- What is a store of value?
- What makes an item a store of value?
- Bitcoin situation
- A store of value, the element of exchange, a unit of account
- What makes bitcoin a bad store of value?
- The Challenges of Using Digital Money
- Lack of own value
- Volatility and correlation
When you think of a store of value, usually precious metals like gold, silver, or platinum are coming to mind. And not for you alone, because these are the resources that are the main way to hedge finance to protect yourself from the turmoil in traditional financial markets.
But lately, the question has been increasingly raised - can Bitcoin become an alternative to precious metals in this regard? In this article, we will provide arguments both for and against. Let's begin.
What is a store of value?
A store of value is an asset that can maintain its value over time. You acquire it with the confidence that after many years it will still be quite valuable, and in the future, it will also increase. And yes, classic gold and silver fit this definition perfectly.
What makes an item a store of value?
To understand what makes a thing a good store of value, it's easier to figure out what might prevent it from becoming one. And the simplest option is fragility.
Take food, for example. Some exotic fruits are expensive and valuable by themselves since their price is determined by transport costs, production complexity and other parameters. But they cannot serve as a reserve since they do not differ in durability.
The opposite situation is buckwheat. It is stored for a long time, has some intrinsic value because it is useful. But it is quite easy to produce it, and a long-term deficit is impossible. Therefore, although there is intrinsic value, it fluctuates, depending on the content of the market. And overflowing the market can completely devalue your buckwheat savings. Therefore, we come to the second important criterion - the presence of a deficit.
Let's move away from food and pay attention to other things. Someone consider fiat currencies as a store of value - dollars, euros, rubles, hryvnia. They have their own price, do not deteriorate over time, their quantity is strictly regulated, so there is some shortage. However, a new problem arises here - the purchasing power of each banknote decreases as their number increases. Simply put, you cannot print new money and hope that its price will not fall. And since no one is going to stop the official issue of banknotes, they are gradually depreciating. Due to such inflation, your savings in foreign currency will be worth much less in 10 years than at the time of their purchase.
The process of issuing new money is not too complicated, but it is completely controlled by the state. And no one is going to stop him, so depreciation is inevitable.
Now let's look at gold. For a start, you need to find it somewhere - it's already kind of difficult. Then - to get it and clean, which is also not too easy. The demand for gold always exceeds the supply - there is a deficit. In addition, it is, a limited product, since it can neither be grown from existing resources nor created from scratch. All this makes gold an excellent store of value.
Since the appearing of the first digital currency, it has been argued that it is more of a “digital gold” rather than a currency. And this thesis is still actively promoted. Most often, in the context of the fact that bitcoin is one of the most reliable assets that humanity has. In fact, this is a rather strange position in relation to a thing that can lose almost 20 percent of its value in a day. However, cryptocurrency has good chances to become a real store of value someday. And let us explain why.
Perhaps one of the most convincing arguments. The fact is that there can be only 21 million bitcoins in total - this is strictly written in the blockchain protocol.
Further. The only way you can get these coins is by mining. Computing systems solve the cryptographic puzzle for speed, and the one who will solve it first - gets a reward. And at the same time - it creates a new block for recording the stored information.
However, this reward decreases over time due to a process called halving. From the very beginning, each miner received 50 bitcoins per block mined. After the event of halving, I began to receive 25. Then - 12.5. Roughly, given the current trends, by 2031 miners will totally stop receiving new bitcoins.
Let's say that 10 years ago, you were able to purchase 25 percent of the total Bitcoin supply. Then it was quite real - the price was low. Time passed, new coins were mined, the turnover increased, but the maximum amount of bitcoins still remained stable, and you have 25 percent of it. Therefore, there is no devaluation due to inflation.
What prevents anyone who wants to take the open source code of the Bitcoin network, add a little fad about adding 100 million new bitcoins to their crypto wallet and add it to the general network? Nothing. Because nothing will work.
In order to interact with the blockchain, you need to become its node. Each node gets at its disposal a complete copy of the entire network. However, any inconsistent change or addition of a new block automatically leads to the fact that the node is thrown out of the system. The blockchain automatically and regularly synchronizes its state on all machines connected to it. And any node containing unconfirmed information is ignored, forming a “fork”. It is impossible to transfer funds from this fork to the main chain, so the whole idea is initially useless.
