ZoneBitcoin EditorialThere are articles that have become real references in the Bitcoin universe. This is particularly the case of the article "The Bullish Case of Bitcoin" published in 2018 by Vijay Boyapati. Faced with such success, the author made a book out of it, in 2021, which you can find on all bitcoin bookstores or even on Amazon, for example. The book “An Optimistic Scenario for Bitcoin” has become a book about Bitcoin reference for understanding Bitcoin, as an alternative currency.
We have decided to translate this article here.
The Bitcoin bullish scenario by Vijay Boyapati
As Bitcoin’s price soared to new highs in 2017, the bullish case for investors may seem so obvious that it hardly needs to be stated. Yet it may still seem foolish to invest in a digital asset that is not backed by any commodity or government and whose price surge has prompted some to compare it to the phenomenon of “tulip mania” or the dot-com bubble.
No comparison is relevant; The optimistic case for Bitcoin is compelling, but far from obvious. There are significant risks to investing in Bitcoin, but, as I will argue, there is still immense opportunity.
The genesis
Never in the history of the world has it been possible to transfer value between distant peoples without relying on a trusted intermediary, such as a bank or a government. In 2008, Satoshi Nakamoto, whose identity is still unknown, published a 9 page solution to a long-standing computing problem known as the “Byzantine General’s Problem.” Nakamoto’s solution and the system he built from it—Bitcoin—made it possible, for the first time, to transfer value rapidly, over large distances, bypassing the need for third-party trust.
The ramifications of the creation of Bitcoin are so profound for both economics and computing that Nakamoto should rightly be the first person to qualify for both a Nobel Prize in Economics and the Turing Prize.
For an investor, the highlight of the invention of Bitcoin is the creation of a new rare digital asset: bitcoin. Bitcoins are transferable digital assets created on the Bitcoin network through a process called “mining.” Bitcoin mining is roughly analogous to gold mining, except that production follows a set, predictable schedule. By design, only 21 million bitcoins will be issued and most of them already have been: around 16,8 million bitcoins have been mined at the time of writing this article. Every four years, the number of bitcoins produced by mining will be cut in half and the production of new bitcoins will cease completely by 2140.
Bitcoins are not backed by any physical commodity, and are not guaranteed by any government or corporation, which raises the obvious question for a new Bitcoin investor: why do they have any value at all? Unlike stocks, bonds, real estate, or even commodities like oil and wheat, bitcoins cannot be valued using standard discounted cash flow analysis or by demand for their use in the production of higher-order goods. Bitcoins belong to an entirely different category of goods, known as “monetary goods” (monetary goods), whose value is fixed according to game theory. That is to say, each market participant values the good according to his assessment of the value that other participants will place on it and to what extent. To understand the game-theoretic nature of monetary goods, we must explore the origins of money.
The origins of money
In early human societies, trade between groups of people was done through barter. The incredible inefficiencies inherent in barter severely limited the scale and geographic scope at which trade could take place. A major disadvantage of barter-based commerce is the problem of double coincidence of wants. An apple grower may wish to trade with a fisherman, for example, but if the fisherman does not want apples at the same time, the trade will not take place. Over time, humans developed a desire to hold certain collectibles due to their rarity and symbolic value (e.g., seashells, animal teeth, and flint).
Indeed, as argued Nick Szabo in his brilliant essay on " The origins of money"The human desire for collectibles provided early humans with a distinct evolutionary advantage over their closest biological competitor, Neanderthals.
The primary and ultimate evolutionary function of collectibles was to serve as a means of storing and transferring wealth.
Collectibles served as a kind of “proto-money” by making trade possible between otherwise antagonistic tribes and enabling the transfer of wealth between generations.
Trade and transfer of collectibles was quite rare in Paleolithic societies, and these goods served more as a "store of value" rather than a "medium of exchange" like the role we widely recognize for modern money.
Szabo explains:
Compared to modern money, early money had a very low velocity: it could only be transferred a few times during the average person's lifetime. Nonetheless, a durable collectible, which today we would call an heirloom, could persist for many generations and add substantial value with each transfer and making it possible.
Early humans faced an important game-theoretic dilemma when deciding which collectibles to collect or create: Which objects would be desired by other human beings?
By correctly anticipating which objects might be in demand for their collectible value, a huge advantage was conferred on the owner in his or her ability to conduct trade and acquire wealth.
Some Native American tribes, such as the " Narragansetts", have specialized in manufacturing otherwise useless collectibles simply for their commercial value. It is worth noting that the earlier the future demand for a collectible is anticipated, the greater the advantage conferred on its owner; it can be acquired more cheaply than when it is in widespread demand, and its commercial value appreciates as the population demanding it increases.
Additionally, acquiring an asset with the expectation that it will be in demand as a future store of value accelerates its adoption for that specific purpose. This apparent circularity is in reality a feedback loop that pushes societies to rapidly converge towards a single store of value.
In game theory terms, this is called a “ Nash equilibrium ". Achieving a Nash equilibrium for a store of value is a major boon to any society, as it greatly facilitates trade and the division of labor, thereby paving the way for the advent of civilization.
Over the millennia, as human societies developed and trade routes expanded, the stores of value that emerged in individual societies came to compete with each other. Merchants and traders would be faced with the choice of keeping the proceeds of their trade in the store of value of their own society or in the store of value of the society with which they traded, or in a balance of the two.
The advantage of maintaining savings in a foreign store of value was the increased ability to trade in the associated foreign company. Merchants holding savings in a foreign store of value also had an incentive to encourage its adoption within their own society, as it would increase the purchasing power of their savings. The benefits of an imported store of value accrued not only to the merchants who imported, but also to the corporations themselves.
Two societies converging on a single store of value would experience a substantial decrease in the cost of doing business between them and a corresponding increase in trade-based wealth.
