Cryptoasset Fundamentals: Considering Store of Value Arguments
Are Bitcoin, Ethereum, Litecoin and other cryptoassets stores of value?
An asset is a good store of value if it maintains similar levels of usefulness with the passage of time. For financial assets, that usually means retaining similar levels of purchasing power. Ability to store value can be assessed through fundamental analysis — thinking critically about both the qualitative and quantitative aspects of an asset.
Store of value arguments have become a cornerstone in the justification for investing in cryptoassets, including Bitcoin, Ethereum, Litecoin and others. But are cryptoassets stores of value? If so, are they good stores of value? We explore some of the common arguments:
Argument: Bitcoin is Like Gold. Bitcoin Will Be Digital Gold
We know that value can be a highly subjective matter. We also know that humans often deploy analogical thinking when attempting to understand new information.
It’s unsurprising then to often find comparisons of Bitcoin (BTC) to gold, Litecoin (LTC) to silver, or X-coin to Y-precious-metal when reviewing cryptoasset value arguments. The surface similarities combine with familiar, deeply rooted visual cues — the golden Bitcoin, the silver Litecoin — to create analogies that are difficult to resist.
We shouldn’t discount the behavioral economics going on here: if increasing numbers of people want to hold Bitcoin because they think it’s like gold or a store of value generally (right or wrong), it could create upward pressure on the price and potentially retain its value during a given time period.
In the short-to-medium term, precious metal comparisons, namely Bitcoin compared to gold, will likely be the single largest driver of the broader market accepting Bitcoin and other cryptoassets as a store of value and thus, an appropriate investment vehicle.
Are we comfortable enough with precious metal analogies to ascribe huge amounts of value across the literal divide between these physical and digital worlds?
Maybe.
But the fundamentally focused stakeholder should consider supplementing these useful analogies with some first principles thinking, both for the traditional stores of value they seek to emulate and cryptoassets individually. To do so, further exploration of the shared characteristics is useful.
Argument: Supply is Fixed and/or It’s Deflationary
Similar to physical gold, Bitcoin should have a stable, predictable supply increase, eventually capping out at 21 million total BTC in circulation. Litecoin is similar, capping out at 84 million LTC total supply. These fixed supply mechanisms give Bitcoin, Litecoin, and other similar cryptoassets deflationary (technically, disinflationary) characteristics over the long term.
Other mainstream cryptoassets, including Ethereum (ETH), have chosen to uncap the total supply of their coins and opt for long-term, pre-determined issuance schedules. These no-cap cryptocurrencies are thus inflationary in nature. The risk with inflationary cryptoassets is that new, future coins entering the market will reduce the value of existing coins by increasing the supply relative to demand.
All things equal, a cryptoasset with deflationary characteristics could theoretically be a better store of value, because existing coins are protected from future supply-based dilution. In practice however, an inflationary cryptoasset could easily maintain a higher valuation than a deflationary one.
How? By creating more demand to hold the cryptoasset due to underlying utility value or some other desirable characteristic. At their most basic level, cryptoassets are potentially useful technologies. Usage will drive underlying utility value and we should therefore weight long-term usefulness more heavily in store of value arguments than a cryptoasset’s monetary policy alone.
Finally, is a fixed supply of BTC really that valuable if there are very close substitutes? Should we add the supply of identical or similar cryptoassets to form a total effective supply? If so, is that inflationary? If we examine the concept of fixed supply value from first principles we can identify the underlying asset having inherent value as a pre-condition. It follows that we should be focused not just on underlying value of a given crypoasset, but on the uniqueness (discussed later) and relative value delivered compared to substitutes.
Argument: Independence Relative To Other Asset Classes
Gold is not easily manipulated by central authority— no single entity can significantly influence its valuation, unlike many other asset classes (e.g. fiat currency and equities), which routinely fluctuate from the decisions of governments and powerful entities. Being independent from the central authorities can be useful for mitigating shifts in value, up or down, arbitrary or intentional, which can be a useful characteristic when attempting to store value over time.
Cryptoassets are defined by their decentralized and open-source nature. The concept of decentralization, and the degree in which to implement each of it’s forms, is a hotly contested topic within the cryptoasset ecosystem today. Some stakeholders support “true”, fully decentralized characteristics, while others prefer hybrids that combine elements of decentralization with more traditional features (e.g. board-like teams who vote and make all the important decisions).
Cryptoasset governance models vary widely, from “benevolent dictatorships”, to balances of power between stakeholders, to true, fully decentralized governance, and everything in between.
Similar to fixed supply monetary policy, if all things are equal, more decentralized systems could be a beneficial trait for hedging against the risk of centralized authorities tampering with asset values. However, some possible problems arise:
- Many cryptoassets are logically or architecturally decentralized, but still very much politically centralized in their governance. Ironically, despite Bitcoin’s initial mission to wrestle trust away from central authority, many cryptoassets can actually require more trust and have far less safety or recourse than the traditional infrastructure they aim to disrupt. At the time of this writing, there are multiple cryptoassets with multi-hundred-million-dollar market capitalizations, who have nothing more than a product demo, whitepaper and a Slack channel. Over time, through iteration, success, and failure, the most effective allocations of decentralization will likely emerge.
