The price of Bitcoin, like any belief about the future, is based on faith — “expectations” in economics. Whether that faith is well-placed depends on whether the underlying expectations are sound or not. In the case of Bitcoin, the market’s collective expectations — its faith in Bitcoin — is, I’d argue, a good deal sounder than its faith in paper money.
A few weeks ago, comedian Bill Maher tried his hand at monetary theory, concluding that “Cryptocurrency is like Tinkerbell’s light - its power source is based solely on enough children believing in it.”
Less colorfully, Bitcoin skeptic Mark Cuban denounced Bitcoin as “a financial religion” while shilling, of all things, Dogecoins. Meanwhile, Bloomberg’s Joe Wiesenthal filled in the religion angle, flagging Bitcoin’s “religious trappings” including “true believers, holidays, and diets.”
Now, there is a grain of truth in all these faith-based critiques. Not only because Bitcoiners celebrate particular diets, but because Bitcoin, indeed, is not directly backed by anything you can drop on your foot. There is no building you can go and present your Bitcoin to a bored teller for shiny bits of gold or airplane tickets. Of course, you can sell your Bitcoin for shiny bits of gold or airplane tickets, but it’s not directly backed any more than the dollar, the yen, or the Swiss Franc.
And yet there’s a much bigger grain of misunderstanding in that, for several centuries now, currencies have not needed physical backing to hold value. This is kind of sad, and it was perhaps surprising to central bankers, but apparently currencies can live on faith in central bankers’ prudence alone.
To be sure, that faith in central bankers is often abused. But this isn’t faith on the order of Tinkerbell or Santa Claus. Rather, this is faith built on expectations about cold, hard, verifiable facts. Facts that constantly change and are hard to predict, but facts nonetheless. The question then becomes whether those predictions realistic or not.
In the case of Bitcoin, to believe it will go up is to believe that it has some chance of displacing the dollar or gold for some monetary demand. For example, if Bitcoin stands a 20% chance of replacing half of gold demand, then it’s too cheap. Or if it stands a 20% chance of replacing, say, a tenth of paper money demand then, again, it’s too cheap.
Now, Bitcoin’s price fluctuates for many other reasons than its monetary fundamentals. Elon’s tweets or trash-talk from Beijing can make Bitcoin’s market price rise of fall temporarily. But the fundamental question is what odds Bitcoin stands of displacing yet more monetary demand. If you think those odds are higher than market expectations, then you have faith in Bitcoin. If you think it’s over-estimated, you won’t. It ain’t Tinkerbell, it’s reality.
The confusion is down to the fact that most languages use the word “faith” to mean two very different things. It sometimes means believing in something without proof, like tree fairies, Santa Claus, or Cthulu. But sometimes it means something you strongly believe will happen. You have faith the sun will rise, jumping off a roof will hurt, McDonald’s will sell burgers tomorrow, and the Federal reserve will inflate the dollar supply next year.
You believe these things not because the fairies told you, but because you carry in your head expectations about how physics and how institutions are likely to operate during the timeframe in question. These expectations yield actionable predictions that you use to navigate life. The predictions may be wrong, and you try hard to revise and improve your predictions, but gravity, Big Macs, and money supply are not myths.
This distinction is important because if Bitcoin or the US dollar are based on a kind of mass hypnosis then we should be very worried. For example, if the USD is floating on a myth, then before ordering at a restaurant you’d want to make sure people didn’t “wake up” about the fairy-backed USD during the drive over. Maybe carry around some bullion just in case. On the other hand, if Bitcoin or the US dollar are sustained by reality-based expectations, then we can rest a bit easier.
So, concretely, you want to focus on what those expectations are built on. Expectations about Bitcoin’s ability to supplant competing monies, from gold to pesos to the USD. And expectations about other currencies holding their value. In both cases, you want to be aware of your own beliefs, but also those of other buyers or sellers who impact the market price.
At core, for any asset, to get price expectations you need to know if it will it exist tomorrow, will there be more or less of it in existence (expected supply), and will more or less people want it tomorrow than today (expected demand).
An important aside on supply: you do care about supply in existence, since that informs the future, but the actual market price comes from circulating supply in that moment — the amount being offered for sale at that specific moment. For example, if there are 5x more USD tomorrow, it won’t affect the price of USD if we’re 100% certain that Elon Musk will keep the extra buried in his backyard forever. Of course, nothing in life is 100%, so even that buried money will influence future expectations.
There’s also a similar dynamic in demand — market price cares about people actually offering dollars for Bitcoin, not people dreaming of someday being able to offer dollars. In both cases, this means actual market price is the intersection of how much is being offered for sale right now vs how much are people offering to buy right now. While future expectations alone spare a thought for Elon’s backyard, the cold wallets and the plucky orphans with a dream.
So, now, you can simply plug in your beliefs. First, the odds that Bitcoin continues to exist. Then compare what you expect to happen to circulating supply and what you expect to happen to effective demand. If you think demand grows faster than circulating supply, price goes up. If you think demand grows slower, price does down.
Of course, since every choice has an alternative, you want to ask these same questions for your next-best alternative, like the dollar, then compare the two. For example, if you think Bitcoin demand will grow by 50% next year while circulating supply will grow 2% next year (48% gain), while you think USD demand will be flat but circulating supply will increase by 10% (10% loss), then you should expect roughly a 2/3 gain (1.48/0.9) in Bitcoin’s price in USD.
Now, are these guesses accurate? Who knows. Expectations change constantly, and there are a lot of beliefs that matter to existence, supply, and demand. This is true of Bitcoin, it’s true of alternatives like USD or gold, and it’s true about just about any price under the sun. Some of these beliefs are relatively durable: say, that central banks inflate or that people like to protect their savings. And some beliefs might be less durable: say, that China doesn’t like crypto, or that rich crypto-whales are trying to destroy small investors.
And remember, throughout, that it’s not only about what you believe: every other buyer or seller, real or potential, has beliefs that figure into future demand and, therefore, future circulating supply. It’s a dance of “I believe that you believe that I believe” that ultimately yields a market price.
So, yes, it’s all based on faith and beliefs, just like every other choice you make in life from driving a car to eating to not walking off roofs or stopping by McDonald’s. It’s based on guesses and unknowns, it’s complicated with a lot of uncertain moving parts that very smart people spend lifetimes trying to predict. And Tinkerbell’s Light doesn’t even begin to capture it.
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