reason #6
bitcoin IS kinda boring
Bitcoin is a digital currency that is mined making use of cryptography. That sentence alone tends to evoke two strong emotions- panicked confusion and sleepiness. This can best be described in the phrase - what the hell did you just say....zzzzzz. This is a good thing because investments are supposed to be boring. Paul Samuelson said that if you want excitement, you should go to a casino.
While the price action of Bitcoin is far from boring, its underlying technology is a bit of a yawn fest. To understand why this is a good thing, you need to understand a few things about asset bubbles.
In the world of investing, price is what you pay and value is what you get. If you pay $1 million for a house, that is the price and that is an objective fact. The sale is recorded at that price and there is nothing you and I can do to change that. What is that house worth? That is more subjective - you could ask ten people what they think the value is and you could get ten different answers. You may know someone who works for the municipality who told you the plot of vacant land next to the house is about to be converted into a toxic waste landfill. You think they are going to build a golf course. You, therefore, think the house is worth 2 million while I think at most it is worth a couple of hundred thousand.
Let's now jump into a real example of an asset bubble. On 1 January 1983, the Internet was born. Not everyone welcomed the internet with open arms. Some said it was a fad and would die a slow and painful death. Twelve years in, however, the mood started to shift. Between 1990 and 1997 the percentage of households in the United States that owned a computer went from 15 percent to 35 percent as we shifted into the information age. Soon "this internet thing is amazing" became a common phrase at dinner tables, barber shops, delis, taxis, and other public places. People started to believe that this was the future and that everything would be done online. You would buy your groceries, books, clothes, cars, etc online and the old school bricks and mortar economy would die. Everyone wanted to be part of this new wave and FOMO started to set in. Companies were formed to exploit this. It soon became so ridiculous that any company with a .com suffix became an attractive investment and investors started to throw billions of dollars at these companies that listed their shares on the Nasdaq exchange.
The poster child of the dot.com bubble was pets.com. As you could imagine, it sold pet supplies to consumers. It opened its virtual doors in November 1998 and within two years it went bust, but it had a crazy ride along the way. Funded by early investments from Amazon and others, the company went on an aggressive advertising campaign including a Super Bowl ad. At its peak, the company was worth almost $1 billion and was only generating a few million in revenue. It was ludicrous and it was soon bankrupt.
Asset bubbles form when there is a big difference between price and value due to false perceptions and expectations. The emotion of dot.com suckered investors into believing a company with almost no revenue was worth $1 billion. In a frenzy of greedy buying mixed with FOMO, they piled in and bought the stock driving the price to insane valuations. When the music at the disco was stopped and the lights were turned on, the true nature of the company was revealed.
Ok, so you now understand the difference between price and value. Let's now go to the issue of boring. Most people have a limited attention span, and this span is contracting thanks to electronic devices. Researchers from the universities of Oxford, Harvard, Western Australia, Manchester, and Kings College in London have published a paper in the journal World Psychiatry, warning that increased use of the internet and "digital distractions" are leading to "decreased verbal intelligence" among children and "cognitive offloading" in adults.
So let's look at Bitcoin. Satoshi described it as a peer-to-peer electronic cash system. Then you get to Bitcoin mining. This uses the SHA-256 hash function. It always outputs a 256-bit number (the most basic unit of computation) which is usually represented in the hexadecimal number system with 64 characters for human readability. A Bitcoin block consists of two components. Mining computers collect enough transactions to fill a block and bundle them into a Merkle tree. Then you have the block headers which are made of six components: the version software the Bitcoin client is running, the time stamp of the block, the root of its containing transactions Merkle tree (obviously), the hash of the block before it, a once and the target.
This information is definitely above my IQ grade. When people start to mention Merkle trees, nonces, hexadecimal numbers, and hashes, my mind tends to wonder. There are a bunch of reasons why this combination of boring and complicated is good for Bitcoin.
