Bitcoin has received and continues to receive a lot of fervent support. Its unsteady yet linear ascent from a paltry $0 in 2009 when it was first created, to a $66,000 peak in 2021 is a testament to this fact. These sterling developments beg the question: why is Bitcoin so popular and what exactly does it do for us? Is it really all that it is made up to be or is it just a passing fad?
Dispassionate investigation into this subject led this author to the sobering conclusion that Bitcoin is definitively worth zero. This conclusion might be confusing to some – disappointing even – because the prevailing zeitgeist paints Bitcoin as a harbinger of unparalleled socio-economic revolution.
Contra this colourful prognosis, emerging truths now reveal that Bitcoin is structurally incapable of delivering on its bold promises. Bitcoin fails as a currency, as an investment, as a store of value and as a hedge against inflation – all of which have been touted as unique selling points of this nascent piece of technology. This write-up will dive deep into each of these issues and in the process dispel the erroneous belief that with Bitcoin we are on the cusp of something revolutionary. This discussion couldn’t be any more timely considering that globally Africa currently has the highest cryptocurrency adoption rate with countries like Nigeria, Kenya, Tanzania and South Africa leading from the front.
Having set the agenda, let us begin. Bitcoin fails as a currency because of two things: volatility and scalability concerns. In its 12 years of existence, Bitcoin has maintained extremely high levels of volatility i.e. 60 per cent to 100 per cent annualized. Contrast this with the US dollar, which has an annualized volatility of 17 per cent. This mercurial nature of the digital coin is problematic given that for anything to be considered a currency it has to exist within certain bounds of stability. Anything that moves 5 per cent a day, 30 per cent a month — up or down — cannot be a currency.
Pundits have tried to peg Bitcoin’s volatility to the fact that it is still in its early adoption phase. When it becomes widely accepted and new investors come on board it will settle, they say. This sounds like a fair argument until you run the numbers and realize that at higher levels of capitalization, Bitcoin’s volatility compounds. Simply put, the more people buy Bitcoin, the more unstable it gets.
The scalability issue, on the other hand, is quite straightforward. Bitcoin’s high energy consumption levels (700 KWh per transaction) render it incapable of satisfying the day-to-day monetary needs of entire populations. That and the fact that it is also painfully slow. It takes on average 10 minutes for a transaction to be verified on the Bitcoin network. This means that if you decide to buy a cup of coffee on the side of the road, you would have to wait a whole 10 minutes for the transaction to be completed.
The more people buy Bitcoin, the more unstable it gets.
Attempts have been made to resolve this problem without undermining the integrity of Bitcoin’s infrastructure under the “Lightning Network” project without any due success. Vitalik Buterin, a co-founder of the cryptocurrency Ethereum, notably stated that no crypto can be safe, scalable and decentralized at the same time. He called this the “Blockchain Trilemma”.
Surprisingly, there have been claims that Bitcoin is extensively used as a currency in El Salvador. This is very misleading. The dominant currency and unit of account in El Salvador is still the US dollar. The use of Bitcoin in that country is primarily for remittances by citizens working abroad to their families back home. These citizens rely on Bitcoin for cross-border money transfers to avoid the high costs that come with such transactions, and also because most citizens of El Salvador, i.e. 70 per cent, don’t have bank accounts. This does not make Bitcoin a currency. It is also worth noting that because of its volatility, Bitcoin is not a reliable medium for cross-border money transfer.
The failure of Bitcoin as an investment arises from the fact that it is a no-yield asset. This means that investors have no expectations of making any future earnings except through engaging in zero-sum games with other speculators. Warren Buffet, one of Bitcoin’s biggest critics, weighed in on this saying, “If you buy something like Bitcoin, you don’t have anything that is producing anything. You’re just hoping the next guy pays more. And you only feel you’ll find the next guy to pay more if he thinks he’s going to find someone that’s going to pay more.”
Basically, sentiment is what drives Bitcoin’s price action. The coin itself has no intrinsic value – it is worth zero. Therefore, given the foregoing, referring to Bitcoin as a pyramid scheme would not be too farfetched. A common rebuttal to this point by economic dilettantes is that the stock exchange might as well be considered a pyramid scheme because people buy low hoping to sell high to the next person. This is a poor comparison because companies listed on the exchanges are actually producing something. Ergo, investors can expect returns on their investments without having to speculate in the markets.
The failure of Bitcoin as an investment arises from the fact that it is a no-yield asset.
Moving forward, Wikipedia defines a store of value as “an asset that can be saved, retrieved and exchanged at a later time, and be predictably useful when retrieved. More generally, a store of value is anything that retains purchasing power into the future.” In simple terms, a store of value is a place to safely put your wealth where it won’t depreciate. Traditionally, gold and silver have been used as the preferred stores of value because of their long-term stability, durability and desirability. So, why can’t Bitcoin match or even supplant gold as the preferred store of value? Simply because it is volatile and untested. These two factors take Bitcoin out of the running.
Get this: on May 19th 2021, Bitcoin dropped by 31 per cent in a matter of hours after Tesla CEO, Elon Musk, publicly voiced his concerns over its enormous energy consumption levels. These sudden drawdowns are exactly why Bitcoin makes for a terrible store of value. A true store of value does not drop by 54 per cent in 1 month, as Bitcoin did in the May-June period.
Secondly, Bitcoin fails as a store of value because it is untried and untested, having been in existence for only 12 years. Compare this with gold, which has been a constant fixture of human civilization for over 5,000 years. The transient nature of technology makes it difficult for us to know for how long Bitcoin will be around. What happens to investors’ wealth if a better alternative to Bitcoin materializes in the next 5 years? Evidently, redundancy is a real risk.
Bitcoin has also been presented as an all-encompassing solution to printer-happy governments notorious for increasing the general money supply whenever they feel like it. These actions usually cause inflation and lower the purchasing power of money, thereby leaving ordinary citizens in dire straits. Since the total supply of Bitcoin is capped at 21 million tokens, governments can’t print any more of them, alas. Inflation problem solved, right? Not quite.
A true store of value does not drop by 54 per cent in 1 month, as Bitcoin did in the May-June period.
While the attempts to end years of state-sanctioned madness are admirable, the notion that Bitcoin is a hedge against inflation is mostly false. The two variables are unrelated. Bitcoin only responds to capital inputs from its adherents, meaning that it marches to the beat of its own drum. Think about it like this: what would happen if, during a recession, investors responded by moving their money out of Bitcoin into safer assets? After answering this question how can you then, in good conscience, still regard Bitcoin as a reliable hedge against inflation?
On a different plane, I would like to address an unsettling observation I made about the Bitcoin community. Many of these investors are, for the most part, oblivious of the financial risk to which they have exposed themselves. To them, Bitcoin is an infallible colossus, and anything outside of that reality is simply ignored. The half-truths and hive mind-set that has entrenched itself in the crypto space is to blame for this major lapse in judgement. This insidious monoculture has ensured that any attempts to question Bitcoin’s legitimacy are met with strawman arguments, hostility and sour rejoinders. How unfortunate. Perhaps the sagacity of Nassim Nicholas Taleb, an eminent risk analyst, will help get through to this unwavering crowd: “When you invest you must focus on what can go wrong, not what can go right.”
According to market predictions, Bitcoin is expected to hit the US$100,000 mark in the near future. Whether that happens or not has no bearing on the intractable truths articulated here. Bitcoin’s worth is still zero, and one day the bubble will pop. This could happen tomorrow, or fifty years from now. Nobody really knows when.
The main take away from all of this is that you don’t want to be the dupe left clutching at their pearls when it happens.