- Is Bitcoin’s stellar valuation warranted?
- Is Bitcoin just the pre-cursor to better crypto?
- The challenges Bitcoin must address for success…
- This one thing will stop Bitcoin becoming a key player in modern monetary systems…
Launched in 1908, the Model T was the world’s first-ever mass-produced car. It completely reinvented transportation, replacing horse-drawn carts and ensuring the development of road networks across the US and abroad. When it was first released it retailed for $835, slightly more than the average industrial wage. At the time other car manufacturers took days to build competitive cars, yet Henry Ford was able to build the Model T in only 93 minutes by reimagining and reinventing the factory line. With economies of scale, he further reduced the cost to just $250, making it vastly affordable and thus an instant success. The car went on to be produced 15 million times before production ceased in 1927.
The Model T’s success was attributed to its “reliability, ruggedness, utility and economy-all in one machine that was eminently affordable.” Its price point was also no doubt a huge factor in ensuring its massive adoption. Throughout history, breakthrough technologies have created paradigm shifts and changed the market landscape in profound ways. Assessing these entrants and understanding the questions they pose and the degree of change they present is an industry unto itself. Get it right and you ride the coattails of the next big thing, get it wrong and you risk owning the ‘Betamax’ of all investments.
The Model T changed Ford’s fortunes and for many years after its launch rewarding it with massive market share. However, that leading edge was eventually surpassed by Ford’s competitors. Why, because the real development of note of course was not simply the Model-T but the birth of mass production and its impact on all heavy industry since.
Today, many investors seek to understand if Bitcoin is valued correctly and if it represents a good investment opportunity. No one really knows the answer to this question. I believe that Bitcoin represents enormous success as a real-world example of a distributed ledger in actual practice. I am a huge advocate of the power of blockchain and its ability to positively alter every facet of human industry. Bitcoin has demonstrated that such ledgers can be built and developed and perform useful functions. As a case study, it has been a tremendous success. Yet I also believe that it may prove ruinous for many investors. It is plagued with enormous problems, many of which may never be addressed in time to justify its value. Let me explain why.
You see Bitcoin is to money what the Model-T was to the car industry. On launch, it was revolutionary, thought-provoking, and capable of delivering profound efficiencies. But in time it was surpassed by new and improved versions which delivered advanced features and better user outcomes.
The Challenges facing Bitcoin
Let’s talk about some of the challenges facing Bitcoin and why its true market value is severely constrained. We’ll also discuss why, ultimately, its legacy will not be as a moon-shot investment, reaping early hoarders enormous windfalls, but as a technological waypoint to a world where data science, technology, and the physical world form a singularity at last.
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Innovation requires skilled visionary leadership and Bitcoin, unfortunately, has none. The old adage goes that ‘a camel is a horse design by committee’; Bitcoin is revealing more than a few humps in the form in ‘forks’ or divergent versions which, while innovative, detract and compete from the core service in equal measure.
In abstract terms, Bitcoin is a purely a peer-to-peer version of electronic cash, allowing online payments to be sent directly from one party to another without going through a financial institution. Digital signatures provide part of the solution, but the main benefits are lost if a trusted third party is still required to prevent double-spending. A solution to the double-spending problem is delivered via a peer-to-peer network. The network timestamps transactions by hashing them into an ongoing chain of hash-based proof-of-work, forming a record that cannot be changed without redoing the proof-of-work. The longest chain not only serves as proof of the sequence of events witnessed but also proof that it came from the largest pool of CPU power. As long as a majority of CPU power is controlled by nodes that are not cooperating to attack the network, they’ll generate the longest chain and outpace attackers. The network itself requires minimal structure. Messages are broadcast on a best effort basis and nodes can leave and re-join the network at will, accepting the longest proof-of-work chain as proof of what happened while they were absent.
Bitcoin is also slow, really slow. It can never serve as a form of modern money to be used by the growing number of middle classes without massive investment, reengineering, and infrastructural expenditure.
Lack of Leadership
Without a visionary leader such as Jeff Bezos at the helm, complete with massive capital and human resources at his disposal, Bitcoin has no chance of keeping up the pace. Today it is estimated that the network which runs Visa can clear 24,000 transactions per second, whilst Bitcoin can only muster 7. No, that’s not a typo. It is not even remotely plausible that Bitcoin could present itself as a network to govern monetary transactions. If it is not a credible monetary network, then what about its core function as a ‘version of electronic cash’ (stated in the original mission statement)? Without official support and massive investment, such a network is unlikely to be developed on goodwill and belief alone.
