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.
The importance of players of any game to have “skin in the game” cannot be understated. This concept has been brought to public attention recently by the irreplaceable Nassim Nicholas Taleb, who is the author of a great book on this theme. One of the major problems of modern society is that too many players don’t have any skin in the game any more, the leading players of society usually do not have to pay any price for their failures – just look at Western politicians: causing disasters they never have to pay personally the price of. How can someone who has not to pay a price for committing mistakes grow any sense of responsibility? There’s no bright future in a society where the principle of having skin in the came has been dismissed.
The main reason for Bitcoin’s impressive resilience and rising value is that most of the players have a lot of skin in the game. The miners have invested gazillions of dollars in their mining equipments, which they would lose should Bitcoin’s value drop too much. And they have to keep investing money every single moment to pay for the electricity which is necessary to mine Bitcoins. It’s true that this procedure, the so-called Proof of Work, is not very ecological (not at all, but we won’t enter in the ethical implications here), but it plays a crucial role in forcing the players to have skin in the game. Moreover, infrastructures are now being built all over the world on top of Bitcoin’s network, to make a wider adoption possible. Big players are investing big money on this. That’s all new skin in the game.
The main reason altcoins are valued so much less than Bitcoin is because there is so much less skin in thre game there. Many altcoins have opted for Proof of Stake (PoS or DPoS) as their method for securing the network, which undoubtedly is more ecological, generally faster and technically more scalable and probably in the whole more efficient, but which has one main downside: once you have enough coins to stake, that’s all the skin in the game you will ever need. You don’t have to add skin in the game every single moment, as miners must do. Miners have to sell Bitcoins to pay for their huge electricity expenses, and this in itself is already setting and keeping an economy in motion. On the contrary, people who stake coins are not obliged to sell coins continuously. The system is less dynamic.
Therefore PoS and DPoS networks will likely need more time for growing and keeping their value just because they need more time for piling up true skin in the game. This doesn’t mean they may not be the long term winners in the crypto ecosystem Darwinian selection – we simply don’t know the future. But for sure, their architectures seems ATM to be less efficient and slower in the necessary task of adding skin in the game.
I should also spend a few words for the case of networks which are born by the way of an airdrop, distributing the coins for free to as many people as possible, relying of Metcalfe’s law to acquire value. Bad and/or copy-cut projects have obviously no hope to acquire any lasting value just by “creating nodes”. A node without some skin in the game is not a real node. If those networks do acquire any value for a while it is because of people playing the musical chair: everybody in the network is just only pretending to believe in their new shitcoin destined to be “mooning” any time soon, while in reality they are all just hiddenly waiting for the best moment (typically a pump) to dump their useless coins on some unlucky bagholder.
But there are also some cases of potentially innovative and anyway technically original new coins which get distributed by the way of an airdrop, like for example it has happened with Obyte. Obyte has a very original and interesting DAG tech and it has been almost entirely distributed through an airdrop. Not unsurprisingly, after a huge initial pump & dump, it’s value has been declining ever since. Most of the coins in the network belonging to “fake nodes” – ie people with no skin in the game, who got them for free – there is nothing to lose for most players for dumping their bags at any price. But if a coin distributed through an airdrop is really good and it really is able to solve some problem better than other projects, long term it will eventually acquire its due value. However this could happen only after all those useless first generation holders without any skin in the game and no interest in the project have handed all their coins to other people, second generation holders, people who are trusting the project, who are choosing to pay for the coins and thus are putting their skin in the game. It is their skin in the game which will ultimately give to the network its value. Thus airdropping a coin is probably the less effective and slowest way to add skin in the game to a project, since you’ll need to wait for the second generation holders to become the “real” nodes which will enable Metcalfe’s law. Even in a good quality monetary network it takes time to clear the background noise of all the useless nodes with zero skin in the game.
So as we can observe, skin in the game is the number one cause of value in the world of crypto.
You Heard It Here First.
Once upon a time FIAT money was all about having skin in the game, being money originally the product of labor. But in time this bond has dissolved, up to the recent exponentially skyrocketing debasement of FIAT currencies which has annihilated all its fundamentals. What’s left by now is only a huge collective delusion in place, which sooner or later is destined to blow. Even though at the lowest level of the food chain common people have still skin in the game of FIAT money, because they have to work to get it, higher up in the food chain reality is very different. In the headquarters of FIAT money the biggest banks are literally playing God by creating limitless money as they please and for their own reasons and purposes with no skin in the game whatsoever. It is true that also BTC whales like to play God sometimes, and if they’ve got their coins in the early days of Bitcoin they too may have no skin in the game, but at least they are bound by limits, algorithmically determined. All that pile of QE money and derivatives shit which is being created by the financial Masters of the Universe at a rising pace has a zero skin in the game value and therefore its doomed to disappear. Since the only real backing of any asset is ultimately skin in the game, having removed that from the FIAT money game is the worst kind of debasement.
Finally, while there is a rising quest for regulating the crypto space, and there may be some rational for that, let’s not forget that it’s bad regulations what ultimately is likely to end up removing all skin from the game. It has happened before, it can happen again.
One of the most abused common places of mainstream commentators is that Bitcoin should not have any value because it is not backed by anything. They are completely wrong. In fact, they couldn’t be more wrong. Bitcoin is backed by pure skin in the game. Something you really cannot say for FIAT money any more. Not at all.
Anyone can draw their own conclusions.
Genova, August 5, 2019
PS. For those who care in 2012 I have already written a short story together with Ian Watson trying to speculate around the mysteries of money. It’s called The Invention Of Beloved Money and you may read it online.