Bitcoin

Bitcoin as an Innovative Payment System

Part VI of The Value of Financial Products and Assets

Part VI of The Value of Financial Products and Assets

Previous Parts

Initially, bitcoin’s instrumental and intrinsic value, it was claimed, laid in it being a new blockchain technology powering a peer-to-peer, decentralized payments and monetary system. The benefits of bitcoin as a payment and monetary system are widely discussed (e.g Benefits of Using Bitcoin as a Payments Method), so there is no need to go over that in our discussion. That said, we are approaching bitcoin as an investment here and not as money, since bitcoin has been more “successful” as a form of an "investment" asset class and is approached as such as opposed to a form of money.

A New Form of Asset Class

As an investment asset, allocating capital in bitcoin can be akin to investing in this new payment and monetary system, since participants need to hold/adopt the asset for this blockchain system to reach its potential and be useful. In other words, for that new payments and monetary system to come to fruition, participants need to hold the digital asset for it to develop. Contrary to traditional investing in companies, the money invested in bitcoin isn’t used to finance operations or other activities (it is not a security), but rather, buying bitcoin is just holding an asset that is necessary for this new blockchain based payment and monetary system to take form and develop.

This perspective on digital/crypto assets broadly can be pointed out to be the innovative aspect of these digital, blockchain based asset classes. Basically, this new form of investing involves holding and acquiring an asset that is key for the blockchain system to be supported and adopted. If the asset isn't held and adopted then the blockchain system fails. It is a sort of investment network effect. To elaborate further on this point, a distinction between Proof-of-Stake and Proof-of-Work blockchains should be made.

In a Proof-of-Stake blockchain system, the digital/crypto tokens held must be staked into the system so that the blockchain can maintain its integrity. In other words, the holders of those crypto tokens must allocate and lock some of their holdings into the system for the system to maintain its security and operation. On the other hand, a Proof-of-Work blockchain, such as bitcoin, does not require holders of bitcoin to stake the asset in the system to maintain its security and operation. Proof-of-Work blockchains are maintained by what is know as mining, which are computer systems, or to be precise, a large amount of GPUs at facilities such as large data centers, working to solve complex mathematical problems. It is these computers that maintain the integrity of bitcoin and Proof-of-Work blockchains. Nonetheless, for miners to keep mining bitcoin, there needs to be an incentive and there needs to be participants that actually hold the bitcoins that are being mined, so while there is no need to allocate the token in the system to maintain it, it is essential for a network effect to occur and for users to hold or transact with bitcoin so miners keep mining bitcoin and keep maintaining the security of the blockchain. The more people buy, hold, or transact with bitcoin, the more likely the bitcoin payments and monetary system will come to fruition.

With the above distinction outlined, bitcoin can be claimed to be an innovative asset since it is part of a completely new operational and monetary system, and that it is necessary to hold it in order to make this future monetary and payments system gain ground and become a reality.

Furthermore, while the price of bitcoin is volatile, one can argue, that it may reach stability as it matures, which will then allow it to be a proper form of money and a more stable payments system in the future. With that reasoning, holding bitcoin is equivalent to investing in the future of money and payments.

Bitcoin's Value as a Payment Mechanism

With all that said, bitcoin as a payments system is extremely inefficient and slow, so if bitcoin’s price represents the potential of this payment and monetary system, it is then extremely overvalued for what it is, how it functions, and for the number of users who use it or perceive it as a payments system. Additionally, the more people use it for payments, the slower, more inefficient, and more expensive it becomes. The underlying technology of bitcoin does not scale effectively to be an adequate payment system. Furthermore, as Bindseil & Schaaf illustrate, Satoshi Nakamoto's “understanding of retail payments was inaccurate. It is therefore doubtful whether his invention effectively addressed the problems he perceived in e-commerce and it is therefore also hardly surprising that Bitcoin was never significantly used in legal e-commerce” (see The Distributional Consequences of Bitcoin). The value of bitcoin as a payment system is thus extremely weak. There are better payment systems out there that work better and are hence more valuable and beneficial.

Sure, if bitcoin through some form of development work or through the lightning network, for example, becomes a better payment system and beats the other payment infrastructure and technology we have, then there is a point to be raised that it has some value to us for moving money or value and executing payments. As it stands now, though, it is not, and it is in fact far from it. With that said, it is important to highlight that the bitcoin blockchain has been forked (Bitcoin Cash) due to disagreement between the community in decisions regarding the development of bitcoin to be more effective for larger transaction blocks, which would potentially make it a better payment system. Bitcoin cash hasn’t gained as much popularity, which is another point that illustrates that bitcoin isn’t approached as a form of money and payments, since if it was, the more effective payments blockchain of Bitcoin Cash would have grown and become more popular than the original bitcoin.

