In 2017 we experienced a crypto bubble, and that bubble burst in 2018. Bitcoin, the Godfather of all digital assets, was trading under $1,000 in January 2017. Bitcoin then famously rallied to just shy of $20,000 in December before starting a 76% price decline over the next 12 months.
Bitcoin has survived. Bitcoin’s narrative has adapted to the needs of a different generation of investors, and it has become a popular answer to the fears of excessive leverage and Federal Reserve printing. The bubble may have burst, but similar to the tech bubble of 2000-2001, we might just be looking at a historic bull run centered around blockchain innovation, digital assets, and of course, bitcoin.
By all accounts, 2020 has been a historic year for Bitcoin and the broader digital assets ecosystem. What was previously dismissed is now an investment allocation for even the world’s most sophisticated investors. Personally, I have seen a significant uptick in interest in the asset class amongst financial advisors and their clients, and that interest is leading to a number of questions. In an effort to help increase education, below I have shared some of the most common questions that I see along with the answers:
- What is Bitcoin and what is it used for?
Bitcoin was originally proposed as a universal digital currency that exists outside of sovereign nations. Bitcoin’s functionality is made possible through cryptography, and specifically through its introduction of a blockchain.
While Bitcoin can be used as a currency in certain situations, the more widely accepted use case is as “digital gold” representing a store of value. This is important as Bitcoin does not have to replace the USD, or any other fiat currency, instead it can represent a liquid means of protecting one’s assets against value destruction as a result of exponentially increasing money printing. While today, this may not seem that important in the United States, remember that bitcoin is global. If you are in a nation where inflation renders your paycheck worth less immediately after hitting your bank account, you’re going to want to be able to swap into something that will better protect the real value of your principal.
Unlike fiat currency, Bitcoin’s supply is fixed via its code base and it cannot be arbitrarily created. Newly issued (‘mined’) bitcoin is released on a fixed, and steadily declining schedule. The final bitcoin will be mined in the year 2140, at which point there will be a maximum of 21,000,000 bitcoin in existence.
- What’s the relationship between Bitcoin and Blockchain?
In short, blockchain is the underlying technology that makes bitcoin possible. A blockchain is simply a ledger, and in the case of the bitcoin blockchain, it is a public, distributed ledger. Every transaction involving bitcoin is recorded to the bitcoin blockchain. There are no other use cases for bitcoin’s blockchain, however, there are near limitless other use cases and possibilities for blockchain technology.
When a blockchain is utilized by other businesses, or for other decentralized purposes, it is a separate blockchain than bitcoin’s blockchain. In many cases these are built upon the Ethereum protocol (token ETH), which is a blockchain technology centered around software-driven ‘smart contracts.’ Blockchains can be public or private, opened or closed, but bitcoin’s blockchain does not offer this flexibility as it was developed for one purpose and one purpose only, to make bitcoin transactions possible.
In summary, blockchain technology exists because of bitcoin. However, since the introduction of bitcoin, blockchain technology has been utilized for many other use cases, largely powered by the Ethereum protocol.
- How can I buy Bitcoin?
Bitcoin is not a regulated security, and as a result it cannot be custodied by a broker dealer. There are two main ways to buy bitcoin:
- Self custody: You can download a bitcoin ‘wallet’, which will be associated with a “public key.” A quick google search will give you plenty of wallet options. Your public key is your wallet’s address, where bitcoin can be sent. Your private key is the means in which you can access the bitcoin in your wallet. This is critical to safeguard, because while the bitcoin blockchain cannot be hacked, you can certainly have your private keys stolen. If your private keys are stolen, your bitcoin is stolen, and the likelihood of recovery is essentially zero.
- Passive vehicle: You can invest in a passive vehicle that is backed by bitcoin. Again, there are plenty of options available, and for a relatively small fee you can realize the economic benefits of bitcoin exposure without having to worry about the security risks of self-custody.
- How do I value Bitcoin?
I think of bitcoin as “Gen Z gold,” and like gold, there is no real intrinsic value to a bitcoin. Bitcoin’s valuation relies on the collective value that the world places on its features as a currency store of value. Or said another way, it’s worth what the marginal buyer is willing to pay for it. While this might not seem like the best answer for a sustainable asset, this is no different from gold, or frankly, the US dollar. If tomorrow, the collective human race decides that it has lost all faith in the creditworthiness of the United States, the dollar becomes worthless. Bitcoin, on the other hand, does not have a centralized entity guaranteeing it nor making rules that govern it.
- Are there any other tokens that matter besides Bitcoin?
Yes, and this is a common misconception amongst advisors. While the bubble of 2017 gave rise to hundreds of tokens with no economic nor practical value, 2019 and 2020 marked the start of the growing trend of token economics, also known as tokenomics.
There are now many examples of real companies, with real revenue and cash flow, that issue tokens leveraging blockchain technology (built on top of the Ethereum protocol for example). These tokens will have explicit benefits that can range from product discounts, loyalty rewards, governance rights and/or monetary distributions based on a percentage of top line revenue. This is a rapidly growing section of the asset class that serves to align the interests of a company and its customer by economically tying that customer to the growth of the company. It’s important to note that these tokens are mutually exclusive from Bitcoin and other digital assets. The only similarity is that all digital assets leverage blockchain technology.
Today, bitcoin and the corresponding digital assets universe are not broadly considered part of a standard asset allocation. However, that is rapidly changing. Given both the macro tailwinds and the technological advances within blockchain, this asset class will not go away. We are in the early stages of massive economic change and wealth transfer. It is my strong belief that bitcoin and digital assets will be at the forefront.
Peter Hans is the principal at Arca, an innovative, investment management company focused on digital assets and blockchain technology.