Why We Should Take Bitcoin Seriously
Objective
Everyone should understand why Bitcoin matters. This post has the relatively modest objective of convincing you that it is worth taking the time to understand it. It won’t explain how Bitcoin works, and it doesn’t focus on whether it is a good or a bad thing. The explanations used will be non-technical, over-simplified and are not intended to be comprehensive. It will focus on the key take-away points to demonstrate that this is most likely not some passing fad and that sitting on the sidelines is not necessarily the ‘safe option’.
My Motivation
I am a relatively recent ‘convert’ to Bitcoin. I have heard it mentioned at various intervals throughout the years, without ever taking the time to understand it properly, which I regret. I am sure that almost everyone has been ‘pitched’ cryptocurrency by a friend or colleague – force-fed may be a more accurate term. The easiest thing to do when confronted with an over-zealous person telling you that a new form of internet money is the future, is to dismiss it as a cult or a Ponzi scheme- and perhaps it has some parallels with both. Those of us who talk about it probably don’t help the cause, and usually end up turning others off being open to the idea through our over-exuberance.
Trying to explain that a technology will upend the global financial system is not straightforward and therefore not conducive to succinct explanations. It is also unrealistic to expect everyone to read a book or listen to hours of podcasts about something they have no interest in. It is for these reasons that I have decided to create this post. I hope it will convince you to approach Bitcoin with an open mind.
I have now invested in Bitcoin, so I cannot claim to be impartial. I have endeavored to be balanced and objective and will try to avoid excessive hyperbole. A thorough understanding of Bitcoin’s potential cannot be claimed through qualification in any one subject. It is truly multidisciplinary, spanning economics, philosophy, history, psychology, technology, game theory and more. Reasoning from first principles is the only way to approach it. Of course, there are risks and I could be completely wrong. With that said, I believe that ignoring Bitcoin is a significant financial mistake.
Keep an open mind, but not so open that your brain falls out…
Everybody wants to feel intelligent, its natural. ‘Bitcoiners’ believe that ‘Digital Gold’ will solve the world’s problems and are flabbergasted others ‘don’t get it’. On the flip side, the sceptics often believe Bitcoiners are easily led, have fallen for the latest round of ‘tulip mania’, and will regret the whole affair when the bubble inevitably bursts and the world runs out of ‘greater fools’. Ted Kennedy’s infamous quote about knowing that it was time to get out of investing in the railways because he was told about it by the shoe-shine boy may seem like a timeless and universal truth. But the majority and the received wisdom have been wrong in the past. The world periodically undergoes seismic change, and Bitcoin just may be one such change.
Don’t close your mind to the idea that Bitcoin truly is revolutionary merely because you have identified with the sensible group of world-wise people that are too grounded to get carried away by something that sounds too good to be true. Engage with the topic logically on its merits, not by reaching for lazy analogies of tulips or an unwavering commitment to your intuition, which would have once prevented you seriously questioning that the earth was anything but flat.
What is the Bitcoin Thesis?
The Bitcoin thesis is that Bitcoin will continue to significantly increase in value over the coming years until it ‘finds’ its true value. It is like a black hole whose gravity is slowly but surely swallowing other financial assets. The reason it is doing this is because it has reintroduced the concept of sound money to the world; money that cannot be altered or inflated. Just as gravity pulls objects towards the earth, sound money attracts value over time, as it is more efficient and a better way to preserve wealth. The value of Bitcoin has grown exponentially for the 13 plus years of its existence, with huge volatility and wild price fluctuations. The thesis is that the more it matures, the more stable it will become, eventually becoming the asset against which the value of all others are measured.
The first rung on the ladder to understanding Bitcoin’s value is to understand the evolution of Gold and the role it has played in the global monetary system. Gold emerged over millennia as the world’s premier store of value. Nobody unilaterally decided that Gold should be valuable, but rather the free market, after much experimentation, elected it as the best way of representing and storing value. Gold has certain properties that made it best suited to this role; it is scarce, verifiable, and does not degrade over time. But Gold also has limitations; it is not easily divisible, and it is difficult to transport and protect. These physical constraints provided an incentive to centralization, which has ultimately led to the diminished role of Gold in today’s financial system. The Bitcoin thesis is that Bitcoin is Digital Gold, but far superior, without the constraints related to storage, transport and divisibility. For this reason, it will play the important role of underpinning global finance that Gold played in the past.
