While I've linked a number of things related to Bitcoin, I've never actually posted my opinion on the matter. This will be an argument as to why Bitcoin is relevant, why it has value, what that value might be, and why I believe it should be considered for including in a financial portfolio. This argument has been made in many places all over the web (some of the best material I know of is linked here), and I am hoping to speak to people that follow me that might not be exposed and the tone of this is for a layperson who has not already spent much time in the space or already invested. I'm not going to delve much in to the technical aspects of how Bitcoin works - nor do I have a deep understanding of them. I do have a rough idea about how it works, but I believe that investing in Bitcoin for most people is more an economic exercise than a technical one. I also believe that generally you should only invest in things when you have an understanding of what you're investing in, and Bitcoin is no exception here.
Despite the fact that I am bullish on Bitcoin, this article isn't financial advice. Firstly, nobody including myself knows what will happen, especially with something as complex as Bitcoin and the world economic environment. Secondly, everyone's financial situation and risk appetite is different, and what's right for one person or myself might not be right for other people. Do your own research and come to your own conclusions. I'm not sure who is an expert on something as speculative and wide-ranging as Bitcoin, but if there is someone, it's not me. I'm just a guy with an opinion. I just want to share my thoughts and hope that they can help some people on their own journeys.
So first I'm going to discuss why Bitcoin is valuable. For those who don't really know what Bitcoin is, there is a lot of great material on the web that can teach you more or less how it works. I'm not going to delve in to that here and don't think it's necessary to understand this blog. That said, having a rudimentary understanding of how Bitcoin works is pretty easy to get and I would recommend doing so if this article makes you interested. Read this link for a nice short piece on Why Bitcoin Matters. Bitcoin is essentially just a ledger. It lets you transact numbers on that ledger (bitcoins and satoshis - the smallest divisible unit of a bitcoin) with other people without having to trust a 3rd party to guarantee the transaction (bank, paypal, credit card, etc...). That is very valuable because now with Bitcoin you don't need to pay for that 3rd party to exist (structural business costs, bank wire fees, credit card fees and interest, etc...) AND you don't have the potential control or censorship from that 3rd party. Bitcoin is not controlled by anyone and is therefore censorship resistant. Bitcoin itself is very secure. All theft is due to carelessness on the part of owners, and incompetency or dishonesty from the companies they used (such as exchanges). Bitcoin transactions are not reversible as well. If you make a mistake, there isn't a way to undo it. That finality can make using Bitcoin intimidating, especially to new users. But that finality is also a feature which ensures increased security for transactions. They will not be reversed, so you know when bitcoin is sent it will not be returned without another transaction, This is a cool chart which shows a potential growth outline of Bitcoin from inception to full blown Global Money from Murad Mahmudov's twitter.
So, Bitcoin is ultimately an attempt at a decentralized, digital/internet money. But Bitcoin isn't really there yet. It's on a path to getting there. The primary thing holding bitcoin back from doing that right now, besides the lack of universal acceptance, is that Bitcoin can't currently process nearly as many transactions as say VISA. But, Bitcoin's most valuable property is not today nor ever going to be its ability to be used as another form of money to buy things every day, even if one day it can be used by people around the world for that. USD, EUROS, and other regular fiat currencies already work very well today when combined with credit cards and other financial instruments in order to facilitate these type of purchases. So I can fully understand why people might ask why they need another internet money to buy things. Most people living in rich countries with successful currencies don't have a need for this (although people living in countries with bad currencies, or poor and unbanked - they are another story. I believe a potential future use case of bitcoin is as a better currency for day-to-day use for the poor unbanked in the world, who can use their cellular phones, computers, or similar devices, and be their own bank with Bitcoin and have their own BTC credit card on say their phone or perhaps later even a card that spends the BTC at your address. That would prove especially valuable in countries with weak and inflationary currencies). But that way of viewing Bitcoin pigeon-holes it in to trying to be something much less than it actually is. Bitcoin doesn't derive most of its value from simply being an alternative currency.
