Michael J. Casey is the chairman of CoinDesk’s advisory board and a senior advisor for blockchain research at MIT’s Digital Currency Initiative.
In this opinion piece, one of a weekly series of columns, Casey argues that Bitcoin‘s appeal as an investment could diminish its effectiveness as a currency and calls for testing alternative cryptocurrency models.
Bitcoin traders like to say their best trading strategy is not to buy and hold, but to buy and “HODL” – hold on for dear life.
For the umpteenth time, it’s paying off. Bitcoin’s price has rebounded from a sharp drop in September, overcoming a bout of wild volatility that would scare off even the most seasoned Wall Street trader from other markets. Despite a slew of unambiguously negative news, from China shutting down Bitcoin exchanges to a looming fork in the cryptocurrency’s code that threatens chaos and acrimony in the community, here we are again with a new all-time high of over $5,200 set today and quite possibly more ahead.
I see two core reasons why Bitcoin commands such value – no doubt to the bafflement of people like JPMorgan Chase CEO Jamie Dimon.
One is somewhat tautological, and that is the fact that Bitcoin exists at all, that it seemingly cannot die. As if to confirm the HODLers’ worldview, circumstances like those of the past two months tend to test, and ultimately prove, the contention that Bitcoin‘s decentralized design can resist any effort to shut it down, whether from outside or within its community of users.
That’s what’s valuable about it. The more Bitcoin shrugs off attacks, the more it highlights its core value as an immutable currency of the people.
The second pillar beneath Bitcoin‘s value is its scarcity. Although Bitcoin will keep generating new coins until its total supply reaches 21 million in 2140, the protocol has front-loaded that distribution such that 80 percent of those are already in users’ hands. That petered-out distribution function will keep Bitcoin scarce into the future.
There is, however, a paradox here: this scarcity feature could actually undermine Bitcoin‘s appeal as a currency.
HODLing = hoarding
In its aspirations to fulfill the three functions of money – a store of value, a medium of exchange and a unit of account – Bitcoin could be cursed by success. The built-in scarcity, up against expectations for growing demand for an immutable financial instrument, has created an awesome store of value for the decentralized, digital economy of the 21st century.
Bitcoin is in this narrow sense is a much better, highly liquid, digital version of gold. But so long as all these HODLers keep coins out of circulation, there won’t be enough of them around for people to use it to buy goods and services.
Yes, payment processor BitPay is reporting a surge in transactions, but such gains come off a very low base. The vast majority of Bitcoin transactions aren’t commercial in nature, and a number of merchants that experimented with Bitcoin in 2014 and 2015 have since stopped accepting it.
As a portion of global commerce, Bitcoin is a pipsqueak.
This particular failure is likely to continue even if one or both of the two sides sparring over how to scale Bitcoin‘s transaction throughput succeed in their goal, whether through on- or off-chain solutions. Fast, low-fee transactions won’t entice people to part with their Bitcoin if they perceive that it’s more valuable to hold it. In keeping with Gresham’s Law that “bad money drives out good,” they’ll instead transact in an inferior currency. Such as the dollar.
Of course, any decent, functioning currency must be somewhat scarce in order to hold its value; no one wants to accept Venezuelan bolivars right now. But as many economists often point out, neither should a currency be overly appealing as a store of value. If too many people hoard the currency, too little gets into circulation as a medium of exchange, which in turn makes it less likely to be quoted as a unit of account.
This theory suggests that an ideal monetary policy includes a small amount of inflationary expectation. It’s why most central banks formally target a 2 percent inflation rate, signaling that they intend to find a balance between too much and too little monetary expansion. The problem is that many of them fail to achieve that goal and end up debasing the currency, in the form of excessive inflation like Venezuela’s, or create harmful deflation, as with Argentina’s currency peg in 1991. Perhaps there’s a better, automated way to optimize monetary policy so that people both save and spend their currency – ideally with a cryptocurrency that no one can shut down.
The problem is that many of them fail to achieve that goal and end up debasing the currency, in the form of excessive inflation like Venezuela’s, or create harmful deflation, as with Argentina’s currency peg in 1991. Perhaps there’s a better, automated way to optimize monetary policy so that people both save…