2020 has been a year without precedent. The COVID-19 pandemic, a historic civil rights movement, and a hotly contested U.S. election are only three of the many occurrences that have made 2020 one of the most chaotic years in decades. This extraordinary year has left many who celebrate the holiday season struggling to find a gift for a loved one that matches our turbulent reality—my suggestion: Bitcoin.
Why Care About Bitcoin?
Bitcoin is a digital currency first created in January 2009, when the world was still reeling from the housing market collapse. The idea for Bitcoin was born in a whitepaper written by a mysterious author operating under the pseudonym Satoshi Nakamoto. The identity of Bitcoin’s creator remains a mystery. Fervent speculation has suggested that everyone from Donald Trump to Elon Musk is responsible for Bitcoin’s creation. The cryptocurrency’s mysterious origins and its use of new technology like the blockchain make it appear more confusing than it actually is. Bitcoin is essentially a network of computers, or nodes, that run Bitcoin’s code and store its blockchain. A blockchain is best understood as a collection of blocks. Each block is a collection of transactions. These blocks are listed on a public ledger, enabling anyone in the world to access the same database of past transactions using a public and private key. This ledger is incredibly important as it effectively replaces the need for a bank, credit card provider, or any other third party financial middleman.
At the most fundamental level, the financial system is built on trust. Generally, people do not trust each other when it comes to exchanging goods and services, so they pay for an intermediary to verify the transactions and ensure neither side is ripped off. These middlemen enjoy handsome profits from the relatively simple task of securing transactions and establishing bilateral trust between two parties. Without trust, global commerce would come to a standstill. Think of the last time you swiped your credit card; you relied on your credit card provider and your bank to work together to ensure who could purchase those groceries. Without trust, you would not be able to buy groceries using a credit card and be forced to use cash, which is a far more inconvenient way to shop. On the flip side, the grocery store had to trust that your credit card provider was legit and would accurately interact with your bank to facilitate the purchase. If the grocery store loses trust in the system, it would be forced to ban all credit cards, sapping it of precious revenue and making shopping far less convenient.
Let’s look at an example. Mark loans Sally $20. Sally then pays Mark back $10. According to the blockchain, Sally still owes Mark $10 on his initial loan. If Mark and Sally, days later, disagree over who is owed what, they can go to the blockchain to resolve the issue. If Sally insists that she has paid Mark back in full, but Mark says he is still owed $10, then together they can review all their past transactions on the blockchain and verify that Sally still owes Mark $10 based on his original $20 loan. This example, while painfully basic, underscores how revolutionary this new technology is. In the past, Mark and Sally would have been forced to get their banks involved or wait on hold for the credit card providers. Now, individuals like Mark and Sally can reclaim their financial autonomy through a decentralized system of exchange.
How Does Bitcoin Work?
Bitcoin is one of the first digital currencies to use peer-to-peer technology to facilitate instant payments. The individuals and companies who transact using Bitcoin are all a part of the same public network. Thus, while remaining anonymous, all transactions are cataloged on a public ledger, as seen in the Mark and Sally example. All Bitcoin tokens are kept using public and private “keys,” which are incredibly long strings of numbers and letters created and linked through a mathematical encryption algorithm. The public key, which is comparable to a bank account number, serves as a public address to which others may send bitcoins. Like an ATM PIN, the private key functions as a guarded secret that is only used to authorize Bitcoin transmissions. These “keys” interact with each other and work together to allow the owner to initiate and digitally sign transactions, providing proof of authorization. This process completely cuts out the middlemen who make life so annoying: banks, credit card providers, etc. Although the most immediate and logical application for blockchain technology is in the financial services industry, it is by no means the only possible application. Blockchain technology has far-reaching benefits that extend well beyond the banking and financial industry and can work in any ecosystem with intermediaries. When you remove the intermediaries (middleman), then suppliers and customers can transact directly. Intermediaries exist in almost all instances where goods and services are exchanged, especially at a mass scale, which means that blockchain technology will soon disrupt global commerce across industries and geographies. Even if you still aren’t convicted of Bitcoin at this point, you should at least acknowledge that the technology that undergirds it – blockchain – is truly a revolutionary technology that will soon transform our world.
