Cars, Gold, Houses, Toys & Stock: What gives value?

The title of this post is intentionally misleading. We frequently discuss the traits that lead to value in this Blog. But today, I was asked a more nuanced question: “What things will hold their value?

And there is a ulterior motive in being a Wild Duck contributor. Analyzing the dynamics of durable value leads to some surprising conclusions about the money supply and what a society chooses to use as money. We’ll get to this at end of this post.


We know that value comes from supply and demand. There are no exceptions. But, we have not addressed the properties that make an asset hold value over the long haul. Let’s consider some examples…

Cars

In an affluent, mobile society, most people desire personal, point-to-point transportation — and so there is clearly a demand for automobiles.

But style & technology change rapidly and automobiles deteriorate with use and weather. After 8 to 10 years, their cost and maintenance rise dramatically, and owners lust for a new model. So cars don’t get our award for assets that hold value.*

Popular Toys

In the 1970s, the Cabbage Patch doll from Calico Industries, and later, Tickle Me Elmo in the 1990s created a buyer frenzy that rivaled a lemonade stand in the desert. Shoppers fought each other to grab a limited supply. Clearly, demand was very high. The one shown below is listed at Ebay this week with a starting bid of $5,000. Other, less popular styles can be found for $4.99.

At first, this demand was driven by clever marketing and crying children in the week before Christmas. Demand was driven by a parent’s love. But at the peak of frenzy, demand shifted to buyers without children who felt certain that they could profit from selling the dolls that they snatched up first.

But the demand was not durable. Fads driven by frenzy don’t hold value for the long haul — especially when a manufacturer can simply turn the spigot back on.

Stocks & Bonds

A share of stock represents ownership in a corporation. A municipal bond represents a lien against a city—or the fees generated by an infrastructure project.

In both cases—especially bonds, which are a limited promise—no one expects value to last forever. It is a time-sensitive bet with the intention of expiration, redemption or exchange. So, these things also fail our criteria for durable value.

Houses & Real Estate

Like cars, homes require ongoing maintenance. But, most people weigh the maintenance cost against the benefit of having shelter, rather than comparing it to their gain or loss in value.

On the other hand, real estate value fluctuates in the long run due to things that are difficult to predict — population density, demographics, and quality-of-life issues related to infrastructure: weather, seismic events, politics, and access to health care and education.

Some real estate rises enormously in value over 50 or 100 years. Yet, we have seen boom-and-bust cycles that wipe out substantial wealth. So, real estate does not cut it in our contest for durable value.

Gold

The allure of gold and other precious metals is that their supply is capped — or limited by slow and predictable growth. The asset is difficult to find. It is acquired only from natural phenomena.

So, if we can also make it fungible, divisible, portable and difficult to counterfeit, then it meets most of Aristotle’s requirements for a functional currency. Theoretically, this can lead to widespread demand.

Gold certainly has exhibited its ability to hold value throughout thousands of years. But it is not so easily tested and divided in the field, and the impression that it has intrinsic value is an illusion. That’s because the fraction of gold acquired by investors dwarfs the amount actually needed for dentistry, electronics and even jewelry. In this modern era, even gold is becoming a house of cards, because its value is built upon speculation and emotion.

Oil (aka “black gold”)

With the rise of the automobile and power plants that burn fossil fuel, oil became a reserve currency of the 19th and 20th centuries. But there are two problems with it holding value over the long haul.

First, unlike gold, oil is a consumable in every market. Therefore it is difficult to think of it as an asset. Also, we now live in a century in which energy and transportation is rapidly switching away from oil, while at the same time, new technology is making it cheap to acquire new oil. This (along with a history of violent political theater) dramatically deteriorates its potential as a store of value in coming years.

Money

The supply-demand dynamics of money is widely misunderstood. More than 2,300 years ago, Aristotle defined the properties of a functional currency.

