What Fraction of Bitcoin Value is Driven by Speculators?

At Quora, I occasionally play, “Ask the expert”. Several hundred of my Quora answers are linked at top right on this page. Today, I was asked “How much of Bitcoin’s value is driven by speculation”. This is my answer…


This is a great question! While the value of any commodity is determined by supply and demand, speculation is one component of demand. Another is the unique utility value inherent in a product or process. This is sometimes called ‘intrinsic value’.

It’s ironic that when a high fraction of value is driven by speculation, short-term value becomes volatile and long-term value becomes less certain—and less likely to produce returns for those same speculators.

Editor’s Note: In the past few weeks, a significant spike in Bitcoin’s value and trading volume relates to a pending regulatory decision expected at the end of next week. This activity is certainly driven by speculation. But for this article, I am considering periods in which the demands of individual events are less clear.

The value of Bitcoin is influenced by:

  • Day traders who buy and churn
  • Long-term speculators who buy and hold. This includes me.
  • Criminals who hope that cryptocurrency transactions can be more easily hidden than government backed currencies
  • Early adopters who use Bitcoin as a payment instrument or to send money
  • Vendors who accept the coin in exchange for products and services
  • Vendors who retain a fraction of revenue in Bitcoin (rather than exchanging to Fiat). To avoid a round trip, they seek to purchase materials, pay staff or settle debts with the Bitcoin they earned.

Here’s the rub: Bitcoin will not become a store of value unto itself (i.e. a currency), and it will not gain a significant fraction of the payment instrument market until the transaction volume of the first to user categories in the above list are overtaken by the the ones further down. Likewise, Bitcoin will not enter its biggest growth spurt until the last two items swamps the others as the largest motive for acceptance and use.

Put another way: Long term value must ultimately be driven by organic adoption from actual users (people who buy and spend Bitcoin on other things).

In another article, I expand on the sequence of events that must take place before Bitcoin grows into its potential. But make no mistake. These things will happen. In tribute to the brilliance of Satoshi, the dominoes are already falling.

In response to the question, I estimate that at the beginning of 2017, 85% of Bitcoin value is still driven by speculators. I have not analyzed wallet holding periods compared against the addresses of known vendors. Furthermore, it would be difficult to understand the relationship between the number of speculative transactions and the overall effect on value. Therefore, my figure is more of a WAG than an calculated estimate. But it’s an educated WAG.

The fraction of speculative transactions will drop significantly in the coming months—even as late speculators jump on board. That’s because uptake from consumers and businesses is already taking off. The series of reactions that lead toward ubiquitous, utilitarian applications has begun. Bitcoin’s value will ultimately be driven by use as a payment instrument and in commerce.

Because it is a pure supply-demand instrument, Bitcoin will eventually be recognized as currency itself. That is, it needn’t be backed by precious metal, pegged convertibility or a redemption promise. When that happens, you will no longer ask about Bitcoin’s value. That would be a circular question, since its value will be intrinsic. Instead, you will wonder about the value of the US dollar, the Euro and the Yen.

As a growing fraction of groceries, gasoline and computers that you buy are quoted in BTC, you will begin to think of it as a rock, rather than a moving target. One day in the future, there will be a sudden spike or drop in the exchange rate with your national currency. At that time, you won’t ask “What happened to Bitcoin today? Why did it rise in value by 5% this morning?” Instead, you will wonder “What happened to the US dollar today? Why did it drop in value by 5%?

Post Mike Hearn: Can Bitcoin still Reign?

Beyond this first paragraph, I won’t mention Mike Hearn—despite invoking his name in the title. Enough has been written about the disillusioned core developer who, in January 2016, publicly declared Bitcoin a failed experiment, even as it continues to garnish adoption and increasing VC investment. Mr. Hearn points to a lack of leadership among the p2p community, dwindling incentives, and a seemingly intractable architecture disagreement among the miners who validate distributed transactions. Mr. Hearn is a terrific engineer, but I suspect that he is not a sociologist or market visionary.

As I began researching the potential for collapse or success, I collected my notes about Bitcoin’s future under the working title: “Market Traction: Clinching an emergent sector” . But this seems rather obtuse and sleep inducing. A good subtitle for this post would be “Random Thoughts About Bitcoin Growth Pains”.

As such, I won’t bother illustrating it with cute or pithy graphics. It’s just a justification and clarification of my continued confidence in a ‘failed experiment’.

A Bitcoin skeptic has asked me to justify my optimistic view of Bitcoin. After all, there is trouble in Dodge City: Dwindling financial incentives, a transaction volume that is straining the architecture and infighting amongst miners about forking and block size.