Is Bitcoin a Currency or a Stock?
The simple answer is both. Part of the confusion and unease surrounding Bitcoin is because its underlying technology, as outlined above, is radically new and disruptive. There is a heated debate over how to classify Bitcoin as some consider it a means of exchange, or currency, similar to the U.S. dollar or European Euro. In contrast, others see it as an investment vehicle, akin to a share of Apple Inc. Both viewpoints are misguided. Bitcoin is both a means of exchange and a store of value. If you take Fordham’s entry-level economics class, you will learn that money has three primary functions: a medium of exchange, a unit of account, and a store of value. If something does not serve one of these functions, it cannot be considered a currency. The first, medium of exchange, refers to money’s use as an intermediary in exchanging goods and services. The second, unit of account, is a standard numerical unit of measurement of the market value of goods, services, and transactions. It is a standard of relative worth and deferred payment, and as such, is a necessary prerequisite for the formulation of commercial agreements. To function as a unit of account: money must be divisible into smaller units without loss of value, fungible with one unit or piece being perceived as equivalent to any other, and a specific weight or size verifiably countable. The third, a store of value: money must act as a store of value to be reliably saved, stored, and retrieved. It must be predictably usable as a medium of exchange when retrieved. Additionally, the value of money must remain stable over time.
With this definition in mind, let’s compare how Bitcoin’s characteristics stack up against those of a fiat currency such as the U.S. dollar. Since no single government owns Bitcoin, anyone in the world is free to use it, which allows it to be a universal medium of exchange. Because of Bitcoin’s digital nature, a guy sitting in Zimbabwe could pay for a sandwich at Rams Deli on East Fordham Road via Bitcoin without ever having to leave Zimbabwe. Secondly, Bitcoin can be considered a unit of account since it is divisible in a theoretically infinite number of ways. 1.0 Bitcoin is worth around $24,000 at the time of this writing, meaning that 0.5 bitcoins is $12,000 and 0.25 bitcoins is $6,000, and so on. Although the numbers get smaller, the underlying value never diminishes, and thus Bitcoin functions as a unit of account. Bitcoin as a “store of value” is the area that sparks the most debate due to Bitcoin’s historical price volatility. In December of 2017, there was a massive spike in Bitcoin’s price; it rose to almost $20,000. Soon after, the value of a Bitcoin came crashing down, leading many people to call it a scam, speculative bubble, and Ponzi scheme. While people have every right to be upset about losing money to Bitcoin mania, claims that Bitcoin is a purely speculative asset, on par with the housing market in 2007, is fundamentally inaccurate and shortsighted. Volatile is natural and too be expected in such a new form of currency and investment vehicle, and what undergirds Bitcoin’s value is its scarcity. Unlike fiat currencies (i.e., U.S. dollar), Bitcoin was designed to be scarce. This means this will be a finite supply of new bitcoins, as new Bitcoin issuances are expected to cease around 2140. On the other hand, the U.S. Treasury is not restricted by a predetermined code and can print potentially unlimited amounts of cash, driving down the value of the dollar the threatening to undermine the long-standing stability of the greenback. The concept of scarcity is essential to global finance because all assets must have intrinsic value. In 2020, as the U.S. government prints dollars at an unprecedented pace and yields on U.S. treasuries stubbornly hover above 0%, investors have warmed to the idea that Bitcoin may serve as a gold-like hedge against inflation and also offer growth opportunities as the world increasingly integrated digital currencies into the existing commercial system.
Why is 2020 the Perfect Time to Buy Bitcoin?
As we’ve discussed, Bitcoin experienced somewhat of a coming-out party in 2017. It was the talk of 2017 Thanksgiving for all right reasons (huge price surges) and the talk of 2018 Thanksgiving for all the wrong reasons (massive price collapse). The bears, or pessimistic investors, seemed to win the first round of the Bitcoin debate as its precipitous fall substantiated their claims of Bitcoin’s lack of value. However, something curious has happened since Bitcoin’s raucous run in 2017; its price has slowly but steadily risen, and it now is worth more than its 2017 peak. The most exciting feature of this prolonged bull run is who is buying Bitcoin. In 2017, retail investors, particularly college students, were principally behind the Bitcoin mania. At the time, institutional investors such as big Wall Street banks, insurance companies, and pension funds mostly sat out the rally, viewing it as pure speculation. However, in 2020, these roles have been reversed. While college traders are busy speculating on Robinhood over Tesla and depressed airline stocks, the professional, institutional investors have quietly entered the Bitcoin market. They have been careful to move slowly, not to raise any alarm as they gradually build Bitcoin positions. Here are a few recent examples of institutional investors entering the space, an unthinkable investment for the same parties in 2017.
