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 is simply the lack of legal clarity everywhere and universal acceptance. Think of Bitcoin like a network. It needs adoption. It needs to keep growing. Many argue though, that Bitcoin's largest fault is that it can't currently process enough transactions, and not nearly as many transactions as say VISA. (This was even a central debate within Bitcoin some years ago and led to Bitcoin Cash, which is interesting but beyond the scope of this article) How can Bitcoin ever be a money then?
I would counter that 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 - as merely another form of digital cash - 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. And I am going to ask you to imagine something that is not precisely like anything else that has come before it. Bitcoin does not neatly fit in to an explanatory compartment and category that has already existed. It is something new, something that blends many different ideas in to one thing. So open your mind, take the red pill, and follow me to see how deep this rabbit hole really goes.
So if Bitcoin's most valuable property isn't its transaction speed, what is it? Bitcoin's most valuable property in my estimation 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 18.5 million bitcoins in existence (9/2020), and the final total will be 21 million. Therefore, in Bitcoin's entire future lifespan, there will only be an inflation of 2.5 million more coins, approximately 13.5% 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. Inflation on assets with some scarcity or cruciality of their own: Real Estate, Equities, Health Care, Insulin, Gold, Ivy League Educations, etc... And it's part of the reason why the average American is struggling. Bitcoin is simply the best way to save. Because of the scarcity, Bitcoin rewards savers more than any other asset ever has.
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. A Saver's asset. 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, at 10 years young. 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. Also, the more valuable Gold gets, the more incentive there is to mine it. And betting/more mining means more Gold. So even though Gold is scarce, it is not as scarce as Bitcoin. It is impossible for Gold to be as scarce as Bitcoin. Thus, Gold is NOT as good of a Store of Value as Bitcoin NOR as useful as a monetary asset.
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, backs it, and collects it for taxes, 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 monetary instrument that man has created to this day. It is also 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, if you choose to privately store and maintain your Bitcoin. And that is an important distinction I am making here - CHOOSE. Bitcoin will have the level of security that its owner chooses. There are increasingly easy and safe methods to store your Bitcoin in other solutions. You will lose some of the absolute security I've previously discussed, but gain in ease-of-use and defense against personal carelessness.
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.
And while Bitcoin has all these properties, it is increasingly becoming easier to invest in Bitcoin or speculate on it, without having to own it yourself. Today there is the Grayscale Bitcoin Trust, GBTC, and a growing number of options to buy, sell, and store Bitcoin. Therefore, many of these properties are scalable to the level of security and ease of ownership that you desire. Thus, Bitcoin can be different things to different people.
When you survey it all together and take it in - you are logically forced to admit that Bitcoin just might be the greatest asset that we have created. The only thing holding it back at this point is simply the acceptance of it by people around the world. After all, an asset needs to ultimately as widely accepted as possible - otherwise its value becomes limited. 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.
In the chart above, you can see the similarity between Bitcoin and what a network growth model would predict with a logarithmic growth curve. The upper and lower bounds in red and green resemble a wide log function. I put in horizontals for the current ATH of approximately 20k, the PlanB predicted valuation of 55k for this halving cycle, and another at 100k (just cuz). The vertical blue lines represent the 3 previous halvings & the future one in 2024. I do believe the halvings create a somewhat cyclic element to the growth of BTC due to the clear effects they have on supply.
Also, this network concept has many interesting parallels as an investment. Tech companies like Google, Facebook, Amazon, Apple - are all essentially networks. Google w/ search, Facebook w/ family & friends, Amazon w/ digial shopping, Apple w/ dematerializing things in to the phone. Once these networks grew to a size of 100B, had the majority of market share - they then continued to progress from there, increasing 10x or more as they went on to peerlessly dominate their respective fields.
Bitcoin is a network that pools monetary energy. That is why it is growing as a network growth model would predict. It currently has a market cap of over 200 Billion, and represents over 92% of the SoV market cap for crypto coins (and over 60% of total crypto dominance, although most other coins are designed for specific application purposes and IMO don't compete with Bitcoin)
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, a seminal paper discussing Bitcoin's value which, despite being 3 years old, is important, timeless, and I would highly 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. 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. While I don't necessarily agree w/ the very long-term implications of PlanB's price estimation model and think there is likely divergence, I think it is a very interesting look and take on scarcity and interesting for price implications for this current cycle.
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. "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. 10 million on a Trezor, ready to go in your pocket, instantly, anywhere.
