November 8, 2018

The demand curve slopes downward”

Some people think of Bitcoin as a Giffen Good.1 The more expensive it becomes, the more in demand it becomes. Sort of like gold.

But that’s the wrong view of cryptocurrencies. They are not Giffen Goods.

Blockchains at their hearts are computing services. To use the distributed computing network, you need coins. If coins get more expensive, then the demand for the coins goes down because the computing on the network gets more expensive.

The demand curve slopes downward.

This means there’s always a downward pressure on cryptocurrency coin prices. The more popular a network becomes, the more expensive it becomes. The more expensive it becomes, the less demand there is for that network.

As a coin’s price rises, one of two things will eventually happen.

  1. The demand will shift to other blockchains. Since The Blockchain” is an open source concept, and since anyone can create a blockchain, there is robust competition in the cryptocurrency/blockchain space. The moment Bitcoin becomes too expensive, people will use Ethereum.
  2. Or, the demand will disappear entirely. Centralized computing is super cheap. If blockchains are too expensive, people will merely rely on AWS or Azure - or even revert back to professionals using pen and paper.

But what about network effects? Could more people using Bitcoin, for example, increase the value of the network and increase the price of Bitcoin?

I think it depends on what the value of Bitcoin is. If it’s a store of value - if it’s a digital gold - then this might be true.

But there are three arguments for why blockchains are valuable:

  1. It’s a store of value
  2. It’s a currency
  3. It’s a computing network

If it’s a store of value, then perhaps it’s a Giffen Good and will behave like digital gold. If this is true, I think only Bitcoin will survive.

If it’s a currency, it will struggle to find adoption because cryptocurrencies are naturally deflationary. Currencies need to naturally, slowly inflate in order to encourage spending.

And if it’s a computing network, I wouldn’t expect much price appreciation. Computing tends to get cheaper, not more expensive, over time. The demand curve slopes downward, after all.

  1. Giffen Goods are goods that have increased demand as they become more expensive.

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