The Case for Bitcoin
Bitcoin reached a new all time high of $66,000 today, following yesterday’s listing of the first bitcoin futures ETF in the US. Despite the price action, the fundamental case for owning bitcoin is still very strong. Bitcoin is potentially better money because you can’t print more of it, nobody can take it away from you and you don’t need a bank to send it. Bitcoin is a good plan B because the existing monetary system is outdated and arguably needs an upgrade. Sooner or later, everything will become digitised and automated, including money and assets.
Printing and QE keeps nominal rates low and real yields negative, increasing the appeal of real assets with a zero or positive rate of return.
Nominal interest rates will have to stay low for longer/forever because of rising debt levels. Governments, companies and borrowers will go bankrupt if the cost of servicing their huge debt loads increases. This creates a vicious circle as debt goes up more because money is cheap. Low interest rates also promote inflation, which is the model governments prefer, because it reduces the debt in real terms or as a percentage of the overall money supply, and encourages everyone to spend. It is also a stealth tax, because it is much easier to implement than austerity, increasing taxes, borrowing more or defaulting. Printing and QE keeps nominal rates low and real yields negative, increasing the appeal of real assets with a zero or positive rate of return. The Fed's balance sheet, already having expanded from $1 trillion in 2008 to $8.5 trillion now (40% of GDP), could breach $10 trillion or more. 35% of all US dollars in existence were printed in 2020.
As Dan Morehead from Pantera Capital states: ‘The unlimited printing of money will push up the price of things whose quantity cannot be increased.’ Bitcoin is not so much a hedge on inflation, as it is a hedge on inflation being higher than nominal rates (resulting in negative real yields) and the long term debasement of fiat currency. We can argue all day about CPI and whether it is transitory, under-reported or misrepresented. Rather, monetary inflation should be the key metric to watch and US M2 is currently +13% yoy. That is the real inflation print and the number how much cash is being debased by. The unit of account is being stretched out, so you need more money to chase fewer goods. Bitcoin, unlike fiat currency, cannot be stretched out by printing or inflation, because it is not controlled by a government and has a fixed supply. Our research on bitcoin and inflation is published here.
Bitcoin is the digital application of sound money principles, whereas gold is the analog application.
The narrative for gold is similar, but bitcoin arguably fulfils the store of value function better, because it is scarcer (gold’s annual inflation rate is ~1.5%), and is more verifiable (harder to fake), transferable and divisible. The other big difference is that you can’t ramp up the production of bitcoin if the price goes up, like with any other commodity. Demand is the only variable as the supply is truly inelastic and can never be manipulated. This, incidentally, is the main reason for the volatility, as there is no self-correcting mechanism. There will only ever be 21 million bitcoin no matter what anybody tells you. Therefore, if there is more demand, the price has to go up. Bitcoin is the digital application of sound money principles, whereas gold is the analog application. This has arguably been the impetus for bitcoin's rally from $5,000 in March 2020 to today’s new ATH of $66,000, coinciding with the extreme money printing and driven by institutional demand from MicroStrategy, Tesla, Square, Paul Tudor Jones, Stanley Druckenmiller, MassMutual, among others. Furthermore, bitcoin can provide optionality as a potentially asymmetric and uncorrelated asset in a diversified portfolio. Research by CoinShares’ Strategist, James Butterfill, suggests a portfolio weighting of 4% for a 120 basis point risk budget, and, importantly, advises rebalancing quarterly.
Bitcoin’s killer app is that it doubles up as a payment system, which allows commerce on the internet, by solving the double spend problem. You can now send money on the internet without a rent-seeking intermediary.
