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Posted on 5 Dec 2017 by BullionStar

Bitcoin isn’t Digital Gold, it’s Digital Uselesstainium

This blog post is a guest post on BullionStar's Blog by the renowned blogger JP Koning who will be writing about monetary economics, central banking and gold. BullionStar does not endorse or oppose the opinions presented but encourage a healthy debate. 

People often like to describe bitcoin as digital gold, but that analogy isn't a very good one. Bitcoin is categorically different from the yellow metal. If we had to choose a metal as an analogy for bitcoin, that metal would be boring grey in colour (and thus lacking ornamental purpose), useless for industrial purposes, but scarce. As far as I know no such material exists, so let's come up with a name for this imaginary metal: uselesstainium. Bitcoin is digital uselesstainium.

Before bitcoin fans get angry with me, I should confess that I got the idea for uselesstainium from a 2010 discussion board post by Satoshi Nakamoto, the creator of bitcoin. Below are his thoughts on a scarce metal that is "boring grey" and "not useful for any practical or ornamental purpose":

Let's dig more into the difference between gold and this stuff we call uselesstainium. There are two reasons to value something: 1) because you want to use it, or 2) because you expect to pass it off in the future. Pass-it-off demand may be for short-term purposes, like money—you only expect to have a dollar bill in your wallet for a day or two before spending it on. Or it may be for the long-term, like a speculative asset that you intend to keep for a few years before selling to someone else. Either way, pass-it-off demand means that the item's value to you depends on what *the next person* is willing to provide, not on its use-value.

The demand for gold is made up of both types of demand. A portion of those active in the gold market value it as jewellery or a collectors item, or because it can be used to make circuitry or in satellites. The other portion likes the metal for its pass-it-off purposes, say they expect that someone else will pay twice the price next year.

Because it is an ugly grey colour and thus unsuitable for collectors or jewellery wearers, and it can't be used in teeth nor for industrial purposes, uselesstainium has no use-value. If it is going to be valued at all, then pass-it-off demand will have to be wholly responsible for generating that value.

Gold and a fat-finger trade

Thanks to this difference, the prices of gold and uselesstainium will act very differently. Let's say the two metals are each trading at $1000/oz. Each of them suddenly suffers from a freak $100 drop in price. No event has occurred to cause it, nor have people's tastes change, nor has the technological backdrop been altered. It's a fat finger event.

In this context there is *no* fundamental reason for uselesstainium to return to $1000. With gold, however, strong market forces will emerge to help fix the mistake and push the price up towards $1000.

Gold is a good conductor of electricity. And unlike copper and other metals it doesn't corrode, which means that gold electrical connections are superior to most. However, an ounce of gold is much more expensive than an ounce of copper or any other metal. When gold was at $1000, manufacturers of printed circuit boards (PCB) will have made a tradeoff between gold and other materials subject to the preferences of their customers, choosing the optimal amount of gold for the parts of the board that are too delicate to suffer from corrosion while directing copper, silver, and other materials to the rest.

But with gold now at $900, the yellow metal has become marginally more competitive than other metals. At these prices, PCB customers can afford to ask for a bit more gold on their boards. This demand will help drive gold back up to $1000. The PCB market won't be the only market to demand more gold. Collectors, jewellers, dentists, and many others will all find gold a little more advantageous than before relative to alternative materials and will step up their buying. Their combined purchases will help counterbalance the mistaken fat finger trade.

Speculators who are attracted to gold solely for its pass-it-off value will contribute to this rebound. Because they are constantly trying to anticipate the needs of future buyers, including those in the PCB market, speculators will purchase as much gold as they can from the fat finger trader based on their informed opinion that they can resell it to board manufacturers at a higher price.

