On Scarcity and Value

I had dinner with some friends recently and the topic of Bitcoin came up, as it does when I’m a part of these sorts of things. Someone asked me why I thought bitcoin was valuable. I said, because it is scarce. We were on round three of our drinks at this point in the evening so I tried to keep my answer brief. Another friend then set his empty beer bottle down on the table and proclaimed: “This bottle is one of a kind. Why isn’t it valuable?” I fumbled an answer that was trying to make the point that I had another one in my fridge that I could drink that would be indistinguishable from his, casting shadows on his “one of a kind” claim. It wasn’t the clearest question, but I also didn’t give a great answer in return.

If I could distill his question down to something a bit more straightforward, I would state it as: Why does scarcity make something valuable? There are plenty of things that are scarce that have no value.

And he’s right, scarcity does not impute value. My son Graham has produced many one of a kind pieces of art at his school, but I haven’t been able to get anything for them at auction. The limited supply of them has not translated into value.

Why does scarcity have anything to do with Bitcoin’s value proposition? It is one dimension used to measure the properties of a good money. It’s been the one dimension that current money, fiat, most lacks. Bitcoin also has the other dimensions but I would argue it’s less notable since it’s not novel in a money. Graham’s artwork scores poorly on the other dimensions of money, which I think is primarily why they’re not being fought over at Sotheby’s.

In addition to scarcity, the other dimensions of a good money are: portability, verifiability, divisibility, durability, and fungibility¹. Fiat scores well on all of these attributes, which is why it has supplanted the previous money, Gold. Gold scored highly on scarcity, durability, fungibility, but it is not very portable, it takes great effort to verify it, and it is difficult to use in small quantities, so it is not very divisible.

Portability #

Bitcoin is the most portable money that has ever existed. I can send it across the world over the internet. I can broadcast it on a short wave radio. I can put it on hardware device and hand it over in person. If you’re fleeing a collapsing country, you could much more easily make that move with your bitcoin than you could with cash or gold. You can store bitcoin in your head, if need be, by memorizing 12 words. It’s difficult to imagine something more portable than that.

Verifiability #

Bitcoin is extremely easy to verify. A computer running bitcoin software can verify a transaction instantaneously. If you do not have your own trusted bitcoin setup running, you can rely on freely available 3rd party services that can verify bitcoin transactions. All you need is a communication line to verify a bitcoin transaction.

Divisibility #

Bitcoin is highly divisible. At present 1 bitcoin is divisible into 100 million fractional units. If this was determined not to be enough, it would be a very straightforward change to allow further subdivision. Changes to bitcoin require buy off of the whole network (via willfully updating the software that is being run). But a change of this nature would be likely to be uncontroversial.

People sometimes confuse divisibility and scarcity as being competing ends. People will say, if something is infinitely divisible, how can it be scarce? This can be unpacked many ways, but maybe the easiest is to ask that person why you can’t feed the world with a single pizza since we can continue dividing the pizza into smaller and smaller slices until there are enough slices for everyone in the world. Cutting something in half is not the same as having two of something. A change to bitcoin’s decimal place would result in everyone’s “number” growing. As opposed to the Fed creating a trillion dollars out of thin air, where that trillion dollars is then given (in part or in whole) to some entity. Your personal number of dollars didn’t change.

Durability #

Bitcoin has an advantage in the durability category over physical forms of money. Digital things have a very high degree of durability because they can be copied and backed up. The same is true of Bitcoin. You can miraculously copy and back up your bitcoin without being able to double spend it. This is one of the main technical breakthrough achieved by bitcoin, through it’s blockchain data structure.

However Bitcoin durability is not a given. You must take the effort to store it responsibly or it could be lost. In the same way that it would be unwise to store large quantities of paper money in a location where it could catch fire, it’s unwise to store bitcoin on internet connected devices that are prone to attacks. Any sufficiently large bitcoin stack should be secured on an offline hardware wallet, with multiple backups to prevent a single point of failure. Bitcoin can be extremely durable, but it does require some effort.

Scarcity #

In scarcity, bitcoin will score the highest. It is currently slightly less scarce than Gold, and at the 2024 halving it will be almost twice as scarce as Gold. It will continue gaining scarcity exponentially until its stock to flow ratio hits infinity. There has never been a resource with a predictable finiteness like Bitcoin. Time² is the only other thing that comes close in terms of finiteness, but the time resource is unpredictable at the individual level.

Scarcity is important because it measures the lossiness of value over time. Scarcity could also be thought of as “portability” but for time instead of space. I read a news article about someone who found in their attic a lockbox that was dated to the 1910s. Inside there was $15,000 USD, which would have been equivalent to, at the time it was stored, the entire economic output of someone’s life. Now, you probably couldn’t buy a new car with it. The ability to store your economic energy for later is valuable for protecting yourself and your family from future uncertainty, or for providing a better life for your future generations. But you cannot do this in a money which has an inflating supply. This is why modern conventional wisdom for saving is to put your money into investments. It is not enough to store it, because it will lose purchasing power over time.

The last point I will make about scarcity is that sometimes people will confuse bitcoin for cryptocurrencies in general and make the claim that because cryptocurrencies in whole are not scarce, bitcoin is not scarce. But this is comparing apples to oranges. Gold is scarce, and aluminum is abundant. My claim of Gold being scarce is not undercut by someone pointing out that metals are abundant. Gold is a metal but not all metals are Gold.

Fungibility #

I left fungibility last because it is the dimension that bitcoin scores the worst on. Fungibility means that one unit of a thing is equal to another one unit of the thing. One gram of Gold is equal in value to people as another gram of Gold. The same is not true of a diamond. A one carat diamond is not necessarily equal in value to another one carat diamond. There are other factors such as color, and clarity that come into play when determining value.

Fungibility is up to the market. As far as bitcoin the software/protocol is concerned, bitcoin is perfectly fungible. But it would not be hard to imagine that if a bitcoin transaction occurred that was known to be paid to a terrorist organization, that exchanges might refuse to accept that transaction. Either by rule of government regulation or personal ethical reasons by the leaders of that exchange.

Because the transaction history of every bitcoin is fully known and auditable, bitcoin that is associated with known illicit activity could become tainted in the eyes of the market and not be worth as much as an untainted bitcoin. The main way to improve this is to improve the privacy of the network. Another way to improve this is by scaling transactions to a different layer. Lightning is a layer-2 network that runs on top of the bitcoin protocol. Unlike the base layer, lightning functions without needing to keep a public ledger of transaction history. People are not able to audit the source of the money coming into them over lightning. They are able to verify that the transaction is valid, but not its intermediate lightning transactions that it has been a part of. This protects institutions like exchanges from being on the hook for censoring transactions. Exchanges are already adding support for deposits and withdrawals over lightning. In part for the added privacy layer, and in part because transactions are cheaper on Lightning.

Scarcity alone does not make a thing valuable, but it is one component that makes something a good money. It is also the main component we are currently lacking in with our current money system. Society will eventually converge on the best money, and I believe bitcoin is the best money.