Bitcoin was launched to the world 15 years ago by a person under the pseudonym of Satoshi Nakamoto. A year after launching it, Satoshi disappeared, never to be heard from again. To this day no one knows who Satoshi Nakamoto is, or who invented Bitcoin. What is known, or is believed, is that Satoshi Nakamoto owns one million Bitcoins which at today’s market price of $40,000 USD per Bitcoin would be valued at $40 billion—making him or her one of the richest people in the world.
If you added up all the Bitcoins in the world today, there are around 20 million of them, they would be valued at around $800 billion. In comparison, the value of all U.S. dollars circulating in the world today is about $2.3 trillion.
Bitcoin, in just 15 years, has come to be worth about one-third of the value of all U.S. dollars, the world reserve currency.
What’s more, if Bitcoin were a company, it would rank eighth in the world in terms of market value, just ahead of Berkshire Hathaway which is valued at $780 billion.
Bitcoin’s ascent has simply been staggering.
Many have tried to dismiss Bitcoin, or outright kill it. Warren Buffett called it “a gambling token” and said it “doesn’t have any intrinsic value”. His late partner Charlie Munger called it “rat poison” and said its “going to zero.” Jamie Dimon, CEO of JP Morgan, echoed these comments, saying its “worthless” and called it a “pet rock,” as did Nobel prize-winning economist Paul Krugman, who called it “uselessly inefficient” and largely a “Ponzi scheme.”
Others believe in it. Cathie Wood, the investment manager who oversees $10 billion of the ARK Innovation investment fund, recently said she thinks Bitcoin will hit $1.5 million per coin by 2030. Kevin O’Leary, a little less optimistically thinks it will hit $150,000 to $250,000 per coin by the same date. Michael Saylor, the CEO of MicroStrategy, has $8 billion of his firms’ money invested in Bitcoin. Elon Musk has also been positive on it.
So who’s right?
The bulls or the bears?
One thing is clear: Bitcoin, like a cockroach, has been hard to kill.
What is Bitcoin
Bitcoin is digital cash. Like physical cash, transactions with it are final. There is no intermediary to go through. Transactions are direct between two parties. Also like physical cash, it is difficult to track by authorities which, in some cases, makes it ideal for illicit activity. Unlike physical cash, the supply of Bitcoin is limited. More cannot arbitrarily be created. Its supply is capped at 21 million coins. Close to 20 million are in existence today, with only one more million to come into existence over the next 100 years or so.
How more Bitcoins come into existence is they are mined by people or companies using computers. To mine them, these people or companies compete to solve complex mathematical problems, which require compute power and electricity. The problems take roughly 10 minutes each to solve. The first to solve the problems receive a number of Bitcoins as their reward. In addition to solving these problems these “Bitcoin miners” also validate transactions on the Bitcoin network, and upon solving the problems, post the transactions to the network, updating the record of transactions on everyone’s computer that’s part of the Bitcoin network. This is what makes Bitcoin unique: it is a decentralized network where transactions are posted and made visible to the entire network. They aren’t stored centrally on one computer or server.
This decentralization is what allows Bitcoin to be used as digital cash, where it can’t easily be tracked or confiscated by authorities. There is no central authority that can intercept payments. It operates independently from authorities, on users’ computers throughout the world. To shut it down you would have to shut down the internet.
This lack of a central authority is also what allows it to limit its supply. No one owns the Bitcoin network or software. It’s considered open source, with changes that can be made by its users, but only with consensus support of the rest of the users. So making changes is difficult, and only if it’s in everyone’s best interest. The design of the software, to restrict the supply of Bitcoins to 21 million coins, is in the best interest of everyone who’s invested in Bitcoin, which is why it’s unlikely to change.
Meteoric Rise in Value
The appreciation of Bitcoin’s price has been nothing short of extraordinary. It has been the best performing asset class in 10 out of the past 12 years. Over that time, its price has appreciated 14093099 percent. If you’re having trouble reading that number, as I was, here’s what it works out to per year: 148.9 percent. One-hundred dollars invested in Bitcoin 12 years ago is worth $5.6 million today. The chart below shows the performance of Bitcoin relative to other asset classes since 2011:
Here is the price of a single Bitcoin over time, from 2015 to today:
Why Has Bitcoin Done So Well?
Simply put, people have demanded it. Today, about 219 million people worldwide, about 3.5 percent of the global adult population, own Bitcoin.
It is being used more for investment and speculation purposes than for transactions. Some people transact with it and use it for transferring money, particularly across international borders. However, it’s mainly being used for investment purposes.
As an investment, the argument for owning Bitcoin goes like this: it is a scarce digital asset with first-mover advantage. Because its network is so broad, and its software so unique, and its supply so limited, it will continue to gain in value. It is seen as a store of value, like gold, but better because of its more limited supply.
The Problem with Bitcoin
The problem with Bitcoin, like the problem with gold, is that it is a non-productive asset, with its value dependent on what someone else is willing to pay for it.