You might think that being first to a new market—or first with a radically new method—increases the chance of success. Alas, it isn’t so. Even if it were a maxim, Bitcoin is not the first digital currency.

Yet, Bitcoin is virtually assured of success. Not because it’s first, but because it is better/cheaper/faster, it has a two-sided market, and it can be extended by the features and benefits of its rivals.

Background

Bitcoin isn’t the first digital currency. Numerous instruments have moved cash across the Internet and in the 150 year mail-order era that preceded the Internet. In addition to credit and debit cards, there was Western Union, DigiCash, E-Gold, Flooz, beenz, Cybercash, Cybermoola, PacketPass, PayPal, and more. There are also institutional and B2B mechanisms for payment or settlement, like wire transfers, letters of credit, SWIFT, EFT and ACH (also known as ‘paperless checks’).

A lot has been said about Bitcoin and what sets it apart from everything that came before. Is Bitcoin truly revolutionary? Heck, yes! It has many unique qualities. It differs from antecedents in three important ways:

  • Pure, Capitalist Dynamics
    Bitcoin is not backed by a government, organization or the promise of redemption for fiat currency. Instead, value is derived from supply and demand. Since the supply is well understood and capped with mathematical certainty, its long term value will be closely tied to growth in recognition, circulation and adoption.
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  • Decentralized & Permissionless
    Bitcoin trade and settlement has no nexus or central authority. Transactions are completely decentralized and peer-to-peer. In the past, a decentralized coin had to be made of something valuable or it had to be backed by a stable government and difficult to counterfeit. Bitcoin is a new breed of currency—a decentralized, permissionless, peer-to-peer currency built on the blockchain.
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  • Not so Anonymous—but traded and stored with impunity
    Unlike cash, its use is not truly anonymous—at least not if you intend to ever convert it to cash or pay for something in the real world. But it is easier to hide then cash and so it can be stored and spent with impunity. That is, no government can force you to turn over your wallet without your cooperation. And the only way you can be prevented from spending or receiving Bitcoin is to be locked in solitary confinement with no visitors, no phone, no mail and no Internet. Since Bitcoin is just a string of numbers, a payment channel can be opened via carrier pigeon or by simply blinking a flashlight with Morse code.

Bitcoin is the first of a new breed of crypto currencies—decentralized, permissionless, peer-to-peer instruments built on the blockchain. That’s because Bitcoin is the original demonstration platform of the blockchain. The blockchain and the payment instrument were described together by the mysterious Satoshi Nakamoto in 1998.

Does creating the table and getting the first seat guaranty success? Of course not! Just ask Sony. The Betamax was beaten by VHS. And there were others before it, like the Sony U-Matic and Quasar Time Machine. But Bitcoin has two things under its wings that Betamax didn’t have…

  1. Adoption of a ‘networked’ service by both buyers & sellers faces a significant entry barrier. The value of any payment network is in its recognition and ubiquity. Yet, even with popular adoption at less than 2%, Bitcoin has achieved a robust two-sided market. Nothing else comes close. A two-sided market results in utility that buids from the ground up. With each passing week, the market clout of adoption shuts out new competitors. (Just ask anyone that has tried to compete with Mastercard–Visa–Amex).* As of this publication date, an altcoin would need to bring a whopping advantage.
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  2. But what if something better comes along? Something clever, faster, more robust or with improved privacy. What then?

    No problem. Bitcoin can freely add any improvement proposed or demonstrated by others. Why? Because unlike payment networks of the past, cryptocurrencies are open-source projects. There are no IP protections or licensing requirements. If an altcoin were closed, proprietary or protected by copyright or patent, no one would trust it. After all, no one could verify who has the coins, how many were pre-mined, what is the monetary cap, and who controls code evolution. Those are each deal-stoppers.Overcoming these obstacles was as much the genius of Satoshi as overcoming the double-spend problem. Bitcoin is free to evolve . It can add improvements or solve its own problems. That’s what is happening right now, as it is forced to address its own growing pains.

Final Thought

One coin, Ethereum, may be an exception. It might achieve the same entrenched and ubiquitous status as Bitcoin. But Ethereum represents another major step in Blockchain evolution. It is not just a coin, it is a contract consensus and enforcement mechanism. As such, it is not just a currency.

Bitcoin has a similar feature (called “Smart Contracts”), but Ethereum is like Smart Contract on steroids … and it has been crafted in a way that makes it easy for anyone to jump on board and create their own contracts. Like Bitcoin, Ethereum has a compelling backstory and a very young, visionary inventor.


* Discover Card is the only entrant into consumer POS credit instruments in the past three decades—and it had a rocky road to recognition and acceptance, passing through multiple owners. During this same time, Carte Blanche and Air Travel Card disappeared.

