What Gives Cryptocurrencies Their Value

Authored by Peter St.Onge via The Mises Institute,

The value of cryptocurrencies like bitcoin, just like any other kind of money, comes fundamentally from what you can do with it. As a follow up to What Backs Bitcoin, I want to dig into that value.

The idea, which comes from Austrian economist Carl Menger, is that just as a shovel’s value comes from its ability to dig, a currency’s value comes from its ability to help you do two things: transactions and savings.

Think of transactions as the money you carry in your wallet or checking account, and savings as the rest of what you have in the bank or buried in the yard. It’s worth mentioning here that that vast majority of money demand is indeed savings, making up 90% or more of all money demand.

The reason this matters is because if we know what transactions cryptocurrencies are good at, we can estimate how much money demand they’ll start pulling from fiat or gold, and therefore how much those cryptos will increase in price.

For transactions, some features that matter are cost and speed of transaction, anonymity, reversibility, counter-party risk, regulatory treatment. For savings demand, those factors are overwhelmed by the specific question of how well the currency keeps its price.

Supply and Demand Determine Price — Always

Price, as always in economics, is simply a matter of demand and supply. When demand is rising faster than supply, the currency will go up in price. And if demand is rising slower than supply, price will go down.

Since bitcoin was born in 2009, it has generally enjoyed demand rising much faster than supply, hence price has soared. While the US dollar, say, has gone down — has “price inflated” — because demand failed to keep up with dollar creation.

Those are the features, now what are the applications: what are people using money for?

When we’re looking at a currency’s price, because we’re looking at total demand we don’t care about the number of transactions rather the total amount transacted.

And here, the vast majority of money moving around in the economy is not goods and services — buying a cup of coffee, or a plane ticket — rather financial movements. Paying salaries, buying and selling stocks or bonds, investments and dividends. These occur mostly by bank transfer, which account for 80% of all money moved in the US. Another 15% goes by check, leaving just 3% for credit or debit cards, and 4% for paper cash.

Bitcoin Still under 0.01% of Global Transactions

A final part of the puzzle, what’s the competition to cryptocurrencies? Most money payments worldwide are, of course, denominated in fiat currency like dollars or yen — about 99% by amount. With the remaining 1% made in gold.

Note that fiat has both physical and electronic forms, such as credit cards and bank transfers. Even gold payments can be made with paper rather than physically moving the gold, including gold-based securities that trade in financial markets (so-called “paper gold”).

Now we’re ready to go through those features for each currency. On cost of transaction, bitcoin’s fees nowadays average about $1, and don’t vary by amount you transfer.

You can send one bitcoin, worth $5,000, or 1,000 bitcoins, worth $5 million, and the fees are still a dollar. In contrast, banks typically charge a percentage of the transaction, which adds up on million-dollar transfers.

Meanwhile, on speed bitcoin is much faster than banks; between 10 minutes and an hour to confirm a transaction, while banks take days.

So bitcoin beats on the most important application of money: financial transfers. The one caveat here is exchange costs. Just as you pay fees and spreads when you exchange your dollars for yen, every time you convert dollars into bitcoin you’ve got to pay fees and spreads.

This means that bitcoin’s low fees only really dominate if both the sender and receiver are keeping the money in bitcoin.

Bitcoin’s Exchange Rate Woes

On the other hand, if you have a bunch of dollars and want to buy a house from somebody who likes to keep dollars in the bank, then you’ll have to convert your dollars into bitcoin, send the bitcoin for a buck, then the other guy converts the bitcoins into dollars again. You saved on the transfer itself, but you had to exchange the money twice.

So, bitcoin as a technology is superior for the main type of transaction by value, but in reality that advantage is eroded if people are keeping their wealth in fiat. This isn’t really a flaw of cryptocurrencies per se, it’s just a standard penalty suffered by any minority currency — having to pay for conversion into the dominant currency.

To finish up on cost and speed, obviously physical cash or physical gold are fantastic on both cost and speed, but only if buyer and seller are touching each other. Given paper cash has only a 4% share today, touchable buyers and sellers is a very small part of demand.

For remote orders, then, bitcoin carries lower fees than credit and debit cards, but again with that double-exchange problem unless both buyer and seller are staying in bitcoin.

Bitcoin’s Potential to Outperform

Next up are some secondary benefits: anonymity, reversibility, counter-party risk, regulatory treatment.

