Written by Student

If you thought Bitcoin was a currency, perhaps one mainly used to buy drugs on the Dark web, you’d be wrong. At least, you’d be wrong if you still believed that today. According to data from BitInfoCharts, the median value of all Bitcoin transactions that took place yesterday was US$934. Let’s think about that. According to Quartz, the median price of a gram of marijuana on the Dark Web was US$7.7 a gram. So if your theory was that Bitcoin is mainly used to purchase drugs on the Dark Web, that would imply an eye-watering 121 grams of marijuana being purchased by the median user (the average transaction value is currently US$74,000, which would imply an almost Pablo Escobar-esque ten kilos of marijuana per transaction). What’s going on here? In January 2013 the median transaction of value of US $14.5 implied a far more believable ratio of 2 grams of marijuana per transaction. Or maybe 5 coffees. Or a meal somewhere? Stuff you’d buy with a currency.

Returning to the present, how do we explain our median transaction of $934 — or our average transaction value of $74,000? Sure, currencies are used to make big transactions all the time. People buy houses or cars, corporations acquire each other, factories pay suppliers. But for the most part, none of that happens with Bitcoin. And it definitely doesn’t happen on a scale to push the average price up that high. So what gives with this currency? To start with, it’s not really a currency. At least not anymore.

Say goodbye to low fees and fast transactions.
If you don’t follow news related to Bitcoin, you may be taken aback to learn that the metioric rise in its value has also largely coincided with a steady deterioration of it’s usability. The median fee to make a payment in bitcoin stands at $4. If that seems inconvenient, just wait: there’s more. Bitcoin transactions don’t just happen on their own, they need to be processed by miners so they can be entered into the blockchain. To entice miners to process your transaction above someone else’s, you need to bid a higher transaction fee. So the higher you bid, the quicker your transaction will go through. According to bitcoinfees.earn.com, which uses past fees and wait times to estimate how long you’d have to wait for a given fee, that $4 median fee would result in a wait time of up to 5 hours (that’s the upper estimate though, you could get lucky and have it processed immediately). By the same estimates, if you bumped your fee up to $8 you’d get your transaction processed in up to 30 minutes (MasterCard executives are surely trembling in their Ferragamos at such blinding speeds). Even the most swinging charges by banks won’t reach the fees and inconvenience currently imposed on Bitcoin purchases, seemingly ruling BTC out as a day-to-day currency for anyone with recourse to other payment options.

Wannabe Scrooge McDucks, inquire within.
But hold on. Maybe it’s just not a currency meant for buying day-to-day things. Maybe we should think of it as less comparable to a paper currency, and more analogous to carrying around bars of gold which you only use for those big purchases. The average transaction fee is currently only $6, which is pretty good when you consider that the average transaction value is $74,000. This idea has already taken hold in the Bitcoin community of late: it’s not a currency anymore, it’s a store of value.

Under the store of value theory, the main source of demand for BTC is no longer its use as a tool with which to transact, but rather as a means of preserving the value of your wealth from the likes of QE-happy monetary authorities or nations with rampant inflation or currency controls. Yet if Bitcoin serves poorly as a currency, it is even worse as a store of value. If I showed two historical price charts, one of a pharmaceutical penny stock and one of Bitcoin, you might at first glance struggle to tell which pattern of intermittent halving in value and upward lurches belonged to the cryptocurrency. But you likely already know that it’s volatile. Let’s look at some less-evident reasons why it’s one of — if not the worst — stores of value available to you if you have access to developed financial institutions (which you do if you’re reading this article; more on developing countries later). To start off: if you opt to liquidate your vault of gold and use a Bitcoin “wallet” as the new store of your vast wealth, your access to your holdings is governed solely based on your knowledge of the private key — losing the key means the coins are effectively blasted into oblivion. You might be indignant if forgetting the password to your online banking account resulted in your bank erasing all your savings, but such is the law of the land with digital wallets. And what if someone broke into your home and found the piece of paper you’d written the key on? What if you’re held at knife point and forced to divulge the key to your assailant? There’s no recourse, you can’t go to a court and ask them to annul the transaction — Bitcoin is designed expressly so that no institution has oversight over it.

The counterargument is that perhaps the denizens of China, Zimbabwae and Venezuela have no other option, and are driving demand for Bitcoin through necessity despite these flaws. Possibly, you could see why a country with currency controls or rampant inflation would be interested in a cryptocurrency which — for all its warts — suffers from neither of those. But it’s hard to believe that demand from such countries accounts for more than a moderate amount of the currency’s use. Records from BitInfoCharts show that a daily average of US$23 billion was sent using Bitcoin over the past 30 days. It’s difficult to estimate how much wealth could be held in such countries — especially since they tend to be murky with data — but given that the combined GDP of Venezuela and Zimbabwae is less than $500 billion it seems unlikely that they or countries like them could account for such volumes over the long term, especially since such flows would presumably be mono-directional (once you shift your wealth offshore, it’s probably staying there for a while). China is a more convincing source, but the country’s combined unease about downward pressure on the Yuan and tight grip over the internet makes it unlikely that we’re witnessing a prolonged capital flight via Bitcoin. Authorities there have already curtailed Bitcoin trading (withdrawals from cryptocurrency exchanges were only recently unfrozen). And remember, to convert your vast amounts of inflation-or-capital-controlled currency into Bitcoin in the first place (outside of an exchange) you need to find someone who wants to convert their vast amount of Bitcoins into your problematic currency.

