#HODL
As a surprise to absolutely no one, I like Bitcoin.
To understand Bitcoin, we really need to zoom out and understand money.
What is money?
Let’s start with an example.
If I am raising chickens, and you are making shoes, money allows us to transact with one another in a simple way. Only being able to interact with one another when you happen to want chickens (or eggs) AND I want shoes at the same time is very impractical. One solution to this would be to start a ledger between us, where we keep track of how many various eggs and chickens I’ve given you, until it comes time that I need new shoes. However, this system has some flaws. Primarily, I need to trust that when it comes time for me to say “I need shoes,” that you’ll provide them. This isn’t a huge problem at the relative values of shoes and chickens, but could become problematic if instead I sell houses in the Bay Area. That’s more shoes than I could ever want.
Rather than keeping the ledger, we could instead agree to generic IOUs that we’re confident can be redeemed not just through one another, but through anyone in society. My “6 chickens of value” ticket could be used to buy me some fresh produce, without having to coordinate the individual wants of the cobbler, the gardener, and myself.
Over time, these generic IOUs have taken various forms. The most common have been metal coins, gold bullion, unique paper, and digital money (such as the account balance you see when you log in to your bank’s online banking site). In this list there are a mixture of state-sponsored moneys (coinage, paper dollars, digital dollars) and commodities (gold bullion).
With state-sponsored moneys (or “fiat money”), the actual value of the thing you are holding is likely much less than the “official value” in society. No one can make any money taking $20 bills and selling them for the paper they are printed on, as the paper is much less valuable. What gives the $20 bill its value is the belief that any shop or restaurant you walk into will give you $20 worth of goods or services in exchange for that piece of paper. This system can work fine, but we should realize it requires mutual trust that the $20 bill is worth something. This equates to trust in the system that produces those $20 bills and mandates their acceptance, which we can simplify as the state/government. This is clear, as a $20 bill is likely not acceptable in a foreign country.
With the commodity, there is no “official value.” There is no $20 bill of gold. The value is dependent on what others are willing to pay for gold. This means that instead of trusting the government, you are trusting the market. People are constantly betting whether the price of gold will rise or fall based on whatever is happening in the world, how much new gold is being mined, and what other opportunities exist to get a return on investment other than holding gold and hoping the value will increase.
Money has a few primary functions, which we can review using the examples above:
Medium of exchange—This allowed us to swap goods for “money,” rather than having to swap goods for goods (which is extremely impractical), and rather than keeping a personal ledger of IOUs between just the parties of a transaction (which would limit how much trade the parties would do, as one would likely not want to keep extending credit to the other if they didn’t have a need for their particular services).
Store of value—Swapping goods for money only works if you believe the money will hold its value. If I give you $20 for a case of beer, you want to be sure that next weekend $20 will still buy a case of beer. If next weekend prices went up and you could only buy half a case of beer, you would stop giving beer away for money, as the beer is holding its value better. Generally, money is a better store of value than durable goods, which can expire or lose value through use (such as driving a new car off the dealership lot, or wearing socks until they have holes).
Unit of account—This is a fancy way to say we can talk about things in terms of money. It’s a common denominator for goods. I can easily compare the $100 I’m offered for a gig job to the $20 meals I want to spend that money on.
There are certain criteria that we can evaluate to determine if a potential “money” would do a good job at fulfilling these functions:
Durability—Will the money degrade over time? With dollars, this could mean surviving the washing machine. This is one reason why bananas would make for a poor currency.
Portability—Can you get the money where you want it? With dollars, generally yes for day-to-day transactions, but it’s more difficult for larger or foreign transactions. Digital money makes this easier, but again is subject to some archaic restrictions on where money can be sent and during what hours.
Divisibility—Can you transfer only a fraction of the money? For dollars, you can get down to $0.01 in physical money, which is a fairly good approximation for “no value” in day-to-day life. However, when paying in cash, sometimes the cashier doesn’t have exact change, and you need to either eat the (minor) loss or use a different payment method.
Uniformity—Is all the money the same? Every $20 bill is equally valuable, assuming it isn’t a counterfeit.
Limited Supply—Do we know how the money is made? With United States Dollars (USD), we trust the government and Federal Reserve to print new money at a responsible rate, such that our existing money operates as a decent “store of value” (from above) and maintains its buying power.
Acceptability—Can you spend the money where you want? The government guarantees you can spend your dollars anywhere you want, within the country.
What is bitcoin?
Bitcoin is a digital currency built on blockchain technology (specifically the Bitcoin blockchain). Blockchains are a brilliant mathematical way to create “digital scarcity,” and Bitcoin is the first application of blockchain technology.
Due to the blockchain technology, these bitcoins can’t be “copy pasted” like most digital assets could in the past. While we’ve had online banking for a while now, we were trusting the bank to do to proper accounting. Our account balances are just numbers stored in their databases. If you were to log in and disagree with how much money the bank said you had, it would be a difficult process to prove you were correct, even if you kept your own ledger of transactions (and didn’t rely on the bank’s version).
