Bitcoin (BTC 0.37%) is, by far, the world’s most valuable cryptocurrency, currently accounting for more than 55% of the total market capitalization of the entire crypto market. For individual and institutional investors, Bitcoin is typically the first cryptocurrency added to a portfolio, and for good reason. Between 2011 and 2021, Bitcoin was the best-performing asset in the world — it wasn’t even close.
Judging by that type of market-beating performance, you might assume Bitcoin shares a characteristic of all top-performing companies: an economic moat. In the investment world, an economic moat describes a sustainable competitive advantage that allows a company to outperform its rivals for long periods. The problem is that Bitcoin’s economic moat appears to be eroding, not widening.
Different types of economic moats
According to investors such as Warren Buffett, there are several types of economic moats, and each acts as a source of long-term competitive advantage. The most common moats are those provided by intangible assets, such as a popular brand. The stronger the brand, the more it encourages customer loyalty and enables a company to charge premium prices for its products. Companies in this category include Nike and Starbucks.
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Another common type of economic moat is created by network effects. Basically, the more people who use a product or service, the more valuable it becomes to every member of the network. These are most commonly found in the tech industry and include social networks and telecom networks. Think of your favorite social network: Every time a new friend, colleague, or family member joins, it becomes more valuable to you.
Other types of economic moats include high switching costs (it’s just too costly or cumbersome to make the switch to a competitor), low cost structures, and economies of scale that make it impossible for a new competitor to enter the marketplace. As a general rule of thumb, the wider the economic moat, the more valuable a company becomes.
Does Bitcoin have an economic moat?
Based on the above, just about the only economic moat Bitcoin might have is a recognizable brand. If you ask anyone in the world to name a cryptocurrency, it’s a near certainty they will name Bitcoin. It has been the market leader since its creation in 2009, and the original Bitcoin white paper is arguably one of the most influential pieces of intellectual property that has ever been created (similar to the original formula for Coca-Cola).
However, plenty of high-profile investors consider Bitcoin worthless. For them, Bitcoin is synonymous with financial speculation and black market intrigue. Warren Buffett has famously said he wouldn’t pay $25 to own all the Bitcoin in the world. His colleague Charlie Munger has called it worthless “rat poison.” So, before you start saying Bitcoin’s brand is a source of competitive advantage, keep this in mind.
Moreover, consider switching costs. There are plenty of other options you can use for payments beyond just Bitcoin (including other cryptocurrencies). So, if your favorite e-commerce shop no longer accepts Bitcoin, there’s not a lot of pain to switch. At the same time, enterprises are not using Bitcoin to replace pieces of their corporate infrastructure, so there’s no risk of them having to rip up their whole IT infrastructure if they have to migrate to another blockchain.
And things become far dicier still when you think about cost structures. Bitcoin is a proof-of-work blockchain that requires energy-intensive mining. The newest blockchains are proof-of-stake and are generally acknowledged to be 99.99% more energy efficient. This makes them faster, cheaper to use, and more efficient. Bitcoin can still process only a handful of transactions per second compared to hundreds and even thousands of transactions per second for other blockchains.
Can you analyze cryptocurrencies like companies?
Of course, I’ll admit that applying economic moat analysis to a cryptocurrency such as Bitcoin may be unfair. After all, cryptocurrencies are not companies. And they are completely decentralized, meaning no CEO or corporate headquarters is making all the decisions.
However, I do think economic moat analysis is one way of sorting through the literally thousands of cryptocurrencies that exist today. Only a handful are built for the long haul, and those are cryptocurrencies with some type of sustainable competitive advantage that makes them attractive to users and investors.
At one time, Bitcoin had a vast economic moat because it was literally the only cryptocurrency on the planet. Now, however, Bitcoin’s economic moat seems to be eroding. This is a common phenomenon in the stock market, as formerly top-performing companies fade into the background after losing their primary source of competitive advantage.
Don’t get me wrong: I still think Bitcoin is a fantastic long-term investment. But I think the record-beating returns it once delivered to investors could fade over the long run as other cryptocurrencies catch up.