Indeed, the 19th century was the first time that most of the world converged on a single store of value – gold – and this period was marked by the greatest commercial explosion in world history. Of this peaceful period, Lord Keynes wrote:
What an extraordinary episode in the economic progress of man this era was... for any man whose abilities or character exceeded the average, in the middle and upper classes, to whom life offered, at low cost and with the fewest problems , facilities, comforts and conveniences beyond the reach of the richest and most powerful monarchs of other ages. The Londoner could order over the telephone, while sipping his morning tea in bed, the various products of the entire earth, in whatever quantity he deemed appropriate, and reasonably expect them to be delivered early to his door.
The attributes of a good store of value
When stores of value compete, it is the specific attributes that constitute a good store of value that allows one to outperform the other at the margin and increase demand over time. While many goods were used as stores of value or as "proto-currency", certain attributes emerged that were in particular demand and allowed goods with these attributes to supplant others.
An ideal store of value will be:
- Durable : the good must not be perishable or easily destroyed. Wheat is therefore not an ideal store of value
- Portable : the good must be easy to transport and store, making it secure against loss or theft and facilitating long-distance exchanges. A cow is therefore less ideal than a gold bracelet.
- Fungible : a specimen of the good must be interchangeable with another of equal quantity. Without fungibility, the problem of the coincidence of desires remains intact. So, gold is better than diamonds, which are irregular in shape and quality.
- Verifiable : the good must be easy to identify quickly and verify as authentic. Easy verification increases its recipient's confidence in the trade and increases the likelihood that a trade will be completed.
- Divisible : the property must be easy to subdivide. Although this attribute was less important in early societies where trade was infrequent, it became more important as trade expanded and the quantities traded became smaller and more precise.
- Rare : as Nick Szabo said, a monetary good must have an “unfalsifiable cost”. In other words, the good must not be abundant or easy to obtain or produce in quantity. Rarity is perhaps the most important attribute of a store of value because it taps into the innate human desire to collect what is rare. It is the source of the original value of the store of value.
- Well established history : the longer the good is perceived as having been valuable by society, the greater its appeal as a store of value. A long-established store of value will be difficult to replace by a newcomer unless through force of conquest or the upstart is blessed with a significant advantage among the other attributes listed above.
- Resistance to censorship : A new attribute, which has become increasingly important in our modern digital society with omnipresent surveillance, is censorship resistance. That is, how difficult is it for an external party such as a company or a state to prevent the owner of the asset from retaining and using it. Censorship-resistant products are ideal for those living under regimes that attempt to impose capital controls or ban various forms of peaceful commerce.
The table below ranks Bitcoin, gold, and fiat currency (like the dollar) based on the attributes listed above and is followed by an explanation of each rating:
Durability:
Gold is the undisputed king of sustainability. The vast majority of gold that has ever been mined or minted, including the gold of the Pharaohs, still exists today and will likely be available a thousand years from now. Gold coins that served as currency in ancient times still retain significant value today.
Fiat currency and bitcoins are fundamentally digital records that can take physical form (like paper bills). It is therefore not their physical manifestation whose durability must be taken into account (since a tattered dollar bill can be exchanged for a new one), but the sustainability of the institution that issues them. In the case of fiat currencies, many governments have come and gone over the centuries, and their currencies have disappeared with them.
The Papiermark, Rentenmark and Reichsmark of the Weimar Republic no longer have any value because the institution that issued them no longer exists. If history is any guide, it would be foolish to consider fiat currencies sustainable in the long term – the US dollar and British pound are relative anomalies in this regard.
Bitcoins, having no issuing authority, can be considered durable as long as the network that secures them remains in place. Since Bitcoin is still in its infancy, it is too early to draw definitive conclusions about its sustainability. However, there are encouraging signs that, despite significant examples of nation-state attempts to regulate Bitcoin and years of hacker attacks, the network has continued to operate, displaying a remarkable degree of "anti- fragility”.
Portability:
Bitcoins are the most portable store of value ever used by man. Private keys worth hundreds of millions of dollars can be stored on a small USB drive and easily transported anywhere. Furthermore, equally valuable amounts of money can be transmitted almost instantly between people on opposite ends of the earth. Fiat currencies, being fundamentally digital, are also highly portable. However, government regulations and capital controls mean that large transfers of value typically take days, or are not possible at all. Cash can be used to avoid capital controls, but the storage risk and transportation cost then become significant.
Gold, being physical and incredibly dense, is by far the least portable. It is no wonder that the majority of bullion is never transported. When bullion is transferred between a buyer and seller, it is usually only the title to the gold that is transferred, not the physical bullion itself. Transmitting physical gold over great distances is expensive, risky and time-consuming.
Fungibility:
Gold is the standard for fungibility. Once melted, an ounce of gold is virtually indistinguishable from any other ounce, and gold has always traded this way in the market. Fiat currencies, on the other hand, are only fungible to the extent that the issuing institutions allow them to be. Although a fiat bank note may generally be treated like any other by merchants who accept it, there are cases where large denomination notes have been treated differently from small notes.
For example, the Indian government, in an attempt to eradicate the country's untaxed gray market, completely demonetized its 500 and 1 rupee notes. Demonetization caused the 000 and 500 rupee notes to trade at a price lower than their face value, making them more truly fungible with their lower denomination sister notes.
Bitcoins are fungible at the network level, meaning that each bitcoin, once transmitted, is treated the same on the Bitcoin network. However, since bitcoins are traceable on the blockchain, a particular bitcoin may be tainted by its use in illicit commerce and traders or exchanges may be forced not to accept such tainted bitcoins. Without the privacy and anonymity improvements of Bitcoin's network protocol, bitcoins cannot be considered as fungible as gold.
Verifiable:
In most cases, the authenticity of fiat currencies and gold is fairly easy to verify. However, even if they include features on their banknotes to prevent counterfeiting, nation states and their citizens are still at risk of being deceived by counterfeit banknotes.
Gold is also not safe from counterfeiting. Sophisticated criminals have used gold-plated tungsten to trick gold investors into paying for fake gold. Bitcoins, on the other hand, can be verified with mathematical certainty. Using cryptographic signatures, the owner of a bitcoin can publicly prove that they own the bitcoins they claim to own.