This means we can know exactly how many bitcoins exist at any given time, and how many have yet to be created. There will only ever be 21 million bitcoins.
This is different from fiat currencies, like USD, of which the total amount can increase based on the will of the Federal Reserve. This is also different from commodities, like gold, of which the total supply being added to circulation is based on both market conditions and on the physical properties of the Earth.
As bitcoin is not state-sponsored and has no “official price,” it’s a commodity. As stated above, it’s a unique commodity in that its total supply is fixed, and its rate of creation (adding supply up until the 21M maximum) cannot be impacted by market conditions.
Why bitcoin?
Bitcoin has stark advantages over both fiat currencies and the most popular “store of value” commodity, gold.
Going back to the criteria of money:
Durability — The entire bitcoin blockchain ledger is replicated on every computer running the bitcoin software, which is now over 10,000. This makes bitcoins extremely durable.
Portability —You can send bitcoins to any bitcoin address, anywhere on the globe, within approximately 10 minutes. Importantly, being able to access and send your funds doesn’t rely on any centralized authority such as a bank or corporation. Bitcoin is self-governed and the transactions are peer-to-peer. This makes bitcoin censorship-resistant, in that transactions cannot be blocked. This is extreme portability.
Divisibility — Bitcoin is divisible to the hundred millionths place (0.00000001 bitcoin).
Uniformity — Bitcoins are all uniform from a technological perspective. Since the ledger is transparent, it’s possible to see if certain bitcoin have been used for illicit transactions in the past, and there could be social reasons not to accept that bitcoin or to make the owner of that bitcoin (if known) a pariah.
Limited Supply — Bitcoin has a mathematically limited supply of 21M bitcoins.
Acceptability — This is coming. In its early days, this was a complete no. You could only spend bitcoin within the small bitcoin community. Today, you can withdraw fiat cash from a bitcoin wallet at a bitcoin ATM, spend bitcoin via a credit card that instantly makes the conversion to fiat, or buy assets directly with bitcoin.
How to value bitcoin
All of this is great, but does that mean I should buy bitcoin?
Well. that depends on the price. When I first heard of bitcoin, at $100, it seemed worth playing around with, but was difficult to get. By the time it was easy to buy, it was over $300 and I’d felt I’d missed the mark. At that time, I had no investment thesis, and very little investing experience; I was anchored purely on the first price I encountered the asset at. I couldn’t imagine something could 3X and still be a good deal.
This logic continued… $1,000, way too expensive now. $3,000, hm… I guess $1,000 was still a good buy, but now it’s certainly overvalued. $20,000?! $40,000?! Okay, I should look into this with more rigor.
A simple way to value bitcoin is to compare the entire market capitalization of bitcoin with that of gold, a commodity used for similar reasons, but that bitcoin outperforms across all criteria.
The market cap of gold is ~$12T. According to online estimates, 11% of that value is based on industrial applications of gold (based on its physical properties, for use in jewelry, manufacturing, technology). That leaves a $10.5T market cap for gold as a “store of value.”. If bitcoin were to reach that same $10.5T market cap, knowing there will only be 21M bitcoins, that puts a price per bitcoin of $500K.
I would consider this a very conservative estimate, as more than just gold could be replaced or supplemented by bitcoin. Governments have begun to make bitcoin legal tender, driving adoption for everyday use. Companies are buying bitcoin as a store of value to pad their balance sheets, fulfilling a role that bonds may have done in the past. Investments in underperforming bonds could also shift to bitcoin.
For all these reasons, bitcoin is a good buy at its current price. That’s not to say it will only be “up and to the right” from here—there will be volatility. However, most of the risks to bitcoin are being overcome as it persists through more challenges and gains more mainstream adoption.
Why now?
Even with the astronomical price target of $500K, what makes bitcoin a good buy now?
Inflation — In the US, everything is getting more expensive. The Consumer Price Index (CPI) is 7.9% for the past year, with energy prices up over 25%. Home prices are up over 20% in many popular cities, and the stock market is trading at a 20-year high price-to-earnings ratio. This means the goods, services, energy, and shelter we pay for to live our lives is all getting more expensive at a rapid clip.Putting money into a store of value that appears to be undervalued, rather than overvalued, is attractive.
Government Censorship—In Canada, the government recently prevented certain citizens from accessing and spending their private property. This was done without due process, by putting pressure on private businesses to comply and cut their customers off from their assets. This overreach was in response to private citizens funding support for a peaceful protest causing logistical and supply chain issues. This shows the need for a censorship-resistant money that does not rely on trust in centralized authorities.
War—In both Ukraine and Russia, individuals are fleeing the country, bringing what assets they can. Bitcoin is an asset that you can bring anywhere, either using a small piece of computer hardware, a physical copy of your keys, or even by memorizing your keys (long passwords that proves your ownership to certain bitcoins on the blockchain). Russian citizens were temporarily deeply affected by an almost 50% drop in the value of their currency. While that has now recovered, it shows the value in storing value in an asset that cannot be devalued by the actions of your government.
