What Is Bitcoin and What Is It Not

What Is Bitcoin and What Is It Not

Hi everyone, I hope you’re doing alright given the current situation in cryptoland. I decided to write an article (https://www.informedinterest.com/) on Bitcoin as I think its good to remind ourselves of what it all started with in times like these. I’ll be debunking some common misconceptions. Enjoy and let me know in the comments what you think! 🙂

Bitcoin is Scarce
Many of Bitcoin’s proponents claim it to be a hedge against inflation which, if true, would make it an extremely relevant investment today. With inflation being at its highest point in 40 year, obtaining real positive returns becomes increasingly difficult. There is, however, no evidence that Bitcoin is correlated with inflation. It is true that fiat currencies such as the US dollar and Euro have lost value due to inflation since the launch of Bitcoin in 2009, whereas Bitcoin’s value (expressed in these currencies) has gone up significantly. So has the price of Amazon stock. So has real estate. A smart reader will note that almost anything has increased in value since Bitcoin’s launch. It happened to coincide with the bottom of the bear market caused by the Global Financial Crisis of 2008.

Even so, Bitcoin is often praised as a better alternative to fiat currencies with regards to inflation. Another common misconception is that this relates to Bitcoin’s fixed supply of only 21 million coins. The number of coins, however, is completely irrelevant. There could have been double/half the number of coins and one Bitcoin would roughly be worth half/twice of what it’s worth today. The fact that you can own the tiniest fraction of a Bitcoin renders this argument even less valid.

The real reason Bitcoin is considered ‘scarce’ is due to its supply rate, which is cut in half roughly every four years. It is therefore that Bitcoin’s supply rate was extremely high right after its launch but has significantly decreased ever since. This is illustrated by the image below which shows a predictable inflation rate that is approaching zero. This effect is equally captured by the blue dotted line, symbolizing all Bitcoins that have been mined already, which is asymptomatically approaching 21 million. These numbers come directly from the code of the Bitcoin protocol and can only be adjusted if more than half of the network agrees with it. Something that is extremely unlikely given the fact it would erase one of Bitcoin’s most valuable properties.

A decreasing and predictable supply makes Bitcoin a unique investment. Regardless of when you buy Bitcoin, the inflation rate will only decrease since the moment you made that purchase. Something that cannot be said of any government-backed currency.

Source: Researchgate

Bitcoin Does Not Produce Anything
I would like to address an often-heard counter argument as to why Bitcoin, despite the above, is not a good investment. It does not create anything. No dividends, no interest, no nothing. This distinguishes Bitcoin from traditional investments such as stocks and bonds, that generally do have some kind of cash flow. It is therefore harder to value which often leads to the conclusion that it has no value.

This is too short-sighted. Gold does not produce a cash flow. Neither does art or your Rolex. Yet these are often seen as valid investments. Not for their cash flow, but for their utility and (you guessed it) scarcity. Bitcoin has both qualities. It is scarce as it has an ever-decreasing issuance rate and capped supply. It has utility as it allows for value transfers from any place in the world to another, granted there is an internet connection. It is often cheaper to buy Bitcoin (or any crypto) and send it to a friend abroad for him or her to sell it for their local currency than to go through the traditional banking sector.

Bitcoin is a Bubble
Bubbles are a unique phenomenon directly attributable to human nature. Humans are not rational. Just think about all the stupid things you have done in the past and how you wish you had made a rational rather than an emotional choice. I know I have. This absence of human ration in decision-making is also very pronounced in the investment world. So many biases lead us (even professional investors) to making mistake that could have been prevented.

One of these biases is called Fear of Missing Out (FOMO). We have all experienced it in our life. Probably as an insecure teenager, but likely still today when you hear your neighbor talk about how he tripled his money with some exotic investment. Most people will only hear about a certain investment when it has been given a lot of publicity, often after a sharp rise or decline in value. Not wanting to miss out, gains are being chased to the point where assets become overvalued. This leads to more publicity and the cycle repeats until the bubble bursts. Although we like to think we are smarter than our ancestors during the Tullip Mania or the South Sea Bubble, we are not. We still exhibit FOMO, overconfidence, and self-attribution bias as well as many others.

The graph below shows the relation between the numbers of Bitcoin users and its value over time. The graph only accounts for active adresses, a conservative figure of the actual number of users. The correlation is, not surprisingly, strong. The main reason for Bitcoin’s enormous growth over the last decade is an increasing number of users and this higher demand (with a decreasing supply) has led to a higher price. This increased adoption does not happen linearly but rather in waves. At the peak of these waves, bubble-like price behavior has occurred but that does not mean the entire price development has been a bubble.

Source: LookIntoBitcoin

Bitcoin is Too Volatile
Too volatile for what? It is a simple fact that Bitcoin is more volatile than many other asset classes. This volatility has been coming down over the years as Bitcoin’s market cap increases. It is, however, still significantly more volatile than basically all other major asset classes as the image below showcases. Is that a problem? Well it depends. For Bitcoin to be a currency that can be used for everyday spending, borrowing and saving, such as the US dollar or Euro, it is indeed too volatile. For transfers of value that would have been too expensive or extremely cumbersome through the traditional financial system, its volatility poses less of a problem. The main question, however, is whether its price swings renders it invalid to be a store of value. This all depends on whether you believe it to hold or increase its value over time. Short-term volatility is irrelevant if your investment horizon is a decade. If it is short-term profit that you are after, Bitcoin likely is not for you. Bitcoin is volatile, and although this volatility is expected to come down as its market cap increases, you should treat it as any other high-risk investment. Take a long-term approach and do not invest more than you can afford to lose and you will able to withstand its temper.

Source: WooBull.com

I hope this article has given you some nuance as to the pros and cons of Bitcoin for you to use in your next discussion. Regardless of where you stand, the future will show which side is ultimately right. I would encourage all of you to learn more about Bitcoin and the wider cryptocurrency/blochchain ecosystem. Even if you are not convinced of its value, the rise of an entirely new asset class is not something that happens every day. And as my username suggests, stay informed! 😉

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