Briefly, bitcoin is nearly anonymous unless the US government cares enough about you to put some serious people on you. In this sense it’s essentially like using cash, but with the advantage you can use it over long distances with those low fees.

In practice, the closest alternative is probably a pre-paid debit card that you buy at 7/11, which can cost several dollars in addition to the merchant fees, and isn’t going to work for large amounts nor overseas.

As for reversibility, the question is whether the buyer can cancel his payment. A problem for online vendors who get scammed by people who buy the product, get it in the mail, cancel the order and keep the goodies.

Credit card companies or Paypal famously always side with the customer, which can suck for the honest vendor getting ripped off online. Bitcoin, again like cash, is irreversible once it’s confirmed — so about 10 minutes to an hour. That’s slower than cash, but faster than Paypal or credit cards where buyers can reverse months later.

Fourth characteristic is counter-party risk; the idea that your bank could go under, taking your money with it. Remember bitcoin was invented in the wake of the 2008 financial crisis, where bank failures were common.

Because bitcoin is distributed across many computers and isn’t managed by a central organization, it has no single point of failure. On the other hand, cryptocurrencies do still have potential technical glitches that probably more than make up for that risk.

Regulation: Not If but When

Finally, regulatory treatment. This is where we’ll probably see a lot of change over the next couple years, as governments digest cryptocurrencies like bitcoin.

So far cryptos have enjoyed mostly benign neglect from regulators; tolerated, neither discouraged nor encouraged. On the bright side this has meant little regulatory burdens or fees, although this is changing in places like New York.

On the down-side, this regulatory grey-zone has meant a lot of companies and institutional investors are afraid to use, or even to buy, bitcoin. So increasing regulations could actually boost bitcoin demand, as those regulated users become unafraid to play.

As for what happens in the future, countries are gradually drifting into two camps: broadly enthusiastic (Japan, Dubai, Taiwan, Switzerland), broadly skeptical (China, Korea), with the USA and European Union still lurching between the camps.

Cryptos: For now, Only for Adrenaline Junkies

Now, given how much savings dominate money use, the elephant in the room is would you feel comfortable keeping your life savings in bitcoin.

As we mentioned, the key point here is how its price will hold up, meaning will demand grow faster than supply. While bitcoin has knocked the socks off dollars or even gold, rising 800% in the past year alone, even this soaring growth has come with the major downside that bitcoin also fluctuates a lot — easily up or down 50% in a month.

However, as with any product, service, or medium of exchange, the value of cryptocurrencies will depend on the future choices of countless users and consumers — based on their subjective valuations of the currencies themselves. Those who can successfully guess what will become more valuable in the future will become wealthy. But risks always remain.


Gap Admirer max2205 Fri, 12/01/2017 - 22:04 Permalink

Pump and dumpers looking for quick, easy, money withoiut having to work for it.And the dudes wanting to move out of their Mom's basements, copying the freely available crypto open source code, generating new sets of electronic 1s and 0s as valuable "money." There are **only** roughly 1400 crypto "currencies" out there now. "Money."

In reply to by max2205

blentus BallAndChained Sat, 12/02/2017 - 06:21 Permalink

Why don't you eat a dick?I paid 0.9 EUR last night, for a transaction.While I would certainly love that transactions are cheaper (and they should be), stop being a retard and spreading pure lies.If all you do is use exchanges and get raped by them for transaction fees - well, nothing I can do about that. You are neither user nor average.

In reply to by BallAndChained

MonetaryApostate blentus Sat, 12/02/2017 - 07:50 Permalink

You aren't seeing the truth though, transaction fees to such a gigantic & purely digital system will basically drain the pool!  For example, lets say 5 milliin transaction happen a day, see the point I am making here?No matter how much money goes into the pool, the hole drains the pool, requiring it to be constantly filled or it depletes down continuously!

In reply to by blentus

BallAndChained Luc X. Ifer Sat, 12/02/2017 - 04:39 Permalink

> the vast majority of money moving around in the economy is not goods and services — buying a cup of coffee, or a plane ticket — rather financial movementsIf a currency isn't being used to buy everyday items like a cup of coffee with a $6 transaction fee, then why is it being called a currency at all? (Oh right, it is scammers trying to fool people that they need to buy their scam, fooling people into believing that their scam virtual item is commonly used in real life.)

