Should You Buy Bitcoin?
+ Bitcoin and Blockchain explained to a 5th Grader
Howdy Y’all!
Over the years, many people have asked me what I think of Bitcoin. And at the root of that question, often-times, they’re asking if they should *buy* Bitcoin — because, well, they want to make money.
Bitcoin is polarizing. Some say: “it’s a pyramid scheme.” While others claim: “it’s the future, it’s going to be huge!”
Earlier this month, Bitcoin hit an all-time-high, surpassing $40,000 USD, per coin. So I felt it was time, primarily for myself (and for my future—hopefully more mature—self) to have a standalone piece on the subject of owning Bitcoin.
[Article published: January 22, 2021. BTC price at the time of publication: $32,500]
Summary:
Intro (why am I writing this?)
Bitcoin Defined (in layman’s terms)
Definitions (feel free to skip)
The “Bear Case” (why BTC won’t work)
The “Bull Case” (why BTC will work)
How To Buy Bitcoin (if you choose to do so)
Further Resources (My Top 5 Picks ✨)
Am I qualified to write this article?
Honestly, I’m still a dummy when it comes to Bitcoin, crypto-currency and blockchain. Truly. I am. Sure, I’ve been keeping tabs on it, on and off, for a few years — so I have a decent grasp on the landscape. But I definitely don’t have all the answers.
So, why should you read this article from a noob like me?
Well, I see myself as being on the “second rung” of the proverbial ladder of understanding Bitcoin. Someone who is “ten rungs” up will give an explanation that would likely go way over many people’s heads. I’m here to take those of you who are still “on the ground,” up to the first or second rung of the ladder of understanding.
If you are an expert in crypto, this article is not for you (though I would love your feedback!). This article may as well be titled: “Bitcoin for Dummies.”
Last, but not least, this is not financial advice!
What is Bitcoin?
When Bitcoin was first introduced to the world in 2008 in a white paper, its mysterious creator, who dubbed himself Satoshi Nakamoto, described it as:
A purely peer-to-peer version of electronic cash [which] would allow online payments to be sent directly from one party to another without going through a financial institution.
Translation: Bitcoin is digital money.
With Bitcoin (AKA “BTC”), you don’t need a bank to pay your friend, you can just pay them directly.
Today, we need intermediaries:
Platform: Paypal/Venmo/Zelle and
Financial Institution: A Bank, which holds fiat currency, such as $ USD.
These intermediaries are required because they hold the system of record (ie: who owns what amount of money) and thus, trust.
Bitcoin, on the other hand, is built on technology called “blockchain” that inherently has trust. This is important. Let me repeat: Bitcoin is built on blockchain technology.
What is blockchain?
My favorite analogy: the internet is a technology created in the 90s. Google figured out a way to leverage said (then new) technology, to create value. Blockchain = “the internet.” And Bitcoin is a use-case that leverages said (new) technology, to create value.
We’ll get to how the blockchain works later. For now, all you need to understand is that blockchain technology enables the process of sending money and is the system of record for all money balances. There is no need for a bank to be an intermediary.
So that begs the next question:
What is money?
The History of Paper Money - Origins of Exchange.
TLDR:
A medium of exchange.
A store-hold of wealth.
Helpful definitions:
(It’s okay if you don’t fully understand these)
Blockchain - a system in which a record of transactions made in bitcoin or another cryptocurrency are maintained across several computers that are linked in a peer-to-peer network.
Decentralized - an activity or organization controlled by several local offices or authorities rather than a single one.
Cryptography - secure information and communication techniques derived from mathematical concepts and a set of rule-based calculations called algorithms, to transform messages in ways that are hard to decipher.
Cryptocurrency - a digital currency in which transactions are verified and records maintained by a decentralized system using cryptography, rather than by a centralized authority.
Many more definitions like Distributed Ledger, Fiat and Stable Coins, can be found in this "Crypto Glossary”.
Here is an example of an extreme bear run:
Let’s start with reasons you shouldn’t buy Bitcoin. And more importantly: the fundamentals of why Bitcoin could be a bubble. Or won’t be around in, say, ten years.
Regulation
Every government wants to control the inflows and outflows of cash. Think of them as the “piping” of cash flow. Even if I want to send my friend $10 for pizza, the government wants that $10 to go through *their* pipes so they can inspect, make sure nothing is wrong* with that money, then let it go through the “pipes.”
*Wrong might mean:
Is it counterfeit money?
Does that money need to be taxed?
Is fraud happening with the transaction?
It’s worth noting: the government (and banks) are open to blockchain technology, if they control the system (crypto-currency) built on Blockchain. But if a crypto-currency is truly decentralized, then no one (including the creator, in this example, a bank or government) has the keys to get in the “back door.”
Furthermore, Bitcoin, specifically, is already out of the government and banks’ purview, so they’d prefer to use a different cryptocurrency. Ideally one that they build and, thus, fully control. However, again, by definition, this would mean that it would be centralized (not decentralized) which breaks the core principles of which cryptocurrency was built on. But more on that later.
