The case for owning Bitcoin

In this article, I’m going to make the case for considering to allocate a small amount of your savings to Bitcoin. I’ll do that by explaining what Bitcoin is, along with how and why it might become valuable.

What is Bitcoin?

Prior to the invention of Bitcoin, there were many attempts to create “digital money”, but they all suffered from the same basic problem: How do you prevent a unit of digital money from being copied, the same way you can copy an MP3 file? If you could duplicate a unit of digital money, you could then spend it more than once, making it worthless.

An anonymous person (or group) named “Satoshi” published a solution to this problem, in which a global network of computers in which anyone (known as “Bitcoin miners”) can participate, compete to process collections (“blocks”) of Bitcoin transactions every 10 minutes, adding those transactions to an ever-growing global database of all transactions, known as the “Bitcoin blockchain”.

Once the database has been modified (a new block of transactions added), the only way it can be changed is for a majority of all miners to agree to modify it. This solved the “double-spend” problem. I can try to spend a Bitcoin twice, but the network of Bitcoin miners will simply reject it, since its original spend is permanently recorded on the blockchain.

Miners are incentivized to compete to process transactions since, anytime they “win”, and get to add a block of transactions to the database, they earn both newly minted Bitcoins, as well as all the fees present in the current block of transactions.

Finally, only 21 million Bitcoins will ever be created, ensuring the “scarcity” that’s such a fundamental characteristic to anything used as “stable money”.

(There is no limit to how many US dollars can exist. Since the United States government can create new money at will, and have always done so, the value of the US dollar, in terms of its purchasing power, can drop as much as 90% over a typical person’s lifetime.)

Once the last Bitcoin, i.e. the 21 millionth Bitcoin, is issued to some miner, future miner revenue will come exclusively from the fees people pay to make bitcoin transactions, and the fees themselves are determine in a free-market process.

In short, Satoshi described, and set into motion, a system of money that runs on the internet, solves the double-spend problem, is permissionless in the sense that nobody can stop you from acquiring or spending Bitcoin, in exactly the same way that nobody can stop you from sending and receiving email, and above all is “sovereign”, meaning that, just like the internet, it’s under the control of nobody and everybody at the same time, such that no state or government can globally stop it.

What gives Bitcoin value?

There is only one thing that gives Bitcoin value, and that’s social agreement. It’s the fact that an ever growing segment of the global population agree that it has value. And since that segment is growing, the demand for Bitcoin tends to exceed the supply (or people willing to sell their Bitcoins) such that, over time, the value of Bitcoin measured in US dollars has increased from zero to (at present), nearly $7,000.

This might seem strange, but there’s nothing to stop society from agreeing to assign value to a scarce commodity. In fact, we’ve been doing that for thousands of years—i.e. gold! With Bitcoin, it’s exactly the same.

Why do people value Bitcoin?

Bitcoin has many of the same money-like properties that make gold valuable, but with improvements:

  • Scarcity — There will never be more than 21 million Bitcoin. If you own 1% of the Bitcoin supply today, you will own 1% of the Bitcoin supply in 50 years from now.
  • Divisibility — The smallest unit of Bitcoin is a “Satoshi”, which is one hundred millionth of a single Bitcoin. With Bitcoin, you can transact in extremely small values, far more conveniently than with gold.
  • Durability — Bitcoin is digital, and therefore doesn’t degrade over time as most commodities do that have been used as money in the past.
  • Transportable — Sending and receiving Bitcoin is as easy as sending and receiving email; far more convenient than gold. Furthermore, given that a Bitcoin wallet can hold any amount of Bitcoin, you could literally cross a border with a billion dollars of Bitcoin stored in your head!
  • Unseizable — If you acquire Bitcoin and choose to hold it yourself (rather than keeping it stored with an institution), no person or government can seize it from you, because no person or government controls the Bitcoin network.
  • Uncensorable — Nobody can stop you from sending Bitcoin to anyone in the world, and nobody can stop you from receiving Bitcoin from anyone in the world.
  • Sovereign — Bitcoin is a truly sovereign network. Just like the internet itself, it can not be stopped by any person, group of people, or government. This is the first time in history that humans have created a truly sovereign form of value, independent of any country. Just as we have international standards for weight and distance, the “Satoshi” (Bitcoin’s smallest unit) could become an international standard of value.
  • Utility — Given the sovereignty of the Bitcoin network, all sorts of innovative applications are emerging that are built on top of the Bitcoin network, which in themselves work to increase its value.

