How We Ended Up in a World of Bitcoin—”Worthless Artificial Gold”

If you follow the world of business news, you will know that Charlie Munger recently called Bitcoin “worthless artificial gold.”

That is not technically wrong, as Bitcoin has no inherent value, nor does it produce anything physical, and, much like the internet, it’s “in the cloud” and people don’t really understand Bitcoin. I do like how Munger compared it to gold though.

Then again, what makes our paper currency worth anything?

What is the different between a $20 bill, and a $100 bill, other than the fact that one has a three digit number in the corner, and one has a two digit number? Or the fact that the face on the $20 Canadian bill is of Queen Elizabeth II, and the $100 Canadian bill is of the 8th Prime Minister of Canada, Robert Borden? I mean, our $1 coin has a goose on it, and our $2 coin has a moose! Are moose just more valuable than geese? Is the plural for “moose”, “meese?” These are all questions that need to be answered!

We want that $100 bill because as a society, we attributed value to our currency for what it can buy us, not because the $100 bill is worth anything by itself.  It’s the same reason why $1 in USD is not “worth” the same as $1 CAD, because we want the USD more than the CAD due to its perceived value.

So, before we discuss the potential of Bitcoin and cryptocurrency and how they all fit into this spectrum as an asset class, let’s roadmap how we got here.

Defining Money

There are many different ways to define the features of money, but most generally, these 3 principle functions are accepted.

1. A store of value
   • (that is, if I hold on to my money, it will retain its value, or potentially even increase in value. Store of value generally exists due to the scarcity of our money. In the 1600’s, tulip buds skyrocketed in value. People thought of it as an asset class, like gold—until people realized that you could mass produce tulip buds and knowing that it was no longer scarce, nor was it a realistic store of value, the “value” crashed. See Tulip Bud Bubble
2. Facilitate as a medium of exchange
   • The agreement that $10 will get me 2 dozen eggs and the person I gave the $10 can then use that $10 to purchase anything he wants within his purchasing power. People will accept currency. If you tried to pay for 2 dozen eggs even with $20 worth of GOLD, most vendors will give you a second look.
3. Unit of account
   1. Now we can price things in dollars, much easier than trying to determine how many T-shirts it costs for me to purchase 2 dozen eggs.

Here is (a brief) history of money.

BARTER SYSTEM

In the “early days”, trade was not facilitated by money, but rather through bartering—the exchange of goods for other goods.

Bartering works as the most fundamental form of trade, but it gets difficult when the person you want to trade with doesn’t want what you have to offer, and vice versa. Let’s go back to the eggs for an example, because I like eggs.

Imagine you approached a chicken farmer and wanted 1 dozen eggs, and you were a sheep farmer who produced wool. However, the chicken farmer has no need for your wool shirts, but rather wants a new cow, which you don’t have. You take your wool shirts to trade 50 shirts for one cow from a friend in the next town over, and you take that cow over to get your eggs. However! One cow ISN’T worth just 12 eggs, and you end up getting 60 eggs instead, a LOT more than you originally wanted. Now you have an excess of eggs that you need to get rid of before they go bad! You end up doing a lot more work than you expected just to get some eggs… That’s the inherent FLAW of the bartering system. 

In the same breath, bartering is how people can trade a paper clip to a house, because when you trade items for items, there is no precise set value. Some people might take 3 eggs for 1 shirt, some might just take 2. When trading items for other goods, without currency as a medium of exchange, the precise value of the goods are not evident, and it’s a lot easier to get a good deal.

COWRY SHELLS

Then came Cowry shells, the first real form of documented currency used as a medium of exchange. Despite the cool factor of trading these shiny shells and hoarding them as a store of value, there was again, an inherent flaw to this form of money. People soon realized the control of the supply of the shells was not controlled. Find a good beach loaded with shells, and suddenly you’re “rich!”

MINTED COINS

The age of minted coins was a good one.

Imagine the ancient civilizations, where you would go down to the local store and have a bag of gold and silver coins, trading a few of them for a sack of rice. Holding those coins also made you feel rich. The inherent problem? It was difficult to hold too much. Not to mention the fact that metal coins are quite heavy.

THE AGE OF CONVENIENCE: PAPER MONEY, E-MONEY, and FIAT

The introduction of paper money backed by physical gold, as well as electronic money and credit cards, added convenience to the equation. Now, all of us can store large amounts of money at bank accounts and carry a little plastic card that contained immense power, but with great power, also comes great…debt.

