Bitcoin in Simple Terms: Analyzing the Intrinsic Investment Logic of Bitcoin

This article analyzes Bitcoin assets in an easy-to-understand manner, combining the author's experience in talks with cryptocurrency fund managers and start-ups to evaluate Bitcoin from the following three aspects.

· Bitcoin’s uniqueness · Bitcoin’s social value · Bitcoin’s investment value

Bitcoin’s uniqueness

To understand Bitcoin, you need to know what it has changed. Bitcoin's public key, private key, cryptography, distributed ledger, public database, proof of work, tokens and other technologies have existed for many years. It combines all technologies in a clever and elegant way to create the first computer sovereignty platform and break away from the state. Before this, kings, queens, national governments and federal governments represented sovereignty. They had the right to mint or print currency. The emergence of the Bitcoin blockchain is the first time in human history that a computer platform has truly represented sovereignty and Bitcoin has been used as a universal currency.

Sovereignty first

Bitcoin Becomes a Decentralized Sovereign

Bitcoin sovereignty is decentralized in nature. That is, Bitcoin does not require third-party verification to determine the authenticity of transactions. Nodes and miners are the two key factors in maintaining Bitcoin's decentralized sovereignty.

The degree of decentralization of Bitcoin depends on the number of nodes. Nodes are key points that create, receive or transmit messages to broadcast transactions on the chain. They support Bitcoin transactions without third-party verification. Nodes can decide whether to upgrade the software. So far, the number of Bitcoin nodes is nearly 10,000 (20% more than Ethereum), making it one of the blockchains with the most nodes.

Bitcoin Node (Source: Medium Blog)

Miners protect and verify the security of the Bitcoin blockchain and the authenticity of transactions on the chain. When miners mine, they use computing power to "pack" blocks and receive Bitcoin as a reward. Today, Bitcoin's computing power consumes more than 7 gigawatts of electricity per day, which is equivalent to the daily electricity consumption of Switzerland. Compared with 2017, Bitcoin's computing power has reached an all-time high, currently at 100 trillion hash rates.

  Bitcoin’s hash rate (Source: Blockchain.com)

The greater the hashrate, the more people are investing in Bitcoin mining. As the hashrate increases, the more secure Bitcoin becomes. Many people criticize Bitcoin for its environmental damage due to its electricity consumption. This is a bit alarmist, as according to Coinshares (see below), nearly 74.1% of Bitcoin's electricity comes from renewable energy (interestingly, 60% of Bitcoin's electricity comes from China). The value of Bitcoin is proportional to the hashrate required. Miners need to invest a certain amount of electricity to mine. If Bitcoin does not consume electricity, security will disappear, leading to the network being hacked. When Bitcoin loses its hashrate, it is no longer a sovereign computer and ultimately loses its value.

If a malicious person wants to destroy the Bitcoin blockchain, he not only needs to invest in mining machines, but also needs enough electricity. At the current scale of Bitcoin computing power, the electricity required by the malicious person every day will be greater than the electricity consumption of Switzerland. As the computing power increases, Bitcoin becomes increasingly difficult to break. So far, Bitcoin has withstood a large number of hacker attacks. This is enough to prove the security of Bitcoin. It can be expected that governments and companies may attack Bitcoin in the future because Bitcoin poses a threat to their power. Perhaps at that time, only time can prove the security and sovereignty of Bitcoin.

Blockchain Myths

Valuable blockchain technology needs to meet two characteristics. First, "decentralization". Ensure that individuals or organizations cannot easily tamper with blockchain transactions or destroy infrastructure. If the information on the chain can be easily changed, it means that it is still a centralized system, and blockchain technology loses its meaning. "Decentralization" is the ultimate goal of blockchain. As far as Bitcoin is concerned, "decentralization" means that Bitcoin has achieved the ultimate goal of "decentralized sovereignty, people control currency". The only innovation of blockchain is to establish decentralized sovereignty in the virtual world. Second, the autonomy, stability and scarcity of monetary policy also affect the value of blockchain. After the blockchain issues tokens, once the tokens lose their value, the blockchain itself loses its meaning. In the past 10 years, there has been no difference in Bitcoin's monetary policy and issuance plan. The three characteristics of stability, predictability and limited quantity give Bitcoin value. Most "blockchain technology" or "cryptocurrency" on the market cannot achieve these three points at the same time.

Bitcoin, not blockchain

Many people are still stuck in the perception that blockchain is more disruptive than Bitcoin. Blockchain is not a world-changing innovation, but a byword for marketing and hype from investors and startups. Many startups have raised hundreds of millions of dollars from investors who have no idea about blockchain. “Bitcoin, not blockchain” is the perfect corrective to today’s unbalanced and under-educated market. The real disruptive innovation is Bitcoin, not blockchain.