On a moral standing, the need for a sovereign asset that cannot be manipulated or censored by centralized authorities has never been more clear.
On a financial standing, bitcoin has a low opportunity cost. While most assets appear overvalued, Bitcoin is undervalued. As such a simple and available investment, it likely belongs in most portfolios.
It’s worth nothing that assets denominated in USD (or any fiat currency) need to overcome the inflation rate to even break even in spending power. In the most bullish case for bitcoin, you never need to convert back to a fiat currency, as its adoption continues towards being a global reserve asset.
Conclusion
Bitcoin is an asset that has better commodity features than gold, is more resistant to inflation than your local fiat currency, and can’t be taken from you by any authority (except under direct duress, such as demanding your keys under threat of violence). Bitcoin is only growing in popularity and adoption, and there is a solid investment thesis that helps give context to the current price.
If you’re interested in this space, now is the time to DYOR (do your own research). I’ve provided some resources below, as well as common questions. If you have questions I didn’t address, please let me know!
Common Questions
Isn’t it risky to store that much money on a computer? If my computer crashes do I lose my money?
No!
Your money isn’t actually stored on any physical computer. The ledger of bitcoin transactions is stored across all computers running the bitcoin software. Trying to erase this ledger would be like trying to turn off the internet.
What you really need to hold on to is private key. This is essentially the password to your wallet (bank account). This will be a set of 12 words that you could write down on a piece of paper, that you could etch into a steel plate, or that you could memorize (bitcoiners would recommend you NOT store that private key online, as that could be hacked). That private key will prove your ownership to certain bitcoin on the blockchain, from any device you’re able to access.
Doesn’t Bitcoin use too much energy?
No!
First of all, we should be adopting an abundance mindset for clean energy. As we continue to harness clean nuclear and solar energy, energy should not be a constraint on our lives. Setting that aside for a moment…
The existing global financial system uses a ton of energy! There are the office buildings, commutes, computers, and person-hours/lives spent pushing the bits around. The status quo is not an energy-neutral
Additionally, why would we police energy for just this one usage? The military-industrial complex uses a lot of energy, Hollywood uses a lot of energy, space tourism uses a lot of energy. Every conceivable thing you want to do uses energy, and none are disallowed based on their energy usage. Implementing the as-of-now best imagined way to secure private property seems like an exceedingly valid use of energy.
Can’t criminals use Bitcoin?
Yes!
But why would they? Today, most Bitcoin transactions can be traced back to a “wallet,” as there is a digital signature in the blockchain of where the funds came from and where they went. The receiving wallet can be blacklisted, and the criminals would have a tough time spending those funds or converting back to their local fiat currency.
It would be much more practical to use large quantities of entirely untraceable physical dollar bills.
An additional point here is the ever-popular “Terrorist vs. Freedom Fighter” argument. “Criminal” depends on your perspective, and a censorship resistant currency would benefit both the law abiding and the vigilantes. While today the United States can sanction another country and diminish their access to assets, in a Bitcoin world this would be more difficult or impossible. That’s a cost reasonable people can disagree about.
Isn’t this insanely complicated? How will my parents use this? What if I appreciate that I can reverse a Venmo transaction if it’s a scammer?
Valid points!
My version of a crypto-utopia is not everyone living extremely inconvenient but highly secure lives requiring deep technical expertise. The ideal will be somewhere in between. Right now, there are many people working to improve the user experience of bitcoin; some via work on the bitcoin protocol, some via private companies that may offer certain conveniences at the expense of security.
One example improvement is a “multi-signature” wallet where you hold two sets of keys and a bank-like private institution holds one. Moving your bitcoin would require two keys, so you’re free to not use the bank at all. However, if you lost a key, or wanted to store one key in an extremely inconvenient place (to prevent it from being lost or stolen), this bank is now offering a service by being the co-signer for you when they can verify your identity.
The benefit of a financial system based on bitcoin is you’ll have the choice of how to participate. You could live will all the conveniences of your life today, but without all the constraints. You’ll be able to “opt out” from anyone you’d rather not do business with. Today, you can only opt out so far. You can’t send $50 to your friend in another country without playing by someone’s rules, especially not in a way that they can make use of it.
What about other cryptocurrencies? Ethereum? NFTs?
That’s a whole other post.
Additional resources
Bitcoin common misconceptions — 2 hour podcast serving as an introduction to Bitcoin; November 2020
Bitcoin fear, uncertainty, & doubt (FUD) — 60 min podcast discussing common questions for people new to Bitcoin; December 2021.
But how does bitcoin actually work? — 30 min YouTube video; July 2017
Freedom to transact — Twitter thread on the freedom to transact, in response to the Canadian confiscation of assets without due process, as part of the trucker’s protest; Feb 2022