Why Bitcoin Is Valuable – Debunking The Greater Fool Theory – Forbes

I speak with a lot of investors about bitcoin, and they raise a lot of questions: about custody, about volatility, and about evolving regulatory standards.

By and large, it's easy to mitigate these concerns: Fidelity offers custody, Jane Street makes markets in bitcoin, and regulators are taking an increasingly proactive approach to the space.

Once you get through the surface objections, however, theres often one more lodged in the back of peoples minds; one people dont even want to raise for fear of being impolite:

Why does bitcoin have any value at all?

This is the objection that has tripped up some of my personal investing heroes, like Jack Bogle and Warren Buffett. Buffett summarized the concern in an interview with CNBC earlier this year: Cryptocurrencies basically have no value. You can't do anything with it except sell it to somebody else."

In the financial literature, this is known as the greater fool theory. The idea is that you should never invest in something if its value depends solely on selling it to someone else at a higher price.

Stocks, bonds, and real estate assets generate cash flows and can be valued based on them, the thinking goes. Bitcoin doesnt create anything at all.

Why, then, do we think it is valuable?

A Lesson From The History Of Crude Oil

Prior to the late 1800s, crude oil was mostly a nuisance. Pioneers in the American West who dug wells searching for water would sometimes find oil and be disappointed. The problem was that oil had no identified utility. On the margin, it could be used for creating asphalt, and it was often used as medicine, but mostly it was ignored. Finding oil was about as interesting as finding mud.

Things started to change when George Bissell had a breakthrough in the 1850s: He wondered whether rock oil, as it was called, could be processed and be used as an illuminant (replacing coal oil for kerosene lamps) and as a lubricant for machines.

Thats how the oil industry was born: One lonely scientist figured out that a sticky, seepy, ugly liquid could be used to create light.

For the first few years, however, demand remained low, as oil had issues. One was that it stunk, as crude oil has a naturally high sulfur content. But subsequent chemical refinements like desulphurizationfunded, interestingly, by oil producers like Standard Oilcreated new uses and markets.

The story doesnt end with kerosene lamps, of course. The turn of the century saw engineers experimenting with internal combustion engines. As automobiles grew from toys to essentials, demand for oil skyrocketed. By the end of the 1920s, 85% of oil production was used toward fuels.

Very few saw the potential of the new light early on, but those who did, like John Rockefeller, were responsible for some of the largest examples of value creation to this day.

Bitcoin today is analogous to oil after the development of the kerosene lamp, but before cars, planes, and the rest. It is a commodity with certain limited but meaningful real-world uses. Individuals use it today to store savings outside of the fiat currency system (digital gold), to move money across borders, and to settle large transactions quickly and in an irreversible fashion. In certain countries, it provides a release valve for citizens concerned about oppressive regimes, and a way to expatriate money with limited physical risks.

But like oil in the late 1800s, these applications are just scratching the surface of bitcoins potential. Kerosene lamps were a proof of concept; oils real value lay in being a store of energy that could be transported easily and released in an intense fashion. Similarly, bitcoins current utility is limited; its real value lies in allowing money to move at internet speeds and allowing it to be held in an autonomous fashion.

Investors buying bitcoin today are betting that the future use cases built upon these core capabilities will be larger than the current market cap of bitcoin. It is easy, in my view, to see how this could be the case. For example, if 10% of the wealth currently stored in physical gold comes to be stored in bitcoin in the future, each bitcoin would be worth around $50,000. If the same amount of wealth stored in gold today is stored in bitcoin in the future, each bitcoin would be worth $500,000. If bitcoin significantly penetrates parts of the offshore wealth, escrow, payments, remittance, or other markets, the potential is significantly larger.

Those numbers may sound extreme, but it is worth remembering that digital versions of analog goods are often met with skepticism initially. People didnt think digital media would replace newspapers, didnt believe that digital advertising could compete with print and TV, and were hugely skeptical that online retail could compete with physical stores. In each case, time proved them wrong.

Future Demand, Current Value

If most of the demand is in the future, you may be thinking, why buy bitcoin now?

This is where the analogy with oil breaks down.

There are two things that are true about bitcoin that are not true about oil:

Buying bitcoin today is like buying oil in 1850 after seeing its early utility with the big difference being that you know that no new oil can ever be created, even as demand grows and new use cases emerge. And unlike oil, with bitcoin, youre in no rush, because as a digital asset, you can store it cheaply for years while demand builds.

Thats the logic behind the value of bitcoin to investors today. Its not about simply hoping for a greater fool, but rather buying a scarce asset before demand is fully developed.

Those of us who have spent time investigating cryptoincluding some of the leading technology companies, entrepreneurs, inventors, and venture capitalistsforesee a future where money moves with the speed of text messages, where financial access is available to all, and where all investors have an easy way to escape the casual destruction of wealth that attends most fiat currencies over time.

As this world arrives, youll be glad to have bought a stake before the value becomes plain for all to see.

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Why Bitcoin Is Valuable - Debunking The Greater Fool Theory - Forbes