Disclaimer: This post is not an endorsement to either buy or sell Bitcoins. I am simply attempting to outline the reasons why there is inherent value in Bitcoins, as well as the risks that come with investing in a crypto-currency. In full disclosure, I personally own and use them, but only a very small portion of my overall portfolio which I would be ok if BTC went to 0 tomorrow. Purpose: submitted by
I’ve been seeing a lot of doom and gloom (as well as irrational exuberance) in a lot of posts lately, and a lot of people saying this or that with no evidence or fundamentals to back up their claims. So I wanted to put my thoughts and experiences [more about me below] out there in the hopes that people actually serious about utilizing Bitcoins (BTC from here on) might find this information helpful, as well as to connect with and solicit thoughts from anybody else that’s done research on the future of BTC. Also mods:
I searched through old posts and the FAQ but couldn’t really find anything like this, so let me know if there is a more appropriate place to post this. I can also add hyperlinked sources to this to make it a reference document if there is interest. Summary/tl;dr:
The fundamentals underlying the intrinsic value of Bitcoins haven’t changed. In fact, they continue to improve day-by-day, as merchant and user adoption increases. As long as this trend continues, and certain risk factors - see below - are minimized, BTC will eventually become widely accepted as a currency. That being said
, you should never “invest” more money than you are willing to completely lose, or money that you would otherwise need for living expenses. Otherwise, you are gambling. (I put “invest” in quotes because I believe BTC are currently far too speculative to be considered an “investment.” This may change in the future, but the technology is still so new, and there are so many unknowns, that it should not be considered anything more than a speculative investment at this point.) This has happened before and it will happen again:
This week hasn’t been good for those holding Bitcoins. In fact, if you invested in BTC anytime in the past year, I’d say it’s been a pretty shitty year, period. But the thing is, we’ve seen this type of thing in financial markets before, almost exactly to a t, and how they tend to play out. There have been various bubbles of all shapes and sizes throughout history, and the run-up in prices earlier this year, was no exception. However, unlike the critics, I believe BTCs are different, as there is significant intrinsic value in the BTC network and BTC as a value store - which I outline below.
I also think it’s useless to speculate about the direction of BTC in the short to medium-term (I would argue the price adjustment has been a good thing for the long-term), so to me the only meaningful way to analyze what’s going on is to examine the fundamentals (apologies if a lot of this is basic, but I wanted to cover all the key points as I saw them):
- Currency As a Store of Value: A currency has value because the holders of it believe it has value. This might seem like a paradox, but it is how fiat currencies (namely, the USD and every other major currency in the world) function, and BTC is no different. As the number of people owning and using BTC increases, the relative value of BTC will have to grow as the supply is limited to 21million BTC (to use an economics analogy: In this case, we can’t find more seashells, we can only break the ones we have into smaller pieces).
What if user adoption were to plateau or decrease? Even if growth were to stop today, and not a single more person in the world were to use BTC than already are, there would still be value assigned to them by those who currently hold, which is reflected in the BTC/USD rate. There is already value there by virtue of the number of people that own it and merchants that accept it.
As of me writing this, there are an estimated 1.2million BTC holders on ledgers worldwide. This number is greater than the population of many countries that have their own currency. I believe BTC are past the point where people should question the viability of BTC as a store of value, and instead look at BTC for the value it provides for the following reasons.
- Worldwide Transaction Network: In my analysis, this represents the true potential value of BTC. Think of the major credit card companies (Visa, MasterCard, AMEX) - they’re accepted pretty much anywhere right? You can walk into almost any shop throughout the world, and as long as you hold one of these cards, the merchant will trade you his/her goods and services for a portion of what you’ve got in your account. And this is hugely valuable. To the tune of $Billions per year these companies make in profit, all because of the network of merchants that accept them worldwide. But one thing that people might forget is these companies had to grow their merchant network, just like BTC, one at a time.
Thus, this to me represents the primary growth potential of BTC. I’ve seen estimates that 10,000 retailers are currently accepting them, and there are some pretty big names in the list (Overstock, Target, eBay via PayPal, CVS). As the number of places that accept BTC increase, so does the intrinsic value. This also has a compounding, even self-fulfilling, effect: as the number of places that accept BTC increases, the value increases, thus more merchants are willing to accept BTC as a currency because it has value…chew on that for a second.
- Growing BTC Eco-system: This is represented by the growing number of Bitcoin-related venture startups and websites/wallets/apps that support BTC transactions. There is a network effect here, and as long as people are invested into it, will continue to grow.
- Security/Anonymity/Ease of Transaction: I think most of us are familiar with BTC security measures (how important the password to your wallet/account is), how the hashes are generated by an algorithm that cannot be faked (essentially counterfeit-proof), and low transaction costs. These are all pluses that make the currency attractive as a value store, with some caveats listed in the “Risks” section below.
- Hedge Against Fiat Currencies: This is a two-edged sword. I think there’s a lot of investment in BTC because of the fear of overactive Central Banks inflating other currencies (again, namely the USD), but as we saw this week, this can work against BTC. I explain more later below.
So I’ve briefly outlined above some pretty clear reasons why there is inherent value in BTC, and the reasons why I personally am optimistic about the long-term future and will continue to use them. That being said, I’ve also identified several primary risk factors
me as a long-term investor, ones that all holders of BTC should be aware of. Please, if you know or can think of any others, reply or PM me so I can add them to this list:
- Continued market volatility: Price volatility might be good for day-traders, but for a currency, it’s killer. As described above, one of the core elements a currency must have is as a store of value, and if the price fluctuates wildly from day-to-day, merchants (and currency owners) will be less willing to accept it. Who would want to hold currency that’s worth 1/2 of what it was last week?
