Making Sense of Bitcoin
Why the new narrative behind Bitcoin’s bull run is likely to establish it as a new financial asset class
Reader’s note: This is an in-depth analysis of what is driving Bitcoin’s latest spectacular price increase and where proponents think it is headed. To get the cliff notes, just read the headings in bold.
This article assumes you have a basic, non-technical understanding of what Bitcoin is (i.e. that it’s the first completely decentralized money with a capped supply at 21 million units). Check out this visual explainer on Bitcoin if you are brand new to the topic.
Lastly, this is not investment advice — it’s just a take on a fascinating development I (and many others) have been following, albeit from the sidelines. This is my way of sharing while hopefully helping you understand “what on earth is going on” with Bitcoin.
“Is Bitcoin a bubble?”
A timeless question asked every time Bitcoin makes the news for breaking an all time high price. This was also the case back in late 2017 when Bitcoin hit $19,000 USD.
And back then, it turned out it was a bubble — to a large extent at least. Pushed by believers as “the future of payments”, Bitcoin still had serious scaling challenges that prohibited it from becoming a better payment alternative than the likes of Visa and Paypal. Once traders realized this the speculation lost its steam and Bitcoin came crashing by almost 80% by early 2018.
Fast forward to today.
Bitcoin has been on yet another spectacular run. At a price per coin of between $32,000-$34,000 USD at the time of writing, the world’s first cryptocurrency has defied the odds and blasted past the previous all time high from 2017 without much of a sweat.
A glimpse at the price starting from 2013 shows a staggering 29,000% increase, making it the best performing “asset” of the last decade. It has not been a smooth ride however, as there were clearly multiple rounds of boom-and-bust cycles with Bitcoin gaining and losing value at high volatility.
To people unfamiliar with Bitcoin’s history, the current price level may look like another obvious bubble waiting to burst at any second. But to many “Bitcoiners”, and especially die hard believers known as “Bitcoin Maximalists” (those who shun any other cryptocurrency as a foolish endeavor and a mostly misapplication of Bitcoin’s blockchain technology), that is not the case. To them, Bitcoin at over $30,000 represents the beginning of yet another bull run that, during its climax, will reach much bigger heights.
Put aside the beliefs of cypherpunks and Bitcoin Maximalists. There is an increasing number of serious investors, including the likes of Paul Tudor Jones and Stanley Druckenmiller, who believe that Bitcoin is undervalued. To get a sense, bookmark Paul Tudor Jones’s letter from May 2020 — The Great Monetary Inflation for later reading. It’s an interesting perspective from an unlikely source.
This begs the question — why is a certain, increasingly larger subset convinced that Bitcoin still has ways to go during this bull run?
Is Bitcoin about to crash like in 2017 and go back to ~$4,000 per coin? Or will it “be different this time”? Ah, those famous last words.
To understand what is happening with Bitcoin at this moment and get a clue for the short-to-medium term price, we first need to understand what has happened in its past.
Bitcoin has been going through similar boom and bust cycles in the past 8 years, every time ending at a price higher than where it started
Bitcoin has been through 2 of these bull runs in the past 8 years, each pretty much exactly 4 years apart. To properly see them, we need to zoom in because each cycle completely dwarfs the other.
The first major bull run was in late 2013, when the price grew by 90%, from $100 to $1,100 USD, in the span of months. It subsequently crashed hard, but higher than where it started — to about $250.
A very similar cycle repeated itself 4 years later in late 2017. The price again ballooned by over 90%, from $1,000 to $19,000, in the span of 7 months. This was followed again by a hard crash to $4,000.
Now, another 4 years later in the beginning of 2021, many Bitcoin proponents believe we are seeing a new cycle start. And there is evidence: The Bitcoin price has already shot above the previous cycle’s all time high in December 2020.
Bitcoin proponents believe the climax is still months away. If it resembles the last two bull runs again, their expectation is that Bitcoin will peak in late 2021 at a price north of $100,000.
What is fascinating and telling, is that there is no coincidence that these cycles are all 4 years apart. Let‘s understand why.
A key driver of these price cycles are Bitcoin’s supply “halvings” — supply shocks that are programmed into Bitcoin to occur every 4 years
Every 4 years, Bitcoin goes through a programmed supply restriction— what is known as the “halving” — where its daily added supply gets cut in half. This added supply is called the “Block Reward”, which is a set number of newly created Bitcoins whenever a new block in the Bitcoin blockchain is mined, which, on average, is every 10 minutes.
In early 2020 the Block Reward was 12.5 of newly mined Bitcoins. Since May 2020, that number was cut in half to 6.25 Bitcoins per block which reduced the rate of increase in the supply stock of Bitcoin.
