I’ve just come from a very nice lunch, where my host and I discussed many life and business topics, among them a new company we’ve set up called Valueverse,- which is essentially an economic value consultancy in the age of blockchains (see: ValueVerse — Digital Finance Strategy Group).

As my host is a successful retired financier, he inevitably wondered about the relevance of a blockchain-managed asset: bitcoin. As I said, ValueVerse is about blockchain, not just digital currency, but I also think the question raised is a legitimate one, and one that is often left unanswered. Worse, when it remains unanswered, it leaves the door open to many economists, including reputable ones, who claim that bitcoin and crypto-currencies in general are purely speculative and have no fundamental value.

This sentiment stems from the fact that cryptocurrencies are for the most part “useless” bits of information, unlike the original money backed by the gold standard and, later, by central banks. But this argument can be counterbalanced by others. Here are three of them:

Empirical evidence

Question: is there a link between the price of bitcoins and the potential intrinsic value of the bitcoin economy?

Let’s start with a few points about how bitcoin works. Firstly, the supply of bitcoins is totally inelastic, determined by a protocol, with a fixed issuance schedule that is halved every four years, up to a final amount of 21 million bitcoins. Secondly, a new bitcoin is accompanied by a block that is only valid by virtue of a protocol such as proof of work that someone (the miner) has committed a certain amount of computing power. Agents on the Bitcoin network compete to have their transactions included in the first blocks. Computing power is measured in hashes per second.

These two characteristics of the bitcoin economy imply that :

A) the limited supply of bitcoin can be anti-inflationary, compared to the supply of money from central banks (just look at what happened post-covid after governments issued lots of money to finance economies, and how that created massive inflation afterwards, and that the bitcoin price should be positively correlated with the supply of money).

B) If the bitcoin price represents a rational representation of the monetary utility of a medium of exchange, store of value or unit of account, we should observe some relationship between the bitcoin price and the token velocity (which represents the exchange value) and the stake ratio (which represents the value of the store for long-term holders).

C) If bitcoin is a valuable network, its price should be linked to its users and the hash rate.

As far as point A) is concerned, all you have to do is look at the narrow dynamic between money supply and bitcoin price growth. However, the correlation is not causal. With regard to points B) and C), a large body of academic research shows that bitcoin prices evolve as a value network and are the cause of Granger hash rates. Similarly, bitcoin prices are correlated with staking and velocity ratio.

Socio-economic data

Question: Can BitCoin become a powerful social network, even if it’s backed by limited original value?

In fact, and contrary to popular belief, economic history shows many cases where money has been created, even in the absence of an intrinsic source of value. The vast majority of them were in fact born of the codification of pre-existing, shared interpretations of debt and credit relations within societies.

Lynette Shaw’s recent work is fascinating because it shows that even in the absence of a shared, explicit understanding of bitcoin’s value, the practical necessity of achieving widespread adoption has finally laid the groundwork for a confrontation with the inevitably social demands of establishing a new currency. Nor should we forget that bitcoin is unprecedented in its leverage of digital communities, giving it global reach. This is also what my former McKinsey colleagues (Arthur Armstrong and John Hagel, 1996) had long anticipated as the powerful social force of the Internet.

Logical proofs

Question — Can bitcoin prices be uniquely defined as an equilibrium resulting from the behavior of a rational agent?

Bitcoin has been the subject of numerous economic models. One strand of research has argued that the bitcoin community can effectively act as a rational force against discretionary government seigniorage. As a private currency, bitcoin acts strategically as a tool to prevent governments from abusing their citizens.

Another line of research has been to reproduce Lucas’s rational expectations equilibrium in models where the currency would be, as some claim about bitcoin, necessarily worthless. These economists show that such a unique rational equilibrium can exist, providing theoretical support for the claim that crypto-currencies are forms of money. Furthermore, the logic may also imply that a central bank, government or active political intervention is not required to stabilize the value of the “supposedly worthless” crypto-currency, if the protocol can be designed to support a unique equilibrium, in effect replicating the Fisher equation of money (wow).

What does the jury have then to say?

The above arguments in favor of BitCoin have the merit of existing. But are they convincing?

Taken separately, they all carry caveats. For example, when it comes to logical proofs, models are just models, and Lucas’ reproduction of general equilibrium is an elegant piece of mathematical work, but it may not take into account the fact that cryptocurrencies are far more volatile than these types of models suggest. According to our own research, long-term cointegration seems to take 5–7 years, implying that equilibrium is at best latent and not visible in a dynamic market such as Bitcoin). Secondly, the use values of crypto-currencies, such as inflation hedges, etc., always depend on the prior establishment of Bitcoin’s value by others.

In general, however, the three lenses are highly complementary and demonstrate the strength of the argument that bitcoin is probably much more than a bubble. In particular,

a) The fact that bitcoin has emerged worldwide and held its own despite the problems encountered by Terra/LUNA, Celsius or FTX, is due to the continued adoption of crypto-currencies and bitcoin for more and more use cases, demonstrating its value.

b) Crypto-currency is just one case of blockchain — blockchain itself is a meta-technology that could democratize finance, for example for real estate, just as crypto-currency could do in developing markets.

c) Cryptocurrencies are still in the wild — the issue is not regulation per se, but observing and supporting proper design. The fact that it can provide a counterweight to excessive state seigniorage is not to be overlooked, and puts governments on a quest for excellence. Ask the citizens of many countries that have experienced hyperinflation, or even Europeans faced with the loss of trillions in negative-yield bonds after the recent spike in inflation (see Lyn Adlen).