Uselesstainium and a fat-finger trade

When uselesstainium falls to $900, no equivalent forces exist to drive the metal's price back to $1000. Remember, because uselesstainium has no industrial value the only basis for valuing it is by trying to guess what price it can be passed off to others. Whereas a gold speculator can try to anticipate the needs of participants in the PCB market, a uselesstainium speculator can only sell to other speculators. This means that she must try to anticipate what other speculators are likely to pay, while at the same time these potential buyers are in turn trying to anticipate what she will pay.

This sort of expectations game was beautifully described by the economist John Maynard Keynes back in 1936 as a beauty contest. Presented with a row of faces, a competitor has to choose the prettiest face as estimated by all other participants in the contest:

"...each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees."

Confronted with a sudden $100 crash, there is no inherent reason for a uselesstainium trader to anticipate that average opinion anticipates average opinion to move the price back up to $1000. A move up to $1100, or down to $700, or a collapse to $0, are all just as likely. In a beauty contest, there is no right or wrong price for uselesstainium.

Bitcoin is digital uselesstainium

Since there is no use-value to anchor uselesstainium's price, we'd expect it to be far more volatile than gold. Likewise with bitcoin, which is both rare and demanded solely for pass-it-off purposes. Let's take a look at a chart of the relative volatility of bitcoin and gold to see what it shows.

What you see in the above chart is the median daily change for each asset plotted over a moving 200-day period. By using the median rather than the average I am stripping out some of the large gut-wrenching changes that assets experience, in an effort to give a sense of what happens on a day-to-day basis.

Gold's median change since 2011 (the black dashed line) is around 0.5%. This means that on a majority of days you should expect a gain or loss of around 0.5% if you hold the yellow metal. Over the same time range, bitcoin's median change (the dashed red line) is about 1.7%, which means that an owner of bitcoin must generally deal with moves of +/-1.7% each day, more than three times what a gold owner must bear.

Bitcoin's rolling 200-day median return (the solid red line) is much less stable than gold's. It almost fell to the same level as gold in late 2016, hitting a low of around 0.75%, but has quickly moved back above 3%, a level last seen in 2011 and again in 2013-14. The volatility gap between gold and bitcoin—the distance between the two solid lines—is currently at its widest since 2012.

Bitcoin will always be an incredibly volatile asset because it exists entirely on pass-through demand. Like uselesstainium, it is a pure Keynesian beauty contest. If all contestants in the bitcoin price-setting game come to believe that the average contestant believes that the average contestant believes bitcoin is worth $0, then that belief will self-realize itself and bitcoin will fall to $0. If they all become 100% sure that it should be worth $100,000, then it will jump to $100,000. These sorts of price implosions and explosions can't happen with gold because its usefulness inspires economic behaviour that counterbalances beauty contest dynamics.

Now it is possible that bitcoin inherits some useful properties and therefore shifts from being a form of digital uselesstainium to a form of digital gold. Bitcoin advocates will often mention time-stamping as a service. People can take a digital representation, or hash, of a document and put it on the bitcoin blockchain by spending a small amount of bitcoin. Once accomplished the owner of the document will be able to publicly prove that they were the owner of that document on that date. Bitcoin time-stamping would in theory compete with other alternatives, like real-life notaries or the post office. In the event of a bitcoin price crash, anyone who wants to get cheap time stamping services may step in as buyers of bitcoin, in the same way that PCB makers support the gold market.

However, time stamping is still in its infancy. Certainly other uses for bitcoin apart from time stamping may eventually be found, but until then bitcoin remains digital uselesstainium, not digital gold. Plenty of money can be made betting on uselesstainium, and much can be lost. But no one should be buying uselesstainum—whether it be the digital type or physical—unless they are comfortable playing in a pure Keynesian beauty contest.

This blog post is the second in a series of guest posts on BullionStar's Blog  by the renowned blogger JP Koning who will be writing about monetary economics, central banking and gold .

JP Koning
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  • Moy Yew Hon

    The reason I could afford to buy precious metals from you is because i made money from my crypto investments. So please be professional and don’t knock bitcoin. I am a loyal customer supporting bullionstar since the first year it opened and I find this article insulting.

