by Roberto Quaglia

When asked what is giving Bitcoin (or any other cryptocurrency) its value, most of the bright people would answer just something like: “Shared consensus.”. Some would add a particular techno-mantra involving terms like “distributed ledger”, “limited supply”, “permissionless”, etc. But the core of the answer would anyway be “shared consensus” – ultimately money has a value only if there is a shared consensus over the fact that it has a value.
However, at a closer look this is telling us nothing about the reasons which are giving value to Bitcoin. “Shared consensus” is not a cause. “Shared consensus” is a consequence. And also all that fancy techno jargon mantra with concepts like “ distributed ledger”, “limited supply”, “permissionless” – is in fact telling us very little about the reasons which are causing the value. After all, there are by now literally thousands of new cryptocurrencies, all boasting about their “distributed ledger”, “limited supply”, “permissionless” nature – and yet none of them manages to achieve more than a minimal fraction of Bitcoin’s value.
In April 2014, Bitcointalk user “Peter R” has written a post in which he observes how Bitcoin’s value seems to be rising according to Metcalfe’s law about networks. “The effect (value) of a network is proportional to the square of the number of connected users (nodes) of the system.” Since Bitcoin is clearly a network, it seems totally legit that its value would rise the more users it would have. And it would do so in accordance to Metcalfe’s law ( https://bitcointalk.org/index.php?topic=572106.0 )
This insight has sparkled a new fashion throughout the whole crypto-space: everyone and their dog would suddenly create a new cryptocurrency to be “airdropped” for free to as many people as possible – this way each time a huge network would rise and according to Metcalfe’s law it would magically acquire tons of value. Herds of people rushed to grab some of this new free money, but… guess what? In most cases the trick didn’t really work out so well. Not much value was created. Did Metcalfe’s law suddenly stop to work? Or instead there was an even more important law – or principle – which had been overriding it?
There is in fact an overriding principle which is the requirement of people who take part in a monetary network to have “skin in the game” – in other words to share the risk of the network. The bigger their investment, the more they’d have to lose should it ever fail, the more they would have a motivation to stay proactive in securing the network against failure. Continue reading →