What Is Bitcoin Really?
- Is Bitcoin a currency, is it money?
- Is Bitcoin an investment?
- Is Bitcoin a service?
- Is Bitcoin a ‘Tulipmania’ style bubble for the 21st century?
- Can Bitcoin go above $5,000.00 and stay there forever?
I am continuously surprised at the confusion surrounding Bitcoin (BTC). Almost every article I read is written by folks who want to neatly place this medium into a category that they are comfortable with. Some want to characterize it as a stock, others as digital gold, still more as some kind of trick being played on a bunch of fools. Many correctly identify it as money but are surprised that it does not behave like other currencies because that too misses a big part of the picture. Thanks to all this pigeonholing, much is missed and public ignorance on the matter is pervasive.
It reminds me of the confusion that surrounded personal computers and later the Internet and the World Wide Web. Conversations on the topic of cryptocurrencies and blockchain technology in 2009 through 2017 will soon be seen as quaint.
Plenty of people do of course appreciate the true nature of this advancement and many of them are busily working to provide us all with innovations that will supplant entire classes of services that we use on a daily basis. Services that have been with us for hundreds of years can be disrupted by what is now afoot in this new revolution.
Is Bitcoin a currency, is it money?
Yes, for the following reasons:
- It is a store of value, regardless of the fact that it is volatile. Someone may object, stating that it could drop in value or even go to zero. For one, most of the currencies of human history have either gone to zero or been subject to inflation. As a kid in Italy, I would spend 3000 Lira on a sandwich, no economist ever regarded the Lira as anything but money, even as the price of a sandwich went from 30 to 3000 Lira over the years.
- It is a medium of exchange. I and millions of others have bought goods and services with Bitcoin. There are even places on earth like Berlin, where acceptance of this currency is becoming pervasive. Regardless of that, there are services like Xapo and SatoshiTango which will allow you to pay for any transaction in any currency with a Visa debit card and simply convert your BTC on the fly, including ATM withdrawals. This may be a patch, but more and more merchants are coming online with the option to purchase directly with Bitcoin including Microsoft and not too long ago JM Bullion which will sell you gold, shipped to your house for free, in exchange for BTC. Overstock.com will take BTC just as easily as Paypal or credit card payments for their products. So yes it is definitely a medium of exchange. Cryptocurrencies are potentially superior mediums of exchange because they have a single ledger that is accessible by all, anywhere on earth. It is borderless. I cannot buy a sandwich in Berlin with USD but I can with BTC. In San Francisco, I cannot buy a sandwich with EUR but I can buy it with BTC.
- It is a better unit of account than most currencies because it has 8 decimal places. The 8 decimal places are important for another reason which I will discuss later.
The answer is clearly yes, Bitcoin is money.
Some might say: ‘But what about the fact that it goes up so much in value? No other currency has ever done that on this scale.’
To which I would answer that it must go up in order to become a useful currency to hundreds of millions of people around the globe. In order to be utilized by a sizable population the way that other major currencies are it must grow in value to somewhere between 15 and 20 times its current valuation (from USD 4000 to USD 60,000 to 80,000.)
That sounds crazy perhaps, and I am not saying that it will necessarily happen. I am saying that for it to be a significant currency in the world this is necessary. The developers knew this of course and the 8 decimal places easily allow for this. If BTC 0.00000099 were equal to USD 0.99 Bitcoin would have a 21 trillion dollar market cap once all the coins are mined in the next century. That is not to say it will happen but its design allows for this.
Will there be a day when USD 0.99 will buy you a house? Never. Will there be a day when BTC 0.99 will buy you a house? It is within the realm of possibility.
Chart via CoinMarketCap
Well then, is Bitcoin an investment?
Bitcoin is clearly not an investment, the currency itself does not represent ownership in something that creates value and yields profits. Buying and holding BTC to see if its value will go higher is purely speculative. If it is to go higher for the long haul its float must grow fast enough to at least partially displace other currencies more and more with each month that passes. It must be accepted as tender by ever higher numbers of merchants and service providers. This is currently happening in some parts of the world where it is being used to stave off inflation and override restrictions on transfers of money. People are also adopting it in wealthier nations just to buck the banking system including their central banks.
The main questions for the speculators in this case:
- How far will it go in displacing other currencies?
- What will the user adoption rate of Bitcoin be going forward?
- Will it be displaced by a better cryptocurrency?
Unlike government issued currency, there are computer systems which anyone can purchase that do yield revenue when applied to the blockchain. One can buy Sha256 ASIC systems (fast enough ones, like the Antminer S9, which yield a profit over and above the cost of power) and become part of the network that facilitates the transactions and the process of mining the coins. These activities do yield a profit in BTC.