Bitcoin's most valuable property is its programmed scarcity. Bitcoin was created with a scheduled inflationary policy. Every 10 minutes when the transactions are processed on the blockchain, bitcoins are "mined" (created) and given to the miners that process these transactions. The number that is created in these blocks is cut in half every 4 years. This process means that every 4 years the inflationary pressure in Bitcoin is cut in half, and that eventually - mathematically - there will be essentially no new bitcoins mined. Right now there are approximately 18 million bitcoins in existence, and the final total will be 21 million. Therefore, in Bitcoin's entire future lifespan, there will only be an inflation of 3 million more coins, or approximately 1/6 the amount of the current supply. EVER. That seems especially valuable when compared to your local fiat currency controlled by your nation's central bank, whose monetary policy is at the whims of the political climate, special interests, politicians, bankers, and everyone who isn't you nor has your best interests in mind. Now there is a lot of debate about the exact affects of monetary inflation and money supply, and it's an interesting topic to look in to. I believe that the massive increase in money supply (eg Quantitative Easing) that banks are employing, even if it currently hasn't caused demonstrably massive inflation, will eventually cause the continual devaluation of those currencies and inflation. Here is a chart of the global money supply over the last 30 years followed by a chart of bitcoin supply.
The first chart is showing an exponential growth in Fiat money supply in the world where the rate of supply has been increasing. That might continue or it might not. The Bitcoin supply rate is decreasing, and that WILL continue. It's programmed scarcity. Which of those two moneys would you rather keep value in based on just the supply curves?
Today the monetary solution seems to be to keep lowering interest rates, and keep printing more money. This has caused massive growth in Real Estate and equities (SPX, stock markets) in the last 10 years as all this loose money and credit looks for a place to go. There is basically no interest for saving money in the bank, bond yields everywhere are going negative, and US Dollars purchasing power has gone down. Sure, for goods where the technology is continually improved - the Purchasing Power has gotten a lot better (eg TVs get better and cheaper). But when you factor out technological improvement, I believe you can see quite a lot of inflation (gas prices worldwide, insulin prices, etc...), and it's part of the reason why the average American is struggling.
And in to this environment, I believe assets that store value and have scarcity will have innate value. Bitcoin's greatest use case is simply being a great way to store value because it has a defined and small inflationary policy - programmed scarcity. In this, it is a lot like Gold. It is a scarce asset that people perceive to have value. Gold, however, has been around for thousands of years... and considered by people around the world to have a lot of value and be a Store of Value. Bitcoin does not have that kind of historical track record, obviously. It hasn't quite gotten to 10 years yet. Bitcoin also doesn't have practical use as gold does as a mineral for various industrial uses and for jewelry. On the other hand, Gold is not a practical form of money as it is difficult to send, transport, divide... or basically use. Bitcoin, on the other hand, does all of those things very well. So, in a very real sense, Bitcoin requires people to discover and accept its value as a programmable scarce asset like gold but with a whole lot more utility as a money. That's a key part of this story. BItcoin needs other people to realize it's great properties, its use cases, and buy it. And if that continues to happen, then eventually Bitcoin will become the Store of Value, Unit of Account, and Digital Currency that right now its believers and investors think it might. In that sense, Bitcoin should exhibit some properties as a network.
Just like other forms of money, you have to believe Bitcoin has value, in order for it to ultimately have that value. We accept the dollar in America because our government prints it and backs it, despite the fact that it's merely a piece of paper or a number in a bank account. Bitcoin isn't backed by a government - but has a ledger of transactions and keeps a Unit of Account backed by Proof of Work done by all the miners in order to guarantee that. Ultimately all money is worth something only because someone else will accept it in a transaction. Money by itself is worthless, and just a value holder everyone accepts in order to efficiently transact in a society. This allowed us to move beyond basic bartering and trading, to specialize labor, and so on. There is nothing inherently more valuable about a currency because it's backed by a government. It does provide a greater perceived security in that currency. But I would submit that many many governments throughout history have destroyed the worth of their currencies, and you've seen all kinds of hyper-inflationary events, like the Weimar Republic, Venezuela today, and others, where things got absolutely ridiculous before they broke down.
The point is this... Bitcoin has a lot of amazing properties that make it, in my opinion, the best money that man has created to this day. It is the most secure asset. Not only can your bitcoin not be hacked, it can't be seized from you. Someone could put a gun to your head and you still wouldn't have to give them your bitcoin if you didn't want to. Literally everything you own can be taken by force, even if you were willing to do anything - even die - in order to try and stop that. Your property can be seized by the government. Your possessions can be seized, or if you are robbed they can be forcefully taken with or without your consent. Bitcoin isn't something you physically own. Bitcoin cannot be taken without your consent. (This isn't suggesting that if someone puts a gun to your head, or a government threatens jail time, that you wouldn't give up your bitcoin. But you would have the choice not to, and thus your consent is required.) You can access it, but your bitcoin is essentially just an agreed upon number that exists on the Bitcoin blockchain on computers around the world. You only control your access to that, and with relatively simple security methods, you can easily make it so nobody can access your Bitcoin unless you want them to. There is literally no asset in the world today that is as secure as Bitcoin.