Earlier, we stated that all value comes from supply and demand. But, it is fair to ask “What creates the demand?” or “What backs the expectation of future demand?” Surprisingly, even if we limit our scope to just one country (USA), the value of government-issued currency has been tied to different things over time:

  • Gold
  • Promise of redemption
  • Legal tender (public must accept it for all debts)
  • Settlement of taxes
  • The “good faith and credit” of workers

Ultimately, demand is influenced by oversupply and by public perception more than government promises or laws. The perception that the US dollar has no cap and that its supply can be inflated whenever a body of transient politicians decides to raise the debt ceiling may eventually cause its value to collapse. Although it has not happened yet, at some point consumers (or those holding our debt), will begin to question if Americans have the capacity and will to produce and export the goods & services necessary to balance their mass consumption of the past half-century.

And so, government-issued Fiat does not pass our smell test for durable value. Sooner or later, all national currencies collapse. On a personal level, the only question that matters is if you will be caught by surprise—with a fraction of wealth tied to your favored currency.

What has the potential to meet all
requirements for holding value?

Wouldn’t it be fascinating if we could find an asset that is a product of pure mathematics? A perfect asset would be fair, fungible, immutable, and capped. It could never be inflated or manipulated by politicians. It would decouple governments from monetary policy. It would be politically agnostic.

If correctly designed, it would be capable of absorbing and incorporating improvements developed by any copycat or pretender nipping at its heels. Most important, it would be open source, peer-to-peer, massively distributed, redundant, and completely permissionless.

This perfect asset would derive trust from mathematics and crowd-sourced consensus. It would not require that anyone believe in a government, a bank, a land mass, or the uncertain supply of precious objects. Authenticity could tested easily and its value transmitted instantly. The history of each unit would be completely transparent. With free tools, anyone, anywhere could trace its history of moving from one owner to the next.

Ten years ago, such an asset was unleashed into the wild by a person or team of developers under the pseudonym, Satoshi Nakamoto. It not only meets all of these requirements, it has built-in immunity from competition. It even resolves a technical problem that troubled Aristotle more than two millennia ago.

I won’t name this radical yet natural evolutionary development in this answer—but, I can confidently state that it passes our test for an asset that will hold value over time. Despite a wildly fluctuating exchange rate with Fiat currency, its inherent value has never dropped. Ultimately, you will no longer asses value based on the exchange rate of an anachronistic currency that fails all of the other smell tests. Instead, you will assess value on how many heads of lettuce you can buy or how much that new sailboat costs.


* A classic car avoids the problems associated with use & maintenance—and it can hold value over a long period. But like a Picasso painting, the market for classic cars has a limited audience, especially for the florescent green ’63 Mustang that I found in in my great uncle’s garage. Additionally, it is subject to the whims of popular perception. Styles go in and out of vogue and so we cannot predict how long that car will hold value. (Please call me if you value my uncle’s Mustang at more than $150,000).

Why would anyone attribute value to Bitcoin?

Oh, Cheez…We’re back to this question, again!

As a Bitcoin columnist, I get this question a lot. Today, an answer was requested at Quora.com, where I am a leading contributor on cryptocurrencies:

“Clearly, some people value Bitcoin. But How can
this be? There is nothing there to give it value!”

Many individuals, like the one who asked this question, suspect that Bitcoin was pulled out of thin air—and that it is not backed by gold, a government, or an authoritative redemption guaranty. After all, it is just open source code. What stops me from creating an ElleryCoin using the same code?!

Let’s start with the short answer:

  • Indeed, it was pulled out thin air
  • It isn’t backed by an asset, government or promise
  • You could easily clone Bitcoin (the entire mining ecosystem) and distribute it yourself. It would be exactly like Bitcoin. Yet, Bitcoin is clearly valued by everyone, and your new coin is unlikely to generate interest or adoption.

A More Complete Answer: What is value?

Bitcoin has more intrinsic value than a government printed paper bill. The value arises from a combiation of fundamental properties:

  • It has a capped supply
  • It is widely recognized, liquid, and resistant to legislation
  • It has attained the robust supply-demand of a growing, 2-sided network.
  • It is open and transparent. This elevates user trust
  • Unlike cash and credit, Bitcoin requires no back-end settlement. That’s because it is not a payment instrument. Rather, it is money itself.
  • Finally, it’s value is likely to be durable, because it is not printed by a country that spends beyond its means and racks up debt. In fact, it can never be inflated.