  • Alexis Zorbaji

    Bitcoin is the world’s largest and most recognised decentralised ledger network and by far the most secure as it is secured by over 10 exohash of computing power. Calling such a network useless in our digital world reveals the sheer ignorance and idiocy of the writer. Such a network does have an intrinsic value even though it is immaterial (read metcalfe law about how to value networks). When gold sellers have to put down bitcoin to sell their metal, I guess that’s when you have to sell your gold and buy bitcoin.
    I will never buy from BullionStar anymore following this insulting piece of ignorant crap.

    • Hi Alexis,

      JP Koning’s blog post is a guest post in a series of guest posts from invited authors. BullionStar does not endorse the opinions of the author. We do however encourage a healthy debate on precious metals and monetary economics in general. Please feel free to debate the opinions presented and state arguments countering those offered by the author.

      As a bullion dealer, we don’t pass judgement on Bitcoin and keep neutral. We were one of the first bullion dealers worldwide to, 16 May 2014, start accepting Bitcoin as a settlement method for buy and sell orders facilitating for customers who would like to trade directly in between bitcoin and precious metals or take profits into either asset.

      Many proponents of Bitcoin as medium of exchange and unit of account appreciate that we don’t only allow Bitcoins as a settlement option but also display Bitcoin as a currency meaning that the customer can select Bitcoin to see product prices, spot prices, charts, account history and Vault Portfolio denominated in Bitcoin.

      Kind Regards
      Torgny

  • Raf Aql

    Hi
    Bit coin will fall soon my advice cash it fast
    No value becomes with value
    Read history many failed before just nice scam
    Thanks

  • wil

    if gold’s intrinsic value is 200 and the balance 800 is “pass-it-off” value, when the price drops to 900 why should it climb back up to 1000? it is the perception of a stable store of value that keeps gold a stable store of value, likewise if bitcoin ever achieves such status it will be so too.

    • JP Koning

      Wil, you ask why gold should climb back to $1000. Given your set-up, a set of forces will be unleashed that at least partly undoes the $100 decline. These forces arise from gold’s intrinsic usefulness in various industrial processes and consumer end products. Whether these forces fill in the entire decline is difficult to say since the price of gold is also influenced (to a lesser degree than bitcoin) by beauty contest dynamics.

  • Mohd Shahid

    I see his points but most are inaccurate. I am a big Bullionstar fan and believer in precious metals however I am an equally big believer in Cryptocurrencies as well.

    1) Bitcoin has as much value as Facebook. What is intrinsic about Facebook with such a high share price and high usage? It’s networking and social aspect. Ditto Bitcoin.

    2) Just like Gold, BTC can be used for purposes such as payments and the underlying blockchain technology can be used to facilitate smart contracts such as the altcoin Ethereum. The possibilities is limitless and certainly with that comes value.

    3) Bitcoin is “programmable money”. If the current process doesn’t work, the developers will be able to tweak and adjust it along the way.

    4) It is decentralised, unlike Fiat money there is no central govt or agencies to control it’s prices and lesser possibility for manipulation. This also means it can’t be shutdown unless you shut the internet down.

    5) It is limited to 21 million coins ever. Unlike Gold which we will never know what it’s total mineable value will be and it can’t be artificially created as well.

    I will always buy precious metal but now I will complement my portfolio with Cryptos. They are not going anywhere and here to stay. Just Dollar cost average it every month in whatever amount you’re comfortable with and ride the wave.

    • JP Koning

      Mohd, thanks for engaging. I would argue that Facebook stock has intrinsic value because it earns a profit for its shareholders. A fat-finger trade would immediately be repaired by value investors who compare Facebook’s suddenly cheap earnings multiple to other shares and leap on the free lunch.

      Since bitcoin earns no profit, it lacks intrinsic value. So there is no such thing as a set of bitcoin value investors who can calculate bitcoin’s earnings multiple and make the determination that it is undervalued.

