I don’t often write two posts in a week, but after the warm responses to last week’s post, and in honor of Bitcoin’s 8th birthday today, I thought I’d indulge in one more!

I just tweeted that out and judging by the number of quick responses, retweets and shares, it’s a pretty hot topic, so I figured I’d expand my views on this tweet a bit more.

I‘ve referred to bitcoin as a commodity in previous posts and tweets, to much bewilderment. Isn’t it a digital currency? Well, maybe, but not yet.

I also don’t believe Bitcoin is suitable as currency — I think it’s a commodity that can be traded for goods and services. It may become a currency in time, but it just isn’t one right now. It’s a scarce, digital commodity — and the trading that takes place on exchanges really reflects the market sentiment around the value of this digital commodity.

Extracted from my first Bitcoin post, Finding Equilibrium, published in March 2014

To better understand my perspective on this topic, let’s spend a few minutes understanding the differences between commodities, stores of value, and currencies at the most fundamental levels — the links go to Investopedia, which has some solid definitions, but I’ll summarise below for brevity.

A commodity is a basic good in an economy which, though it may exist in different grades (A, B, C, etc), is essentially homogenous and easily tradeable. Gold, Silver, and other precious metals are good examples of commodities, but then again so are wheat, corn, pork bellies, etc.

A store of value can be a commodity that’s not perishable (so wheat, corn and pork bellies are not stores of value) or subject to depreciation over time (for instance, mass produced motor vehicles, or other homogenous products where technology & time can render a store of value worthless). There is typically a base level of demand where its price is not expected to drop below a certain level (for example with Platinum, due to industrial demand), with the possible exception of structural changes to the local or global economy, or maybe even a black swan event. Stores of value do not have to be homogenous either — for instance, a Van Gogh painting. Essentially, stores of value are items where the value does not decay over time, but can in fact also increase.

I can already see the alt cryptocurrency people raising their hands and arguing that Bitcoin could decay over time to a better technology. That is true, but Bitcoin has an enormous network effect, similar to Facebook. I’m happy to bet that better technology elsewhere will not necessarily enable another cryptocurrency to get bigger than Bitcoin anytime soon, if ever. It’s no longer about the technology, it’s about network effect and the demand for the commodity.

Currencies are essentially a common basis for trading. It would be very difficult to lug around kilos of gold or other stores of value, so money was created and historically backed by gold (no longer, and I’m not going to go down that discussion path now either!). Currencies constitute money and are used as a medium of exchange — otherwise you would constantly be trying to figure out the exchange rate of one commodity versus another.

If you’re interested in learning more about the origins of money Nick Szabo wrote an excellent essay in 2002 title Shelling Out: The Origins of Money.

So, what is Bitcoin? It started off being defined in Satoshi’s Whitepaper as a “Peer to Peer Electronic Cash System” — which I think misled a number of people. Yes, it’s a great long term vision, but it really doesn’t explain what the steps are to becoming a digital cash system and how Bitcoin needs to evolve through these phases.

For Bitcoin to become a trusted medium of exchange (aka “a currency”), it needs to be stable, and have low volatility. You cannot have a situation where your money is worth less (or even more) in a day or an hour. Volatility and unpredictability in currencies is harmful to businesses in particular, and if businesses cannot be assured that the Bitcoins they received the previous day will help them replenish their stock, then they will be unwilling to accept it and risk their livelihoods. This equally applies to people who are willing to earn Bitcoin. I’m not talking about using Bitcoin as a payment network and converting to fiat, such as Abra or Bitpay. I’m talking about accepting and holding Bitcoins because they are trusted and will not drop in value.

Bitcoin has come a long way since the highly volatile early days, for a number of reasons, including how the market cap / liquidity pool has expanded in the past 3 years (some more info in this prior post). In fact, Bitcoin volatility is at all-time lows — check BTCVol.

It’s getting close to being stable (and in this post, I said we needed to Make Bitcoin Boring Again, to get past the halving and it was for a while — which was great), but I don’t think we are there yet. I believe that we first need to see it get to the $3,000 price range, which I forecast for later this year, and I believe this is entirely possible, but it must happen while maintaining low volatility and steady growth — countries falling apart and pouring money into Bitcoin will not help the cause if it happens too quickly. If we see Bitcoin spiking too quickly to say $4,000+ well before end of the year, then I’m certain we’re going to see an accompanying crash, and then we’re back to square one.

As per my tweet above, I think we’ve just gone past Phase 1. Bitcoin is well accepted as a digital commodity. Millions of people own it, miners mine it and run successful businesses doing it and it’s recognized that it’s scarce and deflationary, so time does in fact benefit the price over the long term because no more than 21 million will ever be created (only 5m more over the next 100+ years).

If Phase 1 was about establishing Bitcoin as the first digital commodity, then Phase 2 is going to be about proving that there is sufficient global demand for it, that the price rises steadily over time. Bitcoin holders are funny bunch — especially the old school ones. They want to see the glory days of 20x returns in a year (and the accompanying crashes!) — almost like a drug addict looking for one more hit. Those days are gone. We should be aiming for 2–3x gains every year for the next couple of years, and then those returns should be steadily declining over time, but always going up and to the right — the power of compound growth will ensure that we still get 20x returns, but over a longer period of time and in more sustainable fashion. The more stable that Bitcoin becomes, the more it will be a store of value, and eventually it will become a currency — which will usher in a new era for Bitcoin. This could take 5–10 years to play out, but ceteris paribus, it should happen.