An Intro to Bitcoin that doesn't make you sleepy

Our story starts in the reception room of Roc-A-Fella Records, the famous American hip hop label. It's a strange place to start. I know. We're starting there because of a scene from Netflix's fantastic new documentary about Kanye West. 

In case you've been living under a rock, Kanye is a grammy award winning rapper, producer and fashion designer who has made himself a billionaire from his brand. This Netflix documentary follows Kanye when he was first trying to get his big break. In this scene, he is trying to talk to someone at Roc-A-Fella records, and the receptionist kind of ignores him. So, he starts rapping for her. He plays a track - that he hasn't yet released at the time - called All Falls Down. In time, this song would hit the billboard charts, become grammy nominated and become a huge hit. But at that moment, he is just a crazy guy rapping in the middle of a working day. So the receptionist ignores him, makes a few phone calls, and eventually asks him to move out of the way so more people can enter the reception. 

This scene makes you think how hard it is to spot greatness early, even when it is right in front of you. It makes you admire the people who spot trends and great things before others do.

I think it's fair to say that Satoshi Nakamoto (Bitcoin's anonymous creator) changed the internet as much as Kanye changed the rap game. In our story, folks like Hal Finney, Peter Saddington, Dave Carlson and Laszlo Hanyecz were the people that read Satoshi Nakamoto's Bitcoin whitepaper, and recognised the genius of it, before the rest of the world had even heard about Bitcoin.  

Kanye changed the hip hop industry by dressing differently, speaking differently and rapping about education, family and religion rather than guns, knives and crime. And Satoshi? Here's how he changed the game...

Digital Scarcity

The key breakthrough that Satoshi made with Bitcoin was that of creating digital scarcity. We all know that any image or text on the internet can be copied and pasted. If you're creating a digital currency... that can't fly - it's called the "double spending" problem. Someone spends digital money, copies it and spends it again. Satoshi found a solution to this issue. Bitcoin was the world's first scarce digital asset. Every bitcoin must be an entry in a valid Bitcoin public blockchain and the blockchain rules allow each Bitcoin to only be present once. If you want more information about how this works, I'll be writing more on blockchain technology in future posts. 

Decentralised 

Bitcoin is governed by code running on thousands of computers around the world. It is money that cannot be controlled by governments, central banks or any individual. This is such a powerful concept, and that's why governments like China and Russia are doing all they can to stop their citizens from owning Crypto. The current situation in Canada is the perfect example to show how powerful a decentralised currency is:

In Canada, truckers were officially ordered to have the Coronavirus vaccine, and they began protesting this decision. The situation escalated to the point where the Canadian government froze the bank accounts of anyone involved in the protest. That means these people couldn't pay rent, pay for food, or do many of the day to day things they needed to survive. A fully decentralised currency means that no one - no individual, company or even government - has the power to do this. 

Not only this, but when I want to make a big transaction or make changes, I have to speak to my Bank. Bitcoin is an asset that I can own, control and transport without the need for any third party. 

Mining

Okay so if there is no one to oversee this system and this currency, how does it work? Who keeps the show on the road? All bitcoin transactions are validated through a process called mining. The computers performing this validation are referred to as miners. Miners are auditing all of the transactions that occur on the bitcoin network and verifying the legitimacy of these transactions. 

Miners follow a set of cryptographic rules to keep the network safe, secure and stable. When miners successfully verify a group of transactions, they earn a reward for doing so - currently 12.5 bitcoins. 

Digital Gold

One of the biggest talking points around Bitcoin is that the monetary policy around it is simple to understand, and can't be changed. There is a fixed supply of 21 million BTC. More will not be created. This is in contrast to fiat currencies like the US Dollar. For fiat currencies, central banks or governments decide on policy and can decide to print more whenever this is needed. 

This fixed supply is why many have begun to consider Bitcoin as "digital gold". Gold is used around the world as a store of value. When inflation is high and the value of the money you have in your bank account is decreasing rapidly, many investors choose to buy gold to protect against this. 

But "digital gold" has a few key advantages over physical gold. The key one is that you can transport it anywhere. Let's say you have to up and move across the world. Carrying 10 tonnes of Gold along with you would be almost impossible. But taking your Bitcoin with you wouldn't require any effort on your part. All you'd have to do is remember the secret key to your wallet and your Bitcoin would be waiting for you when you arrived. On top of this, Bitcoin can be encrypted to provide an additional layer of safety against theft. 

However, recent events have put somewhat of a dent in the case for Bitcoin as digital gold. 