The only way a new branch or new protocol can become generally accepted is network-wide consensus. That means - the overwhelming majority of nodes must agree with the proposal. And this is an extremely slow process. And even the introduction of generally positive changes aimed not at personal enrichment, but at optimizing the code, can meet with resistance. And lead to a split in the community into two groups, one of which will begin to follow the new protocol, and the other will continue to use the old one. In this case, the funds will not be doubled - either they will remain on one chain, or they will go to another.
This means that there is no difference between the individual units. One ounce of gold is no different from another. The same is true for securities and banknotes. Their value is determined by denomination, not history.
Bitcoins have some difficulties with this. On the one hand, 1BTC is always 1 BTC. But on the other hand, the history of each coin can be traced back to the moment of its creation. And it may happen that some of them were used by individuals on the official "blacklist" for criminal purposes. In the worst case, that kind of money will be frozen when it gets there. This seriously increases the risk of using "old" bitcoins and therefore may affect their price.
On the other hand, there are so-called cryptomixers, which are used to "reset" the history of use. After going through the "mixing" procedure, it is impossible to establish what happened to each particular coin prior to this procedure. So it can be argued that everything is fine with bitcoin fungibility.
Ease of transportation of the asset. Thousand dollars in ten bills? Easy. A million in blocks of a hundred is a little more difficult. $ 10,000 in oil? Quite problematic.
Plus, the form factor plays an important role. Banknotes must be compact enough to carry and pay for in any situation. In this regard, gold is a little more complicated, but small bars are still quite easy to transport, although they cannot be used as a means of payment.
Bitcoin is doing just fine here since it has no physical embodiment. It is simply inimitable and unique information that can be recorded on any device. As for transactions, it is still easier here - for a small commission, you can transfer at least a billion dollars anywhere in the world in a matter of minutes.
The ability to split a unit into smaller, but still valuable, elements. A bar of gold can be cut in half - and even dust will have a cost. $ 100 can be exchanged for an equivalent amount of 5 cents coins - they will not become less useful because of it.
Bitcoins have no problems here either. Each unit is divided into a million smaller ones, called satoshis (in honour of the creator of the blockchain - Satoshi Nakamoto). So users can customize their transactions with 8 decimal places.
A store of value, the element of exchange, a unit of account
There is an economic theory that every currency must go through all these three stages on the way of its formation. And this also applies to cryptocurrencies.
On the one hand, bitcoin already has some collectible value, and can also be used to move funds from point A to point B. However, it has not yet received widespread acceptance and is mostly in the hands of amateurs and speculators.
However, there is another opinion. There is the so-called "Gresham's Law", which boils down to a simple formulation - "bad money drives out good money." This means that when an alternative is available, people tend to spend less valuable currency and accumulate more valuable. For example, many people do not keep their savings in national currency, preferring dollars or euros, but in everyday life, they use local money. With bitcoin, the situation is similar - it is accumulated, but not spent. Since they believe that its value, will only increase if it will change.
But the more people believe in the stability of Bitcoin and exchange their money for it, the more liquidity this cryptocurrency will begin to possess. And the more stable the price will be. Which in any case will lead to the fact that people begin to widely use it as an exchange medium.
Active use will stabilize the price even more, which will allow you to move on to the next stage - to become a “yardstick” for other currencies - a unit of account. Now this role is played by the euro and the dollar - in almost every country in the world, prices, salaries, purchasing power and the value of the local currency are equal.
When all three stages are passed, bitcoin will be able to claim to become a new standard that can replace traditional currencies from use.
What makes bitcoin a bad store of value?
There are several critical points that hinder the widespread use of bitcoins as a store of value. And not only from the point of view of skeptics, but also from those who don't understand much about the fundamental principles of cryptocurrencies.
The Challenges of Using Digital Money
When Satoshi Nakamoto created bitcoin, he clearly understood its main task. This is embodied in the title of the white paper - "Bitcoin: A Peer-to-Peer Electronic Cash System". Peer-to-peer electronic payment system.