Most people don’t realize this but it is not just mining new coins that generates returns, there are also small mining fees built into the software that are collected from each and every transaction and paid out to the same Sha256 ASIC mining systems and their owners. If the number of transactions were to grow to the volume seen by Visa (V) or MasterCard this would represent a significant revenue stream to Bitcoin miners of the future. Eventually, once all coins are mined, this will represent the only incentive to maintain such systems other than to support the network. Competition for these fees will allow for the network to grow based on the volume of transactions eventually.
Any individual can own such devices, and whether it is profitable or not, those individuals can effectively take the place of the banks, credit card companies, and Paypal (PYPL) when it comes to the backend task of facilitating digital transactions.
Is Bitcoin a service?
Yes, this blockchain is in and of itself a service. Some are uncomfortable with the fact that there is not an underlying company that owns the intellectual property of the service. It is open source, but it is nevertheless a service and it is potentially a very disruptive one.
Just as open source Linux, MySQL, and many other open source products have provided an alternative to Microsoft and Oracle, diverting billions of dollars away from those companies. This open source service will do the same. It will take billions of dollars of transaction fees and millions of customers from a different set of companies.
Here is a small anecdote from my own life. I need to send my daughter, who is a student in Berlin, funds from the U.S.; I can do that on my cell phone using my Bitcoin wallet in seconds, no middle man, no fees. Anyone who has done this by using PayPal (PYPL), wire transfer, Western Union (WU), ATM cards is familiar with terrible exchange rates, ATM fees, wire transfer fees, and service charges. Then, for many of these transactions, it takes days for the funds to clear. With bitcoin, it is very nearly free of charge, with mining fees of a few cents. This is true for the equivalent of $10,000.00 or $100.00 transactions.
This is a valuable service for hundreds of millions of people on earth.
Is Bitcoin a ‘Tulipmania’ style bubble for the 21st century?
Tulip bulbs have very little in common with everything I have mentioned thus far, with the exception of the fact that Bitcoin can also be driven to crazy high prices by mad speculators.
Tulip bulbs do not have even a remote possibility of displacing poorly managed currencies and even well run multi billion dollar companies such as PayPal (PYPL) and Western Union (WU). Tulip bulbs cannot provide you with savings that will incentivize you to stop using banks for international wire transfers. Most Americans are not familiar with the nuisances of small international monetary transactions or high inflation problems enough to realize the value this brings to hundreds of millions of people. Talk to people in Argentina, Russia, and Venezuela about the problem they face. Consider the hundreds of millions of people working on guest worker visas around the world who need to send money home to Mexico, the Philippines, India, and Thailand.
Even banks are moving to take clearing houses out of the picture so they can save time and money by implementing a B2B blockchain currency called the “utility settlement coin” (USC) discussed in this Reuters article.
New services, such as escrow services will soon be possible all within the blockchain.
What is the tulip bulb analog for the fact that Bitcoin, purely by its design, has successfully incentivized hundreds of thousands of people to spend billions of dollars to build one of the largest computer networks on the planet? Much of the systems that comprise that network infrastructure were purchased from manufacturers using Bitcoin as a means of exchange. Admittedly it is also the most redundant system ever made with most of the hashing power dedicated to nothing more than a competitive exercise.
Just as most of the Internet now runs on open source platforms, soon a very large portion of the world’s financial transactions will run on open source platforms. If that makes you feel queasy, you will probably be a member of the early or late majority in the technology adoption curve.
Right now we are in the early portion of the Innovators phase.
- 1% of Americans are using Bitcoin, or roughly 3 million.
- 0.2% of the world population is using Bitcoin, or roughly 14 million.
At this stage, one of the reasons there is so much bubble talk is that no one is used to currencies being denominated like this:
As opposed to being denominated like this:
The valuation of 1 BTC is getting under people’s skin. Those same people need to understand that this is how you denominate a currency that is not intended to be printed in perpetuity the way that the USD is printed.
No crisis will ever cause Bitcoin’s blockchain to bump up the balance sheet by 1.2 trillion Euro the way Draghi did. No crisis can generate more gold either.
Bitcoin’s valuation growth is all about adoption rate in the long haul, regardless of speculation. If BTC goes the way of Facebook (FB) did in terms of adoption rate, this will happen:
Price of a sandwich in 2017 = 0.000503850 BTC
Price of a sandwich in 2027 = 0.000050385 BTC
Price of a sandwich in 2037 = 0.000005038 BTC
Price of a sandwich in 2047 = 0.000000503 BTC
as the number of users goes from 14 million to 1.4 billion and those same people actually keep some BTC savings in their cranial implants.