Assuming no change in demand, a decrease in supply like this naturally exerts an upward pressure on the price of Bitcoin every 4 years.
It usually takes 6–15 months for the halving effect to play out, which is why we see these price cycles take place a set while after the halving occurs. For a visual illustration of the effect of a Bitcoin halving on its price, check out this great twitter thread.
Logging the price of Bitcoin shows the supposed effect of the halving on the price, and hints at which stage in the bull market we are in
A logged view of the price shows an interesting picture, and suggests that the halvings are not “priced in” unlike what conventional investment theory would tell you.
Bitcoin is still a nascent technology and a lot of buyers don’t completely understand its inner workings (which to be fair, is not not-complex), so it is not a reach to assume the market is not yet completely price efficient. To fully “get” Bitcoin from every angle, one arguably needs a foundational understanding across cryptography, computer science, economics & finance, game theory, and even history itself. If you ever wondered why Bitcoin is rather difficult to fully grasp (I certainly have), that’s why.
So these price cycles seem to repeat themselves and seem to correlate with a reduction in supply which is part of Bitcoin’s code and programmed to take place every 4 years. What about the demand side of things? After all, if demand is non-existent or even just decreasing, supply shocks alone will not raise the price.
Bitcoin’s demand has been skyrocketing thanks to interest from institutional investors
Here is one head scratching statistic: Payment services providers PayPal and Square have been scooping up more Bitcoin on behalf of their users than the roughly 900 Bitcoins that are mined every day (source). And that is not even the main source of this cycle’s increasing demand.
For the first time, we’ve seen substantial institutional money take a large position in Bitcoin. Investment funds, private corporations, trust funds, and even historically conservative insurance companies like 169 year old MassMutual have started to convert a percentage of their cash into Bitcoin.
MassMutual converted $100 million into Bitcoin. Microstrategy, a Business Intelligence software company, converted their entire cash reserves (worth over $2 billion now) into Bitcoin. Check out the growing list of institutional investors here.
Why are institutional investors suddenly buying Bitcoin?
Institutional Investors are looking for an insurance policy (a hedge) against unprecedented fiscal and monetary policy by governments and central banks
Unlike previous bull runs, the value proposition — or the narrative behind why Bitcoin should be more valuable — resonates more than ever during the current macroeconomic backdrop.
Consider two things: In response to the Covid-19 pandemic, central banks have cut interest rates to record lows (near 0%) and have created new money “out of thin air” via quantitative easing (QE) at a pace we have never seen before. In 2020 alone central banks have printed over 25% of all money— ever . Let that sink in for a minute.
Likewise, governments, which did not run at a surplus during the good economic times we enjoyed prior to the pandemic, are going head over heels in debt via debt monetization (the act of creating new money out of thin air with the help of the central bank and QE, and denoting that money as debt you owe — more on that here) to provide stimulus for a hurting economy.
“It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.”
— Henry Ford
A discussion of the merits of this unprecedented increase in money supply, the amount of debt monetization, and the low interest rates is beyond the scope of this post and the author’s expertise (although it’s questionable whether any expertise in something that has had little to no precedent can be credibly claimed by any expert), but it provides context for why investors are getting antsy about holding cash.
The need for a deflationary Store of Value to hedge against potential inflation due to fiscal and monetary policies has become apparent in investors’ eyes.
Bitcoin’s latest narrative: An inflation-resistant Store of Value
Prices for relatively new, intangible, and highly speculative assets like Bitcoin are not based on yield (spoiler: there is none) or any sort of “fundamentals” — rather, they are more so narrative driven.
That is, Bitcoin’s price is driven by prevailing (but yet to be proven) theses about its future state that drives demand and thus the price.
These narratives have changed every price cycle, and understanding how the previous narratives eventually failed, resulting in the aforementioned crashes, helps us understand whether this cycle things will turn out the same (a hard crash) or different (less severe corrections).
The 2012–2013 Cycle Narrative: Bitcoin as New, Electronic Cash
Narrative buster: At only 3 years old, Bitcoin was much too new and the surrounding ecosystem of developers, exchanges, and payment services integrations were not mature enough for it to grow beyond a proof of concept used by a fraction of very early adopters. Once the biggest exchange at the time, Mt. Gox, revealed that it has lost the keys to the majority of the Bitcoin they hold for their buyers, it and the Bitcoin price imploded, ending the bull run.