Divisibility:
Bitcoins can be divided down to one hundred thousandth of a bitcoin and transmitted in infinitesimal quantities (transaction fees may, however, make the transmission of small quantities unprofitable). Fiat currencies are generally divisible into pocket money, which has little purchasing power, making fiat currencies sufficiently divisible in practice. Gold, although physically divisible, becomes difficult to use when it is divided into quantities small enough to be useful in small-value, everyday exchanges.
Rarity:
The attribute that most clearly distinguishes bitcoin from fiat currencies and gold is its predetermined scarcity. By design, a maximum of 21 million bitcoins can be created. This gives the Bitcoin owner a known percentage of the total possible supply. For example, an owner of 10 bitcoins would know that at most 2,1 million people on earth (less than 0,03% of the world's population) could one day own as many bitcoins as they do.
Gold, although it has remained quite rare throughout history, is not immune to an increase in supply. If a new method of mining or acquiring gold ever becomes economical, the supply of gold could increase significantly (e.g. seabed mining or asteroids).
Finally, fiat currencies, although only a relatively recent invention in history, have proven to be subject to a constant increase in supply. Nation states have shown a persistent propensity to inflate their money supply to solve short-term political problems. The inflationary trends of governments around the world leave the owner of a fiat currency with the likelihood that the value of their savings will decline over time.
Established history:
No monetary good has as long and rich a history as gold, which has been valued for as long as human civilization has existed. Gold coins minted in ancient times still retain significant value today. The same cannot be said for fiat currencies, which are a relatively recent anomaly in history.
Since their creation, fiat currencies have had a near-universal tendency to eventually lose all their value. Using inflation as an insidious means of invisibly taxing citizens has been a temptation that few states in history have been able to resist.
If the 20th century, during which fiat currencies came to dominate the global monetary order, established an economic truth, it is that fiat money cannot be trusted to maintain its value over the long term. , or even in the medium term.
Bitcoin, despite its short existence, has withstood enough tests in the market that it is highly likely that it will not disappear as a valued asset anytime soon. Furthermore, the Lindy effect suggests that the longer Bitcoin has been around, the more confident society will be that it will continue to exist long into the future.
In other words, societal trust in a new monetary good is asymptotic in nature, as illustrated in the graph below:
If Bitcoin exists for 20 years, there will be near-universal confidence that it will be available forever, just as people believe the Internet is a permanent feature of the modern world.
Censorship resistance:
One of the largest sources of the initial demand for bitcoins was their use in the illicit drug trade. Many then incorrectly assumed that the primary demand for bitcoins was due to their apparent anonymity.
Bitcoin, however, is far from being an anonymous currency; every transaction transmitted on the Bitcoin network is recorded forever on a public blockchain. Transaction history allows for subsequent forensic analysis to identify the source of a flow of funds. It was such an analysis that led to the arrest of an author of the infamous MtGox heist.
While it is true that a sufficiently careful and diligent person can conceal their identity when using Bitcoin, that is not why Bitcoin was so popular for the drug trade. The key attribute that makes Bitcoin valuable for prohibited activities is that it is “permissionless” at the network level. When bitcoins are transmitted on the Bitcoin network, there is no human intervention to decide whether the transaction should be authorized. As a distributed peer-to-peer network, Bitcoin is, by its very nature, designed to resist censorship. This stands in stark contrast to fiat banking, in which states regulate banks and other gatekeepers of monetary transmission to report and prevent illegal uses.
A classic example of regulated monetary transmission is capital controls. A wealthy millionaire, for example, may find it very difficult to transfer his wealth to a new home if he wishes to escape an oppressive regime. Although gold is not issued by states, its physical nature makes it difficult to transmit over a distance, making it much more vulnerable to state regulation than Bitcoin. The Indian law of Gold Control Act is an example of such regulation.
Bitcoin excels in the majority of the attributes listed above, allowing it to marginally outperform modern and ancient monetary assets and providing strong incentive for its growing adoption. In particular, the powerful combination of censorship resistance and absolute scarcity has strongly motivated wealthy investors to allocate a portion of their wealth to this nascent asset class.
The evolution of money
There is an obsession in modern monetary economics with the role of money as a medium of exchange. In the 20th century, states monopolized the issuance of money and continually undermined its use as a store of value, creating a false belief that money is primarily defined as a medium of exchange. Many have criticized Bitcoin as an unsuitable currency because its price was too volatile to be suitable as a medium of exchange. But this puts the cart before the horse. Money has always evolved in stages, with the role of store of value preceding the role of medium of exchange. One of the fathers of marginal economics, William Stanley Jevons, explained that:
Historically speaking… gold appears to have served, first, as a valuable commodity for ornamental purposes; second, as stored wealth; thirdly, as a means of exchange; and, finally, as a measure of value.
To use modern terminology, money always evolves through the following four stages:
- Collector's item : In the very first stage of its evolution, money will be demanded solely according to its particular properties, generally becoming a fantasy of its possessor. Shells, pearls, and gold were all collectibles before later moving to the more familiar roles of money.
- Store of value : Once enough people demand it for its special features, money will be recognized as a way to retain and store value over time. As a good becomes more widely recognized as a suitable store of value, its purchasing power will increase as more people demand it for this purpose. The purchasing power of a store of value will eventually plateau when it becomes widely held and the influx of new people wanting it as a store of value diminishes.
- Medium of exchange : When money is fully established as a store of value, its purchasing power stabilizes. Once purchasing power stabilizes, the opportunity cost of using money to enter into transactions will decrease to a level where it can be used as a medium of exchange. In the early days of Bitcoin, many people did not appreciate the enormous opportunity cost of using bitcoins as a medium of exchange, rather than as a nascent store of value. The famous story of a man trading 10 bitcoins (worth approximately $000 million at the time of writing) for two pizzas illustrates this confusion.
