Why Bitcoin Has Value, According To One Of Its Biggest Supporters

There's one big unanswered question that dogs Bitcoin: Why does it have any value?

Economist Brad DeLong explained the conundrum best:

Underpinning the value of gold is that if all else fails you can use it to make pretty things. Underpinning the value of the dollar is a combination of (a) the fact that you can use them to pay your taxes to the U.S. government, and (b) that the Federal Reserve is a potential dollar sink and has promised to buy them back and extinguish them if their real value starts to sink at (much) more than 2%/year (yes, I know).

Placing a ceiling on the value of gold is mining technology, and the prospect that if its price gets out of whack for long on the upside a great deal more of it will be created. Placing a ceiling on the value of the dollar is the Federal Reserve's role as actual dollar source, and its commitment not to allow deflation to happen.

Placing a ceiling on the value of bitcoins is computer technology and the form of the hash function… until the limit of 21 million bitcoins is reached. Placing a floor on the value of bitcoins is… what, exactly?

If there is nothing underpinning Bitcoin, it could easily collapse to zero. That would zap all the money people have spent on bitcoins, plus the millions pouring in via venture investing. It would also seemingly negate the technological innovation that makes Bitcoin something special.

We asked Chris Dixon for his take on why Bitcoin has value.

Dixon is an investor in Bitcoin, and one of its most ardent supporters. He wrote an eloquent blog post explaining why he's excited about it. The core of his enthusiasm comes from watching as the economy was nuked by the financial system in 2008, and hoping that a new payment mechanism could create a less disastrous outcome:

If not for political reasons, why am I interested in Bitcoin? Like a lot of people, I was disturbed by the aftermath of the 2008 financial crisis. I thought the government did what it had to do at the peak of the crisis but missed an important opportunity afterwards to reform the financial system. It seemed to me that there were two ways to improve the system: from above through regulation (which I support), or from below through competition.

...

I started getting interested in Bitcoin about two years ago. Like a lot of people I initially dismissed Bitcoin as a speculative bubble ("Internet tulip bulbs") or a place to stash money for people worried about inflation ("Internet gold"). At some point, I had an "aha!" moment and realized that Bitcoin was best understood as a new software protocol through which you could rebuild the payments industry in ways that are better and cheaper.

Nowhere in his post, however, did he address why Bitcoin has value. Without a reason for it to have value, it could lead to the same sort of disastrous outcome we saw with the financial crisis.

I emailed Dixon and asked, "One criticism of Bitcoin, which Paul Krugman made, is that there is nothing in it that stores value. What do you say to that?"

His response: "I think domain names are a good analogy. If someone proposed buying them in 1993, you could imagine lots of counter argument's similar to Professor Krugman's. When you buy Bitcoin's you are reserving a slot on the Internet's digital ledger."

I didn't totally get his analogy, so I asked for a follow up. He wrote:

"The best way to understand the value of Bitcoin is to think of other core internet resources that have a limited supply.

Domain names give you the ability to host a website IP addresses give you the ability to connect a computer to the internet Bitcoin gives you the ability to send payments, property, and contracts anywhere in the world instantly and reliably

There are markets for domain names and IP addresses. The prices tend to correlate to how useful people find those resources. Long term, if Bitcoin gains widespread adoption, I'd expect the Bitcoin price to correlate to how useful people think sending payments, property and contracts anywhere in the world instantly and reliably is. Personally I think this could be more useful than wearing jewelry, but maybe that's just me."

I still didn't fully get it, so we emailed him one more time, and he graciously wrote back. (Keep in mind I was emailing on New Year's Eve, so he was quite generous with his time.) Here's his final response:

"Happy to talk about it more. I might need to write a blog post to fully explain it. My view is that the economists talking about Bitcoin haven't really gotten into the technical aspects and are talking about something completely different ('Internet gold'). If they understood what Bitcoin really is, they'd think about the value in the way I'm describing."

I left him alone after that, it was New Year's Eve after all.

Personally, I'm still a little underwhelmed by this explanation, but pulling back, I don't think it matters.

For lack of a better way of phrasing it, people like Brad DeLong and Paul Krugman are skeptical of Bitcoin, but their skepticism manifests itself as words. People like Dixon believe in Bitcoin, and that manifests itself through millions of dollars in investment, as well staking his reputation as one of the great venture capitalists on the success of Bitcoin.

Dixon is no dummy, so I don't think he's blowing millions for no apparent reason. He's thought through the conundrums and decided Bitcoin makes sense in the long run.

There is reason for a lot of skepticism, but in this case, I think there is reason to believe Dixon's theory on Bitcoin even if he can't perfectly articulate it to my liking.