Misleading Narrative

An interesting narrative has emerged in the cryptocurrency space in the recent years -- that Bitcoin is not meant to be spent, but instead is a Store of Value or rather should be thought of as a savings account and not something you transact with on a daily basis. That is to say, any asset (such as Bitcoin) whose value is only derived from the fact that it gains value from more people buying in has another name -- a Ponzi Scheme (https://en.wikipedia.org/wiki/Ponzi_scheme).

On the other hand, in economic theory, any method of exchange derives its value from its usage. I will try to debunk the Store of Value narrative and will try to demonstrate that Bitcoin, and every other cryptocurrency, have value (and are of value) because they are useful as a method of exchange, which, in turn, potentially makes them a valuable store of value.

The simple fact that Bitcoin's price has only ever increased through the 12 years of its existence tells me that the source of its value must also have been increasing in proportional amounts.

In order to determine if usage is the source of Bitcoin's value, we can start by looking at the number of daily transactions. While they had been increasing for the first few years of Bitcoin's existence, that growth has stopped in 2016 as we hit the blocksize limit of 1MB, which means that the number of daily transactions on Bitcoin can't go far beyond 300,000.

As we can see, there does not seem to be any correlation between the price of Bitcoin and the number of transactions. If the number of transactions are not an indicator of price, what is?

Back to The Basics

To try and understand where Bitcoin might derive its value from, we have to go back to the basics of Bitcoin. The number of daily transactions is an important metric with regards to growth and adoption, but it isn't necessarily the best indicator of usage as a medium of exchange. In trying to measure the economic activity of a network, we have to account for the aggregated amount (in USD) of each of those daily transactions -- I will refer to this measure as economic activity.

While Bitcoin has been expensive and relatively unreliable to transact on since the blocks have been full (which happened in 2016-2017), it remains undeniable that there is a strong relationship between its market cap and the daily transferred value (USD) or daily economic activity.

• As a technical note, this metric "Xfer'd Val, Adj" (from https://coinmetrics.io) differs from the very popular "Sent In USD" (from https://bitinfocharts.com/), as CoinMetrics tries to remove noise and change addresses (the amounts you send back to yourself after making a payment, or in other words, the change you'd get after paying for something in cash). I believe this might be a more accurate representation of the economic activity happening on the chain -- the full description of this metric can be found here : https://docs.coinmetrics.io/info/metrics/TxTfrValAdjUSD

If we take a closer look at the data since late 2019, we can also see that the daily economic activity has increased five-fold from 2.5B to over 12.5B a day on a 7 day moving average, which correlates with its price increase.

It is important to remember that while Bitcoin's fees are high, it remains a much more efficient way to transfer large sums of money internationally without having to go through the legacy financial system. The legacy financial system imposes an inordinate burden on businesses and individuals in the form of regulatory restrictions, fees and delays -- as anything slower than an instant transfer of value is a wasted opportunity.

It is my hypothesis that Bitcoin has been serving an irreplaceable need for businesses and individuals to be able to transfer wealth in a way that is impossible through the legacy financial system.

In order to try to get a ballpark estimate of this baseline economic activity, let us look at the period of April 2018 through October 2020 -- a period of relative calmness in the crypto ecosystem. Here we can see that Bitcoin's daily economic activity ranges between 1B and 3B (USD) at a price of $4,000 to $12,000.

Economic Activity Supports the Price of Bitcoin

Going back to the chart of economic activity vs. price, we can clearly see that following each bull run (2011, 2013, and 2017) the economic activity of Bitcoin never falls back to a point prior to the last bull run. Up until now, every cycle has brought more permanent economic activity to the ecosystem, which has supported the price through the periods of little to no media attention or speculation.

Liquidity

A good question to ask would be "Considering that the fees are so high on Bitcoin why does it have such a high economic activity when there are cheaper alternatives like Bitcoin Cash?". If we assume that every decision is rational, and that the economic activity on Bitcoin exists there because it is the best available choice, then the only logical conclusion points to liquidity.

By liquidity, I mean the ability to buy and sell large amounts without affecting the price much or at all. In that regard, Bitcoin being the largest cryptocurrency by a quite significant margin, is then by definition the best choice when moving large amounts of money in and out of the crypto ecosystem.

Where Does Bitcoin Cash Come Into Play?

Now that we have a model that might describe which properties of a currency might support its price -- the number of daily transactions multiplied by their respective amounts -- we can start to apply this model to other currencies to validate our hypothesis. As a note, we can use the price to compare Bitcoin and Bitcoin Cash, but it is important to instead use the market cap (the price multiplied by the number of total coins) when comparing currencies with different total supply. In the case of Bitcoin and Bitcoin Cash, the supply is nearly identical.

Looking at the above chart, we can see that while Bitcoin Cash's economic activity was very high in the hype of 2017, it failed to retain a significant portion of the economic activity on Bitcoin, explaining the reality that the price of Bitcoin Cash has been declining with regards to Bitcoin. It also seems like the large changes in economic activity are reflected in price with a significant time delay. It only took until early 2018 for the economic activity of Bitcoin Cash to fall down to the baseline of ~50-200M (which was the range of economic activity maintained through 2020), but the price only significantly fell in the later part of 2018.

Another interesting point is that, when looking at the same baseline in Bitcoin Cash's economic activity (~50-200M of daily economic activity in the 2018-2020 period), if we zoom out (chart below), we can see that this was extremely similar to both Bitcoin's 2014-2017 economic activity and price movement.

Bitcoin Cash is Taking Bitcoin's Lunch

In the last few months, the economic activity on Bitcoin Cash has skyrocketed to some really incredible levels while its number of daily transactions has overtaken Bitcoin's. The current economic activity on Bitcoin Cash is in the process of surpassing the baseline economic activity of Bitcoin prior to October 2020, and is still increasing steadily.

The best explanation for this is that it is directly caused by the rising fees on Bitcoin. As we can see in the following chart: economic activity picks up on Bitcoin Cash at the point where it became clear that the mean transaction fee on Bitcoin would not fall back below $5.

While it is difficult to know for a fact that the relatively large increase in economic activity on Bitcoin Cash is occurring due to new activity emerging or because of existing activity migrating from Bitcoin, the timing of the economic activity increase being perfectly timed with the transaction fees on Bitcoin increasing steadily and showing no signs of slowing -- points to it being the latter; economic activity is shifting from Bitcoin to Bitcoin Cash despite having much lower liquidity.

In terms of understanding the scale of such a migration of economic activity, we can look at the price of bitcoin being supported by a daily economic activity of ~1.5B -- $4,000 to $8,000 USD.

So, what kind of conclusions can we take away from this?

In the most conservative take, Bitcoin Cash is severely undervalued and that a significant price correction can be expected in the coming weeks or months. It is also possible that Bitcoin's baseline economic activity that has supported its price until now has recently shifted to Bitcoin Cash.