      • Mohd Shahid

        I don’t dispute that amongst other things, FB brings profit to it’s shareholders just like how BTC brings profits to its HODL’ers. The intrinsic value in both entities are the networking and social aspect.

        Before FB was floated, it was already a very valuable company and Microsoft had a privately held stake back then. Why did MS pour so much money into a company which allows people to post things on an internet? It exists electronically just like BTC and thus derive the same intrinsic value.

        Just like how stocks are traded in real world exchanges, likewise Cryptocurrencies are traded on electronic exchanges. Fat finger trades will get corrected accordingly on both types of exchanges.

    • Going on strike or something

      I wasn’t aware that you can post pictures and news links on bitcoin.

    • Going on strike or something

      Yes blockchain technology is worth something but that’s not why anyone is currently buying bitcoin.

    • Going on strike or something

      I can’t wait for programmers to adjust the value and functionality of my asset.

    • Going on strike or something

      Good luck when the IRS and alll he regulatory bodies wise up.

    • Going on strike or something

      Limited to 21 million but with unlimited forks and unlimited competeing cryptocurrencies. This is the absolute dumbest argument of all.

  • Qualified Expert

    Nowadays, people use Bitcoin as store of values for those who knows and comfortable in the fluctuations.

  • matts118

    “but until then bitcoin remains digital uselesstainium” – Not really true, it facilitates moving money across borders in a secure way and much faster and cheaper than bank transfers. Current transaction costs for bitcoin are about $2, and time for confirmation is a couple of hours. How much does the bank charge and how long does it take? And let’s not forget the most useful part of bitcoin. The goverment or anyone else cannot take it off you without your consent. The same cannot be said about gold or much else for that matter. Not only can thieves steal it, but the goverment can also confiscate it, no matter where it is stored. If they really want it, they can get it.

    • matts118

      Also the blockchain technology that bitcoin is built on is spurring a technological revolution not seen since the 90’s. Problems are being solved that dont even exist yet. Ethereum and Iota are ground breaking. That is why so many of the world’s largest and most intelligent companies are helping them develop.

    • JP Koning

      Matts, you may be right that bitcoin can move money across borders, but that doesn’t refute my point. The demand to get some bitcoins in order to send them overseas still depends on other people people valuing the stuff. So it falls into the category I referred to as “pass-it-off” value.

      To anchor bitcoin’s price, some sort of consumption or industrial demand needs to emerge, or what I called use-value. Time stamping would be an example of that. Whether a viable use-value for bitcoin ever emerges remains to be seen.

      • matts118

        I understand that compared to commodities such as gold and oil, it has no fundamental physical use, but it is not a commoditiy, it is a currency, and several countries have declared it as such (Japan, Australia). But how would you say it is any different from say, a $US? In fact you could argue it is superior in that the supply is limited, it cannot be confiscated, and it’s cheaper to move internationally. All that really gives any currency these days any value is perception, and nothing else, they are all numbers in a computer, and that is all. Look at the euro now, the ECB had printed 40% of the EU GDP within a few years and bought bonds in practically everything with it. This is why bitcoin goes up. People are not stupid and they see what’s going on.

        • JP Koning

          You ask how bitcoin is different from a fiat currency. Let’s extend the thought experiment to include the dollar. Say someone accidentally sells so many US dollars that he/she causes a 10% jump in inflation.

          Unlike bitcoin, the dollars is backed by an issuer, the Federal Reserve. The Fed has an inflation target of 2% a year. The 10% inflation rate brought on by the fat finger trade will cause the Fed to miss its target. The Fed can use its resources to retract whatever quantity of dollars are required to undo the effects of the fat finger trade, thus putting it back on target. There is no equivalent method for retracting bitcoins, and thus no inherent way for a bitcoin fat finger trade to be fixed.