When paper money became widely circulated in the US, it was backed “1 to 1” by physical gold held at the bank. So, if you wanted to, you could approach your bank, hand over a $10 note, and subsequently receive $10 worth of physical gold, on demand.

The Federal Reserve could not “create” more money than it had in gold, held at the banks.

1928 US $10 Note with GOLD CERTIFICATE

Slowly, the Federal reserve instead of backing their bank notes with a 1:1 ratio currency to gold, held only 75% in gold, then 50%, then 30%, until the fateful day of 1971, when Richard Nixon took the US dollar off the gold standard. What this meant was that now the Federal reserve could “create” as much credit and money as they wanted to, without dependency on how much gold that the US banks had in reserve.

This essentially created the current dominated system of fiat money. Fiat, derived latin means “Let it be.” Thus, our currency, our money, has value because, as mentioned above, our society has attributed value to it.

“Let this $10 note be worth X amount of eggs because we say so”

Now, instead of going to the bank and exchanging a $10 note for $10 worth of gold on demand, you can now approach a bank, give them a $10 note, and they will hand you back the note, give you two $5 notes, or 40 quarters, if you wish.

2008: Enter Bitcoin

Post 2008 financial crisis in US, a whitepaper titled “Bitcoin: A Peer-to-Peer Electronic Cash System” was released by an anonymous person or party by the named of “Satoshi Nakamoto” on October 31, 2008.

Let’s look at the qualities of Bitcoin.

Bitcoin is peer-to-peer (I can send to anyone), anonymous (people won’t be able to see that I spent X Bitcoin), and decentralized (not regulated by a central bank). Bitcoin is a type of cryptocurrency. Cryptocurrency is an encoded digital currency, “artificial gold”, with blockchain as the underlying technology.

A Brief introduction to Blockchain:

Blockchain, or Distributed Ledger Technology (DLT) is a system for facilitating transactions by verifying, validating, and replicating data for relevant parties to view by solving complex questions with computers and databases (called “mining”). Transactions are recorded often on a private or public ledger that is widely distributed, so everyone can see that the transaction is authentic. Think of it as a shared Google Document. As transactions are made, relevant parties add the transactions to the Google document. Prior recorded transactions cannot be deleted, and even if they are. When people add on to the document, people can see who edits it, as well as see past versions of the Google document. Blockchain creates trust through this type of system where everyone can unanimously agree that this single ledger is updated and verified.

So how does Bitcoin fit into the system of money? Let’s review.

1. Can it be used as a medium of exchange?
2. Can it be a store of value?
3. A unit of account?

Bitcoin adoption as a means of payment is steadily increasing, particularly jumping this past year. More and more vendors are accepting Bitcoin as a means of payment. Here in Singapore, I currently work at “R3”, a financial services company that developed the DLT platform “Corda.” Right down the street, there is a cafe that accepts Bitcoin and other cryptocurrencies as payment, and also has a Bitcoin ATM where you can purchase Bitcoin right on the spot.

However, right now, using strictly Bitcoin as a means of payment will not get your very far in life.

What about as a store of value? Well, there’s no lie: Bitcoin has been the fastest increasing asset since 2008. If you put in just $10 into Bitcoin back in 2009, you’d now have well over $1,000,000 worth of Bitcoin as of May 10th, 2018. If you sold at the all-time high of nearly $20,000 back in December 2017, you’d have almost double that. In the past year alone, Bitcoin has increased in value by 400%.

Coinbase Chart

However, as a store of value, you’d generally want to own something that retains value over long periods of time, such as gold. You want to feel safe knowing that the price won’t plummet. Bitcoin, since January 2018, has lost 50% of its value. The price is incredibly volatile, and so with great % returns also comes great risk.

Finally, how does Bitcoin work as a unit of measure?

This is indisputably a “Yes”. Bitcoin can be easily denominated into many fractions. You can buy 1 whole Bitcoin, 0.5 Bitcoin, or even 0.025125 of a Bitcoin.

There are many other inherent flaws with Bitcoin, such as increasing fees as more people use it, fewer transactions processed (vs. Visa), and complexity management, but all of these are being addressed by strong development teams looking to advance the technology. Remember, this industry is less than 10 years old, and the technological development is growing quickly.