One can also argue that bitcoin’s payment potential is in the future, and that’s why it is a long-term investment. It takes time for technology to be developed effectively and be adopted, and so dismissing bitcoin as ineffective or not scalable is jumping the gun and not having faith in the technology. To elaborate further on that, many tech startups and companies are typically overvalued just due to the fact that we have faith that their vision will become reality. While the stocks of high growth companies can be argued to be overvalued, they are nonetheless still valued based on the fundamentals, operating activity, trends, innovation, and user adoption. They aren’t valued based on faith, ideology, and potential alone. Eventually, startups that are driven by narrative and hype fail because they aren’t generating enough cash flow, and investors will halt investing in them since they have nothing to show for it and are failing in bringing their vision to life. If the shares of the startup are overvalued with nothing to show for it, then the startup will fail. Bitcoin, as mentioned previously, does not function as shares in a company, but is purely driven by trading dynamics, which is driven by narrative and speculation. While the narrative used to be that it is a better payment system, the developments around bitcoin are rarely around it being a payment system. Much of the hype and narrative revolves around its validation by institutions and government officials, and of course, its price appreciation and new highs. The major developments taking place around bitcoin are mostly for investment and speculative purposes as opposed to building a more effective payment system. For example, news that leads to its price appreciation are things around the launch of a Bitcoin ETF by traditional financial institutions, or by government officials submitting bills to establish a bitcoin reserve. Announcements around the Lightning Network or any potential for bitcoin to be more scalable or effective for payments rarely move the price of bitcoin and rarely make headlines.

While bitcoin might not be the most efficient payments system, bitcoin users might prefer it because of the potential privacy and it enables and its censorship resistance features. They are willing to give up convenience and efficiency for more privacy and censorship resistance when it comes to payments. That said, is bitcoin really that private? While bitcoin used to be touted as a private form of payments and upheld for its anonymity, it is in fact pseudonymous. Transactions aren’t directly tied to your identity or name, but they are linked your public address, which can often be traced back to your identity in some way or another. Bitcoin is also touted for being open source and transparent – anyone can have visibility into all transactions on the bitcoin blockchain. It is not surprising then that many bitcoin crimes and thefts were easily tracked by law enforcement (The Silk Road Investigation). As for censorship resistance, the issue of censorship isn’t due to technology, but is a compliance and regulatory issue. This is clear as we are seeing more and more compliance and “censorship” initiative being put in place by cryptocurrency and bitcoin companies due to regulatory matters as it becomes more accepted and adopted by governments and institutions. Nonetheless, the censorship resistance piece is an inherent use case for the launch of bitcoin; however, this feature of bitcoin isn’t what has been moving its price and growing its adoption. In fact, the opposite is what is making its price go higher – the more financial institutions and authorities adopt and promote bitcoin, the more “censorship” they apply to bitcoin as an asset for compliance and regulatory purposes. Moreover, there could potentially be a more efficient and effective blockchain than bitcoin that is censorship resistant – take bitcoin cash for example.

Main Points

Overall, we found that the innovation around bitcoin as an asset class, as well as some other digital assets, is that they are assets to be held to allow for the support, maintenance, and development of the blockchain system. This is a new form of asset that operates differently and with different goals than the “traditional” assets we’ve examined so far.

As portrayed, though, bitcoin’s value-add as a payment and monetary system is less effective and efficient than other payment and monetary infrastructure, and so if this new innovative and inventive asset is valued according to what it provides, its promise, or its potential instrumental value, it would be categorized as extremely overvalued. From an instrumental value perspective, it is not fulfilling its said use case, and is in fact not effective at it, so it's instrumental value is weak compared to other tools, applications, and means that provide/could provide the value it aims to achieve.

Nevertheless, the narrative around the innovation of bitcoin has transitioned from it being a payments system to an asset with the sole purpose of creating and preserving wealth. In other words, its innovation lies in it being the ideal asset for capital accumulation and preservation. In that sense, bitcoin is considered as “Digital Capital”.

We’ll dig deeper into “Digital Capital” in the following part of this essay series.