Some people say Bitcoin is not a good “store of wealth” because of its volatility. Since it’s not “backed” by anything, it is only good as a “transactional currency”. That is, to do some work, earn some bitcoins and then spend them in Walmart. The price does not matter as long as it’s stable enough between the moments of receiving and spending it.

Some other people say that Bitcoin is bad as a currency. It requires electricity, internet connection, it’s not good at micro-transactions, it’s not instant, it’s hard to exchange to and from government currencies, and it’s complex to understand for regular people. But as a store of value they say it’s okay. It can be safer and cheaper to store than gold, it’s hard to confiscate it, every year it was only growing in value.

Some others even say that Bitcoin growth hurts its use as a currency because people are not spending enough, but “hoarding” money in expectation of even bigger value in the future.

At least one of these groups must be wrong and, unfortunately, all of them do not understand economics at all.

For something (gold, paper, seashells) to become a medium of exchange, it must have some value and market acceptance (in addition to physical ability to transfer ownership, of course). Where does this value come from? People who do not want to hold an asset for a relatively long time do not care about it’s value, thus they do not have any effect on it. Only those who wish to hold an asset will decide what is the fair price for it. They are doing so for one of two reasons: either as a hedge against uncertainty in the future (who knows what you’d need to pay for next month), or as a bet that this asset will outperform alternatives (like Argentinians who buy dollars because their pesos are depreciating way too quickly).

The more people want to hold an asset (regardless of the price), the more liquid it is. Therefore, if someone offers you a payment in this asset, you are more likely to liquidate it, so you are more likely to accept it. Again, regardless of the price.

However, the supply of Bitcoins is very limited and long-term investors compete very hard for its current production. This means that every single new person who wants to hold some number of bitcoins, would have to not only outbid other newcomers, but also the existing holders and their time preferences. Growing demand for a good in a fixed supply have to raise the price.

This has two interesting effects.

First, growing price acts as an indicator of liquidity of Bitcoin. Since it is impossible to control the price of Bitcoin (there are multiple sovereign exchanges in multiple countries and a lot of private trade outside the exchanges), price can’t grow by a decree of a fixed group of speculators. Therefore, growing price means growing number of holders. Which means, growing number of people that will gladly accept Bitcoin from you if you do not intend to store it, but only receive as a payment from someone else.

Second, in a positive feedback loop, as more people are seeing liquidity of Bitcoin, they are getting more likely to hold Bitcoins for a little longer than usual. Either expecting a better value in the future, or as a more safe and easy way to store some cash. This, of course, increases number of people willing to hold bitcoins and thus increases the price even further.

In the end, to become a currency, Bitcoin must have value which only comes from speculators holding it for various reasons. The more people are holding it, the better currency it is. Hot potato that no one wants to hold will never be a medium of exchange because it’s value does not exist.

Of course, there are some physical limits on usage as a currency. Gold is the worst currency: it’s heavy and hard to check and expensive to move and store. Paper bills are much better but still do not fly over the oceans. Banks and clearing houses even better, but historically were very expensive due to risks of fraud, devaluing, fractional reserve lending etc. Bitcoin is much better comparing to what we had. It’s much cheaper to verify the authenticity, it’s faster to fully confirm than credit cards (chargebacks within 90 days) or bank wires, it requires very little infrastructure to work (the internet, laptops and smartphones are widely deployed) and it has some useful features that other assets will never have. Therefore, Bitcoin’s biggest barrier to become a widely used currency is simply number of hands that hold it. And as we see, it is getting into more and more hands very rapidly, just like Facebook or Twitter were attracting more and more people — almost exponentially.