A letter to Investors: The Case for Bitcoin

In this article I give an ‘entry level’ overview to people already familiar with investing, as to why I believe Bitcoin is worthy of your attention. I touch superficially on many topics to provide a starting point for your own research and debunk some common misconceptions. Many of you will have heard of Bitcoin already and I ask you to approach with an open mind…

 

Why was Bitcoin created?

Bitcoin’s very first block in 2009 incorporated a message at the heart of Bitcoin’s purpose.

“The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.”

The creator of Bitcoin laid bare their opposition to bank bailouts, the moral hazard involved and set a path towards a new sound money standard. Later in 2011, the creator, who went by the pseudonym of Satoshi Nakamoto, stepped away from Bitcoin leaving it as an entirely open source form of money under no-one’s direct control.

11 years later Bitcoin has grown from a handful of extremely early adopters to an estimated 50 million users, a daily average transaction volume equal to $1 billion USD and the hash rate of the network (a measure of network security) sits near all-time highs. The current price is c. $7,000 USD per Bitcoin with a market capitalisation of c. $133bn.

 

Who values Bitcoin and why should it be worth anything?

The reason Bitcoin is valuable is because it is money, the best money to have ever existed in fact. Increasing numbers of people are recognising this by asking a question most have never asked – what is money?

Various monies have been used throughout human history as a store and exchange of value across time, space and scale. Money solves problems such as how do economic actors exchange the fruits of their labour, when

  • neither is producing a good that the other wants,
  • neither want to transact at this very moment,
  • or indeed in the quantity offered.

Seashells, cattle, wooden sticks, Rai stones, glass beads, gold and paper have all been used as money in different cultures and during different periods of history. The requisite attributes of ‘good’ money are well understood.

Below shows a comparison across Bitcoin, Gold and Fiat (government issued currency) against these attributes:

(table taken from Vijay Boyapati in ‘The bullish case for Bitcoin’)

The stand out score is Fiat money’s scarcity – F! It is not at all scarce and is created at will by governments around the world.

As well as excelling at the various attributes of ‘good’ money, Bitcoin also solved the Byzantium General’s problem – how to transfer value between two parties without an intermediary. Solving this allowed Bitcoin users the ability to transact peer to peer without requiring trust between them. It also sits at the heart of Bitcoin’s censorship resistance whereby no-one can interfere or interrupt a transaction between two parties.

 

More than just money

Bitcoin is money to a growing number of people, yet it is also more than just money – as viewed through these various lenses:

  1. Digital gold – a scarce, high stock to flow asset.
  2. The world’s first and only immutable digital asset – no other digital asset can realistically claim they are unable to be copied – like a photo or an mp3 for example. Bitcoin is absolutely unique in this sense.
  3. Payment network – a global network capable of transferring $billions of value daily
  4. A protocol – the protocol for trust-less value exchange. Just as IPv4 became the standard for data packet transfer across networks in 1983 and continues to power the internet today, bitcoin is becoming the de facto protocol for digital exchange of value. Protocols once in place are notoriously difficult to dislodge.
  5. Truth machine – An ultra-secure distributed ledger. Once information is committed to it by way of a transaction, it is permanent and unalterable for all of history.

These different perspectives chime differently with different people. Interestingly Bitcoin appeals much more to the younger generation. A United Kingdom YouGov poll in 2018 found that “one in eleven (9%) 18 to 24 year olds say they have bought the cryptocurrency, compared to one in a hundred (1%) of those aged 55 and above.”

As a digitally native audience, the idea of a digitally native money resonates. As wealth is passed down through the generations, an increasing amount of it will find its way into Bitcoin.

 

As an investor, why own Bitcoin?

  1. Asymmetric risk reward. Ask yourself if Bitcoin were to become the new global monetary standard, what market capitalisation would be appropriate? Gold has a total capitalisation of c. $8trillion at current prices. If Bitcoin were to match this, divide $8trillion by the 21 million bitcoin fixed supply and you have a price per bitcoin of $380k – 54 times higher than the current c. $7k Bitcoin price. Many would argue that this is conservative with Bitcoin eventually equalling all global monetary bases which again would be many magnitudes higher.