It is clear that Bitcoin has made significant headway eating into Gold’s role as a ‘store of value’ and is now often described by the mainstream as a Gold alternative or a ‘Gold for millennials’. Most Bitcoiners don’t believe it will stop there though, predicting that Bitcoin will consume significant portions of almost every asset class- currencies, bonds, commodities, stocks, property etc…
Bitcoin and Traditional Currencies
In the past, people used physical Gold coins to make transactions. We subsequently used paper redeemable for (or representing) Gold as it was more convenient. This paper essentially evolved into the currencies with which we are familiar today, and each was pegged to Gold at a specific rate. Our economies were built upon currencies that were backed by Gold. Despite the modern veneer, we were essentially trading Gold until 1970.
In 1971, the US detached the world from the Gold standard and ushered in the era of ‘free-floating currencies’ which we have today. This means that each currency simply has whatever value the market ascribes to it. This allowed the rapid acceleration of debt creation and removed any hard limit on governments ‘printing money’. It is worth recalling that the monetary system we have today, unconnected with Gold or any other scarce asset, is an experiment that is merely 50 years old.
At a basic level, currencies can be viewed simply as spreadsheets. Most Dollars and Euros are computer-based entries on a digital ledger system. These spreadsheets simply track who owns what portion of the currency. But there is a catch. Governments and Central Banks can raise revenue by adding Euros and Dollars to the spreadsheets. In fact, it is the easiest thing they can do to raise money. They don’t have to take the Dollars and Euros you already have through overt taxation, which you naturally dislike, because they can just create new currency out of thin air by selling bonds to the Central Bank and adding to the digital ledger. It is the path of least resistance.
Inflation
If you keep your value, which is the product of your time and energy, stored on the spreadsheets of the Dollar and the Euro, and the government adds to these spreadsheets, this has the mathematical impact of them taking some of your money. It debases and devalues the currency. No new value has been created; they are merely redistributing the existing pizza into a greater number of smaller slices. This is one of the primary drivers of inflation, though not the only one. Oftentimes, it is not that goods and services are actually getting more expensive, it is that your money is losing its purchasing power- becoming diluted.
This is a necessary way of raising revenue in the current system. Without inflating the currency, states wouldn’t be able to service national debts or pay pensions. We are borrowing from tomorrow to pay for today. We could debate the merits of this, but that would be to get distracted. All conventional currencies are inflationary, meaning that their supply is ever-increasing. Some are worse than others, which is why you see drastic situations in Turkey, Lebanon and Venezuela. The key point is that even the best currencies are losing their value at some rate. You will be aware that a small amount of inflation is a target, not a problem.
Traditional currencies are therefore like leaky buckets. If your money is water, keeping it in any conventional currency is like keeping it in a bucket with a hole in it. It will always lose value over time. This is why more affluent individuals and organisations do not store their wealth in currencies. They are forced to use ‘harder’ assets such as property, commodities, and equities. That currencies devalue over time shouldn’t be a surprise. That the price of the stock market and houses has consistently increased over the last 50 years doesn’t necessarily reflect their increasing value, but rather the decreasing value of currencies.
Enter Bitcoin
Traditionally, if you wanted to avoid losing your wealth, your options were limited to investing in the stock market or real estate or some other asset that would hopefully retain its value. But in 2008 an unknown individual or group used cryptography to create a spreadsheet with a fixed supply of 21 million that nobody can alter. It is a bucket with no holes or leaks. If you buy one Bitcoin, it will always represent 1/21 millionth of the total supply. Given that most people act rationally, over time more and more people will choose to store their wealth in this decentralized and immutable spreadsheet because it will not diminish over time in the way that inflating government spreadsheets do.
This is the base case for Bitcoin, albeit hugely oversimplified. It’s not that it is just another form of currency that people may or may not choose to use based on convenience. It is a bucket without a hole. As people realise this, more and more commit their wealth to it. This is why it is likely to succeed, and it now has a significant track-record of growing in value. All that is required for Bitcoin to continue growing is for human beings to continue acting in their own self-interest.
It doesn’t really matter what you use to buy your coffee
There is often debate around whether Bitcoin is a good form of money that can be used for daily life. At the base layer it cannot process the same transaction volumes as other payment systems or even newer cryptocurrencies. Increasing the transaction volume and speed of a cryptocurrency requires tradeoffs with security and decentralization. Bitcoin is maximally decentralized and secure, which makes it a safe and trusted store of value. There are many people working on solutions to improve Bitcoin’s use as an everyday currency with initiatives such as The Lightning Network, which acts like the current account to Bitcoin’s savings account. Building utility in layers, with the base layer maximising decentralisation and security is ultimately the only way a monetary system will stand the test of time.
