I am not an investment professional, and have no opinion on what anyone should do with their money. I also find the speculative side of crypto to be its least interesting. That said, there are times when the value proposition of a coin is so compelling, as ETH was in 2019, that I like to write about it — both to hash out my thinking and to solicit counter arguments.
Now is one of those times, as I believe the value proposition of Bitcoin just took a leap forward in the span of a few weeks.
But first, we need to define what Bitcoin actually is. People usually try to define it by way of analogy, comparing it to other currencies or a digital version of gold, but these are inadequate because Bitcoin is unique — gold doesn’t come with its own payment system. For our purposes, we will define Bitcoin as algorithmically-minted and censorship-resistant money that is apolitical at the protocol layer.
Algorithmically-minted money is appealing at a time of record printing of the government-issued kind, printing that has resulted in — surprise, surprise — record inflation. The crisis in Ukraine has certainly made things worse, but consumer prices in the US and around the world were already spiking before the invasion. This inflation, like most inflation, is primarily a monetary phenomenon, and those who blame it on problems like supply chain disruptions are telling only half of the story. Case in point: 2021, a year that ended with a 40 year high in inflation, also featured record global trade, with 13% more goods delivered by global supply chains than before the pandemic.
The full story in the US is that the Fed printed trillions of dollars during the pandemic, and congress borrowed trillions more, resulting in both spiking demand for goods and services and falling confidence in the dollar. Ergo, inflation. Neither supply chain issues nor war explain why both Netflix and my gym just raised their prices.
Bitcoin is appealing at this time because it is the first currency in history whose supply is controlled by a decentralized protocol and, by extension, has its base inflation fixed. This is a stark contrast to every other currency out there, where day-trading central bankers print money with less deliberation than a group of friends deciding on dinner. Bitcoin’s algorithmic inflation is a brand new phenomenon in the storied history of money, making it arguably even more appealing than commodity money like gold and silver, because higher prices have no bearing on supply. Unlike physical commodities, where higher prices incentivize more mining and eventually more supply, the Bitcoin protocol constantly adjusts itself to maintain steady (and diminishing) coin creation. More mining results in greater security, but not greater supply.
The counter to this inflation-driven narrative is the fact that most central banks are now in tightening mode. Even the profligate Fed is wrapping up quantitative easing and preparing to raise interest rates this week. Some people view this dynamic as bearish. They argue that Bitcoin is only worth owning when central banks are easing.
But this argument is also a half story. Bitcoin’s inflation hedge isn’t just about the direction of travel of interest rates, it’s about the race between rate hikes and (worsening) inflation. For example, if the Fed raises short-term rates from 0 to 2%, but inflation tops out at 10%, then dollar savers are still losing significant purchasing power. So the question we have to ask is whether central banks the world over have the wherewithal to raise rates enough to tame inflation, especially now that it is rising even faster due to war. Owning Bitcoin is a bet that they won’t, in part because they can’t. Too much of our economy is now addicted to cheap money to remain viable. Just imagine what would happen to the red hot housing market if mortgage rates topped 6%, something they haven’t done in 15 years. If the Fed couldn’t raise rates substantially back in 2019 when the economy was in far better shape, it probably can’t now.
But this is a subjective call. If you believe the Fed has the stones to raise rates to the highest levels they’ve been in years, worsen a likely recession in an election year, collapse asset prices, and increase the cost of President Biden’s infrastructure spending, then you should not own Bitcoin.
Inflation and deepening negative real yields (which will remain negative despite moderate rate hikes) are only half of my argument, and perhaps not the stronger half. Even more compelling is Bitcoin’s censorship resistance and apolitical architecture at a time of a fragmenting global monetary system. The economic response to Russia’s evil invasion of Ukraine — however deserved it might be — represents a sea change in how countries interact with each other. It calls into question the dollar’s status as a reserve currency, a trend that’s been slowly unfolding for decades but will now accelerate. The unprecedented freezing of Russia’s foreign exchange reserves is the sort of thing that will give pause to every other country that holds substantial reserves in dollars but pursues policies counter to American ideals, like Saudi Arabia and China.
Also of note is the fact that, like heavily-sanctioned Iran and Venezuela, Russia is a major oil producer who has historically prices its oil in dollars, participating in the crucial petrodollar system of global trade and money that may now be unwound. Weaponizing access to dollar banking is a foreign policy tool for Washington, one that has now been exercised to an unprecedented extent.
There is no clear alternative to dollars for either activity. Switching to a different reserve currency like the Euro just exposes everyone to European government policy, and bilateral currency arrangements (as Russia and China may use) have their own limitations. Many central banks still own gold, but using money that’s even harder to transport than the goods it is meant to pay for is no solution at all. Some countries may switch to a national barter-like system where they trade exports (e.g, Russian oil for Chinese widgets) and settle periodically with gold, but such arrangements require a lot of trust as participants become creditors to each other.
What they need is something neutral like gold that can be transferred as easily as dollars but without having to rely on a politicized banking system. Now there’s a blockchain for that.
Bitcoin’s apolitical architecture and censorship resistance, where nobody can deny access to anybody, make it a potential candidate. I say potential because there are many unknowns about how it may be utilized as an international reserve and trade currency. Where will central banks source their BTC, and how will they handle the total transparency of the blockchain? Will economic sanctions potentially impact the fungibility of each coin, leading to situations where China doesn’t want coins from Russia because it might not be able to use them in trade with America? Will the US try to outlaw use of Bitcoin for such purposes anyway, even if it can’t prevent anyone from accessing it technologically? Will Europe kill domestic mining? Will Russia use its trapped oil to become a major miner itself?
