I Used To Love Investing - And Then I discovered Bitcoin
Turning my investing brain inside out
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This week, we will dig deeper into the Bitcoin (BTC) rabbit hole. Last week’s newsletter generated a fair amount of commentary about the merits of BTC - whether it is a scam.
So, today, we will look at the following:
Fiat currencies and the Gold Standard
The impact of inflation and BTC’s role in hedging that.
Whether fiat money is now broken.
The use cases of BTC and its potential to create substantial societal impact.
Why BTC epitomizes lateral thinking.
Charlie Munger, the famed investor and longtime partner of Warren Buffet, was consistently critical of BTC and pulled no punches in his use of colorful language.
“Rat Poison”: In 2013, Munger first equated Bitcoin to rat poison when it was worth $150. When Bitcoin rose to $9,000, he remarked it was “more expensive rat poison.”
“Disgusting”: Munger described Bitcoin as “disgusting and contrary to the interests of civilization.”
“Massively Stupid”: He called crypto “massively stupid” and said it was “ridiculous that anybody would buy this stuff.”
“Evil”: Munger argued Bitcoin was “evil because it undermines the Federal Reserve system.”
Why so much anger?
Buffet referred to derivatives as financial weapons of mass destruction.
The financial world is full of people with strong opinions. We pay attention if those people have a stellar investment track record.
Buffet didn’t always get it right. He avoided tech for a long time because he didn’t understand it. Eventually, though, he became one of Apple’s largest shareholders.
Is It Rat Poison or Nectar?
Before deciding, we have to look at the insidious effect of inflation.
The best approach is to examine inflation's impact over the last 100 years.
The Coin New Media group has a handy calculator tool for calculating the cumulative impact of inflation.
All the news sources highlight the rate of inflation, which masks the impact of the inflation that has already occurred. If inflation was 2% and then rose to 9%, that feels and sounds terrible. If it goes back down to 2%, all is not well because the price rises are sticky.
Even this tool doesn’t quite convey what is going on. The cumulative inflation rate over the last 100 years is 2.96% annually. Sounds not too bad, but here’s what it means: a dollar of purchasing power in 1924 has fallen to 5c of purchasing power today.
Now, look at the purchasing power of various other ‘currencies.’
One hundred years ago, the average house could have been purchased with 551 ounces of gold; today, it takes 220 ounces.
Narrowing the timeframe, let’s compare the same ratio over 10 years to look at real estate/gold versus real estate/BTC.
Ten years ago, you could have bought the average house with 250 ounces of gold; today, 220 ounces.
Over the same period, the ratio of BTC/gold changed from 0.2856 to 36.36.
That means you needed 875 BTC ten years ago to buy the average house; now, 6.
Both gold and BTC have more than outperformed inflation over the last 10 years, whereas the USD, or purchasing power of cash, has underperformed: 1 USD 10 years ago is worth ~75c today.
When people say gold is a hedge against inflation…they’re right.
When people say BTC is a hedge against inflation…they’re right.
Maybe rat poison is a good hedge against inflation…
How Did BTC Get Here?
(Subscribers who already know this, skip forward…)
The exciting thing about being human is that you can use your brain to imagine something and then make it real.
This is what Satoshi Nakamoto - a mysterious figure or group of figures - did in 2009.
He conceived of a digital currency designed to operate outside the control of any central monetary authority.
It would be capped in its supply - limited to 21 million coins - and earned or ‘mined’ by solving complex mathematical puzzles.
When solved, these coins, or the proof of the work - remember having to show your math teacher your work and not just the answer - are recorded on a digital ledger.
I could explain this using hashes and Merkle trees, but that would be too complicated (for both of us!).
I think this is better:
The Mailbox
Imagine you have a mailbox where you receive letters. Each letter represents a transaction in BTC.
Imagine your mailbox represents the entire BTC blockchain, where all transactions are recorded—a shared mailbox. Each time you receive a letter (a transaction), it is stored in your mailbox.
You must solve a unique puzzle whenever you want to add a new letter to your mailbox. This puzzle is like a combination lock that needs to be opened before you can add a new letter.
To find the right combination for the lock, you must try different numbers repeatedly until you find one that works. It would help if you had powerful computers to try different values (called nonces) until they find an answer (hash) that meets the BTC network's difficulty criteria.
Imagine many people with mailboxes, all trying to solve their puzzles simultaneously. Each person is competing to be the first to find the correct combination to add their new letter (block of transactions) to their mailbox (the blockchain).
The first person to successfully open their mailbox with the correct combination will receive a reward of 3.125 bitcoins for successfully mining a block.
Once someone finds the right combination and adds their letter, everyone else checks to ensure it was done correctly. They update their mailboxes with this new information if they agree it's valid.
If too many people solve their puzzles too quickly—let’s say everyone is finding combinations in under 10 minutes—the difficulty of the puzzles increases, making them harder to solve. If it takes too long, the puzzles become easier. This adjustment ensures that new blocks are added approximately every 10 minutes, maintaining a steady flow of new transactions.
Scarcity
When BTC was first created, the reward for mining one BTC was 50 coins. The reward decreases every four years, and in April 2024, it was reduced to its current level of 3.125.
If coins are awarded every 10 minutes - 525,600 minutes in a year (Seasons of Love…) - then there are 52,560 victories each year.
Based on the current halving schedule, all 21 million BTC are projected to be awarded by ~2140.
This limit can be compared to the physical limit of gold in the ground, meaning BTC is scarce and getting scarcer.