You will be telling your grandkids how you spent the equivalent of $20,000 on a sandwich back when we used to use iPhones.
Buying into the Grayscale Bitcoin Investment Trust (OTCQX:GBTC) is the height of laziness and as Andrew Left cautioned us, you are not getting your money’s worth. The exception to that may be if it is for your IRA account, otherwise follow these steps instead and become part of the system:
- Download the JAXX cryptocurrency wallet on to your smartphone.
- As a backup install JAXX on your personal computer and synchronize it with the one on your phone. This is effectively a backup.
- Apply a pin to both wallets to keep the kids from using it on the dark web.
- Take down the backup phrase onto a sheet of paper and put it in the safe in case both your phone and computer are simultaneously destroyed or lost.
- Open up a Kraken account and get verified, this takes a few minutes. Don’t bother with Coinbase, they charge fees that are ridiculous in the cryptocurrency space, and have inexplicable delays and other glitches in their service.
- Fund your Kraken account and buy BTC.
- Send the BTC from your Kraken account to your JAXX wallet so that you are the one holding it and you don’t encounter a Mt. Gox type situation if something goes wrong at Kraken.
After you have done this you can send BTC to anyone and make purchases with it, receive BTC from any mining activities you get into, and buy and sell BTC and other crypto currencies like ETH (Ethereum), LTC (Litecoin). Your JAXX wallet will hold any of the currencies mentioned above, just don’t get them mixed up. Whenever you like you can send them back to your Kraken account to trade for USD and transfer back to your bank account.
Daily USD — BTC Exchange Trade Volume
Some facts about mining Bitcoin
There is a limited supply of BTC. It is estimated that the last coin will be mined in 2140 based on the block reward halving frequency of four years.
As the value of the remaining coins grows, so does the competition to mine them. It is a processing power arms race. Mining revenue is increasing in USD terms over time despite the rate of Bitcoins being dispensed by the blockchain going down; this is due to the appreciation rate of BTC:
Daily Miner Revenue
Some of you may be familiar with Moore’s law; similar principles apply to the Bitcoin network since it is driven by semiconductors. The speed at which newer processors hash through the calculations increases over time due to advancements in semiconductor technology. For example, the current machines that are mining profitably are running at 14000 GH/s (Giga Hashes per second) whereas just a few years ago the fastest mining machines were running at one-quarter of that speed. Those older machines burn as much power as they earn in Bitcoin rewards so they have been taken offline. The newer machines run with 189 ASIC processors on board (each machine plus the power supply costs 2500$ to $3000). For comparison, your laptop probably has 4 processor cores.
In a short time, newer machines will replace these with even higher processing power. As you add chips the power consumption goes up. One of the current machines runs 24/7 burning at a rate of 1.4 kWh, enough to heat a small apartment. All of this is not very environmentally friendly of course, but printing money isn’t either.
Roughly 75% of all coins have been mined in the past, but at much lower valuations. As the price grows it pays for the processing power arms race. The coins are doled out at the same rate regardless of how many processors are working on the network. The more ASIC processors you have the more coin you make.
Naturally, as more people jump in, the difficulty of mining increases. In addition, the algorithm cuts the coins doled out per time interval in half every 4 years (a 4 year half life.) The half life combined with the processing power arms race is the real baseline that drives the price higher. Most people can’t believe that someone can consider a Bitcoin to be worth $4000, they think this must be a case of speculators gone wild. What most of them don’t realize is that if the price were to drop much lower it wouldn’t cover the cost of hardware, maintenance, and power that it costs for miners to run the network.
One-third of the coins mined are sold every day just to pay the power bill. Some of these mining facilities pay over $100,000 per month in electricity bills and that is at a rate of only $0.05 per kWh in China. The manufacturers of the chips happily take payment in Bitcoin.
If the price of BTC drops, old machines are taken offline, reducing the competition for a short time. As this happens, for a short time, more BTC is mined per ASIC until demand for BTC kicks in again paying for a new generation of ever faster, ever more power hungry processors.
People believe they are talking about something very intangible when referring to Bitcoin; like it is just a silly idea that is out of control. What they are missing is that it has an underlying infrastructure that has more processing power dedicated to it than any other application on earth.
Can Bitcoin go above $5,000.00 and stay there forever?
This is a distinct possibility. I could say the same about $20,000 and much higher figures as long as the market adoption rate keeps up with the price. At the moment, with a total market cap of 70 billion dollars, if Bitcoin has any future at all as a service and as a currency then this is just the beginning.
DISCLAIMER: Be a responsible person and make your own decisions about where to put your hard earned money. I am not a financial adviser and this is not financial advice.