Downside and Risks

But wait! What about the long transaction delay and high cost? There are sharp disagreements anong miners, users and developers concerning block size, transaction malleability, and replay issues. Aren’t these a deal killers? And what about wild volatility in the exchange rate? Doesn’t this retard adoption as a functional currency?

These are transient issues associated with a new technology. Bitcoin is weathering growth pains that arise from a new and distributed governance technology (democracy can be messy!). But, all of these issues have sound solutions. We have witnessed and tested the solutions with various forked coins. Think of these imrpoved altcoins as beta tests. Even if current problems delay the day when you can spend bitcoin at every retail establishment—it is already sucking liquidity from national currencies and becoming the world’s de facto reserve currency.

Many individuals find all of this hard to accept. That is because we have been conditioned to think that ‘value’ arises from assets with ‘intrinsic’ value, the promise of redemption, or by edict. This is not true. In all things (including gold, a Picasso painting, or your labor), value arises from simple supply and demand.

Some individuals claim that all other factors are secondary. But, even this statement is false. All other factors are irrelevant. They may be related, but they are not the source of value.

I recognize that this answer may seem smug or definitive. So, allow me to suggest related questions with answers that are a bit more interesting, because they are subtle. Unlike the question of value, these two questions are open to analysis and opinion: (1) “Will people continue to value bitcoin in the future?” — And (2) “When will Bitcoin stop swinging wildly in value?” (measured by its exchange rate with other currencies).

This is fun! Let’s explore…


Ellery Davies co-chairs CRYPSA, publishes A Wild Duck and hosts the New York Bitcoin Event. Last month, he kicked off the Cryptocurrency Expo in Dubai. Click Here to inquire about a live presentation or consulting engagement.

What gives Bitcoin Value?

For most of us, figuring out the value of something that we want, comes from research. If you want a new set of wine glasses, you check the price online. Perhaps you consult a catalog. If the set of 8 stemware goblets that you like are a current model from a major company, there are probably many places to buy them. If there are multiple Ebay sellers and many recently completed sales, then you can establish the value with precision.

I’ve written a lot of Bitcoin articles at A Wild Duck. So, let’s dig a bit deeper this time. Let’s talk about the real Pros and Cons of buying crypto currencies. If you are interested in trading bitcoin, crypto revolt would be the place to do it!

Supply and Demand

In the end, an item’s value is a direct result of supply and demand. It’s no different with a currency. And let’s be clear: Despite a raging debate, Bitcoin is a currency and not just a payment instrument. How can I be certain? Try this mental exercise—

Amazon_Gift_CardWestern Union money orders and Amazon Gift cards are each trusted monetary instruments. They facilitate cash transactions. But are they currencies with inherent value? If so, there would be no need to denominate them in units of fiat currency.

A money order is only worth something before it is redeemed. The gift card is only worth $500 when it is purchased or received as a gift. As the $500 is depleted, it becomes worthless. Eventually, it is just a piece of plastic. But like a dollar bill, a bitcoin can be circulated over and over. You may believe that its value comes from the government, but more realistically, its value arises from brand recognition and from pure supply and demand—not from a trusted redemption authority. Of course, Bitcoin’s intangibility does have its downfalls, especially in the world of crypto casinos. While Bitcoin casinos are fairly popular among many, they are seen as very untrustworthy due to their lack of security. On the other hand, crypto casino alternatives such as FunFair.io offer a more transparent option, and the pro’s and con’s between FunFair and Bitcoin Casinos seem to be relatively clear to see.

Bitcoin isn’t the first ethereal stash of bits with value. But it is more durable than others. The latest Pixar film on DVD or On Demand from your cable service provider has value. But piracy reduces the value dramatically. The supply is no longer scarce (no matter the demand) because of the ease and willingness to replicate digital files in any quantity. A Picasso painting is very rare, but it is so scarce, that we cannot gather enough data points to establish a stable value. Even worse, it’s not portable, divisible or fungible and it is nearly impossible to validate in the hands of the average person.

But, commodities like iPhones, Doritos tortilla chips—or even non-branded things, like Idaho potatoes, have a large and fluid market. These things have very measurable value and we can track the change in value over time.

