Bitcoin founder Satoshi Nakamoto originally suggested it as a peer-to-peer form of electronic cash. But as the cryptocurrency gains credibility as an asset class, and demand grows for its use in emerging markets, it is beginning to resemble gold as a store of value, writes Daniele Bianchi.
Since the birth of Bitcoin in 2009 there has been one key question that has repeatedly made the headlines and led debates: is Bitcoin a store of value? On the surface, this question seems at odds with what Bitcoin was originally designed for – namely, a peer-to-peer electronic cash system.
As a matter of fact, the original white paper of Bitcoin founder Satoshi Nakamoto does not mention 'value storage' properties but makes a strong case for a purely peer-to-peer version of electronic cash, which allows payments to be sent directly between parties without going through a financial institution.
Value storage and medium of exchange are two aspects of Bitcoin that are inherently interlinked. The intrinsic value of Bitcoin crucially depends on the fact that it attracts large-scale market operators and gains legitimacy. In other words, the utility of Bitcoin as a store of value is dependent on its diffusion as a method of payment so that its volatility will decrease concerns about its perceived riskiness as an investment.
Generally speaking, a store of value is any form of investment that is not perishable and maintains its value without depreciating – gold being the common example. The working assumption is that there is a base level of demand that does not drop below a certain level, with the possible exception of global structural changes. However, as of now at least, Bitcoin is just too volatile for anybody to believe it can be safely used for a long-term portfolio strategy, long-run economic decisions, or even for hedging risks coming from other standard financial instruments – volatility and unpredictability in currencies are harmful to investors and businesses.
An emerging option
Nevertheless, Bitcoin can be especially appealing for those investors living in emerging or frontier economies. The advocates of the digital currency argue that Bitcoin’s biggest value proposition is its characteristic of being government censorship and judgement-resistant money. The absence of central authorities and trusted third parties make both the production and the circulation of Bitcoin essentially free from governments’ controls and intervention.
Anecdotal evidence shows that indeed Bitcoin may provide a valuable instrument for investors to escape capital controls, hyperinflation and demonetisation. For instance, Bitcoin’s price climbed as much as 10% in a day on Zimbabwe’s Golix exchange on November 15, 2017, after the country’s armed forces seized power amid a shortage of hard currency.
By the same token, the intentional devaluation of the Chinese yuan and the government policy of capital controls spurred the initial fuel to Bitcoin prices driven by the increasing demand by Chinese investors looking for a safe and anonymous way to send their money offshore.
Introducing Bitcoin futures
Although it has been thought of as a peer-to-peer payment system, it is evident that Bitcoin recently is gaining more and more legitimacy as an asset class. The Chicago Mercantile Exchange and the Chicago Board Options Exchange proposals to introduce Bitcoin futures has the potential to add further legitimacy and thus increase the appeal of the cryptocurrency to both institutional and retail investors.
The introduction of derivatives provides the necessary market structure for institutions to trade on Bitcoins without owning them as, in fact, futures contracts on Bitcoin are cash settled. This likely will lead to the creation of exchange-traded funds and other more liquid instruments, potentially increasing market activity and aggregate demand by orders of magnitude. The possibility to trade Bitcoins by using standard instruments is likely to lend more and more legitimacy to Bitcoin as an emerging asset class with limited supply, and therefore possibly as a store of value.
Australian blockchain move
At the time of writing, there are more than 16.5 million Bitcoins in circulation, and more than 800,000 Bitcoin users (unique addresses). Early this year there were 300,000 fewer users while the number of coins mined and circulating barely changed (at 16.1 million). Demand pressure is intensifying, while available supply is flattening as indeed designed by the protocol. A further boost of confidence for cryptocurrency investors came after the Australian Securities Exchange declared it will replace its current clearing system with blockchain technology.
Bitcoin’s utility plus its scarcity ultimately determines its price. Just like gold, if you increase its appeal for investors, you increase its price; and just like gold, you do not need to use it to make payments. So is Bitcoin a medium of exchange or a store of value? Financial markets seem to already be giving their answer.
Daniele Bianchi is assistant professor of finance at the Warwick Business School at the University of Warwick.
