Since participating in my first Bitcoin hackathon in 2016, I’ve come to appreciate the currency’s powerful attributes: decentralization, transparency, and sovereignty for the many. As of September 2021, Bitcoin’s market capitalization surpassed $1 trillion, exceeding that of Citigroup, JP Morgan, and Wells Fargo combined. Daily, hundreds of billions of dollars change hands as people bet on Bitcoin’s value fluctuations. But is this investment or speculation? What are the root causes driving Bitcoin’s long-term price?
In this article, I argue that Bitcoin’s utility has only a marginal influence on its market price, which – in case any one doubted it – is purely speculative.
Note: The prices of Bitcoin and other cryptocurrencies are correlated. In this discussion, I use Bitcoin as a placeholder for other cryptocurrencies, even if they have different features that can influence their price.
What Determines the Bitcoin Price?
Cryptocurrency exchanges operate similarly to stock markets. Open trades are posted, and buyers and sellers are matched to fill orders. As with most securities, the price of Bitcoin is determined by the collective beliefs of all traders. If a large buyer believes the price will rise and purchases enough to fill sell orders, that purchase alone can push up the price, unless matched by an equal number of sellers believing it will fall.
The largest participants in this economy include fund managers, institutions, and traders. However, unlike stocks, Bitcoin’s valuation isn’t based on earnings projections. Nor does it resemble fiat currency rates, which are influenced by factors such as central bank policies and foreign currency reserves. Instead, Bitcoin’s value is determined by investors immediate investor sentiment and prospects based on the adoption and use of cryptocurrencies. But on what basis can fund managers predict the future of blockchain and cryptocurrency adoption?
What is the Real-World Use of Blockchain?
Wether blockchain will increase its share of “real-world” use cases in the next decade remains itself a matter of speculation.
Blockchain applications can be divided into two non-mutually exclusive categories: blockchain-based cryptocurrencies as means of payment, and blockchain-based smart contracts for executing business logic. Both face serious competition from centralized systems. Blockchain proponents, including investors, often resort to ideological arguments. While I’m a strong advocate for decentralization, I’ve found that idealism has been the Achilles’ heel of the crypto community.
First, most of the industry’s revenue comes from trading, which is a zero-sum game. While top-tier VC funds pour money into the ecosystem, the majority of crypto unicorns (startups valued at over $1 billion) derive their income from transaction and trading fees. This is true for exchanges like Binance, which distribute part of their wealth to upstream technology suppliers such as anti-money laundering tools, like the one I founded in 2020.
Second, usability remains low. While there are signs of broader cryptocurrency adoption in countries like Nigeria and the Philippines, where users increasingly use them to bypass costly remittance fees, high exchange rates from crypto to fiat and competition from other fintech startups have weakened this promising value proposition. The 2020 rise of DeFi, a set of financial protocols fully embracing blockchain decentralization, is promising. However, the high fees for each transaction hamper adoption beyond crypto-enthusiasts. For most people, centralized systems remain far easier to use. Regardless of whether Google Pay and WeChat are under Big Brother’s control, their zero fees and instant transactions are preferable to Bitcoin or ERC20 transactions. Consequently, despite a growing number of companies accepting Bitcoin as payment, cryptocurrencies remain concentrated among a minority of the global population—predominantly male technophiles investing for potential returns. Or have you seen your mom use MetaMask yet?
Third, real-world applications work better with centralized databases. Blockchain requires consensus mechanisms that are costly for companies to set up and maintain. Moreover, the companies and engineers implementing enterprise blockchain are centrally coordinated, which defeats the purpose of a decentralized technology layer. High costs and intangible ROI have led enterprise blockchain protocols like Hyperledger, Corda, or even Ethereum to generally experience slow growth beyond the proof-of-concept stage.
Fourth, centralized organizations make faster decisions. Compare the speed of a well-run fintech startup like Wise.com, founded in 2011, with the decision-making process in the Ethereum Foundation, or the time required to reach consensus for Bitcoin hard forks.
Bitcoin as a Store of Value
Many consider Bitcoin a potential store of value, an asset that would retain its purchasing power into the future. Some even compare Bitcoin to gold, the traditional leader in that category.
Even after Nixon ended the Gold Standard in 1971, gold’s price maintained a strong tie to economic reality. Over half the total demand for gold comes from the jewelry industry—twice the purchase from banks and other investors. Constraints on demand and supply anchor gold’s price, making it almost an order of magnitude less volatile than Bitcoin. Gold has historically correlated positively with inflation, making it a key store of value.
Bitcoin’s fixed supply suggests it could serve as an inflation hedge, but in practice, it lacks the consistency of gold. Its demand is mostly influenced by investor sentiment, and unlike other stores of value, its price isn’t anchored by real-world economic fundamentals or usage-based feedback. For instance, Elon Musk’s Twitter rant in May 2021 wiped out $365 billion in Bitcoin’s market capitalization overnight.
Conclusion
Bitcoin represents a generation of promising and powerful technology. However, unlike other securities, its price isn’t regulated and isn’t intrinsically tied to any service or entity. Its market capitalization isn’t a function of rigorous economic analysis. Moreover, society-wide adoption of Bitcoin or its underlying technology has yet to occur.
Bitcoin’s price will continue to fluctuate according to the whims and endorsements of regulators and public figures. Adoption numbers will likely play only a marginal role in the foreseeable future. Simply put, if Bitcoin’s value rises to $100,000 in 2022, there’s nothing to prevent it from returning to $20,000 in 2023, as historical corrections have shown.
In the zero-sum trading game, professional traders outperform non-professionals not because they better understand blockchain’s future, but because they use superior algorithmic trading engines. The speculative buying and selling generate transaction and trading fees which keep the insular crypto ecosystem on life support.
This isn’t to say that crypto or blockchain will never have a bright future. Rather, it means that if you want to avoid losing money, you should invest in assets whose valuation is closely tied to the adoption of the underlying service. In other words, place your bets on public or private stock of technology companies. The decision is ultimately up to everyone—after all, there are “only” trillions of dollars in capitalization at stake.