Bitcoin, not blockchain (Source: The Bitcoin Standard) The socioeconomic value of Bitcoin

Comparison | Bitcoin, US Dollar and Gold

Because Bitcoin is not a business, it has no profits or dividends, and therefore no inherent value. Bitcoin can be considered a currency, and like most currencies, it has no inherent value. The reason why gold, the US dollar, and other national currencies have value is because they are backed by state-led monetary policies. The biggest challenge for Bitcoin at present is how to gain widespread social acceptance.

Today, Bitcoin can be used for transactions and settlements around the world. Bitcoin follows the same logic as gold for more than 2,000 years or the US dollar for more than 70 years, all three of which are world currencies. In terms of currency, Bitcoin is even more scarce, more open, and fairer than gold and the US dollar. Scarcity is because the code sets the number of Bitcoins at 21 million, and to change this number, at least 51% of the miners in the entire network must agree. Moreover, Bitcoin is not regulated by a third party, no one can tamper with transactions on the chain, and no one can prevent the use of Bitcoin. It has brought unprecedented economic freedom to the world, just as the Internet brought information freedom to society. In contrast, most people recognize the value of gold, which has existed for thousands of years, and Bitcoin cannot be compared with gold in terms of time or reputation. The advantage of the US dollar is that it is now a global currency and has a network effect that Bitcoin does not have. These advantages are not something that Bitcoin can replace in a short period of time. However, perhaps one day, the public will realize the value of Bitcoin - a currency that cannot be expanded or controlled by a third party.

Comparison of Bitcoin, US Dollar and Gold (Source: Kitco)

Bitcoin becomes an intermediate currency and a non-political international settlement standard

If Bitcoin succeeds, it will not necessarily replace any national currency. It can become an intermediate currency, above national currencies, as a neutral monetary clearing system and value standard. We already have global, apolitical measurement standards, such as the mile and the kilogram. These units of measurement do not change for political reasons, but since we abandoned the gold standard, there has been no basic standard for measuring the value of money. Although the world's currency is based on the US dollar, the dollar is susceptible to political influences and monetary policy and the long-term depreciation of the dollar, and its value measurement standard is imperfect. In today's world of excess money, what we need is an apolitical monetary value standard.

Likewise, Bitcoin has the potential to become an apolitical international clearing standard. Today, only banks can participate in international or regional clearing networks (such as SWIFT, Fedwire, ACH, CHAPS, Visa, and MasterCard). Individuals, businesses, and governments can only participate in these clearing networks through banks. Using these clearing networks to send money can take days, is opaque, and expensive, and sometimes political factors affect the transfer of money. Imagine an open platform where individuals, businesses, and governments can clear money peer-to-peer 24/7, regardless of time, location, number, race, and political ideology, for reasonable and transparent fees. This will disrupt the conventional monetary system just as the Internet disrupted the spread of information.

In the Bitcoin world, all currencies will be settled based on Bitcoin and Satoshi (the smallest unit of Bitcoin, about $0.0001). When your grandfather asks you how many Bitcoins are worth to a dollar? You can say $1 = 9718 Satoshi. Oil = 19000 Satoshi. The gross domestic product (GDP) of the United States = 5 million Bitcoins. Taiwan's national reserves = 100,000 Bitcoins. Use Bitcoin as a unit to exchange other equivalent currencies.

If other currencies are denominated in Bitcoin in the future, the world will be very different. When the currency depreciates, people tend to spend, because if they don't spend it today, it may depreciate. Today's financial institutions encourage customers to invest in order to ensure that their assets are preserved. After all, investing in non-monetary assets is the only way to fight inflation. Even large financial institutions are affected by national monetary policies. If the monetary system is based on non-inflationary currencies, people will change their consumption habits and prefer to save rather than spend. As capital becomes conservative, future investments will be more cautious. As a scarce currency in the era of capital expansion, Bitcoin can be a tool to fight inflation.

The investment value of Bitcoin

Bitcoin is an open source protocol. Unlike company history, Bitcoin protocol history has not experienced prosperity, innovation, competition, and disruption (e.g., Amazon disrupted traditional retail, Apple replaced Nokia). Once a protocol is established, it is difficult to change. For example, we use IP (Internet Protocol) to transmit data on the Internet (CISCO tried many protocols in the 1990s, but IP became the best choice). We still use IP Internet Protocol today. There have been attempts to invent other protocols, but they have not succeeded. Once a protocol is established and has a certain network effect, it is difficult for new protocols to surpass it. Currently, the Bitcoin protocol is the standard for the Internet of Money and is irreplaceable.