- Account unit : When money is widely used as a medium of exchange, goods will be valued based on this unit. That is, the rate of exchange for currency will be available for most goods. It is a common misconception that bitcoin prices are available today for many products. For example, although a cup of coffee may be available for purchase with bitcoins, the price listed is not the true price of bitcoin; rather, it is the trader's desired dollar price, translated into bitcoin terms at the current USD/BTC market exchange rate. If the price of bitcoin were to fall in dollar terms, the number of bitcoins requested by the trader would increase proportionally.
Only when merchants are willing to accept bitcoins as payment, regardless of bitcoin's exchange rate against fiat currencies, can we truly consider bitcoin to have become a true unit of account.
Monetary goods which do not yet constitute a unit of account can be considered to be “partially monetized”. Today, gold serves such a role, being a store of value but having been stripped of its role as a medium of exchange and unit of account by government intervention. It is also possible that one good fulfills the role of a medium of exchange for money while another good fulfills the other roles. This is generally true in countries with dysfunctional states, such asArgentina or Zimbabwe. In his book Digital Gold, Nathaniel Popper writes:
In the United States, the dollar seamlessly fulfills the three functions of money: providing a medium of exchange, a unit of measurement for the cost of goods, and an asset where value can be stored. In Argentina, on the other hand, while the peso was used as a medium of exchange – for everyday purchases – no one used it as a store of value. Keeping your savings in pesos was wasting money. So people exchanged all the pesos they wanted to save for dollars, which then retained a better value than the peso. Due to the volatility of the peso, people generally remembered prices in dollars, which provided a more reliable unit of measurement over time.
Bitcoin is currently moving from the first stage of monetization to the second stage. It will likely be several years before Bitcoin transitions from a nascent store of value to a true medium of exchange, and the path to get there is still fraught with obstacles and uncertainties. Strikingly, the same transition took several centuries for gold. No one alive has seen the real-time monetization of an asset (as is the case with Bitcoin), so there is little empirical experience regarding the path this monetization will take.
“Path Dependency”
During the monetization process, a monetary good will gain purchasing power. Many have noted that the increase in the purchasing power of Bitcoin creates the appearance of a “bubble.” Although this term is often used disparagingly to suggest that Bitcoin is vastly overvalued, it is unintentionally appropriate. A characteristic common to all monetary goods is that their purchasing power is greater than what their use value alone can justify. Indeed, many historical currencies had no use value.
The difference between the purchasing power of a monetary good and the exchange value it could obtain due to its inherent utility can be considered a "monetary premium." As a monetary good goes through the monetization stages (listed in the section above), the monetary premium will increase. However, the premium does not evolve in a straight and predictable line. A good Silver's monetary premium almost entirely disappeared by the end of the 19th century, when governments around the world largely abandoned it as a currency in favor of gold.
Even in the absence of exogenous factors such as government intervention or competition from other monetary goods, the monetary premium for a new currency will not follow a predictable path. Economist Larry White observed that:
The problem with [the] bubble story, of course, is that it is consistent with any price trajectory and therefore provides no explanation for any particular price trajectory.
The monetization process is game theory; each market player tries to anticipate the overall demand of other players and therefore the future monetary premium. Because the monetary premium is not tied to any inherent utility, market participants tend to default to past prices when determining whether a monetary good is cheap or expensive and whether to purchase it. or sell it. The connection between current demand and past prices is known as "path dependence" and is perhaps the greatest source of confusion in understanding the price movements of monetary goods.
When the purchasing power of a monetary good increases with increasing adoption, market expectations of what constitutes a “cheap” good and an “expensive” good shift accordingly. Similarly, when the price of a monetary good collapses, expectations can transform into a general belief that previous prices were "irrational" or excessively inflated. Money's path dependence is illustrated in the words of famed Wall Street money manager Josh Brown:
I bought [bitcoins] at around $2 and immediately got double that in my hands. Then I started saying "I can't buy more" as the price went up, even though this is a strongly held opinion based on nothing other than the price I was buying it for. I originally purchased. Then, as it fell last week due to China's crackdown on the exchanges, I started thinking, "Oh well, I hope the price gets even lower so I can buy more."
The truth is that the notions of “cheap” and “expensive” goods are essentially meaningless in reference to monetary goods. The price of a monetary good does not reflect its cash flow or utility, but rather a measure of the extent of its adoption for the different roles of money.
The fact that market participants act not simply as impartial observers, trying to buy or sell in anticipation of future movements of the monetary premium, but also as active evangelists, further complicates the path dependence of the cash. Since there is no objectively correct monetary premium, proselytizing the higher attributes of a monetary good is more effective than for ordinary goods, whose value is ultimately anchored to cash flows or demand of use.
The religious fervor of Bitcoin market participants can be observed on various online forums where owners actively promote the benefits of Bitcoin and the wealth that can be generated by investing in it. By observing the Bitcoin market, Leigh Drogen made this comment:
You recognize this as a religion – a story we all tell ourselves and agree on. Religion shows an adoption curve that we should think about. It's almost perfect: as soon as someone enters the circle, they tell everyone about it and start evangelizing around them. Then their friends come in and they in turn begin to evangelize.
Although the comparison to religion may give Bitcoin a sort of irrational religious aura, it is entirely rational for the individual owner to evangelize for a greater monetary good and for society as a whole to normalize on this topic. Money forms the basis of all trade and savings, so adopting a higher form of money has enormous multiplier benefits in terms of wealth creation for all members of a society .
The form of monetization
Although there are no rules beforehand on the path that a monetary good will take when it is monetized, a curious trend has emerged over the relatively short history of Bitcoin monetization. The price of Bitcoin appears to follow a fractal pattern of increasing magnitude, where each iteration of the fractal corresponds to the classic shape of a " Gartner's "hype cycle".
In his article on the speculative theory of Bitcoin adoption and prices, Michael Casey states that Gartner's hyper cycles represent phases of an S-curve that shows the adoption curve that has been followed by many technologies as they become commonly used in society.