So who does control Bitcoin?

Just like the US government has three branches to provide for checks and balances (the President, the Legislature and the Judicial), Bitcoin has three fundamental groups that independently and inter-dependently control Bitcoin:

  • Software developers — Bitcoin is open-source software. Anyone can participate, and through consensus, changes are proposed and integrated into that software. The Bitcoin “Core” development community have been extremely conservative regarding changes to the software. They prioritize security, simplicity and stability to features.
  • Miners — Bitcoin miners run the computers that run the Bitcoin software that processes blocks of transactions every 10 minutes, adding them to the blockchain. If miners as a group disagree with a new release of the Bitcoin software, they can collectively choose not to upgrade.
  • Users — These are people like you and I. If our evolving needs are not met by the current Bitcoin network, we can vote with our feet, moving to another crypto currency.

In a famous historical dispute, one group wished to increase the number of Bitcoin transactions that get processed every 10 minutes, thereby allowing the Bitcoin network to function more like the Visa network (high transaction volume, low fees). Increasing the number of transactions per block would result in only those with the most powerful computers being able participate in Bitcoin mining (transaction processing).

The Core community preferred to keep the number of transactions fixed, thereby trading off higher fees (as many transactions compete to be included in the next constrained-sized “block”, the transaction fees get bid up) for ensured broad distribution (minimal centralization) of Bitcoin mining.

The conservatives won that dispute, and the “big blockers” duplicated the Bitcoin software, creating what’s known today as “Bitcoin Cash” (a completely different cryptocurrency.) Bitcoin Cash (known as BCH) has never achieved the value of Bitcoin Core (BTC).

What could Bitcoin become worth?

There are many scenarios that would lead to different values of Bitcoin in the long term:

  • Digital gold — If one-third of the existing gold market moved to Bitcoin, a single Bitcoin would be worth more than 50,000 dollars. However, given the advantages of Bitcoin over gold, if Bitcoin emerges as a “digital gold”, then the market of people interested in holding a state-independent money could well increase beyond gold’s current seven trillion USD market.
  • Increasing utility — Innovative technical solutions are being built on the Bitcoin network. For example, a company called Abra built an app that allows people anywhere in the world to connect a bank account, transfer in money in any currency, and buy US stocks.Unbeknownst to the users, the app is built on top of the Bitcoin network. When a person transfers in 1,000 USD, they are, under the hood buying Bitcoin, and the amount of Bitcoin they own will fluctuate such that the app will always show them that they own “1,000 US dollars”. If they purchase four shares of Apple stock with that 1,000 USD, the app deploys a “smart contract” on the Bitcoin network that tracks the price of Apple stock. In actuality, they own Bitcoin, and the amount of Bitcoin fluctuates up and down to show that they own “four Apple shares”. As far as they can see, they’re working with US dollars and Apple shares, but under the hood, it’s all Bitcoin. Why did Abra choose Bitcoin? Because they considered it the most secure network in the world, and it allowed them to democratize the purchase of US shares without having to get a money-transmitter license in any state or country. Innovative applications like Abra increase the buy pressure on Bitcoin, and therefore its price.
  • Stock-to-flow model — An anonymous economist on the internet has built a mathematical model that predicts the price of commodities like gold, silver, diamonds, palladium, etc. based on something called “stock-to-flow”, and with those commodities the model has been extraordinary in its price prediction. When applied to Bitcoin, the stock-to-flow model predicts an eventual price of one Bitcoin to be worth multiple millions of dollars.
  • Crash and burn — At the other end of the spectrum, a bug could be discovered in the Bitcoin software, or a competitor could emerge, that would cause the value of Bitcoin to go to zero. However, at the time of this writing, Bitcoin is over 10 years old, has been the target of continual, unsuccessful hacking attempts, and has a lead in “network effect” that would be extremely difficult for any other cryptocurrency to overcome.

