₿itcoin: First Principles Money
In order for Bitcoin to gain global adoption its proponents must be able to present a simplistic investment case that is easily understood
Before we get into our main piece, it's been a minute 🕰️ We haven't stopped producing content, in fact we've been producing more than ever! Our Substack remains an experiment where we might post original content or reshare content we publish across our social media.
If you like our content, please visit our website (hudsonfarwest.com), which has the links to our various social media pages. Without further delay, we hope you enjoy this piece about ₿itcoin!
Summary:
🌎 In order for Bitcoin to gain global adoption its proponents must be able to present a simplistic investment case that is easily understood.
💰Since many don't understand, or haven't taken the time to understand, the history of money and currency, it's difficult for them to honestly assess the merits of Bitcoin.
⚛️Approaching Bitcoin from "first principles", or a basic truth(s) framework, might be the best way to explain the BTC thesis.
🪙Bitcoin is a technological iteration on gold and silver, "store-of-value" commodities that were the basis of many historical money systems.
📈 We believe Bitcoin can achieve a similar "store-of-value" commodity status and therefore think there is significant upside to investing in BTC.
Bitcoin ($BTC) is difficult for many to understand because few actually think about what money or currency fundamentally is or represents.
In previous articles, we've compared Bitcoin, often referred to as "digital gold", to physical gold. We used that comparison to outline our thesis related to Bitcoin taking market share from "store-of-value" gold on its way to $100,000+ per BTC, a view we still hold. We also made the point that it wasn't a zero sum equation - Bitcoin AND Gold could both co-exist.
In this piece, we thought it made sense to peel the proverbial onion to its core and think from "first principles", a term Tesla CEO Elon Musk often uses. First principles logic is working UP from basic truths, not depending on assumptions. Musk often cites the example of electric vehicle (EV) batteries.
We're going to use this same logic in making a first principles case for BTC. If you don't understand money, it's almost impossible to understand Bitcoin.
Barter: Our Pre-Currency Origins
Let's use the example of bartering in "pre-currency" societies. For example, if I had excess meat that you needed and you had excess corn I needed, we would enter into an agreement where X amount of meat was acceptable for Y amount of corn. As economies got more complex, it became difficult to match demand for goods and services exactly, therefore an accepted measurement and accounting system needed to be created.
In other words, every product or service can't have a practical denomination in every other product or service. Layer on payment for government services, such as taxes to fund an army, conducting an economy and society based on the barter system is impractical. Money or currency arose to create a measurement and accounting system that enabled economies and societies to efficiently function.
The abundance and nearly universal evidence of movement of exotic goods over diverse regions inhabited by people who were independent of each other – from hunter-gatherers to pastoralists, to farmers and city dwellers – points to the significance of currency as a uniting principle. It’s like a common language everyone could speak. - Smithsonian Magazine
The Rise Of Money, Reserve Commodities & Currencies
To extend the story above, goods and services needed to be valued via a common denominator. So, what characteristics would make something an attractive candidate to be used as that common denominator, or the basis for a money system?
For example, whatever was selected would need to have certain features, including:
Inability to easily create (limited inflation with scarcity properties)
Difficulty in forgery and attractive verification properties
Resistance to aging (i.e., rust)
Easily measurable and divisible to facilitate a range of transactions
Ability to easily (relative term) move or carry
When contextualized like this, it becomes obvious why gold and silver were perfect commodities to form the basis of a currency or money system.
No one can create gold or silver and there is a "natural" built-in inflation due to scarcity and effort required in extraction.
Pure gold and silver don't rust.
Gold and silver reserves can be found in various geographies.
Both metals could be weighed, verified and were malleable (i.e., coins of different weights and mixtures)
When cross border and reserve currencies arose as global trade expanded, money backed by gold and/or silver were often used. In fact, "Silver & Bimetallic Standards" were more common than the "Gold Standard", before the 1800s. In other words, if England was trading with Spain or vice versa, both countries tradespeople were likely to accept gold/silver-made currency that neither could directly manipulate (Note: obviously simplifying here). It was the most agreeable money system for centuries. It was only beginning in the 1900s, for reasons discussed next, that currencies backed by accepted global reserve commodities, such as gold and silver, were replaced by fiat "paper" reserve currencies. However, gold and silver, continue to be valued as global monetary reserve commodities for many of the same reasons our ancestors valued them for.
