Following the discontinuation of Segwit2x, the recent weeks have seen frantic activity around Bitcoin Cash. Most of it has been price manipulation (pump and dump), but there has also been a lot of uncertainty in the market. In times of uncertainty (or why not always?) it’s good to understand the fundamentals, on which the value is based. Bitcoin Cash will not be the last attempt to challenge Bitcoin, and understanding the fundamental value of Bitcoin (and why its opponents have no value and will fail) can decrease uncertainty the next time.

The value proposition of Bitcoin Cash is based on a perceived scaling problem with Bitcoin. The argument goes something like: “If only transactions were immediate and free, I could use bitcoin to buy coffee!”. That implies that stores would accept bitcoin, if only it was more usable for small payments. However, in reality, the causal relationship is reversed. The reason scaling is not an urgent priority is that there is no real demand for such payments. Stores and online shops already offer debit and credit card payments, and are happy to do so for free. The reason being that both debit and credit cards increase the liquidity of the customer, thus generating more revenue for the store. For the customer, the benefits include not having to endlessly visit the ATM, or free credit for a few weeks. None of these benefits exist with cryptocurrencies. Paying with bitcoin from a wallet implies having to fill up the wallet continually, albeit this can be done electronically from home (unless one is careless enough to carry around the private keys to the bitcoin pension fund in the smartphone, in which case it can be done from anywhere until the keys are stolen). As long as there are no incentives for stores and users to accept and make cryptocurrency payments, it won’t happen. Crypto-anarchists may feel incentivized for ideological reasons (and many others for legitimate privacy reasons), but few stores care to cater for those special needs. A few cryptocurrencies will have some limited value for the time being for use on the dark web, but this is limited to a special use case and not scalable.

So what makes Bitcoin valuable, but others not? Why is one bitcoin worth thousands of dollars, but one PizzaCoin or Pesobit or PonziCoin or whatever comes next worth virtually nothing? And how do the fundamentals that make Bitcoin valuable make other coins worthless? To understand that, we have to look at why bitcoin is valuable to its users, and how this value is created.

You can make a lot of money by speculating in bitcoin, but if this was the only value, it would truly be just a Ponzi scheme. Instead, Bitcoin has three main fundamental values, making it a totally new asset class:

Censorship-resistant and anonymous store of value (no government can take it from you)

Censorship-resistant and anonymous medium of exchange (no government, institution or other entity can prevent you from sending or receiving funds)

Inflation-resistant store of value (even if Keynesians disagree)

The first two items, which are the important ones, require that the system is predictable, stable and large.

Predictability means that all stakeholders know the rules, know that others know the rules, and that any changes to the system are made in a way that maximizes the value to all stakeholders (consensus). Predictability increases with time, since history is usually a good predictor of the future.

Stable implies that the system is difficult to change, or that there are no incentives for the stakeholders to change it in the first place (the system is in Nash equilibrium). This is related to predictability, but is not the same. Stability comes from system design, time and size. (As a side note, the genius of Bitcoin is how the incentives have been designed for Nash equilibrium, and not the “blockchain”, which media frequently reports).

Large is important because it makes the system more stable, minimizes the chance that some stakeholders “go rogue” and maximizes the resistance against external threats (think many and diverse nodes). Additionally, the value as medium of exchange increases exponentially as the user base grows (network effect).

Bitcoin has been around and growing for 9 years, and has today over 10.000 open nodes. It has in this period proven to be extremely resilient against threats of all kinds. Changes have been carried out in a predictable and evidence based fashion. Loud voices from corporations with own agendas have been ignored. This has led to the ecosystem and user base growing rapidly, in turn creating even more incentives for others to join. In comparison, altcoins are continually being hacked, manipulated and changed without any consensus, or in many cases even consent. If a few guys with hurt feelings can do that over a glass of wine, imaging what state sponsored attackers could do.

When users decide to use an alternative cryptocurrency (altcoin) to benefit from one of the three fundamental values, they have an opportunity cost in terms of the lost benefit of using the more safe and secure Bitcoin. No rational player (to use game theory lingo) would make such a decision, which leaves altcoins with zero fundamental value. This is also similar to why it’s impossible to compete with Facebook — any competitor would have virtually zero value, because of the opportunity cost for the users of leaving Facebook where all other users are. In Facebook’s case, the value is however only based exponentially on the number of users. In Bitcoin’s case, the value is based both exponentially on the number of users, as well as the three requirements previously discussed (being large and old, with a proven record).

Even if some altcoin solves some technical problem in a more efficient manner, this doesn’t increase the fundamental value per se. For the same reason, a Facebook competitor wouldn’t have any more value because it found a way to use an order of magnitude fewer servers — no users would care.

So why do some altcoins have market value, even if they don’t have any fundamental value? There are basically two reasons:

Lack of understanding of what drives fundamental value, and FUD Speculation (mostly based on 1.)

Some altcoins will continue to have some speculative value for the foreseeable future. But just like the now infamous tulips, the hysteria will eventually subside.

When Bitcoin has become more widespread, the price increase has stabilized, and a sufficient number of people have bitcoin holdings they want to start using (like because they turned 65), stores will start seeing the opportunity in accepting bitcoin to increase their sales. At that time, there will also be Lightning Network and other solutions which don’t decrease the Censorship-resistance of Bitcoin, which is the only thing that matters in the end.

Some governments will in the coming years increasingly try to kill Bitcoin. This will be attempted by ‘divide and conquer’ and other strategies. As long as we all understand how the value is created and maintained, we will have the advantage and these governments will fail.