People like to think that money is different than other commodities. In practice, it differs only by its handling characteristics: Compared to a Bitcoin-08Picaso painting or a new iPhone 6, currency has these properties. It is:

  • portable
  • fungible
  • divisible
  • widely recognized
  • resistant to forgery
  • backed by something tangible

Bitcoin has all of these characteristics. In fact, it surpasses your national currency in every way. But many people are confused about that last niggling detail… Aristotle called it intrinsic value. They worry that there is no gold—or at least the promise of a stable government—to establish and stand behind the value of a bitcoin unit (BTC). This concern is understandable, but misguided. It is based on wrong assumptions.

Recall that value arises through supply and demand and not simply because of authority or promises. The real question is Can we trust that the supply is limited and that the demand is durable?” — Or at a personal level: “Will my coins be recognized, coveted and honored in the future? And will they be easy to buy, sell or exchange”

The Case Against Bitcoin as a Currency

At first glance, Bitcoin enthusiasts and early adopters face a frightening fact: Bitcoin is manufactured out of thin air. It lacks the underpinnings of a traditional currency. Referring to that last item on Arisotle’s list above, Bitcoin seems to fail the test of intrinsic value, because it lacks at least one of these properties that guaranty future redemption:

  • A promise of a trusted authority
  • An edict to remit taxes in Bitcoin
  • A fractional reserve requirement
  • Any claim of pegging it to the value to some essential commodity (intrinsic value)
  • Bitcoin doesn’t even offer a perception of uniqueness. The source code is open for anyone to copy. You could create a competing ‘Bob-coin’ tomorrow.

In the absence of at least one of these things, detractors claim that Bitcoin lacks a foundation—and so it is effectively worthless. But value does not come only from authority. It comes from trust and is governed by supply and demand.

snoop-03

The dollar is backed by trust — Not gold, math, nor even history

In fact, math may be a more trusted ‘authority’ than the directors of your national treasury and reserve board. Supply and demand leads to more tangible value than bankers, especially if the math leads you to believe that the demand will continue to outpace the supply. This is why you are comfortable with a $20 bill in your pocket. You have a pretty good idea, that—next week—it will still buy two movie tickets or two pizzas.

Bitcoin has achieved a “two-sided network effect” (Google the term and the economist “Marshall Van Alstyne”). It has captured the public imagination more than Picasso. It cannot be manufactured. With a reasonable understanding of wallets, it cannot be seized, stolen or lost.

The ability to mine new bitcoins is capped with a total supply of 21 million units, and so there is no opportunity for governments to inflate it through mismanagement of taxation or spending. They cannot even inflate it with good intent (for example, when they need to repair a bridge or provide for the poor). Instead, the ability to pay for these services (and all other government functions) forces them to live within a balanced budget. Spending cannot outpace the revenue generated by taxes and bonds. In a Bitcoin economy, the bonds will more likely be paid back by user fees rather than the future debt of unborn generations.* You get the point: Because governments no longer control the printing press, they cannot make hollow promises and then kick the problem into the next administration. With a limited money supply that everyone recognizes as money, governments are forced to live within their means.

What About Uniqueness?

The last item in the list above decries Bitcoin’s lack of uniqueness. You cannot mint your own bitcoins of course—but you can create an equivalent bitcoin ecosystem yourself. If your name is Bob, you can call it ‘Bobcoin’. Many countries and organizations are already doing this.

A Bobcoin is no different than a US Dollar or your own national currency. A government note is difficult to counterfeit, but so is your own signature when placed on a fancy printed currency (call it a Bob-Buck). The problem is that the dollar is widely recognized, trusted and accepted, but few people other than your kids collect Bob Bucks.

Your own currency faces the challenge of adoption. Whether it’s Bob Bucks (paper) or Bobcoin (cryptocurrency), how will you get the world to covet, mine and trade your new currency? That’s the point of a two-sided network. It becomes increasingly more difficult after one method rises to the top—especially if that method is open, transparent and extensible. Bitcoin is open. It is subject to worldwide scrutiny. But this works both ways. Bitcoin can also add incremental improvements that are part of any pretender to the throne.

Bitcoin is not just a transient coin-du-jour. It evolves and so it will not die.

