What we should really build is productive assets and stablecoins
Special thanks to David Andolfatto, Vitalik Buterin, Chih-Cheng Liang, Barnabé Monnot and Danny Ryan for comments that helped me improve this essay
I think the “store of value” narrative and the misunderstanding of what “fiat” currency really is are a huge problem undermining the whole of the cryptocurrency world. Only when we come to an honest understanding of this will we really be able to build something better.
Here are some core theses of what I believe and which I will try to illustrate in the full article:
- The “store of value” narrative doesn’t hold water. There is no such thing as a guaranteed way of transmitting value into the future, and just having an asset with a fixed supply doesn’t fix that.
- If you want your best bet on sending the most value possible into the future, what you really need is productive assets (for long term) and stablecoins (if you need you money in the near future).
Why “store of value” does not exist
Here is a common form of the cryptocurrency narrative: “Look at fiat currency. 1 US Dollar from 1950 had about 10 times more purchasing power than one US dollar now. It’s a scam. If you store your value in US dollars, then you are constantly losing due to inflation. This is because the central bank/government can just print more US Dollars. You should instead store value in an asset with predictable supply, such as gold or Bitcoin, which does not have this problem.”
The true part of this statement is that if you stored your money in USD, then you would have lost a large part of your purchasing power over the decades. That is not in question. The question is, is there another way, implied by the term “store of value”, that does not have this property? Store of value proponents claim that there is if you instead used an asset with a predictable supply. And of course, historical data backs this up to some extent: If you had used gold instead of storing your value in USD, then you would have fared better: You could have bought an ounce for $35 in 1950, and it would now be worth around $1765 (price as of June 20 2021 from here). Given that the Dollar is worth 10x less now due to inflation, that’s $176.50 in 1950-Dollars or a 5x increase in value.
But we could have done much better than this: If we put the $35 in an S&P 500 tracker in 1950, then we would now have a staggering $74,418.65, which is a 212x increase after correcting for the 10x loss in purchasing power of the US Dollar (so 7,441.87 1950-Dollars). So clearly, this investment is a much better “store of value” than investing in gold.
Now Bitcoin has fared much better than both gold and the S&P 500 over the last 10 years. However this is a very short timespan, in which Bitcoin went from an absolutely tiny niche to an asset that most people in the world have heard of and some significant minority has invested in. There is no reason to believe that this can be repeated (I don’t think it can). The historical data for gold says, over long periods of time, stores of value that are purely based on “limited supply” do much worse than productive assets.1
So why do people believe gold, or Bitcoin, would make a better store of value than just investing in productive assets like companies, real estate, etc.? There are two reasons that I can see:
- Stock markets clearly have a lot of volatility. So maybe they believe productive assets are a good long-term store of value, but not for the short term.
- The people who believe in “limited supply” stores of value have an apocalyptic mindset. So they believe that in the case of a major social collapse, their stores of value will somehow fare better than more productive assets.
Argument number 1 does not convince me at all. That would depend on their preferred store of value having lower volatility than productive assets, which simply does not bear out in reality. Both gold and Bitcoin are much more volatile than holding an S&P 500 tracker fund. If you want low volatility, then you should still go for the productive assets.
Number 2 means that you can simply “send” value into the future even when society collapses. I think that’s a pretty crazy belief – because when society collapses both the value you can buy as well as the demand for the “limited supply asset” will do as well.
Of course, people think companies (and therefore the S&P 500) will probably go down, but other assets don’t fare any better:
- Is property a good “store of value” in a catastrophe? Property is mostly valuable because of where it is in relation to valuable economic and social activity. Central Manhattan property is so valuable because it’s in a city where many want to live. A random plot of land in the middle of nowhere usually has very little value. It’s unlikely to fare that well in a major disaster (and might even work out worse than property with a garden to grow your own vegetables)
- Similarly the value attributed to gold is a social convention, albeit one that has lasted for an extremely long time. Society could decide on a new asset to value highly, which is indeed what Bitcoiners argue for. But more importantly, your gold isn’t worth anything if there’s nothing of value to buy.
If we accept that value depends on a society that provides valuable goods, we have to accept that there is simply no guaranteed way to send money into the future. You might as well make real investments in productive assets.
What we need – productive assets and stablecoins
Above, I argued why I think “limited supply stores of value” (unproductive assets like gold or Bitcoin, that derive their value simply from being scarce and not utility value) are of no advantage to productive assets like stocks. They have the same or higher volatility, but at least for gold (for which we have a decent amount of history) is outperformed by productive assets in the long term. The same will probably happen to Bitcoin once it’s absorbed the initial demand and has arrived at a stable position like gold (other results, with it largely losing its current value, are certainly also possible). They also don’t necessarily fare better in catastrophes; if this is what you’re afraid of you might want to buy goods that are useful in a catastrophe instead.
This means productive assets should be the better long-term stores of values, as they are better on all dimensions.
But clearly the volatility that comes with them is undesirable for many applications that fiat currency is used for now: I don’t think many people would appreciate their salary fluctuating by 50% month on month; in fact the vast majority of people would struggle to pay for all their expenses if their salaries suddenly fell by 50%. Many people simply need or want much more stability than that.
Similarly, if you keep money around to buy a house in the near future, or run a company that keeps cash reserves to make sure they can pay their employees and suppliers, you need stability.
Even if we assumed that everyone suddenly started using Bitcoin, it would simply not fix this problem. Since its supply can’t be dynamically adjusted, its value would continue to be very volatile due to economic fluctuations.
Luckily, there are mechanisms around to create stablecoins using only volatile assets for these situations. My favourite system is the idea behind MakerDAO and DAI, which I describe in an article here.
So if the current system is so great why do we even need cryptocurrencies?
I think we need to become more nuanced thinkers in the cryptocurrency space, and start seeing the real properties of the systems we are trying to rebuild if we want to be successful. I think fiat currencies as we know them at the moment have been tremendously successful, as long as we see them for what they are: A hedge against short-term volatility rather than maximizing value long term.
I believe that crypto can vastly improve the current financial system, but hopefully not mainly by providing an asset with a limited supply (which won’t solve most of our most important problems). Instead we should make sure our assets are productive to maximize long term value, and create stablecoins for applications where volatility has to be avoided. This system improves on our current financial system because:
- It is much more transparent – anyone can verify balance sheets and exposures, not just specialized audit firms. This is pretty important because currently, the detailed exposures of banks are not public, which means depositors simply don’t know enough to about banks to make an informed decision which ones they can trust
- We can make it fairer – giving everyone access at the same conditions. For example, why should banks have access to central bank accounts whereas normal people and companies don’t?
- Governance can be improved, bringing everyone to the table when big decisions have to be made (like Quantitative Easing after the Global Financial Crisis)
- Getting rid of the baggage (for example physical currency) and thus allowing more flexibility of the system; for example there is no technical need for inflation when all balances are electronic (though in practice, it might be required for psychological reasons or “price stickiness”)
- And most importantly, creating a permissionless and censorship resistant system that anyone can participate in at all levels
Vitalik pointed out that this will overstate the case against Bitcoin somewhat, because gold supply has increased much more (ca. 3x) since 1950 than Bitcoin will over a similar period. I do not think this will make up for the massive difference in returns between gold and the S&P 500, though. ↩