Crypto Assets Are Primarily Communication Networks
When I was in college there was a joke going around that the easiest way to piss off the physics professor was to ask him “what is gravity?”, upon which the professor would launch into a 45 minute diatribe on gravitons and the latest advances at CERN; but the truth is, we don’t really know. The best we can answer the question is that gravity is a force, but anything beyond that is currently conjecture. The same principle applies to Bitcoin.
It has been proposed, for example, that Bitcoin is a currency. If so, Bitcoin today is a very poor currency because of high transaction costs and long confirmation times. Bitcoin is also not a particularly reliable store of value (future value is unpredictable) or unit of account (due to volatility).
Then we have the “digital gold” argument which I find infinitely frustrating because it puts the cart before the horse. Gold does not have value because it can be made into jewelry, rather it is made into jewelry because it has value. In the same vein, Bitcoin can not be viewed as a “reserve” asset because it lacks the basic qualities of a good currency, as to make it a practical store of value. But, as we shall see, none of this matters.
The two briefly mentioned hypotheses regarding what Bitcoin is (cash vs. digital gold), are the dominant models of cryptocurrency philosophy, embodied by Bitcoin Cash and Bitcoin Core. But I favor a third definition, that I believe suits the nature of cryptocurrencies much better: they are communications networks first, on top of which value can be exchanged. A good example of this would be the Western Union franchise.
Western Union allows persons to send money to other individuals anywhere in the world. I can walk into a Western Union broker in Boston and send money, near instantly, to a remote province in China (for a hefty fee of course). All I need to do is pay a service fee and receive an MTCN (Money Transfer Control Number) I will forward to my friend so he can collect his cash.
The way this works is that Western Union representatives share a common database of transactions and when my friend in China shows up to collect his money, all he has to do is prove his identity (with government issued ID) and the Western Union computer will tell the broker how much money to dispense.
The value in the Western Union franchise, or, if you prefer, Western Union’s corporate moat, is not in the ability to transfer money between users, but rather in the worldwide network of franchisees running Western Union software, which tells them who to pay and how much to charge. The value of Western Union as a company, for the purposes of money remittance, lies entirely in the size and quality of its network of nodes (franchisees). Money remittance is secondary to network quality.
Does this remind you of anything? Sounds a lot like Bitcoin doesn’t it? Yet when dealing with Bitcoin, we tend to not understand where the value is coming from and we fall into the red herring of Digital Cash vs. Digital Gold; forgetting that these two forms are subject to the quality of the underlying communications network. Value out of either of these propositions comes entirely from Metcalfe’s law. This helps explain why Bitcoin’s token value, denominated in fiat, has risen as spectacularly as it has; as long as users can be added to the network, value of the underlying tokens will tend to increase.
The future of cryptocurrency, and here I would like to expand beyond just “currency” tokens to include other base layer assets such as Ethereum or PolkaDot or whatever else, will be determined by their ability to grow their communications network by attracting and retaining a growing base of active participants.
But what about Western Union? There is a point of critical mass where the asset will grow at a slower rate, because there is a limit to adoption, but if the asset can keep adding users, even marginally, investors will continue to be rewarded, and all indications are that this will be the case. The benefit of running money on top of any communications network, is that it damn well spreads itself. So as we have seen, it does not matter to the intelligent (profit seeking) investor, whether crypto assets in general, or Bitcoin in particular, become DIgital Cash or Digital Gold, what matters is our understanding of the network’s future growth. For all intents and purposes, network growth will equal investor profits.