How Can the Value be Measured?

I get this question a lot, and so I am adding the answer here. There is no need to measure the value of Bitcoin or define debt. Its value floats with supply and demand like a true world currency. Because the supply growth is capped and well understood, it is resistant to manipulation. As time goes by, it becomes far less likely to exhibit wild swings in value.

A few years from now, if Bitcoin spikes or tanks by 10% in a short time, you will be more likely to wonder “What is affecting the dollar?” (or Euro), rather than “What is affecting Bitcoin”. Consumers will budget for the cost of a new car or refrigerator in BTC rather than dollars or Euros. You will even see catalogs that print prices in BTC and honor them for the life of the catalog or online sale. After all, in an international market, it makes sense to quote a price in units with no geopolitical boundaries, just as we quote time in UTC (formerly called GMT).

Are these predictions crazy? They are not even bold. For Wild Ducks, they are rather obvious. If we can be accused of dreaming, it is because we are ahead of the game. Look ahead, yourself. The signs are clear…

If Bitcoin has Value, What is the Value?

As Bitcoin adoption moves past enthusiasts and early adopters, the capped supply of coins (21 million, max) will be spread thinner and thinner. This doesn’t play out like a classic shortage, because unlike a supply squeeze on food or medicine, you can work with a smaller piece of the pie each year. The piece needed to pay for a car or an iPhone simply gets smaller as the unit price floats higher and higher.

Last year, I set up an equation to predict how high Bitcoin will float in 5 or 10 years. It involved a lot of WAGs (wild *ss guesses). Although I am a pundit, I am not a mathematician, and so the attempt was incomplete. No need to rehash that exercise.

Passport-s-TAs Hysteria Withers, Bold Becomes Mundane

Eventually consumers, banks, brokers, and governments will recognize that Bitcoin is a far greater opportunity than it is a threat. It pulls the world together by decoupling currency controls from national agenda, inflation, manipulation and loss (You can back up your Bitcoin. Try doing that with your paper money or a defunct bank).

[Ellery Davies is editor of AWildDuck.com. He is also CEO &
Co-Chair of CRYPSA, a recognized standards organization]

_____________
* This is just one reason why an eventual transition to Bitcoin (as currency, and not just as a payment instrument) is in the national interest. It demonstrates to citizens that monetary policy is backed by more than growing debt, inflation or the promises of transient officials. It returns any government or economic entity to a non-inflationary, limited-supply pie. The pieces of pie can grow in value, but the pie cannot be watered down by printing more ingredients, counterfeit or even by enemy action.

Further Reading

Calculate Bitcoin Value: Modest assumptions

December 2017 Update:
In a major update to the article below, I describe a different methodology for determining Bitcoin fair value. Since Bitcoin is gaining traction as a reserve currency rather than a daily payment instrument, it presents a more accurate method of predicting Bitcoin’s eventual fair market value. [Switch to updated article]


An experienced investor recognizes a speculative instrument or commodity. Depending upon your frame of mind and your opinion about its future, Bitcoin is either a payment instrument or a commodity. But either way, its supply is capped (not by edict, but by an indisputable mathematical formula), and so its value is a product of simple supply and demand economics.

Value: What assumptions are reasonable?

Value: What assumptions are reasonable?

I would never claim the foresight to predict the value of a bitcoin five minutes from now, let alone five years from now. Yet, I am baffled by its dollar exchange value today ($450 as I write this Wild Duck article). A reasonable and conservative calculation suggests that it should be—not $1200, as it was in late November 2013—but rather 100 times its current value.

Let’s consider one way to approach a calculation of the exchange rate necessary to support a low ball likelihood of its future utility…

Conservative Assumptions

  • Let’s say that Bitcoin never achieves the status of a currency—and that eventually, the expectation of enthusiasts that it will become its own “value store” turns out to be wishful thinking. Let’s assume that exchange rate mania was no more than the Dutch tulip-mania.
  • As a result, let us further assume that all speculative “investment” ends. Let’s just say that in 5 years, no one is interested in holding on to a bitcoin based on the expectation that its value will rise.

