The Bull: Where does crypto currency value come from?
And native crypto currencies as commodities
Intro
After 4 weeks away, my first article back will capitalize on the crypto euphoria reverberating all around us. Between SAGE Labs releasing and Breakpoint in Amsterdam, I’ve been a bit bogged down for the last month. But with the recent shift in the markets, I thought it was a great time to hop in with an article about value. Specifically, native crypto currency value and where it comes from.
I’ll speak specifically to Native Blockchain Tokens like SOL, BTC, and ETH. I’m mostly not talking about stable coins (which I personally believe are perfect currencies). The model in this article extends far outside of crypto, blockchains, and even virtual stuff. It applies as much to crypto as it does to a skid loader.
This discussion was sparked by a conversation I was having with a non-tech, non-gaming, non-crypto friend of mine over the weekend. They couldn’t understand why this digital thing that you can’t touch would have value. Apple stock, for example, gives you the rights and ownership over the underlying company which, in turn, gives you ownership over all future earnings of that company. So how can a crypto currency, or really any digital asset, have value when I can’t go to a physical location and interact with the underlying asset?
The TL;DR is this: like any asset, crypto currency has both intrinsic and extrinsic value. The intrinsic value comes from its usefulness as a currency and it’s usefulness in operating the underlying blockchain. I’m always surprised how misunderstood this concept is by normies. All blockchains run on crypto currencies and computation. Just like with the computation, without the currencies, the chain shuts down. The shininess of unique assets and the excitement of their scarcity also lead to extrinsic value. The same type of value that gives gold such a high price tag. So, with these two types of value, we can understand where the crypto price tag comes from and in what ways it is similar to traditional assets like stocks, bonds, currencies, and commodities.
Value in two parts
If you’re reading this, I’ll assume you’ve read my article with Ted and if not, here it is.1 There are 2 general reasons why a crypto currency (or any asset, for that matter) has value: intrinsic value and extrinsic value. In the aforementioned article, our pricing model accounts for both intrinsic (z in the paper) and extrinsic (n and i in the paper) value. Departing from a traditional finance framework, my definitions follow.
Intrinsic Value - Comes from within the object itself. The value that something inherently provides. A brick is intrinsically valuable because it is useful in building houses. Gold is intrinsically non-valuable because it can’t make good tools.
Extrinsic Value - Comes from outside the object itself. The value that others apply to something for one reason or another. A brick is not extrinsically valuable because it is not beautiful and there are many of them. Gold is extrinsically valuable because there is very little of it and it is beautiful.
Queue the Water-Diamond Paradox.
Intrinsic Value
Intrinsic value is the value that is generated by the asset itself. In my example above, Gold has very little intrinsic value because it can’t be used to make tools or anything essential to life (minus some techy stuff). Oil, a commodity, has much intrinsic value because it can be used for many things from moving stuff to keeping machinery running 24/7. So, what intrinsic usefulness does crypto currency have?
Quite simply, crypto’s intrinsic value comes from its usefulness as
A means of validating a blockchain.
Renting space on a blockchain
Paying for transactions on chain
A currency
Like a computer chip, it’s easy to take the underlying function of a crypto currency for granted. It’s probably because in some cases, the currency does not actually have one of the first 3 purposes mentioned above. ATLAS, for example, is mostly a currency for a game and only intrinsically valuable in the point 4 sense. It is not used to confirm transactions or rent space on a blockchain (except through ATLAS Prime — shameless plug). In this case, the ATLAS currency’s only intrinsic value is how useful it is as a currency in the Star Atlas game.
But in the case of the major currencies, those associated with a blockchain, they’re intrinsic value goes way beyond their usefulness as a currency. They can be used for points 1 through 3.
A hot take:
Non-Game, non-blockchain native cryptos should probably be stable coins. Games need the floating price because it provides an additional career path for players as well as a unique gaming experience (ISK, in EVE is floating, for example).