Each Gartner hype cycle begins with a surge of enthusiasm for the new technology, and the price is raised by market participants joining the bandwagon. Early buyers in a Gartner round typically have a strong conviction in the transformative nature of the technology they are investing in. Eventually, the market reaches a crescendo of enthusiasm as the supply of new contactable participants in the cycle is exhausted and buying becomes dominated by speculators more interested in quick profits than in underlying technology. underlying.
After the peak of the hype cycle, prices drop rapidly and speculative fervor is replaced by despair, public derision, and a sense that the technology has not been transformative at all. Eventually, the price reaches a plateau and forms a plateau where the initial investors who had strong conviction are joined by a new cohort who have been able to withstand the pain of the price drop and who continue to appreciate and measure the price. importance of this technology.
The plateau lasts for an extended period of time and forms, as Casey calls it, a “stable, boring depression.” During this plateau, public interest in the technology will wane, but it will continue to develop and the number of convinced believers will slowly increase. A new basis is then established for the next iteration of the hype cycle, as outside observers recognize that the technology is not going away and that investing in it may not be as risky as it seemed during the crash phase of the cycle. The next iteration of the cycle will attract a much broader number of adopters and be much larger in scale.
Very few people participating in any iteration of a Gartner hype cycle will correctly anticipate rising prices during that cycle. Prices typically reach levels that would seem absurd to most investors in the early stages of the cycle. When the cycle ends, the media usually attributes a popular cause to the crash. Even if the cause mentioned (such as a failure of exchanges) may be a triggering event, it is not the fundamental reason for the end of the cycle. Gartner hyper cycles end due to an exhaustion of reachable market participants in the cycle.
It is telling that gold followed the classic pattern of a Gartner hype cycle from the late 1970s to the early 2000s. One might assume that the hype cycle is a social dynamic inherent to the monetization process.
Gartner Cohorts
Since the creation of the first exchange-traded price in 2010, the Bitcoin market has experienced four major Gartner hype cycles. Looking back, we can accurately identify the price ranges of previous cycles in the Bitcoin market.
We can also qualitatively identify the cohort of investors associated with each iteration of previous cycles.
- $0 to $1 (2009 to March 2011) : The first hype cycle in the Bitcoin market was dominated by cryptographers, computer scientists and cypherpunks who were already ready to understand the importance of Satoshi Nakamoto's revolutionary invention and who were pioneers in the establishment of the Bitcoin protocol. was free from technical defects.
- 1 to 30 dollars (March 2011-July 2011) : the second cycle attracted both early adopters of new technologies and a steady stream of ideologically motivated investors dazzled by the potential of a stateless currency. Libertarians such as Roger Ver were attracted to Bitcoin for the anti-establishment activities that would become possible if the nascent technology was widely adopted. Wences Casares, a successful and well-connected serial entrepreneur, was also part of the second Bitcoin hype cycle and is known for evangelizing Bitcoin to some of Silicon Valley's most prominent technologists and investors.
- $250 – $1 (April 100 – December 2013): The third hype cycle saw the arrival of the first retail and institutional investors willing to brave the horribly complicated and risky methods by which bitcoins could be purchased. The main source of liquidity in the market during this period was the MtGox stock exchange based in Japan, led by the notoriously incompetent and dishonest Mark Karpeles, who was later sentenced to prison for his role in the stock market collapse.
It is worth noting that the rise in the price of Bitcoin during the aforementioned hype cycles was largely correlated with an increase in liquidity and the ease with which investors could purchase Bitcoin. During the first hype cycle, no exchanges were available and acquiring bitcoins was primarily through mining or directly trading with someone who had already mined bitcoins.
During the second hype cycle, rudimentary exchanges became available, but obtaining and securing bitcoins from these exchanges remained too complex for all but the most tech-savvy investors. Even during the third hype cycle, significant obstacles remained for investors moving money into MtGox to acquire bitcoin. Banks were reluctant to handle exchanges and third-party providers who facilitated transfers were often incompetent, criminals Or both at the same time. Additionally, many of those who managed to transfer money to MtGox eventually faced a loss of funds when the exchange was hacked and eventually shut down.
Only after the collapse of the MtGox exchange and a two-year lull in the Bitcoin market price were mature and deep sources of liquidity developed; examples include regulated exchanges such as GDAX and OTC brokers such as Cumberland Mining. At the start of the fourth hype cycle in 2016, it was relatively easy for retail investors to buy bitcoin and secure it.
- $1 to $100? (19-?) : At the time of writing this article, the Bitcoin market is going through its fourth hype cycle. Participation in the current round has been dominated by what Michael Casey described as the “early majority” of retail and institutional investors.
As sources of liquidity have grown and matured, large institutional investors now have the opportunity to participate through regulated futures markets. The availability of a regulated futures market paves the way for the creation of a Bitcoin ETFs, which will then usher in the “late majority” and “laggards” in subsequent hype cycles.
Although it is impossible to predict the exact magnitude of the current e-cycle, it would be reasonable to assume that the cycle will peak between $20 and $000. Much higher than this range, Bitcoin would represent a significant fraction of gold's total market cap (gold and Bitcoin would have market caps equivalent to a Bitcoin price of around $50 at the time of writing).
A significant fraction of gold's market capitalization comes from central bank demand and central banks or nation states are unlikely to participate in this particular hype cycle.
The entry of nation states
Gartner's latest Bitcoin hype cycle will begin when nation states begin accumulating it as part of their foreign currency reserves. Bitcoin's market capitalization is currently too low for it to be considered a viable addition to most countries' reserves.
However, as private sector interest increases and Bitcoin's capitalization approaches $1 trillion, it will become liquid enough for most states to enter the market. The entry of the first state to officially add bitcoin to its reserves will likely spark a rush for others to do so. States that were early adopters of Bitcoin would see the greatest benefit to their balance sheets if Bitcoin ultimately becomes a global reserve currency.
Unfortunately, it will likely be the states with the most powerful executive powers – dictatorships like North Korea – that will progress the fastest in bitcoin accumulation. The reluctance to see these states improve their financial situation and the inherent weakness of the executive powers of Western democracies will cause them to procrastinate and lag behind in accumulating bitcoins for their reserves.