There are no easy answers to those questions, but the cryptocurrency’s architecture has a few positive things going for it. Other than censorship-resistance, the Bitcoin blockchain is highly secure, thanks to the parabolic growth in the network hashrate in recent years. The network is also resilient thanks to widespread distribution of nodes all over the world. These features protect it from any kind of single-nation (or even single-continent) disruption — as proven by the quick recovery from the Chinese ban on mining last year.
This is a testament to the network’s organic ability to recover from setbacks and continue to propagate itself. Trying to restrict it usually only hurts the aggressor, as China did by depriving itself of billions of dollars in annual mining revenues. Last but certainly not least, the blockchain’s immutability makes Bitcoin a real-time gross settled (RTGS) payment system, which is important for global trade. Nobody wants to sell big ticket items for money that might get taken back — a fact lost on the skeptics who still complain about transactions being irreversible.
That Bitcoin is now being included in the conversation about reserve currencies is in and of itself a game changer. Ironically, there are not enough Bitcoins in the world to fulfill a reserve function. At $750b, the current value of all coins in existence is barely enough to cover Russia’s total foreign exchange reserves, never mind the greater than $12 trillion in reserves held by global governments in aggregate.
But this insufficiency is a core part of my bullish thesis. Like a wrestler putting on weight for a heavyweight bout, Bitcoin needs to appreciate materially to fulfill that function. If it does, a country like El Salvador that has already been acquiring Bitcoin will look smart, leading to more central banks following in its footsteps, creating a virtuous cycle of national adoption and price increases.
Years down the road, we could see a situation where many central banks keep a small portion of their reserves in BTC, partly to benefit from its appreciation against inflationary currencies like the dollar and euro, and mostly so they can still make payments regardless of the geopolitical situation. If this reality comes true then we’ll see nations good and bad adopt Bitcoin — as is the case for the dollar today.
I don’t mean to belittle the moral implications of rogue regimes dodging the financial consequences of their actions, but Bitcoin’s apolitical design is still a net good, even if used by an evil regime like the one in Russia. Critics often point to its openness as a gateway to illicit activity, but this (still mostly theoretical) use is the ultimate half-story.
It ignores the fact that the existing financial system allows a shocking amount of illicit activity, despite a “guilty until proven innocent” approach that discriminates against the poor and powerless. It also leaves out the countless positive uses of apolitical money, such as Nigerians who used Bitcoin to fund a protest movement against police brutality; Venezuelans who used it to save their family; legal sex workers who use it to circumvent a hypocritical banking industry that has no problem serving arms manufacturers, opiate makers, Russian oligarchs and Saudi princes, but draws the line at OnlyFans; legit cannabis companies that can legally sell their product but can’t open a bank account; and thousands of Iranians, Argentineans, Turks and others who use it to escape soul-crushing hyperinflation.
Not to be left out are the Ukrainians whose Bitcoins will be a lot harder to seize than their bank accounts should Putin succeed in installing a puppet government in Kiev. Banking based on fiat is political by design (banks can only exist by government charter) and will always bend to the wills of the government, no matter how unjust that government may be. This is not just a problem in Ukraine but also Russia, where until very recently the biggest victims of Putin’s kleptocracy were his own people. However stringent the economic sanctions against Russia, the one thing we can be certain of is that neither Putin nor his oligarch enablers will starve. An increasing number of innocent Russians however will. The fact that some may be able to use Bitcoin to remain economically viable is both a political and a moral good.
Criticizing Bitcoin’s censorship resistance is a luxury of affluent people in the developed world, where things usually work and the financial system mostly does what it’s supposed to. This is why per capita adoption is highest in countries where it doesn’t. Wanting money that discriminates against the bad guys but not the good is like wanting a democracy where only informed people vote. There are no perfect solutions in a diverse and increasingly volatile world, only trade offs, and this one is a net benefit.
Owning Bitcoin is not just a sound investment strategy but also a way of perpetuating something positive: money designed to benefit the user, not the issuer.
As the icing on the cake, BTC is currently trading significantly below its highs from a year ago, thanks to foolish narratives that it is correlated with stocks and only a “risk on” asset (Bitcoin prices fell 50% last spring in a 3 month period when the Nasdaq gained 10%). There’s also the false belief that central bank digital currencies (CBDCs) will somehow replace Bitcoin, as if money that can be politicized and weaponized even more easily is a good thing. CBDCs and their programmable policy tools and instant censorship will only elevate the need for Bitcoin.
Last but certainly not least is the misunderstood environmental impact of proof of work. There are those who believe Bitcoin will fall out of favor during an energy crisis, but I believe this concern is overrated. Bitcoin mining is increasingly based on non-hydrocarbon and otherwise trapped/surplus power, as it is one of the few high energy activities that can be done virtually anywhere. Counterintuitively, its energy consumption may even help make the case for using it as a reserve currency. Money not based on coercion or the might of a military needs to derive legitimately from somewhere, so why not the cost and complexity of creating each unit?
As the old saying goes, markets like to climb a wall of worry (and cryptos occasionally leap them). I believe BTC can trade significantly higher in the next 12 months. At worst, it is a viable inflation hedge at a time of spiraling prices and decline in central bank credibility. At best it’s a call option on a future reserve currency. Put together, those two variables can take it to $100k and beyond. War and volatility can also take it below $30k first, but that would be a good thing as it would embolden the skeptics and get rid of the last remaining tourists.
Disclaimer: I own some bitcoin and this is not investment advice. If you are unsure about any of this, have never initiated your own private key or don’t know what hashrate means then you should not buy any. Cryptocurrencies are highly volatile and my two satoshis can cost you a lot more.