So bitcoin’s price has been all over the map this month. Are you thinking about getting in before it’s too late? Or maybe you’re thinking it’s already too late and now might be the worst time to buy?
With 2017 coming to a close I wanted to share my thoughts about bitcoin.
I’m not going to really cover what bitcoin is or how it works in this article. Here are some resources I recommend if you’re looking for a primer on bitcoin.
Frankly, understanding every detail about the mechanics of bitcoin is about as important as understanding every detail of how your car works. It’s nice to know, but doesn’t tell you what car to buy, how much to pay, or how to sell it for a profit.
The Price of Bitcoin has Exploded In Recent Years
The price of bitcoin on Jan 1, 2017 was just below $1000. The price on Jan 1, 2018 will be just below $13,500 – an enormous jump in a 12 month period. But what’s caused the dramatic increase?
- The Trump administration?
- The tax bill?
- The lack of clear alternative investment vehicles with sound fundamentals?
- Money fleeing troubled places around the world?
- Argentina is in a state of crisis – the socialist government is struggling to feed its people but there is still wealth trapped in the authoritarian state. Some Argentinians have turned to mining bitcoin with state electricity in order to feed themselves.
- North Korea has been rocking the boat, affecting both Japan’s and South Korea’s large economies.
- China continues to become more and more capitalist as hundreds of millions have entered or are about to enter an economic middle class.
- Russian elites and wealth-holders are also looking for ways to move money out from underneath Putin’s oversight.
The United States economy has had the appearance of being fairly strong in 2017. The S&P 500 had a great year, gaining 19.4%. But the S&P’s great year is overshadowed by bitcoin’s 1400% year – a ~72x better return.
*Google Finance won’t let me select 01/01/2017 to 12/31/2017 since the public markets weren’t open on those exact dates.
Now, more than ever, bitcoin has been dominating the national headlines. The naysayers have been naysaying louder than ever. The fanboys and girls have reached new levels of giddiness. And there are many more people picking teams each day.
But how do you make sense of all of this? How do you not miss out – if there’s even anything left to miss out on still. I’ve been researching the theory, the bitcoin protocol, and the ecosystem since late 2013. In February 2014, I took the better part of a month to deep-dive into the cryptography and economic underpinnings. I spent time researching the history of money, currency, and how our current monetary policy works – and doesn’t. But few people have time for this level of research, and even if they did, the stakes are much higher right now than they were in 2013 because of the dramatically higher price of bitcoin.
So how do we even answer the question “Should I invest in bitcoin today?
Of course, this beautifully simple yes/no question has an ugly “it depends” answer and that’s what this article is all about.
At this point I need to give the disclaimer that I am not your financial advisor and am not giving you financial advice. Consult your friendly financial advisor, accountant, lawyer, doctor, or dog-whisperer for advice. These are just my thoughts and what you do with them is your business, not mine.
Bitcoin’s fundamentals are there and this has been the over-riding factor that has informed my decisions to date.
- Bitcoin solves an important trust problem that fiat currencies are only getting worse about
- Bitcoin’s inflation schedule is both transparent and regular
- Bitcoin is a currency and a medium of exchange
- Bitcoin isn’t controlled by an army, ruler, central bank, or cartel
- Bitcoin can be used anonymously, protecting the privacy of users
- The balances of all bitcoin accounts are public
- Bitcoin transactions can be cleared quickly (although there’s a long way to go here)
- Bitcoin transactions can be cleared inexpensively (although this isn’t the case in December 2017 due to the huge rise in bitcoin’s popularity)
- A single bitcoin can be subdivided into 1,000,000 units (called a satoshi), meaning that 1 satoshi is worth $0.014 in Jan 2018.
Compared to bitcoin, the US Dollar has many unattractive properties:
- More dollars can be created or destroyed at any moment by the Federal Reserve Board of Governors, a group of 4 individuals appointed by the president of the United States. As of January 2018, 3 additional seats are vacant.
