An Update On The Role Of Bitcoin

Digital currency acceptance among the general population has made great strides since we last wrote about it in 2017. Many have predicted that governments will adopt digital currencies as a better way to track and influence currency supplies. This government adoption is happening in China as we speak. It will likely happen in the US in the not too distant future. It’s often difficult to get a balanced read on the state of crypto given there are so many fanatical supporters. Here is a balanced update on the role of bitcoin and cryptocurrencies as they stand today.

(*Disclaimer – this is not advice to invest in crypto – especially for legal and compliance reasons. Please contact me directly if you’d like to discuss in more detail. In the meantime, I’ll offer up my current opinion, which could change at any time for any reason.*)

Which crypto?

It’s tough to get an honest take on crypto. Many people who own a lot of Bitcoin will endlessly argue that it’s the future. Unfortunately, those arguments are deeply biased towards their own financial interest. 

Coin Market Cap can show you the existing market caps of all available cryptocurrencies. Given that the currency is made up of code, most other “coins” are copies of the original code with small tweaks introduced. None have accumulated assets approaching Bitcoin. I’m a believer in the power of the first-mover advantage which means I’m only interested in Bitcoin as the first, largest and most recognizable cryptocurrency. 

Facebook tried a digital currency, Libra, last year but regulators did not like an association with any company. Facebook made all reasonable concessions but Libra was not accepted. This strengthens the case for Bitcoin because there is no identifiable backer for Bitcoin for a government to shut down. 

The next big run is probably here 

There are two main reasons Bitcoin will likely do very well in the coming months, if not years. The first has to do with authority, the second has to do with access.

Authority: On Monday, Stanley Druckenmiller said on CNBC that he is a Bitcoin investor and believer. Last month, Paul Tudor Jones offered his bullish thesis for Bitcoin on CNBC. His reasons have to do with inflation protection and most importantly, the “enormous contingent of smart and sophisticated people who believe in it.” Nassim Taleb calls Bitcoin a tail risk hedge – which means owning a small amount is useful if wild and unpredictable scenarios were to unfold, as they often do. 

These three people have huge audiences and millions of people take their authority seriously. Even if you don’t follow these people or their opinions, many others do. More public converts are likely to follow.

Access: In order to buy bitcoin ten years ago, you had to be a sophisticated technologist. In 2013 you needed obscure exchanges. In 2017, Coinbase became mainstream and opened another door for people to buy Bitcoin via an easy to use mobile app. Starting last year, you can buy bitcoin via a simple Robinhood brokerage account, but that’s pretty much the only brokerage that offered it. 

Today PayPal is starting to roll out cryptocurrencies to its consumer base. It’s important to note they have 346 million active users. Traditional brokerage firms like Schwab and Fidelity will be offering easy access to crypto sooner rather than later because the demand is there.

Network effects

Bitcoin is a network. Networks are valued by squaring the number of participants (Metcalfe’s law), which means additional users add exponentially increasing value. 

Somewhere between 25m and 50m people hold bitcoin globally. If that were to increase to 100m at some point in the next few years, you would likely see a 15x increase in the value of bitcoin. Seems extreme? That growth curve follows the same one that many tech companies have experienced along with user growth. Exponential math is powerful and never intuitive. 

Interesting features of Bitcoin

Some people will always want to avoid crypto as “voodoo”, which is a perfectly legitimate opinion. Here are some interesting Bitcoin features that add value to Bitcoin:

• Bitcoin is decentralized. It’s owned and maintained by its users.
• Bitcoin is the only method available to transfer a person’s entire net worth out of a country anywhere in the world. Citizens of oppressive governments can transfer 100% of their assets to bitcoin and access it later in another country. No bank would ever facilitate that transaction.
• The supply is fixed at 21 million coins and 18.5 million have been created. Each participant that joins the Bitcoin network is taking a bit of that fixed supply. Scarcity creates value. That’s a central tenet of all currencies.
• You can’t hack it, for now. 100% of the hacks related to bitcoin have had to do with people stealing the passwords and key signatures to gain access. The integrity of bitcoin’s structure is not a concern today. 
• There’s no customer service. This is a fundamental problem and I’m not sure how it’s going to be resolved. Once a bitcoin is lost, it’s gone forever. If someone dies without sharing the password, there’s no retrieving that asset. It’s unknown how much bitcoin is permanently lost. Some say it as much as one third. 
• The blockchain system incorporated in bitcoin has become more common and is actively being researched as a means for automating back office financial functions.

Relation to gold

Gold and bitcoin have similar strengths as currencies. They both have a fixed supply and they can’t be faked. As governments print more money, the fixed supply of gold and bitcoin should increase in value. 

Passage of time

We are a long way from common acceptance of bitcoin. Yet, the appeal and usage of bitcoin keeps growing. Bitcoin is a complex system and should be treated with caution. Bitcoin has gone through three major growth cycles over the last decade and I believe we have entered the fourth growth period for the reasons outlined above.