Is Bitcoin an asset or a currency?
What Bitcoin is can be confusing. It doesn’t have to be. It’s just a bank.
What is Bitcoin?
People ask this a lot and it’s a good question. The original Bitcoin whitepaper says Bitcoin is a peer-to-peer electronic cash system.
Yet, today, people rightfully point out Bitcoin isn’t really used that way. It can be, but using Bitcoin that way requires something on top of Bitcoin to make it happen efficiently and cost effectively.
A common criticism of Bitcoin is that supporters keep changing the story. Now, instead of digital currency, Bitcoin is supposed to be an inflation hedge, property, an asset, a store of value, etc.
It’s confusing. I get it.
I’d also like to point out that it is normal for people to find new uses for things. Case in point, crude oil.
When they first discovered crude oil, the first major use for it beyond lubricant was kerosene. At the time, whale oil was used to power lamps for light.
Whale oil comes from the blubber of whales. Whale blubber gets rendered down to a liquid state, where it can be used to power lamps by burning a wick soaked in it.
To get kerosene, crude oil needed to be refined down to kerosene, much like whale blubber needed to be rendered down to whale oil. This was a huge innovation at the time.
Crude oil was very abundant and easy to extract from the ground. Whale blubber is not. It was expensive, it required a lot of time and effort and it killed a lot of whales.
Funny thing was, one of the by-products of the crude oil refining process was gasoline. It was highly volatile and reactive. The fumes were explosive and early oil men discarded it as dangerous waste.
Turns out, gasoline was pretty important.
Another example of finding a new use for things would be the internet. The world wide web was initially designed to send messages from one computer to another.
Obviously today we use the internet for a lot more than sending a message. In fact, in the early days of the internet, TV personalities like David Letterman would mock the internet.
“Have you ever heard of a fax machine?” he’d say.
Today, multi-billion dollar corporations are exclusively on-line. We use the internet daily for things ranging from video communication to entertainment, banking, health care, you name it.
Point is, just because something was conceived with limited information, that doesn’t mean it can’t change or become something more useful with more information.
Bitcoin is a store of value
We hear this a lot today. Critics are quick to point out that, as a store of value, meaning something that holds value over time, Bitcoin is not great.
They say the price of Bitcoin is highly volatile. There are even jokes and memes about the fleeting nature of crypto wealth.
Rich one day, gone tomorrow.
So, how could it possibly be a store of value? If Bitcoin is worth $70,000 one day and $20,000 a year later, how did that store value?
Well, obviously, it didn’t.
At least, not over that time period. And, if you bought Bitcoin at $70,000 and sold it at $20,000, well you would have lost a lot of dollars, wouldn’t you?
Yet, people often say gold is a store of value too. Governments, central banks and institutional banks hold massive amounts of gold in their vaults and on their balance sheets.
Odd, because in 1970, you could buy an ounce of gold for $35. Ten years later, it would cost you $750. Five years after that, it was only $325.
What gives?
Take it a few years forward, gold went from $260 in 2001 to $2000 in 2011, before dropping to $1000 and then shooting up to $2150 today. This is a “store of value?”
Yes.
It’s a store of value, because over time it retains purchasing power better than dollars do. Dollars are continually being debased. Meaning, the central bank keeps making more and more of them, which dilutes the value.
It’s just like adding more and more plain soda water to your Coca Cola. Add enough soda water, and pretty soon, you won’t taste any Coke.
Same thing is happening with dollars. They keep making more and more dollars out of thin air, but they aren’t making things you buy with dollars nearly as fast.
Thus, it takes more and more dollars to buy things. This includes gold. That’s how and why it stores value. The central bank prints more dollars, which makes the cost of gold priced in dollars go up.
And, since you don’t eat gold, or use gold to live in, at some point in the future, you can sell that gold to someone else and get more of the debased currency than you put in.
Make sense?
As I pointed out above, it’s not perfect. People can buy and sell gold whenever they want. This means gold “floats” on the open market.
It’s price fluctuates based on demand. If more people want to hold and use dollars than gold, they will sell gold and the price goes down.
But, if people are worried about monetary debasement, they will not sell their gold. Instead, they will hold it, causing the price to rise. This is why gold’s price is so volatile.
Same is true with Bitcoin.
Bitcoin is a bank?
Imagine a large bank that is able to accept deposits in any currency from anywhere in the world. To encourage people to use this bank, they issue redeemable shares in the bank that float on the open market.
It would be like a bank that accepts currency and then gives you a certain weight of gold to mark your deposit. That share of gold they give you is equal to what the market price for gold is at the time.
As long as you have that piece of gold, you can always go back to the bank and redeem it for its present cash value in any currency you choose.
The neat thing about that gold “share” is it floats on the market. Meaning, you don’t have to trade back to the bank. You can sell it to someone else. Then they get your share of the gold and you get their cash.
Or, if you choose to hold it, you could choose to redeem that share from the bank later, especially if you’re worried about your currency getting debased, like what is happening in Turkey, Egypt, the United States and everywhere else in the world.
But, if a lot of people are aren’t worried about that and they’re turning in gold for their currency, the market price for the gold “share” would go down.
This is because, there would be less demand for the gold share, but more demand for the currency. Make sense so far?
