Understanding Opportunity Cost and Bitcoin
Updated: Dec 27, 2020
In life, you make choices. For nearly every choice you make, there are both positives and negatives to each alternative as well as unknowns that are potential positives or negatives.
Consider for example that you are offered a new job in another country. You may choose to take the job, or you may choose to stay in your current position. The new job may have a better salary and more interesting responsibilities. But it also may be difficult for you to adjust to a new culture and you may be leaving a position where you’re well-respected to enter one where you’re a stranger to all of your new colleagues. Staying at your old job, you may get to use your respect and seniority in the company to move up to a higher position or maintain a high quality of life with a job where you feel valued and comfortable. Either choice that you make is going to mean that you miss out on the potential advantages of the other choice. This is what is meant by opportunity cost.
A much simpler example is the decision to purchase an apple. If you do purchase the apple, your opportunity cost is the loss of the ability to use that money for something else. If you don’t purchase it, your opportunity cost is not having an apple.
Opportunity costs exist for every possibility whether you’re aware of them or not. Maybe if you’d gone out to dinner last night instead of eating at home, you would have met a rich eccentric old man at the restaurant who would write you in to his will for taking the time to talk to him. It’s extraordinarily unlikely, but not impossible. Since you – definitionally – can’t plan for the unknown, it’s not worth worrying about these opportunity costs, but it is worth keeping them in mind when it comes to the value of knowledge. The more you know, the less unknowns there are, and therefore the less opportunities you may miss.
Bitcoin vs the Dollar
Bitcoin’s opportunity cost is actually of a relatively simple financial kind, because Bitcoin is a financial tool (specifically: money). If you exchange dollars (or euro, or pounds, or yen, etc) for Bitcoin, your opportunity cost is the purchasing power of the dollars. If you exchange Bitcoin for dollars, your opportunity cost is the purchasing power of the Bitcoin. Equally, if you choose not to exchange dollars for Bitcoin, your opportunity cost is the purchasing power of the Bitcoin and if you choose not to exchange Bitcoin for dollars, your opportunity cost is the purchasing power of the dollars.
As already described, not knowing about an opportunity cost doesn’t somehow mean that it’s not there, you simply didn’t know about it. Therefore, not knowing about Bitcoin doesn’t remove these opportunity costs.
Another way to phrase these opportunity costs would be as a gamble. Storing your wealth in or moving your wealth from dollars to Bitcoin is essentially equivalent to betting that Bitcoin’s value will appreciate against the dollar. Storing your wealth in or moving your wealth from Bitcoin to dollars is essentially equivalent to betting that the dollar’s value will appreciate against Bitcoin.
The timeframe for this bet is undefined. People who perform any kind of frequent trading between dollars and Bitcoin are making this bet over short terms. Essentially, gambling on the exchange rate fluctuations in order to increase their overall wealth (whether they store it in Bitcoin or dollars at some “end” point is then a matter of their long-term perspective).
On the other hand, there are people who don’t trade frequently or at all. These people are making a long-term bet on the relative values of the currencies.
Here’s some salient facts we can give that are likely to be considerations for these bets:
Like any asset, supply and demand are the largest contributors to a currency’s value. If you print more money, it becomes worth less. This is clear and obvious throughout history, both in terms of hyperinflation as well as normal planned inflation.
Fiat currencies like the dollar are generally designed with continuous “controlled inflation” in mind. A part of this requires that there is continuous money printing, devaluing the currency (the intention is to “encourage spending” which “stimulates the economy”; this is a fallacy, but I won’t address it in this article).
Bitcoin has a fixed supply of just under 2.1 quadrillion satoshi (21 million BTC). This will never change although it is possible for some to be “lost” or otherwise rendered “unspendable”.
Bitcoin has significant short-term volatility against the dollar but has a clear long-term strong upwards trend. This trend is supported by multiple financial models including stock to flow modelling that clearly shows a relationship between the availability of Bitcoin and the dollar value.
The opportunity cost of spending Bitcoin
This leads to the obvious conclusion that Bitcoin is a good long-term bet. The opportunity cost of holding dollars is simply too high given the long-term outlook.
So why would anyone want to spend it? If I spend 10000 satoshi on a cup of coffee today, maybe I could have spent those sats on a new computer in the future! Now that we understand the opportunity cost of spending Bitcoin given its upwards trend, we’d be crazy to spend it. Surely, I should spend my dollars instead?
Yes, you should… if you have them. But the question is framed incorrectly. It assumes that you have both dollars and Bitcoin available to spend. If this is the case, you’re now in a situation where you can spend 10000sats worth of dollars on a cup of coffee or could exchange those dollars for sats that you save in order to buy the new computer in the future.
That is to say: the opportunity cost of spending dollars on goods and services instead of exchanging them for Bitcoin is identical to the opportunity cost of spending Bitcoin on goods and services. As long as it’s possible to freely exchange between the two currencies, the opportunity cost exists.
If you choose to hold dollars as well as Bitcoin; spending the dollars first makes sense. If you choose to only hold Bitcoin and no dollars, spending it is no different than spending the dollars you would’ve spent if you had them.
The opportunity cost of spending dollars (?!)
A naïve conclusion for this analysis would be that I simply shouldn’t buy anything at all anymore. I should exchange all of my money for Bitcoin and live as frugally as possible so that my savings are worth more in the future. I say it’s naïve because it assumes the only goal for a human life is the acquisition of wealth rather than the enjoyment of life that one can use that wealth for. Perhaps drinking a cup of coffee today, chatting with good friends and enjoying their company in the comfort of a cosy café really is worth more than a new computer at some undefined point in the future. To me at least, it often is.
Therefore, the more nuanced version of the conclusion is that I should be more mindful of my spending. I don’t spend money that I really don’t see as enriching my life (or by proxy as I enrich the lives of those I care about). I do spend my money on luxuries, but I don’t waste it. What I don’t spend, I get to save – in Bitcoin – so that my savings can grow over time and bring more joy to myself and my loved ones in the future.