To Understand Bitcoin’s “Intrinsic” Value, Look No Further Than Diamonds

To Understand Bitcoin’s “Intrinsic” Value, Look No Further Than Diamonds

Editor’s note: Vin Narayanan here, stepping in for a vacationing Andy Gordon. Over the next few weeks, you’re going to be hearing more from me as Andy and Adam Sharp take some well-deserved time off. But that doesn’t mean you have to do without them while they’re at the beach! At a conference in Las Vegas earlier this year, Adam spoke to investors about cryptocurrencies. You’re not going to want to miss what he had to say!

You can watch them – and all of the other presentations – in The 2018 Millionaire Blueprint. Click here now to get it.

Dear First Stage Investor,

Mark Twain has been famously misquoted as saying “reports of my death have been greatly exaggerated.”

“The report of my death was an exaggeration,” is what he actually said.

If bitcoin could talk, it would agree with either statement. When bitcoin briefly dipped below $6,000 last weekend, the “I told you so” army was out in force. Here’s a sample (and remember, this is just a sample):

As you know, bitcoin didn’t die last weekend. In fact, it bounced back to the $6,000 mark within 24 hours and is currently trading at around $6,639, according to CoinMarketCap.

So why were so many people moving so quickly to declare bitcoin’s demise? And why do bitcoin’s critics seem to be enjoying the 2018 market correction?

I actually don’t think they’re driven by bitterness or schadenfreude. It’s something more visceral. For some people, bitcoin has no value because it’s not physical. It’s not tangible. It’s just ones and zeros on a computer. And if it’s not physical and tangible, it cannot – by definition – have (monetary) value or worth.

But this point of view fundamentally ignores what gives things like gold, silver – and yes, bitcoin – value. And that’s consensus and scarcity. Gold and silver are valuable because a long time ago, societies decided they were valuable. And desirable. And something people wanted to own. Gold and silver didn’t emerge from the ground with those attributes. People imbued these “precious” metals with those attributes.

If you want to see this process in action, consider the fairly recent (in historical terms) popularity of diamonds.

The average cost of an engagement ring in the United States is $6,351, according to a survey by The Knot. In 2011, the average cost was $5,095. The average carat size for the center diamond is 1.2 carats and the average carat size for the entire ring is 1.8 carats.

But it wasn’t always like this. Expensive diamond rings were not always a thing. In fact, it took some serious market manipulation for this to become an economic and cultural phenomenon.

The Atlantic does a great job tracing the diamond’s journey from irrelevance to the heights it sits at today. But I’ll summarize it for you. Let’s start on the supply side of the equation.

In the late 1800s, diamonds from new mines in South Africa flooded the market, effectively cratering prices. The diamond industry realized the only way to inflate diamond prices was to create a fictitious story – that diamonds were scarce and therefore inherently valuable. It did this by creating a cartel (De Beers) that controlled virtually every aspect of the diamond industry, including a restriction of supply.

After De Beers choked off supply, it turned to the demand side. In the beginning of the 20th century, diamond engagement rings weren’t common. And the ones that were given used cheap stones. Diamonds were considered a luxury for only the super wealthy. De Beers needed a way to goose demand. Otherwise, its diamonds had little “real” value.

So it hired N.W. Ayer, a New York ad agency, to make diamonds desirable. From The Atlantic:

Meanwhile, the price of diamonds was falling around the world. The folks at Ayer set out to persuade young men that diamonds (and only diamonds) were synonymous with romance, and that the measure of a man’s love (and even his personal and professional success) was directly proportional to the size and quality of the diamond he purchased. Young women, in turn, had to be convinced that courtship concluded, invariably, in a diamond.

What Ayer did next was nothing short of genius (and was possibly the world’s first Instagram campaign).

It used the movies and Hollywood stars to promote the idea that diamonds symbolized love – that they were the true representation of a love that lasts forever. Ayer would get stories and photos into the society pages and gossip columns that linked romance and diamonds. It got fashion designers to talk up the “trend toward diamonds” on radio shows. It gave talks at high schools about the importance of diamond engagement rings. And it came up with the slogan “A Diamond is Forever.”

It was a giant influencing campaign – and it worked. And the campaign didn’t just drive demand. It helped regulate the diamond market. Once again, from The Atlantic:

A diamond that’s forever promises endless romance and companionship. But a forever diamond is also one that’s not resold. Resold diamonds… cause fluctuations in diamond prices, which undermine public confidence in the intrinsic value of diamonds. Diamonds that are stowed away in safe-deposit boxes, or bequeathed to grandchildren, don’t.

In 1939, De Beers’ wholesale diamond business in the U.S. was worth $23 million. It’s now worth $2.1 billion. That’s not because diamonds are “intrinsically valuable.” It’s because society decided they were intrinsically valuable (with an assist from De Beers).

Just like gold, silver and diamonds, bitcoin’s value comes from consensus. People see the utility and the power of technology and agree that bitcoin has value, so it’s valuable. And unlike diamonds, bitcoin didn’t need a big New York ad agency to convince people of this. Its growth has been completely organic.

Critics that scream bitcoin has no intrinsic value need a history lesson. And if you’re so inclined, now you can give them one.

Good investing,

Vin Narayanan

Senior Managing Editor, First Stage Investor

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