However, the crucial point is that something has to have demand from being able to do something, and not only limited supply, for it to have value. There are only ten (or eight?) of my fingernails in the world, but nobody wants them because they can’t do anything, so they are worthless. While it is true that bitcoin does not generate any income or cash flows, its critics are wrong to say it will go to 0 for having no utility and therefore no intrinsic value. Bitcoin’s killer app is that it doubles up as a payment system, which allows commerce on the internet, by solving the double spend problem. You can now send money on the internet without a rent-seeking intermediary. It’s like the game of Monopoly which works because it is truly transparent and nobody is in control. Everyone is the bank which means the bank cannot cheat. This is worth briefly explaining, in order to fully appreciate the breakthrough.
When I hand someone a £5 note, it is an efficient transaction because it is fast, cheap (at least on the front end), secure and anonymous. The transaction is peer-to-peer. There is nobody in the middle complicating things. The problem arises if you are far away or the amount of money is large. Now you need an intermediary (bank), because the transaction needs to be made digitally, usually with a wire. The bank stops me from copying the digital asset, adding 1,000 zeros to the end of the number and sending it to 10,000 other people. This is called double spending and would result in a fraudulent transaction. The bank stops the double spend by verifying my identity and validating that the funds are in my account. Bitcoin’s technology (Blockchain being one of the key components) enables the same function and lets you send digital money in a peer-to-peer manner, like that original cash transaction. This is why bitcoin is often called digital cash for the internet or money without a bank. This means that all assets, similar to information on the internet (PDF’s, photos, emails) which you can copy and send to many people, because it has no value, will become digital. Your financial assets will live on your phone and sending them will be as simple as sending an email (in turn a letter that was digitised). If you would like to learn more about Bitcoin the protocol, Bitcoin the network or bitcoin the asset you can access Knowledge Bytes, our guide to understanding Bitcoin.
...the more people use it, the more valuable it becomes. Bitcoin is a network where energy is converted into security.
So, you now have something which is scarce, useful and not controlled by anyone (decentralised in crypto parlance). This combination has the potential to be very valuable. In my mind, I don’t really have to think about the scarcity and the utility as they are constant and cannot change. The big variable or delta is how many people might end up using it. This is what people call the network effect and is already quite large (~200 million bitcoin wallets, ~100,000 nodes running the software, $1.2 billion market cap). This network could become much larger still, as younger people start replacing older ones. Michael Saylor, CEO of MicroStrategy, talks about dominant digital networks and how hard it is to disrupt them once they have critical mass. Apple is the dominant digital mobile network, Facebook the dominant digital social network, Google the dominant digital information network, Amazon the dominant digital commerce network etc, and bitcoin is the dominant digital monetary network. In other words, the more people use it, the more valuable it becomes. Bitcoin is a network where energy is converted into security. There then arises a positive feedback loop between cost (of electricity) and security (of the network) which the market reflects through price.
The above mentioned cost of electricity that miners have to use, brings us to the environmental issue. This is a complex topic, on which CoinShares’ Head of Research, Chris Bendiksen, has written an excellent report. Yes, bitcoin uses a lot of energy and it is a problem. However, that is the trade off for being the most secure network in the world and for never having been hacked. Mining is energy-intensive so that it is prohibitively expensive to attack the bitcoin network. Miners are also increasingly using greener (hydro), wasted (natural gas flaring) and stranded (shale) energy and the complete exodus from China has meant a reduced use of coal. The criticism also comes from the assumption that bitcoin is doing nothing useful and is not worth the energy it is using. This takes us back to bitcoin’s utility discussed above.
Some think that Covid and the co-ordinated monetary and fiscal response which followed, will be the needle that pricks a debt fuelled bubble. A crisis, potentially larger than 2008, and ultimately a reset, will follow as the market deflates from the excesses of over-indebtedness, artificially low interest rates, QE, share buybacks, and so on. The counter-argument to this view is to keep calm and carry on. We are simply nearing the end of one credit cycle before the next one begins again shortly. Invariably, there will be bumps on the way, but governments and central banks will bail us out like always, and asset prices will revert to the mean and continue to rise forever. If you want to consider a peaceful insurance policy against these two possible scenarios, bitcoin does not seem like a bad option.
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