Bitcoin: Digital Capital in the Digital Age

Understanding Ownership

Bitcoin, at its core, is a “bearer asset”. This means that it is a financial asset owned by the individuals who have physical possession over it rather than by third party institutions such as banks and stockbrokers. ?More classic examples of bearer assets include gold bars held in someone’s personal safe or a rare watch or comic book. There are two obvious benefits of bearer assets: an absence of counterparty risks such as asset seizure and the allowance of permissionless asset transfer. Transactions involving bearer assets are final, meaning they cannot be reversed. ?Because no third-party institutions are involved in exchange of bearer assets, transactions between two individuals cannot be undone via involvement of such an institution.

For example, if Alice sells Bob a gold coin in person but then changes her mind, Alice cannot call a bank to have this transaction voided. ?

To put this into perspective, Bitcoin is a bearer asset because ownership is determined by private key ownership (private keys are protected by cryptography). When one possesses the private key to access a Bitcoin wallet, they have sole access and control over the Bitcoin in that wallet. There is no backdoor into that wallet. When an individual transfers Bitcoin to another wallet, the transaction is final and cannot be reversed. This is different from what is typical of digital transactions through traditional payment networks.

However, traditional bearer assets like gold can come with certain material downsides, such as transportation challenges and the risk of loss due to theft.

For example, how do you transfer gold from one person to another? The only way is through physical exchange, which is manageable for people close by. But what if they're on different continents? And what if they're transferring gold worth millions or billions of dollars? You start to see how difficult this process can become.

In this scenario, those transferring gold would likely need to hire security for protection and insure the gold against potential incidents during transit. Even if the gold arrives safely, it might take weeks or even months depending on the shipping process. The main point is that there are many ways the transfer of traditional bearer assets can go wrong, making it clear how quickly it can become a costly logistical nightmare.

What is the Utility of Bitcoin?

Here's where Bitcoin is different: You can initiate and settle large transactions in just a few minutes. The fees for these transactions usually range from pocket change to just a few dollars. For example, a transaction of 26,139 Bitcoin worth $1.347 billion was sent on the network with a fee of ~ $2.06.

Facilitating transactions worth billions over the internet and achieving final settlement without any third-party involvement is groundbreaking.

These transactions can be more secure than conventional transactions. Imagine this: It would be much easier for someone to walk up to you and take money from the wallet in your coat pocket or steal your banking information than to steal the private keys to your Bitcoin wallet. Those private keys, which are essential for accessing your Bitcoin, are typically a series of randomly generated words stored offline on a piece of paper in a secure location.

What Makes the Bitcoin Network Secure?

As mentioned earlier, the Bitcoin network is sufficiently decentralized, meaning that there is no party or individual that controls the network. This is a common misconception surrounding Bitcoin. Let me be clear: Bitcoin is not a company or organization. There is no CEO of Bitcoin. There is no central figure of Bitcoin. There is no entity that can seize Bitcoin from the network, increase supply, and/or censor transactions. Bitcoin is an internet protocol like email. Saying an entity controls Bitcoin would be like saying an entity controls email. Sure, there are large number of email providers that we use every day but if one provider were to go out of business, email itself would not be destroyed with it. This is an imperfect comparison but useful, nonetheless.

All Bitcoin payments made in the network are peer-to-peer and do not require mediation from a financial institution such as a bank. A Bitcoin transaction, on its blockchain, exists 100% out of the traditional financial system.

So then how are Bitcoin transactions settled?

Bitcoin transactions are settled via the combined efforts of “miners”, that contribute their computing power to the network to secure and process transactions (minting Bitcoin in return), and thousands of “nodes”, that validate and record all transactions through Bitcoin's consensus rules.

I’m not going to go into all of the technicalities behind Bitcoin miners and nodes, but the key point here is that there is no single point of failure of Bitcoin. If one miner or node were to go down, there are many more functioning miners and nodes that could step in and provide coverage.

What is Bitcoin's Intrinsic Value?

I can’t give you a number.

Bitcoin doesn’t have intrinsic value like stocks, which generate cash flow and can be valued using traditional financial methods such as discounted cash flow models or P/E ratios. It's important to distinguish Bitcoin from these as Bitcoin is a monetary good like gold. I invite those who argue that Bitcoin lacks intrinsic value to quantify the intrinsic value of gold. While gold has various practical uses, including its application in computer chips and its creation into jewelry, the vast majority of gold’s estimated market cap of $16-18 trillion is its monetary premium over its utility. Think of the gold bars held in central bank reserves and safes across the world. Gold does not innovate, provide cash flow, or present itself as a productive asset, but it is still accepted globally as a monetary asset. Gold has always been gold and will remain gold in the future.