What we can be fairly certain of, is that in ten years from now, Bitcoin will not be $7,000. It will likely either be worth zero, or much much more than it is today. And as every year passes, the latter outcome appears more probable!

Should you own some Bitcoin?

The dramatic range of possible outcomes for the price of Bitcoin in the long term (zero to millions of dollars) makes investing in it a tremendously asymmetric bet. For that reason, it would seem to make sense (as recommended by successful entrepreneur Wences Casares) that everyone should own a small amount of Bitcoin, perhaps one to five percent of your wealth.

At that level, if it goes to zero, your life won’t be impacted too much, but if it increases by 100 from where it is today, it would have a big impact on your net worth.

The Unfolding — Anatomy of the COVID-19 financial crisis

In 2020, I learned about the macro economist Raoul Pal through a number of podcasts, and his pessimistic view of the global macro situation resonated with me prior to the COVID-19 crisis. He believed a nearly perfect-storm of characteristics existed that pointed to the coming of a deep recession. And then COVID-19 happened.

To continue having access to his views, I subscribed to his Real Vision service, which he dubs, “The Netflix of Finance”. One of his latest videos, titled “The Unfolding”, lays out the ideas behind his belief that we are headed into the worst economic crisis of our lifetimes.

Although I don’t pretend to understand all of this completely, I’m wanted to try to summarize his thesis here, as much for myself as for the reader. I would, however, encourage readers, if they can afford it, to subscribe to Real Vision, as the content for those interested in finance is outstanding. (I felt The Unfolding alone was worth the subscription price.)

How we got here

COVID-19 hit the world at the worst possible time; at the tail end of a sequence of bad events:

  • In 2016, interest rates began to rise globally, which, as one would expect, caused economies to slow as we saw GDPs around the world begin to drop.
  • This would generally lead to a “normal” recession, but a second bad event happened at the same time: a trade war, which pushed world-trade into the negative, as seen by the dropping of the PMI (purchasing managers’s index), an index of the prevailing direction of economic trends in manufacturing and services sectors.
  • Less trade resulted in a stronger United States dollar, as USD were being removed from the global system. A strong dollar isn’t good for the world as a whole.
  • Lastly, we had an oil conflict, as Russia and Saudi Arabia began competitive production, which led to the collapse of oil prices. This severely impacts economies like the United States, which are heavily dependent on their energy industries.

Then we had the massive black swan, COVID-19, in which world economic out has ground to a halt. COVID-19 has created both demand and supply shocks. Demand, as in people are not consuming. Supply, as in companies aren’t producing anything.

Raoul anticipated three resulting phases:

  1. Liquidation
  2. The Bounce
  3. The Insolvency

Phase 1: Liquidation

Because of sudden panic and uncertainty, we saw the sale and liquidation of everything—stocks, bonds, gold, bitcoin, etc.—as people rushed to get into the temporary safety of cash.

Credit spreads widened, as everybody realized credit was going to get liquidated as well. This caused the financial system as a whole to freeze-up, at which point the Federal Reserve stepped in with a huge stimulus package.

However, this wasn’t really providing “stimulus”, but rather an attempt to simply getting the financial plumbing working again.

The stock market dropped by over 30%, which would be characteristic of a mild recession. Raoul feels there’s a strong possibility it will later drop by 80%, characteristic of a true depression.

Phase 2: The Bounce

Just like in 1929, we can expect and have seen an initial bounce. Over the past week, the stock market has risen more than 10%. In a six month period of 1929, the bounce of the Great Depression saw a 45% rise in the stock market.

Why? Because there is optimism in the face of the initial shock. New COVID-19 case numbers are stabilizing. Maybe we’ll find a therapeutic. Maybe we’ll get a vaccine. Maybe, maybe, maybe!

But the 1929 bounce was based on a false narrative, and this one likely is as well. Raoul believes things are far worse than the market is reflecting.

And this leads us into the final phase, the insolvency.

Phase 3: The Insolvency

Raoul believes we’re going to see the largest insolvency event in recorded history.