Initially, it was assumed that bitcoins would be used for regular transactions, and not for accumulation. After all, if the cryptocurrency does not represent value as payment, its price begins to be regulated not by the utility, but by speculators.
However, most users did not think so - traditional funds were enough for people, and bitcoins were used as backup storage. However, the situation changed in 2017, when the first major fork occurred, as a result of which users tried to create exactly the blockchain that Nakamoto had planned.
The idea was to increase the size of the basic block - so that it would accommodate more transactions, and the commission would decrease accordingly. However, larger blocks are more difficult to mine, so miners with more computing power immediately get an advantage. However, the new protocol was introduced and some (smaller) users switched to it. This is how Bitcoin Cash was born.
But the main protocol also had to be somehow adapted to the new requirements. This was achieved by implementing the SegWit protocol, which increases the efficiency of storing information in blocks. And besides this - to create an opportunity to use "add-ons", such as the Lightning Network, transferring the processing of some information outside the original blockchain.
However, this didn`t solve all the problems, so the Bitcoin network still cannot properly cope with the problem of scaling, which is a serious obstacle to using it as a method of payment. And its value continues to be formed exclusively by connoisseurs, which prevents its formation as a store of value.
Lack of own value
Any asset is valuable only because a large group of people think so. The dollar is valuable because the United States controls world politics. Gold is valuable due to historical conventions, even though the "gold standard" has been abolished. Artworks are valuable because they are rare, unique, and it was decided by wealthy connoisseurs which buy them at auctions. The situation with bitcoin is very similar.
Strictly speaking, cryptocurrencies are valuable only because those who use them think so. But this is an extremely small and not very influential group of people. Those who have at least some power look at this innovation with scepticism, figuring out how to get at least some benefit from it.
But if the value of paintings and sculptures is at least a little, but obvious to every cultured person - at least due to the cost of materials and the work of the creator, then the importance of Bitcoin has to be regularly proved. Every crypto enthusiast has probably more than a dozen times face a situation in which he had to explain what bitcoin is and why it is at least worth something. Plus, people still don't really believe in things that can't be touched.
Volatility and correlation
Those who managed to buy or mine bitcoins at the very beginning of the development of blockchain networks received a lot. At least - emotional attachment to this currency and confidence in its potential. And those who joined cryptocurrencies later also lost some of their savings due to the bursting "bubble", on the contrary, they consider Bitcoin to be meaningless nonsense, the price of which is so high solely because of connoisseurs.
Alas, bitcoin is incredibly volatile and its price fluctuates widely. Wide and unpredictable. It is easier to predict the dynamics of prices for gold and securities, even despite the fluctuations. In extreme cases, you will earn less on speculation than you could. With cryptocurrencies, you can never say for sure what will happen to assets after a while.
Besides, there is one more important point. The dollar exchange rate, for example, is practically independent of national currencies. Simply put, the correlation between it and other assets is clear. With Bitcoin, so far, such a correlation has not been tracked, since this requires that it remain stable, while other currencies, on the contrary, begin to fall. And yes, the current slow uptrend does not guarantee that the trend will continue if, for example, the dollar falls.
A phenomenon that is already inextricably associated with bitcoin is the "economic bubble". An analogy is the so-called "tulip mania" (the exuberant demand for tulip bulbs in the period from 1636 to 1637).
In both cases, investors started buying things that were considered rare, with the goal of then reselling them profitably. However, there was no real value behind them - only "imaginary". Therefore, at some point, the "bubble" burst, and many investors lost a significant part of their investments.
And there is no guarantee that Bitcoin will not repeat this event again in the near future. Therefore, as a store of value that can depreciate solely due to spontaneous growth in demand and further disappointment, Bitcoin is not very reliable.
Despite the fact that bitcoin has every chance of becoming not only a reliable store of value but also a world currency, only time will tell what will happen next. Economics, alas, is not a very exact science, and its forecasts often fail for independent reasons.
However, at the currenct moment, while the situation is relatively stable, it is possible to use bitcoin as one of a saving methods.
Finance and investmentAuthor: EXBASE.IO | Nov 09, 2020
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