The ups and downs of Bitcoin – currency, investment opportunity, both… or neither?

Today’s question comes from Richie, who asks, “Have you been following the Bitcoin ETF at all? If so, are you able to do an episode on this and if it is worth looking into?”

Thanks for the question, Richie…and yes in fact I actually have been following it. I noticed that the price jumped up about 20% on the news that the SEC in the US was considering allowing ETFs for Bitcoin.

Crypto currency fascinates me, but not as an investment option. That is, I like the technology but haven’t bought any as an investment option. To start with why, I want to break down the ‘currency’ part in crypto currency –

Currency is money: Comparing Bitcoin to money

1. Functions of money
   • Unit of account – Divisible, identifiable amounts
   • Medium of Exchange – Can you use it for transactions for the purchase of goods and services
   • Store of value – Is worth something now and will be in 10 years (food isn’t a good currency long term). Can I hold onto this to be able to exchange it in the future?
2. Characteristics of money fall under this
   • Durability – Want money to last
   • Portability – Need to be able to take it with you
   • Divisibility – Units to break it down into – or have many 1s
   • Uniformity – Same consistency – Helps avoid risk/time/effort in barter
   • Limited supply – Needs to store value – Endless supply devalues
   • Acceptability – Widespread use and people want to take it – this isn’t the case when there’s hyperinflation

How does crypto fall into this? Crypto currency is a decentralized monetary system

1. There is no central authority that regulates the monetary base.
2. Currency is created by the nodes of a peer-to-peer network.
3. The algorithm that generates Bitcoin defines how and when the currency is created (methods and timeframes)
   • Currency can be generated by malicious users (does not follow the rules) but will be rejected by the network and thus is worthless – this does affects the Spendable Supply

 How does bitcoin fair?

1. Unit of account – yes
   • Has divisibility
   • Uniform as well
2. Medium of exchange – Transactional
   • Portability – Bitcoin whitepaper makes it clear that it will be one day: A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution. — Satoshi
   • To be unit of transaction, need available supply – people holding it though (54% are holding for longer than 3 years)
3. Acceptability – Wider spread acceptance – not 100%
4. Store of value – Price isn’t value – Fiat (current system isn’t great)
   • Volatile and inconsistent without any underlying value
   • Limited supply – Not really
5. Durability – as long as computers last
6. Another comparison – Time people expect to hold it – good measure of investment or medium of exchange
   • Shows that Bitcoin is seen as an investment
     • 12% think longer than 10 years, 10% for 7 to 10 years, 46% expect up to 3 years
   • It doesn’t look so compelling as a medium of exchange

How will the ETF pan out? – History of bitcoin

1. Back in the early days: Bitcoin was flat for a long time.
   • What causes price rises? People buying bitcoin. The price spiked when then even more people bought it – which seems super obvious
   • This also comes back to Supply and Demand – and there was high demand while supply was only slowly increasing.
2. What caused the sudden rise in demand?
   • Technology making it easier – Buying Bitcoin 2009 was almost impossible unless you had computer smarts
   • March 2010 – Price of $0.003 – Someone auctioned 10k bitcoin for $50 ($111m today) – Was $240m at the peak – Stories like this increased the hype/demand for coins – But the technology barrier stemmed a lot of demand potential
   • Now – Currency trading platforms do it for you – Very simple – Almost like buying foreign currency – Massive spike in buyers
   • New regulation being discussed – Bitcoin Exchange Traded Fund

What will the ETF achieve?

1. The ETF will simply help to increase demand in bitcoin – as people buy the ETF, the ETF needs to buy the bitcoin
2. ETF – Success depends on underlying assets – NTA
   • Remember you are really buying the underlying asset when buying an ETF
   • Designed to track the yield and returns of the benchmark
   • ETFs are an easier way to buy Bitcoin – but may not be the best for the future
   • It solidifies it as an investment
   • Reduces the quality of the currency as you technically cannot trade the ETF for something else – This diminishes the medium of exchange potentials for Bitcoin

Market state

1. Supply – Bitcoin is capped at 21M total circulating supply.
   • Current: 17.2 million mined coins (but 4M BTC lost or dormant) = 13.2M available to trade
   • How is supply created – mining increases the overall supply
   • This can be manipulated – bitcoins can be lost/destroyed

I like the concept of it: What I like

1. Supply – Supply is capped, but only due to the programming
   • Alternatives (substitutes) are available
   • Example – The Gold Standard – Capped Supply, until more was mined (Ever wonder why increasing supply in crypto is dubbed ‘mining’?). But gold has no close substitutions in terms of the qualities it has
   • Crypto has alternatives (sometimes better) – increases speculation
2. Blockchain technology – Digital credit for transactions
   • (Avoided) taxation – The Governments are wising up now with reporting requirements
     • Business accepting bitcoin may be charged CGT on payments

What isn’t working so far in terms of Bitcoin becoming a true currency

1. Medium of exchange – Currently being tested
   • Acceptability – Wide spread use
   • Available supply (Unlike fiat where more can be created when some is lost)
2. Store of value
   • Volatility – Can be a risk to transact in
   • Supply – Can be manipulated, alternatives are available
   • Nothing backing the underlying asset –– fiat has the law to fund their monetary system
     • At lease it is guaranteed unlike with crypto
     • Gold was the old way to avoid excess monetary inflation

For now:

1. Crypto remains as a ‘canary down the coal mine’ for the future of decentralised monetary systems
2. I like the concept of decentralised
   • No one person has much control
   • Value comes from the network of people using it
3. One problem – the statement ‘decentralised currency isn’t controlled by any bank or Government’ seems to not be certain
   • James Garfield (US president) – He who controls the money supply of a nation controls the nation
   • Purchasing crypto is anonymous, and whoever owns the asset technically is the controller
   • The market cap is $140bn – China had $3.1trillion sitting in foreign reserve account
4. No idea what the future holds on this
   • Will spend an episode in the future – Feel like I’m just scratching the surface on this subject of the mechanics of crypto, supply and demand etc
   • Are they created to act only as speculative investments, or are they evolving?
5. ETF – Increase access to BTC – Likely increase demand of it, while potentially reducing supply
   • Note – That it doesn’t mean that fundamentals of it are any better

Thanks for the question Richie, and thanks all for listening!