          • matts118

            Precisely why bitcoin is superior. It is not manipulated. And those inflation numbers they use, most people agree they are wrong. You know how the CPI is calculated, even with food they can switch things out if they go up too much, like bananas for apples, etc. And housing accounts for a huge amount of people’s budgets, but if that was fairly weighted inflation in places like Australia would be enormous. So what we have is fiat currencies that have indeed been massively inflated, which has drastically affected people’s disposable income, but the inflation stats don’t show it.

          • matts118

            And also, these days, it’s not the fed protecting us from the fat finger. They are the fat finger, and we have no savior at all, except to move our assets to something that is inflating as quickly as everything around us. But even with inflation at 2% and 0% interest, they are still destroying your money if you have it in fiat.

  • Koos Jansen

    I don’t agree with JP, but I encourage everyone on both sides – bitcoin or gold proponents – to keep debating. Now bitcoin is becoming bigger and bigger of course it’s also getting critical questions. Saying “bitcoin critics are ignorant” is no argument.
    “In the free market place of ideas good and bad ideas compete until the good ones win.”
    And naturally, one does can own both ‘Distributed Ledger Technology units’ and physical gold.

  • Mark Choong

    What’s up with the offence-taking and grievances among some people here. Has bitcoin followers become a total cult now which can not be criticized in any way or they call foul? Grow up and debate the post instead if you disagree.

    Matts118 – Bitcoin doesn’t facilitate moving money across borders more than any of the other 1324 cryptocurrencies (yes, really, 1324 according to wikipedia). Oh no, now it’s 1325. Bitcoin is using a technology that facilitates moving money across borders. But what if central banks start to offer the public the same technology, which some of them like the UK and Swedish central bank are considering, with the same properties, even anonymity, what is then the purpose or value with Bitcoin, or pot coin or dog coin. The technology may have some value but not bitcoin. You’re conflating the two.

    Qualified Expert – How can Bitcoin even be discussed as a store of value? The whole purpose with store of value is that the asset in question has robustness in terms of predictable long-term stability. Bitcoin is the antithesis to store of value.

    Mohd Shaid – 1) Agreed that Facebook and most of all paper or semi-paper assets are overvalued although facebook may have some value in terms of its technology and platform but the valuation is certainly ridiculous.

    2) Yes, the underlying technology may be useful of gaining wider adoption. Bitcoin is not. It’s like saying that Zimbabwe currency is valuable because of the underlying technology of printing bank notes.

    3) Still worthless if it’s worthless.

    4) Yes, that’s great actually, agreed. However it is a two-edged sword. All major bitcoin exchanges at the time have been hacked. Mt Gox went under. Bitstamp was hacked with disastrous consequences. Bitfinex was hacked with disastrous consequences. 10 accounts are hacked EACH DAY at coinbase. People like the irreversibility right up until the point where they lose their money. If someone has held bitcoins from the early days, the chances are overwhelming that you’ve either been hacked or at least lost a big chunk of your bitcoins when the exchanges have been hacked.

    5) It’s a set limitation, not a natural one.

    Wil – Yes, I agree with you. Gold certainly also have some pass-off value. A more relevant example is if bitcoin and gold both go to zero. Then gold will be pushed up above zero because of it’s inherent properties with it being valuable whereas no one will pay anything for a bitcoin because there’s nothing you can do with a bitcoin. If you want to disprove me, at least show me what a bitcoin looks like so I can get an idea of its physical form and shape.

    Alexis – Ok, if the technology is so great, central banks will eventually start to use it. There’s at least about 5 of them currently investigating it. Tell me, what is a bitcoin worth if the Federal Reserve on demand, like for cash, let base money be created on a ledger-based blockchain system?

  • Mark Choong

    What’s up with the offence-taking and grievances among some people here. Has bitcoin followers become a total cult now which can not be criticized in any way or they call foul? Grow up and debate the post instead if you disagree.

