Introduction
Let’s knock out the obligatory CYA responsibilities an investment advisor has when publishing a post on Bitcoin…
This post is not to be taken as advice! This is for educational and informational purposes only. You should always discuss personal financial matters with a professional who is familiar with your goals and objectives.
What is Bitcoin?
Bitcoin is a finite, decentralized, digital currency. Bitcoin owners can transact with one another directly without the need for an intermediary like a bank or payments company (Visa, Apple, Venmo, etc.) or the need of a sovereign nation/league of nations and their currencies (dollar, Euro, yen, etc.). Bitcoin gives users the ability to opt out of the traditional finance system and all its flaws. As you will read later in this post, the overly simplified analog for Bitcoin is digital gold.
The Volatility of Bitcoin
Bitcoin addresses many of the issues that exist within our current financial systems, which is why it might have viability as an investment for some investors. However, Bitcoin is more difficult to value than are traditional assets like stocks and bonds because Bitcoin does not have cashflows that can be discounted to their present value, which can make an investment into Bitcoin high risk. Instead of calculating its value based upon the present value of future cash flows, Bitcoin’s price is like any other commodity and is driven solely by supply and demand. Additionally, Bitcoin has a much shorter track record than other commodities and currencies, which further makes pricing it difficult. Because Bitcoin does not have cash flows and is a (relatively) new technology, Bitcoin possesses extreme volatility relative to more traditional asset classes.
This post will be divided into three sections:
Click on any of the section headers above to be taken to that section.
If reading long blog posts isn't your thing, check out the Summary at the end. Finally, check out the Resources section to learn more about Bitcoin.
Let's dig in...
The Problems Bitcoin Solves
Bitcoin solves many problems – some of which Americans, who enjoy a stable currency, strong property rights, and a reliable banking system do not care about (at least not yet). However, there is one major problem Bitcoin potentially solves that Americans (and citizens of nearly every country on earth) should care about… Inflation.
The U.S. dollar is becoming weaker and weaker when measured against the goods and services they are exchanged for. You feel this when you go to the grocery store, when you see the listing price of the houses for sale in your neighborhood, and even if you are hiring a babysitter – the price of everyday goods and services has gone through the roof in recent years. Prices have always gone up, but the inflation we have seen in the last few years has been exceptional. The blame for this phenomenon has been directed toward many scapegoats: corporate greed, an “expansion of the economy”, changing consumer habits as a result of COVID, a war on the other side of the world, etc.
Whatever…
None of that matters when compared to the massive levels of money-printing governments around the world have engaged in and the dilutive effect this money-printing has on the currencies they administer.
This article by Ron Surz[i] published by Nasdaq.com shines a light on the extent the U.S. government has become dependent upon money printing.
The money supply in the U.S, as determined by M2[ii], has increased by 36% in the four-year period from 01/01/2020 – 12/31/2023. See chart below:
Past performance is not indicative of future results
The increase in the money supply is the result of our government issuing debt, our Federal Reserve Bank buying that debt with newly created dollars, then the government spending those dollars, thereby introducing new money into our economy.
Our government has reached Lloyd Christmas levels of spending...
With every new dollar created out of thin air, there is a decrease in the purchasing power of existing dollars – this is the true definition of inflation. Below is a 10-year chart (run as of 3/12/2024) that shows the relationship our money supply has with inflation:
Past performance is not indicative of future results
These charts illustrate why many investors prefer to hold gold in their portfolios –
gold is a more reliable store of value than dollars and offers a hedge against inflation. Why? Unlike U.S. dollars, which are recklessly printed, gold is much harder to produce, which means the value of existing gold is not easily and rapidly diluted by massive increases in the supply of new gold. To introduce new gold into the total supply means hard work must be conducted to dig it out of the earth. Bitcoin is similar in that “unearthing” new Bitcoin necessitates hard work – we aptly call this work mining. We will talk more about mining later – for now, what you need to know is:
Only 21,000,000 Bitcoins will ever exist[iii]
94% of these 21,000,000 Bitcoins are already in circulation[iv]
The last Bitcoin is generally expected to be mined around the year 2140[v]
The rate at which new Bitcoins are issued is pre-determined. The number of new Bitcoins introduced to the supply is currently 450 per day. This number is halved every four years. These events are called halvings and Bitcoin just experienced its fourth ever halving on 4/19/24. In another four years, the number of Bitcoins introduced to the supply will fall to 225 per day.[vi] This feature, which has been part of Bitcoin's design from the beginning, makes Bitcoin more and more scarce over time and is Bitcoin's solution to the insidious expansion of the money supply that dilutes currencies like the dollar.
