Bitcoin zealots struggle to explain what the signature cryptocurrency is good for. Some of its fans claim that Bitcoin will soon compete with the dollar as a widely accepted currency; others say that its scarcity provides a great hedge against raging inflation and economic crises. It’s also lauded as a “store of value,” as the new digital gold whose price is destined to keep rising because its supply is fixed in stone and its popularity will only continue to soar.
In reality, Bitcoin has flopped as a vehicle for buying things, and it failed in its first big test as a safe harbor during the past year’s stock market crash. Its extreme volatility—featuring as many collapses over the past three years as crude oil has suffered in two decades—means that it’s anything but a reliable store of value. Its lurching trajectory of late is true to form: After hitting an all-time peak of $64,800 on April 14, Bitcoin skidded over 23% to $49,700 at midday on April 23, shedding over $200 billion in market cap. “The only ‘use case’ Bitcoin has left is hoping the value goes up and someone pays you more than you paid,” says Alex de Vries, a Dutch economist who runs the website Digiconomist, which tracks Bitcoin’s energy consumption.
Mostly a no-go for shopping
As a piece of global financial infrastructure, the Bitcoin network is hobbled by severely limited capacity. The worldwide network of miners can process a maximum of only seven transactions a second, and today the rate is running at around five, according to de Vries’s estimates. In comparison, Visa can process up to 65,000 payments per second. Hence, any spike in the volume of payments or transfers causes a backlog. Customers must pay miners to register their transactions on the blockchain. As the system gets more and more congested, the miners grant priority to the transactions that offer the highest fees. The purchasers that pay the most go to the head of the line and get their transactions finished first.
The process is always costly, and it gets much more so as transactions swell or computing power goes offline. “For most of this year, the cost per transaction has been between $16 and $20,” says de Vries. “But it hit $30 in February because of high volumes and was $59 on April 23, because the flood at a coal mine in China caused a big loss of computing power. Then the network got even more congested with lots of selling.”
De Vries adds that Bitcoin performs poorly at the checkout counter. If you were to buy $100 in groceries using Bitcoin, it may take an hour to receive adequate confirmation. During that period, the store is at risk for any change in the price. “The price of Bitcoin could drop 10% in that hour, causing a loss for the retailer,” says de Vries. “And the customer is paying the processing fee of $20 or even more.” His conclusion: Unless you’re using it to buy something with a luxury price tag, like a digital NFT artwork or a Tesla SUV, paying with Bitcoin is “hellishly expensive, and an extremely unfriendly user experience.”
Any asset whose value fluctuates this wildly and whose processing costs are this high is going to struggle to catch on as a currency. And anyone who thinks Bitcoin’s status as “the currency of the future” makes it worth investing in is working from a definition of “currency” that most of the planet doesn’t share.
Too volatile to provide protection
Gold, the world’s most prized “store of value,” has proven a poor investment over the past nearly half-century. Since 1980, its price has matched inflation, but with gigantic swings along the way. Over the next 21 years it lost over three-quarters of its “real” value and didn’t get even until 2011. It’s anything but a reliable inflation hedge, since it only keeps up with CPI measured across many decades, or even centuries. Gold does romp in periods of turmoil, as in the oil crises of 1974 and 1978, and the Great Recession. But if you didn’t sell the precious metal when the economy started to recover, you’d give back the gains.
Gold’s drawback is its big, unpredictable fluctuations. At times, speculators think it’s a jewel; in other periods, it’s viewed as a dog. Overall, gold displays about the same volatility as the dollar and other major currencies, and as the S&P 500. The difference with U.S. stocks is that over the long haul, you get well rewarded for the bumpy ride. With gold, you don’t.
Yet Bitcoin is four times as volatile as gold. From December 2017 to February 2018, its price collapsed from $19,000 to $6,300. It experienced another 65% drop from April 2018 to January 2019, then recovered by June of that year, only to plummet another 60% by December.
