Ark Investments: Refuting Five Criticisms of Bitcoin from Traditional Media

Original title: "ARK Fund (ARK) refutes the five major cryptocurrency criticisms from traditional media"
Written by: Yassine Elmandjra, Analyst at Ark Funds

Note: This article was originally published on June 28. The translator believes that the article is a hype for The B World online summit held some time ago.

More than 12 years after its birth, Bitcoin is still struggling to gain broad institutional acceptance. While constructive criticism is beneficial, ARK believes that some influential financial research institutions are dismissing Bitcoin based on outdated information, incoherent arguments, and flawed analysis.

In light of Goldman Sachs’ recent stance on Bitcoin, Ark is revisiting the most common misconceptions that affect its adoption. We look forward to participating in the healthy and educational debate about Bitcoin and the important role we believe it should play in a diversified portfolio.

Critics claim: Bitcoin is too volatile to be a store of value

ARK counters: Bitcoin's volatility highlights the credibility of its monetary policy

Critics often refer to Bitcoin’s volatility as a “store-of-value deal breaker.” Why would anyone want to store value in an asset whose daily price fluctuates so wildly?

In our view, these critics fail to understand why Bitcoin is volatile and why its volatility might be decreasing.

While distracting naysayers from assessing its role as a store of value, Bitcoin’s volatility actually highlights the credibility of its monetary policy. An impossible trinity, the macroeconomic policy trilemma, explains why. As shown in the figure below, the trilemma posits that when setting monetary targets, policymakers can meet two of three goals, but not all three, because the third goal would contradict one of the first two.

Source: Ark Investment Management LLC, 2020

Each side of the trilemma is mutually exclusive. For example, a monetary authority that chooses to fix the exchange rate and allow free capital flows cannot control the growth of the money supply. Similarly, a monetary authority that chooses to fix the exchange rate and control the currency cannot accommodate the free flow of capital, and a monetary authority that chooses to accommodate the free flow of capital and control the money supply cannot fix the exchange rate.

Based on the trilemma, we can understand why volatility is a natural consequence of Bitcoin’s monetary policy. Compared to modern central banks, it does not prioritize exchange rate stability. Instead, based on the quantity rule of money, Bitcoin limits the growth of the money supply and allows free capital flows, giving up a stable exchange rate. Therefore, the price of Bitcoin is a function of demand relative to its supply. Its volatility should come as no surprise.

That is, Bitcoin's volatility decreases over time, as shown below. As its adoption increases, marginal demand for Bitcoin should become a smaller percentage of its total network value, reducing the magnitude of price fluctuations. All else being equal, for example, $1 billion of new demand for a $10 billion market cap or network value should have a greater impact on Bitcoin's price than $1 billion of new demand for a $100 billion network value. Importantly, we believe volatility should not rule out Bitcoin as a store of value, primarily because it often coincides with large price increases.

Source: Ark Investment Management LLC, 2020. Data source: Coinmetrics

Over long periods of time, the purchasing power of Bitcoin has increased significantly. For example, since 2011, the price of Bitcoin has compounded at an annual rate of approximately 200%, and despite significant fluctuations during the year, it has appreciated year-over-year every year since 2014, when measured against its lowest value year.

Source: Ark Investment Management LLC, 2020. Data source: Coinmetrics

Critics declare: Bitcoin is in a bubble

ARK counterclaims: Bitcoin is a competitor for the role of global currency

Some economists, such as Nouriel Roubini, believe that Bitcoin is in a bubble that will burst. The line of reasoning is that Bitcoin has no intrinsic value and its appreciation depends on speculation like hot potatoes or tulips and "greater fools" willing to pay higher prices. In their view, Bitcoin is not an investable asset.

We believe this argument refutes why Bitcoin accrues value over time. Indeed, Bitcoin does not behave like traditional investable assets. Equity value is determined by discounting expected cash flows. Given higher future cash flows based on growth and/or returns on invested capital, a stock appreciates independently of its shareholder base.

However, a monetary asset like Bitcoin is non-productive, and its appreciation depends on its effectiveness in maintaining or increasing its value over time. In a way, the value proposition is circular: a monetary asset appreciates as more people demand it, and if it is an effective monetary asset, more people will demand it. In other words, "money is a shared illusion" and "money is valuable because other people think it is valuable."

However, claiming that the value of money relies entirely on a common illusion suggests that its form is arbitrary. In reality, the most common and sustainable currencies have qualities that sustain their demand, according to monetary history. For example, for thousands of years, economists have considered gold to be the most successful form of money due to its scarcity, fungibility, and durability.

Often referred to as digital gold, we believe Bitcoin not only possesses many of the characteristics of gold, but improves upon them. While scarce and durable, Bitcoin also possesses a host of monetary characteristics of being divisible, verifiable, portable, and transferable that confer superior utility and are likely to drive demand and make it suitable (if not superior) to the role of a global digital currency.

We believe that as a suitable contender for the first global digital currency, Bitcoin should attract at least similar demand as gold. However, contrary to claims that it is in a massive bubble, Bitcoin’s network value – or market capitalization – is less than 2% of gold’s, as shown below.

Data source: Ark Investment Management LLC, 2020. Data source: Coinmetrics

Critics claim: Bitcoin will lose value with ‘forks’ and digital copies

ARK counterclaims: Bitcoin’s value cannot be replicated by software alone

In the digital realm, goods are intangible and can be easily copied without destroying the original. For example, an individual can widely send a Word document via email while retaining the original copy. Similarly, millions of people can listen to a song on repeat at the same time, actually increasing the value of the original, especially when other songwriters imitate its differentiated sound.

