Is crypto's value in utility or storage?

19 February, 2019

A small handful of the biggest names in cryptocurrency have used the occasion of the recent bear market to critique Bitcoin and other cryptocurrency platforms that seem unusually aligned to it. Their contention is that Bitcoin is on its way to zero value due to its lack of utility. Is such a criticism valid? By extension, is a cryptocurrency's value in its utility or storage?

The market will ultimately decide what happens to Bitcoin. But still, the cryptocurrency community really needs to step back and look at the utility vs. storage debate. Why? Because if one is truly more important than the other, all of the cryptocurrencies on the wrong side of the equation are destined to fail. No one wants that.

The value in utility

Many of those predicting Bitcoin's ultimate demise lay the blame at the feet of Bitcoin itself; primarily its lack of utility. We will explain later why that lack of utility exists. For now, though, let us focus on the impact it has on the value of Bitcoin.

Regular visitors are fully aware that they can play casino games at online gambling sites by depositing bitcoins instead of fiat. Doing so is an example of utility. Remember that Bitcoin was originally intended to be a digital, peer-to-peer payment system. It was designed to provide utilitarian function: allowing people to conduct financial transactions among themselves without bank or government interference.

Any use of bitcoin that facilitates private financial transactions is considered utilitarian. As such, the more utility a payment system offers, the more likely that payment system is to be adopted by both buyers and sellers.

Main challenges to utility

The difficulty with Bitcoin is that so few merchants are willing to accept bitcoin payments. Some simply do not want the hassle of having to constantly convert between bitcoins and fiat, which would be necessary in order to keep their businesses running. Others don't accept bitcoin payments because coin prices fluctuate so wildly.

Still others do not accept bitcoin because there is not a large enough demand to warrant it. They see no reason to go to the trouble of setting up a payment system when the vast majority of their customers have no interest in it.

From the customer's perspective, it can be awfully difficult to take the plunge into cryptocurrency when you know there are so few merchants who accept it. Considering the cost of BTC, ETH, LTC, etc., there is a reluctance to buy coin under the assumption that it may never get used.

As you might imagine, the decisions of both merchants and customers creates a vicious cycle with one feeding off the other. Merchants avoid bitcoin payments because not enough customers use them. Customers do not invest in bitcoins because they don't have enough opportunities to spend them.

Utility and demand

The value of Bitcoin and its competitors is ultimately determined by supply and demand. There is no arguing that. But utility certainly impacts value in that it drives demand. If Bitcoin was intended to be a peer-to-peer payment system and yet nobody uses it, it has very little practical value. And if it has no practical value, its real value in terms of fiat comparison is also limited.

To put it another way, let us compare Bitcoin to gold. As a metal, there is nothing inherently special about gold that makes it so expensive. It is only worth as much as it is because world players agree to that worth.

Gold is used to make fancy jewelry that costs a lot of money. But what would happen to the price of gold if no one wanted it anymore? What if everyone suddenly decided they wanted their fancy jewelry made of aluminum instead? Both the price and value of gold would drop.

It is hard to argue against a value in utility. If there is no practical purpose for a given product or service, there is very little value in it. You cannot sell something people don't want.

The value in storage

The other side of the proverbial bitcoin is value in storage. What do we mean by that? We mean purchasing bitcoins as an asset. You buy them, park them, and just wait for their value to increase over time. It is the same principle that drives buying stocks, shares, bonds etc.

Value in storage is derived through the same supply and demand forces that control value in utility. For purposes of explanation, know that Bitcoin's original developer wrote a limited supply of bitcoins into his code at its inception. In short, there are only 21 million coins to be had. Once they have all been mined there will be no more.

Knowing that, try to imagine the value of bitcoins once they are all in circulation. If one person owned all 21 million and there were 30 million people wanting to purchase them, that owner would be in the driver's seat. He or she would have ultimate control over the price because no one else owns any coins.

Although this is an oversimplification of a complex financial truth, the principal should be easy enough to understand. Investors who previously poured large amounts of money into Bitcoin did so with the understanding that the basic laws of economics would gradually drive the price of the coins up as more were mined.

So far, so good

Go back and track the history of Bitcoin and you will see that the strategy of deriving value from storage has worked fairly well so far. Even in the current bear market, Bitcoin is hovering around US$3,300. That is pretty impressive when you consider that a single coin was worth only $0.08 back in July 2010.

You could have purchased 100 coins back then for a total of just $8.00. Those same coins today would be worth roughly $330,000. Buying, parking, and waiting would really have paid off had you made such an investment back in 2010.

Just from this example we can see the legitimacy of value in storage. But does value in storage stand the test of time? In other words, would the profits you derived from purchasing 100 coins some nine years ago continually grow in perpetuity? The obvious answer is no.

At its peak, Bitcoin was worth nearly $20,000 per coin. Purchasing 100 coins in 2010 would mean your total investment was worth some $2 million at its peak. But today it is only worth $330,000. Clearly the derived value you could have achieved between 2010 and 2017 - when Bitcoin peaked - would have been greatly diminished from that peak point until now. And that brings us back to value in utility.

Bitcoin's limited block size

According to those convinced that Bitcoin is on its way to zero, the lack of utility in the Bitcoin platform is a direct cause of its limited block size. As the thinking goes, block size makes Bitcoin too difficult to use as a peer-to-peer payment system, thereby limiting utility. A lack of utility means there is no real purpose for bitcoins, thus average consumers do not want them. And if consumers don't want them, the price drops.

For the record, a block is a chunk of computer data. All the data created by Bitcoin transactions is stored in its blockchain (or ledger) as a series of blocks connected in one long chain. Compared to other cryptocurrencies, Bitcoin's block chain allows for only very small blocks of data.

When a block reaches its size limit it is automatically closed. It is added to the chain while a new block is opened to start receiving new data. Here's the problem: the smaller the block size, the more blocks in the chain. This is one of the things that makes Bitcoin's processing times slower than some of its rivals.

Furthermore, when you combine small block size with the kind of proof-of-work required to finalize Bitcoin transactions, you create a system that requires a tremendous amount of power to mine a single coin. In short, you have a system that businesses don't want to use because transaction times are too slow and mining is too complicated.

Bitcoin's prophets of doom claim the world's dominant cryptocurrency is headed to zero because investors are pulling out. They say investors are pulling out because of a lack of utility. Does that seem reasonable to you?

The future of crypto

No one really knows where Bitcoin will be a year from now, let alone 5 or 10 years down the road. And as previously stated, the market will ultimately decide its fate. But it is worth looking at utility vs. storage. If the true value of Bitcoin is derived from utility, there are a lot of other cryptocurrency platforms out there at risk of failure.

It would behoove all of them to stop worrying so much about market capitalization and daily price fluctuations and, instead, put their time and energy into increasing the utility of their coins. For example, it would be wise to start courting online casinos in hopes of getting them to accept your coins. It would be wise to start courting merchants, large corporations, B2B Enterprises, and so forth.

If you can increase utility, you can give investors a reason to put money into your crypto platform. Utility will derive value for the investor, and that value will be further enhanced by storage.