Why Bitcoin Apps and Bitcoin Speculators Need Each Other

Adam Ludwin co-founded Chain.com, a bitcoin developer platform. Prior to Chain, Adam was a venture investor in companies including Vine, Slack, Kik and Paperless Post. He holds a B.S. from UC Berkeley and an MBA from Harvard.

Here’s one way of looking at the bitcoin market:

• Miners mint new bitcoins
• Speculators buy/sell them
• The price of bitcoin is affected
• Miners with a marginal cost lower than the price of bitcoin keep mining

Here’s a visual representation of that story:

But is this the complete picture?

After all, new bitcoins aren’t the only thing that miners create.

Their competition with one another to mine the next block (and receive the current reward of 25 freshly minted bitcoins for doing so) also produces, by design, a secure financial network: one which is open, decentralized, programmable, and very inexpensive to use. The beekeeper gets honey, and the rest of us get flowers.

So here’s the other half of the story which completes the picture:

• Miners create a secure network
• Because it is open and programmable, apps and services are built on this network, driving demand for bitcoin
• The price of bitcoin is affected
• Miners with a marginal cost lower than the price of bitcoin keep mining

Here’s how it looks together:

What can we learn from looking at the system as a whole?

• Without speculators, there would be no bitcoin. They provide miners, applications, and other participants with liquidity. If you have bought or sold bitcoin as a speculator, you have helped enable the emerging ecosystem of bitcoin apps. While speculative bubbles will swell and pop from time to time (see: 2013-2014), this does not change the underlying value of the network or the possibilities for the protocol.
• Bitcoin-enabled apps and services are the main driver of underlying demand for bitcoin, and as a result, the main driver of the price of bitcoin, since the supply of bitcoin is fixed. But it will take time to see the effect. It is much faster and easier to place a buy/sell order than it is to build a bitcoin-enabled service. Still, 2014 saw the emergence of the first wave of these apps, enabled in large part by services like Chain, which significantly reduce the cycle time for building them. As these services grow, and more services come online, the price of bitcoin will steadily rise.
• But what about price volatility? Whether volatility increases or decreases, one thing is likely to be true: it won’t matter as much going forward as people think. Why is that? Because bitcoin apps will increasingly hedge their users’ exposure to price volatility, thanks again to the speculators, who want leveraged exposure to bitcoin. In other words, the only people that will experience bitcoin volatility will be those who choose to. This is no different than any other financial market comprised of hedgers and speculators, except for the important fact that it is likely even easier, cheaper, and more efficient to hedge using the block chain and smart contracts than it is in other markets.

tl;dr: Miner’s main output is a secure network, apps will be the main driver of bitcoin’s price, speculators are healthy, and volatility should not be feared.

Disclaimer: The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to, CoinDesk.

This article previously appeared on the Chain blog.

Speculation image via Shutterstock