🚀 The evolution and relevance of Bitcoin and cryptos ₿

Nothing in this article is intended to be financial advice and should not be taken as such, please do your own research before investing.

Many of us live in countries with a stable government, a relatively stable currency, and a well-regulated banking system that we trust. We can become cynical and unempathetic about Bitcoin and cryptos as they are often associated with scams, frauds, Ponzi schemes, hacks, leverage and speculations.

Do Bitcoin and cryptos have any good uses? Are they relevant?

An investing idea with opposing views

Whether it goes up or down in the next year, or five or 10 years, I don’t know. But the one thing I’m pretty sure of is that it doesn’t produce anything. It’s got a magic to it and people have attached magic to lots of things.

Warren Buffett. 2022

In my life, I try and avoid things that are stupid and evil and make me look bad in comparison to somebody else — and bitcoin does all three.

Charlie Munger, 2022

Instead, it’s a gambling contract with a nearly 100% edge for the house, entered into in a country where gambling contracts are traditionally regulated only by states that compete in laxity. The U.S. should now enact a new federal law that prevents this from happening.

Charlie’s latest article: Why America Should Ban Crypto, WSJ, Charlie Munger, Feb. 1, 2023

I think all that’s been a waste of time and why you guys waste any breath on it is totally beyond me. Bitcoin itself is a hyped up fraud. It’s a pet rock.

…. How do you know it’s gonna stop at 21 million? Maybe it’s going to get to 21 million and Satoshi’s picture is going to come up and laugh at you all,

JP Morgan CEO, Jamie Dimon in a CNBC interview, January 2023

While Warren Buffett, Charlie Munger and Jamie Dimon are highly critical of Bitcoin and cryptos, there are investors with high convictions.

In an interview with Barron’s in December 2022, Bill Miller continued to be bullish on Bitcoin as it remains one of his top personal holdings. He sees cryptocurrency as a potential store of value, much like digital gold.
His post on Bitcoin on September 8, 2015: The Value Investor’s Case for… Bitcoin?!

In an interview with Bloomberg in August 2021, Andreessen Horowitz’s co-founder, Marc Andreessen viewed crypto as a technological transformation. The asset class could be kind of confusing for investors. To him, it is like “the parable of the blind man and the elephant,” a reason why some people get distracted and carried away. Still, he outlined that cryptocurrencies and the underlying blockchain technology are superior to fiat money. Many of the smartest people in computer science are going into the field.
His article with The New York Times published on January 21, 2014: Why Bitcoin Matters

El Salvador became the first country in the world to use Bitcoin as a legal tender in 2021. Remittances accounted for 23% of GDP in 2020. Their President claimed that the adoption of Bitcoin would make it easier for Salvadorans living abroad to send remittances to their relatives in the country. Bitcoin would also make digital transactions more accessible to underbanked people.

As of 27 December 2022, MicroStrategy has 132,500 bitcoins.
Michael Saylor’s interview with Lex Fidman (Bitcoin, Inflation, and the Future of Money) in April 2022 is worth watching/listening to; it is almost 4 hours.

These legendary investors have strong yet opposing views about Bitcoin and cryptos; people can be easily confused. Who are right?

Other great resources:

• A must-read: Bitcoin whitepaper – Bitcoin: A Peer-to-Peer Electronic Cash System
• A great book worth reading: The Basics of Bitcoins and Blockchains: An Introduction to Cryptocurrencies and the Technology that Powers Them (Cryptography, Derivatives Investments, Futures Trading, Digital Assets, NFT) by Antony Lewis

Bitcoin’s growing relevance in fragile states

Developed country bias
Many investors are from developed countries and having a privileged life do not appreciate why and how common people in dire economic conditions are using Bitcoin and cryptos. They face several challenges:

• Depreciating local currencies
• High inflation
• Banking and financial systems
  • Limited availability of banking services (even with digital banking) and the difficulties in moving money
  • Capital controls
  • Low/no trust: able to deposit, yet difficult to withdraw
  • Unfair restrictions: daily withdrawal limit or worse, deposit levy
  • Bank bail-ins:  provide relief to a financial institution on the brink of failure by requiring the cancellation of debts owed to creditors and depositors.
• Lack of trust and confidence in the governments that have been responsible for many economic failures resulting in high inflation, depreciating currencies and unfair banking controls bringing suffering to the people

While some countries face economic challenges, some face invasions and civil wars. Many are affected by these challenges and more will be affected. People have to find alternative stronger currencies to preserve wealth and ways to store them.