It is ironic that the United States is currently one of the most open countries in its regulatory stance towards Bitcoin, while China and Russia are the most hostile. The United States risks the greatest disadvantage to its geopolitical position if Bitcoin supplants the dollar as the global reserve currency. In the 1960s, Charle de Gaulle criticized “exorbitant privilege” which the United States enjoyed in the international monetary order that it had developed with the Bretton Woods agreements of 1944.
The Russian and Chinese governments have yet to realize the geostrategic benefits of Bitcoin as a reserve currency and are currently concerned about the effects this could have on their domestic markets. Like de Gaulle in the 1960s, who threatened to reestablish the classic gold standard in response to the exorbitant privileges of the United States.
Therefore, the Chinese and Russians will, over time, come to understand the benefits of a large reserve position in a non-sovereign store of value. With the largest concentration of Bitcoin mining power residing in China, the Chinese state already has a distinct advantage in its ability to add bitcoins to its reserves.
The United States prides itself on being a nation of innovators, with Silicon Valley being one of the jewels of the American economy. So far, Silicon Valley has largely dominated discussions with regulators about what stance they should take on Bitcoin. However, the banking industry and the US Federal Reserve are finally getting a first sense of the existential threat Bitcoin poses to US monetary policy if it becomes a global reserve currency.
The Wall Street Journal, known as the mouthpiece of the Federal Reserve, published an article on the threat that Bitcoin represents for American monetary policy:
There is another danger, perhaps even more serious from the point of view of central banks and regulators: bitcoin may not collapse. If the speculative fervor around cryptocurrency is only the harbinger of its widespread use as an alternative to the dollar, it will threaten the monetary monopoly of central banks.
In the years to come, there will be a great struggle between the entrepreneurs and innovators of Silicon Valley, who will try to keep Bitcoin free from state control, and the banking sector and central banks who will do whatever is necessary. in their power to regulate Bitcoin to prevent their industry from being disrupted.
The transition to a medium of exchange
A monetary good cannot become a generally accepted medium of exchange (the standard economic definition of "money") until it is widely valued, for the tautological reason that a good that is not valued will not be accepted in exchange.
By becoming widely valued, and therefore a store of value, a monetary good will see its purchasing power skyrocket, creating an opportunity cost linked to its abandonment for use in exchange. Only when the opportunity cost of giving up a store of value falls to a sufficiently low level can it become a generally accepted medium of exchange.
More precisely, a monetary good will be suitable as a medium of exchange only when the sum of the opportunity cost and the transactional cost of using it in exchange falls below the cost of carrying out a transaction without it.
In a barter-based society, the transition from a store of value to a medium of exchange can occur even as the monetary good increases in purchasing power, because the transaction costs of barter are extremely high. In a developed economy, where transaction costs are low, it is possible that an emerging and rapidly appreciating store of value, such as Bitcoin, could be used as a medium of exchange, albeit in a very limited scope. An example can be given with the illicit drug market, where buyers are willing to sacrifice the ability to hold bitcoins to minimize the substantial risk of purchasing drugs in fiat currency.
There are, however, significant institutional barriers that prevent an emerging store of value from becoming a generally accepted medium of exchange in a developed society. States use taxation as a powerful means to protect their sovereign money against the displacement of competing monetary goods. Not only does a sovereign currency enjoy the advantage of a constant source of demand, due to the fact that taxes can only be paid on it, but competing monetary goods are taxed each time they are exchanged at an appreciated value. This latter type of taxation creates significant friction in the use of a store of value as a medium of exchange.
The handicap of commercial monetary goods does not, however, constitute an insurmountable obstacle to their adoption as a generally accepted means of exchange. If confidence in a sovereign currency is lost, its value can collapse in a process known as hyperinflation. When a sovereign currency hyperinflates, its value first collapses relative to society's most liquid assets, such as gold or a foreign currency like the U.S. dollar, if they are available. When no liquid assets are available or their supply is limited, a hyperinflationary currency collapses against real assets, such as real estate and commodities.
The archetypal image of hyperinflation is that of a grocery store emptied of all its products as consumers flee the decreasing value of their country's currency.
Eventually, when faith is completely lost during hyperinflation, sovereign currency will no longer be accepted by anyone, and either society will turn to barter or the monetary unit will be completely replaced as a medium of exchange. An example of this process was the replacement of the Zimbabwe dollar with the US dollar. Replacing a sovereign currency with a foreign currency is made more difficult by the scarcity of foreign currency and the absence of foreign banking institutions to provide liquidity.
The ability to easily transmit bitcoins across borders and the lack of having a banking system makes Bitcoin an ideal monetary asset to acquire for those affected by hyperinflation. In the years to come, as fiat currencies continue to follow their historical trend toward eventual irrelevance, Bitcoin will become an increasingly popular choice for global savings to flee to. When a country's money is abandoned and replaced by Bitcoin, Bitcoin goes from being a store of value in that society to being a generally accepted medium of exchange. Daniel Krawisz coined the term “ hyperbitcoinization » to describe this process.
Errors of judgment
Much of this article has focused on the monetary nature of Bitcoin. Thanks to this database, we can now answer certain Common Misconceptions About Bitcoin.
Bitcoin is a bubble
Bitcoin, like all commercial monetary goods, presents a monetary premium. The currency premium is behind the common criticism that Bitcoin is a “bubble.” However, all monetary goods present a monetary premium. Indeed, it is this premium (the excess over the use-demand price) which is the defining characteristic of all money. In other words, money is always and everywhere a bubble. Paradoxically, a monetary good is both a bubble and may be undervalued if it is in the early stages of being adopted for use as money.