In John Burr Williams’s book The Theory of Investment Value, written in 1938, he defined the value of an investment as: “The present worth of its future distributions.” In other words, an investment is worth what it’s going to produce and distribute, discounted back to the present. With non-productive assets, because they don’t produce anything, it’s hard to determine their intrinsic value. That’s not to say they’re not worth anything. Rare paintings and sports memorabilia, and luxury watches have value. It’s just hard to say what that value is, or will be.
Warren Buffett in his 2011 letter to Berkshire Hathaway shareholders said this about non-productive assets:
The second major category of investments involves assets that will never produce anything, but that are purchased in the buyer’s hope that someone else—who also knows that the assets will be forever unproductive—will pay more for them in the future. This type of investment requires an expanding pool of buyers, who, in turn, are enticed because they believe the buying pool will expand further. Owners are not inspired by what the asset itself can produce—it will remain forever lifeless—but rather by the belief that others will desire it even more avidly in the future.
Buffett went on to talk about the world’s favourite non-productive asset, gold, which was rallying in price at the time. He could just as well have been talking about Bitcoin:
The rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis. As “bandwagon” investors join any party, they create their own truth—for a while…But bubbles blown large enough inevitably pop. And then the old proverb is confirmed once again: “What the wise man does in the beginning, the fool does in the end.”
The chart below shows the price of gold after Buffett wrote that letter, to today:
It increased from about $1600 per ounce to $2000 per ounce today, which works out to be a 2.3 percent average rate of return per year, which failed to beat inflation. U.S. stocks, in comparison, increased in value by 13.3 percent per year over the same period. I’ll let you decide which is the better store of value.
But Bitcoin is Better
Investors in Bitcoin argue Bitcoin is better than gold. It’s more scarce. It has more utility as a medium of exchange. More people will demand it as a store of value as they seek out money with a fixed supply that cannot be inflated away by governments. However, consider this:
The best long-term store of value is owning a business, or stocks which represent the ownership of businesses. When there is inflation businesses can raise prices, as we’ve clearly seen over the past few years, raising their profits and the value of those businesses and the purchasing power of the money that’s invested in them. They are the best store of value available.
Owning bonds which pay reasonable interest that match or beat the rate of inflation also serves as a store of value. They’ll protect the purchasing power of your money. So will owning real estate, provided its purchased at a reasonable price. Much as Bitcoin and gold is claimed to do.
We already have stores of value.
Currency functions primarily as a medium of exchange. To buy things. You don’t need it to store value. You need it to be stable in value. Which Bitcoin most certainly isn’t. Money that you don’t need to spend you can invest, which will protect your purchasing power—store value—over time. Bitcoin is a redundancy.
This is where investors in it, I think, get it wrong.
Austrian Economics
Those who support Bitcoin mostly subscribe to the Austrian Economic theory, which is that a fixed money supply, like we had under the gold standard, enables the economy to grow and prices of goods and services to drop, allowing people to buy increasing quantities of goods and services with their money in the future. While this is true in theory it fails in practice as inevitable shocks to the economy throw it off its orbit, which require central banks to intervene and increase the money supply to stimulate the economy. John Maynard Keynes, the father of modern economic theory, described the situation in 1931 as Britain was readying itself to go off the gold standard:
In the three chief industrial countries in the world, Great Britain, Germany, and the United States, I estimate that probably 12,000,000 industrial workers stand idle. But I am not sure that there is not even more human misery today in the great agricultural countries of the world—Canada, Australia, and South America, where millions of small farmers see themselves ruined by the fall in the prices of their products, so that their receipts after harvest bring them in much less than the crops have cost them to produce. For the fall in the prices of the great staple products of the world such as wheat, wool, sugar, cotton, and indeed most other commodities has been simply catastrophic. Most of these prices are now below their pre-war level; yet costs, as we all know, remain far above their pre-war level. A week or two ago, it is said, wheat in Liverpool sold at the lowest price recorded since the reign of Charles II more than 250 years ago.
The problem with the gold standard, and a fixed-supply currency like Bitcoin if widely adopted, is that it handicaps central banks from responding to economic crises. Which make the crises worse. When people get depressed about the economy prices drop—deflation sets in. Once deflation sets in, if central banks can’t respond by loosening credit and increasing the money supply, people stop spending. When people stop spending it causes prices to drop further. Meanwhile businesses can’t reduce employee wages due to labour unions and other factors. So they lay off workers, further depressing the economy. It’s a vicious cycle. Keynes described it here:
Deflation does not reduce wages “automatically.” It reduces them by causing unemployment.
Imagine what would have happened if central banks didn’t respond during the Covid pandemic. There would have been mass layoffs and likely a depression, which we may not have yet recovered from.
Modern economic theory seeks to avoid this. In developing the theory, Keynes considered the evils of inflation versus deflation:
Rising prices and falling prices each have their characteristic disadvantage. The inflation which causes the former means injustice to individuals and to classes—particularly to rentiers; and is therefore unfavourable to saving. The deflation which causes falling prices means impoverishment to labour and to enterprise by leading entrepreneurs to restrict production, in their endeavour to avoid loss to themselves; and is therefore disastrous to employment. The counterparts are, of course, also true, namely that deflation means injustice to borrowers, and that inflation leads to over-stimulation of industrial activity.
