Bitcoin’s Growth Can Be Tracked Like a Social Network

Bitcoin has changed the way millions of people around the world think about money, and many have written about the idea that bitcoin can work as money as long as there is a sort of belief or shared hallucination around the use of the digital asset — sort of how Tinkerbell only exists in the world of Peter Pan if people believe in her.

The relative success of Bitcoin in a digital age has also led people to create analogies between the peer-to-peer digital cash system and social networks. If Bitcoin were a social network, one could say that holding some bitcoin would be the equivalent of having an account on the social media platform, while opening a Lightning Network channel with someone may eventually be the equivalent of “friending” them.

Using the analogy of a social network, the growth of Bitcoin as a store of value and medium of exchange can be tracked more easily and perhaps better understood.

Joining the Bitcoin Social Network

If Bitcoin is viewed as a social network, acquiring some bitcoin is the equivalent of signing up for a new account. Once you have some bitcoin — or even just a Bitcoin address — you are able to interact with this social network by sending and receiving the underlying cryptocurrency used in the system.

In this sense, the bitcoins themselves are similar to likes or upvotes with a built-in mechanism for scarcity; they’ll increase in value as the network itself becomes more popular.

In terms of raw numbers, it’s difficult to track how many Bitcoin network “accounts” exist today because one person can own bitcoin in many different addresses and custodial services, such as exchanges, can hold bitcoin on behalf of millions of users.

According to FundStrat co-founder Tom Lee, one way to measure user growth is through the combination of unique Bitcoin addresses with the average USD-denomination transaction volume per address. Lee has said this method of tracking user growth has shown 94% correlation with the bitcoin price over the past four years.

Additionally, storing value on the Bitcoin network improves the overall security of the system. After all, as the bitcoin price goes up, more computing power is pointed at the network in an attempt to collect block rewards. This means a nefarious actor must purchase or build more computing power to attack the network as the price increases.

A Medium of Exchange Between Friends

If two people are on the same network in terms of choosing a specific asset as a store of value, then they can also transact in that asset because both individuals are fine with storing value in it. For this reason, it is more likely that bitcoin’s use as a medium of exchange will increase as more people do not see an issue with holding some of it as a store of value.

There are a few different issues involved with only using bitcoin as a medium of exchange and instantly converting it into other assets.

For one, exchange fees will add extra costs to using bitcoin as nothing more than a medium of exchange.

Secondly, those who would prefer to store some other asset will be subject to possibly-volatile price swings during the window in which the user is waiting for one or more confirmations on the blockchain. Bitcoin users are generally unwilling to accept some bitcoin without at least one confirmation in situations where some other irreversible asset, such as cash, is being traded for it.

According to applied cryptography consultant and sometimes Bitcoin Core contributor Peter Todd, bitcoin ATM operators have been defrauded by those who took advantage of the acceptance of unconfirmed Bitcoin transactions.

Bitcoin’s Lightning Network and other layer-two protocols have the potential to improve the use of bitcoin as a medium of exchange for those who do not wish to hold the asset as a store of value. Transactions on the Lightning Network are effectively confirmed instantly, which means users will be exposed to the volatility of an asset they do not wish to hold for a shorter period of time.

Going back to the social network analogy, creating a Lightning channel between two users could be seen as similar to friending someone on Facebook or following each other on Twitter. It intends to allow for much cheaper and faster transactions for those who are connected. However, those who are not “friends” on the network can still transact with each other directly on the blockchain.

Even with the Lightning Network, users who are mainly focused on bitcoin as a medium of exchange will face extra fees for exchanging between currencies and be forced to go through a registration process for said exchange.

The relative lack of liquidity on different exchanges around the world has also led to widely different prices on different exchanges. This is another issue that could be counteracted by more value being stored in the network by a diverse set of users.

For these reasons, it makes more sense for bitcoin to become a store of value before a medium of exchange, as Xapo CEO Wences Casares explained at the Chicago Gold Ideas conference in 2015. One could argue that bitcoin’s usefulness as a store of value was reinforced by the failure of the SegWit2x hard fork attempt.

Unit of Account

Finally, bitcoin could potentially be used as a unit of account if enough users join the network and price volatility at least calms down to the levels seen in gold or silver. Bitcoin will have to reach some sort of stable price level — avoiding big moves to the upside or downside — before it can be used as a unit of account because no one wants to price goods and services (or loans for that matter) in an asset that can go up or down by double-digit percentage points in a single day.

While many people transact on the Bitcoin network today, those transactions that involve real-world commerce are almost always denominated in U.S. dollars or some other fiat currency because these government-backed currencies are much more stable over the short term.

If bitcoin were to become a unit of account, the digital asset would have reached the level of notoriety of a Facebook or a Twitter. Telling someone about a bitcoin-denominated payment would be as commonplace as telling someone about a tweet.

Article written by: Kyle Torpey