In reply to by Luc X. Ifer

BallAndChained Luc X. Ifer Sat, 12/02/2017 - 04:51 Permalink

> Meanwhile, on speed bitcoin is much faster than banks; between 10 minutes and an hour to confirm a transactionWorst case can be several hours. How many people wait in line for several hours to buy a cup of coffee?Oh right, people don't actually use Bitcon as a currency, only for speculatioin.If people actually used Bitcon as a currency, with all the real items that is purchased every day, Bitcon transaction time would drastically slow down to a crawl, days and weeks for a transaction. There would be such a huge backlog of transactions if Bitcon was actually used as a currency that most transactions won't even go through!And the size of the Blockchain would explode in size from the current over 150 GigaBytes to PetaHumongousGazillion size. 

In reply to by Luc X. Ifer

solidus Mister Ponzi Sat, 12/02/2017 - 14:03 Permalink

Wrong, settlement for credit cards can take several months.  I just had a chargeback from Wells Fargo for $5100 that we processed on 9/1 from a scumbag who said it was a fraudulent transaction.  The same Wells Fargo that had a data breach for tens of thousands of their customers which I now have to pay for.  Can't wait for these monstrosities to go the way of the tally sticks.

In reply to by Mister Ponzi

HRClinton Gap Admirer Sat, 12/02/2017 - 03:31 Permalink

Are you another shill for TPTB, or are you too dumb to recognize FLIGHT OF CAPITAL (FoC)?FoC can not be explained by Asset Bubble Theory. But most here are too dumb or psychologically stuck on Casino models, to recognize polar shifts in Monetary Systems.Go have another 'hit', another 'bong' of Casino Bennies, if it helps keep your world in balance.When it's all over, you can claim "I saw it coming all along!"  Even though you lacked the balls and brains to catch the early waves and are as dumb, poor and gutless as ever.LMAO.

In reply to by Gap Admirer

HRClinton HRClinton Sat, 12/02/2017 - 04:21 Permalink

p.s. I've become so disgusted by the combination of low-IQ plus hick arrogance, that I'm going to make a list of names.In a few months I'm going to post that Honor Roll of Losers (the obnoxious combo of dumb + arrogant jerks), to teach you some humility. I can't fix your IQ, but maybe Humble Pie will be good for you as a teaching tool.

In reply to by HRClinton

Michigander jaxville Sat, 12/02/2017 - 08:32 Permalink

I wonder if there would ever be a point that you would consider that you may be wrong. Could you answer that? I really am curious. Let me help...BTC 40,000 EOY 2108...will you be wrong then?BTC 80,000 EOY 2020...will you be wrong then?BTC accepted as money by most nations...will you be wrong then?2030 Silver still 16.00...will you be wrong then?I may be wrong. We both dont know. I hedged my bullion and am up 600% with cryptos. I'll be willing to admit I was wrong if that day comes. Question is...will you? Ever?

In reply to by jaxville

malek Michigander Sat, 12/02/2017 - 13:10 Permalink

Are you also one of the bemoaners of fiat dollars and fed control, who however has no problem declaring profits, even "unrealized profits" denominated in fiat to be the ultimate measuring stick for everything?

I mean do you also consider [richest man] Jeff Bezos to be the most intelligent, smartest, wisest, sexiest, most powerful, and most admired person in the world?

In reply to by Michigander

jaxville Michigander Sat, 12/02/2017 - 14:57 Permalink

  I am wrong because I never profited from a particular trade?  I missed the NASDAQ run up , I missed BreX, I missed Apple .....  I missed a lot of things.  I am up about 4% for the year on my overall wealth.  It might not sound like a lot but I measure my wealth in ounces of gold.  Dollar (bitcoin) price is just a lot of noise that is little more than a distraction.   If you have made some serious dough on bitcoin I hope you are smart enough to turn a good portion of it into something real.  In the meantime , please quit telling me that it is real.  It's no more real than dollars or euros.  Just because some act as though it is real does not make it so.

In reply to by Michigander

Gap Admirer jmack Sat, 12/02/2017 - 11:32 Permalink

Agreed.  There are currently roughly 1400 crypro "currencies" with new ones created every day.  Many of the crypto algorithms are open source so anyone can copy them and use them.  Of course they won't go away. As long as someone with a computer in their mom's basement can copy the code, host it, then put out a press release about their new, "valuable," "money."

