Cryptocurrency and Value
I recently read an article in the New Hampshire Bar News:
While there were parts that I think would be helpful to an audience that isn’t conversant with cryptocurrency, such as the railroad analogy. In that analogy, Attorney Lisa Braganća describes cryptocurrency as similar to early railroad technology. The thrust of her point is that while it may seem clear that the technology will last the test of time, we don’t know which particular cryptocurrencies will see long term economic success. Will Bitcoin (BTC), Ether (ETH, sometimes referred to incorrectly by the name of its network- Ethereum), ADA (on the Cardano network) or any of the other cryptocurrencies still exist in 20 years or will they go the way of Bitconnnect (BCC). For those that don’t know, BCC had a precipitous and infamous fall from prominence.
This leads to the major issue with the NH Bar article. It quotes Michael Lucia, President and CEO of Webster First Federal Credit Union describing the value of cryptocurrencies as akin to “handfuls of air.” Mr. Lucia incorrectly describes United States Dollars (USD) as being “like a handful of air” but at least you have “a piece of paper with a serial number on it.” USD actually derives its value from two major sources, its utility (intrinsic value) and its market value relative to other assets (extrinsic value). You can watch how the market value of USD fluctuates relative to other world currencies on a FOREX exchange. The utility of USD is that it is legal tender in the United States and that taxes can always be paid in USD. Other than the uses that the paper itself could be used for such as fire, there isn’t really another utility for USD.
Gold is another asset that you can watch its market price fluctuate relative to other assets. But gold has more numerous uses and thus greater intrinsic value than USD. Gold can be used for decoration such as in jewelry, medical purposes such as dental fillings, electronics, and probably more that I am unaware of.
Making general statements about where cryptocurrencies derive their value is difficult because they all work slightly differently and many have different utilities from one another. It is easier to break cryptocurrencies into two major categories of value, the first is cryptocurrencies that derive their value from being a distributed ledger that allows permissionless transfer of value anywhere in the world. Examples of this category are BTC, Dogecoin (DOGE), and Litecoin (LTC). To understand the value they provide you need to understand the normal financial system.
When you buy groceries, you don’t pay the grocery store directly for the items (unless you pay cash), you swipe your credit card to tell Visa to tell your bank to transfer the money to the grocery store’s bank account. This example shows you all of the “middle-men” that need to give permission for this simple transaction to go through. If you were to use BTC for the same transaction, you would use your crypto wallet to tell the Bitcoin network to send BTC to the grocery store’s crypto wallet and pay a transaction fee. The Bitcoin network will transfer the money as long as you have enough BTC to cover the amount you want to send and the transaction fee. There is NO ONE in the network that can object to the transaction. There are no middlemen involved. This also means that if you sent money to someone who swindled you, there is no one to dispute the charge with like you could with a credit card transaction. In this way it is just like a cash transaction. But it also means, for example, that I can send money to a political dissident in China without having to worry about the Chinese government preventing the transaction.
The second group of cryptocurrencies do usually have the distributed ledger and allow permissionless transfer of value anywhere in the world, but they also have the ability to perform more complex transactions. In this group the computers on the network perform these more complex transactions by executing code and are compensated for their computations in the cryptocurrency.
Because of the difficulty of describing this motley group, I will stick to a couple of examples such as ADA, ETH, and Filecoin (FIL). ADA and ETH are both smart contract platforms that allow things such as having cryptocurrency exchanges that don't require a middleman, known as DEX’s. The smart contract code takes the place of the middleman. So rather than having the New York Stock Exchange (NYSE) match buyers and sellers, this matching is done by computers and the computers are paid for the work. Just like you pay your stock broker for your stock trades, you pay the computers of the DEX for your DEX trades.
Filecoin is a peer-to-peer network that allows anyone to store and retrieve data on the internet. How it works is that storage is paid for in FIL, the native cryptocurrency of the Filecoin network. If you wanted to store some data on the Filecoin network, you would purchase some FIL with USD and use the FIL to pay for the storage of your data. Conversely, you could receive FIL by making your computer part of the Filecoin network and allowing it to store other users’ files. I can hear you say “how is this different from my dropbox account?” The difference is that instead of signing up with a centralized company, in this example Dropbox, you purchase a cryptocurrency that pays the computer storing your data directly. That could be anyone, anywhere in the world that is willing to accept FIL and has a computer capable of participating on the Filecoin network.
I know that this is a complicated subject, but I hope that my explanation has helped to shed some light on the issue of value in cryptocurrency.