Below are some official rates against the US Dollar, inflation and the price of BTC to the local currencies; the realities are usually worse.

The U.S. Dollar, gold and precious metals (though gold is more popular) are possible options. They are available through the black market at a high premium. They are not safe to store them at home. They are prone to theft and fire. Gold is not easily divisible and prone to fraud; we are unsure whether the gold bought is genuine. This is where Bitcoin becomes relevant.

1. Durability – Bitcoin cannot be destroyed. Even as the blockchain operates on even a single computer, Bitcoin exists. ‍
2. Portability – Bitcoin can be sent anywhere there is an internet connection.
3. Divisibility – A single bitcoin consists of 100 million smaller units known as satoshis.‍
4. Fungibility – Bitcoins are all the same. No coin is any more valuable than the next one. Unlike with gold or paper currency, counterfeiting is impossible.‍
5. Scarcity – Bitcoin is the first provably scarce object. There will only ever be 21 million bitcoins. Anyone can check the protocol’s code to confirm this limit. A vast majority of nodes, the enforcers of Bitcoin’s rules, would have to act against their economic self-interest for the limit to be altered.‍
6. Acceptability – More people are having Bitcoin. The adoption rate will continue to grow as knowledge of the protocol spreads and Bitcoin becomes easier to buy, spend, and store (network effect).

Bitcoin operates on the peer-to-peer network without intermediaries (no central banks and banks). Transactions are verified by network nodes via cryptography and recorded in a public distributed ledger called a blockchain. The network bypasses the control of the governments.

We can store these digital assets ourselves with self-custody wallets. The latter can be hardware wallets (such as Ledger) or software wallets (such as MetaMask or Coinbase Wallet).

While people are using bitcoin, ether, stablecoins and other cryptocurrencies as alternatives to the fiat currency, self-custody wallets and decentralised finance (DeFi) are alternatives to the traditional banking system; more on these in a later section below. 

Money has been lacking innovations compare to tremendous technological advancement we see in products and services. Money is one thing that governments have huge control over; much to the dislike and suffering of people in failing countries. Bitcoin and cryptos through blockchain represent a major breakthrough.

People in fragile states tend to convert their depreciating currencies to stablecoins and a portion into Bitcoin and ether as investments depending on their risk preference. They have limited investment opportunities available: the local stock market is not attractive or not available with unattractive property investments. Or simply, they do not want to invest in the local economy due to their distrust of the government.

For the plausible reasons highlighted above, many developing countries are leading in crypto adoption shown below. They have a better appreciation of the practical use and value of cryptos with the challenges they faced.

References on how people cope with depreciating currency, high inflation, low trust in banks and financial restrictions:

• An early use case of Bitcoin and example of a bank bail-in: Cypriot financial crisis during 2012–2013 when the government closed the country’s second-largest bank, the Cyprus Popular Bank (also known as Laiki Bank) and imposed a one-time bank deposit levy on all uninsured deposits there, and seizing possibly around 48% of uninsured deposits in the Bank of Cyprus: Bitcoin Bonanza: Cyprus Crisis Boosts Digital Dollars

• Why is Argentina’s Currency SO CRAZY?, 26 Mar 2022
• We’ve Seen Bitcoin’s Future and It’s Lebanon, 16 Nov 2022
• Argentines hot on Bitcoin and tether despite “crypto winter”, report finds, 30 Jan 2023
• ‘Basically a Savior’: Why Crypto Is So Popular in Turkey, 26 Oct 2022
• The interview also explains the use of cryptocurrency before the war as people have low trust in the banks: How Ukraine’s wide use of cryptocurrency is playing out during the war
• A great read: December 2022 Newsletter: The World’s Money Problem
• Bitcoin is poised to blow up Africa’s $86 billion banking system, 26 Mar 2023

If he (Charlie Munger) was a business leader in South America or Africa or Asia, and he spent 100 hours studying the problem, he would be more bullish on bitcoin than I am. The Western elite, they haven’t had the time to study it.

