What Makes Bitcoin a Store of Value?

What Makes Bitcoin a Store of Value?

Basics

Bitcoin is a digital asset that has been debated as a potential safe-haven asset, similar to precious metals like gold or silver. Individuals often invest in these metals as a hedge against instability in traditional markets. However, whether Bitcoin can be considered a store of value like these metals remains a subject of discussion. In this article, we will explore the main arguments both for and against Bitcoin's status as a safe-haven asset.

Definition of a Store of Value

An asset that can maintain its value over time is referred to as a store of value. This means that if you invest in such an asset today, you can be confident that its value will not decrease over time. The asset's worth will likely increase over time. Precious metals like gold and silver are typically considered to be safe-haven assets that retain value. These metals have historically been valued for several reasons, which we will discuss in detail shortly.

What Makes an Asset a Good Store of Value?

To be a good store of value, an asset must be durable and maintain its worth over time. Food, while essential for survival, is not a good store of value due to its perishable nature. Even if it retains its intrinsic value, its worth will significantly decrease over time. Dry pasta, while more durable than perishable food items, is still not a reliable store of value. Although it may retain its intrinsic value, its worth can be easily diminished due to oversupply.

Fiat currencies such as dollars, euros, and yen are not reliable stores of value either. While they may retain their worth over time, the purchasing power decreases as more units are created, which is known as inflation. Inflation can be caused by the excessive printing of fiat currencies by governments to stimulate economic growth.

For instance, if you hold 25% of the total supply of $100 billion, your share would be $25 billion. However, if the government prints an additional $800 billion, your share will decrease to ~3%, resulting in decreased purchasing power. As a result, for an asset to be a good store of value, it must be durable, maintain its intrinsic value, and be scarce.

When choosing a good store of value, it's essential to consider durability, scarcity, and difficulty of production. Food, for example, may be valuable during times of scarcity, but it's not a good store of value as it will degrade over time. Fiat currencies, like dollars, may retain value in the short term, but their purchasing power decreases as more units are created, resulting in inflation. In contrast, a good store of value, such as gold, has a finite supply and is difficult to mine, making it challenging to flood the market with new units. Its scarcity means that even if demand increases, supply cannot be significantly increased to cater to it.

Bitcoin as a Store of Value

Bitcoin has been championed by enthusiasts as a "digital gold" since its inception. This idea has gained momentum in recent years, with many proponents arguing that it is one of the most reliable assets. According to the "store of value" theory, Bitcoin is the best way to protect your wealth from being devalued over time. Despite its reputation for extreme volatility, with fluctuations of up to 20% in a single day, Bitcoin remains the top-performing asset class to date. But why is Bitcoin considered a store of value?

Scarcity

The argument for Bitcoin as a store of value centers around its finite supply. The protocol ensures that there will never be more than 21 million bitcoins, with the only way to create new coins being through the mining process. Miners use computational power to guess a huge number, which earns them fresh coins.

Over time, the reward for mining diminishes through a series of halvings. For example, the reward was reduced from 50 BTC to 25 BTC during the first halving, then to 12.5 BTC, and so on until the final fraction of a coin is in circulation. Unlike fiat currency, once you acquire a percentage of the Bitcoin supply, your percentage remains the same since no entity can add more coins to the system. This makes it an ideal asset for storing value.

Decentralization

If you're thinking about making your own version of Bitcoin by copying its open-source code and adding 100 million more coins, think again. While you could technically do this, it won't work out as you planned. Once you make changes to the software, the rest of the Bitcoin network will ignore you because your version is no longer the same as the globally accepted Bitcoin. It's like claiming there are two Mona Lisa paintings when there's only one.

All users who run the software make up the "government" of Bitcoin. The protocol can only change if the majority of users agree to the changes. Convincing the majority to add more coins would be a tough task because you're asking them to devalue their own holdings. Even small changes to the protocol take years to reach a consensus across the network.

As Bitcoin grows, making changes will become even more difficult. However, holders can be confident that the supply won't be inflated due to the decentralization of the network. Even though the software is man-made, Bitcoin behaves more like a natural resource than a code that can be changed at will.

The Properties of Good Money

Bitcoin is often considered a good form of money due to its similarities to traditional currencies. Proponents of the store of value argument cite Bitcoin's scarcity and unique features as reasons for its value. Throughout history, gold has been used as currency because it's durable and rare, but it lacks other characteristics necessary for use as currency. For something to be a good currency, it must also be fungible, portable, and divisible.