Bitcoin is easy to store. There are currently wallets that are very secure - like a Trezor - which you can carry with you and access your Bitcoin via a USB port (or not carry with you and therefore not be able to access). It's easy to take this with you wherever you want, traveling anywhere in the world with you with the ability to access and send/receive infinite. What other asset is that easy and practical to use? Bitcoin is also divisible to any amount you would conceivably need to send, making it easy to transact. It can be sent relatively quickly (it is not currently as fast as instant transactions such as Credit Cards, but much faster than Bank Wires). It has relatively low fees, that are not based on the amount sent - therefore Bitcoin is perfect for sending and receiving large amounts.
Bitcoin is the perfect asset to store liquid net worth. I believe that one of Bitcoin's primary use cases will be the best way to store net worth that you want to keep liquid. Rather than sit on a fiat currency which will devalue over time because of inflation, someone would instead choose to keep their liquid net worth in Bitcoin, which can be at the very least quickly exchanged to a fiat currency if not used directly.
When you survey it all together and take it in - you are logically forced to admit that Bitcoin is the greatest asset that we have created. The only thing holding it back at this point is simply the progression of it technologically and the acceptance of it by people around the world. Slowly more and more people own and are using Bitcoin, and this growth needs to continue if Bitcoin is going to ultimately succeed. The world doesn’t have to be logical and rational - and individuals mostly aren’t - but I would bet that the emergent decisions we make economically will tend to be. Interestingly Bitcoin's growth in price as an asset over time is very similar to a network growth model - which makes intuitive sense to me.
Bitcoin has been growing very similar to what a network growth model would predict with a logarithmic growth curve.
So now that hopefully you agree that Bitcoin has value, the next step is trying to wrap your head around how to try to estimate what Bitcoin's value could be. Pfeffer attempts this in his article on Cryptoassets, which I recommend checking out. He postulates the following sources of value: 1) Replacing Gold Bullion 2) Becoming an International Reserve Currency 3) Unit of Account for international trade 4) International payments & Domestic payments in countries w/out stable sovereign currencies. The total speculative range he gives for this if Bitcoin were to become the dominant monetary store of value cryptoasset and realize some or all of those use cases is 4.7 - 14.6 Trillion USD, which gives Bitcoin - fully diluted (all 21M) a range of $260k - $800k per Bitcoin. I would add as a potential use case, Bitcoin supplanting or taking a share out of the offshore private banking market; a market which has been estimated as having over $21 trillion USD worth.
PlanB models scarcity by quantifying it as a stock-to-flow ratio, and gives this mathematical prediction for Bitcoin's value based on this in his work HERE. I would highly recommend reading this, it's very interesting. To take a simple snippet, his estimation for Bitcoin's worth after this halving event next May 2020 is $55,000USD. Every 4 years Bitcoin increases in scarcity with each successive halving, and thus increases in value.
People ask where the money comes from to get Bitcoin from its current price levels to the types of valuations that are being discussed here. This is a great answer to that "People ask me where all the money needed for $1trn bitcoin market value would come from? My answer: silver, gold, countries with negative interest rate (Europe, Japan, US soon), countries with predatory governments (Venezuela, China, Iran, Turkey etc), billionaires and millionaires hedging against quantitative easing (QE), and institutional investors discovering the best performing asset of last 10 yrs." Imagine someone wealthy living in a country with a predatory government wanting the ultimate get-away quick plan to escape with some of their wealth should they need to. Bitcoin is literally perfect for them.
I believe that in the next year or two, a trading firm - like TD - will allow people who have accounts with them to buy and sell Bitcoin. Whether it is through an approved ETF, or because the institution themselves works out a storage solution privately and processes the transaction (with fees), I believe this will happen soon and open up easy access to all the money private investors hold in their brokerage accounts.