Michael Saylor, Microstrategy founder, defending cryptocurrencies following Charlie Munger’s Wall Street Journal op-ed (quoted above)

Bitcoin and cryptos are not ideal solutions and are far from perfect given their volatility, plausible frauds and scams and issues with centralised exchanges and decentralised projects. However, many find them better than their depreciating currencies and banking systems that they do not trust. Cryptos will continue to innovate to get better to fulfil the needs of these people as their fiat currencies worsen over time.

The invention and the development of bitcoin, cryptos and blockchains have led to more economic freedom than being shackled by the depreciating currency, banks that we do not trust and the unfair financial system of the country.

Bitcoin and cryptos push the boundaries of libertarianism. They represent an ideology where the government should have less control over the lives of its people; that people can have more free choices. It is an idea of maximum liberty. Many who embrace Bitcoin and cryptos are distrustful of governments and large corporations. Hence, others may not be comfortable and disagree with these ideologies and values.

Bitcoin as outside money and de-dollarisation

Credit Suisse analyst, Zoltan Poszar, popularized a term called “outside money,” which is a more elegant descriptor for non-sovereign currencies. According to Zoltan, the trend towards deglobalization and on-shore manufacturing, domestic supply chains, and commodity reserves would have a persistent inflationary effect.

After Western governments froze Russia’s foreign exchange reserves in 2022 for the invasion of Ukraine, speculation mounted that some central banks would acquire cryptocurrency as a form of insurance against financial blockades from the U.S. and its allies. The idea has remained a fixation among Bitcoin investors, who tend not to support U.S. foreign policy objectives, and who view it as a good thing that crypto could provide a workaround.

A working paper on the subject by Matthew Ferranti (PhD candidate in Harvard’s economics department) argues that it makes sense for many central banks to hold a small amount of Bitcoin under normal circumstances, and much more Bitcoin if they face sanctions risks, though his analysis finds gold is a more useful sanctions hedge. Bitcoin is a form of diversification when there is not enough gold to hedge the sanction risk adequately.

Other reasons for outside money include:

• Growing high government debts and off-balance sheet liabilities (US Medicare, social care). Can they continue to pay the interest and reduce the debts? Is this sustainable?
• De-dollarisation: reducing the US dollar’s dominance of global markets; a process of substituting the US dollar as the currency used for trading oil and other commodities with other currencies, buying US dollars for the forex reserves. It is a trend worth monitoring.
• Plausible quantitative easing in the future as a solution (though is this sustainable?)

We can observe such patterns in developed and developing countries.

As a result, many including central banks are buying gold. Demand for gold is worth monitoring as it can have implications for Bitcoin.

Cryptos as alternatives to traditional financial

Bitcoin and cryptos allow easy self-custody; we do not need banks or crypto exchanges to safeguard our assets. There is a growing category within crypto called decentralized finance (DeFi) that aims to be an alternative to the traditional financial system. Here are the key uses:

1. Decentralised exchanges (DEXes): Allow users to trade digital assets amongst each other without the need for a central entity to hold their funds or deposit fund in the first place. Users link their wallets to the exchange and then verify the transaction themselves.
   Examples: Uniswap, Sushiswap, Curve
2. Borrowing and lending: Allow users to borrow and lend cryptocurrencies where the loan agreement is governed by a smart contract. Due to over-collateralization, there is only a minimal risk of the assets not being repaid. There are no credit checks for borrowers, low transaction fees, and instant settlement. 
   Examples: Compound, Aave
3. Earning interest through staking: Enable users to act as a validator for transactions and earn profit for doing it so.
   Examples: Ethereum, Lido, Curve

Besides the unfriendly and low-trust banks and banking systems that DeFi is targeting, the unbanked is another huge potential segment.

Bitcoin and alternatives

Since the invention of Bitcoin, many crypto alternatives have been launched and failed.

Notable developments:

• Layer 1 and Layer 2
  Layer 1 refers to a base network, such as Bitcoin, Ethereum, Cardano, Solana, Polkadot and their underlying infrastructures. Layer-1 blockchains can validate and finalize transactions without the need for another network. They are analogous to the operating systems on our computers (Windows) and mobiles (Android and Apple iOS)
  
  Making improvements to the scalability of layer 1 networks can be difficult, as we have seen with Bitcoin and Ethereum. Layer 2s complement Layer 1s to compact the bottlenecks of scaling and transaction costs.
  