Now, imagine that same bank, except it’s online. And, instead of people running the bank, it’s run by a massive super-computer. There are no bank tellers. There is no one saying who is allowed to make a deposit or a withdrawal.
The only thing you need to access the bank is a private key that only you have. Without that key, no one but you can get your gold or your cash.
Now imagine that same bank only has 21 million gold coins. But, they have a neat way to fraction those coins down, so each gold coin can be divided 100,000,000 times.
That’s Bitcoin.
Bitcoin is just like a decentralized bank with no employees, that takes deposits in any currency and gives the user a redeemable, tradeable, fractional share of the contents of the bank.
That share is called Bitcoin.
And, because the “shares” in the bank are limited to 21 million, the more currency that comes in, the more valuable the share will trade for. But, if more Bitcoin comes in than currency, the less value Bitcoin will trade for.
Stability and time
The neat thing about Bitcoin is, we can all reliably expect the government to create more money out of thin air every year.
It is baked into the protocol. They call it a target inflation rate, which in most western countries is around two-percent per year.
What that really means is, they are trying to “only” steal two-percent of your purchasing power every year. That, by the way, is on top of the tax you have to pay back to the government if you earn any money.
Trouble is, the government keeps promising to do things that cost more than they collect in taxes and what two-percent a year of theft will cover. But, since they can just make more dollars, that’s what they do.
They “print” more money out of thin air to pay for things they can’t afford. What happens to people like you and me is, things cost more and more dollars to buy.
Before Bitcoin, the only way to protect yourself from losing purchasing power was to buy things like stocks, bonds, real estate, gold, or art and then hold on to them.
As more and more dollars get printed, those things become more and more expensive to buy. But, if you bought them when prices were lower, then you could sell them for higher prices later.
Not because those things went up in value. It’s because the government made more dollars, but those things are relatively scarce. Just like the gold shares in the bank example above.
More importantly, it’s just like Bitcoin.
Except, unlike gold, stocks, bonds, real estate or art, no one can make more Bitcoin. We can always mine more gold. Stocks can be made out of thin air (it’s called a stock split), and bonds are made out of thin air.
Houses can be built, areas can be developed, buildings can be raised. New art is created daily. But, once all the Bitcoin is mined, there will be no more Bitcoin.
Bitcoin does inflate slowly. Right now, miners create 6.25 Bitcoin every 10 minutes. But, next month, because of the math behind Bitcoin, miners will only receive 3.125 Bitcoin every ten minutes.
And, four years from now, that reward will be cut in half again. This means, every year, there will be less and less Bitcoin available to buy.
Meanwhile, the central banks keep creating new currency out of thin air. And, after Covid, they created more currency out of thin air than any time in the history of the world.
That is why the price of Bitcoin (and everything else) is so high and will likely keep going higher. Not because Bitcoin makes a “profit” but because more and more people will want to deposit their cash in the Bitcoin bank and hold on to their tradeable share of Bitcoin.
The nice effect of this is, as time goes on, and more and more people deposit currency into the Bitcoin “bank,” the less and less volatile the Bitcoin price will become.
Why?
Because as more and more people are storing their value in the network, it will take increasingly more people selling to make the price go down.
And, as fewer and fewer people sell, more currency value will come in, which makes it even less likely for people to want to sell, because their value of their savings keeps going up.
It’s called a virtuous circle and it solves a lot of problems with fiat money.
Conclusion
I realise Bitcoin can be a confusing topic for many. And, I don’t blame people for not trusting it, or thinking it’s some kind of scam.
It really sounds too good to be true. You put money in and then your value just goes up forever? How could that possibly work?
I hope this explanation helps you understand how the mechanics of a decentralised bank like Bitcoin can work.
Bitcoin is unique because it is the only crypto that has these characteristics. All other “cryptos” out there were created by someone, are managed by someone and can be manipulated and/or changed by someone.
Bitcoin cannot. There is no owner. The “creator” disappeared and even if he or she returned, they have no way to control the network.
There are over 18,000 node operators around the world ensuring the Bitcoin network stays true. And, the network itself is defended by the largest global super-computer ever conceived.
All of the computers at Amazon, Google, Netflix and every other tech company don’t produce as much compute power as the Bitcoin network uses to defend your money.
Think about that.
I share this here because I believe that Bitcoin is truly one of the most revolutionary inventions in the history of mankind. It is the first and only time in history when a person or a government didn’t control a bank.
It’s automated. It’s decentralized. It gives free and fair access to anyone anywhere at any time. No one can stop you from using the network. No one can stop the network itself.
Most importantly, no one can use the network to steal from you.
They can’t inflate Bitcoin to create more “money” to get some votes. The only way you can use the bank is to put currency in, just like everyone else. You can access the network and be held to the same rules as a king.
I get why Bitcoin can be confusing. I hope you can see it’s revolutionary.
These are just my opinions. I’m not a financial advisor, this isn’t financial advice, and always DYOR. Following any of these ideas might cause you to lose all of your money. I am 100% serious about that. I like tinkering with this stuff, but I’m on record acting like a total baboon. Invest accordingly.
Until next time, be safe, be smart and be sure to tie the camel.