- Between 1900 and 2012, inflation reduced the purchasing power of the US dollar by over 96.4%.
- Excessive and complex regulations have dramatically reduced the number of banks in existence, reducing both competition for consumer’s business and the quality of products and services that banks offer consumers.
- Customers must trust banks, the Federal Reserve, the Department of the Treasury, and the Internal Revenue Service (IRS) to accurately and honestly account for dollars.
- Paper dollars were originally designed to be banknotes, paper notes that represented some asset – gold, silver, tobacco, deer skins (“bucks”).. anything that a society values. Trusted warehouses (which eventually became bank vaults) issued banknotes to individuals upon receipt of goods so that they wouldn’t have to barter the good they had for the good they wanted (for example buck skins for tobacco). These notes could be traded instead and then redeemed for the good they represented. The US dollar is no longer redeemable for anything.
Bitcoin isn’t backed by anything. How can it have value?
When I hear this question, I always like to pause and ask what’s backing any modern currency or specifically: What’s backing the US Federal Reserve Note?
Many people think that US currency is backed by precious metals like gold, silver, or even more common metals like copper. However this is false. The United States – like the vast majority of countries – left a commodity-backed note system decades ago.
Since 1971 when president Nixon pulled the US completely off the gold standard, the US Federal Reserve Note (FRN) is backed only by the trust and confidence others have in it.
Some of that trust & confidence is a result of US’s history of paying its debts – the federal government has never defaulted on its debts… except in 1790 and 1933.
Some of that trust & confidence is a result of the federal government’s assets – at the end of 2016, the federal government held assets, both financial and non-financial, valued at $5.6 trillion (table S.7.a, pg 177). While this number excludes land, federal land holdings are estimated to be worth less than $2 trillion. The total US gold reserve is – shockingly – only $11 billion. It’s worth noting that US liabilities at the end of 2016 were $18.5 trillion meaning that the net assets of the federal government is approximately -$10.9 trillion (yes, that’s a minus sign).
Some of that trust & confidence is a result of enormous US military might – the US can use it’s might to take resources from others. The United States military spends more than the next 10 countries combined (China, Russia, Saudi Arabia, India, France, United Kingdom, Japan, Germany, South Korea, Italy).
But speaking of coercion, the greatest source of trust & confidence in the dollar may be the requirement that federal taxes be paid in dollars. A taxpayer’s options ultimately come down to either 1) pay taxes in dollars or 2) go to jail. This assures a demand for dollars and therefore some sort of non-zero floor for the value of dollars.
Bitcoin also relies on trust & confidence to define it’s value. And while no government will deploy it’s army to defend bitcoin’s value, and bitcoin doesn’t collect taxes or hold assets and liabilities, there is currently tremendous demand for bitcoin.
Bitcoin’s value is primarily determined by what people think it will be worth in the future. In December 2017, so many people are buying bitcoin because they think it will be worth more in the future, the the price has rocketed up.
Will the Value of Bitcoin Continue to Rise?
I believe so. Today, most exchanges list the value of 1 bitcoin between $13,000 and $15,000. But given how difficult bitcoin still is to use and how few people understand even the basics, I believe that there will be substantially more demand for the currency going forward.
It’s easily possible for millions of additional people to become interested in bitcoin during 2018 – resulting in a huge increase in demand for the currency. This demand could drive prices upward – far outpacing 2017’s growth.
My theory is that after bitcoin’s ease-of-use dramatically increases and after the currency reaches a certain level of penetration, the growth in bitcoin’s valuation will begin to decrease.
The primary driver for bitcoin’s increased valuation since its inception has been its sound fundamentals and its increased adoption. The bitcoin protocol is far from perfect, but the protocols underlying the internet aren’t perfect either. In fact, basic security was completely left out of all of the low-level internet protocols – meaning that we’ve had to tack on security, which is never an ideal approach.
Adoption is everything. The technological inadequacies are surmountable – just as they’ve been with the internet. But if parties choose not to adopt Blockchain based currencies, then there will be no demand and therefore no real value.