The Rise of Fiat "Paper" Reserve Currencies
Paper currency initially arose as a more effective way to conduct commerce. Fundamentally though the paper was backed by "hard" commodities, such as gold and/or silver. This all began to change with World War I in the 1910s, the Great Depression in the 1930s and finally when President Richard Nixon officially ended the dollar-gold peg in August 1971. There is a very detailed and complex history to why this all occurred, which I think Bridgewater Founder Ray Dalio's recent video, Principles for Dealing with the Changing World Order, does a nice job summarizing. If you watch the first eight minutes of the video, that's probably sufficient background.
It should be noted that there are drawbacks of currency only backed by reserve commodities, such as gold. For example, it can hamper economic growth and flexibility (i.e., money supply can't keep up). In addition, if a country finds itself on the wrong side of history, trade or in tough economic circumstances, it can cripple an economy leading to political unrest. During the Great Depression, imagine if President Franklin D. Roosevelt (FDR) couldn't effectively deficit spend because everyone had lost faith in the US dollar. That is why FDR and Congress forced people to hand in their gold in 1933 during the Great Depression.
“We have gold because we cannot trust governments” - President Herbert Hoover's statement in 1933 to FDR, who later that year enacted the Emergency Banking Act, which forced all Americans to convert their gold coins, bullion, and certificates into U.S. dollars
FDR's actions in 1933 were the beginning of the end for the Gold Standard. With the official elimination of the dollar-gold peg in 1971, as mentioned above, the fiat "paper" US dollar became the de facto global reserve currency. To be clear, the dollar was now a currency no longer backed by gold, but backed by a sort of intangible value associated with the US government, military, society, rule of law and economy.
As the sole global economic superpower, the US was uniquely able to create this status quo. For example, if you consume the most oil, you have the direct and indirect power to influence, by force or otherwise, the currency oil is priced in (i.e., Petrodollar regime). If a core energy commodity like oil is then globally priced in dollars, it forces other countries to hold dollar reserves and accept the currency. Given the US was the only global economic superpower, the country was in a unique position to enforce the fiat USD currency regime globally.
Don't get us wrong, strategically this was a brilliant move in many ways. As long as the US government and Federal Reserve could control inflation, the country had a power unlike any other before. It had the ability to create money. The US didn't need to have large reserves of gold and silver, although it did still keep large amounts, that matched the money supply it created. However, think back to first principles. Historically, the concept of a paper money system not backed by "hard" commodities like gold and silver would just not be accepted because the common denominator could improperly be influenced by people or government.
To conclude this section, we are now entering into a world where:
Dollar inflation is occurring at a record pace for several reasons, including historic fiscal and monetary interventions due to the COVID pandemic
US share of global trade is declining
Non-American political ambitions and foreign policy turmoil, including historic Russian sanctions, are seeding the rise of a second global reserve currency, the Chinese Yuan
Up until this point we really haven't said anything controversial, and you might be wondering how Bitcoin relates to any of the above. To be clear, we don't think Bitcoin is replacing global reserve currencies. Rather we think it's an asset that can serve as a unique hedge, not too dissimilar from gold or silver, during a changing global money order.
The Rise of a Decentralized Reserve Commodity
The tweet below, which nicely summarizes the history of currency and ends talking about monkey jpegs, might be a good place to start talking about Bitcoin. We know and agree with many skeptics of cryptocurrencies (in general). In fact, we think it's probably not too dissimilar from the late 1990s, when the vast majority of ".coms" were either completely worthless or years ahead of their time (Pets.com < Chewy.com).
The survivors of the initial "dot com" generation though went on to become the most valuable, profitable and influential companies in financial history. Bitcoin, is somewhat unique in the sense that it's not a company but rather a commodity, but the overall analogy is probably appropriate.
The main criticism of Bitcoin, cryptocurrencies, monkey jpeg NFTs, etc is that they appear to be made up "internet money" and assets, easily copied ("right-click > save") with no intrinsic value or defensible moat. We actually agree that a large majority of cryptocurrencies will likely, in the fullness of time, have no intrinsic value.
So, what makes Bitcoin so special?
The Bitcoin network went live in early 2009 ('White Paper' published in October 2008), during the height of the Great Financial Crisis. A crisis that saw governments bail out financial institutions that posed systemic risks, in part enabled by their control of the fiat "paper" money system.