Decentralised money systems such as Bitcoin are known to sap power from governments and their Central Bank proxies. This is a delightful prospect for liberal thinkers but, in reality, it will be resisted by a multitude of interested stakeholders. The management of money flow and markets is not just a tool used by authorities to control our societies; it is the largest tool used (arguably misused) today. This influence will never be surrendered willingly. The alternative is a monetary coup and, given the lack of capital and governance, this is unlikely to happen.
Bitcoin lacks Flexibility
Fiat money’s primary purpose is not to exist as an asset class in its own right, but to animate and access actual value held within pledged collateralized assets. An entrepreneur can access cash by borrowing money from a bank, pledging his assets as security. The cash borrowed is created by the bank via its balance sheet by introducing a claim on the pledge asset. Banks are licensed by the state with this incredible power. When the money is paid back, the pledge on the asset is relinquished. This, very simply, is how money is created by banks. Once issued, money acts as a system of record for services and products that are transacted with the economy, a unit of measure if you will. It is an eloquent way to activate societies assets and allocate capital. As money is created and destroyed, it is very flexible and can be adapted to different economies. Bitcoin has no such mechanism, it cannot animate or access value held within a capital asset. This is a major shortfall and removes Bitcoin as a key player within modern monetary systems.
Bitcoin and Criminality
Bitcoin is favoured by criminals worldwide. I know that this will annoy many Bitcoins fans but it is true and must be accounted for in any analysis. This is not necessarily a fatal flaw; Fiat currency is also used by criminal enterprises. However, the extent of the criminal use of Bitcoin is eye-watering. It is estimated that 46% of all Bitcoin transactions involve illegality and that 25% of its users are involved in criminal activity. It is anticipated that these numbers would actually decrease as societal adoption increases. When monetary authorities develop their own crypto-backed currencies, addressing the limitations expressed previously, they will put pressure on Bitcoin by increasing the regulatory burden required to operate a business with it. There will likely be a report from the ‘Financial Action Task Force’, ascribing the unique risks of Bitcoin. either as a facilitating factor in criminality or a factor in financial system risk.
Bitcoin’s Price is Speculative
Bitcoin’s Price is speculative without much value in terms of actual latent utility. At a guess, I would say that 90% of Bitcoin buyers today are buying it as speculators; to simply sell at a higher price and make a profit. There is nothing wrong with this but it should not be confused with investing. It is high risk and, as history testifies, most people will likely lose money. Curiously, within this bubble, the buying narrative is very weak. There is no magic recipe, no talisman, no market of limitless possibilities. Bitcoin was lauded as the next new currency with no credible evidence. It was humorously stated that Bitcoin combines everything you never knew about money with everything you never knew about computers!
Tactically, Bitcoin faces some serious headwinds, especially as a form of money. The world of cryptocurrencies has seen enormous development in Decentralised Finance applications, where traditional functions of money are being explored. These include the ability to earn interest on your cryptocurrencies and to borrow and partake in the world of derivative style smart contracts. While in their infancy these developments have attracted many well-known early adopters and promoters such as Andreessen Horowitz. Unless Bitcoin can be engineered to avail of such opportunities it may be shunned by investors seeking more utility on their deposits.
Bitcoin’s Ownership is Concentrated
Bitcoin’s ownership is highly concentrated, whereby approximately 2% of its accounts control 95% of Bitcoin. Defying the definition of an orderly market, it is cornered already, before it even starts. Those 2% of accounts are also incentivised to manipulate the market to their satisfaction. These aberrations never end well for the typical investor. A market with wide participation breeds stability as the wisdom of the crowd prevails.