  • Global GDP growth will be negative, quarter after quarter.
  • The world has far too much debt. United States corporate debt between 1950 and 2019 has grown as a percent of GDP from 20% to 45%.
  • The United States government debt has grown to 110% of GDP, and will take massive additional amounts to try to stimulate the economy with new money. Central banks all around the world will try to stimulate.
  • The problem, however, is that the velocity of money will be zero. People have clearly changed their habits, until a COVID-19 vaccine is available. We can see this in sales data (50%+ drops) and traffic data from TomTom (down 80% in China on the weekends). I personally see this in myself; Even after this lockdown is over, I’m not going to expose myself to infection by going to restaurants, coffee shops, gyms and other group settings before a vaccine is available.
  • Perhaps one third of the $3T of BBB-grade United States corporate debt will be downgraded to junk rating, requiring their sale by credit-rating-constrained entities. But there won’t be any buyers, and so the market will freeze.
  • A pension crisis is being born, as the largest wave of people ever (the Baby Boomers) enter retirement, and they currently own (and will sell) a huge amount of stocks and bonds.

None of this can get resolved quickly, as “flattening the curve” means power cycling the economy over and over, country after country, as localized outbreaks occur, preventing the full economic re-synchronization.

US 10-year bond yields are dropping to zero. But then, the Consumer Product Index (CPI) will go negative (because nobody’s consuming). This means that real yields (the difference between CPI and the bond yields) will go up, and when real yields go up, you destroy the economy.

And this time, the Federal Reserve can not fix this. They have no room to continue dropping rates.

The growing strength of the US dollar will break the global financial system, as there is far too much global debt denominated in dollars, and not enough dollars to go around to pay this debt. All non-US currencies will drop, and some will collapse.

Corporations in South Korea, India, Brazil and elsewhere are desperate for dollars, and the banks will issue the limited supply to the best creditors. The worst will be left scrambling, and go insolvent.

The end result in a world of negative GDP, nobody with cash, everyone in debt—is insolvency. And full debt-deflation then happens when everybody becomes insolvent.

Raoul believes this is a generational shift, the “Fourth Turning” that Neil Howe talks about in his book. A massive, massive change in which the market crashes to depression levels, everybody goes bust, and which may end with the world having to abandon the dollar standard, as the US dollar skyrockets.

Protection

How to protect yourself? Raoul believes:

  • United States bonds should be OK in the short- to medium-term.
  • United States dollars should be OK for the short- to medium-term.
  • Gold and bitcoin should do very well in the medium- to long-term.

Readers of my book Money for Something who followed my own allocation, the Golden Butterfly—a slight tweak on the Harry Browne Permanent Portfolio—will fortunately already have a sizable allocation to long-term bonds, gold and cash, that will have held up well in the current crisis, and hopefully going forward.

A botched change of policy at Goldmoney

This is the story of how Goldmoney botched the communication of a fundamental change in policy, that ultimately may lead to me taking my business elsewhere.

Buying gold in the early days

As you know from reading my book, I’m a fan of the Harry Browne “Permanent Portfolio”, which promotes holding a quarter of your wealth in gold, and at least a part of which is held in physical gold.

Back in the day, there were two major online options for purchasing and storing physical gold—BullionVault and the original GoldMoney. Both were located in the United Kingdom, and each controlled over a billion dollars in gold for their respective customers.

While both services offered web-based access to their customers, they both felt old-fashioned and rigid. Neither company’s websites would win any kind of design award, although BullionVault’s was, in my opinion, thoughtfully useful. Both companies restricted incoming and outgoing funds to a single linked bank account. Account changes required phoning in. While GoldMoney allowed you to buy and sell directly with them, BullionVault implemented an “exchange” model, whereby you felt like a participant in a “marketplace”.

Both companies had similar revenue models—BullionVault charged commission on both buying and selling, while GoldMoney charged only on buys (though that commission was considerably higher). And both companies charged an annual fee to store your gold.

Enter BitGold, and free storage

Later, a third player emerged, located in Canada, which caught my attention—BitGold.

