What the 21% Flash Crash Proves About Bitcoin

The price of bitcoin plunged overnight by more than 21 percent: this placed the digital "asset" $26,756 (38.8 percent) below its November 10 high. While some bitcoin speculators are unfazed by the decline, citing past volatility to assuage their concerns, their indifference to the price action of bitcoin exposes yet another of its weaknesses: bitcoin is not a store of value; it is not money; and its use case is exclusively limited to its use as a speculative risk asset. 

Since its conception, bitcoin enthusiasts have characterized the cryptocurrency as an alternative monetary asset, namely "Gold 2.0". They have likened certain qualities of bitcoin to those of gold, and they've claimed that bitcoin improves upon gold just as every other digital asset has improved upon its predecessor: whether it's e-mail, audio files or online shopping, the bitcoin enthusiasts claim that the digital space is the preferred domain for all things. 

Unfortunately, the bitcoin enthusiasts have forgotten that e-mail replicates physical letters because you can still read it; audio files replicate tapes, records and CDs because you can still hear them; and online shopping replicates in-store shopping because you actually take physical delivery of the goods. With bitcoin, however, you can neither see nor hold the "asset"; on the contrary, the bitcoin speculator must simply accept that, because it carries a price today, it will always be there and it will always remain valuable. 

As opposed to gold, which is tangible, recognizable and indisputably valuable for its unique elemental properties, a bid on bitcoin is predicated on sheer faith, the belief that some greater fool will pay more for it tomorrow, the next day, or next year: this is virtually the only "use case" for bitcoin, which is to say there is no use case at all for bitcoin; it's nothing more than a speculative risk asset.

It's worth noting that, just because people prefer digital alternatives for some things, that needn't necessarily imply that digital alternatives are preferable for all things. Sure, the tradeoff between the physical CD, tape or record for the weightless and easily-transferrable digital audio file often justifies the latter, but not in all cases. Sure, e-mail is faster and cheaper than sending a letter by mail, but the former hasn't completely replaced the latter. Meanwhile, online shopping is often cheaper and easier than in-store shopping, but once again the former has not yet altogether replaced the latter. There are still qualities about the more antiquated methods that appeal to people: some people prefer the sound quality of a vinyl record, or the fact that you don't need to rely on a computer to store music; some people prefer to hold a physical letter with one's handwriting and a personal touch; and some prefer in-store shopping in order to try on clothing or to enjoy the experience. While the digital world can help to facilitate many wants and needs, it cannot entirely replace the physical world. 

Indeed, whereas the digital domain functions fairly well in logistical operations and transmitting information, it cannot form the basis for all human affairs. This is especially true in the performance of affairs which require absolute and unquestioned fidelity. Just as a parent would never hire a virtual babysitter to look after her children when she's away, there are many tasks in the human experience which require tangible assurances. The reason for this is clear: fidelity. 

A babysitter is effective only insofar as she is present to observe and manage the children, to keep them safe and to prevent them from destroying the house. A residence is effective only insofar as it physically provides shelter. Transportation is effective only insofar as it physically transports goods and people. And money is effective only insofar as it reliably insures the fruits of our labor, and the reliable exchange thereof: whether it takes the form of one commodity or another, the fruits of our labor are best kept in a stable and reliable store of value, one that can withstand the test of time and still retain its useful qualities. In the case of money, its best form is that which preserves its purchasing power over time, which reliably returns value upon receipt, which exacts not too hefty a cost in exchange, which is divisible, transportable and readily recognizable. Above all, sound money must insure the fruits of our labor, meaning that sound money minimizes the role of faith through its timeless demonstration of value, and that it stands to remain useful even in the absence of an outside appraisal. 

This is where bitcoin misses the mark: in their irrational exuberance to get rich, the bitcoin enthusiasts have justified an elaborate wealth transfer scheme with enigmatic language and protocol which seeks to superficially simulate some of the features of money. However, bitcoin fails miserably where it counts most of all. In the end, bitcoin won't be remembered as "Gold 2.0"; it's more than likely to be remembered as a contemporary iteration of fool's gold.

Gold doesn't require an appraisal to justify its use cases: gold inherently possesses physical properties which uniquely satisfy consumer and industrial demands. It is useful in and of itself; it is relatively scarce; and, historically, it is mined at a fairly consistent and predictable rate. Furthermore, gold can never be used up; regardless of its applications, gold that is recovered, recycled or repurposed presents the same properties as when it was originally refined. Whether it’s panned from a stream, unearthed within a mine, recovered from a shipwreck or elsewhere, it is gold all the same. This is to say that gold is durable and fungible; that, in possessing these unique elemental properties, it will function indefinitely; and that, in this way, it functions as a true store of value. Remember, price and value are two separate phenomena: whereas they tend to correspond over the long run, they can diverge over the short term, especially during speculative booms and manias.

Bitcoin, on the other hand, requires an appraisal in order to justify a bid; absent any appraisal, bitcoin possesses no inherent properties to offset market risk, and it is precisely because of its price action that it presents any use case at all. Put another way, bitcoin has no value where it doesn’t have a price. Of course, because of this, bitcoin's "use case" is limited to use as a speculative risk asset; for this reason, bitcoin suffers from the lack of downside insurance. Ultimately, no asset can possibly function as a store of value that does not first present a use case independent of its price.

Whereas gold offers insurance through its physical properties, its increased scope of application, as well as its historical performance and relationships, bitcoin offers merely the illusion of endless upside potential: wherever bitcoin assumes a secular price decline, there is absolutely no use case for holding it. This is not the case with gold, which, independent of its price, presents more use cases virtually every year. 