So, the majority of demand for Bitcoin is evidently not coming from Dark Web drug purchases (potential ten-kilo orders of marijuana notwithstanding). High fees and lengthy transaction wait times all but rule out day-to-day transactions, as if that wasn’t evident with median and average transaction values of $934 and $74,000 respectively. Capital flight from regimes with problematic currencies is convincing, and could account for such massive transaction sizes, but there are either practical stumbling blocks to moving vast amounts of Bitcoin out of these regimes or simply not enough wealth to account for such large daily volumes. But people with money are evidently buying Bitcoin. And they probably aren’t doing so to replace their bank accounts, given how flawed Bitcoin is as a store of value.

’FUD’ Incoming
Let’s stop dancing around the elephant in the room: it’s speculation. You buy it because you think you’ll be able to sell it to someone else for more later. You need to sell it to someone else later, because it has no inherent value. It’s not a stock or bond that gives you ownership over cash flows, it’s not deed to physical property, it’s not even comparable to Gold – probably the closest comparison – because it lacks a record as a store of value that’s as old as civilization. It’s not comparable to fiat currency either – even though both Bitcoin and fiat rely on trust – since the trust in fiat doesn’t refer to trust in the currency itself, but rather trust in the government’s ability to regulate and tax its subjects.

Bitcoin’s mysterious creator probably didn’t intend for things to end up as they did, but Bitcoin today is undeniably in the midst of a bubble. Bubbles don’t necessarily have to end in tears: if the underlying asset has an inherent value — derived from cash flows say, in the case of stocks — then it’s possible for the underlying value to grow until it matches the valuation on the asset. If internet stocks (say Amazon, for example) during the Dot Com bubble in the late 1990’s had simply maintained their high stock prices until they ’grew into’ their valuation in the 2010’s, could you have even called it a bubble? Yes, you could. The issue in real life is that people need to be compensated to hold on to assets that might suddenly collapse. This rent comes from the continued increase in the price of an asset. Amazon couldn’t have just maintained its stock price for a decade until the fundamentals justified the valuation, since once it became clear that no price rise was on the cards for the next ten years you would have headed for the exits to buy a better returning asset. Along with everyone else.

If you derive little or no inherent utility from Bitcoin’s functionality as a currency — and you could argue that most of those who currently hold it do not — then the only incentive for you to continue bearing the risk of the bubble bursting is the rent you derive from the expected continued increase in value. The greater the danger of the bubble bursting, the larger the rent needs to be to compensate you for the risk. There’s no limit on how high speculation can push the price. Even if you were standing in a room trading an asset that everyone knew to be totally worthless — say, monopoly money or degrees from Trump University — you could keep bidding up the price as long as you believed someone else in the room would pay even more. Even if you know the asset has no value, you don’t really believe that you’re going to be the one left holding it in the end. You might even loudly shout down anyone who dared point out that the asset you’re trading had no value, lest they pop the illusion before you made your escape (the Bitcoin community refers to negative sentiment as ’FUD’, spread mainly by illusive conspirators who seek the downfall of the cryptocurrency).

Not everyone has accepted that Bitcoin can’t grow out of its current valuation. Efforts to fix the currency’s value as a currency are afoot, which could hopefully see speculators replaced with genuine users once the former inevitably head for the exits. Bitcoin Cash, a new currency which was split off from the main Bitcoin fork after a contentious debate on how to scale up to larger usage, has much lower fees and transaction times. Within the main fork of Bitcoin, a scheme called the Lightning Network is in the works which promises to speed up transactions and lower fees by processing transactions without directly registering them on the blockchain. Yet it remains to be seen how well Lighting’s claims stack up to reality, and by any means, bypassing the blockchain could potentially leave transactions in the hands of a less secure technology. And the fork of Bitcoin Cash from the main branch now means that each has its own separate price.

Even with fixes in the works, it seems unlikely that current prices could be justified purely by genuine demand for Bitcoin as a currency. For people in Western countries buying legal products, there are a bevy of better alternatives for transacting — including Fintech companies like Revolut. As it stands, even bank accounts and credit cards from much-hated traditional financial institutions offer far better products than Bitcoin. Demand for Bitcoin isn’t driven by drug dealers. It’s not driven by emerging market wealth. And it damn sure isn’t driven by use as a store of value. The bulk of Bitcoin owners are speculators standing in that imaginary room, trading an asset without any underlying value.


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