In reply to by jmack

jmack Gap Admirer Sat, 12/02/2017 - 12:53 Permalink

http://www.goldscape.net/gold-blog/gold-backed-cryptocurrency/     and from within that article the link to the Royal Mint which is using a CME developed trading platform and block chain to decentralize and digitize gold trading, which is how I see all trading evolving, going from centralized exchanges or data centers to a peer to peer decentralized network with greater transparency and hopefully more fair price discovery, although CME"s involvement does not really bode well for that, seeing as how they collude with the PPT and HFT's generally. http://rmg.royalmint.com/how-rmg-works/

In reply to by Gap Admirer

jaxville jmack Sat, 12/02/2017 - 15:14 Permalink

  You may be right.  There are some huge issues with the blockchain in general and bitcoin in particular that make it less than ideal for use as a currency.  For the most part, until the trend toward statism is reversed; a cashless society is the future. The believers in bitcoin have become myopic because of the huge gains in price.  They don't see it has gained nothing in value. Sadly, in this gratuitous age, few can differentiate between the two (price vs value)  All they can do is call me a Luddite or whatever to make up for their inability to rationally examine the limitations of their favorite play.

In reply to by jmack

OverTheHedge HRClinton Sat, 12/02/2017 - 06:25 Permalink

"FoC can not be explained by Asset Bubble Theory"

That sounds disturbingly similar to "This time it's different".

You better put me on your list, too. I will be happy to use your much-vaunted cryptocurrency when i can be (reasonably) confident that it will be worth a rough approxmation of what it was worth yesterday.

As a means of exchange, it is far too volatile; as an investment it is truly weird. Good luck with your punt, i hope you make a bundle.

In reply to by HRClinton

LSD - Lower Sl… jmack Sat, 12/02/2017 - 11:41 Permalink

Wow.  Thanks.  Your own crypro "currency" in 10 minutes.  Step by step.  It obviously takes studying cryptology, discrete maths, group theory, rings, elliptic geometry and coding for 20 years to click through the site in 10 minutes.  LOL!SuperMegaBlasterCoin will be out right after ZHCoin.

In reply to by jmack

Mister Ponzi mickrussom Sat, 12/02/2017 - 04:33 Permalink

In Europe noone goes to prison for not filling out FBAR forms that don't comprise any taxable events. So, yes, I think the IRS is bad.A friend of mine moved from his European home country to California. He recently told me the sheer insanity of reports he has to submit to the IRS regarding his bank accounts in his home country including the max amount over the year on each of his accounts. So, yes, I think the IRS is bad.Where do you live? An American defending "his" IRS? I moved to one of these socialist countries in Europe, Germany, some time ago. Here, I don't have any reporting requirements regarding foreign assets, only of the cashflows I received. A foreign bank account not generating interest income does not have to be reported. Real estate in any other EU country and the rental income in those countries (where it is taxed) does not have to be reported. So, yes, I think the IRS is bad.The German finance ministry has declared cryptos to be neither a currency nor financial assets. Therefore, the gains on cryptos are tax-free after a holding period of more than one year. Compare this to the US. So, yes, I think the IRS is bad.

In reply to by mickrussom

peterk MonetaryApostate Fri, 12/01/2017 - 22:07 Permalink

There is only ONE thing that gives CRYPTO their value....  and its NOT   bitcoin  itslef  that im referring to but the  bitcoin technology   , ie  BLOCK CHAIN technology.So  BLOCK Chain technolony VALUE  =  the COSTS SAVING  of using blockchain  over  the  COSTS BANKS traditionally have in doing  the business of banking.Thats it.Bitcoin itself has ZERO VALUETHe problems with botcoin as a speculative asset is that its not wildly held nor traded. like apple shares. Its LIQUIDITY is ARTIFICIAL in that its based on  high value per unit relative to  share holding/distribution.  This is oppossite to  stocks  on averag that have a  wide shareholding and ow value.Hence it is a bubble..... a flash in th e pan in time.

In reply to by MonetaryApostate

Slomotrainwreck peterk Fri, 12/01/2017 - 22:49 Permalink

Of course Bitcoin has no value. It's the users that give it value. Without users, it would be as valuable as dust.I can go to my LCS and hand over a silver monster box and receive a bitcoin for my trouble. On the other hand, I could go to my LCS and use my bitcoin to purchase that same silver monster box.Bitcoin has no value.

In reply to by peterk