Although Bitcoin went live in early 2009, it was the product of decades of work and also inspired by rise of the internet. It was trying to essentially solve for one problem - creating a digitally-native asset that would not need an intermediary and therefore be near impossible to manipulate. In other words, a perfect monetary common denominator for a digital age.
It's a simply stated problem, that is exceptionally difficult to solve. However, aided by cryptographic technology, the pseudonymous person or group Satoshi Nakamoto seemed to have solved it, likely helped by decades of previous work (see Hashcash, Bit gold). How can we reach such a conclusion you may ask?
Has anybody been able to create a fake Bitcoin?
Think about this question because it's deceivingly uninteresting. In the 13+ years since its creation, no one has created a fake Bitcoin although the financial incentive has been immense. What other commodity or decentralized asset can successfully make such a claim, that can also be verified? Even reserve commodities, such as gold and silver, while difficult to counterfeit, can be mixed with other metals or substances and be manipulated.
After achieving what many thought was technically impossible, what remained was widespread adoption and the network continuing to prove that a fake Bitcoin couldn't be created or that its code couldn't or wouldn't be changed ("will only ever be 21 million BTC").
Going back to money and currency fundamentals, think back to gold and silver. Core attributes that make these commodities so ideal for a money system, included scarcity that was outside the control of people/governments. Other attractive features were malleability and fungibility. Bitcoin takes all of these attractive characteristics to another level, built for a new paradigm - where commerce and interaction increasingly occur on the internet.
Not only is Bitcoin scarce, it is absolutely and programmatically scarce - there will never be more than 21 million. Bitcoin is fungible and malleable (divisible into Satoshis or 0.00000001 BTC) in a fundamentally better way than gold or silver. It can be transferred globally and almost instantly. It's traded 24/7/365 and in highly liquid markets. It also serves as a core collateral asset within Decentralized Finance (DeFi) and also allows its owners to borrow fiat currency against their Bitcoin holdings.
In an increasingly uncertain world that faces inflation driven by unprecedented fiscal/monetary interventions and political turmoil, people will need to protect their purchasing power. In addition, the rise of China and a second global reserve currency that operates outside of the US system, creates a demand for a hedge. The ideal hedge historically has been global monetary reserve commodities, like gold and silver. Bitcoin, is an iteration on the modern shortcomings of gold and silver, a "harder" monetary commodity that has, thus far, withstood the test of time.
Risk, Volatility & Investing
Finally, we wanted to reiterate and make clear, that investing in general carries risk, let alone Bitcoin and the crypto asset class. Some of our published ideas have worked out thus far, others have not, and we take full responsibility for any and all mistakes*. More importantly, we learn from those mistakes. We take the trust you show us and the time you spend reading what we write seriously.
Now, that being said, investors must distinguish between volatility and risk. These are two separate and distinct concepts for the most part. Markets, in the short term, can be volatile for all sorts of different macro and/or microeconomic reasons. However, risk relates to a fundamental underwriting of a company and in this case a commodity.
So, can Bitcoin be worthless? Can it go to zero? YES.
For example, if Satoshi was(were) a dictator, alien or bad actor that wouldn't be good. If a 1933 style Emergency Banking Act outlawing Bitcoin came to pass, that wouldn't be good. However, the better question to ask is what is the probability of Bitcoin being worthless and whether you are being compensated for the risk? This is the question for the thoughtful investor.
If there is any probability of Bitcoin achieving the thesis we've laid out above, the return is asymmetric. In other words, you're being compensated for the risk. For example, if there's an 75% chance in 3 years time Bitcoin is 0, but a 25% chance it's $500,000, at current prices of ~$40,000 is that a good trade or investment to you?
Let's say, in the course of reading this piece you accept most of the history, some of the arguments, but still doubt Bitcoin. What can't be doubted is network adoption. Very few things have achieved Bitcoin's network adoption, this really isn't a matter of debate, it's just numbers. This adoption has also been achieved over a time period where easily accessible retail investment vehicles, such as a Spot ETF, remain unavailable. "Main Street" financial advisors with limited Bitcoin products to sell have also hesitated, lacking incentive, to onboard clients. Whether you decide to agree or disagree about our Bitcoin thesis, we believe we've made the argument. BTC is a unique asset and commodity that forces you to go back to first principles in a way few other investments do.
We believe Bitcoin is an attractive investment proposition and continue to invest and hold the asset.
*To be clear, nothing we write should be construed to be investment advice. This is an opinion piece