What You’re Missing About Bitcoin

I find that talking about bitcoin is a lot like talking about President Trump. Either you love it or your hate it; there’s no in-between. Just so you know, I have no personal investment in bitcoin. At first, I thought it was the stupidest thing ever. Why would you pay for something that has no tangible value and doesn’t exist outside of a computer? But I have talked to many people well versed on the subject and I can tell you, it’s a little more nuanced than you think.

I’m not going to bore you with the details about how bitcoin works. I thought the whitepaper written by Satoshi Nakamoto was very helpful in understanding the technology, which you can find here. Instead, I’m going to focus on what most people are missing about bitcoin.

Bitcoin is Not a Currency

I don’t care what anybody tells you. Bitcoin is not a currency. A currency is defined as a medium for the exchange of goods and services. Very few retailers take bitcoin, which makes its use as a currency limited. Just like how gold and my beanie babies aren’t really currencies either. Yes, I’m sure I can find somebody that will exchange goods and services for my beanie babies, but in most cases, I’ll be refused service. Laughed at first, then refused service. US dollars, which are a currency, will be accepted by almost any retailer or person here in the US.

Long Transaction Times

The other issue with bitcoin are transaction times are too long. Bitcoin can’t effectively be used as a medium for exchange if it takes at least 10 minutes to process a transaction. When EMV first came out, people were upset because it took 10 seconds to process a transaction.

Let’s be honest – you were upset this page took 2 seconds to load.

And that’s assuming retailers are fine waiting for just one block to process. For larger transactions, retailers may want to wait until a few blocks are processed to be absolutely certain a transaction is valid. So wait times could be up to an hour or more!

Deflationary, Not Inflationary

Another reason bitcoin isn’t a currency is it’s deflationary, while currencies are generally inflationary. Remember all those stories from your grandpa about how a coke used to cost a nickel? A dollar becomes less valuable over time due to inflation.

As a holder of that dollar, inflation is a bad thing. But for the economy as a whole, inflation is good because it incentivizes the owner to spend it. A dollar in my pocket is going to be worth less in the future, so I better spend it now. If I buy an item from you, you’re now the holder of that depreciating dollar. Since you don’t want to lose value, you’ll go out and spend that dollar. It’s like a game of hot potato. Our economy is driven by people going out and buying stuff.

Now imagine that a dollar appreciates over time. If you know it’s going to increase in value, there’s no hurry to spend it. With a fixed number of bitcoin, it should be an asset that appreciates over time.

Is Bitcoin an Asset?

Bitcoin isn’t a currency, but is it an asset, or a store of value? Anything can be a store of value. All it takes is scarcity and demand. Let’s use gold for example. There aren’t many tangible uses for gold, but it’s widely considered to be a good store of value because since the dawn of man, people have valued shiny things.

Comic books are another good example. The first comic book to introduce Superman was sold for $3.2mn in 2014. Clearly, the paper in the comic book isn’t worth $3.2mn, let alone $0.32. So why is it worth so much? Namely because of scarcity value since there are so few mint condition copies available. Also, Superman is globally recognized. If you had a mint condition #1 of some no-name comic book hero, it wouldn’t be worth $3.2mn, even if it was the only one in the world, because there wouldn’t be any demand.

Action Comics - Superman
$3.2mn for a comic book sound ridiculous, but it’s probably a more lucrative and safer investment than anything you have right now.

Why Use Bitcoin as a Store of Value?

For many of you reading this in a first world country, it seems rather silly to consider bitcoin a store of value. Like I said earlier, gold has been considered an asset for basically forever. Land is also another good asset because they’re not making any more of that either. Why would you invest in bitcoin, which has only been around since 2008, when there are so many other good assets?

You have to remember that bitcoin is used globally. And in other countries, good asset options may be more limited. Let’s use the example of some poor girl in Venezuela. She has no faith in the government or its currency. Crime is rampant. Inflation is running at 4,000%! Hoarding cash makes no sense because its value is decreasing by the hour. She could try to buy USD on the black market, but carrying that much cash makes her an ideal robbery target. She can’t move the money off-shore because of capital controls. Bitcoin suddenly looks like a very appealing asset.

Maybe Losing 50% Isn’t Such a Bad Thing

Bitcoin prices are volatile, which is one of the reasons why I can’t invest in it and makes it unattractive as an asset. But let’s assume you knew with 100% certainty that bitcoin values would drop by 50% over the next year. You and I would have to be crazy to buy bitcoin if it was guaranteed to lose money. However, that Venezuelan girl would be buying it all day long. At 4,000% inflation, something that costs 1 bolivar today will cost over 40 bolivars in a year from now. That means her currency is going to be worth 2% of what it’s worth now, or a 98% decline. Faced with that situation, only losing half your value sounds like a dream scenario!