1) Barrier to the Uncurious
In its early years, people are incurious and will not do the research necessary to understand the true beauty of Bitcoin. That gives the curious (people like us) the opportunity to get in before the masses.
2) No Bubble - Yet
Many critics of Bitcoin said it was a bubble when it hit $68,000. They were comparing it to pets.com. You will recall that an asset bubble is characterized by a massive divergence between price and value. It is a financial phenomenon where the price of an asset is far above its value. Let's take the most simple valuation of Bitcoin using Metcalfe's Law. This law was used to value network companies like Facebook in their early phases of growth. It states the value of a network is proportional to the square of the number of connected users of the system. There are between 700,000 and 1 million active addresses per day. Let's look at the lower end of the range. The square of 700,000 is 490 billion. We divide that by the 19 million BTC in circulation and we arrive at a lower-end valuation of $25,800. If we use 1 million, we get to a valuation of $52,000. You would be hard-pressed to say that $68k was a bubble on BTC - sure, you could argue the price was a little rich, but bubbles are dramatically more exaggerated than that. If you are not convinced by the pets.com bubble, consider another bubble - the Japanese real estate bubble. In the 1980s the Imperial Palace in Tokyo was worth more than all the real estate in California. So you can understand the size of the Californian economy, if it was a stand-alone country, it would have the fourth largest economy in the world!! Now that is a bubble! If you are still not convinced that Bitcoin is not a bubble consider this - in 2022, the price of Bitcoin has an average of $30,000 which is the low end of the range. As of December 2022, it was trading at $17,000 which is almost $9,000 below the lower end of the range.
This, however, is not the complete picture. You need to understand how financial assets are priced. Financial markets are forward-looking in the sense they are the present value of future expectations. That is why it is possible for a company to company valuable even though it is losing money. Tesla is a good example. The company was founded in 2003 (incidentally, not by Elon Musk - he only came on board in 2004 but a lawsuit agreement allows Musk to be called a co-founder). Tesla only turned a profit in 2009 and at the time it was worth $1 billion. As of the end of 2022, the company was worth $600 billion and has revenue of $5 billion. Toyota is the second biggest automaker by market cap at around $200 billion on $250 billion in revenue. How is it possible that Tesla has one-fifth of Toyota's revenue but is worth three times more? It makes no sense unless you accept the fact that markets are discounting mechanisms. The market is placing a hefty premium on Tesla on account of its unique offering of electric vehicles and solar energy. As the world demands greener energy, so too will companies that align with this new vision be rewarded by the market. I mention this to try and defend the $68k price that Bitcoin reached at the end of 2021. You will notice that I used the current number of daily users in Metcalfe's law calculation. That is flawed thinking. I should use a blend of existing users plus a projection of what that number could grow to in the future. In order to justify that valuation we would need to get to 1.15 million average daily users of Bitcoin. That is not a far reach going forward if we currently sit between 700k and a million. You could even argue that $68k was a conservative valuation.
So, Bitcoin was not a bubble then and most certainly is not a bubble now. That is not to say it will not become a bubble in the future. While the world is so distracted by their smartphones watching TikTok, you are quietly accumulating Bitcoin. Then events transpire that open the way for large investment funds to buy Bitcoin (currently they are precluded from doing so due to lack of regulation). They enter the market with tens of billions. Billionaires decide to allocate 5 percent of their wealth to Bitcoin and all of a sudden the price starts shooting up. The distracted people, those who bought pets.com realize that the price is getting away from them so they jump in and before you know it the price hits $1 million!
Do you now understand why Bitcoin, which on the surface is a little boring, geeky, and overly technical, is very unlike the bubbles we have seen in the past? Bubbles happen when there is mass hysterical adoption. We are far from that- there are still millions who either hate it or have absolutely no interest in researching it. Another counterintuitive rule of asset bubbles is that if everyone is calling it a bubble, it probably is not a bubble. In financial markets, the mass consensus is generally always wrong.