The Recent Bitcoin Surge
This week Bitcoin surged to an all-time high of approximately $42,000. So why have we seen such enormous price rise in Bitcoin recently? I believe the answer is as much to do with the extraordinary investment environment that Bitcoin inhabits as it has to do with Bitcoin’s specific and unique properties. There are several factors at play here, few of which have anything to do with Bitcoin’s properties or technology. I have outlined some of the factors driving recent price action:
- Negative yields and the law of unintended consequences: Governments and their Central Bank proxies (be under no illusion as to who calls the shots) have intentionally forced yields of bonds to all-time lows across the board in government and corporate debt. This allows governments to easily issue debt at low or positive costs to the exchequer. They have taken the yield that investors ordinarily earn when they lend money and forced those who need or demand a yield to place their investments into other, ordinarily inappropriate venues. The biggest recipient of this flow has been equity markets, especially the US markets and in particular technology stocks. But other assets have benefited too, including precious metals, junk bonds, commodity currencies, and private equity. This effect is not to be underestimated. It is estimated that the world now has $18 trillion in negative-yielding bonds. The ECB is expected to consume nearly all EU government bonds being issued in 2021, leaving nothing for actual investors such as pension funds. When officials carry out such massive market operations they are creating huge aberrations and one such effect is the flow of funds into Bitcoin, in the vain attempt to generate a return on assets.
- In December 2017 the Chicago Mercantile Exchange launched the first Bitcoin Future. This innovation greatly expanded the addressable market for Bitcoin beyond the hobby investor class and into the investment mainstream. Speculators could lay down a small amount of money and gain a leveraged exposure. This allowed professional investors an opportunity to speculate in a market that is prone to severe volatility. As any trader will tell you, volatility is your friend and the key to making short term profit. Futures may add to price volatility and that could cause gyrations and resulting headlines. Yet they also add liquidity, a key to market core function which is price discovery. Unfortunately with central banks flooding the global markets, liquidity speculative bubbles will result and fester. Bitcoin Futures are the recipient of such ‘refugee flows’ and, as a result, may be responsible for the price velocity we are seeing.
Cash is Trash
It is no surprise that a new monetary option, which is supposedly immune from Central Bank debasement, is attracting safe-haven flows. There is a growing belief that inflation is on the horizon, due to uncontrollably explode later this year. Lockdown, pent up demand, and ‘helicopter’ cash dropped into bank accounts have all contributed to the current situation. The US government has followed Japan by printing money in extraordinary amounts. In the last 12 months M1 money supply has increased by 41%. This newly printed money will drive up everyday prices far above wage growth over the next 12-18 months. It will likely lead to severe market stress and create enormous societal inequalities.
When you buy Gold you are also responding to the same fear. In some ways, both Bitcoin and gold are competing for the same dollar. It is useful to remember the rule of 72; essentially if you divide 72 by the inflation rate, that is the number of years before your money will half in buying power. So, at 5% a year, your money will half in under 15 years. This fear is currently a major factor for investors.
People own Bitcoin because they think the price will continue to rise regardless of its utility. Every single experienced investor who has known success and loss will tell you that this is the single worst reason to own an investment. When that price starts to plateau the rationale for owning it is called into question and alternatives will be voiced. The scramble for the exit then ensues.
Circling back to the Model T example, Bitcoin has been an extraordinary success as a case study in a modern and ruggedly robust way to make payments. Yet this initial success led many to confuse it with the advent of a new worldwide currency. We will see many new and exciting cryptocurrencies issued over the next few years that will build on Bitcoin’s strengths and deliver far more robust payment systems than we could ever dream.
These new technologies, much like the Model T’s competitors, will use Bitcoin’s advantages and build on them, leaving it trailing in the dust. On the other hand, if the powers that be embrace Bitcoin as a component in some new global currency basket, it will pivot and perhaps then its legions of fanboys will be proven correct!
NEWS and COMMENTARY
GOLD PRICES (USD, GBP & EUR – AM/ PM LBMA Fix)
18-Jan-21 1852.40 1858.85 1354.85 1362.17 1521.56 1527.97
15-Jan-21 1853.85 1839.00 1357.57 1352.40 1527.20 1519.93
14-Jan-21 1840.25 1841.75 1347.62 1349.82 1513.05 1519.63
13-Jan-21 1852.40 1858.85 1354.85 1362.17 1521.56 1527.97
12-Jan-21 1861.85 1841.25 1369.58 1353.87 1531.93 1515.35
11-Jan-21 1847.80 1847.25 1369.59 1371.58 1520.19 1521.21
08-Jan-21 1891.30 1862.90 1391.81 1371.28 1545.19 1521.06
07-Jan-21 1911.05 1920.10 1406.34 1415.11 1559.23 1566.03
06-Jan-21 1957.20 1931.95 1433.65 1423.27 1586.11 1570.10
05-Jan-21 1946.55 1940.35 1432.47 1426.93 1584.88 1582.74
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