This article was originally published in 2017 on Philosophy Of Bitcoin.
What good are bitcoins if you can’t show them off? I can’t wear a bitcoin chain around my neck or a bitcoin watch on my wrist. Nor can I hang a bitcoin on the wall. And because bitcoins are highly divisible and fungible they make for poor collectibles. I can’t possibly complete my bitcoin collection or impress people with the story of a specific bitcoin’s particular place in history or what makes it different from the other bitcoins out there.
These limitations are one reason why bitcoin is a peculiar store of value.
We typically think gold is expensive because people value it as jewelry, that original works of art are valued for their beauty and their place in history or the oeuvre of an artist. People collect old coins because they find them beautiful or fascinating and because they are driven by the human instinct to collect things that are rare and meaningful in some way.
It seems to be the aesthetic, historical, cultural features of these kinds of objects, together with their rarity and the human drive to collect that give them their value. But bitcoin doesn’t seem to have such qualities. Nor are bitcoins backed by governments or central banks who can create a demand for them the way they do with regular money. Bitcoins also don’t provide returns in the way stocks do.
So if not through these properties, institutions or returns, how could bitcoins have become so valuable? Is bitcoin just in a big bubble that will inevitably pop?
In this article I first argue — much in agreement with Moldbug’s Bubble Theory of Money — that while it is true that bitcoin is in a big speculative bubble, it is a sustainable one.
And secondly, contrary to how we usually think about them, most of the value of the objects I mentioned above — gold, fine wines, works of art etc — is also bubbly.
Bitcoin is special only in that it is an extreme case of the same bubble mechanism. While much of the price of original works of art, fine wines and gold can be explained by this bubble-blowing mechanism these objects do also have some consumption value. Bitcoin’s value on the other hand is nothing but bubble. The same principle holds for other cryptocurrencies such as Ethereum.
One common answer to the question of what gives bitcoin its value appeals to bitcoin’s qualities as a medium of exchange. Bitcoin allows people to transfer value — value embodied by the bitcoin itself — from one person or non-person to anyone or anything else in a fast, cheap, secure way without the involvement of any third parties. And while these days bitcoin transactions are not as cheap or fast as they once were, there seems to be something to this answer.
On the other hand, it is not as though bitcoin is currently actually used very much as a medium of exchange. And although it is not very clear how to relate the one to the other it seems that this currently very limited use as a medium of exchange hardly justifies its current high value.
Things change when we consider the promise of its future use as a medium of exchange. If the technical problems involved in scaling up bitcoin can be solved so that more, faster and cheaper but still secure bitcoin transfers are made possible bitcoin’s value could become much higher still. This possibility of bigger future value could justify its current high value.
While there is definitely something to this, it does not actually show that it is bitcoin’s medium of exchange function that is the source of its value. The problem is that in order to be used as a medium of exchange at all bitcoin already needs to have value. Something valueless cannot be used as a medium of exchange. It is only through speculation about its future value that bitcoin was able to make that leap from valueless to valuable and come to be used as a medium of exchange in the first place.
Alternatively, if bitcoin itself cannot accommodate a much higher number of transactions, it may be possible to build a fast, cheap and secure payment system (or combinations of such systems) on top of bitcoin and its blockchain. Transactions in that payment system would not involve moving bitcoins around. Instead bitcoin would be used in the settlement system in the background.
In that case, though, it would not really be bitcoins that are used as a medium of exchange in regular, everyday transactions. Instead, the technology and institutions built on top would form the payment system while bitcoins themselves would not actually be moved around very much.
Yet in this scenario in which they are not highly demanded as a medium of exchange, bitcoin would still be very valuable. Or rather, it would need to be very valuable for its blockchain and hence the payment systems built on top to be secure at all, and for bitcoin to be able to be used in the settlement system below.
All our attempts then to explain the value of bitcoin fail. Bitcoin doesn’t have the properties that seem to explain how traditional stores of value such as gold, original works of art, fine wine or collectibles become valuable, and its uses as a medium of exchange or as the settlement layer behind a payment system depend on its having a value in the first place.
The reason we can’t explain the origins of bitcoin’s value, I suggest, is that when we think of the store of value function of objects such as gold, original art, fine wine, collectibles and bitcoin we get the causation backward.
Sure, gold is shiny and durable, works of art are beautiful and meaningful, old coins connect us to our human history and so on. But ultimately, gold is not valuable because we use it in jewelry; we use gold as jewelry because it’s valuable. Gold becomes interesting as jewelry because it allows us to show off to others or, as Drake explains, even to ourselves.
And the fundamental reason bitcoin is valuable right now is that people think bitcoin will be even more valuable in the future.