The 2016–2017 Cycle Narrative: Bitcoin as a Commercial Payment Network
Narrative buster: As Bitcoin gained more mainstream attention and more adoption as a medium of exchange (together with a more developed ecosystem that was lacking in 2013), scaling issues surfaced: due to inherent redundancies in the underlying technology (called the Bitcoin blockchain — or just “Blockchain”), transaction costs for sending Bitcoin grew prohibitively high for small, day to day purchases such as a cup of coffee. Nonetheless, speculation for Bitcoin and other newly created cryptocurrencies (known as Initial Coin Offerings or ICOs) intensified. It all again came crashing down as it became clear that Bitcoin failed to live up to its narrative as a suitable payment method for commercial transactions.
The 2020–2021 (Present) Cycle Narrative: Bitcoin as an inflation-resistant Store of Value
This time around, Bitcoin has yet again a new narrative. The value proposition of Bitcoin is, quite literally, to hold value. A Store of Value, akin to Gold. In fact, Bitcoin has properties which, its proponents argue, make it an excellent store of value:
- Bitcoin is absolutely scarce. There will ever be only 21 million Bitcoins, which makes Bitcoin deflationary money. No additional Bitcoins can be issued, and thus the value of existing coins cannot be depreciated in that way unlike other Stores of Value like government issued fiat money or even Gold (2% average inflation rate via mining). This property of Bitcoin is its most underappreciated its proponents argue.
- Bitcoin is decentralized. There is no centralized authority like a bank that controls the issuance, manages the transfer, or manipulates the price of Bitcoin by setting (artificial) interest rates. Bitcoin is a completely peer to peer solution to money that does not require a trusted third party as it is a “trustless” solution (more on that here)
- Bitcoin is easily transportable. It can be sent to anywhere in the world fast and for relatively little fees. At the moment, one can send billions worth of dollars in Bitcoin internationally in 20 minutes for a <$5 fee (even less if one can wait a bit longer). This would be unthinkable with Gold or fiat. For example, the German government recently spent close to 8 million euros just to repatriate their Gold.
- Bitcoin is divisable. Unlike Gold, Bitcoin can easily be divided into a 100,000,000th fraction of a coin (known fittingly as a “Satoshi”, after the name of its pseudonymous creator) that can be traded and owned.
- Bitcoin is secure. Bitcoin’s blockchain is the most secure in the world. To attack the Bitcoin network and effectively hijack it (known as the “51% attack”), one would have to amass computing power worth in the billions to outcompute the existing computing power behind Bitcoin. Any attacker is better off using that power to mine Bitcoin for profit which explains why since its inception 12 years ago, we’ve yet to see Bitcoin being “hacked”.
All these inherent properties give credence to the “Store of Value” narrative and explain why institutional investors and long time Bitcoin believers are still buying in at these seemingly exorbitant prices.
But the question remains, what will the narrative buster be this time? Will there be one, causing Bitcoin to crash hard again, or is this Bitcoin’s destiny, to serve the world as its defacto Store of Value in a time of abundant fiat money?
There is no obvious (or convincing) narrative buster for Bitcoin’s Store of Value proposition, poising Bitcoin to repeat the same price cycles of the past
As we’ve seen, Bitcoin has corrected pretty hard every bull run. This time around, expect these corrections to be less severe. This is because Bitcoin’s current Store of Value narrative will likely not be completely invalidated (opinion), as happened during the previous bull runs with their respective narratives.
Let’s take a look at a couple of factors as evidence for why Bitcoin proponents believe the Store of Value narrative will hold— view them as supply and demand tailwinds that result in a sustained upwards pressure on price, if you will:
- Institutional investors have long time horizons. Unlike retail investors, which were driving demand in previous bull runs, institutional investors have longer time horizons and react less to short term price swings. Grayscale Bitcoin Trust, a trust fund that holds Bitcoin on behalf of investors, holds 572,644 Bitcoins which will never be sold —and is currently on a buying spree due to investor demand.
- More and more HODLERS. Even among retail investors, there is strong evidence indicating more buy and hold Bitcoin rather than trade it (these are known as HODLERS, which is a misspelling of the term “Hold” that was memed into common Bitcoin verbiage back in 2013). The fact that no one who has ever bought Bitcoin has lost money, provided they never sold, plays a key role. There’s also something cult-like about hard core believers — and I mean that in a good way. To them, Bitcoin represents an entirely new way of how we view money and store wealth. It’s easy to part with an asset for profit; it’s harder to part with an idea. To many, Bitcoin represents both an asset and an ideal of a different future, which means they won’t easily part with their coins.
- Age — Bitcoin has now been around for 12 years without a failure or hack. Time adds credibility and with every additional year Bitcoin exists, the case for it as a new financial asset that is here to stay becomes proportionally stronger (this is known as the Lindy effect, as popularised by the brilliant Nassim Taleb). At a fundamental level, anything a group of people collectively agrees to be money can be money — there’s no intrinsic value required. With every day that passes and Bitcoin sticks around as this new type of money, confidence in it and its narrative grows.