In other words, inflation is bad but deflation is worse. The chart below shows how frequent deflation was while the world was on the gold standard, and how infrequent its become since the world went off it:
Since ending the gold standard central banks’ feet have firmly been on the accelerator, which has accelerated the economy but also inflation.
Keynes described how inflation benefits the economy and businesses:
It has long been recognized, by the business world and by economists alike, that a period of rising prices acts as a stimulus to enterprise and is beneficial to businessmen…When the value of money falls, it is evident that those persons who have engaged to pay fixed sums of money yearly out of the profits of active businesses must benefit, since their fixed money outgoings will bear a smaller proportion than formerly to their money turnover…But…while prices are rising month-by-month, the businessman has a further and greater source of windfall. Whether he is a merchant or a manufacturer, he will generally buy before he sells, and on at least a part of his stock he will run the risk of price changes…Anyone who can borrow money and is not exceptionally unlucky must make a profit, which he may have done little to deserve…To the consumer the businessman’s exceptional profits appear as the cause (instead of the consequence) of the hated rise of prices.
Keynes described how it also benefits those who borrow money:
The benefit of a depreciating currency are not restricted to the government. Farmers and debtors and all persons liable to pay fixed money dues share in the advantage.
If you borrow money for a home, because of inflation, the value of that mortgage decreases over time as the value of your income and assets, including your home, increase. Deflation has the opposite effect: it makes your loans more expensive as your income and assets decrease in value, while the value of your loans stay the same.
Inflation benefits borrowers and hurts lenders; deflation benefits lenders and hurts borrowers.
Keynes went on:
When the value of money changes, it does not change equally for all persons or for all purposes. A man’s receipts and his outgoings are not all modified in one uniform proportion. Thus a change in prices and rewards, as measured in money, generally affects different classes unequally, transfers wealth from one to another, bestows affluence here and embarrassment there.”
If you’re an asset owner you benefit more from inflation than if you own no assets. In particular, it benefits business owners, which is why you want to be a business owner, either outright or through the ownership of stocks.
As Britain officially went off the gold standard in 1931, Keynes said this:
There are few Englishmen who do not rejoice at the breaking of our gold fetters. We feel that we have at last a free hand to do what is sensible…There will be strong motives driving a large part of the world our way. After all, Great Britain’s plight, as the result of the deflation of prices, is far less serious than that of most countries…So long as the gold standard is preserved—which means that the prices of international commodities must be much the same everywhere—this involved a competitive campaign of deflation, each of us trying to get our prices down faster than the others, a campaign which had intensified unemployment and business losses to an unendurable pitch…But as soon as the gold exchange is ruptured the problem is solved. For the appreciation of French and American money in terms of the money of other countries makes it impossible for French and American exporters to sell their goods.
Keynes knew that once Britain went off the gold standard it would be hard for any other country to remain on it. France and the U.S. would soon follow. Following World War II the world went back on a looser gold standard with the U.S. disembarking for good under President Nixon in 1971, never to return.
A New World
Under the gold standard, prices indeed were stable. If you tucked a dollar under your mattress in 1880, it had about the same purchasing power 30 years later. Money maintained its value.
Since the world went off the gold standard, and in particular since President Nixon nixed it in 1971, there’s been persistent inflation. The purchasing power of the dollar since 1971 has declined around 90 percent, as shown in the chart below:
This means a different approach to protecting and growing the value of your hard-earned money.
It means investing it.
And the investments that benefit most from inflation are businesses.
You could own gold. You could own Bitcoin. But I don’t think they’ll do as well as productive assets, like businesses.
Bitcoin Versus Berkshire
Imagine having $800 billion to invest and having a choice between investing all of it in Bitcoin or Berkshire Hathaway.
With Berkshire Hathaway, you get a company that is generating about $50 billion a year in profit, and growing, through wholly owned companies like Geico, Duracell, Dairy Queen, Sees Candies, Fruit of the Loom, and BNSF Railway Company, and investments in publicly-traded companies like Apple, Bank of America, American Express, and Coca-Cola. Over the next 20 years Berkshire Hathaway will probably generate trillions of dollars in profit.
With Bitcoin, you get a digital currency that will produce no profit. It will pay no dividends. It will generate nothing. In twenty years from now hopefully someone will give you back the money you paid for it.
I think you would have to be crazy to choose Bitcoin over Berkshire.
Same goes if you have $800 to invest.
Crystal Ball
Maybe Bitcoin keeps rolling. Maybe it hits $1 million per coin as some people are projecting. But, personally, I find it hard to believe.
What is this based on?
Bitcoin, as a currency, competes with a government monopoly on money.
When you bet on Bitcoin you are betting on it to overcome this monopoly.
As an investment, it competes with traditional stores of value like stocks, bonds, and gold. There are many reasons why these are more rational investments than a digital currency.
Bottom Line
Bitcoin’s rise is spectacular.
But buyer beware.
Recognize what you’re investing in and proceed with caution.
I marvel at what Bitcoin has become but personally stand on the sidelines.