But, clearly, Bitcoin is very cost effective when used simply to transmit money for a purchase, loan, gift, or exchange. Even if both parties expect to convert back to regional currency after a short time, it reduces cost and leads to increased retained revenue.

Furthermore, it’s cost effectiveness is maximized as users retain their receipts in Bitcoin pending their own purchase of goods and services. In this way, they avoid any cost associated with a round trip exchange.

  • So let’s assume that consumers and businesses eventually hold 10% of their receipts in Bitcoin longer than a day. In this way, a certain amount of “coins” are required just to cover circulation.

Now, for more of our facts & assumptions…

  • Today, 85% of transactions are US dollar denominated.
  • Each day, the world needs about $3 trillion dollars to float current transactions. Additionally, the currency markets require another 3.98 trillion dollars for banks, exchanges, escrows, reserves and other activities driven by currency “markets”.
  • Let’s further assume that these 2010 figures never grow. Despite China’s massive growth and significant recover in the west after the 2010 recession, we will effectively freeze the world economy at 2010 levels.

There is no reliable data on the turnover rate of purchase and settlements, cash reserves—or how long a dollar typically stays in an individual’s pocket.

  • But if we assume that each dollar is turned over twice each day, we still require more than $3 trillion to grease the world’s daily needs. And that’s just US dollars.

Now, let’s make some reasonably conservative assumptions.

• Let’s assume that in 5 years, the faction of global transactions conducted online amounts to about 5% by value. (I believe that it is already far past this, but I am striving to be very conservative).

• Let’s further assume that 5% of these transactions use a new age cryptocurrency built on Satoshi’s model.

• My boldest assumption is that Bitcoin will be the market leader in virtual currencies. If any become viable, Bitcoin will be involved in 90% of digital currency transactions. That’s because it has already attained critical mass as evidenced by media frenzy, attempts at regulatory action, and the comparative market caps for various “coins”.

For these reasons—and the mechanisms of a two-sided market effect, it is unlikely that two parties will find it quick, simple and inexpensive to designate an alternate cryptocurrency for their transaction.

Finally, here is a fact rather than an assumption.

• There are currently 12.6 million BTC in circulation (the Bitcoins that have been mined to date, less a few that have been lost). But the total number of Bitcoins that can ever be available is 21 million. That’s it. There will never be inflation. No one can mint additional coins to cover national debts, public works bonds, or war reparations. It simply cannot be done. Bitcoin is product of math and not of monetary policy.

O.K. So, where does this leave us? It leaves us with a fairly straightforward calculation. Let me set up the calculation this way:

If there are eventually 21 million “units” divided amongst a daily liquidity requirement for $6 trillion dollars. And, if we divide the liquidity assumption by our very conservative assumptions, how thin must you slice the unit to buy a house or a hamburger? Or, more specifically, what fraction of a bitcoin will be equivalent to $1 of purchasing power?

If I were to complete the calculation, my Blog subscribers would think that I have lost my senses! The resulting value of Bitcoin dwarfs any speculative assessment that I have seen—even those that don’t restrict their analysis to conservative assumptions. But just because I am copping out of the final numbers crunch, don’t let it stop you! Play with the assumptions and the numbers…Just don’t play with the facts!

Now, it’s your turn to speak up. Where do you think that Bitcoin will be in 5 years?

— Worthless?
— Still around $450/BTC?
— Or very much different?

Others perspectives on the value of a bitcoin:

Disclosure:  AWildDuck and its editors are charter members of the Cryptocurrency Standards Association.

China creates a Bitcoin buy opportunity

When governments seek to inhibit, retard or ban a grassroots movement, it almost always has the opposite effect. Official acts of suppression tend to fuel publicity and growth by shining a light on the activity or venue that some wish to suppress.

The US government apparently knows this. Perhaps that is why a Justice Department official said on November 18 that Bitcoins can be a “legal means of exchange” at a U.S. Senate committee hearing.

  • Mythili Raman, acting assistant attorney general at the department’s criminal division, told the Committee on Homeland Security and Governmental Affairs “We all recognize that virtual currencies, in and of themselves, are not illegal”.
  • Federal Reserve Board Chairman, Ben Bernanke, told the Senate committee that the U.S. central bank has no plans to regulate the currency. He wrote to lawmakers: “Although the Federal Reserve generally monitors developments in virtual currencies and other payments system innovations, it does not necessarily have authority to directly supervise or regulate these innovations or the entities that provide them to the market”.