The U.S. hasn’t suffered any inflationary episodes in Bitcoin’s lifetime, so we don’t know how it would behave if the cost of living suddenly jumped. But we did see how Bitcoin fared during the shutdown-driven slide in U.S. stocks early last year. From the S&P 500’s record close on Feb. 19 to the bottom on March 23, the index shed 33%. Bitcoin dropped by exactly one-third as well, from $9,633 to $6,416. “That was a crucial test,” says de Vries. “Bitcoin was 100% correlated with the big drop in stocks.” It didn’t provide any of the protection its enthusiasts predicted. “When it mattered, Bitcoin was completely correlated with both the market crash and the recession’s onset,” observes de Vries.
The only apparent pattern, he says, is the opposite: Bitcoin seems to prosper when the economy is thriving, as in the current reopening recovery. But even that correlation is questionable. On the road to quintupling from mid-2020 to today, it weathered declines of 20% from August to September of last year, a 30% fall in January, and a 24% hit in February, not to mention the new almost one-quarter drop in mid-to-late April.
No tangible, fundamental value
Although gold has been a lousy long-term investment, its value is still strongly influenced by fundamentals. Seventy percent of all gold that’s mined each year is used to manufacture jewelry, and another 5% is deployed in electronics. So demand is fairly steady. When prices drop, mines shut down or curtail production, pushing prices back up, and when its value leaps, mines reopen or new digging starts, raising the supply of bullion and curbing prices. Of course, the reason gold strays so far from the basics is that heavy speculation frequently sends its price far above production cost. Then, after lots of new mining starts, its price can fall way below what it costs to unearth, sometimes for years.
Put simply, gold has intrinsic value even in the worst of times, when output exceeds demand, and prices drop. Its value in jewelry and electronics provides a floor.
Unlike gold, Bitcoin isn’t produced by a private enterprise. Its supply is determined by a protocol. It’s not only that the total of all Bitcoin that can ever be issued is limited to 21 million coins. The coming 2.3 million will be released at a predetermined rate set by its protocol that doesn’t vary with the money supply, GDP, or any other factor. Right now, “miners are making tons of money,” says de Vries. “If the price falls 80%, a lot of mines will shut down, but the algorithm for gaining new Bitcoin will get easier and match the new, lower computing power. The rate at which Bitcoin is released will stay exactly the same.” If the price rises and the number of computers doubles, no more Bitcoin will be forthcoming. That’s a totally different dynamic than the one governing gold.
That Bitcoin isn’t linked to Federal Reserve policy, national income, or the decisions of private companies might appear an advantage. The amount that’s minted next year, and what can ever exist, is strictly limited. But new coins that can make similar claims are appearing all the time, and they’re eroding Bitcoin’s dominance. Since the start of 2020, Bitcoin’s share of total capitalization of cryptocurrencies has fallen from two-thirds to one-half. Ether’s share has doubled, to over 14%.
Although Ether’s supply isn’t capped like Bitcoin’s, its system releases new tokens at an extremely slow rate. So it can advance a comparable case as a store of value. The run-up in Bitcoin’s price is breeding lots of competitors vying for the title of digital gold.
Bitcoin is an “intangible” asset. No one knows what it’s really worth because it has no practical, moneymaking uses. If you’re looking to assess the value of Bitcoin fan Elon Musk’s Tesla, you can run forecasts on the size of the future EV market and Tesla’s probable share, and estimates of gross margins. For Bitcoin, no such metrics apply. “There’s no future cash flow or intrinsic value in Bitcoin, so technically, its value is always zero,” says de Vries. “No wonder Bitcoin fans’ infamous war cry is Hodl, for ‘Hold on for dear life.’”
To buy Bitcoin, you have to believe that in the future, other true believers will be paying a lot more than you paid. A reigning cliché in the business world posits that hope isn’t a strategy. Believing may not be a viable strategy either.