I believe that now that this idea is out there, something will become a decentralized, digital Store-of-value, unit of account, and currency. Once the proverbial cat is out of the bag, then you can't put it back. I believe that Bitcoin is by far the best option for that, but why not something else? While I do think it's possible that Bitcoin doesn't realize this and something else does, I think that is unlikely. There are some other cryptocurrencies out there that have been started with other features, like for example Ethereum and many others. A lot of these have good features and will likely be useful and valuable for what they are designed to do. But different functions have different values. First, let me differentiate between the value of a cryptocurrency in so far as it runs some other project - vs the value of a cryptocurrency in so far as it is a digital store of value. Pfeffer discusses this in some depth in his paper and makes the argument that the primary value is in becoming the dominant digital store of value. It's a somewhat intricate argument that I would suggest reading, especially if you own ALT coins or are seriously considering investing in them. I personally do not believe that ALT coins should accrue value like Bitcoin if they are trying to perform some specific function (DAPP platform, decentralized betting market, etc...), because even if their chain is used, there is no direct function or reason why the token itself will accrue the value the chain is being used for. The token is not like stock in the company, it is not a part of the total value being passed by users of the blockchain. It really just represents the grease inside the machine, necessary to process the transactions, and will likely converge to the value of the processing power needed to run the network. This differs because whatever is being used as a digital store of value will accrue the value of what's used to invest in the network, as it is storing that value.
And why won't one of these coins take over Bitcoin? I would argue that Bitcoin has a large first mover advantage. Its name is much more popular and it's more well known, both important for network growth. Also in terms of a currency, Bitcoin has been proven to be secure for 10 years and with network valuations of 200 Billion USD and higher. No other blockchain has this kind of stability, security, and proven track record. The blockchain is open, on the web, not behind a firewall, open to hostile attacks and hacks - and has remained safe. Many projects aren't nearly as proven, and aren't decentralized enough - and IMO centralization and control would largely defeat the point and one of the main attractions of this type of digital currency. Bitcoin has shown it is reliable and robust, and those things are both extremely important for a currency. I don't believe it will be replaced by a newer cryptocurrency because no added feature will be worth more than that reliability, robustness, or security that has been established already on Bitcoin insofar as it simply being a SoV, Unit of Account, and currency. And most features, if they proved valuable, could eventually be added to Bitcoin if necessary.
So to me the Sharpe Ratio, or return given risk, of every single Alt Coin is significantly lower than Bitcoin when considering as an investment. Therefore at the current time, I believe the best allocation for a prospective investor buying Cryptocurrency is 100% Bitcoin. It is possible and even likely that today there is something out of the 1000s of coins that will outperform Bitcoin in 5 years, but I don't believe it will be easy to pick and investing in many will almost certainly do worse than Bitcoin as a group.
When considering Bitcoin as an investment, I think an investor should think about it like this... You are making a long term investment speculating in Bitcoin realizing the use cases and properties discussed here. If it does this, it's very likely to reach much higher valuations than today (today Bitcoin is just over 10kUSD). Let's say that for this current bull market cycle, we are looking at a 2-3 year price target of. 50-120k. If Bitcoin doesn't work out, or if there is some kind of systemic problem, the value of Bitcoin is likely to crash and it's unclear how much of the value you might be able to recover. So for simplicities sake, let's say that you are looking at Bitcoin going from 10k to either 0 or to 100k in 2-3 years. So, for this bet to be +EV, it only has to be successful 10% or more of the time. With this view, this is a very asymmetrical bet with potential upside much greater than the downside. High risk, high reward, that even if it is +EV should be taken with some caution. That said, I consider the likelihood that Bitcoin fulfills these potentialities to be significantly higher than 10%, and therefore think buying BTC to be a +EV long term move. (Obviously a Bitcoin bear would likely disagree w/ that probability allocation). So something like buying Bitcoin today to hold half for 2-3 years before taking profit at the end of this bull cycle, and the other half in order to hold for a much longer time frame (forever?) seems like the makings of a reasonable plan.
Despite the fact that Bitcoin has a very high long-term risk factor, it seems to be not correlated with other assets like the S&P 500 and equities, therefore a Bitcoin allocation could be part of a balanced portfolio that might achieve higher expected returns without raising raising a portfolio's risk of ruin - something increased by having a lot of correlated assets.
Other good Bitcoin resources: Ultimate Bitcoin Argument podcast w/ Murad & Pomp - good podcast with discussion about why Bitcoin is important
Woobull charts by Willy Woo - interesting charts modeling different aspects of Bitcoin