BitGold’s stated mission was to build technology that allowed one’s gold savings to be used as a currency. Compared to BullionVault and GoldMoney, BitGold felt innovative and modern. You could buy gold with your credit card, or even Bitcoin. You could link multiple bank accounts. You could transfer gold instantly between members. You could even spend gold in the form of a gold-backed MasterCard.

Having hired the talented and motivated designer, Mike Busby, the BitGold website looked and behaved like the kind of high-quality website my own company strives to build for its customers.

And from a cost point of view, BitGold was uniquely attractive in offering no storage fees:

Now, as you know from my book, long-term investors are particularly sensitive to annual fees, due to their destructive compounding effects over time, and so the absence of storage fees was a highly attractive selling point for BitGold.

In terms of revenue models, given that BitGold themselves would certainly have storage fees, it was speculated that their business model hinged on earning surplus revenue through their technology-driven value-add services.

BitGold jump starts their business through acquisitions

I didn’t initially open an account with BitGold, since they were still a new and unproven participant in the market, but that changed when the news emerged that BitGold had acquired GoldMoney, providing them with an considerable jump-start, and making them one of the world’s largest retail holders customer gold.

It was unclear at the time how existing GoldMoney accounts would be integrated into BitGold, but GoldMoney CEO James Turk’s statement certainly implied that the objective of the acquisition was integration:

We created GoldMoney with the vision of making gold accessible for savings and payments, a vision that BitGold is rapidly expanding in a new era of cloud computing and mobile technology. […] Users can expect a gold debit card, expanded payment options, as well as the many applications and features being developed by this innovative team.

One step towards this integration seemed to occur several months later when the company announced that BitGold was changing its name to “Goldmoney” (dropping the capital, “M”), and introducing three types of accounts.

My own account became a “Personal” Goldmoney account. A “Business” account was introduced for businesses. Finally, a “Wealth” account was introduced, that included storage fees, but benefitting from things like a special phone number to call for support, a dedicated “relationship manager”, the ability to hold money in several different currencies, and a couple of other features that I had no particular interest in.

It seemed the terms of my own, now “Personal”, account fortunately remained unaffected. Which was true for a while, anyway—bringing us to today, and to the point of this story.

A major change of policy at Goldmoney

Something has happened recently at Goldmoney, which has forced them to implement a major change in policy affecting Personal accounts:

  • While Personal accounts are still free of storage-costs, they are now limited to holding 1,000 grams of gold. Once you reach that limit, you are not allowed to purchase more, and are directed to open a separate Wealth account, which does apply storage fees of between 0.18% to 0.12% per year, and increases purchase commissions from 0.5% to 2.5%.
  • Existing Personal accounts with more than 1,000 grams of gold will not be forced to reduce their balance, but will have 0.18% storage charge applied to that portion of balance above 1,000 grams, and no further purchases can be made in the accounts.

This is a very big deal, for the following reasons:

  • Wealth accounts are held with a completely different company, i.e. the corporate entity behind the original GoldMoney service, located in the UK Channel Islands, and not the company behind the Personal accounts, located in Canada.

  • When you login to a Wealth account, you’re transported back in time to the original GoldMoney website, with only a visual update (currently in beta) to provide some consistency with the Goldmoney (nee BitGold) product.
  • Gold purchases are subject to a 2.5% commission, with no commission for sells. For comparison, BullionVault (and Goldmoney Personal accounts) charge 0.5% on buys and sells, and so your Goldmoney Wealth account purchases would need to appreciate by a factor of four before you’d come out better there. Storage fees between the two are nearly identical.
  • Unless your Personal holdings are stored in the Toronto vault, it’s going to cost you a 0.5% vault-to-vault transfer charge to move funds from Personal to Wealth.

This seems to change the basic Goldmoney service proposition to something sort of analogous to “checking” and “savings” accounts with a bank—i.e. you’re to hold your savings in a Wealth account, and any funds you want to use for low-fee transacting should be held in a balance-limited Personal account.

But while all this represents a fundamental, and arguably unfortunate, change, it’s not what I’m here to complain about. What I’m here to complain about is the way in which Goldmoney has communicated this change, which relates to the issue of trust.

