The value of cryptocurrencies like bitcoin, just like any other kind of money, comes fundamentally from what you can do with it. As a follow up to What Backs Bitcoin, I want to dig into that value.
The idea, which comes from Austrian economist Carl Menger, is that just as a shovel’s value comes from its ability to dig, a currency’s value comes from its ability to help you do two things: transactions and savings.
Think of transactions as the money you carry in your wallet or checking account, and savings as the rest of what you have in the bank or buried in the yard. It’s worth mentioning here that that vast majority of money demand is indeed savings, making up 90% or more of all money demand.
The reason this matters is because if we know what transactions cryptocurrencies are good at, we can estimate how much money demand they’ll start pulling from fiat or gold, and therefore how much those cryptos will increase in price.
For transactions, some features that matter are cost and speed of transaction, anonymity, reversibility, counter-party risk, regulatory treatment. For savings demand, those factors are overwhelmed by the specific question of how well the currency keeps its price.
Supply and Demand Determine Price — Always
Price, as always in economics, is simply a matter of demand and supply. When demand is rising faster than supply, the currency will go up in price. And if demand is rising slower than supply, price will go down.
Since bitcoin was born in 2009, it has generally enjoyed demand rising much faster than supply, hence price has soared. While the US dollar, say, has gone down — has “price inflated” — because demand failed to keep up with dollar creation.
Those are the features, now what are the applications: what are people using money for?
When we’re looking at a currency’s price, because we’re looking at total demand we don’t care about the number of transactions rather the total amount transacted.
And here, the vast majority of money moving around in the economy is not goods and services — buying a cup of coffee, or a plane ticket — rather financial movements. Paying salaries, buying and selling stocks or bonds, investments and dividends. These occur mostly by bank transfer, which account for 80% of all money moved in the US. Another 15% goes by check, leaving just 3% for credit or debit cards, and 4% for paper cash.
Bitcoin Still under 0.01% of Global Transactions
A final part of the puzzle, what’s the competition to cryptocurrencies? Most money payments worldwide are, of course, denominated in fiat currency like dollars or yen — about 99% by amount. With the remaining 1% made in gold.
Note that fiat has both physical and electronic forms, such as credit cards and bank transfers. Even gold payments can be made with paper rather than physically moving the gold, including gold-based securities that trade in financial markets (so-called “paper gold”).
Now we’re ready to go through those features for each currency. On cost and speed of transaction, bitcoin’s fees nowadays average about $1, and don’t vary by amount you transfer.
You can send one bitcoin, worth $5,000, or 1,000 bitcoins, worth $5 million, and the fees are still a dollar. In contrast, banks typically charge a percentage of the transaction, which adds up on million-dollar transfers. Meanwhile, on speed bitcoin is much faster than banks; between 10 minutes and an hour to confirm a transaction, while banks take days.
So bitcoin beats on the most important application of money: financial transfers. The one caveat here is exchange costs. Just as you pay fees and spreads when you exchange your dollars for yen, every time you convert dollars into bitcoin you’ve got to pay fees and spreads.
This means that bitcoin’s low fees only really dominate if both the sender and receiver are keeping the money in bitcoin.
Source/More: What Gives Cryptocurrencies Their Value | Mises Wire