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Crypto Valuation

Lets use Bitcoin as an example. Why does Bitcoin have value?

First lets think about different ways for something to have value.

  • Future earnings
    • e.g. Dividends. Dividends contribute to the value of a Stock
  • Ownership of assets
    • e.g. Cash. Stock in such companies is valuable because shareholders could close the company and pay themselves the cash.
  • Utility
    • e.g. Gold. Usefulness contributes to the value of gold. It is malleable and it conducts.
    • You could even argue that gold jewellery provides utility.
    • Similarly the demand for Bitcoin from technology enthusiasts can be viewed as utility.
    • All sources of value really come down to utility either directly or indirectly.
    • Advantages over Fiat Currency
      • Crypto can be useful if it has advantages over fiat currency
      • e.g. reduced transaction costs, anonymity
      • See here for my thoughts on Crypto Use Cases

Lets extend the above notes and thing about "price supports". These are mostly variations on the utility point above. In particular, "price supports" can be helpful in stabalising the value of an asset.

  • Taxes
    • If governments denominate taxes and fines in Bitcoin then this can act as a demand and price support.
    • If bitcoin becomes too cheap than people can arbitrage and pay their taxes in bitcoin rather than fiat.
    • This point is more poignant for fixed nominal taxes and utility bills rather than percentage taxes such as income tax.
    • It's important to make a distinction between denominating in Bitcoin and accepting Bitcoin based on nominal fiat currency amounts.
  • Contracts
    • If businesses start writing contracts in bitcoin.
    • This is similar to the taxes argument and can add similar stabilising pressures
    • To get this benefit Bitcoin would need to "convince" people that it's more useful in some way than fiat currency
  • Anticipated Future Utility
    • Even if bitcoin is not super useful right now, the anticipation that it might be useful in the future can help support its price.

Now lets consider the Speculation Bubble aspect:

  • Speculation can support the price of something which doesn't really have any value.
  • e.g. Pyramid Schemes. Pyramid/Ponzi schemes where new entrants fund the profits of early adopters
  • If there's no inherent usefulness then people are only participating because they hope they can flip Bitcoin to someone else for a profit. Such an arrangement will almost surely run out of steam eventually.
  • Rough reasoning:
    • The price only goes up if the volume of demand increases
    • At some point things run out of new participants and or exhaust the demand of existing participants
    • If the participation level is low a bubble can perhaps be maintained for a long time through churn (new people enter, old people leave). Even then it will lack the stability provided by price supports and usefulness.

Risk Aspects

Crypto is Non-Physical

Unlike gold or vegetables, you can't store cryptocurrencies physically.

Just as how fiat currency can make you dependant on the issuing country, cryptocurrencies have their own dependancies and modes of failure outside of a holder's control.

For example:

  • Collective Reassignment
    • Rollback of ledgers
    • Fork on the ledger
    • Even if the code appears to prevent such reassignment, particapants could just collectively aggree to jump to some alternative ledger.
    • See Bitcoin Cash and and the Steem events for some context of how blockchains can be reassigned in unexpected ways.

Stablecoin Depegging

On the topic, I think Stablecoin projects could benefit from Black Start contingency plans.

Outline:

  • Suppose some stable coin is useful for frictionless small transactions (like buying coffee)
  • Then one day the coin depegs (no biggie, hopefully people only had small holdings in it)
  • Why not have a plan to "Black Start" just like electricity grids do?

Why is this interesting:

  • Stablecoins have an inherent depegging risk.
  • In contrast with Bitcoin which looks volatile to begin with, a stable coin could look stable for many days but then crash to near zero one day.

External Links