On Bitcoin, Value and Wise Crowds

Disclaimer: Though I have some formal education in financial matters, any opinions expressed below are not in any way financial advice and should not be taken as such. Do your due diligence, study for yourselves and most of all, ask the advice of a certified financial adviser. You have been warned! That being said, let’s dig in.

When discussing bitcoin, some people make the argument that it is not money and can’t be used as such because it does not have intrinsic value, like, say, the US dollar. That statement is not correct, but not because bitcoin is worth something just in itself, but because the dollar isn’t either. Like the currency of most nations, the dollar is fiat money, 1) unbacked by any physical asset. The US stopped redeeming dollars for gold in the 1960s 2). So what gives the dollar – or the bitcoin – value? Is bitcoin a form of money or something else? For that we need to talk a bit about value.


What is value? The notion itself seems to be difficult to define. One man’s trash is another’s treasure, as the saying goes. Different people ‘’value’’ things differently. People have ‘’values’’ – principles and things they hold dear, that might differ from other peoples’.

In the past, economists like Karl Marx used to believe that the value of a good was determined by the amount of work that its creators put into it, and thus objective. These are proponents of the intrinsic theory of value, believing that price should follow the amount of effort, the intrinsic qualities of the underlying object or service but as the world has shown time and time again that this is not always so.

Today the consensus seems to be that value is perceived and thus subjective. One definition of value is “the importance, worth, or usefulness of something”, or „the material or monetary worth of something” or „the worth of something compared to the price asked for it” 3) The current way of thought about value is that it is relative to both the buyer and the seller. The number they agree on when deciding to make the transaction is the current value of the object or service disputed, if and only if they both are willing (as in not coerced) to buy or sell, and both are informed (meaning they both know what they are transacting, no hidden flaws, etc). This means that value is impermanent and subjective – it changes with both time and people, as something can be of great value to somebody who needs it, and of no value to somebody who already has enough, and most of the time perspective is everything.

But how is value generated? Is it strictly an objective thing, or subjective only or both? Surely, the supply and demand have a great influence on value. People will always pay more for something they think they need if there’s fewer of it around. Also, difficulty in obtaining said good (which might make it scarce) is important as well. If the good is made only as a result of a long and expensive technical process, or by searching around for a long time for it (think refining for rare ores) then surely it has to be expensive as well? Though diamonds are not really rare at all, as they are routinely manufactured on an industrial scale, but they are still perceived as desirable. It is true their supply is limited by choice by the biggest players in the market, but the apparent difficulty in obtaining one isn’t the reason prices are high - it’s people’s perception of them that drives the price.

Surely some things are expensive just because they’re hard to find or manufacture. Among the shortlist of most expensive substances by weight, near the top will be a mauve-colored gem that’s a million times more scarce than diamonds, plutonium, which has to be refined in an expensive process and antimatter, which at $62 trillion per gram is the most expensive substance there is (it owes that first place to the extraordinary difficulty of production) 4).

However, on that same list there are some substances that are not nearly hard enough to find to justify the high price. Drugs, for one, are up there, as well as diamonds and gold which are anything but scarce. They have a lot of value because people say they do and they will shell out hard earned cash to get them. So bottom line has to be that at this point in time, most things have value because people say so - and that value changes over time and with preference. Usually, said value is a lot higher than might be pragmatically accepted as reasonable - note this painting that was recently sold at auction for $43 million - but as long as there is someone who can pay the amount asked by the buyer, that value is very real. This means that for value to exist, a buyer and a seller must exist as well, and they (should) be well informed. Thus value can be decided. Of course other factors apply - scarcity of the good or service, importance to both, quantity available and so on, but for those reasons to be important, someone must exist to consider them. Thus the needs for markets where valuation can occur.

The advent of modern communication and the availability of the Internet have made this process faster and scaled it by a million. Nowadays, people can trade goods and securities from the comfort of their couches and they are informed in near real time about the changes in price and quantity. At the end of this spectrum are the players who engage in High Frequency Trading - organizations who need latency and round trip times to be as low as possible in order to have the information milliseconds before everybody else. (As a side note, they usually employ dedicated equipment right in the telecommunications providers’ datacenters, on high bandwidth and very short connections , to have as low a trip time between the network and their servers as possible. )

This provides us with a very interesting opportunity: it is possible to have a lot of people value the same goods in near real time, on a massive scale. This should, in theory, be a good way to decide what the “real” value of said goods is, and should be a good way to average out the prices, making arbitrage less lucrative and converging into something stable and more resilient to attempts to manipulate the market. This massive scale combined with the near instant communication, however, does have some major drawbacks, as we will discover shortly.

The importance of crowds

Perception is a powerful thing, and it makes the world go round. Not money, that’s just a tool to use to get what is perceived as worthy. As people will never have perfect information about their environments, they have to rely on judgment based on what they do know, which is incomplete. We as a species have needed to make decisions regarding the future without knowing all the facts beforehand. Reasoning, logic, projecting from past experience, all of these come into play when trying to predict a future situation and it helps immensely - but it is not perfect. We even have evolved to quickly assign worth based on subtle cues – as anyone who studies how attraction between people works must know.