As opposed to bitcoin, a "position" held by speculators praying for higher prices, gold's use cases operate entirely independent of its price action. Even if gold were hypothetically assigned a market price of zero, it would still present the same use cases by its physical properties. Whereas bitcoin operates exclusively as a speculative vehicle, gold's tradability is merely one of its many features; indeed, as opposed to bitcoin, which depends exclusively upon this feature in order to survive in any form, gold's tradability is the result of its inherent, unparalleled and timeless properties. 

Whereas some people value bitcoin for its promise of future riches in still other forms (i.e. US dollars), investors and end users utilize gold for a wide array of purposes. Whereas bitcoin speculators aim to get rich in other terms, namely dollars and other fiat currencies, gold buyers and investors aim to actually use gold or hold it as a store of value. Gold is actually scarce and it possesses unique qualities not possessed by other assets: this lends to its timelessness, its recognizability, and its unrivaled application in industry across the globe. 

Indeed, the world is truly richer and better off with the marginal ounce of gold, whereas the marginal unit of bitcoin makes the world hardly any better off at all, and in fact that marginal unit stands only to dilute the purchasing power of its pre-existing supply. This is not a problem for gold, as its mine production is essentially inelastic and predictable over time: in fact, between 1917 and 2013, the supply of gold increased by only 1.52 percent per year. If one looks at the rate of change since the beginning of the new monetary era, since the end of the Bretton Woods agreement, the growth rate of base money (USD) is actually significantly higher at 9.95 percent. The gold supply, by comparison, grew by only 1.5 percent per year in the same time period. This relative scarcity is one of the main advantages of gold compared to fiat currencies, and one of the only qualities that bitcoin can seek to simulate. 

Moreover, gold also presents an extraordinarily high stock-to-flow ratio. The total amount of gold amounts to approximately 177,000 tons: this is the stock. Annual mine production amounted to roughly 3,000 tons in 2013: this is the flow. If one divides the total gold mined by annual production, one arrives at a stock-to-flow ratio of approximately fifty-nine years. The ratio expresses the number of years it would take to double the total stock of gold at the current rate of production. 

Since the year 1900, the stock-to-flow ratio has managed a mean of 66. This means that gold is relatively scarce, that mining and future supply are fairly predictable, and that supply changes tend to weigh minimally on the long-term market value of gold. As stated previously, however, while these market dynamics can influence the price of gold, and while bitcoin can artificially simulate some of these qualities, gold's use case is still wholly independent from its price performance. Of course, bitcoin relies exclusively upon its price performance, and from its very conception it has sought to artificially simulate the properties of gold; however, in aiming to simulate those properties, bitcoin has failed to replicate the finer qualities which actually make gold reliable and progressively more valuable by the day. 

Whereas the supply of bitcoin is artificially limited — its maximum supply is limited to 21 million Bitcoins — the supply of bitcoin might as well be measured by the Satoshi, its smallest unit equivalent to 100 million Bitcoins. You see, the difference here between gold and bitcoin is rather simple: whereas gold can likewise be reduced to progressively smaller quantities, the marginal unit of gold (of whatever quantity) physically improves upon the wealth of the world; it is constant and measurable, independent of valuation. However, the difference between a Satoshi and a Bitcoin is a contrived ratio conceived out of thin air, whereby an artificial supply of one arbitrarily implies the quantity of the other. 

In yet another effort to simulate the increasing difficulty in mining new gold supply, bitcoin undergoes “bitcoin halvings” whereby the number of bitcoins entering the system with every new data block, every 10 minutes or so on average, is cut in half. These "halvings" take place roughly every four years, suggesting that bitcoin will theoretically become progressively driven by demand over supply. By this particular protocol, the bitcoin enthusiasts claim that they can simulate the performance of gold. Of course, they cannot, as their entire model relies squarely on the assumption that the scarcity of bitcoin alone should drive value, but this may not be the case into the future. 

Beyond the fact that bitcoin is far more numerous depending upon the preferred unit of measure, whether Bitcoin or Satoshi, it's not entirely immune from competition. There is virtually nothing which prevents future advents and technologies from rendering bitcoin completely obsolete, which implies that the supply is unlimited. Eventually, this will happen, and bitcoin will be left as nothing more than a marginal trading vehicle. 

Gold, on the other hand, is an element with unmatched properties that will survive at any price and against any and all competition. Even if a new element were theoretically discovered which improves upon each of gold's properties, gold will still be useful. However, the trend has decisively suggested that the applications for gold will only continue to grow into the future. 

Whereas the success of cryptocurrencies and industry would subject bitcoin to still stiffer competition, developments in industry will uncover only further applications for the yellow metal. Whatever the case, whatever the circumstances, whether beloved or ignored, gold will continue to shine and perform. Bitcoin, on the other hand, is forever beholden to the whims of speculators and popular opinion. 

Like a plastic bag in a storm, bitcoin is nothing more than the direction of the wind; and like any populist movement, it's full of air and endless empty promises. It simulates the properties of gold the way a cartoon simulates life: both simulate the conspicuous features yet ignore the inherent qualities which make them viable in truth, not only in principle. While the cartoonist can make his characters lifelike, they will never have life; in just the same way, while bitcoin can seek to simulate the qualities of gold, it will never be gold. And where it fails in this particular regard, it fails in every regard which would otherwise make it truly viable. 

Bitcoin is ultimately a fool's errand, and the only winners are the people who ultimately sell out of their positions. There are only two kinds of bitcoin fans: those who truly believe in it, and those who seek to exploit the ignorance and gullibility of the first. In the end, the only winners are those who will be lucky enough to leave their bags with the other guys who were so eager to hold them that they didn't even bother taking a look to see what's inside. Unfortunately for the latter, it'll eventually be all too late by the time they realize that they don't even get to keep a bag as a souvenir.