The point is though, even if we continue to use traditional currencies in digital form for transactions, the ‘better spreadsheet’ argument is still relevant and the Bitcoin thesis will likely hold. Why would you keep more in a traditional currency than you need for the next week or month, when you can just convert in and out of Bitcoin as required? You would only keep the water you need to tend the plants today in the leaky bucket, not a year’s supply. This is an example of an argument people fixate over that isn’t critical to the decision as to whether they should convert some portion of their wealth into Bitcoin. Even if we will all still use Dollars or Euros to buy our coffee, it won’t make any logical sense for us to keep more than a small ‘float’ in these inflating currencies. Online payment apps are making it seamless to convert in and out of Bitcoin, so what we actually use at the till isn’t as relevant as you might expect.
Real Estate, Stocks, and Bonds
The absence of sound money in the economy over the last few decades has led the financialization of other assets, creating the bubbles with which we are all familiar. The more people see the potential of Bitcoin as a store of value to preserve their wealth, the less of a need there will be to use property, bonds, and stocks to do so. This will reduce the investment value of these other assets until they reach their utility value- ie property will be worth what owners are willing to pay to live in it, rather than its current overinflated and speculative investment value. The stock market will reflect the value of expected earnings of companies and future growth, not the added premium of an inflation hedge to keep money from depreciating. The bond market is most compelling. Bond yields have decreased steadily with the lowering of interest rates, and are now returning a negative real yield (ie the bond is giving a lower interest payment than the inflation rate). Who will buy bonds if they can better preserve wealth with Bitcoin?
These asset classes are all in the hundreds of trillions of dollars. Bitcoin is currently valued at a few hundred billion. Bitcoin is likely to swallow a huge portion of their value.
Why does this affect you?
Ultimately, failing to understand Bitcoin’s potential implications should not be viewed as a missed investment opportunity. Failing to understand Apple, Microsoft and Tesla in good time constituted a missed investment opportunity, but others always come along and sitting them out was not a ‘risk’. They represented a change within the current system, whereas Bitcoin represents a new system.
The Bitcoin thesis is that Bitcoin will lead to the eventual devaluation of all other currencies and seriously deflate other asset classes by poaching their existing roles as stores of value. If this thesis is correct, then everyone will eventually convert to a Bitcoin standard. Bitcoin will become the primary global reserve asset, the standard against which everything else is measured.
Get on board the train early, you’ll get a better seat
Converting sooner rather than later will exponentially impact your net value in this new system. Even if you’re not fully convinced, I believe that the thesis is credible enough to make it worth your while hedging your risk and diversifying into Bitcoin to some degree. After all, isn’t this what prudent financial advisors advocate- not relying too much on any one asset class?
If the Bitcoin thesis is correct, Bitcoin will lead to one of the greatest wealth transfers in history. The early adopters will see disproportionate returns, and those last to embrace it will not do as well. It is not at all fair, but there is a strong argument that it is much fairer than the current system. By the time mainstream advice advocates buying Bitcoin, you will be late to the table. In time, people may want answers as to why their own governments and financial advisors counseled them against it. That public institutions are conservative is understandable, but ultimately the system will have winners and losers. That is why I believe it is imperative that people take Bitcoin seriously.
The Rational Investment
People dismiss Bitcoin for all sorts of reasons. They conjure a flaw and disregard it, saying it will never work. The objective reality is that it is in the process of working; the thesis is playing out in front of us- we need to zoom out to see it. Bitcoin has gone from zero to a multi-hundred billion dollar asset in just over a decade. The adoption rate is currently over 100% a year and it is now owned by millions of people. This is likely to be over a billion people within a few years given the rate of growth. Looking at the trend alone is highly persuasive- something that was once used primarily by criminals is now offered by the major banks to their customers and adopted as legal currency by a country- El Salvador. Elected representatives are accepting their pay cheques in Bitcoin and publicly traded companies are adding it to their balance sheets. The network effect is increasing every year, making it more and more likely to succeed.
One of the most important but overlooked arguments in favour of buying Bitcoin is that of expected value. Most people suffer from a logical fallacy when they consider investing in it. They act as if the good outcome is doubling their money, and the bad outcome is losing it. If this were the case, a person should only invest if they believe there is a greater than 50% chance of Bitcoin succeeding. But the Bitcoin thesis is not that Bitcoin will double in value. It is that Bitcoin’s value will be somewhere in the region of hundreds of times today’s value in the future. This means that if you concede that the Bitcoin thesis is 5% likely to be correct, it is still logical to invest in it.
