Over the past year, I have gotten interested in blockchain technology.
I invest across a variety of sectors and I am always thinking about how the companies I invest in might be disrupted. This approach follows Charlie Munger’s advice to “invert, always invert”. As someone who once focused on investing in technology companies, I have always been ultra-aware of how quickly things can change or be disrupted. One of the questions I always asked when evaluating a potential technology company was, “How is Moore’s Law going to affect this company and its industry?”
As I learned more about blockchain technology, the more apparent its disruptive potential became. At the same time, there was just so much noise around the topic: the rise of Bitcoin, alt coins, frauds, hacks, regulatory uncertainty, bubble talk etc. My approach to this is to try to ignore all of the noise and just focus on the real-world use cases with a very targeted, analytical approach.
The first use case I looked into was the one that started the whole “revolution” — the potential for Bitcoin or a blockchain-based technology to replace money both as a medium of exchange and as a store of value. I have analyzed this by trying to understand — at a fundamental, First Principles level — how to think about the intrinsic value of money itself, whether in the form of gold, fiat currency or Bitcoin.
I will release these findings serial-style in three sections, with each one tied to existing Quora questions that examine the intrinsic value of each, one by one:
Part 3: What is the intrinsic value of Bitcoin? (to come)
In the meantime — with the caveat that I am still exploring and learning as well as the fact that things in the blockchain world can change very fast — here are my key conclusions and observations:
Fiat currency ultimately derives its intrinsic value — both as a medium of exchange and a store of value — from being sanctioned by its nation-state.
As a medium of exchange, fiat currencies — whether in traditional or digital forms — will most likely always dominate transactions that take place within a common economic zone.
As a store of value, fiat money will be as strong as the nation-state that backs it. If you live in a stable, well-run nation-state, fiat money is an attractive store of value for most cases. If not, fiat currencies from strong nation-states are also attractive alternatives.
Fiat currency will likely be dominant as long as the concept of nation-states and organized economic zones exist.
Borrowing language from the blockchain ecosystem, one can loosely think of a nation-state as another “protocol” that has developed and matured through the years: A system based on laws, culture and processes that evolve in an effort to (hopefully) drive improvement in the lives of its members.
Gold derives nearly all of its value from being a store of value.
For most of human history, gold was useful as a medium of exchange but progress has neutralized most of its advantages in this area. Today, gold is a terrible medium of exchange compared to fiat currency (whether in physical or digital form) and blockchain-based currencies.
From a store of value perspective, breaking it down to First Principles, gold’s intrinsic value is based on the fundamental need for humans to signal wealth.
Humans are social creatures and the need to signal wealth is built into our biology through evolution. As long as humans exist as a species, this impulse will exist. This permanence is ultimately what makes gold a dependable store of value.
Gold is superior to fiat currency and Bitcoin (or crypto assets in general) in signalling wealth because it can signal in physical form — through jewelry which comprises the vast majority of individual use.
Gold stored in the form of bullion sitting in the foreign reserves of nation-states is merely a derivative of the fundamental human need to signal wealth.
In the modern world, there are clearly plenty of other ways to signal wealth. But usually gold is considered as a store of value in the context of disaster scenarios e.g. where a nation-state may have collapsed. In these cases, the utility of gold as a physical wealth-signalling mechanism can rise again.
Since we are talking about very low probability scenarios, demand for gold as a store of value will likely remain niche and could decline (as it has been for decades). But it will likely never go to zero because there is always a non-zero chance of a disaster scenario occurring and, more significantly, an even higher probability of the existence of many people who feel the need to over-prepare for these sort of scenarios.
Bitcoin’s intrinsic value will ultimately be derived from fundamental real-world (i.e. non-speculative) use cases, including as a medium of exchange for certain types of transactions and as a “native” reference currency for the broader “blockchain economy”.
Just like a traditional nation-state economy is the sum total of the economic transactions between members of that nation-state, the blockchain ecosystem may be thought of as an overlay state whose economy is the sum total of the various transactions that flutter across its many inter-related networks.
As a medium of exchange, public blockchain-based crypto assets (including Bitcoin) are best suited for:
Cross-border transactions between two different economic zones.
Transactions where anonymity and privacy are extremely important (e.g. black/gray market, skirting capital controls).
On the other hand, non-sovereign crypto assets do not appear to be well-suited for transactions within a single economic zone especially when competing with digitized fiat currency like Alipay because their value relative to the specific economic zone is always going to fluctuate more than sovereign fiat currency.
The value of Bitcoin or other crypto assets as a store of value ultimately comes down to a couple critical questions:
What are the use cases for decentralized networks over traditional and centralized ways of doing things (including as a medium of exchange)?
How much better are they at doing these things?
Critical to determining the value of crypto assets’ value is figuring out how much market share the “blockchain economy” can take from the rest of the world and that is what these two questions aim to figure out.
And then specific to Bitcoin itself, there is the question around how likely it is to remain the reference asset for the entire “blockchain economy” or whether it gets replaced by a technologically superior crypto asset.
Given how early it is in the development of the blockchain ecosystem, it is way too early to jump to any hard and fast conclusions about it. The best we can do is come up with some mental frameworks of how to think about it to expend time and effort into exploring how to apply the decentralized approach to existing models.
There will always be a place for fiat currency and gold. But whereas fiat currency will grow in importance (with general economic activity), the demand for gold may rise or shrink depending on the specific time and place.
For Bitcoin and other crypto assets, there is an extremely wide range of possible scenarios ranging from a little over zero to “something big”. That about as tight a range as I am comfortable predicting at this point. Nothing earth-shattering in making such a pronouncement, but sometimes the right way to think about something is by knowing the bounds of what you don’t know.