People use cryptocurrencies for investment, crypto gambling, and making profits. The Greater Fool Theory increases many cryptocurrencies’ market value, but it is not true for all crypto.
Many holders of bitcoin use the currency to join the best crypto casino. This increases the demand for BTC and indirectly increases its market value.
There are many cryptocurrencies on the market today. Some offer products like application development and faster international transactions, while others do not have a product, and their only purpose is for trading.
Let us look at what value cryptocurrencies hold and whether the Greater Fool Theory is true for all cryptocurrencies.
What Is The Greater Fool Theory?
The Greater Fool Theory (GFT) dictates that an investor can purchase an overvalued stock or security and easily sell it again and make a profit because there will always be a greater fool who buys that stock.
The logic implies that novice investors do not do enough research when buying assets, so they only buy trending securities or cryptocurrencies. Also, they do not consider an asset’s intrinsic value or utility. Utility refers to how the asset can be used as a product or service.
For many people, bitcoin is a good example of this. It is the entry point for any investor to join crypto trading and many traders purchase Bitcoin because of its price and not its intrinsic value. Additionally, bitcoin has extremely limited utility compared to other assets.
What Is Intrinsic Value?
Financial analysts use different methods to determine an asset’s intrinsic value. Intrinsic value is the objective value of an asset. This means it is separate from its market price or other external factors.
Analysts use Dividend Discount Models, Residual Income Models, and Discounted Cash Flow Models. They use these methods to determine an asset’s intrinsic value to compare it to its market value. The difference between the two indicates if an asset is undervalued or overvalued.
BTC’s only intrinsic value lies in its use of blockchain technology. Blockchain has many uses for finance and beyond, but Bitcoin is exclusively used as a currency. It is purely digital and not backed by a reserve asset, so its value comes from its finite supply (21 million BTC) and increasing demand from investors looking to profit from the market price. But mining for Bitcoin is expensive, and other currencies like the US Dollar and Ethereum have more utility.
Is Bitcoin Valuable?
Advocates of the Greater Fool Theory state that Bitcoin derives its value from being overvalued by the market. This implies that Bitcoin has no intrinsic value, and the only reason investors purchase it is because they can make a quick profit from selling on the market at a higher price.
This might be true to an extent. Investors and traders who only see it as a quick money-making tool satisfy the tenets of the Greater Fool Theory. Their investment strategy relies on increasing demand for BTC. Therefore, they do not take other factors into account.
These factors include future demand and current value, the nature of intrinsic value, and the goal of selling the cryptocurrency at a higher price.
Future Demand And Current Value
Bitcoin is still a young asset. Its utility needs to be realised by much of the world. Many countries have begun using blockchain in their institutions, but it is still far from becoming a standard. That is why bitcoin has the potential to be in demand in the future, and its value will increase with that demand.
To illustrate, bitcoin has a finite supply. It is digital, so it does not degrade over time, and it does not take up any physical space. As demand increases in the future, the supply will remain the same and increase the crypto’s market value as a result. Furthermore, currency holders can store their assets in a wallet in perpetuity.
Early adopters of BTC believe that cryptocurrency will eliminate the need for lengthy transaction verifications and transaction fees. Because transactions are verified on the blockchain, there is no need for third-party verification. This would revolutionise every aspect of finance.
Hence, following the idea that bitcoin will have more utility as more institutions adopt its decentralised ledger, investors are purchasing a limited supply asset that will be valuable and indispensable in the future. They see how it will shape much of the financial world in the coming years.
The Problem With Selling To A Greater Fool
The Greater Fool Theory dictates that an investor’s main motivation for buying an asset is to sell it at a higher price without considering its intrinsic value.
The problem with this tenet is that investors expect their assets to appreciate. Whether they are investing in oil, gold, or other commodities, there is an expectation that they will gain profits from their investment.
Investment is pro-profit, so the GFT’s first tenet applies to all investments. No investor purchases stocks or cryptocurrency to make a loss. Whether they hold on to their assets or immediately sell them does not matter.
The Nature Of Intrinsic Value
Financial analysts determine an asset’s intrinsic value by using various methods. They look at financial statements, market analyses, and business plans. These analysts use agreed-upon metrics to determine values and cannot view the asset objectively. Because intrinsic value is determined through a process run by individuals, it cannot be considered “intrinsic.”
For example, a piece of land might be worth 20 million dollars in 2020 because it is in a big city with high growth potential. That same piece in 1846 would have much less because it held no value to purchasers. This is not the same as the property’s market value because the only factor is the utility and current environment of the property. It means that subjective and changing factors determine an asset’s intrinsic value.
Hence, intrinsic value cannot be defined using objectivity. There are always other factors in play when determining the value of an asset. So the GFT cannot refer to intrinsic value as one of its tenets because of its subjectivity.
Initial Coin Offerings And Centralised Exchanges
Crypto exchanges launch their coins for trading. These exchanges are centralised because it determines the supply of coins released on their platform. These centralised exchanges hold onto users’ assets and charge them to buy or sell on the platform.
This means they can add or burn coins according to their needs. And because these exchanges control the supply of the coin, it also controls its market value.
Moreover, many centralised exchanges only launch coins for trading. This means it has no other utility. Other exchanges also pre-mine their coins, meaning there are very few nodes on the blockchain outside those who run the exchange.
Ultimately, the GFT rings true here. The cryptocurrencies on these exchanges can only be bought and sold, and their value lies in selling at a higher price in the future.
Companies launch initial coin offerings (ICOs) to distribute their cryptocurrency to as many people as possible. Ideally, these would include developers, investors, and traders who use the crypto to increase its utility and market value.
On the other hand, other companies launch ICOs without an actual product. This means they create tokens that only increase the company’s wealth. The promise of higher returns on token or coin purchases is the only factor driving the ICO. It is similar to a pyramid scheme where the company is at the top, token holders are in the middle, and the greater fools are at the bottom.
What About Other Cryptocurrencies?
Bitcoin, Ethereum, Litecoin, Bitcoin Cash, and other popular cryptocurrencies are decentralised and have varying degrees of utility.
Bitcoin mining is a lengthy process that requires a miner to use expensive hardware and a lot of electricity. It has a finite supply and can be used to purchase goods and services. And because mining is so difficult, it compels adopters to invest in the currency for the long term.
Ether is a currency within the Ethereum blockchain, so the coin has many purposes. Furthermore, Ethereum’s blockchain employs smart contracts for development. So, its utility is quite high.
To summarise, ICOs, and centralised exchanges that do not offer a product fall into the definition of GFT.
Bitcoin and Ethereum have the potential for future demand from their novel use of blockchain technology. Furthermore, Bitcoin has a limited supply, so its market value will only increase.
But ICOs and centralised exchanges without products or services conform to the Greater Fool Theory. Their growth comes from the hope that the cryptocurrency can be sold at a higher price to a greater fool.
In the end, the Greater Fool Theory applies to ICOs and exchanges without any other purpose than making a profit from trading.