I’ve blogged about this before, but probably less clearly than I should have. A “Why aren’t you blogging?” email from Bob Murphy inspired me to try to boil this down to a few paragraphs:
Let’s imagine a future where cryptocurrency (or more specifically Bitcoin) is widely accepted, and we have infrastructure in place that makes it very easy to exchange Bitcoin for other assets.
I’ve seen many people — both journalists and economists — suggest that in that future, Bitcoin will be quite valuable. (That is, one Bitcoin will be worth a great many dollars, or a great many Teslas.)
But it seems to me that the opposite is more likely to be true. Here’s why:
1) Both today and in that hypothetical future, if I want to send a million dollars to a guy in, say, London, and have him know with certainty, within an hour, that the transaction is irreversible, then I am definitely going to use Bitcoin.
2) Today, if I think I *might* want to send that million dollars to London sometime this week, I am going to hold a million dollars worth of Bitcoin for a while, just in case. That’s precisely because acquiring a million dollars worth of Bitcoin at the last minute is kind of complicated and I don’t want to deal with it.
3) But in that hypothetical future, I will keep my million dollars in an interest-bearing asset, and then, using that marvelous future financial infrastructure, trade the interest bearing asset for Bitcoins about ten seconds before I want to send them to London.
This means that as Bitcoins become easier to use, the demand to hold them should go down, not up, and the value of the Bitcoins themselves should go down, not up, accordingly.
Am I missing something?
It kind of depends on what future Bitcoin (or other crypto currency) looks like, but for now the strategy of buying bitcoin ten seconds before you spend it doesn’t really work. Bitcoin transactions can only settle when the next block is mined, and aren’t really final until several blocks after that. Most of the value now is speculative, and it’s hard to predict what the speculators will think of it in the future. At some point the power-consumption financial drain may outweigh the speculative inputs, but it does seem to be holding up for now.
The ability to exchange Bitcoin for other assets doesn’t necessarily mean people will want to. What if Bitcoin (or some other crypto) is able to remain anonymous and avoid taxation? Why would you create a taxable event by exiting Bitcoin frequently? I imagine some people would want to stay in Bitcoin forever.
Though maybe that is too naive to think that in a world where Bitcoin is widely accepted it is also able to remain outside the law.
Jon Leonard (#1): (This response has been edited.) Yes, it would have been safer to say an hour before, but I am talking about a hypothetical future in which there are all sorts of extremely convenient off-chain ways to exchange Bitcoin. I want to use the blockchain for my transfer to London, because my correspondent there is very concerned about being able to trust that the transaction is irreversible. But maybe on my end, I can trade bonds for Bitcoins in ten seconds, because I am trading with a partner I already trust so there’s no need to wait for confirmations (which means that the transaction might be either conveniently off-chain or conveniently on-chain with a trusted partner—and maybe doable in ten seconds either way).
Steve (#2): But things like anonymity and tax avoidance are not relevant to the argument at hand, which is that Bitcoin’s value will rise specifically because it will become easier to trade in Bitcoin.
I guess I’m having a hard time separating the two. Is the guy in London dumping his million dollars in Bitcoin the second the transaction posts? Who buys it from him? Somebody has to be holding reserves to sell for these last minute transactions. If price of Bitcoin goes down I imagine the transaction fees go up.
It sounds like you are just using Bitcoin as a substitute for a wire transfer. In which case fees kind of equilibrate with whatever it costs to do that. But I can’t imagine this will ever be the majority of use cases to cause the kind of drop in long-term-holding that you envision.
I fully admit I haven’t thought about this for more than 30 minutes so poke holes in this at will…
I know little about crypto but I don’t see anything in your analysis that suggests there won’t be others doing the same thing. I don’t know how to estimate the increased transactional demand vs the argued-for lower sequestering demand.
Steve (#5): Is the guy in London dumping his million dollars in Bitcoin the second the transaction posts? Who buys it from him?
The whole point is that the guy in London wants to trade those Bitcoins for interest-bearing assets as fast as possible — and to get someone to take them off his hands, he has to offer them at a low price. Multiply by many many transactions, and in equilibrium, the price of Bitcoin must arguably be quite low.
Bitcoin will trade at the price that will induce people to hold the entire current stock.
If early bitcoin is relatively illiquid then people will hold a higher number of bitcoin per potential transaction they might wish to conduct in the currency. At the same time its illiquidity will limit the desire to use it for transactions.
If later bitcoin becomes more liquid then this will increase the demand to use it for transactions while at the same time reducing the need for bitcoin held per potential transaction.
Depending upon the elasticities involved then this could mean that the total demand to hold later (and more liquid bitcoin) might exceed the demand to hold earlier (and less liquid bitcoin) and lead to a higher price for the later.
“… as Bitcoins become easier to use, the demand to hold them should go down, not up, and the value of the Bitcoins themselves should go down, not up, accordingly.
Am I missing something?”
If we postulate that Bitcoin becomes more popular, what does that mean? It becomes acceptable as currency, hence it displaces dollars. Demand growth – converting dollars into bitcoin – translates into a rising price, denominated in dollars.
The upside is enormous. Take the limit as dollar usage shrinks to zero… the limit doesn’t exist. What’s the value/price, in a world without dollars?
According to OECD, gross world product is $90 trillion. Eventually, 21 million bitcoins will be mined: $4,000,000 each
Not a bad ROI on high speed silicon, and that gas fired electrical generator –