Of course, as with any monetary authority, the US government needs to preserve public faith in the dollar, and also avoid an exodus to digital currencies, even if used only for online transactions. But rather than attempting to ban individuals from investing in Bitcoin or using it as a currency, the US subtly discredits Bitcoin by placing fear and doubt in the minds of would be traders. For example, in this interview, former fed chairman, Alan Greenspan, explains with remarkable clarity why he believes it is foolish to accept Bitcoin as a currency.

Dr. Greenspan is smarter than me and I am certain that he believes what he says. But I respectfully disagree that trust comes only from the Aristotle doctrine of intrinsic value. Even without the backing of a trusted government or bank, investment value can arise from a combination of provable scarcity and widespread recognition.

Short term investment?  —  or
Long term exchange medium?

I prefer to study Bitcoin as an emerging global currency rather than as an investment vehicle. But even as an investment, its potential is inextricably linked to the likelihood that it will catch on as a currency—at least in some sectors or in some countries. So, let’s look at this possibility…

The long term viability of Bitcoin as a currency depends upon sustained trust by a large number of vendors and consumers. That is, buyers and sellers must feel that there will be broad or growing audience to accept the coins that they accrue, and that the value of their savings—or even of daily receipts—will not be eroded by inflation or a sudden lack of faith. (I am not too concerned with wild swings in exchange value during early adoption. These tend to be overlooked by “bleeding edge” adopters or at least the significant fraction of them that have a strong stomach).

Why is Bitcoin falling?

Bitcoin_pullbackThe short answer: it’s not falling for long. It is adjusting in response to politics, but it almost certainly will return to its historical trend.

The upward path of Bitcoin is already the stuff of legend. The exchange rate with the US dollar rose from nothing to $12 in the first 2 years of trading. This year, it peaked at $1240 on Thanksgiving Day in late November, but then pulled back as low as $650 over the next week. The fall was precipitated by a warning from the Chinese government to its citizens. Their announcement did not ban owning or trading Bitcoins, but it warned citizens that it was a very risky investment and also that it must not be used as currency in any transactions.

After pausing at around $700 for a day, it returned to a range of $850~1050 for most of December. But there was another sudden drop last night, on December 17. It pulled all the way into the high fours before settling between $550 and $600. (This posting was written on Dec 18).

But what happened last night? What caused the second nosedive in this graph?

China_effect_on_Bitcoin

Answer: China is at it again. It is using direct engagement rather than subtle persuasion in an attempt to block gradual adoption of a decentralized, uncontrollable phenomenon. Last night, China’s biggest Bitcoin exchange was barred from accepting new Yuan deposits. But it was not shut down. Citizens can continue to sell and trade Bitcoins that are already in their account and the exchange can still accept cash from outside the country.

Some would say that the downward pressure is a natural response to law and public policy. Wild Ducks augment this argument by pointing out that the fall is a temporary and technical effect. More to the point—we see it as a buying opportunity.

Of course, I acknowledge the short term risk and I continue to downplay the role of Bitcoin as an investment. But I can’t shake the notion that early adoption leads to appreciation over the course of a maturing commodity. I also can’t shake extreme excitement over a property of Bitcoin that places it head-and-shoulders above government and bank-backed currencies: The supply is capped. It simply cannot be printed, inflated, or used as a political tool. It also resists efforts of governments to attack personal wealth as the basis for mandatory redistribution, at least without full and wholehearted consent of the governed.

Given the choice of using it as currency later or owning it earlier, why not do both?

Further reading:

Ellery Davies is acting technology editor for AWildDuck. He dabbles in law, economics, and public policy and has been fascinated with Bitcoin for years.

Droid RAZR for 1¢? Max time-value compression

Most of the things that we own are more valuable when new — at least in the period before they become antiques or “ collectibles” (a term for anything that brings nostalgia to aging baby boomers). The value drops over time, because potential buyers are interested in the next hot item.