Gold is known as a "save haven" asset. Meaning that during times of uncertainty and turmoil, investors put their money into gold to keep their money safe, and the price of gold goes up. For Bitcoin to be "digital gold", it needs to follow this same trend. When Russia declared war on Ukraine in February 2022, Bitcoin's price plummeted. Since then, it's recovered slightly, but the price of BTC certainly hasn't risen rapidly, the way a "safe haven" asset "should" do in times of crisis. 

The Timeline of Adoption

Satoshi Nakamoto published the Bitcoin whitepaper in late 2008. The bitcoin network was launched in early 2009. On May 22nd 2010, the first real-world transaction was made in Bitcoin. 10,000 BTC were exchanged for two pizzas. At today's prices, those 2 pizzas cost almost $400 million. 

2011-2012 was the period where Bitcoin started to be adopted in niche circles. During this time, Coinbase launched. At the time, Brian, Coinbase's founder, was actually giving people free Bitcoin to encourage them to create an account on Coinbase. And nobody cared! Bitcoin was being used for less ethical business ventures too. The Silk Road, a famous internet site where illegal items were bought and sold, used Bitcoin as currency because when someone used Bitcoin to pay online, their identity wasn't traceable. 

In 2013 the first crash came. The price of Bitcoin fell from its peak of $1000 to around $300. It would take more than two years for Bitcoin to reach the price level of $1000 again. In 2014, the largest Bitcoin heist in history occurred. Mount Gox, the world's largest Bitcoin exchange at the time, went offline and the owners lost 850,000 bitcoins. 

2017 was when Bitcoin started hitting the mainstream. During this year, the price rose from $900 to $20,000. This run-up was followed by a huge crash in 2018. 

Since then, Bitcoin and Crypto, in general, has seen a resurgence, new heights, and another crash. But most importantly - crypto seems to have captured the imagination of many around the world. In June 2021, El Salvador took the shocking decision of announcing Bitcoin as legal tender. The mayors of Miami and New York City have very publicly opted to take their salaries in Bitcoin. There are almost 100,000 bitcoin millionaires and there are more US citizens with a crypto account than with a savings account. 

The Current Limitations

It's not all sunshine and rainbows for Bitcoin. Transactions on the network take a long time to confirm, and the mining-based system described above uses a lot of computing power, which means a lot of energy is burned in the process. The price of Bitcoin is also volatile, which makes it tough to use as a means of payment. There are a variety of different altcoins (an altcoin is any cryptocurrency other than bitcoin) that have been invented to tackle these issues, but it is yet to be some of these issues can be solved when it comes to Bitcoin itself.  

The Four Levels of Belief

Vijay Boyapati is an OG in the crypto space. He's been around since 2011. When he spoke on The Investor's Podcast, he outlined four levels of belief in Bitcoin and the valuation that corresponds to each level of belief. 

1. The first framework is that this is all a huge bubble. Bitcoin has no value or no comparative advantage to the current financial system. According to this framework, the price of BTC would eventually crash to 0. It all falls down (see what I did there).

2. This is a cool, new technology but it is for a niche, tech-savvy, ideologically minded audience. So this would mean that Bitcoin eventually has a committed, but small base of users. A small base of users would mean lots of volatility. If you believe this, Vijay says you would assign a price target to Bitcoin of $10,000 - $100,000

3. The third framework is the digital gold argument we mentioned before. This argument says that Bitcoin serves the same function as gold, but does it in a better way, and that the market will eventually realise. Using this framework, you would value Bitcoin at $300,000 if you think the market cap of bitcoin eventually catches up to the market cap of gold. If you think Bitcoin is better, you would be willing to adjust your price target upwards. Vijay sets a price range of $300,000 - $1,000,000 for this framework. 

4. With the fourth framework, you believe that Bitcoin will eventually be the world's reserve currency. Nations and large banks will use Bitcoin to save and settle large transactions. Everything from houses to bottles of milk will be priced in Bitcoin. If you believe this, you would be looking at a price target of $10 million to $100 million. Yes.. $100 million... PER BITCOIN. 

Vijay first outlined these scenarios back in 2020, but back then he said that the dominant narrative for bitcoin was somewhere between 2 and 3. Two years later, that consensus doesn't seem to have changed. 

Conclusion

So now that you know the basics, where do you stand? Do you agree with the four valuation frameworks outlined? If you do, which one of the four do you think will be the correct way to view Bitcoin in future?

Then there's another consideration. Never mind where the price of Bitcoin ends up going, where do you want it to go?  Is it actually good for the world or does it just make life a little more convenient for drug dealers? More on that in the next post.