In response to Francisco Blanch’s analysis: “Bitcoin: a new liquid market?” Merrill Lynch, 24 July 2017
The fact that Mr. Blanch has taken the time to dissect Bitcoin as a currency is in itself monumental. The thoroughness of his analysis, respective of his deep background and experience in current larger markets, is invaluable, both as a symbol of growing maturity of Bitcoin and as a level set for where and how Bitcoin and the broader cryptocurrency space needs to mature. That being said, I did want to respectfully push back on some of his conclusions, in particular the language highlighted below that was presented in the summary of the report:
From the summary:
“(L)arge inherent risks to digital tokens such as fraud, hacking, theft, new protocol adoption, limited acceptance, and that it is not legal tender many places in the world make it an unlikely development.”
First, I want to separate two aspects of the Bitcoin system to help clarify the hacking and theft that has been happening — the Bitcoin ledger itself, and the systems / processes designed to interact with the ledger. Given my (relatively laymen) understanding of the technology, it is orders of magnitude more difficult to hack / defraud / or otherwise maliciously affect the core ledger, as compared to a centralized system (e.g. bank, corporation, etc). Bitcoin itself has never (not yet?) been hacked. Ever. It has persisted for 8+ years thus far without incident.
All of the hacks you have heard about center around the key one uses to access an account on the ledger. Each account on the ledger has its own private key needed to debit from the account. (Each account also has a public key, allowing others to credit the account by sending Bitcoin to that account). This private key is not a password; it is not replaceable. If it’s lost, it’s gone. If it’s found, it’s yours. Most of the stories on hacks / fraud center around gaining access to someone else’s private key.
When these hacks happen, it is public due to the desire to publicize an exciting story. However, the reality is that even these hacks have been incidental to the entire system. Last week, there were two hacks of Ethereum’s Ether coin totaling $37M. $30M was due to a bug in a software some people were using to store their private keys. $7M was because someone changed the public key for a fundraiser that was posted on a website, unbeknownst to the website owners. This represented 0.6% of the cryptocurrency trading volume that day. Material, yes. Catastrophic, no. The public nature of these hacks is itself a significant advantage as compared to other stores of value.
Our take is that these events are more a signal of a maturing space / nascent business processes, versus catastrophic weakness — especially when you consider the hardened nature of the ledger itself. In comparison, how often have corporate ledgers been hacked or defrauded? Or banks? The answer is not actually known, but it is likely (much) greater than one.
Mr. Blanch suggests new protocol adoption as a risk as well. I’m not sure what is meant by his argument here. Bitcoin is the current cryptocurrency leader, but our view is that by no means is Bitcoin the de facto long-term leader in the space. There are plenty of other opportunities to hedge against Bitcoin among the 800+ other cryptocurrencies available today, especially if you believe in cryptocurrencies but are not convinced a) it will be “winner take all” (my view), or b) Bitcoin is not “the one.”
Limited acceptance is not the right lens to use when determining the long-term opportunity of cryptocurrency assets. First, there are >10 exchanges around the world that will convert your Bitcoin into n other coins and/or most any fiat currency. The markets are nascent, but they exist and they are growing every day. Second, cryptocurrency assets can be used within a system; thus, the system itself accepts the coin. Of note, this is where we see a ton of opportunity and advancement happening in the coming months and years.
For example, Factom provides a service to prove the existence of any piece of data at any point in time. Banks are using it now to prove mortgage documentation compliance at the point of close. The service uses the immutability of the Bitcoin ledger to “stamp” the existence of the files into the Bitcoin blockchain. This process uses Factoids, Factom’s cryptocurrency, as a means of transaction for the service. So, the more the Factom system is used, the more Factoids are needed and the more valuable they become. This alone makes the Factoid cryptocurrency valuable, even though it is only accepted within the system itself.
Suggesting Bitcoin is not legal tender neglects a foundational aspect of Bitcoin — it is permissionless. No authorization is required to participate in any form within the system. No one can systematically prevent me from using Bitcoin to receive something in return from you. No government agency needs to “authorize” Bitcoin as a form of legal tender. Of course, governments can try to regulate / legislate, but this then makes other economies that choose to be more friendly likelier candidates for any innovation or economic development the technology provides.
The last point I’d like to make is that Bitcoin and the larger cryptocurrency ecosystem is far from static. It is very early and new ideas are being implemented every day. Suggesting that Bitcoin is unlikely to break out en masse as a store of value neglects the evolution of the protocol (and its surrounding business processes) that is sure to come in the months and years ahead. This dynamism has allowed Bitcoin to persevere and, as such, we remain bullish that this perseverance will continue.
Cofounder and Partner