Spinning a story

It would not be surprising to learn that BitGold/Goldmoney couldn’t manage to earn enough through their technology offerings to cover their own gold storage costs. Clearly, a company has to be profitable to be sustainable in the long-term and so even though it was good while it lasted, I can understand the need to apply storage costs.

What I dearly wish, though, is that Goldmoney had simply communicated the changes in a straightforward plain-English way, respectful of their customers ability to understand the reality of the situation.

Instead, this is the email I received today, which appears to spin the story as if the whole change is somehow “a great thing!”, and in the process, introduces confusion, and leaves many questions unanswered:

After leading with a positive-trending graphical chart and congratulatory message, the communication of the fundamental change in policy is delivered in this perfect example of corporate-speak:

We’ve worked to expand the capabilities of the Network and want to share the benefits of applying for a Goldmoney Wealth Holding, as storage fees will apply to Network account balances above 1,000 grams at a rate of 0.18% per year as of January 1.

Whatever this mess of a sentence is saying, here’s what it does not communicate:

  • You can NOT continue with your Personal account—If you’re currently a Personal account holder with over 1,000 grams, you must open a Wealth account in order to continue saving. There is no option to continue with your Personal account.
  • The whole Goldmoney experience changes—If you decide to continue saving with a Wealth account, the whole experience will change. The company changes. The website changes. The funding methods will change (no more purchasing with credit cards). The costs will change.
  • The transition may cost you—Depending where your Personal funds are vaulted, it may end up costing you 0.5% to move any excess balance from your Personal account to a new Wealth account, in order to get the storage fees down from 0.18% to 0.12%.
  • Why this all had to happen—Most importantly, the email doesn’t explain why we’re being subjected to this change. Reading it, you’d simply get the impression that, despite things going really, really well at Goldmoney, they’ve just decided to start charging Personal account holders with storage fees, above the arbitrary balance of 1,000 grams.

To understand any of the above (except for the justification), you have to login to your Personal account, and try to make sense of all the error messages and alerts. Overall, this was a botched communication.

Why this matters

Here’s a quote from 37 Signal’s book, “Getting Real”, from the chapter entitled “Publicize your screwups”:

If something goes wrong, tell people. […] Be as open, honest, and transparent as possible. Don’t keep secrets or hide behind spin. An informed customer is your best customer. Plus, you’ll realize that most of your screwups aren’t even that bad in the minds of your customers. Customers are usually happy to give you a little bit of breathing room as long as they know you’re being honest with them.

Although the change at Goldmoney isn’t necessarily the result of a screwup, it’s a major event that completely changes the product experience for savers, involves an inconvenient transition, and potentially involves costs.

Goldmoney’s communication should have clearly addressed these things. When you break your promises to someone, you better explain why. But it didn’t. Instead, it spun the story as a positive event, downplayed how fundamental the change is, and left many questions unanswered. And the result of that approach is twofold:

  • First, it leaves me to figure out all the consequences of the changes myself. It was only when I logged into the website that I realized I could no longer use the Personal account. It was only when I started to create a Wealth account that I realized it’s a completely different company, with a different website that lacks many of the features of the Personal account. And it was only when I started the migration process that I realized costs will be involved.
  • Second, it introduces distrust, and damages my confidence in this company. Is this how I can expect to be treated again in the future if/when they’re required to make major changes that affects me?

The whole situation has left me with such a bad taste in my mouth that I’m quite likely to take my business elsewhere. I hope this story finds its way to those in charge at Goldmoney, and that the folks working in PR there learn the lesson that it’s OK to tell things as they are.


Update 1 of 2: A week after posting this article, I posted some follow-up thoughts including a Twitter conversation I had with Goldmoney’s founders.


Update 2 of 2: To clarify what I would have liked to have received, I’ve drafted an alternative version of the Goldmoney email.


Investment returns of the average investor — What happens when you don’t stay the course.

In my book, Money for Something we discuss how important it is to “stay the course.” Most people, however, don’t stay the course, and this chart from the J.P. Morgan Guide to the Markets illustrates the astounding consequences.

Continue reading Investment returns of the average investor — What happens when you don’t stay the course.