I’m not referring to asset depreciation as with a car or an old pair of jeans. These things lose value because they deteriorate as they are used. (My kids pay big bucks for used jeans, but they claim that they’re not used, but rather, distressed. Go figure! No, I am referring to the cost difference of buying something new today-vs-buying the same model in 6 months or a year. If it has not slipped into the realm of “antique”, then it’s hotness drops rapidly.

Example #1
Yesterday, I was traveling in New England. I purchased a Sunday Boston newspaper for $3.50. (Well, OK—I paid $4 due to a quirk of local geography).* What do you suppose that my paper will be worth after 2 days? That’s easy! Just as with stock quotes, information loses value rapidly. After 1 or 2 days my newspaper will line a bird cage, or get tossed into the recycle bin. It’s also pretty useful when dashing into a taxi through the rain.

A few online news outlets reverse this model by making current news available for free and charging for access to archives. This is a transient effect of booming internet growth and the fact that older articles have not yet been digitized. When consumers figure out that anything previously free on the web can always be located for free, this model will fall into the dustbin of history.

Example #2
In 2007, Apple introduced the iPhone to throngs of gear heads camped out at stores overnight. Were you surprised at a $200 price drop after two months? Few would be surprised today. Even an iPhone is superseded by other gadgets after a few months. The cost dropped because of a drop in pent up demand and an increase in supply.

Additional examples are all around us. Movies cost $10 when released to theaters. Within 2 months, Netflix pushes them through an all-you-can-eat pipe. Even Avatar was available on DVD and Blu-ray within weeks, and at a fraction of the cost of a night at the movies. (Less, if you have figured out how to use a Torrent).

Enough economics & history. Now, for a WildDuck observation…

9 days = $320.

Even with the historical perspective of the iPhone cost plunge, I was dumb struck by an offer from Amazon Wireless, a Verizon reseller. Anyone reading this in 2011 knows that the hottest recent phone is the Motorola Droid RAZR, especially if you choose Android over Apple. I want this phone and if I hadn’t been traveling when it was introduced on 11/11/11 (at 11:11 AM), I would have nabbed one at full price. After all, it certainly won’t drop significantly in price during the first 10 days, right?

Wrong! Despite a phenomenal debut (and ongoing demand), Amazon has dropped the subsidized price by $320. For those of you scratching your heads, it’s below zero, because the deal includes a $100 Amazon gift card.

What’s wrong with this phone? Does it suffer from a glitch worse than the iPhone death grip? No! What’s wrong is that it is 9 days old. Normally, this is well within the courtship window. Heck! Some early buyers haven’t even received their RAZR. But in the case of über-hyped gadgets, there is a delicate interplay between advertising, production capacity, retail logistics and lust. In the very hot market for 4G LTE phones, a model introduced last week is a relic of the Jurassic era. Who knew?!

* I picked up a Sunday newspaper at Starbucks in Marlborough Massachusetts. The city sits within a major beltway encircling Boston and within the region that gets a Boston news distributor and Boston-local pricing. But wait!

Welcome to Marlborough…Oops! You’re outside of Rt 495!

The hotels & shopping mall that cater to visitors like me are situated in a small section of town just outside the beltway. Retailers at the western edge of Marlborough know that the west highway exit is labeled for a town in the next county. They train cashiers to point out the fine print next to the newspaper price. Every time I visit this city, some barista or french fry queen puts on an empathetic face and glibly informs me in a rehearsed voice: “It says: $4 outside of Rt 495”.

Well, that may sound reasonable to a first time visitor, Babs—but it just doesn’t wash! News distributors don’t bisect towns into price tiers. The out-of-town delivery premium applies to towns beyond Rt 495—and only if the distributor charges for an outlying region. Retailers know this. After all, the sidewalk paper kiosks are all configured to charge the metro price. But the barista continues her script, shrugs and says, “You’re past the circle. That’s the dividing line.”

An unsuspecting visitor doesn’t realize that he is being fleeced. But at least, I can complete the transaction with the inner knowledge that I am being plucked like a holiday turkey. (Yeah, I know…It’s only 50¢. But it’s the principle, dear reader! What happened to fair play?!)