- The current macroeconomic environment: No end to cheap money in sight. We live in a time of cheap fiat money and that will likely be the case for the foreseeable future. The US federal reserve itself indicated that they changed their approach to inflation, allowing consumer price inflation to overshoot their historical 2% target for the first time. This means savings accounts will continue to pay little to no interest, making saving money in the bank a fruitless endeavour.
An aside: arguably inflation is already here, and it is hiding in plain sight in the asset classes. When, during a pandemic nonetheless, asset prices are at all time highs across the board (stocks, bonds, real estate, precious metals, and yes — Bitcoin) our current use of the term “inflation” referring only to increases in the consumer price index (CPI) seems seriously outdated at best and deceptive at worst.
- Tax (dis)incentives. Since Bitcoin is classified as a commodity by governments in most countries, trading Bitcoin frequently introduces tax complications since capital gains taxes apply. This favours the Store of Value narrative as well, as people are incentivized to hold rather than sell Bitcoin to avoid complicated taxes. Talk about unintended consequences from unexpected sources.
Combine these reasons with Bitcoin’s absolutely scarce supply and its other technical properties discussed earlier, and the case for Bitcoin as a Store of Value becomes a strong one in the eyes of more people.
There are risks, but none seriously narrative threatening
Bitcoin is still a speculative asset however — speculation that it will become the world’s defacto Store of Value in the future. That is certainly not a guaranteed thing by any stretch.
Chances are high that a major government will yet again try to ban Bitcoin or introduce heavy handed regulation as to stifle its adoption, as Bitcoin does introduce competition to the traditional monopoly government has over money. However, such attempts won’t be that effective because of Bitcoin’s decentralization and (therefore) censorship resistance. Banning Bitcoin (China tried in 2013 and failed) is like banning the internet itself (as Bitcoin can be understood as an internet protocol like email), but surely news like this will scare some investors for a period of time.
There are also still shady practices in the non-Bitcoin cryptocurrency space (particularly with the “stable coin” Tether) which may rub off on Bitcoin purely from a perception perspective, leading to potential temporary corrections in its price.
None of these are narrative threatening however, or very likely to take place, as they don’t challenge Bitcoin’s use as a Store of Value directly. But it’s a good reminder that this space is still very early and there will be challenges (and definitely price corrections) ahead. To overcome them will still require serious conviction from Bitcoin holders. But the Store of Value narrative has made it easier than ever to an increasing number of investors to have that conviction and hold some Bitcoin as an alternative Store of Value.
Bitcoin in 2021: A new financial asset class that is here to stay?
Narratives are ways we make sense of many things in the world, and especially when there is not much to go off by, such as with nascent monetary technology like Bitcoin.
Every new price cycle Bitcoin has tried on a new narrative and its price curve, its spectacular rise and fall, provided us the information that Bitcoin did not yet find its product-market-fit (or rather, technology-narrative-fit).
In this price cycle, which is just getting started if one believes history is a guide and Bitcoin’s halvings matter, the new Store of Value narrative seems poised to become Bitcoin’s destiny. The narrative has strong support by a myriad of internal and external factors touched on in this article, without the same challenges that previous narratives had.
Investors are looking for a viable “savings instrument”, and Bitcoin might be the answer once its price has settled in the future. What we are seeing at the moment is select investors and believers make a bet and front run this future. If Bitcoin becomes as valuable as Gold for example, which has historically been the defacto Store of Value, a $500,000 price tag per coin is a reasonable projection based on Gold’s market capitalization alone (which is ~$11 trillion).
Bitcoin turns 12 years old today. On January 3rd, 2009 its pseudonymous creator Satoshi Nakamoto, who has since disappeared, mined the first “genesis” block. 2021 then will determine if Bitcoin, at 12, has finally grown up enough to become a serious financial asset class that is here to stay – and so far, it’s looking like it’s on its way.
To dive deeper into topic of Bitcoin as a Store of Value, I recommend the book The Bitcoin Standard by Saifedean Ammous, even if you never intend on getting involved with Bitcoin. It’s a fascinating read on the history of money, central banking, and the role Bitcoin could play in its future.
For a more technical understanding of Bitcoin’s inner workings, including how halvings work, I recommend Mastering Bitcoin by Andreas Antonopoulos as well as reading the original Bitcoin whitepaper from 2009 by Bitcoin’s creator, Satoshi Nakamoto. For beginner resources on Bitcoin, check out this landing page by Jameson Lopp.
And for less carefully measured analysis like this and more outlandish hot takes on Bitcoin, follow my twitter.