The reason we typically get this causation backward is that in the case of traditional stores of value like gold, works of art and fine wines this causal mechanism is typically embedded in and obscured and complicated by social, cultural, aesthetic, epistemic norms, values and practices that accompany, explain and so seemingly justify an asset’s value.
For example, it is exceedingly unlikely that a painting made by your 5 year old daughter will ever be valued at $100 million. It lacks the aesthetic and historical properties that will move or inspire people. Art experts won’t write catalogs, articles or books about it, museums won’t include it in exhibitions, and art historians won’t try to situate the work in its (art) historical context.
And while a good photocopy of a Rembrandt may have many of the same aesthetic qualities as the original it will never sell for more than a couple of hundred dollars on the market because it lacks the historical properties and the rarity of the original, making it a hopeless candidate to satisfy our drive to collect. Similarly, a supermarket wine could taste just as good as a 1947 Cheval Blanc but it lacks the latter’s history and rarity, and the lyrical descriptions with which experts try to express its supposed intrinsic qualities.
Speculation Matters More
But although these qualities may have been important for these types of objects to become valuable in the first place, it is through the speculation mechanism that they actually gain the largest part of their value in the market: People value them because within this context of cultural, social, aesthetic norms, values and practices they expect other people to value them in the future. This way, these objects store (and typically grow) value, and people can sell them or show them off to capitalize on that value. It is this speculation mechanism that causes the price of these objects to be much higher than it would be for their consumption value alone.
To illustrate this principle, imagine what the effect on the market price of original works of art would be if it became law that after the death of its next owner the piece had to be destroyed. In that case the current owner and the next owner would still get the direct use value of the piece (save for the comfort of the knowledge they’d be leaving something for their descendants) but it would cease to function as a store of value. This would be a dramatic disruption in the valuation mechanism described above and it would result in a drastic drop in price.
Or imagine you would not be allowed to show pieces of art or jewelry to other people or even let them know you possess them. You could still freely buy works of art and jewelry in anonymized markets and enjoy them in the privacy of your own home but you could no longer show them off. This too would dramatically disrupt the valuation mechanism described above and cause a huge drop in price.
So although the rich cultural contexts in which stores of value such as gold, works of art, fine wine and so on are embedded were important conditions for such types of objects to become valuable, the primary driver of the store of value function of these objects is the speculative one. They are as valuable as they are now because people expect them to be valuable in the future. But this speculative mechanism gets obscured and made more complicated by these elaborate social, cultural, aesthetic, epistemic norms, values and practices that seem to provide an explanation and justification for the object’s value.
True, experts wax lyrical about the superior qualities of a 1947 Cheval Blanc, or the superior sound coming from a Stradivarius but what may really be going on here is projection and rationalization.
People project the high market value of these objects onto the objects themselves, in the form of alleged superior aesthetic qualities. They do so because we need good stories, good reasons to explain, or rather, to rationalize the huge value of these objects that in reality is due in large part to speculation.
This is also why the results of research and blind tests in which experts fail to pick out the supposedly superior expensive wines from other wines or the sound of a Stradivarius from that of other violins have so little effect on prices paid for these objects in the industry.
In a way such earnest research and clever experiments miss the point. People want and need to believe the stories and descriptions of the supposed superior properties that explain the high value of these goods even though there are good empirical reasons to think those descriptions and explanations are false. A Stradivarius does not sound or even play better than new high quality violins do. But to admit this or even to genuinely treat it as a statement that is in need of empirical verification would implode the whole thing and lay bare the mechanism of speculation that was responsible for the high value all this time.
The profoundly strange aspect here is that the element of pretend inherent in these kinds of shared cultural contexts helps sustain the high value of these objects by obscuring the mechanism — speculation — that is actually responsible for most of that value.
People have to take the stories and descriptions seriously and literally but at the same time they can’t act the way they would if they actually did take them seriously and literally: In that case they would have to be open to the possibility of falsification, for example.
It’s a remarkably delicate balance of seriousness and non-seriousness that all involved in these contexts seem to be able to maintain effortlessly. It’s only outsiders — such as the earnest researchers — who unsuccessfully try to disrupt it from time to time.
The Beauty of Make-Believe
Although the previous paragraphs may sound critical of what goes on in these kinds of practices and beliefs, there is nothing inherently objectionable or wrong with them. The drive to accept, to go along with and indulge in them, to form and sustain norms and rituals around them is as human and non-objectionable as the drive to collect rare and meaningful items, or the drive that makes rational people cheer when ‘their’ football club wins or cry when it loses. In all these cases, there are elements of pretend or make-believe, a semi-deliberate choice to not analyze these things until there is nothing left.