While Bitcoin possesses many of the benefits of gold, it doesn’t share in some notable challenges – specifically, the difficulty to move and hold gold. Unlike gold, sending Bitcoin across the globe can be done in minutes and holding Bitcoin in your own custody doesn’t necessitate an expensive safe or the digging of holes in your backyard. These attributes might not seem like a big deal to most Americans today, but they are life-giving features to many people around the world who don’t have access to a stable and widely accepted currency, property rights, or the reliable banking system we are blessed with.
Because Bitcoin is a game-changer for so many people around the world, its adoption is ramping up…
The Rapid Increase in Bitcoin Adoption
Something historic is happening – Bitcoin is being adopted by sovereign nations as legal tender, by pensions and endowments as a holding in their portfolios, and by some of the world’s largest asset managers as a bona fide investment to offer their clients and customers.
Currently, El Salvador, Argentina, and the Central African Republic have made Bitcoin legal tender in their countries. It wouldn’t be surprising to see additional countries formally adopt Bitcoin as legal tender in the future – especially third world countries where the currency has been absolutely devastated by corruption, incompetence, and inflation.
However, Bitcoin is not only being rapidly adopted by third world countries out of necessity, but also in developed countries with reliable currencies. Why? Because of the potential upside Bitcoin possesses. The price of Bitcoin has been explosive, up 109% in the last 365 days (as of 4/19/24). What is interesting, though, is that Bitcoin’s Risk-adjusted returns, as measured by Sharpe Ratio (a calculation used to evaluate the risk adjusted returns of a given investment - the higher the Sharpe Ratio, the better the risk-adjusted returns) is currently higher than that of the S&P 500 (as of 4/19/24). Keep in mind that the Sharpe Ratio, commonly used by investment professionals to determine the risk of stocks in the marketplace is not the sole determinant one should use in evaluating investments, but the fact that Bitcoin’s risk adjusted returns currently offer superior value relative to the S&P 500 by its calculation is not insignificant.
See the below chart from PortfoliosLab[vii].
Past performance is not indicative of future results Chart shows calculation run on 4/19/24
Because of its potential as an asset class, Bitcoin has caught the eye of many Wallstreet firms, 11 of which applied for and were granted the ability to create a Bitcoin ETF from the SEC. One of those 11 firms, Blackrock (the world’s largest asset manager), has turned on their nose regarding their view of Bitcoin. In 2017, Blackrock CEO, Larry Fink, blasted Bitcoin by calling an “index of money-laundering”. Fast-forward seven years and Fink is a self-professed "big believer in Bitcoin" and for good reason – Blackrock’s Bitcoin ETF (IBIT) became the fastest ETF to accumulate $10B in assets – it did so in just seven weeks. The previous record for the quickest ETF to accumulate $10B in assets was GLD (ironically, GLD tracks the price of gold). How long did it take GLD to reach the $10B mark? Two years. Bitcoin adoption is happening everywhere from third world countries to the largest asset manager in the world and everywhere in between at a historically rapid pace. The chart below from FiatMarketCap[viii] shows how the rapid adoption of Bitcoin has made it the 14th largest currency in the world:
Past performance is not indicative of future results Chart shows calculation run on 4/19/24
A High-Level Overview of How Bitcoin Works
Every Bitcoin transaction happens within the Bitcoin network. The Bitcoin network is open-source and viewable by anyone, thus providing perfect transparency, while also retaining the privacy of its users. The “network” refers to the computers participating in the broadcasting and recording of Bitcoin transactions, thus forming the public ledger. These computers are called nodes. You have heard it said that Bitcoin utilizes a technology called Blockchain, which is simply a method of record keeping – the Bitcoin blockchain lumps many transactions into blocks. Every block is cryptographically locked, and there is only one key that will unlock it, and thus, prove and codify the transactions within that block. Miners devote computing power to find the random numeric key that will unlock the block so that the transactions within it can be proven and then broadcast to the nodes and recorded forever. The miner who finds the key (or gets closest) does so by devoting large amounts of computing power to find (guess) the random key which unlocks the block. The miner who successfully unlocks the current block of transactions is rewarded with newly minted Bitcoin. This process is called mining and it is how new Bitcoin is introduced to the network.
Below is a summary of how this process from beginning to end:
Bitcoin users transact by sending and receiving Bitcoin.
