The Case for Bitcoin
Introduction
Bitcoin, often dismissed as complex and speculative, we believe deserves serious consideration as a component of a multi-generational investment portfolio. This memo aims to demystify Bitcoin and present a compelling case for its inclusion in your investment strategy. We'll explore Bitcoin's fundamental properties, its technical factors, and the current economic context that makes it increasingly relevant.
As we make the case for Bitcoin, it is important to consider its intrinsic value and the market dynamics driving its adoption. Let's begin by understanding what makes a currency effective and how Bitcoin fits into this framework.
Understanding Currency
Throughout history, societies have used various forms of currency, from beads and fur to precious metals. The evolution from barter systems to standardized currencies solved the problem of the "double coincidence of wants" in trade. The “double coincidence of wants” happens when two individuals each possess an item or service the other desires. For example, the baker wants fish and the fisherman wants bread so they can create a barter system. However, the rarity of this occurrence is one of the main reasons why societies develop money as a medium of exchange. But what makes a good currency? Several key properties are essential:
1. Durability: Resistance to wear and tear over time.
2. Portability: Ease of transport and use in transactions
3. Divisibility: Ability to be split into smaller units
4. Uniformity: Consistency in quality and value
5. Recognizability: Ease of authentication
6. Scarcity: Limited supply to maintain value
These properties explain why gold, for example, became a widely accepted currency, while other materials, like iron, fell short. Unlike gold, iron is prone to corrosion (i.e., not durable) and more abundant than gold (i.e., not scarce). Moreover, gold is extremely malleable and can be shaped into coins (i.e., uniformity); whereas iron is harder to shape into standardized units (divisibility). Also, gold’s unique color and luster make it easier to recognize whereas iron is less visually distinctive (i.e., recognizability). Considering these important properties, it becomes clear that gold has intrinsic qualities that make it well-suited to being used as a currency. And while gold has some industrial use cases, it is primarily used as jewelry and currency (i.e., as a store of value). In contrast, iron has many industrial uses and so its value could fluctuate based on industrial demand as opposed to its use in a monetary system.
With this understanding, let's consider how we believe Bitcoin embodies these characteristics and why it could be considered a viable form of money.
Bitcoin's Fundamental Value
Bitcoin, created in 2008 by an unknown entity using the pseudonym Satoshi Nakamoto, is a decentralized digital currency designed to enable peer-to-peer transactions without intermediaries, such as banks or governments.
Bitcoin transactions are recorded on a public ledger called the blockchain, which records all transactions and is managed by a network of computers. The blockchain ensures both security and transparency without relying on a central authority. The transaction process in the Bitcoin network is both elegant and robust. When a user initiates a Bitcoin transfer, the transaction is broadcast to the entire network. Before it can be added to the blockchain, it must be verified by miners (i.e., specialized computers within the network). These miners compete to solve complex mathematical problems, a process that requires substantial computational power. The first miner to solve the problem earns the right to add the new block of transactions to the blockchain, receiving newly minted Bitcoin as a reward for their effort.
The blockchain's structure is key to its security and immutability. Each block in the chain is cryptographically linked to the previous one through a unique code called a hash. This interconnected design makes retroactive alterations virtually impossible. Any attempt to modify a single block would necessitate changes to all subsequent blocks, a task that would require an unfeasible amount of computing power, thus ensuring the integrity of the entire transaction history.
Though Bitcoin’s detractors argue that it is nothing; they are missing the intrinsic properties Bitcoin possesses which make it an effective currency:
1. Durability: As a digital asset, Bitcoin is immune to physical damage.
2. Portability: It can be sent globally with just an internet connection.
3. Divisibility: One Bitcoin is divisible into 100 million units called satoshis.
4. Uniformity: All Bitcoins are identical and indistinguishable.
5. Recognizability: The Bitcoin network automatically verifies all transactions.
6. Scarcity: There will never be more than 21 million Bitcoins as it is written into the code.
Bitcoin's decentralized nature makes it similar to gold, earning it the moniker "digital gold." However, its adoption as a medium of exchange is still in progress due to the sometimes arbitrary nature of currency acceptance.
While Bitcoin's fundamental properties make it suitable as a currency, its value will ultimately be driven by its adoption – people need to want to use it as a medium of exchange or store of value before there will be increased demand for the currency. This is true for all currencies: they need the properties of an effective currency and they only have value when they are widely accepted.