Bitcoin is too volatile
Bitcoin price volatility is a function of its nascent nature. During the first years of its existence, Bitcoin behaved like a penny stock, and any large buyer – like the Winklevoss twins – could cause its price to rise sharply. As adoption and liquidity have increased over the years, Bitcoin volatility has decreased as a result. When Bitcoin reaches the market cap of gold, it will display a similar level of volatility. As Bitcoin exceeds the market capitalization of gold, its volatility will decrease to a level that makes it suitable as a widely used medium of exchange.
As previously noted, Bitcoin monetization occurs according to a series of Gartner hype cycles. Volatility is lowest during the plateau phase of the hype cycle, while it is highest during the peak and crash phases of the cycle. Each hype cycle has lower volatility than previous ones because market liquidity has increased.
Transaction fees are too high
A recent criticism of the Bitcoin network is that the increase in bitcoin transaction fees makes it unsuitable as a payment system. However, fee growth is healthy and predictable. Transaction fees are the cost necessary to pay Bitcoin miners to secure the network by validating transactions. Miners can be paid either through transaction fees or block rewards, which are an inflationary subsidy borne by current Bitcoin owners.
Given Bitcoin's fixed supply schedule – a monetary policy that makes it an ideal store of value – block rewards will eventually fall to zero and the network will ultimately need to be secured through transaction fees. A network with “low” fees is an insecure network and subject to external censorship. Those who tout the low fees of Bitcoin alternatives are unknowingly describing the weakness of these so-called “alt-coins.”
The specious root of criticism of Bitcoin's "high" transaction fees is the belief that Bitcoin should be a payment system first and a store of value second. As we saw with the origins of money, this belief puts the cart before the horse. Only when Bitcoin becomes a deeply established store of value will it become a suitable medium of exchange. Additionally, once the opportunity cost of trading bitcoin reaches a level that makes it suitable as a medium of exchange, most transactions will not take place on the Bitcoin network itself but on networks of " second layer” with much lower fees.
Second-layer networks, such as Lightning Network, provide the modern equivalent of promissory notes used to transfer securities for gold in the 19th century.
Promissory notes were used by banks because transferring the underlying bullion was much more expensive than transferring the note that represented title to the gold. However, unlike promissory notes, the Lightning Network will allow the transfer of bitcoins at low cost while requiring little or no trust from third parties such as banks. The development of the Lightning Network is an extremely important technical innovation in Bitcoin's history and its value will become evident as it develops and is adopted in the years to come.
Competition
As a protocol open source software, it has always been possible to copy Bitcoin's software and copy it. Over the years, many imitations have been created, ranging from ersatz copies such as Litecoin, to complex variants like Ethereum that promise to enable arbitrarily complex agreements using a distributed computing system. A common investment criticism of Bitcoin is that it cannot maintain its value while competitors can be easily created and able to incorporate the latest innovations and technologies.
The fallacy of this argument is that the many competitors to Bitcoin that have been created over the years do not have the "network effect" (Network effects) technology dominant in the space. A network effect – the increased value of using Bitcoin simply because it is already the dominant network – is a feature in itself. For any technology that has a network effect, this is by far the most important feature.
The network effect for Bitcoin encompasses the liquidity of its market, the number of people who own it, and the community of developers who maintain and improve its software and brand awareness. Large investors, including nation states, will look for the most liquid market so they can enter and exit it quickly without affecting its price. Developers will flock to the dominant development community that has the most talented talent, thereby strengthening the strength of that community. And brand awareness is self-reinforcing, because potential competitors to Bitcoin are always mentioned in the context of Bitcoin itself.
A fork in the road
A trend that became popular in 2017 was to not only imitate Bitcoin software, but also copy its entire past transaction history (known as blockchain). By copying Bitcoin's blockchain to a certain extent and then splitting it into a new network, in a process known as "forking", Bitcoin's competitors were able to solve the problem of distributing their token to a large user base.
The largest such fork occurred on August 1, 2017, when a new network known as Bitcoin Cash (BCH) has been created. An owner of N bitcoins before August 1, 2017 would then own both N bitcoins and N BCash tokens. The small but vocal community of BCash supporters has relentlessly attempted to expropriate Bitcoin's brand recognition, both through the name of its new network and through a campaign aimed at convincing Bitcoin market neophytes that Bcash is the " real » Bitcoin.
These attempts have largely failed, and this failure is reflected in the market capitalizations of both networks. However, for new investors, there remains an apparent risk that a competitor will clone Bitcoin and its blockchain and manage to overtake it in terms of market capitalization, thereby becoming the de facto Bitcoin.
An important rule can be drawn from the major bifurcations that occurred with the Bitcoin and Ethereum networks. The majority of market capitalization will be concentrated on the network that maintains the most knowledgeable and active developer community. Because although Bitcoin can be considered a nascent currency, it is also a computer network built on software that must be maintained and improved. Buying tokens on a network with weak or inexperienced developer support would be like buying a Microsoft Windows clone that was not supported by Microsoft's top developers. It is clear from the history of the forks that took place in 2017 that the best and most experienced computer scientists and cryptographers were committed to developing the original Bitcoin and not any of the growing legions of imitators that were created based on it. of it.
Real risks
Although common criticism of Bitcoin in the media and business circles is misplaced and based on a flawed understanding of money, there are real and significant risks to investing in Bitcoin. It would be prudent for a potential Bitcoin investor to understand and evaluate these risks before considering an investment in Bitcoin.
Protocol risk
The Bitcoin protocol and the cryptographic primitives on which it is built could have a design flaw or could become insecure with the development of quantum computing. If a flaw is discovered in the protocol, or if new means of calculation break the cryptography that underpins Bitcoin, trust in Bitcoin could be seriously compromised. Protocol risk was highest in the early years of Bitcoin's development, when it was not yet clear even to seasoned cryptographers that Satoshi Nakamoto had actually found a solution to the Byzantine generals problem. Concerns about serious flaws in the Bitcoin protocol have dissipated over the years, but given its technological nature, protocol risk will always remain for Bitcoin, if only as an outlier risk.