In contrast, the same people who can suspend their disbelief when they indulge in these practices will be utterly serious and rational when it comes to the factuality of another aspect: When a presumed 1947 Cheval Blanc wine or a Stradivarius violin turns out to be a forgery it immediately loses all its value. When it comes to that aspect, people do take things entirely literally and seriously.
Which is entirely sensible when we realize that for the collectibility and the speculative mechanism rarity and originality are crucial features while demonstrably superior aesthetic qualities need not be.
The remarkable thing about bitcoin, in contrast with the objects described above, is that it exists almost entirely without these kinds of contexts of established cultural, social, aesthetic norms, values and practices.
Bitcoin is the purest embodiment of the speculative, bubble-blowing mechanism responsible for the store of value function. People buy a bitcoin not because books were written about the beauty of a specific bitcoin, or to show off that bitcoin in the club but because they think that this bitcoin — or any bitcoin — will be more valuable in the future.
For this reason bitcoin shows that for an object to become a store of high value it is not just not sufficient for it to have — or be said to have — certain valued properties the way that fine wines, works of art and so on do, it is not even necessary. Bitcoin’s value is the result of nothing but speculation. It is nothing but bubble. It doesn’t even require the pretense that its value is attributable to some feature inherent in bitcoin itself.
Admittedly though, this is a somewhat exaggerated way of putting it. In bitcoin’s history there have been aesthetic, cultural or ideological factors that probably motivated some people to buy them. Some people admired the beauty of bitcoin’s design or were fascinated by how exactly it works so that they wanted to buy bitcoins to try it out or study it for themselves. Or they may have valued bitcoin because they saw it as driving political change they agreed with, or they appreciated the humanity in its promise to allow anyone to directly engage in value transfers with anyone else in the world. In such cases people may have bought bitcoins more to help kick-start these processes than to profit from them themselves.
In order for bitcoin to have taken off in the first place such a wider context of motivations other than speculation may well have been crucial, at least to the extent that in their absence speculation about its future value might well have been insufficiently optimistic.
It is also possible that in the future a richer context of cultural, aesthetic, social and other norms, values and practices will evolve around bitcoin. Maybe somebody will figure out a way to stylishly show off bitcoins to others as you would a gold chain.
Or maybe despite bitcoin’s general and essential fungibility some (parts of) bitcoins will become more valuable than others, due to some unique feature. Maybe people would pay, for example, five bitcoins for a one-bitcoin transaction from one of the earliest Satoshi blocks. Then again, the divisibility of bitcoin may complicate this as the bitcoins in the Satoshi blocks could be divided up into billions of parts so that they are hardly rare. Also, even if bitcoins from the earliest blocks could somehow become collectibles, this would still not explain the value of all the other bitcoins in circulation.
I have argued that the store of value function responsible for the non-use value of objects is a bubble-blowing mechanism. It is a mechanism by which people give objects value by expecting others to continue to value them in the future. And I have argued that this bubbly non-use value constitutes the largest part of the value of assets such as gold, works of art, fine wines, collectibles — but especially of bitcoin.
But don’t bubbles pop? And if bitcoin embodies this mechanism most purely, does this not mean that bitcoin’s value is nothing but bubble, and that it can pop any moment now?
No. Not all bubbles pop. If anything, the continuing high value of the objects we have discussed here — gold, works of art, fine wine, collectibles — are evidence that store of value bubbles can be sustained, that they are not inherently unstable or destined to pop.
And as for bitcoin, yes, it is mathematically true that its value cannot continue to grow at this pace indefinitely. There is simply not enough value in the world to sustain decades of this pace of growth. But while a slowing down of the growth of bitcoin’s value may mean the end of bitcoin as a high risk-high return speculative asset, it does not mean the end of the value of the asset itself.
This is what makes bitcoin fundamentally different from a Ponzi scheme. While it is impossible for a Ponzi scheme to survive for very long if it stops adding enough new users to pay for the returns and withdrawals of existing users, bitcoin could at least theoretically survive an end to its growth. It could do so by transitioning into a stable, low-growth store of value.
Such price stability would, incidentally, also increase its appeal as a medium of exchange. But even if it never does come to be widely used as a medium of exchange, bitcoin could still continue to exist as the purest form of a store of value the world has ever seen, as something that is valuable for absolutely no other reason than that people expect it to continue to be valuable in the future.
Of course the other side of this is that when people — for any number of reasons — stop expecting bitcoin to have value in the future it will cease to have value today.
The bitcoin bubble does not have to pop, but it could.