Bitcoin is a new kind of asset, that has got much attention since its inception in 2009. It is a totally digital asset, for some is a currency, for others is a commodity or store of value. It is something so new that the opinions about it are contradictory and it is pretty hard to have a clear view.
We will skip a thorough explanation of what Bitcoin software is and how does it work. Useful material is available here, here and here. We will expose instead the Mass Rentiers view: an interpretation of what Bitcoin can be in a world of accumulated capital and unearned income.
Bitcoin is a digital pie, divided in 21 million slices called bitcoins. Every single slice in turn can be divided in 100 million particles called satoshis. The baker of the pie is an algorithm, not a human, so the pie is set a priori.
Bitcoins can be exchanged, and every transaction is recorded in a public ledger, the so called ‘blockchain’. It is censorship-resistant: it means that no authority can modify a transaction. That implies that if you make a mistake, there is no way to go back, no entity can help. The Bitcoin blockchain is irreversible like time and it is designed to work like a clock.
The ‘time’ of the blockchain is not the human time made of days, hours and minutes. It is an order, the order of the ledger: a mechanism by which every party can verify that one event took place before or after another. One cannot spend money that has not been received, nor can one spend money that is already spent; to achieve that, blockchain transactions are ordered unambiguously and immutably. The state of the chain is reflected by its blocks, and each new block produces a new state. The blockchain state moves forward one block at a time, and the average 10 minutes of a block is the smallest measure of blockchain time.
The Bitcoin clock works without the need for a trusted third party: it is independent from banks and works just with computer-nodes and the internet (it could also work offline, but synchronizing blocks online is much more convenient).
The fact that Bitcoin is governed by an algorithm, and not by humans, could give cause for concern among many investors of the older generations. But year after year we are getting used to algorithms performing tasks in business, science and health care. We are experiencing a loss of control on our lives: algorithms have many advantages, are more stable, less whimsical than human in taking decisions. In an age of distrust towards banks, young investors are every day more confident in the reliability of the Bitcoin algorithm.
Brave New World
Bitcoin is a pie and a clock, but it is also a new continent. Like land, bitcoins cannot be created, only discovered and traded. This land at the moment does not yield any income (but there many ‘farming’ projects under way). Like a new continent, who gets the land first, in the discovery phase, will be rich for long. Unlike land it does not require much efforts, travel and work to be maintained. A smartphone can be enough to stack some satoshis: what is really necessary is a little bit of study to grasp the underlying mechanisms.
Bitcoin introduces a new asset class: native digital assets. It is a revolution that reminds the dawn of financial markets and has similar risks of ending into nothing like tulips.
Bitcoin is not inflatable, the supply is fixed, so it should offer a hedge against monetary inflation. We will talk about monetary policies and the inflation they cause in the next post. At the moment we must recognize that tangible assets are still preferred by investors for that purpose. Although bonds have negative yield, stocks still have earnings and represent real, solid companies. And much more important: stocks and ETFs are bought systematically by central banks and at the same time companies like Apple do enormous buybacks, so stocks and ETFs have shorter supplies every month and revaluate even faster than fixed assets. There is a fierce competition for scarcity out there.
Bitcoin, compared to traditional assets, has the advantage of giving an anchor value: bitcoins owned, divided by 21 million, is a crystal-clear percentage of the pie and reinforces an idea of property. With Bitcoin it is really easy to understand how much one possesses of total wealth, whereas traditional financial assets increase their total every year, with immense jumps, like in 2009 and 2020, caused by unconventional policies of the Central Banks.
Brave New Gold
For centuries investors have looked for protection in precious metals and gold in particular, since states could issue debt and print their own money (fiat money) but could not control the supply of gold.
Gold tends to maintain its value overtime and is a hedge against fear. It is a store of value that conserves its purchasing power overtime, independent from governments and central banks policies. Therefore, gold is considered as an insurance asset, a store of value in times of uncertainty.
Now many commentators compare Bitcoin to gold because of its limited supply and independence from state authorities. They share also the lack of yield, like any commodity.
Gold is scarce, globally recognized and mining is limited. But the supply is not fixed and grows 1 to 2% every year. It is very difficult to store and impossible to ship, and investors cannot easily divide their stock in small fractions. It is hardware whereas Bitcoin is software, with all the advantages of numbers that travel at speed light on the Internet compared to a physical body. And then there is a general trend toward digitalization and virtualization of life.
New generations, native digitals, put more trust in algorithms then in things. Their whole life is digital: commerce, banking, even sport. They watch other people playing videogames on YouTube. They do not understand the value of physical presence, they just live online.
Digital natives have no patience for the burden and difficulties of real material goods. They want their gold to be on their smartphones, they want to buy it online and send it with a tap. They already want Bitcoin although they cannot afford it. But the future belongs to them.
Central banks traditionally support fiat currencies accumulating gold reserves and major foreign currencies. In the future they will be managed by digital natives: the next generations of bankers will accumulate algorithmic reserves, totally decentralized and politically neutral, because it will be the only mean to keep their credibility in front of the markets. And the only decentralized and neutral asset at the moment is Bitcoin.
Cash Reserves Revolution
Many companies are sitting on a pile of cash, but cash has negative interest rates. Bitcoin would be a natural destination for Big Tech cash: it is digital and cannot be inflated. The move to digital cash reserves would be gigantic, we are talking trillions of dollars in the US technological sector alone. It would change the situation for good and could even lead Central Banks to need algorithmic reserves to keep credibility in front of companies whose reserves would reflate every year. Otherwise Big Tech giants could even build their own super-currency (Facebook is already working on it: project Libra).
Let us go now trough bubble analysis for Bitcoin. The key elements of our ReLLANPI synthesis are:
- Retail involvement: is everyone already crazy about it?
- Legislator role: is the price rise influenced positively or even caused by laws?
- Liquidity and leverage: how much money is in the system? Is it sustainable? Do people invest their own money, or do they invest borrowed capitals?
- Asset class: is it totally new? If not, what do historical data tell?
- News: how much hype is around?
- Product: is there a technological and/or financial innovation? How will it impact peoples’ lives? Is there still room for improvement/adoption?
- Investment plan: do people invest following a plan and/or generic prudency or are they under psychological pressure? And you, do you have a plan?
Retail involvement: increasing, but still at an early stage.
Legislator role: at the moment legislators across the world are quite suspicious, but they cannot block Bitcoin, unless they stop the whole Internet; for sure they are not incentivizing its usage and try to apply Anti Money Laundering rules every time the border Bitcoin-fiat money is crossed.
Liquidity and leverage: the whole financial sense of Bitcoin lies in protecting people from the excessive liquidity of the last decades; but Bitcoin is not close to the source of it: the central banks printer works only for banks and corporations.
Asset class: absolutely new, not interconnected with traditional economy, could well crash to zero without repercussions, and no public intervention would be deemed necessary.
News: in the news every once in a while, not hyped in 2020.
Product: since the Computer Age the utility of digital money was apparent. Nowadays life digitalization and assets inflation are an everyday reality for most of the world population, and a digital store of value looks like a necessity. Probably still not easy enough for most of the potential users, but new apps are under development.
Investment plan: the core investors are so called Hodlers, they just hold bitcoins and wait. Wave of FOMO are periodical though.
Experimenting and curiosity bring always the unexpected. Learning about Bitcoin is as much about studying a new asset as opening the eyes on the trends of our digitalized societies and on the financial mechanisms that surround us, the Central Banks printer in particular. More about this in the next article.