Bitcoin: Store of Value?

Is Bitcoin a store of value? There are urban legends of people making millions because they bought Bitcoin a couple of years ago, and now it’s worth a lot more. However, that is not “store of value”. That’s speculation. They could have done that with anything; commodities, art, wine, baseball cards or even antiques.

Store of value means people don’t mind holding it. When a currency or asset becomes a store of value, it has not only utility and speculative value, but it has low risk in keeping it around. Here is link to a chart of Bitcoin/US Dollar from Trading View. They took the data from BATS. Here is another chart, using data from Mt. Gox.

Here is a chart of the Japanese Yen to US Dollar since Bretton Woods in 1971.  In 1971, foreign currencies were allowed to float.  Prior to that there was a fixed exchange rate tied to gold. It could be said that Bitcoin is having a Bretton Woods moment right now.

US Dollar to Japanese Yen Exchange Rate data by YCharts

I think it’s useful to compare only to get a sense of where Bitcoin is, and where it could go.  It also pays to think about what Bitcoin needs to get to a level where it becomes a store of value-because it certainly isn’t today.

To become a store of value, a currency needs to be able to be used for much more than just payment:

• lines of credit
• margin
• collateral
• debt instruments
• swaps, options
• salary
• benefits
• wealth
• accepted readily and converted easily
• public reputation
• where people and entities are indifferent to holding Bitcoin vs other currency

Bitcoin is none of these things, but it is early.  All anyone talks about today is potential.  Is the potential there for Bitcoin to be something?  Yes, there sure is.  Does it fill holes that have existed in the internet since inception?  It seems that it does.  Is it more than just a cryptocurrency?  Yes, it’s a platform as evidenced by the Etherum project.  Can it add value and grow worldwide economic GDP with wide adoption?  It’s clear to me that it can plug leakages in the system-and the only question I have is are the benefits of Bitcoin greater than the cost of the leakages.  If so, it is GDP additive.

But, Bitcoin is nothing until it becomes an easily used currency.  That’s the first step.  How does it get there?  By dampening volatility.

There is only one way I know of to dampen volatility in markets.  It’s through the use of futures and options. Futures allow participants to transfer risk from one party to another efficiently. Currently, there is no futures market in Bitcoin.  Options allow people to hedge risk in a precise mathematical, probabilistic way .  There is no options market in Bitcoin.  Today, if one checks out prices at different exchanges, Bitcoin value is very different.  Arbitrage opportunities prevail.

Entities come together out of their own economic self interest to determine prices, transfer and hedge risk. Speculators join the fray and grease the wheels of the market trying to buy and sell for their own individual profit.  Having a centralized system like that will dampen volatility and allow Bitcoin to be a stable base to build on.   If you don’t like speculators, check the volatility of price when it comes to onions and crude oil over the last 50 years.  One has futures.

The current exchange market in Bitcoin is simply a cash price. While it helps, it’s highly fragmented.  If a traditional exchange stepped into the market, and created a centralized platform to trade and hedge, Bitcoin would get to where it needs to go much faster.

Governments already are looking at regulating Bitcoin, and banks are trying to figure out ways to stomp it out.  However, because it fills a big hole in the system for techies, and because the targets on the back office payment system is so big, the internet army has an economic incentive to try and make it work.

It’s very easy for governments and traditional institutions to fan the fires of fear when the holders of Bitcoin are exposed to all the risk of holding Bitcoin.  If we think about Bitcoin in terms of traditional marketing metrics on product adoption, we are in the stage of innovators.

It will be a long time until we get to early adoption. To get to early majority, the question of risk will have to be answered. If it’s possible to diversify risk early, the early adopter stage will happen sooner.  It’s important to remember that we aren’t talking about some mobile app or game when it comes to Bitcoin.  We are talking about the utility value of people’s well being.

Even with all the crazy actions the Japanese and US Central bank have taken since 1990, the Yen/Dollar relationship is relatively stable.  Could Bitcoin stand that test of time given actions by central bankers?  Not in its present state, but it is early days.  Central banks will have a say in the value of Bitcoin, because fiat currency by government isn’t going away anytime soon.

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