Bitcoin's Technical Factors
The fixed supply cap of 21 million Bitcoins, enforced by its underlying code, creates scarcity that potentially allows it to act as a store of value over time. This scarcity, combined with increasing demand, could drive Bitcoin's value upward.
The recent creation of Bitcoin ETFs marks a significant technical signal. As of Q3 2024, approximately 1.3 million Bitcoins (valued at $88.4 billion) are owned by various ETFs. Major investment firms like Fidelity and BlackRock now offer Bitcoin exposure, potentially leading to broader adoption.
Larry Fink, the CEO of Blackrock, has said that “We believe that Bitcoin is an asset class in itself.” Blackrock, the owner of the iShares Bitcoin ETF, is clearly motivated to encourage all investors to allocate at least a portion of their portfolio into Bitcoin. In addition to large flows from ETFs, we are seeing well respected investors such as Stanley Druckenmiller and Paul Tudor Jones publicly share that they are bullish on Bitcoin.
If Bitcoin were to be widely considered as a new asset class, similar to stocks, bonds, or gold, it could attract a significant portion of global investment capital. This shift in perception and allocation could lead to substantial price increases. As more investors hold Bitcoin, it could create a network effect, further legitimizing it as an asset class. If Bitcoin becomes a standard part of investment portfolios, it could lead to more stable, long-term holding patterns. This could potentially reduce some of the volatility associated with Bitcoin, making it a more stable store of value and therefore more valuable as a currency.
This rising interest in Bitcoin is an important driver behind our recommendation to buy Bitcoin, but it's also crucial to consider the current economic context that makes Bitcoin particularly relevant today.
Current Economic Context
The U.S. government's mounting debt and shifting spending priorities create a compelling backdrop for Bitcoin's relevance:
1. Government debt as a percentage of GDP has been consistently increasing since the early 1980s.1
2. Interest expense has risen dramatically since 2021 due to higher interest rates.2
3. Non-discretionary spending (e.g., Social Security, Medicare) now comprises about 2/3 of the budget, up from 1/3 in 1962. This, in combination with higher interest expense, makes it very difficult to stop this trend towards an ever-increasing debt load. 3
These factors suggest continued money printing, potentially eroding the U.S. dollar's value. In addition, some foreign governments are actively seeking alternatives to the dollar as a reserve currency, further threatening its global dominance.
Investment Case for Bitcoin
Bitcoin offers a potential hedge against dollar devaluation, complementing traditional hedges like stocks, real estate, and gold. Its decentralized nature and fixed supply make it an attractive option in an uncertain monetary landscape.
The growing institutional adoption of Bitcoin, evidenced by the launch of multiple ETFs and endorsements from respected investors like Stanley Druckenmiller and Paul Tudor Jones, suggests increasing mainstream acceptance.
While Bitcoin's price volatility and relatively recent emergence may give some investors pause, its fundamental properties as a currency and the current economic context make a compelling case for its inclusion in a diversified, multi-generational portfolio.
As with any investment, it's crucial to understand the risks and potential rewards. Bitcoin's journey from a fringe asset to a standard component of investment portfolios is ongoing, and early adopters may be well-positioned to benefit from this shift.
Risk and Disclosure:
This material is provided for educational purposes only and does not constitute investment advice.
Investing in bitcoin involves a high degree of risk, including possible loss of principal. An investment in bitcoin is not suitable for all investors, may be deemed speculative and is not intended as a complete investment program. An investment in bitcoin should be considered only by persons who can bear the risk of total loss associated with an investment.
Investing in digital assets, such as bitcoin, involves significant risks due to their extreme price volatility and the potential for loss, theft, or compromise of private keys. The value of the shares is closely tied to acceptance, industry developments, and governance changes, making them susceptible to market sentiment. Digital assets represent a new and rapidly evolving industry, and the value of bitcoin depends on the acceptance of bitcoin. Changes in the governance of a digital asset network may not receive sufficient support from users and miners, which may negatively affect that digital asset network’s ability to grow and respond to challenges. Investing in bitcoin comes with risks that could impact the value, including large-scale sales by major investors, security threats like breaches and hacking, negative sentiment among speculators, and competition from central bank digital currencies and financial initiatives using blockchain technology. A disruption of the internet or a digital asset network, such as the Bitcoin network, would affect the ability to transfer digital assets, including bitcoin, and, consequently, would impact their value.