  Bitcoin’s Lightning Network is one example of a Layer 2 protocol. Layer 2 for Ethereum includes Polygon, Loopring, Arbitrum and Optimism. There are many Layer 1 blockchain and Layer 2 protocols.
  
  Ethereum: Among cryptocurrencies, it is second only to Bitcoin in market capitalization. It aims to be better than Bitcoin (so are many other layer 1s) with its smart contract functionalities and ecosystem. It has successfully transited to Proof-Of-Stake which allows Ethereum to be staked to validate transactions with staking rewards instead of relying on miners.
• Stablecoins
  • Centralised stablecoins (such as USD Coin (USDC), Tether and Binance USD): Backed by fiat currency or an asset with equivalent fair value (supposed to)
  • Decentralised stablecoins (such as Dai and Frax) where value is pegged to a particular external asset. What makes decentralized stablecoins different from centralized stablecoins is that they have full transparency and they are non-custodial, meaning a company or centralized party does not control them. Any collateral that backs the stablecoin is transparent to users, so they know it exists. There are several categories of decentralised stablecoins.
  • Stablecoins such as USD Coin and Tether have been the top cryptos in terms of market capitalisation after Bitcoin and Ethereum. They benefit from blockchain networks and avoid the volatility of cryptos (hence, the name “stable” coins). The demand for stablecoins has been growing.
  • Stablecoins need layer 1s or 2s to operate.

Gartner hype cycle

The Gartner hype cycle is a graphical presentation to represent the maturity, adoption, and social application of specific technologies. The hype cycle aims to provide a graphical and conceptual presentation of the maturity of emerging technologies through five phases.

In July 2022, Gartner published the Hype Cycle for Blockchain and Web 3.

In 2022, cryptos were at the Tough of Disillusionment of the cycle caused by the fall of Voyager Digital, Luna, Celsius, 3AC Capital, Hodlnaut and FTX with poor risk management and lying to customers or lenders about what they were doing with their money. There were also funds stolen from attacks by (supposedly) hackers.

It will take time for good use cases to emerge. For now, most users focus on the practical utility of the technology: storing and transmitting value anywhere cheaply, seamlessly and permissionlessly. Use cases for NFT (non-fungible token), blockchain games and DeFi (decentralized finance) are still evolving. Many use cases simply use existing use cases (on Web 2) and are introduced into the crypto/web 3 with marginal improvements.

Will Bitcoin and Ethereum continue to stay relevant with improvements? Will they be disrupted by better solutions (new cryptos taking over their places)? This is something worth monitoring.

It will evolve similarly to how the tech era evolved from dot-com hype. There will be booms and busts, ebbs and flows. Cycle after cycle, technology will improve with more unique, practical and safe uses to emerge, allowing the value of the network to grind higher with time (network effect).

Do not focus just on their price actions but also on the improvements in technology and how it will improve our lives.

The “Snap” test

Motley Fool co-founder David Gardner has a simple filter: Will the company be missed by society if it disappears in a “snap”? Yes, I believe that Bitcoin, Ethereum, stablecoins and blockchain as the underlying technology pass the snap test.

• People in many countries are experiencing depreciating currencies, high inflation and low-trust and unfriendly banking system. There is also de-dollarisation. This makes investing (properties, stocks) not attractive.
• Countries (developed and developing) are having increasing deficits and debts.

It is a messy world that governments have created and we are at their mercy. Our monies and their derived values are a function of the governments and their financial systems. They control how we send money from one country to another. Real estate and financial markets are also affected by their actions (as well as inactions and poor actions). Yes, they are huge external forces that will affect what we have and we have to pay attention to them.

That is the “intrinsic value” of Bitcoin and the blockchain networks such as Bitcoin and Ethereum. It presents capabilities that bank deposits, physical cash, and gold cannot do: send permissionless payments globally, or maintain access to your self-custodial funds even if you move around the world, across borders and through airports.

Valuing Bitcoin and cryptocurrencies

NYU Professor Aswath Damodaran said that Bitcoin and cryptocurrencies (like other fiat currencies, precious metals, fine art and collectables) cannot be valued as they do not generate cash flow. They can be priced against other currencies, which with greater acceptance and more stable purchasing power can command a higher price.