Bitcoin's software is no exception. It is free and open source. Individuals can copy the software, "fork the network" and create their own version. However, skeptics still ask, if Bitcoin is based on open source software that can be infinitely copied, how can it become scarce?

First, forking the Bitcoin network does not create new units of Bitcoin, just as inflating the Venezuelan Bolivar does not add dollars to the U.S. monetary base. Instead, forking Bitcoin creates a new network with new units or coins. While existing Bitcoin holders retain rights to the new coins, the forked network operates under a separate set of rules supported by unique stakeholders. Rather than diluting the original network’s money supply, open source software encourages not only cheap experimentation and new networks, but also new coins and competitive markets.

The scarcity of Bitcoin is essential to its network. Now at 18 million units, the number of Bitcoins is mathematically measured to 21 million units as shown below. Each Bitcoin is associated with one wallet at a time and cannot be duplicated. Importantly, the only way to control a user's Bitcoins is to access their associated private keys.

Source: Ark Investment Management LLC, 2020. Data source: Coinmetrics

So, at the time of the fork, what makes 21 million units in the Bitcoin network more valuable than 21 million units in a Bitcoin (BTC) fork like Bitcoin Cash (BCH)? Equating the value of Bitcoin Cash to the value of Bitcoin is like assuming that Facebook's source code could be "forked" and automatically replicate the value of its 2.6 billion users and 50,000 employees. Their value derives from the network effects of Bitcoin and Facebook, not just their existence.

In the case of Bitcoin, we believe that network effects include not only the hash rate dedicated to securing the blockchain, but also Bitcoin's liquidity and the infrastructure that supports its adoption and use. If diluted, forks would have to share Bitcoin's hashrate, users, and liquidity. As shown in the figure below, Bitcoin Cash and other forks appear to have failed to undermine Bitcoin's network effects.

Source: Ark Investment Management LLC, 2020. Data source: Coinmetrics

Critics claim: Bitcoin is for criminals

ARK counters: Bitcoin is censorship-resistant

Critics still accuse Bitcoin of facilitating criminal activity in its early nefarious years. In its early years, Bitcoin funded Silk Road, an online black market platform known for selling illegal drugs.

We believe that criticizing Bitcoin for facilitating criminal activity is to criticize one of its fundamental value propositions: censorship resistance. As a neutral technology, Bitcoin allows anyone to conduct transactions and makes it impossible to identify "criminals." Rather than relying on a central authority to identify participants by name or IP address, it distinguishes them through cryptographic digital keys and addresses, giving Bitcoin strong censorship resistance. Anyone can conduct transactions at any time, anywhere, as long as participants pay fees to miners. Once secured, transactions cannot be easily reversed.

If criminal activity can be censored on the Bitcoin network, then all activity can be censored. In contrast, Bitcoin enables anyone to exchange value permissionlessly across the globe. This does not make it an inherently criminal tool. Phones, cars, and the internet are no less injunctive in facilitating criminal activity than Bitcoin.

That said, it appears that only a small fraction of Bitcoin transactions are used for illegal purposes. According to Chainalysis, the number of Bitcoin transactions associated with illegal activity remains below 1%, which may be a nod to Bitcoin's transparency. Any user can view the full transaction history on the network, suggesting that physical cash is a better medium for conducting illegal activity. In fact, as discussed below, cash transactions account for a larger share of illegal activity than cryptocurrency transactions, both in absolute and relative terms.

Source: Ark Investment Management, LLC, 2020.

Critics claim: Bitcoin wastes too much energy

ARK counters: Bitcoin is more energy efficient than gold and traditional banks

Bitcoin critics often assert that mining consumes more resources, especially energy, than it generates in revenue. However, where critics argue that the computations are inefficient and non-scalable, advocates consider not only the expected tradeoffs, but a fundamental characteristic. As Bit Gold founder and Bitcoin pioneer Nick Szabo has emphasized, "the massive resource consumption and poor computational scalability unlock the security needed for independent, seamless global and automated integrity."

Bitcoin’s energy footprint is easier to quantify and susceptible to superficial criticism. However, measured solely by electricity costs, Bitcoin is much more efficient than traditional banking and gold mining on a global scale. Traditional banking emits 1,368 megatonnes (Mtoe) of carbon per year, and gold mining emits 144 Mtoe per year. Bitcoin emits 61 million Mtoe, less than 5% and 45% of traditional banking and gold mining, respectively.

Note: Carbon dioxide equivalent (CO2e)
Source: ARK Investment Management LLC, 2021. Data source: Hass McCook

Contrary to consensus thinking, we believe that Bitcoin mining has minimal environmental impact. Renewable energy, especially hydroelectric power, makes up a large portion of Bitcoin’s energy mix. As Castle Island Ventures partner Nic Carter points out, in their search for the cheapest form of electricity, miners will continue to flock to regions with large supplies of renewable electricity, leaving stranded energy assets as “power buyers of last resort,” creating highly liquid underlying demand for any source of electricity that can produce at a lower price than current producers, regardless of location.” Therefore, from a climate perspective, Bitcoin mining may be a net positive.

in conclusion

Bitcoin’s complexity shouldn’t prevent financial institutions from analyzing it in depth. In this post, we discuss some of the most common objections to Bitcoin in hopes of sparking conversation and debate in the institutional investment community. As the Bitcoin network continues to mature, we believe it will solidify Bitcoin’s position as an emerging monetary asset and that financial institutions will seriously consider it. Working toward broad institutional acceptance. While constructive criticism is healthy, ARK believes that some influential financial research institutions are dismissing Bitcoin based on stale information, incoherent arguments, and flawed analysis.