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.