It doesn’t have to be all or nothing. Depending on your risk tolerance, you may not want to put too many eggs in this basket. If the Bitcoin thesis is correct, and you allocate 5% of your net worth to Bitcoin, this will likely be worth more than the other 95% of your portfolio in the next decade or two. Surely the upside considerably outweighs the downside. With an approach like this, there is a lot to gain, and less to lose. If nothing else, its success should surely be hedged against, given what it means for other investable assets.
Don’t get distracted by the price
One of the main arguments against investing in Bitcoin is the high volatility in its price- it swings much more violently than most other assets and currencies. This is a natural consequence of the fact that Bitcoin is growing and finding its value. Its price fluctuates wildly because people speculate on it. People get greedy and fearful in turn. The believers borrow money to buy more, and when it doesn’t go up in price fast enough, they are forced to sell, which actually drives the price down. Given recent events, nobody needs a lesson on how leverage and bad actors can impact the volatility. Notwithstanding, this is a normal market dynamic given the age and size of the network. There is no alternative where it grows up in a straight line, and its distribution is fundamentally a function of education. Understanding this is key, and it is a mistake to invest in Bitcoin without realizing this. It is hard to stomach an investment going down in value by 75%, but understanding that the fundamentals remain unchanged helps. Those who wait until Bitcoin is a stable asset will sleep soundly at night, but they will have missed the growth phase. You need to decide if the volatility is a price you are willing to pay for an early slice of the future.
It is a fair criticism that Bitcoin’s huge price volatility would deter people from using it to trade for goods and services due to a lack of certainty. This criticism has to be viewed in the context of the overall thesis. People invest in Bitcoin because they believe that its price will become more stable as it matures and grows in value. There are already signs of this occurring as institutional investors have started diversifying into Bitcoin. At 13, Bitcoin has just hit its teenage years, and it seems like the analogy of the early years of a human life may be a close fit. The more value that Bitcoin consumes, the greater its mass becomes relative to other things, making its price less prone to speculation and wild swings. Bitcoin started its life as a makeshift raft, suffering every small wave in the ocean. It is now a 40-foot yacht, less susceptible to smaller waves, but still vulnerable to swells. In the years to come, it will be a large cruise liner, unshakeable by all but the largest storms.
There is simply no way in which a decentralized asset or currency could have ‘popped into existence’ at a stable price, as the critics would seem to demand. Technology and cryptography has, for the first time in history, allowed us to experiment with a decentralized currency system. It is foolish to write it off because it has never worked in the past. It has never been trialed in the past.
What are the risks?
Nobody can state that a particular course of action is risk-free, it would be delusional to claim otherwise. Unknown unknowns can’t be discounted; however, there seem to be three primary risks that require consideration. The first is some sort of glitch- a problem with the code or a ‘hack’. The general consensus among cryptographers appears to be that this risk is extremely minimal. Bitcoin’s 13-year track record is also reassuring. The second risk is regulatory, that Bitcoin will be ‘banned’ by government. This cannot be discounted but appears highly unlikely given its current level of adoption. It is now owned by publicly traded companies and lawmakers. An outright ban would be highly controversial. The recent policy-level legislative debates in the US are also indicative that the risk of an imminent outright ban is highly unlikely and is not being actively considered. Every year that passes sees the number of users double, and with that the risk of a ban less likely. Conversely, many believe that proper regulation will bring clarity and further investment to Bitcoin. The third main risk is that something will replace Bitcoin, ie another cryptocurrency. Since Bitcoin’s creation, thousands of other cryptocurrencies have been created and as of yet, there are no serious contenders as a digital store of value, and given the importance of network effects and trust, it appears highly unlikely that this will change. Bitcoin maximises decentralization and security, removing any need for trust in counterparties, which is why it is the world’s premier store of value.
The above paragraph is not intended to be a comprehensive answer to the possible risks to Bitcoin. The important point to make is that many are using these risks to justify their unwillingness to invest wholesale. I would frame my point as follows: to bet against Bitcoin is effectively to bet that one of these risks will transpire. Given the expected value argument made above, you would need to be quite sure that one of these risks will materialise for it to make sense not to invest something in Bitcoin.
The Good, the Bad and the Ugly
I said I would not get into the merits of Bitcoin. I personally believe its potential positive impact on the world cannot be overstated, but if you have borne with me until now, I will spare you a further lecture on the merits of a deflationary currency on equality. I will briefly however address two of the main accusations levelled at Bitcoin.