Extrinsic Value
Crypto, like many assets, has extrinsic value and people may want to hold it and buy it for more than its underlying usefulness. Why do people hold baseball card collections? The cards themselves can’t even be used in a game. They are only there to be looked at. Cards get their value from their scarcity and desirability en masse.
Ultimately, extrinsic value comes from the masses. Every additional person that wants something, regardless of motivation, adds legitimate value to that thing. Sometimes, a large mass of people decide they don’t want a thing anymore and the price plummets. We call this a bubble if the original reason people wanted it was based on something untrue (Enron, FTX, Ponzi Schemes).
For a brief period in the 90s, everyone wanted a Beanie Baby. Their value skyrocketed only to plummet when everyone simultaneously decided they didn’t actually care about Beanie Babies that much. Some things are bubbles like Beanie Babies, but for other assets like baseball cards, the extrinsic value sticks for many scores of years (100+ years in the case of a baseball card).
Some examples of assets that have a lot of value because of their extrinsic value: baseball cards, diamond rings, precious metals,
Bonus: Native Cryptos as a commodity, not currency or security
Is crypto a currency or is it a security? I’m of the personal belief that it’s neither. It’s a new thing just like currencies and securities were when they were invented. The closest analogue we have is what’s known in the finance world as a commodity.
Not a Currency
We’ve all heard the 5 (or 6 depending on who you’re talking to) key aspects that make good money.2 Of these, native crypto currencies like ETH, BTC, and SOL lack stability. Given the intrinsic value of crypto and the ever-changing nature of that value, it will never be quite stable in my opinion. This is why I believe crypto currency is a bit of a misnomer. Obviously, stable coins are a different story and very well may qualify as a currency.3
Not a Security
Similarly, Crypto cannot be a security because it has literal use cases outside of just being a representation of ownership. Thus, the only similarity between crypto and a security is they are both speculated on (extrinsic value) based on their underlying usefulness in the world (intrinsic value).
A Commodity
The closest thing we have in the traditional world to a native crypto currency is the commodity. That is, crypto is a useful and essential piece to any blockchain operating successfully. If you destroyed all of the SOL in the Solana ecosystem tomorrow, that blockchain would fail to operate because nobody has the capital or resources to work it anymore.4 Without oil, your car engine overheats and blows up.
If all the Apple stock were to disappear tomorrow, nothing would happen except that Apple would be a hell of a lot less rich. However, assuming the value was delivered back to them, almost nothing would physically change in their day-to-day (except for employee LTI plans and their ability to borrow capital).
The same cannot be said of crypto currencies. If a native crypto token were to disappear, the blockchain would literally not be able to function.
Conclusion
Crypto currency is a bit of a misnomer because it’s not really stable enough to be a currency. And crypto isn’t a security because it has actual real-life usefulness on chain.
Crypto is probably something completely unique, but the closest analogy we have in the traditional world is a commodity - absolutely essential to operating an economic system that has both intrinsic and extrinsic value.
About Me
My name is Chris K-S. I write about web2 and web3 virtual economies and analysis. I got my PhD in Economics from Purdue University where I studied labor economics and, eventually, virtual economies under Edward Castronova. I’m the Head of Game Economics at Star Atlas. I’m also a co-chair for the IDGA Game Economics SIG as well as the co-host of the Game Economist Cast with Phillip Black and Eric Guan. Please visit my website or reach out to me on LinkedIn, Twitter, or my email if you want to connect.
You’ll notice there are now two versions. Fingers crossed.
This FRED article seems as good as any: Durability, Portability, Divisibility, Uniformity, Scarcity, and Acceptability all make for good money.
I don’t want to imply that I don’t think that blockchain tech provides probably the best currency in the world. It does. But I’m not convinced that native crypto tokens like ETH, BTC, and SOL are the best options. A stable coin like USDC is better served as a currency.
If native crypto currencies are the commodities then NFTs are the capital. Someone should probably look into that.