This is also a reason why it’s essential for the currency to have a limited supply (or perception thereof), or else rampant inflation would occur - look at Zimbabwe. The bottom-line is, if the USD (US Dollar) were to drop 25% in one week, like we saw with BTC this week, it would indicate a complete economic collapse was occurring. Faith in the currency would be destroyed, and it would take extreme measures to preserve it. It’s actually kind of a small miracle BTC hasn’t completely collapsed, but I think it’s because (1) there is real value in it, and (2) BTC are not widely used yet.
The remedy for this is there has to be either (1) a large holder of the currency that is able to inject or take out some currency to keep the price stable -- if you look at the US Federal Reserve this is one of its two primary mandates, or (2) the number of BTC owners has to reach a saturation “tipping point” where enough people are utilizing the currency for day-to-day transactions, and not for speculative reasons. I don’t believe we’re quite at this point yet, but getting there.
- Governmental regulation: This is a big unknown for me, and with recent news that Russia and China have prohibited use of BTCs, presumably in the effort to curb illegal transactions, could become a trend. However, to address people who are concerned about this, I would make the following points:
- What is the reason for government regulation? Is it to curb illegal activity transacted in BTC? If this is the case, there is plenty of illegal activity being transacted in US Dollars, Russian Rubles, gold coins, jewelry, etc… What makes BTC special? If the reason is to prohibit a competing national currency, then that is a separate legal issue which will have to be resolved, but probably not until far in the future. In the US, a case like this would almost definitely go to the Supreme Court for clarification.
- Which government agency should have regulatory authority? In more democratic societies (than Russia and China) that have a strong rule of law (most of the rest of the western world), government agencies can’t simply do something because they want to (unfortunately the trend is changing even in the US). There has to be a legal jurisdiction or precedence that would allow this, and because crypto-currencies are so new, none has been set. For example, just look at how long it took most state governments to start taxing Amazon purchases. I used to live in Virginia, and they just started in Dec 2013, almost 20 years after Amazon was founded…
- How would governments enforce restrictions? Would it be by imposing fines on merchants that accept the crypto-currencies? Legally, how is this different than restricting payment in gold or silver then, or Craigslist transactions?
- Ease of use: BTC are not quite easy enough to use where the average person will find it appealing. I think a lot of companies are working to address this (e.g. the hardest part of signing up on Coinbase was remembering my password), so to me this risk is what we can do the most about, but still a concern.
- Loss potential: If you forget or lose your password, you’re SOL at this point. But this isn’t really different from losing cash on the street.
- Market Cornering(added): There is the possibility a large percentage of the total available BTC are owned by a handful of individuals. For example, it is estimated that Satoshi alone owns ~1 million BTC. In the event that one or more of these owners were to attempt to corner the BTC market there could be extreme price volatility.
- Current overall valuation may be a bit high: Back of the napkin calculation follows- Total valuation of BTC = (# of BTC available) x (current price/BTC) Total valuation of BTC = ~13million x $330 = ~$4billion $4 billion of perceived value is probably high for as small as the BTC network currently is. But, this number is reflective of the high growth rate in the number of users/owners and merchants that have accepted BTC. In other words, this may be a fair price. And, by definition, it is technically the actual fair price since it is, after all, an actual currency.
I could go on, but those are the major value and risk factors I see. If you have anything to add, please feel free. So, in the context of everything I said above, I’d like to talk about what happened this week in particular:
I believe this week’s price movement (as of me writing this, has been a 25% drop) is a result of several factors:
- News that US Dollar is very strong
- Capitulation: I don’t have the ability to do Technical Analysis on BTC right now, but just eyeing the 1-year chart, it looks like $400 was a key support point for the price of BTC. Once it broke through that, psychological barriers were broken and selling cascaded.
- Russia and China potentially banning BTC
And that’s it. That’s all I can find about Bitcoins in the news. The value fundamentals I listed have not changed one bit, and if anything, the rate of user adoption has increased as more people are learning what it is
Which is why I’m excited about the future of BTC. It’s a product that I use and like, and see tremendous value for. This week’s sell-off just means I can buy more. About me:
In a past life, I was an equity research analyst responsible for due diligence, fundamental/technical analysis, and making recommendations to the PM on which stocks a certain mutual fund should buy or sell. This meant reading through a lot
of annual reports, financial statements, 10-K, 10-Q, shareholder calls, etc… My primary influences were Warren Buffett, Philip Fisher, and Ben Graham. If you recognize these names, you’ll probably guess that I was a value investor1
, and you’d be right. The fundamental premise behind value investing, for those that don’t know, is that you can find companies that are trading at a discount to their “true” intrinsic value, and thus can make money by buying the stock at a low price and selling when the market has realized the fair value of the company and the price has subsequently gone up. This is essentially how Warren Buffett built Berkshire Hathaway and became the world’s richest man (for a short period); his strategy has since greatly evolved, but this was the core philosophy he used for a long time. 1
Utilizing this strategy, our fund bought a significant stake in AAPL when the price per share was less than the amount of cash
per share the company currently held (split adjusted something like ~$2 per share when we bought). It hasn’t all been a bed of roses, we’ve made some not-so-great investments, but that’s a story for a different time :)
Edit: Paragraphs within bullets? How do you do them?
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