  • Fungibility means that each unit of currency is identical in value, regardless of its history. While Bitcoin is functionally fungible, businesses have blacklisted funds that were involved in criminal activities in the past.
  • Portability is the ease of transporting an asset, and gold has traditionally been excellent in this regard, although smaller denominations are required for everyday purchases. Bitcoin, on the other hand, is superior to precious metals when it comes to transportability as it does not have a physical footprint.
  • Divisibility is the ability to split currency into smaller units, and both gold and Bitcoin excel in this area. While gold can be divided into smaller denominations, each Bitcoin can be divided into one hundred million smaller units, or satoshis, allowing for greater control over transactions and making it easier for small investors to buy fractions of bitcoin.

Store of Value, Medium of Exchange and Unit of Account

Bitcoin's role in the financial world is a topic of debate. Some view it as a mere currency, useful for transferring funds from one point to another. However, this is opposed by the store of value advocates who believe that Bitcoin must first pass through certain stages before becoming the ultimate currency.

The first stage is the collectible phase, which is where Bitcoin is now. It has proven its functionality and security, but only a small niche has adopted it, consisting mainly of hobbyists and speculators. Proponents of Bitcoin as a store of value argue that for it to progress to the next stage, it needs greater education, institutional infrastructure, and more confidence in its ability to retain value. Some believe it has already reached this level.

However, Bitcoin isn't widely spent at this point due to Gresham's law, which explains that bad money drives out good money. Individuals prefer to spend the inferior currency and hold onto the superior one. Bitcoin users prefer to hold their bitcoins, as they believe that they will retain their value. As the Bitcoin network grows, more users will adopt it, increasing liquidity and stabilizing its price. As a result, there won't be as much of an incentive to hold onto it for long-term gains, and it will be used more in commerce and daily payments.

If Bitcoin can achieve these three monetary milestones – store of value, medium of exchange, and unit of account – it could displace the currencies used today and become a new standard. In such a world, the value of other assets would be measured in bitcoins.

Arguments Against Bitcoin as a Store of Value

Bitcoin's proposed role as "digital gold" has generated differing opinions from various groups. Both cryptocurrency skeptics and some members of the Bitcoin community have raised concerns regarding this notion. Some view it as a logical progression for the currency, while others see it as an ill-advised idea.

Bitcoin as Digital Cash

When it comes to the concept of Bitcoin as "digital gold," there are criticisms from both Bitcoiners and cryptocurrency skeptics. While some argue that Bitcoin was intended to be spent from the start, others believe that hoarding Bitcoin harms its adoption. In 2017, there was a significant fork in the Bitcoin network, with the minority seeking bigger blocks for cheaper transaction fees.

The original network's upgrade, SegWit, increased block capacity and laid the groundwork for the Lightning Network, but it's not without its challenges. The Lightning Network requires a steep learning curve, and on-chain transactions are no longer cheap during busy times. Critics argue that not increasing the block size damages Bitcoin's usability as a currency.

It Has No Intrinsic Value

Although some compare Bitcoin to gold, others find it an absurd comparison. Gold has been an essential part of societies for thousands of years, while Bitcoin is an eleven-year-old protocol. Gold has been revered as a status symbol and an industrial metal for millennia, while Bitcoin has no use outside of its network.

Bitcoin may emulate gold with its finite supply and mining, but it is still a digital asset. All money is a shared belief, and Bitcoin is no different. The value of Bitcoin is still given by a small group of people compared to gold, which is accepted worldwide. Bitcoin is still unknown to many, and most people are not aware of it.

Volatility and Correlation

The early adopters of Bitcoin have seen immense growth in their wealth, while those who bought at its peak experienced significant losses. Bitcoin is known for its high volatility, and its markets are unpredictable, in contrast to the relatively stable fluctuations of gold and silver. Bitcoin’s ability to act as a store of value is still questionable, as it has not yet stabilized in price.

Additionally, Bitcoin's relation to traditional markets is uncertain since it has never been tested as a safe-haven asset while other asset classes are also performing well. Some argue that Bitcoin is uncorrelated with other assets, but it remains to be seen if it will hold steady if other assets suffer.

Tulip Mania and Beanie Babies

While some people compare Bitcoin to previous bubbles such as Tulip Mania and Beanie Babies, it's important to note that these comparisons are not entirely accurate. Tulips and Beanie Babies were overvalued due to a perceived rarity that did not exist. Bitcoin, on the other hand, has a finite supply, which means its value is not based on a false perception of scarcity.

Conclusion

Bitcoin has similarities to gold as a store of value, such as a limited number of units, a decentralized network, and the ability to hold and transfer value. However, it needs to demonstrate its worth as a safe-haven asset which is yet to be seen. It remains uncertain whether Bitcoin will be adopted widely during economic turbulence or remain confined to a small group of users. The verdict is yet to be determined over time.

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