This is largely in response to Nassim Taleb’s paper Bitcoin, Currencies, and Fragility. I don’t know much about finance or economics, this is merely my best guess and I may have made some elementary errors, or missed some possibilities.
The relentless volatility of Bitcoin and other cryptocurrencies continues to astonish me. As far as I can figure out, the volatility of an asset cannot be synthesized: you cannot construct a pure asset (that is, with no liability) with volatility higher than the assets used to construct it. So the volatility must be “natural” in some sense. One can try to chalk it up to “investor irrationality”, but that’s unhelpful, because guesses about the long future are inevitably irrational. Bitcoin is all about the long future, and the future is not only open, it’s unguessably open, and induction always fails eventually (at least, it always has in the past…).
In my experience, owning cryptocurrency is like owning an insane, incomprehensible fragment of the future, the true contemplation of which will fill your head with terrifying visions, visions that gleefully mock your sense of order and justice, of which “Lambo” is only the most well-known. As the price increases, your sanity is traded for wealth. The price should not be this high. As it falls to what seems like a more defensible level, you may get it back again, for the moment. Is Bitcoin in a bubble? If so, why has each “bubble” been succeeded by a bigger bubble?
But maybe the present behaviour is temporary. What is the fate of the value of Bitcoin, the scenaro that best describes its behaviour in the long term, over a thousand years perhaps, or ten thousand years, or as time stretches to infinity?
As Taleb points out, gold has value as jewellery. For example, if it’s worth $10 to you to be able to show off your gold necklace at a party, then whatever the necklace is worth at the end of the night, it’s worth $10 more to you at the beginning. Thus, while on the face of it gold seems like useless soft metal, it has a “bling” value preventing its price falling to zero.
Not so Bitcoin. Owning Bitcoin provides no revenue or value over time, so comparison to gold is inapt. Furthermore, Bitcoin has absorbing barriers: the accumulating probability that Bitcoin will fail catastrophically, becoming worthless. Since over infinite time this will eventually happen, and Bitcoin yields no other value, then logically this means Bitcoin is worth zero now.
But as far as I can tell, Taleb is wrong.
Firstly, perhaps surprisingly, Bitcoin does have a very tiny amount of “bling” value. This isn’t obvious, because Taleb fails to distinguish between “close to zero” and “exactly zero”. Let us suppose that the market capitalisation of Bitcoin falls to $1000. I think this could be reasonably, if loosely, described as “Bitcoin falling to zero”. But there are plenty of people who would buy all the Bitcoin at this price, just so they can have the bling value of “being the person who owns all the Bitcoin”.
Secondly, Bitcoin does not actually seem to have absorbing barriers. For something to be an absorbing barrier, it must have all of these properties:
- There is a non-zero probability of reaching the barrier, that accumulates to certainty over time.
- The asset is unusable at the barrier.
- There is exactly zero probability of escaping the barrier.
Taleb gives three examples of absorbing barriers, but they all miss one of the properties:
- Miners become extinct (but there is a non-zero probability that mining starts again).
- The technology becomes obsolete (but Bitcoin would still be usable).
- Future generations lose interest in it (same).
To this we might add:
- Most major governments ban it (but there is a non-zero probability that they un-ban it again).
- There is a fatal flaw in the Bitcoin protocol that, for example, makes it possible to obtain private keys, or to trivially mint infinite coins. This has properties 2 and 3, but the probability of this is fixed and does not accumulate over time to certainty.
- All copies of the blockchain are lost. The probability of this per unit time is so low, and thus the time horizon is so long, perhaps millions of years, that It’s not clear to me that predictions about human destiny are good enough to rule out the probability that this will never happen.
Stable Low Value
OK, so Bitcoin won’t eventually reach true zero. What happens if almost everyone loses interest in it and it only has value to hobbyists and collectors? Surely it would stabilise at some low market cap, corresponding to its “hobbyist value”? Surely no more than this is the “true” or “intrinsic” value of Bitcoin?
But without its characteristic volatility, and since Bitcoin has limited supply and is easy to trade and store, it becomes valuable as a hedge against inflation, which would cause its price to rise. So stable low value is not a fate either.
Why aren’t Beanie Babies® a hedge against inflation? Because Beanie Babies are expensive to store and trade in sufficient quantities, and their supply is not limited, among other reasons. By contrast, the supply of Bitcoin is limited, holding large amounts of Bitcoin long-term is effectively free, and trading fees are constant regardless of the size of the trade.
What if Bitcoin is volatile enough to discourage hedging against inflation, but otherwise remains generally of low value? In this case, in the long term, people would eventually discover the bounds of its value, and buy when it was relatively low, and sell when it was relatively high, causing the price to stabilise.
“Stable” High Value
If Bitcoin becomes established as some kind of hedge against inflation, everyone who wants such a thing will buy it. Perhaps major governments will obtain reserves, and the price may more-or-less stabilise relative to the world economy, at least within one order of magnitude. This seems to be the fate that a lot of Bitcoin advocates, particularly “Bitcoin maximalists”, predict. This seems possible to me, but it’s not the only possibility.
It’s also possible that Bitcoin remains deeply volatile, with swings of value that not only cannot be predicted, but even defy attempts at any probabilistic modelling. Bitcoin would then be useless as any kind of hedge, and might continue to be fairly useless as a currency. Indeed, Bitcoin could remain almost completely useless, and yet still have arbitrarily high swings of value.
This fate for Bitcoin arguably reflects the fate of the world at large, which is also deeply unknowable. Why is there something instead of nothing? Why is Bitcoin worth something instead of nothing?
— Ashley Yakeley