On an expected value calculation – you should invest in Bitcoin if you assign a higher than 1.85% probability of Bitcoin reaching golds market cap. If you are wrong, you may lose 100%, if you are right, you stand to make 5,400%.

  1. Sharpe ratio. The Sharpe ratio is a common metric used in investing to denote the risk-adjusted return of an asset. Bitcoin has a higher ratio which means that you are getting higher returns compared to other assets for the risk taken. If this continues to be the case, there’s a strong argument for an allocation to Bitcoin in your portfolio.

  1. Non correlation. Bitcoin is generally uncorrelated to stock markets. The below chart shows that Bitcoin has historical low correlation to the S&P 500. (1 is correlated and -1 is oppositely correlated). From a portfolio allocation perspective, a prudent investor wants to own uncorrelated assets. If Bitcoin continues to be uncorrelated, then owning some as part of a larger portfolio is entirely sensible.

  1. Inflation Hedge. As a finite and scarce asset Bitcoin can be viewed as an inflation hedge similarly to Gold or other finite assets such as land. With the unprecedented actions governments and central banks around the world are currently taking, there is a growing possibility of inflation or even uncontrollable inflation in the future. Owning Bitcoin may be an insurance policy against this. It is also a hedge against negative interest rates which in previous decades were considered fantasy but are now closer to reality – with interest rates now sitting at next to zero.
  2. Ownership in a new financial system. Bitcoin is a standalone and separate financial system. Global massive investment into ‘on and off ramps’ from fiat currency have been built in the last 2 years allowing greater funds to flow into and out of the Bitcoin network. If Bitcoin’s success continues however, it’s not hard to imagine at some point in the future a world in which Bitcoin becomes a standard denominator of exchange and from a Bitcoin user’s perspective, there being no requirement to interact with fiat currency whatsoever.

 

But Bitcoin is bad!

In quickfire fashion I tackle a couple of the common myths and misconceptions around Bitcoin that people may have, particularly if they are new to the space.

  1. Terrorist money. Bitcoin is pseudo-anonymous, not anonymous. It’s public record of all transactions actually helps law enforcement track bad actors in many cases. Not to mention that bad actors use all forms of technology including mobile telephony, the internet, transportation, pounds and dollars.
  2. Governments will shut it down. Bitcoin was designed with this in mind. It’s decentralised and open source, running on many thousands of nodes and miners across the globe. As the network grows, the possible forced shut down of any of them becomes increasingly irrelevant. There is no person or organisation in charge. No group or person can be coerced in any way that can stop the Bitcoin network.
  3. Bitcoin is Myspace, the next coin is Facebook. Bitcoin was not the first digital money but was the first successful one. This supposition makes even less sense if you think of Bitcoin as a protocol rather than a company. Protocols once established are difficult to replace, even when a new improved protocol is available. The Lindy effect states that the longer a technology has existed, the higher the probability it will continue to exist. Bitcoin’s 11 year track record is a hurdle any competing money would need to overcome. Finally, the network effects at this point are huge with recognition and mind share amongst consumers, developers and investors increasing relentlessly. The 11 year growth of the network explains the current high security of the network. Any competing money would need to convince possible users to store value in a less secure money – clearly against a rational economic actor’s best interests.
  4. It cannot scale. Think of Bitcoin as the base settlement layer of a new financial system. It exhibits properties of security and trust-lessness and it fulfils these properties vigorously. It could be changed at the base layer to enhance another attribute – for example increasing transaction throughput. But in doing so there would be an engineering trade off and some of the prior attributes would be diminished. Ultra-secure and ultra-fast are mutually exclusive. Bitcoin would become a swiss army knife able to do a lot of things but none very well.