    Matts118 – Bitcoin doesn’t facilitate moving money across borders more than any of the other 1324 cryptocurrencies (yes, really, 1324 according to wikipedia). Oh no, now it’s 1325. Bitcoin is using a technology that facilitates moving money across borders. But what if central banks start to offer the public the same technology, which some of them like the UK and Swedish central bank are considering, with the same properties, even anonymity, what is then the purpose or value with Bitcoin, or pot coin or dog coin. The technology may have some value but not bitcoin. You’re conflating the two.

    Qualified Expert – How can Bitcoin even be discussed as a store of value? The whole purpose with store of value is that the asset in question has robustness in terms of predictable long-term stability. Bitcoin is the antithesis to store of value.

    Mohd Shaid – 1) Agreed that Facebook and most of all paper or semi-p aper assets are overvalued although facebook may have some value in terms of its technology and platform but the valuation is certainly ridiculous.

    2) Yes, the underlying technology may be useful of gaining wider adoption. Bitcoin is not. It’s like saying that Zimbabwe currency is valuable because of the underlying technology of printing bank notes.

    3) Still worthless if it’s worthless.

    4) Yes, that’s great actually, agreed. However it is a two-edged sword. All major bitcoin exchanges at the time have been hacked. Mt Gox went under. Bitstamp was hacked with disastrous consequences. Bitfinex was hacked with disastrous consequences. 10 accounts are hacked EACH DAY at coinbase. People like the irreversibility right up until the point where they lose their money. If someone has held bitcoins from the early days, the chances are overwhelming that you’ve either been hacked or at least lost a big chunk of your bitcoins when the exchanges have been hacked.

    5) It’s a set limitation, not a natural one.

    Wil – Yes, I agree with you. Gold certainly also have some pass-off value. A more relevant example is if bitcoin and gold both go to zero. Then gold will be pushed up above zero because of it’s inherent properties with it being valuable whereas no one will pay anything for a bitcoin because there’s nothing you can do with a bitcoin. If you want to disprove me, at least show me what a bitcoin looks like so I can get an idea of its physical form and shape.

    Alexis – Ok, if the technology is so great, central banks will eventually start to use it. There’s at least about 5 of them currently investigating it. Tell me, what is a bitcoin worth if the Federal Reserve on demand, like for cash, let ba se money be created on a ledger-based blockchain system?

    • Moy Yew Hon

      to say that you can do nothing with a bitcoin shows what a stupid fella you are.. bitcoin allows a person to invest like a venture capital into any project anywhere in the world.. i could fund sirin labs, I could fund tenx , I could fund EOS. cant do that with gold. so gold is the real useless metal sitting in the cupboard, while bitcoin and other cryptos disrupts VC funding . gold is scare, bitcoins are fixed. do more research before saying stupid things.

  • danhogl

    Why should the use value of anything only be considered from the perspective of the individual? As a network service Bitcoin has use value for a group of individuals, where as uselesstanium has not. No network product has any use value from the perspective of the individual. I am not a Bitcoin fan, just curious.

    • danhogl

      Or put another way perhaps I am arguing that Bitcoin has use value for the individual as something that gains access to a pretty good accounting system. Couldn’t it be argued that something has use value as a good token? What about a physical set of poker chips?

  • Moy Yew Hon

    Bitcoin and cryptos are not useless. it is a medium of exchange that allows me to invest and crowdfund any tech project anywhere in the world. you can never do that with precious metals. Bitcoin is currently disrupting gold, VC funding, banking etc. It has outperformed Gold more than 10 times, the first full consensus publicly verifiable transparent distributed ledger. Gold has no distributed ledger and not transparent. A lot of fakes gold going around not to mention blood gold, gold sourced from slavery, but there is no such thing as a fake bitcoin. It takes 32 billion dollars worth of computing power to create a fake bitcoin transaction and that only lasts for a few seconds.

  • Moy Yew Hon

    When bitcoiners are making money, there is no reason for us to get into silly debates. cos hodling bitcoins and making money in the rally has proven us to be the winners. those hodling gold and missed the boat has sour grapes and will want to engage us in a debate so they can feel better about their stupid investment. winners need not argue with losers.

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