Cryptocurrencies will only be worth serious money over the long term if they are recognised and accepted in transactions and confident of their store of value. A handful of cryptocurrencies will continue to make up most of the market share, while many others will lose their value over time. So far, Bitcoin and Ethereum are maintaining their market shares among the growing number of coins over the years.

Several others have developed many approaches towards valuing Bitcoin and other cryptos.

Plan B came up with the stock-to-flow model in 2019. Each commodity has a stock-to-flow ratio, a measure of how much is mined or produced per year compared to how much is stored.
Plan B: Modeling Bitcoin Value with Scarcity
The chart is available free on several sites such as Glassnode and Coinglass.

Market-value-to-realized-value ratio (MVRV) is another method. It is a ratio of an asset’s Market Capitalization versus its Realized Capitalization. By comparing these two metrics, MVRV can be used to get a sense of when the price is above or below “fair value”, and to assess market profitability. Extreme deviations between market value and realized value can be used to identify market tops and bottoms as they reflect periods of extreme unrealized profit and loss, respectively.
The chart is available for free on Woobull Charts. The site has many other charts available to estimate the value and direction of Bitcoin and provide data intelligence.

Most crypto buyers and sellers are trading with price charts and technical analysis.

Conclusion

Stay open-minded and curious; keep learning and validate the thesis

Weakening fiat currencies, de-dollarization, debasement, high inflation and unfair/unfriendly banking system are big problems. Over time, more countries and more people are affected. Bitcoin and cryptos have become the solution, hence, a huge market potential.

Marc Andreessen compared Bitcoin in 2014 to personal computers in 1975 and the Internet in 1993. Still new, some people are cynical and sceptical, yet, some are bullish and convinced of its potential. Many prominent people like to make bold predictions. History has shown not all are true; some went very wrong.

“I think there is a world market for maybe five computers.”

Thomas Watson, president of IBM, 1943

I predict the Internet will soon go spectacularly supernova and in 1996 catastrophically collapse.

 Robert Metcalfe, founder of 3Com in 1995

There’s just not that many videos I want to watch.

Steve Chen, CTO and co-founder of YouTube expressing concerns about his company’s long-term viability in 2005

There’s no chance that the iPhone is going to get any significant market share.

Steve Ballmer, Microsoft CEO in 2007

The worst tech predictions ever

Cryptos and blockchains are very different in technology, ideologies, revenue and business models. They evolve and improve quickly; it can be difficult to catch up. Many of us are taking snippets of information and views of others to conclude. They may not be accurate. Stay open-minded and curious, keep learning to have our independent view and keep validating the investing thesis to hold long. Strong opinions, held loosely.

Keep to Bitcoin, Ethereum and gold (for now)

Few survive and thrive. There are always new projects and tokens; many will boom and bust with each cycle; similar to tech cycles.

In terms of market capitalisation, the more battle-tested and established ones are Bitcoin and Ethereum.

Listed companies release financial statements periodically and announcements where we can ascertain their valuation, progress and quality. There are enforcement agencies and regulators that listed companies have to compile.

Regulations are still far behind in cryptos. Unfortunately, this gives opportunities for scams and frauds. It also highlights the nascent stage cryptos are in. We have to keep safe ourselves. Self-custody if need to. Do not FOMO (fear of missing out) and degen (buying into crypto projects not because they see the value; they do so with the belief that others will join in after them and speculate on the price swings). Do expect rekt (wrecked).

Gold and precious metals are alternatives to cryptos to serve as a hedge against currency debasement or inflation.

Expect wild rides

In 7 years between 2015 to 2022, while there are four times that Bitcoin has fallen at least 70% from its high, it advanced from USD 317 on 1 January 2015 to a high of USD 67,145 in November 2021 before settling at USD 16,600 on 31 December 2022. We can buy and hold and/or trade with volatile price ranges.

Cryptos are suitable for investors who believe in its secular trends and potential, especially those who invest in technology stocks and are familiar with the technology cycles that cryptos may have similarities in.

Buy good, buy low, keep validating to hold long to enjoy the wonders of compounding. 

Buying good will be Bitcoin and Ethereum. Do expect a very wild ride. Start with a small allocation where we can sleep well and be comfortable holding. Given the high volatility, we can trade with technical analysis, market-value-to-realized-value ratio chart or stock-to-flow chart.

A related article: Multi-baggers with growth companies
Other investing deep dives can be found here.