Skeptics of bitcoin and other cryptocurrencies have had their prejudices reinforced. The two main use cases—fraud and crime—have been exposed to the public in dramatic fashion, so now all we have to do is sit back and wait for the inevitable collapse in value.
Except the market price suggests this is wrong. Sure, bitcoin fell a bit after Binance accepted a $4 billion fine on Tuesday, but it’s still trading above where it was last Friday. The number of transactions in bitcoin hit a record high for the seven days to Tuesday.
There must be something underpinning this value, so what is it? Here are the options:
Digital art: The latest fad in crypto is a bitcoin “ordinal,” digital art—or anything else—virtually inscribed on a fraction of a bitcoin in the digital ledger known as the blockchain. The popularity is behind a rush of small bitcoin purchases in recent months that has driven the record trading and reduced the median transaction size to about $20, from around $500 last year, according to Coin Metrics data.
The sudden demand supports bitcoin’s value, in the same way that shopping in bitcoin would. I don’t understand why anyone would pay a cent, let alone real money, to inscribe art in the bitcoin blockchain, but hey, whatever floats your boat.
The problem with relying on this to support the value of bitcoin is that what’s fashionable today may be the Beanie Baby of tomorrow—along with rival ethereum-based nonfungible tokens. Longer-term value needs something more.
The rise in small bitcoin transactions also shows just how useless it is as a currency, and why it’s nonsensical to think bitcoin could ever be used as real money. The median fee leapt to more than $5 over the past week, even as transaction sizes plunged, an insane cost to pay for something invented as a payment method.
Digital gold: When it became clear that bitcoin was useless as a currency, its backers switched to claiming that it is a store of value, with its maximum issuance offering protection against the money-printing tendencies of the Federal Reserve. The argument was tested to destruction over the past two years. Inflation was last below the Fed’s 2% target in February 2021, when one bitcoin cost close to $50,000. By the time inflation peaked in June last year the price had collapsed to $20,000, the opposite of what it should have done.
Bitcoin’s moves over the past three years have been much closer to the S&P 500 than to gold or inflation. But stocks are an investment in real assets that pay dividends, while bitcoin produces nothing. Unlike gold, a bitcoin can’t even be a pet rock, and unlike gold, anyone can create a new cryptocurrency, and thousands have. The supply of bitcoin may be limited, but the supply of cryptos isn’t.
There was a time when savers in countries with dodgy currencies and bad governments would buy bitcoin or other crypto to escape devaluation and avoid capital controls. But the rise of stablecoins allows these savers to buy digital dollars without the pain of trying to open offshore bank accounts, so they have no need for other cryptocurrencies. Dollar stablecoins have value, but they are all derived from the value of their holdings of underlying dollar assets.
Gambling: Crypto offers a store of volatility more than a store of value. Its volatility makes it an excellent way to bet, and the pretense that it is an investment asset gives speculators cover; it sounds much better to say you are a crypto trader than that you just bet $100,000 at the track. The prevalence of speculation by people who are meant to be investors helps explain the close link between the S&P and bitcoin, too.
Basing the value of an asset on speculation is risky, because the value depends on everyone else betting that it has value. But so long as the merry-go-round continues, it looks like it has value, and decentralized finance, or DeFi, provides the infrastructure for speculation in the language of Wall Street.
Crime: I was tempted a few years ago by the idea that the value of crypto could be underpinned by genuine transactions that need to avoid the financial system: Buying illegal drugs; money laundering; avoiding sanctions; anonymous (but legal) pornography purchases; terrorist finance; and ransomware.
Lots of that was going on, and Binance has paid the price for helping. Bitcoin isn’t a particularly good way to hide from the cops, anyway, as repeated police busts have demonstrated. Crypto has to clean up its act, so basing its value on illegal transactions no longer makes sense.
Bitcoin has failed to live up to its original promise of being cheap online cash, but crypto keeps on reinventing itself. It’s so technically satisfying that it must be the solution to something, but quite what remains a mystery.
Write to James Mackintosh at james.mackintosh@wsj.com
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