But actually Bitcoin is scaling. There are improvements being made to enhance throughput at the base layer, but the majority of scaling enhancements will come at the second layer and above – these are protocols and applications built on top of Bitcoin. The lightning network is a brilliant example of this – allowing 1 million payments per second! And although still extremely secure, not as tremendously secure as a base layer transaction.

  1. Bitcoin mining uses too much energy – Bitcoin miners spend energy in mining on the bitcoin network as it makes economic sense for them to do so. They perform costly ‘proof of work’ and in doing so contribute to Bitcoins security. But compared to what does it use too much energy? Do we compare to the energy used in servicing the existing financial system or gold mining for example – which are both enormous. This misconception neglects the innovative use of bitcoin mining in reducing oil and gas field waste emissions and in enhancing business cases for renewable power generation which, often in remote locations, have difficulty in selling energy produced back to the grid. This is a whole topic worthy of further investigation.
  2. Volatility makes it worthless – Bitcoin is volatile but in the medium to long term this has been reflected in ever increasing prices. At only $133billion in value it is small compared to other asset classes such as stocks, bonds or foreign exchange which measure in the tens or hundreds of trillions. As Bitcoin grows, expect this volatility to diminish.

Getting Exposure to Bitcoin

Bitcoin is a digital bearer asset and taking self-custody of your own bitcoin at some point is important, however falls outside the scope of this article. At present you can:

  1. Buy Bitcoin on an exchange. There are many well known exchanges with Coinbase being one of the biggest brands globally and CoinFloor being a popular UK based exchange. Once purchased, your Bitcoin resides on the exchange where you have the option to leave it there on the exchange or take self-custody into your own wallet. The most secure and safest method of owning Bitcoin is to take self-custody by using a hardware or ‘cold wallet’.
  2. There are two existing funds: Grayscale Bitcoin Trust based in the United States and Bitcoin Tracker One based in Sweden. Access to these may be possible through a stocks and shares trading account/ISA/SIPP.
  3. Spreadbetting/Contracts for Difference. Companies like IG markets allow you to take a position on the Bitcoin price, albeit it with a high funding cost – so not ideal for long term holding.
  4. Bitcoin ATM. It is possible to exchange cash for Bitcoin at one of many Bitcoin ATM’s around the world, although fees can be in the region of 10%+. Note: using a Bitcoin ATM involves taking immediate self-custody of your Bitcoin.

 

Final thoughts…

Bitcoin has come a long way in 11 years but is just getting started. There is a huge community of people around the world dedicating their lives to Bitcoin. Their numbers grow and they are absolutely committed to the concept of sound money and the societal and economic improvements this will bring. Through exploring this new technology and dedicating many hundreds of hours to understanding the space, I now count myself amongst them.

Hopefully this article has provided ideas for further investigation on your own part, satisfying any burgeoning curiosity. Below is a handful of places you may like to start for further research.

 

Raoul Pal (Real Vision) and Dan Tapiero (DTAP Capital) discuss Bitcoin from a macro and institutional investors perspective https://www.youtube.com/watch?v=BtjziNDqC4E

Vijay Boyapati outlines The bullish case for Bitcoin in early 2018 https://medium.com/@vijayboyapati/the-bullish-case-for-bitcoin-6ecc8bdecc1

Jameson Lopp with a number of links to Bitcoin investment thesis’s and approaches to valuation https://www.lopp.net/bitcoin-information/investment-theses.html

‘Bitcoin for beginners’ YouTube playlist from Anton Antonopoulos – one of the space’s foremost thinkers https://www.youtube.com/watch?v=l1si5ZWLgy0&list=PLPQwGV1aLnTuN6kdNWlElfr2tzigB9Nnj

Bitcoin Wiki page https://en.bitcoin.it/wiki/Main_Page

And finally, one of the best known Bitcoin related podcasts, Peter recently recorded a season of interviews aimed at newcomers to Bitcoin. Start with the first 2 episodes and you’ll be gripped https://www.youtube.com/watch?v=RpcZ1DvCAf8