No control over inflation/deflation
Today, the Fed uses its tools to control the supply of money to help stabilize the economy. When the economy is slumping, the Fed increases the supply of money to spur growth. Conversely, when inflation is threatening, the Fed reduces the risk by shrinking the supply.
You can read more about how The Federal Reserve uses three main tools to accomplish this goal. But bottom-line, with Bitcoin, there would be no way to control the supply (up or down) of currency in circulation (more on the finite amount of Bitcoin later).
Speculative asset overshadows its original purpose to be a currency
This entire article is worth reading as a bear case: The Bitcoin Dream is Dead. Here is an excerpt:
In 2010, a Bitcoin developer named Laszlo Hanyecz paid someone 10,000 Bitcoins to pick up and deliver two pizzas from Papa John’s. Given that one Bitcoin is now worth more than $30,000, those pizzas cost, in retrospect, somewhere north of $300 million*.
Bitcoin has, in some sense, been admitted to the club and is now seen by many as a plausible competitor to assets like gold. But along the way, something odd happened: Bitcoin completely lost its original reason for being. Bitcoin was, after all, not designed to be a speculative asset. It was designed to be a currency, a new medium of exchange that people could, and would, use to transact daily business with each other.
The more people hoard Bitcoin, treating it as a speculative asset, the less appealing it seems as a currency.
It’s a bubble
Many speculate that in some timeframe (maybe 5, 10, 20 years) it will pop. The last people who join “the pyramid scheme” will get left with nothing. And everyone will look back and laugh, in awe at how big this multi-level marketing scheme grew.
Tulip mania is the most referenced bubble (though, fun fact: it was not actually nearly as bad as most people make it out to be today). But in any case, Tulip mania is often brought up in comparison to Bitcoin just being one big Ponzi scheme.
A different crypto-currency emerges
Okay, so you believe in blockchain technology. But you’re not sure Bitcoin will be *the* cryptocurrency that will win long-term.
One quick counter-argument: I’ve heard several smart folks who know “network effects” very well (e.g.: Reid Hoffman, co-founder of Paypal and LinkedIn, Chamath Palitapitiya, former exec at Facebook, Jack Dorsey, founder of Twitter and Square) compare Bitcoin to any other network effect community. Once enough people own it, it will be very hard for another crypto-currency to emerge.
But, it’s true. There are other “alt coins” that could become the go-to currency. Ethereum, for instance, is gaining a ton of traction. But that’s for other reasons, which we don’t have time to go into today.
Someone takes down the Bitcoin network
A 51% attack is a potential attack on a blockchain network, where a single entity or organization is able to control the majority of the hash rate, potentially causing a network disruption. In such a scenario, the attacker would have enough mining power to intentionally exclude or modify the ordering of transactions. They could also reverse transactions they made while being in control - leading to a double-spending problem.
Speed and costs
Currently, the speed of Bitcoin is slower than that of, say, Visa (by design). And the cost to transfer funds can be expensive. These will improve over time, but the reality is, today, they are not in an ideal state.
Here is an example of an extreme bull run for the price of Bitcoin:
When people first encounter Bitcoin, most go through a succession of thoughts that looks something like this:
BTC is BS
BTC is illegal
BTC does not make sense
BTC is only based on speculation
BTC is being talked about by a lot of smart people
BTC is something I’m interested in learning more about
I’m going to attempt to unpack the major mental hurdles most folks bump into along the final step outlined above. If you are on one of the first four steps, I can’t do too much to help you.
Below, I will make “The Bull Case” for why Bitcoin will win long-term — and thus, why you should buy Bitcoin.
[Warren Buffet is] betting against change. We’re betting for change. When he makes a mistake, it’s because something changes that he didn’t expect. When we make a mistake, it’s because something doesn’t change that we thought would. We could not be more different in that way.
- Marc Andreessen
When evaluating the scale of impact a new business may have, I find myself revisiting the mental model laid out by Mike Maples Jr. in his essay “How to build a breakthrough.” He makes the case that you need to go to the future, and “backcast” what happened to get you there. Mike says: “Exponential inflections power massive breakthroughs. They resemble waves with a giant gathering force.” There are four inflection points he says you should look for:
Technology inflections involve exponential improvements in the price/performance of technologies like computation, sensor accuracy, bandwidth, and the like.
Adoption inflections involve nonlinear changes in the adoption rate of a technology.
Regulatory inflections involve changes in regulations that open up massive new opportunities.
Belief inflections involve contradicting long-held beliefs. Some ideas that are now considered heresy but might someday be viewed as reasonable.
One could argue that Bitcoin checks all four of these boxes of inflection points.
What makes money worth anything?
You can read more here. But here’s the TLDR:
Divisible: Can be divided into smaller units of value.
Fungible: One unit is viewed as interchangeable with another.
Portable: Individuals can carry money with them and transfer it to others.
Durable: An item must be able to withstand being used repeatedly.
Acceptable: Everyone must be able to use the money for transactions.
Uniform: All versions of the same denomination must have the same purchasing power.
Limited in Supply: The supply of money in circulation ensures values remain relatively constant.