Bitcoin Adoption: Series of reactions

What is Bitcoin?

Bitcoin-05Sure—You know the history. As it spread from the geeky crypto community, Bitcoin sparked investor frenzy. Its “value” was driven by the confidence of early adopters that they hitched an early train, rather than commercial adoption. But, just like those zealous investors, you realize that it may ultimately reduce the costs of online commerce, if and when if it becomes widely accepted.

But what is Bitcoin, really? To what class of instruments does it belong?

  • The most ardent detractors see it as a sham: A pyramid scheme with absolutely no durable value. A house of cards waiting to tumble. This is a position of my close friend, JD, a former IRS auditor and the first to comment on this post below.
  • Many people recognize that it can be a useful transaction medium—similar to a prepaid gift card, but with a few added kicks: Decentralized, low cost and private.
  • Or is it an equity asset, traded by a community of speculative investors, and subject to bubble psychology? If so, do the wild swings in its exchange rate diminish its potential to be used as a payment mechanism?
  • Does Bitcoin have the potential to be a full-fledged currency with a “real value” that floats based on supply and demand? Can something that lacks intrinsic value or the backing of a bank or government replace national currency?

Regardless of your opinion about Bitcoin, it does one thing that few pundits dispute: Although the exchange value fluctuates, it reduces transaction costs to nearly zero. This characteristic, alone, is a dramatic breakthrough. It was achieved by virtue of its designer overcoming the “double-spend problem”.

Peering Into the Future?

Removing friction is certainly what it is all about. As a transaction medium, Bitcoin achieves this, but so does any debit instrument, or any account in which a buyer has retained house “credit”.

Bitcoin_pullback-sCurrently there is a high bar to get money exchanged into and out of Bitcoin. It’s a mess: costly, time consuming and a big hassle. Seriously! Have you tried using an exchange? Even the most trusted one (Coinbase of San Francisco) makes it incredibly difficult to get money in and out of BTC. Fortunately, this situation is gradually improving.

Where Bitcoin really shines (or more accurately, when it will shine), occurs at the time when more vendors choose to leave revenues in BTC, pending their own purchases from suppliers, shareholder payouts, or simply as retained savings.

When this happens, all sorts of good things will follow…

  • A growing fraction of sellers leave their bitcoin in their wallets, realizing that they will need to spend it for their own labor and materials.
  • Gradually, wild exchange-rate gyrations diminish—not because fewer people are exchanging money, but because the Bitcoin supply/demand value is driven more by actual commerce than it is by speculation.
  • Sellers begin pricing merchandise in Bitcoin rather than legacy units (i.e. national currencies)—because they are less anxious to exchange out of BTC immediately after each sale.

When sellers begin letting a fraction of bitcoin revenues ride—and as they begin pricing goods and services in BTC—a phenomenal tipping point will follow…

  • If goods and services are priced in BTC, then everyone involved saves money and engages in transactions more efficiently.
  • If goods and services are priced in BTC, then the public will begin to perceive exchange rate volatility as a changing dollar rather than a changing bitcoin.
  • Eventually, vendors will begin spending the BTC that they acquire in commerce (or paying staff in BTC), rather than converting quickly back to national currency. More than anything else, this will transform Bitcoin into a stored value unto itself, and not just an exchange chit. This may seem to be a subtle footnote to adoption, but the ramifications are great. That earthquake is the world gradually moving away from centralized treasury-issued bank notes and toward a unified and currency that we can all trust.

People, everywhere, will one day place their trust in a far more robust and trustworthy mechanism than paper promissory notes printed by regional governments. A brilliantly crafted mechanism that is fully distributed, p2p, transaction verified (yet private), has a capped supply and is secure.

What Then?

O.K. So we believe that Bitcoin is the future of money and not just a replacement for credit cards. But what does this really mean? Can the series of cause-and-effect be extrapolated beyond widespread user adoption? Absolutely! …

Adoption of Bitcoin as a stored value (that means as a currency) leads to the gradual realization among governments that Bitcoin is not a threat to sovereignty nor even to tax policy. Instead it presents unbounded opportunity: The opportunity to stabilize markets, eliminate inflation, reduce costs and restore public trust. In short, Bitcoin will ultimately level the playing field, revive entire economies, transform the role of government, and save consumers and businesses billions of dollars each year.

Did I mention that Bitcoin is the future of commerce and a very possible successor to legacy currencies? Aristotle must be smiling.

Lease rooms in the US Treasury to pay off some of the debt brought about by inflation

Uncle Sam can lease the US Treasury building to pay off debt brought about by inflation