- Value is an outcome, agnostic of the degree of centralization or governance. We should attempt to avoid forming rigid partisan stances and instead focus on the optimal mix of decentralization characteristics that produce the highest overall value. We should acknowledge that utility value will likely dictate the long term value of cryptoassets, including their desirability as stores of value. A completely independent, fully decentralized X-coin that is not widely used will likely not retain it’s value compared to a more centralized Y-coin that has tremendous demand and utility.
Argument: Cryptoassets Have Underlying Utility Value
Traditional store of value assets have underlying utility value that forms a backbone for their overall value. Gold has underlying utility value in applications such as semiconductors and jewelry. Real estate has underlying value for building, farming, and mining, among others.
Cryptoassets have an enormous amount of potential underlying utility value, promising to disrupt just about everything, including payments, record keeping, legal contracts and many other industries. It’s not difficult to add up traditional market sizes, assume a level of market share capture over time, and produce large potential market size figures for a cryptoasset.
However, as rational stakeholders we should maintain a healthy level of skepticism about the ability of cryptoassets to deliver on their promises at superior economics compared to existing solutions.
It is difficult to dispute that cryptoassets have become a worldwide phenomenon for transferring money and wealth. There are countless examples of cryptoassets being used as a medium of exchange, including times where centralized stores of value failed to be effective.
However, outside of being an effective global medium of exchange, cryptoassets are relatively unproven in other arenas to be superior to existing models at the desired economics. Right now, that’s OK — progress is being made and the ecosystem is developing rapidly — given the amount of resources and intelligent people working within the cryptoasset space, it’s reasonable to expect some cryptoassets will cross over into actual use.
But, for store of value considerations, we’d like to guess and expect as little as possible. We can attempt to limit our guesswork with skepticism and diligence on the cryptoasset’s ability to create and retain utility value at superior economic levels (lower cost, faster for same price, etc.) versus traditional substitutes.
Problem: Uniqueness and Value Permanence
One of the potential threats to cryptoassets becoming a store of value are their relative lack of uniqueness.
Gold possesses fundamental properties that has no identical substitutes. Said another way, it is unique. While many gold applications (e.g. conductivity or jewelry) have practical substitutes, they are often other finite materials (e.g. copper, silver, platinum) that themselves also have unique fundamental properties.
Uniqueness allows some traditional stores to achieve value permanence over time. We might estimate that an average increase in uniqueness results in an average decrease in the velocity of new substitutes, assuming value is constant.
One of the most valuable attributes of cryptoassets is that many are open in their nature. Whether it’s the open source code that allows audit-ability and rapid developer adoption of the platforms, or the actual open nature of the underlying distributed ledgers themselves, which can provide security and other benefits, openness is an innovation that is part of the promise to unseat traditional models.
However, the strengths associated with openness could be a headwind for cryptoassets as they attempt to become long-term stores of value. The fact that current mainstream cryptoassets are freely available to copy limits their ability to establish uniqueness, a possible precursor for value permanence.
Indeed, due to the rapid uptick in interest for blockchain technologies, and perhaps combined with perverse economic incentives — access to large amounts of capital with very little recourse or rules — we’ve seen a huge explosion in initial coin offerings (ICOs) and the number of cryptoassets generally. Many of these new altcoins offer very similar value propositions as existing cryptoassets or small, marginal improvements. Of course, these small, marginal improvements are often marketed as novel ways to disrupt massive industry X or Y.
Since uniqueness cannot be comfortably relied on for open cryptoassets, possibly less sticky attributes like network size, developer interest and market adoption have to be considered for retaining value. That inevitably leads to questions like:
- Will Bitcoin be the de facto cryptoasset for money transfers, the most established current source of utility value, or will it be Ethereum, Litecoin, Monero or some other altcoin?
- Will Ethereum come to own transactions on internet or things, or will it be the blockchain-less IOTA?
- Will Ripple become the standard for bank settlements, or will they form their own, private blockchains to do the job?
- What about the future cryptoasset clones that haven’t been formed yet? What about cryptographic technologies that don’t use an openly traded coin at all?
- Are openly traded cryptoasset coins even an appropriate long-term asset, let alone a store of value, to begin with?
Good News: Fundamentals Can Be Applied to This Market
That we can even seriously debate whether cryptoassets are stores of value is a very positive signal for their outlook and legitimacy. As cryptoassets continue to cross the chasm from unproven experiments to real, global assets with expanding amounts of value, discovering their fundamentals will increase in importance.
Ideally these fundamentals will inform best practices that will flow back into the ecosystem. Best practices around important issues such as monetary policy, degree of decentralization and governance will have a deep impact on cryptoassets’ long term potential as a worthy instrument of long-term value.