It’s worth expanding on “limited in supply” as it relates to Bitcoin…
Fixed supply: 21 million coins
One of the biggest differences between fiat currency (ie: the USD) and Bitcoin, is that there are only a fixed number of coins that can ever be mined. Currently there are about 18.5M coins in circulation.
In November of 2013, Ben Bernanke, the then-current Chairman of the Federal Reserve wrote a letter to the Homeland Security committee. In it, he pointed out the Fed’s long standing view that while virtual currencies pose money laundering and other risks, “there are also areas where they may hold long-term promise”.
The simple thought here is: BTC creates a true free market with supply and demand. And takes the government out as a dependency, when it comes to money. Remember how Satoshi defined it: “A purely peer-to-peer version of electronic cash [which] would allow online payments to be sent directly from one party to another without going through a financial institution.”
This also leads to Bitcoin being a:
Deflationary hedge
Look no further than the endless memes all over Twitter, Reddit and the internet at large, to see that: Money Printer Go Brrr.
20% of all money in circulation was printed in the last 12 months.
So, Bitcoin is a hedge against inflation. This is not a new concept. Again, gold is the classic example here. But there are many other examples of deflationary hedges.
Store of value
Let’s talk about it being compared to gold, another store of value.
The narrative of Bitcoin has shifted recently to being called “this generation’s gold.” In other words, Bitcoin is an asset to hold over time, but not necessarily use (similar to gold — you don’t buy pizza with your gold). Also, similar to gold, there is no “backing.” Meaning, it’s worth is not tied to anything. It’s entirely worth what people deem it to be worth. In other words, a true free market.
In these terms, we can compare the Market Cap of Bitcoin to the Market Cap of Gold.
BTC, at the time of writing this (mid-January 2021), has a market cap just north of half a trillion USD.
Gold, depending on where you look, has a market cap of around $3T in reserves, and about $9T if you are counting all gold (jewelry tucked away in drawers, etc.)
So, the simple math here, is that if you believe BTC will overtake Gold in terms of market cap, the market cap of BTC will grow anywhere from about 5x to 15x from where it sits today.
But what gets really crazy, is if you think Bitcoin can become a new:
Form of currency
If this happened it would finally create the first ever true separation of money and state.
That would be a really big deal.
As we move to a global economy, in an internet-first era, a currency that was built on the internet, for the internet, makes intuitive sense to me. And now, more than ever, decentralization, privacy, pseudonymity are important.
Twitter CEO and Square founder Jack Dorsey said:
The world will ultimately have a single currency. I personally believe that it will be Bitcoin.
And finally, this was Satoshi’s original intent in the creation of Bitcoin. It wasn’t to have it as a store of value, but to be used in peer-to-peer payments.
If you decide to invest
Never put in more than you’re willing to lose. This is a new and highly risky asset.
Dollar Cost Average (“DCA”) your way in.
Do not think in days, weeks or even months. Think in years, or ideally decades.
Purchase on a trusted exchange (such as Square or Coinbase) and secure your coins on a hard wallet or have a trusted third party hold it on your behalf. Tons of content on these subjects here.
If you do choose to dip your toes in, remember to HODL (this is a great backstory on “HODL,” highly recommend reading it)!
Resources for further learning
The resources I referenced throughout this article can tell a *far* more robust story about how Bitcoin came to be, and how it works, than I will ever be able to do. If you have the time, I highly recommend you dive into these, and climb out on other branches of research from there.
It would take you hundreds of hours to get through all of these. So I have “starred” (✨) my top 5 picks.
Bitcoin: A Peer-to-Peer Electronic Cash System (Satoshi’s White Paper AKA the advent of Bitcoin)
What is money?
✨ Ray Dalio: What is Money? (4 minutes)
What gives a dollar bill its value? - Doug Levinson (4 minutes)
The History of Paper Money - Origins of Exchange (8 minutes)
✨ Why Bitcoin Matters (by Marc Andreesson, written in January 2014)
Finite Amount of Coins (21M)
Cryptography for Distributed Ledger Technologies in a Nutshell
No one knows who Satoshi is (or if it’s a group of people)
The Quiet Master of Cryptocurrency (Nick Szabo, with Naval Ravikant)
Pomp’s Podcast (pick any episode that grabs your attention)
✨ #464: Mitch Garber on Understanding Bitcoin (fast-forward to 26 minutes in)
Two great YouTube videos:
✨ How does a blockchain work - Simply Explained (6 min YouTube video)
But How Does Bitcoin Actually Work? (26 min YouTube video)
Two good books on the history of BTC:
✨ The Bitcoin Dream Is Dead (written Jan 2021; a bear case against Bitcoin)
Bitcoin Information and Resources (open-source project by Jameson Lopp)
How did you feel about this week’s post?
(All feedback is 100% anonymous)
Thanks for making it to the very end of the 3,000 word beast. If you enjoyed this post, please like/comment/share. Y’alls feedback keeps me going!
And here’s to the next decade! What a ride it will be. But until then, see you next week.
Cheers,
Brendan J Short
Thanks Brendan. I’ve been skeptical about bitcoin and continue to be, but it has caught my interest after an interview by Glenn Greenwald with Alex Gladstein, which I highly recommend. I’m a new subscriber and I look forward to future posts.