Bitcoin: Why the lack of a ‘use case’ could undermine the cryptocurrency

Bitcoin fanatics struggle to explain what the signature cryptocurrency is for. Some of its fans claim that bitcoin will soon compete with the dollar as a widely accepted currency; others say its scarcity offers great protection against raging inflation and economic crises. It is also being hailed as a “store of value” as the new digital gold whose price is destined to continue to rise because its supply is set in stone and its popularity will only increase continue to rise.

In reality, Bitcoin flopped as a buying vehicle, failing its first major test as a safe haven during last year’s stock market crash. Its extreme volatility — with as many collapses in the last three years as crude oil has suffered in two decades — means it’s far from a reliable store of value. Its erratic trajectory of late is true: After hitting an all-time high of $64,800 on April 14, Bitcoin slipped over 23% to $49,700 at noon on April 23 and plummeted $200 billion market cap. “The only ‘use case’ Bitcoin has left is to hope that the value goes up and someone pays you more than you paid,” says Alex de Vries, a Dutch economist who runs the Digiconomist website, which tracks energy use tracked by bitcoin.

As part of the global financial infrastructure, the Bitcoin network is hampered by severely limited capacity. The global network of miners can process a maximum of seven transactions per second; today, de Vries estimates the rate is around five. In comparison, Visa can process up to 65,000 payments per second. Therefore, any spike in payment or transfer volume results in a backlog. Customers have to pay miners to register their transactions on the blockchain. As the system becomes more and more congested, miners give priority to transactions that offer the highest fees. The buyers who pay the most go to the front of the line and have their transactions completed first.

The process is always costly and gets even more expensive as transactions swell or computing power goes offline. “For most of this year, the cost per transaction was between $16 and $20,” says de Vries. “But it hit $30 in February on high volumes and $59 on April 23 because flooding at a coal mine in China caused a large loss of computing power. Then the network was overloaded with lots of sales.”

De Vries adds that Bitcoin performs poorly at checkout. If you buy $100 worth of groceries with bitcoin, it can take an hour to get a proper confirmation. During this period, the store is at risk of a price change. “The price of bitcoin could drop 10% in this hour, resulting in a loss for the retailer,” says de Vries. “And the customer pays the processing fee of $20 or even more.” His conclusion: Unless you’re using it to buy something with a luxury price tag, like an NFT digital artwork or a Tesla SUV, paying with Bitcoin is “hellishly expensive and a Extremely unfriendly user experience”.

Any asset that fluctuates so widely in value and has a high processing cost will have a hard time establishing itself as a currency. And anyone who believes that Bitcoin’s status as the “currency of the future” makes investing in bitcoin worthwhile is assuming a definition of “currency” that most of the world doesn’t share.

Too fleeting to offer protection

Gold, the world’s most valuable “store of value,” has proven to be a poor investment for the past nearly half century. Since 1980, its price has adjusted for inflation, but with gigantic swings along the way. Over the next 21 years, it lost more than three quarters of its “real” value and only recovered in 2011. It is far from a reliable protection against inflation, as it only keeps pace with the CPI, which is measured over many decades or even centuries. Gold thrives in turbulent times, like the 1974 and 1978 oil crises and the Great Recession. But if you haven’t sold the precious metal When the economy started to recover, you would give back the profits.

The disadvantage of gold is its large, unpredictable fluctuations. Sometimes speculators think it’s a gem; in other periods it is regarded as a dog. Overall, gold exhibits about the same volatility as the dollar and other major currencies, as well as the S&P 500. This is where it differs from US stocks On the long haul, you are well rewarded for the bumpy ride. Not with gold.

But Bitcoin is four times as volatile as gold. From December 2017 to February 2018, the price plummeted from $19,000 to $6,300. It dropped another 65% from April 2018 to January 2019, then recovered through June of the same year, only to plummet another 60% through December.

The US didn’t suffer any episodes of inflation during Bitcoin’s lifetime, so we don’t know how they would fare if the cost of living suddenly skyrocketed. But we saw how Bitcoin fared during the shutdown-induced drop in US stocks early last year. From the S&P 500’s record close on February 19 to its low on March 23, the index fell 33%. Bitcoin also fell by exactly a third from $9,633 to $6,416. “It was a crucial test,” says de Vries. “Bitcoin was 100% correlated with the big drop in stocks.” It didn’t offer the protection its enthusiasts had predicted. “When it mattered most, Bitcoin was fully correlated with both the market crash and the start of the recession,” observes de Vries.

The only apparent pattern, he says, is the opposite: Bitcoin appears to thrive when the economy is thriving, as in the current reopening rally. But this connection is also questionable. On its way to quintupling from mid-2020 to date, it has weathered declines of 20% from August to September last year, a 30% drop in January and a 24% plunge in February, not to mention the new almost a quarter drop mid to late April.

No tangible, fundamental value

Although gold has been a lousy long-term investment, its value is still heavily influenced by fundamentals. Seventy percent of the gold mined each year is used to make jewelry and another 5 percent is used in electronics. So the demand is pretty constant. When prices fall, mines shut down or cut production, driving prices back up, and when the value spikes, mines reopen or new prospecting begins, increasing the supply of gold bullion and driving prices down . Of course, the reason gold deviates so far from fundamentals is that heavy speculation often drives its price well above its cost of production. Then, after many new mining starts, its price can drop well below the cost of excavation, sometimes for years.

Simply put, gold has intrinsic value even in the worst of times, when production exceeds demand and prices fall. Its value in jewelry and electronics provides a bottom.

Unlike gold, Bitcoin is not produced by a private company. His supply is determined by a protocol. Not only is the total number of bitcoins that can ever be issued capped at 21 million coins. The next 2.3 million will be released at a rate set in the protocol that is not dependent on money supply, GDP or any other factor. Right now, “miners are making tons of money,” says de Vries. “If the price falls by 80%, many mines will be closed, but the algorithm for mining new bitcoins will become simpler and adapted to the new, lower computing power. The rate at which bitcoin is released will stay exactly the same.” If the price goes up and the number of computers doubles, no more bitcoin will come. That’s a completely different dynamic than the one that rules gold.

That bitcoin is not bound by Federal Reserve policy, national income, or the decisions of private companies may seem like an advantage. The amount that will be minted next year and what can ever exist is strictly limited. But new coins that can make similar claims keep popping up, and they’re undermining Bitcoin’s dominance. Since the beginning of 2020, Bitcoin’s share of the total cryptocurrency capitalization has fallen from two-thirds to half. Ether’s share has doubled to over 14%.

Although Ether’s supply is not capped like Bitcoin’s, its system is releasing new tokens at an extremely slow rate. So it can use a comparable case as a store of value. Bitcoin price surge breeds many competitors vying for the title of digital gold.

Bitcoin is an “intangible” asset. No one knows what it’s really worth because it has no practical use for making money. If you want to estimate the value of Bitcoin fanatic Elon Musk’s Tesla, you can make forecasts of the size of the future EV market and Tesla’s likely share, as well as gross margin estimates. No such metrics apply to Bitcoin. “There is no future cash flow or intrinsic value of Bitcoin, so technically its value is always zero,” says de Vries. “No wonder bitcoin fans’ infamous war cry is Hodl, for ‘hold on for dear life’.”

In order to buy bitcoin, you must have faith that other true believers will pay much more in the future than you paid. A prevailing cliché in business is that hope is not a strategy. Faith may not be a viable strategy either.

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