Understanding Bitcoin — A Course Study
Framing The Questions And Collecting The Infographics
Blockchain. Cryptocurrency. Asset Bubbles. What the hell is going on? This article doesn’t have the answers. It is a succinct primer for helping you figure out how to think about Bitcoin. I don’t hold any bitcoin personally and I am not advocating for or against it. This article is just an analysis on how to think about it.
What is bitcoin?
Bitcoin is currently (December 2017) the most popular form of cryptocurrency available. It utilizes blockchain technology and has grabbed the world’s attention. It has also risen in price immensely in just the last year.
What is blockchain?
Blockchain allows distributed networks to track things and assure their validity. PwC offers this informative infographic, so I didn’t have to.
What is cryptocurrency?
Cryptocurrency is a medium of exchange similar to gold and money. It relies on cryptography and encryption rather than a central government or geologic scarcity to control the quality and quantity of money.
Put succinctly:
Bitcoin is the current most popular brand of secure Open Source Money
Is it real or hype? Is it an asset bubble?
Honestly, only time will tell. Anyone is free to offer an opinion. Each side will justify it with their own arguments. History will judge one side the winner, at least for a while. The analytic reality is we may never really know.
Let’s examine some arguments for and against. Not the stuff you can easily Google. A coarse, but more analytic take.
Assets have value. Does Bitcoin have value?
Good question. Blockchain has value. Cryptography has value. But a cryptocurrency is, by definition, a medium of exchange. The market doesn’t rise or fall on value. It rises and falls on supply and demand. But — it is backstopped by value. Does Bitcoin have tangible value — probably not.
But neither does gold or the dollar!
Fair point. Gold does have some intrinsic value, though much is preference based. There is also value in the paper and security features of dollar bills. The latter though is backed by the “full faith and credit of the US Government”. The former is backstopped by about 5000 years of human history. Still not incredibly tangible arguments for either.
Value has another determining feature — cost.
Gold has a very tangible cost to mine it and refine it. The dollar has a printing cost. Gold is more tangible. Bitcoin is certainly more inline with the latter. With no true tangible form, Bitcoin is also called an e-currency or digital currency, the cost is in the storage of the blockchain and that is distributed across the internet.
In other words — Bitcoin is hard to backstop with a value evaluation. But it is in good company.
Isn’t It Really About Supply & Demand?
Supply is supposedly a strong argument for Bitcoin, although we will really need to wait and see. Financial analysts believe that supply will taper in a few decades. This could be a great advantage over paper currencies as governments have never shown this sort of discipline. Will Bitcoin? Are you certain?
Demand on the other hand is a little harder to qualify. Clearly it is increasing, but why? Because more and more companies are accepting it as a medium of exchange? Perhaps. Or because the price is rising? Likely. Price is just perceived value at best… but that is another common trait of currencies.
Compared to benchmarks…
Everyone has a benchmark for bitcoin. They compare it to other currencies, to large companies, even to tulips circa 1636. Benchmarks are important. Finding the right one could be the analytic breakthrough that makes you a genius, but this is complicated. As if that wasn’t evident…
Business Insider provided this wonderful infographic in June of 2017. In my opinion, their call-out of the Bitcoin to Gold comparison seems best targeted. I offer this reasoning: both are voluntary mediums of exchange widely, but not easily accepted.
Some will argue a myriad of alternative points. They will say that Bitcoin is still early in its adoption, that it will eventually take hold in more places, and that it has less government interference. Perhaps? For now? Perception will clearly change — but “how” is not clear by any definition.
It Is Wise To Invest In Things That Exploit Inefficiencies in the Market
The train, the internet, and many other civilization-changing, billionaire-creating technologies prove this to be accurate. So what inefficiency is bitcoin exploiting? Assuming you have a strong answer or dozens of reassuring ones, does it do it better than its competitors? That may be the better question.
Also remember — trains, telecom, e-commerce, and credit default swaps all exploited inefficiency. All of them also bubbled and popped. Also be careful with the supposed facts, things like transaction costs and timing are often oversimplified — the graphic above is a case in point.
Did Bitcoin already bubble and pop? Will it again?
More great questions. How could anyone possibly know? If someone does, how will we know it wasn’t just dumb luck? Confirmation bias and survivor bias are rife in financial circles. A decade from now, we will certainly have perceived winners and losers. But we almost certainly won’t be sure that they didn’t just get lucky.
Externalities
Our framework or model is already complicated, but many things remain outside. These externalities could change everything! Government intervention, a hack, an EMP, run away inflation, the list is limitless.
So buy a bitcoin, or don’t. Trust in bitcoin or don’t. Only time will tell which elements of this framework mattered the most. Even then, we may never know the truth. This was a course study… causality and prediction can never really be more refined. Thanks for reading!
