Important points
For the past decade, cryptocurrencies, led by Bitcoin, have circulated around Wall Street’s major stock indexes.
Investor perception is what gives Bitcoin its value.
However, while assets may have value without practical utility, this value often declines over time.
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For more than a century, no asset class has matched the stock market in terms of annualized returns. Despite volatility, the benchmark S&P 500 (SNPINDEX: ^GSPC) It has vastly outperformed commodities, real estate, and bonds over very long periods of time.
But over the past decade, cryptocurrencies, along with Bitcoin, have completely trounced the S&P 500 in terms of returns. (Cryptocurrency: BTC)leading the way as the world’s largest digital currency. Over the past 15 years, Bitcoin has skyrocketed from about $1 per token to about $68,500 as of late evening on February 15th as of this writing.
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There is probably no asset or investment on the planet that causes as much polarizing debate among professional and everyday investors as Bitcoin. However, there are problems with these arguments. Value and usefulness are often confused. As you will see, value and utility are two very different things in the investment world, especially in the area of cryptocurrencies.
Investor perception gives value to Bitcoin
In its simplest form, value is determined by the amount an investor is willing to pay for an asset. If someone is willing to buy Bitcoin for $68,500, this is a very clear indication that the token has value (at least at that particular point in time).
While the value of a stock market is determined by a combination of management fundamentals and investor perception, the value of a digital currency depends almost solely on perception. Without a close reading of the income statement and balance sheet, emotions tend to dominate Bitcoin and the vast list of important altcoins.
Bitcoin’s stratospheric rise can in fact be attributed to the perception of a handful of investors.
First, it is one of the relatively few digital currencies that has a fixed or limited supply. When all Bitcoins are eventually mined, there will be only 21 million tokens in circulation. Just as the scarcity of a product allows companies to increase its price when demand increases, Bitcoin’s value has increased due to the perception that it is scarce.
This scarcity also plays a key role in the belief that Bitcoin is an inflation hedge. With a few exceptions, the US M2 money supply continues to expand. Fixed supply tokens like Bitcoin are seen as a smart hedge against inflation, as the value of fiat currencies such as the US dollar is eroded by inflation over time.
Additionally, the Bitcoin blockchain network is expected to be increasingly used as a peer-to-peer payment platform that operates without the need for a centralized financial institution. For example, the average number of Bitcoin transactions per day has increased from 200,000 to 300,000 in 2022 to 400,000 to 600,000 in the past six months.
Based on these perceptions, Bitcoin has value.
Image source: Getty Images.
An asset may have value without any utility, but this rarely persists over long periods of time.
But Bitcoin’s value in no way proves that it offers real-world utility.
Wall Street is full of examples of companies with substantial market capitalizations that are technically useless. Purely clinical-stage drug developers can command market capitalizations in the billions of dollars based on the perception of how one or more experimental treatments will benefit patients. However, these companies are not practical until they have a treatment approved. If a clinical-stage drug developer fails to produce an approved drug, its stock (and market capitalization) will ultimately pay the price.
Perception of value has never been an issue with Bitcoin. It has a fervent following online, with Wall Street analysts and commentators (including Cathie Wood and Tom Lee) coming to its defense. However, Bitcoin did not pass the utility test.
Although Bitcoin is recognized as scarce, its supply is limited only by lines of computer code that can be changed according to the agreement of its developers. The chance of reaching consensus is very low, but not 0%. In comparison, precious metals such as gold and silver are truly finite resources that cannot be created from scratch. We are still in the process of recovering these metals from deep within the Earth, but we cannot create additional gold or silver beyond what already exists on Earth.
Bitcoin’s payment network also lacks competitiveness. Although it still enjoys a first-mover advantage, Bitcoin’s blockchain network costs about $0.30 per transaction, and depending on the size of the payment, verification and settlement can take 10 minutes to an hour. Comparatively, coins that facilitate payments like XRP and Stellar have transaction costs of just a penny and are typically settled within five seconds on their respective blockchain networks. Importantly, several other blockchain projects can orbit around the essential Bitcoin network.
We also witnessed Bitcoin fail a real-world utility test in El Salvador. The Salvadoran government legalized Bitcoin as a tender form in September 2021, with the aim of allowing citizens to use Bitcoin for everyday transactions. Ultimately, 2024 data showed that about 8 out of 10 Salvadorans do not use Bitcoin. Although the Salvadoran government continues to hold the world’s largest digital currency as a reserve asset, Bitcoin does not function as a medium of exchange.
Given what history tells us, Bitcoin’s very limited uses should eventually weigh in on its value, but there is no blueprint or exact timeline for when that will happen.
Does Bitcoin have value? Yes, thanks to investor awareness. But does the world need Bitcoin? Based on the data we have, no, it doesn’t.
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Sean Williams has no position in any stocks mentioned. The Motley Fool has positions in and recommends Bitcoin and XRP. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