19 of the 21 million available BTC have already been mined.
Use Cases
BTC has ~six uses:
Currency - increasing numbers of individuals and institutions accept BTC as payment.
Remittances - BTC can remit ‘money’ with little friction or regulation domestically and internationally.
Store of value - its scarcity has led to its being referred to as digital gold.
Investment asset - its return since its inception has been stellar
Although the slope of the line between the two charts is similar, BTC has much more volatility. However, the two can’t easily be combined into one chart because the return scale is different by an order of magnitude.
The 10-year cumulative return for BTC is 26,145%, whereas the 10-year return for the S&P 500 is 261%. (I haven’t yet figured out how to do a logarithmic scale on my charting software. That might help!)
Decentralized finance is probably worth another deep dive. The concept is to create fractional ownership interests in a range of assets on the blockchain and allow trading without traditional exchanges.
Hedging against inflation - the role of BTC (and gold) as a hedge against inflation is apparent from the charts above.
What Are The Problems?
Volatility - on the chart below, gold is the red line…
Scalability Issues—BTC transactions over the blockchain are not rapid right now. However, Fantom and its upgraded successor, Sonic, substantially improve transaction fees, transaction time, and volume capabilities.
Limited Acceptance—merchant acceptance of BTC is increasing but is still not widespread.
Security Risks—Users face risks such as losing access to their BTC if they forget their wallet passwords or their wallets are hacked. Unlike traditional banks, there is no way to recover lost BTC.
Regulatory Uncertainty—Gary Gensler's announced resignation from the SEC Chairman role, to be replaced by Paul Atkins (who is very pro-crypto), should improve this position in the US.
Environmental Concerns—BTC mining consumes significant energy, raising concerns about its environmental impact. Finding sustainable energy sources to power BTC is a priority.
Lack of Buyer Protection—Transactions with BTC are irreversible, meaning there is no recourse if goods or services are not delivered as promised.
Broken Money And Linear Thinking
I just started a book by a prolific macroeconomic commentator, Lyn Alden. It’s called Broken Money.
She starts the chapter on stateless money with a quote from Friedrich Hayek, the renowned Austrian economist:
“I don’t believe we shall ever have a good money again before we take the thing out of the hands of government, that is, we can’t take them violently out of the hands of government, all we can do is by some sly roundabout way introduce something that they can’t stop”
Alden points out that discussions about currency debasement in the US can be a bit theoretical. We have had a relatively stable domestic currency over the last 100 years, even though it has lost 95% of its purchasing power…
Countries like Nigeria, Argentina, Turkey, and Brazil are no strangers to hyperinflation. In 2022, in Lebanon, people were robbing banks…to access their own money.
These countries are very familiar with the concept of broken money. El Salvador accepts BTC alongside the USD.
Central bank money printing has become rife, and it is beginning to erode people’s confidence in the government's ability to maintain stable money.
The US has the luxury of being the world’s reserve currency. While this persists (and it will for a long time), it can print money to service its mountain of debt.
However, there is considerable impetus among BRICS countries to develop alternative payment and settlement systems and recycle trade surpluses with the US into assets other than USD.
The USD is not broken yet but shows some signs of wear.
I argued last week that BTC offers a way out of this.
The lateral thinking part is to imagine how this might work. As I argued in that article, if the US monetized the mark-to-market gain on the gold it holds in the Federal Reserve System and purchased $700 billion of BTC, it would have a chance to pay off its debt in 20 years.
The math is straightforward:
$36 trillion of debt, at an average rate of 5%, grows to $95 trillion in 20 years.
$700 billion of BTC would grow to $95 trillion over 20 years if it compounded at 28%.
28% seems high…except when you compare it with the average annual return of over 2600% for the last 10 years, the average annual return of 240% over the previous 5 years, the average annual return of 32% over the last 3 years, or the average annual return of 47% over the previous 2 years.
Takeaways
BTC requires a paradigm shift in investing, understanding currencies, thinking about the role of the central government in managing fiat currencies, and understanding the respective powers of government and the individual in all of these.
If we refuse to make these shifts, we may miss the most critical advance in finance since the invention of currencies.
If we want to find a way to pay off government debt in the US, we need to embrace Bitcoin's potential.
The incoming Trump administration seems to be all-in on crypto, so we may have a front-row seat to this movie.
On balance, while crypto is challenging my approach to investing, I am prepared to turn my head inside out to take a serious look.
I think you should, too.
To clarify: Fed Reserve Banks hold 261 million ounces of gold marked at $42. They are not selling. They are just marking them to market and recognizing the unrealized gain. They are not going to sell, just create the credit to buy the bitcoin. It is almost like printing the money, except this time they have the collateral to justify it. They will still own the gold. Great question on how the government would buy that much BTC without moving the market massively. Let me go ask Michael Saylor…
Worries about fiat currencies are quite rational right now but… wouldn’t the value of gold fall precipitately if the US government began liquidating even a fraction of its holdings as part of a strategy to reinvest it in Bitcoin, and the price of Bitcoin shoot up, before much could be bought? Arguably this would support its value growth story but too quickly to be useful for the purpose. And isn’t BItcoin much like gold anyway? Finite rather than limited in volume, less bulky but, as you say, with its own issues, and also limited in practical terms as a medium of exchange. And does credit die under Bitcoin? Who would borrow in a currency which is expected to grow at 28%?
Or am I taking this all a bit too literally?