The real value of crypto isn't the price

By Zihao Xu on Monday 15 February 2021

OpinionDigital Banking

Yes, bitcoin is over-hyped, but distributed digital scarcity is very real, writes Zihao Xu, principal at Octopus Ventures.

The real value of crypto isn't the price
Image source: Surface/Unsplash.

Watching the price of Bitcoin go up while tweeting rocket emoji is fun, but restructuring the incentives that govern how we trade and collaborate could reshape society for the next thousand years.

Every few years the price of bitcoin jumps by an obscene amount in a matter of weeks. It's hard to predict when it will happen next (or whether it will ever happen again), but when the price of bitcoin hits the front pages two things are guaranteed. 

The first is that each of us will torture ourselves with some quick mental maths on how much we could have made had we only followed through with our plans to buy some more crypto with last year's birthday money. 

The second is that journalists will manage to find a few more unlucky souls who lost their private keys eight years ago and make them relive their anguish in the public eye. Most of us will have a cry, have a chuckle, and get back to our lives.

Yet this would be to miss the point. Bitcoin and other cryptoassets represent more than just a sci-fi penny stock that refuses to die. Cryptoassets have the potential to reshape how humans participate in productive society fundamentally. There are myriad hurdles still to be overcome, but the genie is out of the bottle.

The internet and the digital revolution have changed everything. By encoding information in electrons, we can trade ideas and information with anyone in the world at lightning speed for zero marginal cost. This has supercharged our ability to collectively get smarter and collaborate on building the amazing things we have in the world. But replicating information at zero marginal cost means that we can't inherently capture real world value. 

Things in the real world are scarce—they cost time and resource to create and replicate. Things in the digital world are not scarce—they cost nothing to replicate. In order to put real world value in the digital world we need to replicate its inherent scarcity, and we entrust organisations to do this. It would theoretically cost my bank nothing to add a few zeros to the end of my current account balance, but that would break the whole system of trust.

The system of trust usually works. We put trustworthy people in regulated environments so that they won't steal from anyone. Sometimes, however, the people connive against us (famously Bernie Madoff). Sometimes, they change the rules on us (like blocking us from trading $GME). More importantly, the people we trust are also the gatekeepers to progress. If we want to change the way a network is run, we need to convince those in charge to give us permission. These are closed ecosystems.

On the other hand, open ecosystems have created the vast majority of the innovation in the world over the last fifty years. Because nobody needs anyone's permission to write code and share it with others on the internet, we've seen an explosion in amazing digital services that have put a rocket under human productivity. Anything involving value and money, however, has, for the most part, remained behind closed ecosystems because to open it up would make it too easy to cheat, until crypto came along.

Creating distributed digital scarcity is the fundamental premise behind why crypto is so interesting. For the first time, we're able to ascribe real world value to digital assets without a central gatekeeper's control (or protection). We're effectively able to create 'permissionless' financial lego bricks governed by encoded and tamper-proof incentive structures that anyone can see, scrutinise, and replicate.

This means nobody can steal (at least not on-chain), nobody can suddenly change the rules, and anyone can run experiments. The incentives become wildly different to those we know today. Our current hierarchy of centralised power formed as a necessity of the physical world.

For thousands of years, it was harder to protect value from bandits' violence than to create value in the first place. We quickly figured out that we would need institutions to wield legitimate violence and protect us from the bandits if we wanted to incentivise participation in productive society.

In the digital world the things we create are no longer subject to the same threats, so we can start to re-assess our need for the structures we've long taken for granted. That's certainly worth paying attention to.

Zihao Xu is a principal at Octopus Ventures. The views and opinions expressed are not necessarily those of AltFi.

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