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Are Bitcoin and other cryptocurrencies useless?

Are Bitcoin and other cryptocurrencies useless?

There has been a lot of excitement around the market collapse of cryptocurrencies lately. So much so that even The Economist recently published an article headlined “Bitcoin and other cryptocurrencies are useless — for blockchains, the jury is still out”. That a leading publication such as this believes cryptocurrencies are useless highlights the lack of awareness of their value and how misunderstood they are.

Is Bitcoin useless? It all depends on what underlying fundamental value it offers. Much like blockchain, it has become a source of great confusion as to what its purpose is and the role it has to play. To gain a better understanding of Bitcoin’s underlying value, it can be helpful to take a look back at its history and original purpose.

Breaker magazine published a fascinating article this month titled “All In: The Hidden History of Poker and Crypto”, in which it hypothesised online poker’s role as a motivating factor in the creation of Bitcoin.

As evidence it references snippets of code from version 0.1.0 of the source code of Bitcoin that appear to be building blocks for the user interface of a virtual poker game. From this, it draws parallels to the nascent online poker industry of the mid-2000s that suffered waves of regulatory pressure, which effectively shut out industry innovators and later opened the market for established players in the industry.

The challenge for the industry was that taking payments and paying out winnings became an insurmountable problem once United States legislators became involved. Legislation was passed that made it illegal for payment processors to provide their services to online gambling sites. The industry had its share of scams as well as reputable businesses doing their best to stay within existing gaming regulations. All businesses were effectively roped together under this legislation at the federal level. At the stroke of a pen, many businesses were wiped out, creating much angst in the online poker community.

If the regulatory crackdown on online poker indeed did serve as inspiration for Bitcoin, it would be of little surprise. Why else would Satoshi Nakamoto, the anonymous individual behind Bitcoin, open his White Paper by suggesting “A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution”.

Herein lies the essence of Bitcoin’s purpose. It was designed primarily as a censorship-resistant means to transfer money between people. In other words, it was a means of facilitating online payments that could not be corrupted or controlled by anyone. Disappointingly, this has led to its initial uses for unsavoury practices far beyond online poker and has resultantly mired it in controversy. It does, however, have practical and useful applications that many don’t realise.

Anyone who tries to draw comparisons of Bitcoin’s use to that of, say, the Visa network has strongly misconstrued its purpose. It is highly unlikely that Bitcoin will ever be used as an everyday, global payment mechanism for purchases in a local economy. The incentives simply aren’t aligned. It is, though, far more likely that Bitcoin has a place as a means of facilitating global trade — in the case of acting as a replacement for global remittances, trade of resources such as oil or, perhaps, just for those who want to engage in a game of online poker.

For example, Bitcoin and other censorship-resistant cryptocurrencies have become quite popular in Venezuela as the bolívar struggles with runaway inflation and manipulation. These currencies have allowed Venezuelans to circumvent and bypass government controls to maintain wealth and provide a viable means of exchange. There are considerable uses for Bitcoin and similar cryptocurrencies in these sorts of cases where Bitcoin’s true original purpose shines.

Although there are clear-use cases for Bitcoin in the realm of censorship-resistant trade, this is not necessarily a sole driver of its value. Fundamentally, Bitcoin’s secondary purpose is to act as an incentive mechanism. You see, Bitcoin’s nature as a currency is reliant on a distributed network of public entities that will process and agree on information, commonly referred to as a blockchain. These entities contribute computing power to enable transfers of value and information on the network in a way that no one entity controls the data, but rather the collective does.

To get people to contribute their computing power to power the network, an incentive is needed. In the case of processing transactions on the Bitcoin blockchain, that incentive takes the form of fees charged in Bitcoin and a reward. Thus, Bitcoin’s utility is closely linked to how much demand there is for transactions such that fees are paid to the network to process them. Indeed, Bitcoin can be used quite effectively as a medium of exchange in situations that were not accessible previously.

As a compelling example, consider the situation of a small-business owner or entrepreneur in Argentina. That person may desire to buy a large box of car parts, shoes or hair extensions from China and then resell them in a store. The challenge is that, unlike for Bermudians, access to banking and debit-card services for Argentinians is limited.

So, how do Argentinians make an online payment to somewhere such as Alibaba.com without easy access to wire transfers or credit cards? Well, one option is to use a Bitcoin ATM machine. They deposit their Argentine pesos in a machine and enter the Bitcoin address of the person or business in China whom they wish to send their money to. Their cash is exchanged for Bitcoin, that Bitcoin is sent to the Chinese recipient, who can then exchange their Bitcoin for Chinese yuan. Neither party really cares to hold Bitcoin itself; just to use it as a medium of exchange between their two currencies and economies. Their transaction fees are paid as an incentive to process that exchange.

The challenge is that Bitcoin’s underlying usefulness as a global medium of exchange declines as it gets more expensive to use. Speculators over the past year drove up the price of Bitcoin quite substantially. Since the transaction fees used to power the network are tied to the price of Bitcoin, the transaction fees rose as well.

In January, average transaction fees hit nearly $50. This damaged Bitcoin’s underlying utility as it lowered its usefulness. As Bitcoin’s value has dropped in recent months, its transaction costs have also dropped to near an average of 50 cents, which has increased its usefulness and utility.

Are you likely to buy a coffee with it when you have access to debit cards or cash? Likely not. However, at 50 cents, Bitcoin is far more attractive as a transfer mechanism for Argentine small-business owners than it is at $50.

So, are cryptocurrencies useless, having little practical value beyond hype? Well, as we have noted, the challenge is that it is the very notion of hype and speculation that drives up the price, which is a key factor in reducing its usefulness. Rather than thinking Bitcoin is worth millions or is worth zero, is it more reasonable to consider that perhaps Bitcoin is worth only as much as there is demand for its actual use?

Hype and speculation do little more than to damage its value. What we will likely see is that cryptocurrencies such as Bitcoin aren’t actually useless; they just need to reach a price of reasonable balance where it is cheap enough to be actually used and more compelling than alternative solutions.

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