It is the same with objects and ideas – for various reasons, we perceive some as valuable, and some as not so much, and we frequently rely on other people to validate said judgment. This works because for the most part, when information is incomplete, aggregation of information within the group makes the group reach a better decision than could have been made by any single individual. Surowieki’s example, in his Wisdom of Crowds 5), is that when people in a group were asked to give an estimate regarding an animal’s weight at a county fair, although the individual guesses naturally varied, the average was closer to the ox’s true weight than even the experts’ estimates. Extrapolating this, on as grand a scale as the Internet can provide, the process should yield impressive results and correct evaluation of factors that pertain to the value of a security or fund - unfortunately though that doesn’t always happen.

However, Surowieki notes that not all crowds are wise and considers as examples mobs or crazed investors in a stock market bubble. He also studies cases where the crowd produced very bad judgment and tracks the failure to being too connected - as members of the crowd were very aware of the opinions of others and begun to conform and emulate each other instead of thinking outside the box. Indeed, one of the four criteria Surowieki notes that separate wise crowds from irrational ones is Independence - people’s opinions shouldn’t be swayed by the opinions of those around them. Oinas-Kukkonen, based on Surowieki’s book, determins that among other things too much communication can make the group less wise as a whole. 6)

The Bitcoin Community

This is nowhere more apparent than with Bitcoin. It is a fast network, that runs 24/7, and markets also run around the clock. The confirmations are quick, the APIs usually allow one interrogation per second which is slow compared to High Frequency Trading standards, but fast enough that information is always up-to-date and available instantly. All the blocks are in place to have a decentralized mass of independent, informed people make value judgments quickly. While regular businesses work regular hours, and news outlets disburse information on schedules (as newspapers and older forms of media refresh their information a few times a day at the most), the Bitcoin network and its supporting forums are live all day, every day. The abundance of information and availability of members make for a good premise for a well informed market. The crowd should be “wise”, but is it?

Surowieki studies some scenarios where crowds produce very bad judgment and quantifies some factors that might increase the likelihood of failure. 7) Some factors for failure like Centralization might not pertain to the Bitcoin network; most others do. Some of them are Homogeneity, Imitation and Emotionality.

Homogeneity is rather easy to detail: most adopters of Bitcoin are technically inclined people, keen to discover new technologies. They see intrinsic value to the new technology and stand by it, want it to succeed. Variance is needed in thought process, approach and private information, but if everyone wants the same and takes the information from the same sources (a couple of forums and the same news outlets as everyone else) then the diversity needed for a wise crowd, as Surowieki defines it, is not attained.

Imitation is no more difficult to explain. People should make decisions based on their own interpretation of events and facts, even if the news source is the same as other people’s. However, a lot of people decide to follow the first members of a community to express their opinions in regard to Bitcoin and new bitcoin-related ventures - either believe it is a scam, or believe it has potential and go for it, as the first few do. The forums are ripe with scams, which does raise the level of paranoia, and lack in real, verifiable information most of the times, which makes imitation a good enough strategy. Somebody thinks this is worthwhile, so it must be! Or, look, somebody else thinks it’s a scam, let’s stay away. The opinions differ at first but for lack of independent confirmation opinions tend to converge after a while.

This is also in part described by the third factor in the failure of the wisdom of crowds - emotionality. The fast-paced Bitcoin network moves a lot of money and has seen people become rich overnight, and people will always be emotional about money. Peer pressure, herd instinct and sometimes collective hysteria can explain why seemingly neutral (though admittedly foreboding) statements in the press can trigger sell-offs - like the information that some countries will look more closely at Bitcoin, which is a healthy and normal process when confronted with a new technology. Bad news, such as all out banning of bitcoin by some states has triggered even worse reactions, taking down the bitcoin value from its all time high of $1200 to $440 - a 60% decrease. This volatility is extremely emotional in nature and shows the community is extremely sensitive to bad news which, foreboding as they might seem, have not as big as impact as people might think since bitcoin remains the oldest and leading virtual currency in use in real businesses across the world despite the information that some parts of the world refuse to accept it as of yet. This is a dismal sign for the community as a group, as emotionality is a good indicator that the group isn’t wise, and its decisions might not be the best when it comes to deciding a good price for bitcoin.

Thus we find that for all the information flow, and the online forums and the global character of the technology, the Bitcoin crowd does not accumulate the characteristics of a group whose decision making when it comes to valuation is better than the decisions each member could make on their own. Lacking in Independence and Diversity, ranking high in Emotionality as money matters tend to be, the community’s valuation of various cryptocurrencies can be flawed at times and should not always be considered a good trend to follow. Each participant is advised to think for themselves, try to verify the information and its sources and keep their cool as much as possible. Belief in the community is good, but the collective might not be smarter than a person as it does not fulfill the requirements set forth by Surowieki and Oinas-Kukkonen for a “wise” crowd. Sometimes an action contrary to popular opinion is required if one desires to make a profit, lest one is caught in the bubble and the hunt for the greater fool; other times, when the market is decidedly bearish, the right action might be to buy - because some bad news from somewhere in the world do not nullify the effort and the money already spent on making the Bitcoin network useful with all the miners and the investments and large datacenters dedicated to keeping this dream alive.

Finance | Bitcoin

Surowiecki, James (2005). The Wisdom of Crowds. Anchor Books. pp. xv. ISBN 0-385-72170-6.
Oinas-Kukkonen, Harri (2008). Network analysis and crowds of people as sources of new organisational knowledge. In: A. Koohang et al. (Eds): Knowledge Management: Theoretical Foundation. Informing Science Press, Santa Rosa, CA, US, pp. 173-189.

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