TCP/IP

Winner Takes All

In the decentralized space, the winner-takes-all effect will be even more pronounced. Currently, many new startups are experimenting with blockchain technology and applications, and even if they succeed, the possibility of replacing Bitcoin is slim. There are more than 1,000 cryptocurrencies on the market, and the vast majority have low transaction volumes, no experienced engineers or large communities, and some have even gone to zero. In contrast, Bitcoin has performed well in the past 10 years. Currently, Bitcoin has more than 60 million users, an average monthly increase of 1 million users, and processes billions of dollars in transactions every day. The total number of users of other cryptocurrencies is less than 5 million, and the transactions processed per day are less than 1% of Bitcoin (almost 92% of transaction fees come from Bitcoin's on-chain transactions).

Bitcoin’s dominance in the cryptocurrency market (Source: @ceterispar1bus)

Today, Bitcoin has a certain network effect. If you want to replace it economically, you need to invest a lot of money, electricity, talent and hardware to replace the existing Bitcoin blockchain. In contrast, building on Bitcoin is a more cost-effective way. For example, the controversial issues of transaction speed and high handling fees. Bitcoin has a block time of 10 minutes, and each block processes about 3,000 transactions. Users must wait 10 minutes before the transaction is recorded on the chain, and the transaction takes an hour to complete. Miners must also be paid a handling fee of about $0.5 or more. The Lightning Network solves the problems of slow Bitcoin transactions and high transaction costs. It is a second-layer decentralized network built on top of Bitcoin. It integrates the underlying security while supporting thousands of transactions per second and reducing transaction fees to 1 satoshi ($0.00001) per transaction. As long as the security and sovereignty of Bitcoin are not violated, more second-layer technologies will be transferred to Bitcoin in the future, and more companies will participate in the establishment of the Bitcoin ecosystem. The development of the Bitcoin ecosystem will bring more value and practicality to Bitcoin.

Bitcoin's ecosystem (Source: The Block)

Bitcoin price history and trends

The ICO bubble in 2017 was a replica of the dot-com bubble in 2000: the value and prospects of the technology were seriously overestimated in the short term, and the price reflected investors' temporary pessimism. Unlike the dot-com bubble, Bitcoin has experienced three price crashes since 2010, with an average drop of 79%. Each time the price fell, a new round of price increases followed. In 2017, the Bitcoin crash was the same as the previous two times, which was a cyclical market adjustment and did not affect the long-term trend of Bitcoin. By April 30, 2020, the production of Bitcoin will be halved for the third time, and the number of Bitcoins generated per block will be reduced from 12.5 to 6.25.

Bitcoin price history chart

Bitcoin Market Size

Bitcoin's total market value is about $180 billion, accounting for only 0.09% of the gold and fiat currency markets. If Bitcoin eventually becomes an international value standard and clearing network, its value will far exceed that of gold. The total market value of gold is about $8 trillion. If Bitcoin's market value is equal to gold, 1 Bitcoin will be worth $300,000. If Bitcoin is compared to the narrow money in circulation (currently worth $40 trillion), 1 Bitcoin will be worth $2 million. The reason why this is a conservative estimate is that the total amount of Bitcoin is limited, while the total amount of fiat currency is unlimited.

Bitcoin dominates the currency market

The value of Bitcoin as digital gold and a non-correlated asset

As digital gold and a non-correlated asset, Bitcoin is a tool to hedge financial risks. In today's turbulent world, the US-China trade war, the bloody protests in Hong Kong, and other geopolitical risks will further push up the price of Bitcoin. In the current market environment, traditional assets such as stocks, bonds, and real estate have limited gains. It is even more difficult for investors to find an asset that is undervalued and has asymmetric risk and return. Among all major asset classes, Bitcoin has the highest Sharpe ratio when measuring risk-return.

Sharpe ratio of Bitcoin to other assets (Source: @woobull)

Conclusion

Bitcoin was born in the financial crisis of 2008, when the news that "The Times on January 3, 2009, the Chancellor of the Exchequer is about to bail out the banks for the second time" was widely circulated, claiming to solve the decline of the financial industry and the loose monetary policy of the central bank. Ten years later, social problems and financial risks remain as they were back then. With the new round of financial crisis, the price of Bitcoin has reacted strongly. Perhaps it is the only hope for mankind to escape the reckless monetary policy of the central bank and the excessive expansion of government credit. If Bitcoin succeeds, early investors will have an advantage over others. Their understanding of the future digital world will lead today's society forward. Bitcoin is an invention that changes the world, and its power and imagination far exceed those of "tulips". Bitcoin opens up another possibility for society: it is a decentralized, peer-to-peer, digital, limited supply, transparent, and open monetary system.

Author | Louis Liu Source | Medium Translation | First.VIP Tracey Please keep the information at the end of the article when reprinting.

Editor’s Note: The original title is “Analysis of Bitcoin’s Intrinsic Investment Logic”