- Guggenheim Partners reserved the right to set aside as much as 10% of its $5.3 billion Macro Opportunities Fund to invest in Grayscale Bitcoin Trust (GBTC), a Bitcoin holdings company that trades in the OTC markets.
o Guggenheim’s CIO, Scott Minerd, recently told Bloomberg TV that the firm’s “fundamental work shows that Bitcoin should be worth about $400,000.”
- PayPal announced it now allows its 346 million users to buy and spend Bitcoin, as well as a handful of other cryptocurrencies.
- Payments platform Square purchased $50 million in bitcoin, as part of a more considerable investment in cryptocurrency.
o Square added bitcoin trading to its Cash App in 2018 and now lets customers get bitcoin back on purchases.
- J.P. Morgan recently said Bitcoin has ‘considerable’ upside as it better competes with gold as an alternative currency. “Even a modest crowding out of gold as an ‘alternative’ currency over the longer term would imply doubling or tripling of the bitcoin price,” J.P. Morgan said.
- Massachusetts Mutual Life Insurance Co. bought $100 million of bitcoin as part of its general account, which totaled roughly $235 billion as of September 30th, 2020.
- Stanley Druckenmiller and Paul Tudor Jones, two famed and respected investors, have publicly acknowledged their investments in Bitcoin and highlighted its potential as a hedge against inflation.
- According to a Bloomberg poll of institutional investors, Bitcoin is now the third-most crowded trade, behind long technology shares (betting the tech companies rise in value) and shorting the U.S. dollar (betting that the U.S. economy will suffer and investors will shift capital to other countries). The poll was taken between December 4th and December 10th 2020.
What Makes 2020 Different Than 2017?
Many retail investors appear nervous to reenter the Bitcoin market after being burned in 2017, which is why institutions have been so eager to step in and fill demand while prices remain cheap. The difference in the 2020 Bitcoin market can be boiled down to a couple of key points: inflation, COVID-19, and public acceptance. In 2020 alone, estimates say that the U.S. central bank has created 22% of all U.S. dollars ever printed before this year, making it the largest money supply surge in history. Surging supply brings devaluation, which is why shorting the U.S. dollar is so popular right now. Investors are betting that the unprecedented support the Federal Reserve is providing the market right now will backfire in the longterm and result in dollar depreciation and valuation bubbles. Even more critically, money printing will likely bring inflation, a complex financial issue that the U.S. has not dealt with in decades. Bitcoin could serve as a stable place to park money during an inflationary period to protect against capital depreciation amid the inflationary environment. Secondly, COVID-19 has had a transformative effect on how the world engages in commerce. Everything that can be digitized has been or at least will be soon. People increasingly do not want to hold cash, viewing it as dirty and inconvenient. Instead, the public will continue opting for more seamless monetary transactions, which digital currencies like Bitcoin offer. Thirdly and finally, public acceptance has grown; time heals all, or most, wounds, and it appears that institutional investors have gotten over the 2017 craziness and embraced Bitcoin’s potential. It has a strong track record since its inception in 2009 and has shown no signs of disappearing. As blockchain technology is applied to more and more industries, people will begin to view Bitcoin as the future of global commerce.
Now, with all this being said, you should make your own decision on Bitcoin. I am merely a college student with a partially completed finance degree and a couple of internships under my belt, so don’t take my word for it. Do your own research, and come to your own conclusions. I am simply making the argument that we have just endured one of the most challenging, bizarre, and unprecedented years in human history. If there was ever a year to give a loved one a unique and surprising gift (see: BITCOIN), it is 2020. Happy Holidays everyone!