These transactions within the Bitcoin network are lumped together into a block.
A decentralized group of computers called miners devote computing power to unlock the block with the goal of being rewarded with the prize of new Bitcoin.
The miner who finds the key to the block communicates the transactions within the block to the network of nodes.
The nodes record the transactions in a shared and permanent ledger.
The successfully mined block is permanently affixed to the block that preceded it, which lengthens the blockchain and cements the transactions within the public ledger forever.
The successful miner is rewarded Bitcoin – currently, the reward for a successfully mined block is 3.125 BTC.
Once the block is mined and broadcast to the network, all miners work to begin unlocking the next block… this process happens from start to finish roughly every 10 minutes.
Summary
Bitcoin is a decentralized financial network where transactions are made public for all to see, but still allows for users to retain their privacy. The network is secured by miners, which are specialized computers that prove transactions and secure the network– this secure, open network does not require the participants to blindly trust a government to maintain the currency, nor do they need to trust an intermediary like a bank to facilitate transactions. For their effort to facilitate and secure the Bitcoin network, miners are rewarded with Bitcoin, but their reward is systematically cut in half every four years to help ensure Bitcoin becomes increasingly scarce (deflationary). This creates the possibility of Bitcoin acting as a hedge against inflation as it is perfectly finite (only 21M Bitcoins will ever be mined). Bitcoin provides real world benefits, such as access to a sound currency to those who live in countries with nearly worthless money. The adoption of Bitcoin is on the rise as sovereign nations, pensions/endowments, and some of the world’s largest financial institutions have begun adopting Bitcoin. The rise of Bitcoin ETFs has dramatically increased the rate of adoption, as the average retail investor can now invest in a Bitcoin ETF as easily as he/she can invest in any other ETF. Ultimately, Bitcoin is an ultra-volatile digital currency in which investors should educate themselves on and discuss with their personal investment advisor before investing.
Resources
The resources below are shared for educational purposes only and should not be considered investment advice.
Swan Bitcoin is an onramp to purchasing and even holding Bitcoin, but they also host a great blog that is incredibly informative and a valuable resource to learn more about Bitcoin.
Natalie Brunell is a leading voice and educator in the world of Bitcoin. Her YouTube channel is a great place to learn.
For those curious about the inception of Bitcoin, here is a link to the original Bitcoin whitepaper, authored under the pseudonym Satoshi Nakamoto in 2008.
The Resources page on Bitcoin.org is a great place to access a compilation of learning materials.
The information provided is for educational and informational purposes only and does not constitute investment advice and it should not be relied on as such. This is not a solicitation to buy, an offer to sell or a recommendation to hold any specific security. It does not take into account any individual investor's particular investment objectives, strategies, tax status or investment horizon. Prior to any securities transaction, you should consult your financial advisor, attorney or tax advisor.Foster Capital Management Inc. dba Generations Wealth Design (“Generations Wealth Design”) is a registered investment advisor, located in and regulated by the state of Kansas. Advisory services are only offered to clients or prospective clients where Generations Wealth Design and its representatives are properly licensed or exempt from licensure. For additional information, please visit our website at www.genwd.com.
References
[i] Ron Surz, “Money Printing and Inflation: COVID, Cryptocurrencies and More”, Nasdaq.com, November 16, 2021, https://www.nasdaq.com/articles/money-printing-and-inflation%3A-covid-cryptocurrencies-and-more
[ii] The Investopedia Team, “M2 Definition and Meaning in the Money Supply”, Investopedia, March 2nd, 2024, https://www.investopedia.com/terms/m/m2.asp
[iii] Bitcoinblockhalf.com, “Bitcoin Block Reward Halving Countdown”, https://www.bitcoinblockhalf.com/
[iv] Bitcoinblockhalf.com, “Bitcoin Block Reward Halving Countdown”, https://www.bitcoinblockhalf.com/
[v] Bitcoinblockhalf.com, “Bitcoin Block Reward Halving Countdown”, https://www.bitcoinblockhalf.com/
[vi] Bitcoinblockhalf.com, “Bitcoin Block Reward Halving Countdown”, https://www.bitcoinblockhalf.com/
[vii] PortfoliosLab, Sharpe Ratio Calculator, https://portfolioslab.com/tools/sharpe-ratio
[viii] Fiat Market Cap, “Major fiat currency market cap in BTC”, FiatMarketCap, April 30th 2024, https://fiatmarketcap.com/
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