number of people using it as a store of value. A logical impossibility!!!
Rick Falkvinge is 100% right. “Store of value” is a secondary feature that is only made possible because the asset generates a positive ROI from its other use cases. Or as Rick put it:
It follows that a commodity cannot store value, unless ongoing supply and demand from its primary function preserves the market value.
So what is driving Bitcoin’s price up to $2,800? Speculation about Bitcoin’s future usefulness. That’s it. A small portion of present demand may come from present use cases, but my suspicion is that demand only accounts for a small percentage of Bitcoin’s current price.
So what happens if some of the loud voices in the community have their way and destroy all of Bitcoin’s use cases through skyrocketing fees?