Closure of trade
Decentralized in design, Bitcoin has demonstrated a remarkable degree of resilience in the face of numerous attempts by various governments to regulate or shut it down. However, the platforms where bitcoins are exchanged for fiat currencies are highly centralized and susceptible to regulation and closure. Without these exchanges and the willingness of the banking system to do business with them, the Bitcoin monetization process would be severely delayed, if not completely stopped. Although there are other sources of liquidity for Bitcoin, such as peer-to-peer platforms and decentralized markets for buying and selling Bitcoin (like localbitcoin), the critical price discovery process takes place on the most liquid exchanges, all of which are centralized.
Mitigating the risk of stock market closures is a jurisdictional arbitration. Binance, a major exchange that started in China, moved to Japan after the Chinese government halted its operations in China. National governments are also reluctant to stifle a nascent industry that could prove as big as the Internet, ceding a huge competitive advantage to other countries.
Only with a coordinated global shutdown of Bitcoin trading would the monetization process be completely disrupted. The race is on for Bitcoin to be so widely adopted that a complete shutdown becomes as politically unfeasible as a complete shutdown of the Internet. The possibility of such a shutdown is, however, still real and must be factored into the risks of investing in Bitcoin. As we saw in the previous section on the entry of nation states, national governments are finally waking up to the threat that a non-sovereign, censorship-resistant digital currency poses to their monetary policies. It remains an open question whether they will act on this threat before Bitcoin becomes so entrenched that political action against it proves ineffective.
fungibility
The open and transparent nature of the Bitcoin blockchain allows states to mark certain bitcoins as “tainted” by their use in prohibited activities. Although Bitcoin's resistance to protocol-level censorship allows the transmission of these bitcoins, if regulations prohibiting the use of these tainted bitcoins by exchanges or traders emerge, they could become largely worthless. Bitcoin would then lose one of the critical properties of a monetary good: fungibility.
To improve the fungibility of Bitcoin, improvements will need to be made at the protocol level to improve transaction privacy. Although there are new developments in this regard, notably in the area of digital currencies such as Monero and Zcash, major technological trade-offs must be made between the efficiency and complexity of Bitcoin and its policy.
It remains an open question whether privacy-enhancing features can be added to Bitcoin in a way that does not compromise its usefulness as a currency.
Conclusion
Bitcoin is an emerging currency that is moving from the collectible monetization stage to that of a store of value. As a non-sovereign monetary good, it is possible that at some point in the future, Bitcoin will become a global currency, much like gold during the classic gold standard of the 19th century. The adoption of Bitcoin as a global currency is precisely the optimistic argument in favor of Bitcoin, and was expressed by Satoshi Nakamoto as early as 2010 in a email exchange with Mike Hearn:
If you imagine that bitcoin will be used for a fraction of global commerce, then there will only be 21 million coins for the entire world, then its value per unit will be much higher.
This situation was presented even more convincingly by the brilliant cryptographer Hal Finney, recipient of the first bitcoins sent by Nakamoto, shortly after the announcement of the first working Bitcoin software:
[I] envision Bitcoin succeeding and becoming the dominant payment system used around the world. The total value of money should then be equal to the total value of all the wealth in the world. Current estimates of total household wealth around the world that I have found vary between $100 trillion and $000 trillion. With 300 million coins, that makes each coin worth about $000 million.
Even if Bitcoin did not become a full-fledged global currency and were to simply compete with gold as a non-sovereign store of value, it is currently massively undervalued.
Mapping the market cap of the existing above-ground gold supply (around $8 trillion) with a maximum Bitcoin supply of 000 million coins yields a value of around $21 per bitcoin.
As we saw in previous sections, for the attributes that make a monetary good a store of value, Bitcoin is superior to gold on all axes except established history. As time passes and the Lindy Effect takes hold, established history will no longer provide a competitive advantage for gold. It is therefore not unreasonable to expect Bitcoin to approach, or even surpass, the market capitalization of gold over the next decade.
A caveat to this thesis is that much of the capitalization of gold comes from central banks holding it as a store of value. For Bitcoin to reach or surpass the capitalization of gold, some participation from nation states will be necessary. It is not yet clear whether Western democracies will participate in Bitcoin ownership. It is more likely, and regrettably, that dictatorships and kleptocracies will be the first nations to enter the Bitcoin market.
If no nation states participate in the Bitcoin market, there still remains a bullish argument for Bitcoin.
As a non-sovereign store of value used only by retail and institutional investors, Bitcoin is still early in its adoption curve – the so-called “early majority” are now entering the market while the late majority and latecomers are still far from entering. With broader participation from retail and especially institutional investors, a price level between $100 and $000 is achievable.
Owning bitcoins is one of the few asymmetric bets that people around the world can participate in. Much like a call option, an investor's downside is limited to 1x, while their upside potential is always 100x or more.
Bitcoin is the first truly global bubble whose size and scope are limited only by the desire of the world's citizens to protect their economies from the vagaries of government economic mismanagement. Indeed, Bitcoin rose like a phoenix from the ashes of the 2008 global financial catastrophe – a catastrophe precipitated by the policies of central banks like the Federal Reserve.
Beyond the financial arguments in favor of Bitcoin, its rise as a non-sovereign store of value will have profound geopolitical consequences. A non-inflationary global reserve currency will force nation states to change their primary financing mechanism from inflation to direct taxation, which is much less politically palatable. The size of States will decrease in proportion to the political pain linked to the transition to taxation as the exclusive means of financing. Furthermore, world trade will be regulated in a way that satisfies Charles de Gaulle's aspiration that no nation should have privilege over another:
We consider it necessary that international trade be established, as was the case before the great misfortunes of the world, on an incontestable monetary basis which does not bear the mark of any country in particular.
In 50 years, this monetary base will be Bitcoin.
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Original article in English here.
You can find the book in French version on Amazon.
About the Author
Vijay Boyapati is a former Google engineer interested in the Austrian economy.
Follow him on Twitter.
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The opinions presented in this article and any errors therein are those of the author.
This article is for informational purposes only. This is not investment advice. Seek a properly licensed professional for investment advice.
