The Debate on Bitcoin and Cryptocurrencies

Bitcoin bubbleBitcoin, Ethereum and other cryptocurrencies have seen an astronomical ascent in the last years, culminating in an extraordinary rise in 2017. As to the reasons behind this unprecedented rise, they actually seem far less nebulous than the identity of Bitcoin founder Satoshi Nakamoto: good old ANIMAL SPIRITS. However, the sustainability of the rise remains one of the most hotly debated topics of the year.

All this has many people asking us to opine on the whole cryptocurrency landscape and determine whether or not we are just in a bubble here – and this is something that we here at Blackbird Capital have debated vigorously as this isn’t an easy topic to come to a landing on. So to put simply, let’s start by breaking down the arguments for and against bitcoin…

To start with, how to think of cryptocurrencies in a nutshell:

  • Think of it as a private currency, i.e. as opposed to fiat currencies not issued or backed by a central bank and government
  • This is a key feature promoted by crypto-advocates, who often tend to have a distaste for the existing monetary system built on the back of central banks, fractional reserve banking through commercial banking entities, and correspondent banking networks across borders
  • Who issues Bitcoins then – effectively so called Bitcoin miners in return for their efforts of validating transactions on the so called blockchain; think of the blockchain as a (distributed) ledger technology, that verifies and accounts for every transaction made
  • How is it possible that Bitcoins, which can be created by anybody investing in “mining capacity”, can function as a currency? The key ingredient is the same as with any commodity (e.g. gold) or fiat currency – TRUST: once a critical mass of people agree to honor them as “IOU contracts”, they become a form of currency

Arguments for Bitcoin:

  • Bitcoin in theory provides for almost frictionless transactions globally – this has significant benefits in terms of costs, time and administration; in practice we are still far away from frictionless transaction costs.
  • All transactions are recorded on a distributed public ledger (as opposed to central and non-public, as in existing central bank & commercial banking systems) but at the same time are very safe and not easily hacked, counterfeited or secretly created.
  • If you believe that Bitcoin will be accepted as legal tender in the future, then there will be significantly more people who will want to have bitcoin than the few people that actually own them today – and given the limited increase in supply, the price should rise in theory.

Arguments against Bitcoin:

  • First, for widespread adoption of Bitcoin, people need to use bitcoins as transactional currency, and vendors/retailers need to accept bitcoin as a payment method.
  • However, currently, the large proportion of Bitcoin demand is held for speculative price appreciation – as a result, it will be difficult for Bitcoin to gain traction as currency.
  • Furthermore, the extreme short-term price volatility means it will be difficult for vendors to accept without taking on significant exchange rate risk.
  • Second, although fiat currency is premised upon faith in an issuing government, this faith is backed by the rule of law, tax revenue and significant military force. If a breakdown of trust occurs among Bitcoin owners, who is going to intervene and restore that trust, a function today fulfilled by government and central banks?
  • Third, since Bitcoins and its supporting infrastructure are not regulated you can be rest assured that there is plenty of market manipulation going on, e.g. miners painting the tape, etc.
  • Fourth, there is no practical approach available to value Bitcoins at this stage, similar to performing a company valuation, e.g. by means of a DCF
  • Fifth, limits of scaleability are already apparent today, e.g. takes too long to verify new transactions, insufficient liquidity when exchanging bitcoin into key currencies (e.g. USD) in practically meaningful quantities
  • Last, the viability of Bitcoin as a currency will need to be a substantially disruptive event that may not have any historical precedence.

Interesting Bitcoin myth:

  • As Bitcoin has no central governing body, the currency cannot be debased with unlimited issuance but in contrast has a pre-fixed money supply
  • This argument is often brought forward, however, not true. Bitcoin supply can be increased, which requires the support of more than 50% of all Bitcoin owners. Since Bitcoin ownership is highly concentrated this is not only a theoretical but a practical scenario.

Bottom Line?

There is a degree of underlying truth to the arguments for Bitcoin, and it is true that faith alone could potentially drive a network effect whereby more people transacting in Bitcoin, leads to more people willing to accept Bitcoin, which leads more people transacting in Bitcoin and so on.

The hurdles to this stage are not insurmountable but we definitely see them as significant. We’ve always appreciated the convex nature of cryptocurrency values – a “financial asset” that could result in complete capital loss, or 10x, 50x or 100x return. Put simply it is a highly speculative asset. 

However, there is a viable, albeit slim, path for Bitcoin to find its way into the “wallets” of a much larger population than the one it has already captured today. We’ll hence continue to track the progress and key milestones in that space, particularly given the interest our friends, families and subscribers have shown us here at Blackbird Capital.

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