Just recently a NASDAQ listed company, Microstrategy MSTR, purchased over 38,000 bitcoins for over $400 Million US Dollars, deciding to invest in Bitcoin as its Primary Treasury Reserve Asset. **Article**
Square invested $50 Million US Dollars for the same reason. On October 21, a UK firm Mode put 10% of its cash reserves in to Bitcoin. And PayPal announced on the same day that it will allow its 350 million users to buy and spend Bitcoin.
So not only are private investors deciding to buy Bitcoin, but now legitimate companies are joining the fray.
Today, Bitcoin is the 35th largest currency in the world as calculated by Marketcap size, *here*
And now imagine one day in the future, when Bitcoin is multiples larger in size. Say 10x the current price, which would place it 9th on the Fiat Market Cap, behind the CAD and ahead of the HKD. In this world, Bitcoin is likely legally accepted worldwide. It's been established as secure for even longer, with even more trust in its security that relies on no central authority or individual. There are BTC ETFs. It has legal regulations and rules. Many individuals, institutions, and companies are owners. Next up, countries. Bitcoin makes the move towards being an international reserve currency, as countries want exposure to an asset not controlled by any one country and that country's financial policy. From a Game Theory perspective, I believe this is inevitable. It is a matter of when, not if. And Bitcoin is likely the answer. New customers have stepped up with obscene purchasing power, and the hardest, scarcest asset ever continues to rise. The farther Bitcoin goes, the more likely it keeps going. Momentum. Lindy.
The biggest hurdle currently, in my view, is legal clarity in the USA. I believe many large banks are taking a conservative stance on Bitcoin due to the lack of full legal standing as an asset, commodity, or currency, and are waiting for further clarification by the government. Part of this process involves increased regulation on trading, on clarity for Bitcoin ETFs being set up, etc... that happening would be a huge step in the right direction for receiving the US Government's blessing. All eyes for this are on the SEC, and especially who is the Chairman. Right now, it is Jay Clayton, who hasn't been friendly to Bitcoin ETF proposals. But, he will be replaced in 2021 by the next President. I would make the argument that the freeroll of replacing Clayton alone from electing Biden should likely be the primary economic consideration for any decent crypto holder. Trump likely = 4 more years of Clayton.
When trading firms 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) - it will open up easy access to all the money private investors hold in their brokerage accounts, especially tax sheltered money. To get an idea of how bullish this might be, take a look at gold when ETFs opened up in 2003.
While it likely isn't reasonable to give all of the credit to ETFs for this price explosion in gold, I do think the new ease of speculation and opening of demand channels played a part. For Bitcoin, not only would an ETF have the same effect on demand channels - it will additionally be a type of legal blessing and legitimacy as well, which was impossible to bestow on gold.
I believe that now that this idea is out there, something will become a decentralized, digital Store-of-value, unit of account, and currency as expressed as a monetary network. 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 firstly that most of these coins are being designed for specific applications, and because of this will always be inferior to Bitcoin in terms of only being a secure monetary network. Also, 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.
And exactly Bitcoin's status as the oldest, largest, most reliable, secure, resistant to change, defended by users Crypto - is exactly why it is the best Crypto to be the dominant, digital, SoV monetary network. And why another one won't replace it.
REMEMBER: Bitcoin is a network that pools monetary energy. That is why it is growing as a network growth model would predict. It currently has a market cap of over 200 Billion, and represents over 92% of the SoV market cap for crypto coins (and over 60% of total crypto dominance, although most other coins are designed for specific application purposes and IMO don't compete directly with Bitcoin)
Bitcoin has already won the race to be the dominant, digital, SoV monetary network IMO. Now is a matter of that playing out.
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 long-term 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 or 10 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. Bitcoin is already speculating on whether or not "crypto" will work out. But additionally, most of the cryptos do nothing today and are additional speculation plays on their use case working out AND winning the competition game within their domain. All of that on top of the "crypto" speculation play that you are already making when investing in Bitcoin. Thus, in a situation where Bitcoin is already a high-risk/high-reward play that is quite speculative, I think (often times greatly) increasing the risk, in order to possibly increase the reward - usually makes for a poorer investment (and poorer Sharpe Ratio). This is essentially the argument for a 100% Bitcoin Crypto allocation.
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 2-5 year price target of 50-120k. But really, once Bitcoin is there - I would be wary of selling, because now due to the momentum / Lindy effect, it is probably extremely likely to continue growing to a more fully realized MCAP/price even higher.
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 2-5 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. -- 2020 has shattered this claim up till now -- That said, it isn't clear to me that Bitcoin needs to be correlated with equities markets, and thus at any point going forward I wouldn't be surprised if this correlation ceased.
Other good Bitcoin resources:
Light & Su Zhu on Art of Trading - Uncommon Core podcast w/ Hasu 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