What The Heck Is Bitcoin?

Theses days I am being asked a lot about bitcoin (BTC), the digital asset that is the talk of the investment world whether in Board rooms, parties or social media. BTC has doubled in price in the last year and risen over 50% this year. It is about to surpass its all time high.

Here are some FAQs on BTC:

What is BTC? Bitcoin is primarily a store of value like gold or your house. It is also a medium of exchange – you can use it to buy stuff – and a unit of accounting; but these are less useful qualities.

Why buy BTC versus say gold? Gold is messy because it must be stored and insured, is hard to transport and is indivisible: You cannot use it to buy a cup of coffee. BTC is finite in supply, liquid, mobile, discreet, convenient and politically agnostic; with a good chance of outperforming competing asset classes.

What is BTC’s central thesis? The world is heading for a financial crisis: Governments are running deficits and borrowing beyond their capacity to repay their debts and Central Banks are printing money uncontrollably to finance these shortfalls. The US is increasing its $34.5 trillion debt by $1 trillion every 100 days; the Philippines’ its PHP 14.5 trillion debt by over Php 1 trillion a year. This is fueling inflation and creating a bubble in real assets like homes. These monetary and fiscal abuses of Governments can be corrected with a new currency, a “hard” asset which is limited in supply so it cannot be debased. The USD used to be backed by gold but abandoned the Gold Standard in 1972.

There are other issues with our current monetary system. Fiat money i.e. the paper currency in your wallet; is governed by central banks and commercial banks with so many bureaucratic restrictions and subjective policies some politically driven. For example, to open a bank account or simply add a signatory you need to pass increasingly stringent KYC (Know Your Client) rules. In many countries you cannot wire money to your children without attracting scrutiny from bank compliance officers looking for money laundering. Nations like Argentina, Venezuela and Nigeria are currently experiencing hyper inflation which has debased their currency.

BTC is the only savings technology that will preserve the buying power of ordinary people. For example the price of homes in the US more than doubled in dollar terms in the last decade but have more than halved in BTC terms because of the latter’s appreciation in value.

So why does BTC have a bad rap? Bitcoin is accused of being used by criminals and tax avoiders but so is fiat currency but nobody talks about banning it.

Why are major investors like Warren Buffett, the CEO of Berkshire Hathaway, who is considered an astute investor; and Jamie Dimon, CEO of JP Morgan; calling BTC a scam? Buffett knows brick and mortar businesses like Coca-Cola and railways which have done well for him; but very little about digital businesses. Buffett never got into tech companies like Microsoft, Facebook and Nvidia, the so called Magnificent Seven companies which today make up more than 30% of the total market value of the S&P 500. He did not invest in Apple (which currently is Berkshire’s biggest holding) until only some 10 years ago. It is therefore not surprising that he should bad mouth BTC, a digital asset. He does not understand the digital transformation now taking place in the world.

Jamie Dimon has an interest in denigrating BTC. The latter is an existential threat to his business because it by-passes the traditional banking system.

Bitcoin has its corporate champions: Larry Fink, the CEO of Blackrock, one of the world’s largest fund manager and. Elon Musk, CEO of TESLA, are huge supporters of BTC. Tim Cook, CEO of Apple, has admitted to personally owning BTC. Many fund managers personally own BTC even if they cannot on board it to their clients because of regulatory restrictions.

Why has BTC not flourished if it is that attractive an investment? Like all socio-economic innovations it takes time. BTC is being likened to the advent of the internet. The latter was founded over 50 years ago by a group of U.S. Government techies but did not gain traction until decades later. Today it is the center of our lives. The internet is the base layer over which so-called layer 1 and layer 2 platforms like email, mobile phones, social media, and business giants like Amazon are super imposed. The same is happening with crypto.

The key to any successful innovation is its “network effect” or rate of adoption by users. A phone is useless if there is only one in the world because there is nobody to talk to. It becomes more valuable when there is a second phone and a third and several millions after because now it is the principal means of communication.

Similarly a currency whether analog or digital is based on its network effect. The P100 bill in your wallet is only worth P100 if everybody agrees to it; otherwise it is only a piece of paper. The network effect is based on public trust. People trust fiat currencies because they are theoretically backed by Central Banks. When this trust disappears which is what is happening with the uncontrolled printing of money; then the public seeks safety in limited supply assets like gold or prime real estate. The supply of BTC is limited by its algorithm. This supply will be cut by half in April 2024 further restricting the issuance of new BTCs.

BTC has also been hurt by bashing from regulators, politicians and banks because it represents a threat to their existence. They prefer regulated centralized systems over which they can exercise their powers. BTC does not offer them that opportunity.

What are the downsides to BTC? The extreme volatility of BTC is one of its biggest weaknesses. The volatility is due to market manipulation by bad financial actors. However this volatility should dampen with greater adoption.

BTC has also been tarnished by scams but various big time prosecutions of individuals and exchanges has strengthened its ecosystem. BTC is evolving from the Wild West to the main stream with regulatory oversight.

Can one’s BTC holdings be hacked? Yes but one can protect against this by downloading your BTC into a secure e-wallet or flash drive.

Is BTC a good investment? BTC is not suitable for those with a short investment horizon and conservative risk profile. I believe it is a good investment over a multi-year period but should represent not more than 1-5% of one’s portfolio. Fifteen years ago one BTC was worth less than one dollar. Today it is worth over $60,000.

How does one buy BTC? The most convenient way is via Exchange Traded Funds which are publicly listed platforms that mirror the underlying bitcoin. Your regular stock broker should be able to do this for you. Given its volatility, it is best to buy a little of BTC at a time so on average you should overcome the price swings.

Why should BTC continue to rise in price? Price goes up when demand exceeds supply. The BTC supply is limited by its technology while demand has still to surface in its full form. The market value of BTC alone (apart from other crypto assets like Etherium, etc.) is presently about $1.2 trillion. This is small compared to other asset classes like gold (market value over $10 trillion), stocks and bonds (each over $100 trillion) and real estate (over $300 trillion). If it approximates these competing investments, BTC will do extremely well, just do the math. Major institutions (mutual funds, pensions, hedge funds, etc.), Sovereign Wealth funds, private asset managers that advise over $200 trillion of individual money, corporates and retail investors in Western countries, China and India have still to invest in BTC because of the regulatory restrictions; but this is now changing with the introduction of BTC ETFs. Since their debut on Jan. 10 2024, these ETFs have attracted new money at a record scale and speed.

What are the advantages of BTC? It is portable, has a limited supply and therefore cannot be debased, it is inexpensive to transfer value and cannot be controlled by Governments. BTC is your own private bank with a good chance of serious price appreciation once it is accepted as a valid investment class.

Bitcoin is hard to understand. It is transformative. It requires a paradigm shift in thinking. It will take time to be fully adopted but could be the future like the internet was. Its biggest supporters are the young which tells us something about its potential.