Many people believe bitcoin is worthless, but that’s not a guaranteed fact. However, our fictional Venezuelan girl is guaranteed to lose 98% of the value of her money if she keeps it in cash. I’d rather take a possible total loss over a guaranteed one any day.

Why is Venezuelan Inflation so High?

I’m going off on a tangent, but getting a sense of how currencies and central banks work will help to understand the appeal of bitcoin. Every country with its own currency has its own central bank, which has control over the currency.

MoS Bucks in Action

Let’s say I create my own country (it’s a tropical country) and currency, called MoS bucks. I pay my government workers with MoS bucks and it’s used by the people of my country. I have $1,000,000 MoS bucks in circulation.

Times are tough in my country and I start spending more than I bring in. One way to do this is like everybody else – I take on debt! I can borrow from my citizens or other countries, but I’ll need to pay them interest and eventually pay them back.

However, let’s say I’m a credit risk so people don’t want to lend to me. There’s a much easier way to get more money – I just print more MoS bucks! Now I have $2,000,000 MoS bucks in circulation.

But holders of MoS bucks aren’t going to like that. With increased supply, demand for MoS bucks will be lower. When I trade internationally, people are going to assign a lower value to MoS bucks, hence my currency will depreciate vs. other currencies.

In turn, when I pay for goods from other countries, I’ll need to give them more MoS bucks for the same amount of goods. Workers in my country will complain about the lower value of the currency and how imports have gotten more expensive. In turn, they’ll demand higher wages. Since I need to keep my workers happy, I’ll need to give them raises.

How do I get even more MoS bucks? Remember, I can’t raise debt because I’m considered a credit risk. So I print some more money! Now, I have $4,000,000 MoS bucks in circulation, and the value of the currency drops even more. Now, goods purchased internationally cost even more and my workers demand even higher wages. Rinse and repeat.

The Inflation Trap

This is a vicious cycle that is very difficult to end. So why do countries do this? Because nobody else will lend to them. Also printing money is an easy fix. You never have to worry about defaulting or non-payment when all you need to do is print more money. The only thing you need to worry about is finding a scapegoat for the cause of the inflation. Usually some minority group or foreigners. Those tend to be the easiest targets.

Could Bitcoin Take Hold in the US?

In the US, we have a (kinda) functioning government with a strong and reliable currency. We also have so many other assets we can buy over bitcoin. But maybe this won’t be the case forever.

If you haven’t noticed, the federal debt is over $20.6tn and expectations are for trillion-dollar deficits again, potentially as early as next year.  We’ve been able to finance this by borrowing from other countries. We can do this because the USD is the reserve currency of the world and we’re the largest economy in the world. But it’s unlikely we’ll remain this way forever. If at some point foreigners refuse to lend to our government, which is possible if our debt continues to balloon, the Federal Reserve could start printing money, devaluing our currency.

In turn, demand for assets in the US, like stocks and real estate, will decline because everything is priced in US dollars, which will depreciate vs. other countries. Also, demand for anything in the US will decline as a whole because of uncertainty around the government and our fiscal/monetary policy. Basically, we could be like Venezuela in the future.

The great thing about bitcoin is the number of coins that will ever by created is fixed, so you don’t need to worry about somebody creating more and devaluing it.

I’m painting a doom and gloom scenario here, but lately, it doesn’t seem so far-fetched. In a situation like that, owning bitcoin goes from something stupid to one of the smartest decisions you can make.

How Much is Bitcoin Worth?

How the heck should I know??? According to this article, over 20% of speculators are using borrowed money to buy bitcoin. Given the volatility of bitcoin, these speculators have very weak hands because they need to sell even with small prices declines, due to the use of leverage. This exacerbates the selling pressure in bitcoin.

To understand the true worth of bitcoin, you need to get the speculators out, so you can see how many people actually believe in bitcoin as an asset and what they’re willing to pay for it.

Is Bitcoin the Cryptocurrency of the Future?

Right now, bitcoin is the most popular cryptocurrency because it was the first. But it’s probably not the best. Newer cryptocurrencies have faster transaction times compared to bitcoin. They’re still not currencies because they’re still not widely accepted, but that could change over time. Remember, an asset only has value if people believe it has worth and are willing to pay for it. If one of the newer cryptocurrencies catches on, bitcoin could go the way of MySpace or Friendster.

But then again, sometimes people stick with what’s most popular, even though it may not be the best. So in short, I don’t know if bitcoin has staying power and neither does anybody else. If you’ve decided to invest in cryptocurrencies, you’re better off investing in a basket instead of picking one horse.

Leave a Reply

Your email address will not be published. Required fields are marked *