The impact of Bitcoin mining on the climate is often cited as a concern, but there are many complexities to this topic. I will offer two brief thoughts. On one hand, it can be argued that securing a sound monetary system is more than worth the environmental price tag and that there is not necessarily an obvious alternative. A fair comparison would necessitate consideration of the impacts of many aspects of the current system, which rarely faces the scrutiny that Bitcoin mining does. The second angle is that Bitcoin is logically a driver of renewable and cheap energy. Because it monetizes cheap energy, most of the energy used is already excess. As renewable energy is getting cheaper every year, Bitcoin incentivizes the migration to these renewable sources of energy. A constant buyer that can be scaled up and down as needed will also provide a much-needed subsidy to the grid build-outs we will need to achieve over the coming decade to meet our collective energy needs. This debate is currently live and will be an interesting one to monitor.
That it is used by criminals is often used to sully Bitcoin’s reputation; however, this argument is actually somewhat irrelevant. As long as there is some usable crypto-currency, criminals have a means to pay and get paid for nefarious activities outside the banking system. Unless we effectively ban them all, which is likely impossible, avoiding Bitcoin because of this is illogical. It is not necessarily more or less useful to criminals dependent on price. In any event, criminals have now turned to other more anonymous cryptocurrencies that do not have Bitcoin’s transparency. To limit the potential for good of the technology by associating it with criminality is nonsensical and socially irresponsible. Nobody advocates banning knives from butcher shops just because they are sometimes used to commit murder.
But Bitcoin isn’t backed by anything!
Finally, a criticism often levelled at Bitcoin is that it is ‘backed by nothing’. What is the Dollar or the Euro ‘backed’ by? You may retort- ‘the government’. What does that mean? The government doesn’t mandate that a shop gives you an apple for a fixed number of Euros, they simply declare that Euros are accepted. The free market does the rest and dictates value. Every currency is merely a belief system. A belief in present and future value. Bitcoin’s belief system is not qualitatively different or less tangible than that of traditional currencies, to Gold, or to Art.
You may claim that these comparisons are unfair, as other things have an ‘inherent value’. Art is aesthetically pleasing, and Gold can be worn as jewelry. Consider this- we don’t value Gold because it is pretty; rather we find it pretty and desire to wear it because it is scarce, which makes it valuable. Gold evolved to be appreciated because of its properties. Bitcoin is digital scarcity. Would you claim that a book-keeping system that accurately reflects the income and expenditure of a company has no inherent value? Bitcoin’s inherent value is that it has the potential to be the most truthful and accurate system in the world for recording, storing and exchanging value.
It is not clear that money is supposed to have any value in and of itself. This should be obvious when we consider traditional currencies. There isn’t much you can do with a Dollar or Euro note unless someone else wants it. Money is simply a facilitator of barter (or more accurately a way to avoid it). The barter system has never truly been replaced, we have just made it more sophisticated and efficient. It can only be a facilitator if there is a common belief that it will be accepted by others. In a sense, the whole concept of money is built upon a version of the greater fool theory that works. Bitcoin’s belief system is growing and growing. To state that a common belief by hundreds of millions of people can’t give Bitcoin the legitimacy of a traditional currency because these people aren’t all grouped on the same piece of land is to think in the past. We live in an internet age, where people are connected by more than physical proximity. Bitcoin is money in a digital age.
Conclusion, finally!
The most common reaction I get from people when I advise them to look at Bitcoin is- “I would have bought it when it was €150, but not now that its €15,000!”. They then go on to say that they will be open-minded to the next big thing. The fact is that they wouldn’t have bought Bitcoin at €150, because if they don’t understand it now, they wouldn’t have then. The Bitcoin thesis has not significantly changed, but the bigger it gets the more likely it is to succeed. The direction of travel is clear, and at what point will Bitcoiners be proved right?
What does a €15,000 Bitcoin even mean? Why is it expensive or cheap? How do you measure it? The thesis is that Bitcoin is now a four-hundred billion dollar asset on its way to over a hundred trillion. Don’t be the person saying you would have bought it at €15,000 when it’s €150,000. It will never be obvious until you’re using the benefit of hindsight. Those that think they have ‘missed the boat’ are on the Titanic watching the first three or four lifeboats leave the ship, lamenting that they weren’t on one of them. There are dozens of other lifeboats with space, but it is going to require a leap of faith right up until the moment the bow sinks. The phrase ‘jump before you are pushed’ comes to mind.
People on both sides argue a lot from emotion and intuition when dealing with Bitcoin. I personally believe that the Bitcoin thesis will probably transpire. More importantly though, I believe that most people who have properly researched it with an open mind would accept that it is at the very least credible. If it is credible, it is logical to own some and it is risky not to own any. At a minimum, I hope you will see that it is reckless to dismiss it out of hand.
Do your own research, this is not investment advice.
Posted originally on https://richmoney.substack.com/