Bitcoin as Digital Gold

Gold has many redeeming physical properties that has made it successful as a monetary asset throughout history:

• Rare
• Highly durable
• Resistant to corrosion

But there are also clear downsides to gold’s properties:

• Supply increases
• Not easily divisible
• Difficult to transport

Bitcoin improves upon the monetary properties of gold in various ways:

• Bitcoin has provable scarcity—there will only ever be 21,000,000 Bitcoin. This is ensured because Bitcoin's code is fully open source, meaning that anyone can audit it. Bitcoin's blockchain is also transparent, which means that anyone can view any transaction. The network's nodes validate the consensus rules, which are responsible for maintaining consistency and determining the validity of Bitcoin transactions. The nodes reject any transaction that does not adhere to these protocols. While gold technically exists in a finite amount, new gold is mined every year increasing the supply typically around 1% to 3% annually.

Let’s run through a thought exercise.?Imagine that you wake up tomorrow, and the price of gold has doubled. What likely happens next is that you see gold miners investing more resources and efforts into extracting more gold from the earth, thereby increasing the supply at a higher rate to achieve a new equilibrium between supply and demand. With Bitcoin, the supply is completely fixed regardless of demand.

• Bitcoin is easily transferable —in reference to the earlier example of billions in value continuously being transferred over the Bitcoin network, this can prove useful to many companies and individuals. Bitcoin is also highly divisible, capable of being split up to 100 million smaller units, which enhances its transportability. ??

For which traditional asset could billions of dollars in value be transacted from New York to Tokyo in a matter of minutes for a minimal fee and with zero involvement from third parties?

Limitations of Bitcoin

While I’ve been making quite the bull case for Bitcoin’s monetary properties, it isn’t a perfect network.

• Transaction Processing: The Bitcoin blockchain can only process ~ 3 to 4 transactions per second, which is significantly less than networks like Visa which can handle up to ~ 65,000 transactions per second. While this is an obvious disparity, it isn’t exactly an apples-to-apples comparison. In contrast, Bitcoin transactions reach final settlement, whereas Visa transactions can usually be reversed weeks after the initial transaction. Because of this, Bitcoin transactions should be reserved for larger transactions that need quick final settlement.
• Price Volatility: It's no secret that Bitcoin price has been highly volatile over the course of its lifespan. Bitcoin has historically seen massive increases in price followed by periods of significant decline. Rinse and repeat. Again, though I already said I won’t be making price predictions, having only been around for 16 years, Bitcoin is still quite young relative to other financial innovations. While this price volatility makes it tricky to store value long term, as the network has matured and liquidity has increased, we have seen reduced volatility over time compared to its earlier years. I would estimate that over the long term (next 15+ years) we will see even further decreases in its price volatility as the trend in adoption continues and liquidity grows.

Is Bitcoin the New Tulip Bubble?

Over the years Bitcoin has often been compared to the Tulip bubble which occurred in the Netherlands during the 1600’s. The story goes that during this period, rare tulips traded for multiple times the average annual salary at that time. This comparison is often made during the large price increases and subsequent declines in Bitcoin’s price which has occurred many times since its inception.

It is highly unlikely Bitcoin is comparable to the tulip bubble.

The tulip bubble lasted no more than a few years and the tulips' value never returned to its peak price. Again, Bitcoin has existed for over 16 years and has seen continued adoption of its network regardless of its price action. Further making the case for Bitcoin’s longevity is the concept known as “The Lindy Effect”.

“The Lindy effect is a theorized phenomenon by which the future life expectancy of some non-perishable things, like a technology or an idea, is proportional to their current age. Thus, the Lindy effect proposes the longer a period something has survived to exist or be used in the present, it is also likely to have a longer remaining life expectancy. Longevity implies a resistance to change, obsolescence or competition, and greater odds of continued existence into the future” - Lindy Effect Wikipedia

It can be thought that the longer the Bitcoin network has been around and remains secure (as discussed above), the more resilient and likely it is that the Bitcoin network will continue to survive.

In addition to this, flowers are obviously a terrible store of value since they wither away and more can always be planted.

Bitcoin is Bitcoin

The main aim of this article is to shed some light into how Bitcoin functions separate from its price. Most Bitcoin coverage that exists today solely discusses Bitcoin’s price in the short term and doesn’t discuss what gives it any value in the first place. No one knows what Bitcoin’s price will be tomorrow, next year, or 5 years from now, but I would strongly make the argument that whether the price goes up 10x or down 80% (or both), Bitcoin will remain.

Sources:

Bitcoin Wiki - bitcoin.it

Mempool - mempool.space

Bitnodes - Bitnodes.io

Lindy Effect Wiki - https://en.wikipedia.org/wiki/Lindy_effect

Visa Site - visa.com

All opinions expressed are solely my own and do not necessarily reflect the views of my employer.