Why Bitcoin Works

Now that I’ve addressed the flaws of Bitcoin, much like I’ve noted the flaws of all the other types of money, let me address why Bitcoin works.

Like fiat money (our current system today remember!), Bitcoin has value because as a society, we attribute value to it. Japan has the fastest growing cryptocurrency adoption, and so anyone that is interested in this industry needs to keep an eye on how Japan pushes this technology.

But unlike fiat money, where countries can continuously print and create money, the supply of Bitcoin is fixed. Although this is a bit hard to explain exactly why, just know that there is a limited supply of Bitcoin. 21 million, to be exact, with 17 million currently in circulation. More Bitcoin is “mined”, or added into the supply as more transactions with Bitcoin are verified. If you ever “lose” your Bitcoin, it can’t be recovered and cannot be replaced. The 21th million Bitcoin is said to be added to the supply around 2140.

This scarcity of Bitcoin is great for many reasons. It means that as a store of value, it has a necessary quality: limited supply. “Saving” paper currency doesn’t make sense because the longer you hold your $100 bill, the less you can actually buy with it, as more “money” is added into the supply, your $100 bill will slowly become less. This is why inflation exists, and both Canada and US target a 2-3% annual inflation, meaning your $100 will also contrastingly lose 2-3% of its value every year. Even gold, although often hailed as the perfect store of value, can “crash”. What if suddenly an asteroid strikes Earth, which contained large amounts of gold? Basic economic theory teaches us that when supply increases, demand and price will decrease. If everyone owns a gold chain, it’s not as valuable anymore. The novelty of being the only guy on the street who has a gold chain is taken away and owning gold items won’t make you seem as cool. With scarcity also means that the value of Bitcoin, granted that demand slowly increases, will also steadily increase.

Bitcoin is great in that it is digital, fast, peer-to-peer, and decentralised. Back in November of last year, I sent thousands of dollars worth of Bitcoin internationally to my mother (in Vancouver) while I was at Villanova through the Coinbase app on my phone. All I needed was her personal wallet address (account number), and without going through any type of bank, Visa, or Paypal, she received my Bitcoin within an hour. Over the weekend. With minimal fees. I didn’t need to go through a bank, nor did I have to wait till the weekend ended. I can access my Bitcoin 24/7, and send it to anyone in the world. Just 2 weeks ago, my mother had to send me US dollars to my bank account so I could pay for my school tuition. She had to wait till Monday, because bank transactions already closed on Friday, and then I had to wait another ~3 business days for the money to be debited to my account.

Now imagine the potential of cryptocurrencies as a form of remittance, migrant workers sending money back home. If fees are low, and transaction speeds are fast, and without the need for the other party to own an account with the bank (as many people living in developing countries don’t have access to financial services anyways), there is a lot of upside potential with the adoption of Bitcoin.

Bitcoin is also “cool”. When you get your first Bitcoin, it’s a novelty. Being able to say you own a part of this fast-moving industry that could potentially disrupt the entire banking and payment system is fascinating. Not to mention that you now own a fraction of the 21 million limited supply of Bitcoin. No one can take that away from you. YOU OWN YOUR OWN BITCOIN. Unlike the currency we currently use, the central bank can confiscate and regulate your money. You ever have your own debit card declined? That has honestly been one of the worst feelings because Wells Fargo is essentially telling me that I can’t spend my own money. Absurd!

Bitcoin’s potential is combining the best of fiat money, digital bank accounts, and paper money, the 3 systems of money we currently use. So, like fiat money, Bitcoin has value because society attributes value to it. Like holding a bank account or having a debit/credit card, your Bitcoin is “digital” or “in the cloud”, so it’s a convenient way to hold, send, and receive your currency. However, like physical paper cash, Bitcoin is anonymous and unregulated. People like to use cash because it’s fast, and no one can regulate or stop you from spending it. You can go to any store and purchase whatever you want (granted you have enough Bitcoin), without a bank having to verify your transactions. You won’t get your Bitcoin declined by Wells Fargo, because you own your own money. It’s also anonymous (which has numerous good and bad qualities. One of the biggest criticisms seems to be that Bitcoin is used for illegal transactions, but if that is your primary reason for not supporting Bitcoin, then you must also not support $100 bills, which most contain traces of cocaine).

“I have invested in Bitcoin because I believe in its potential, the capacity it has to transform global payments is very exciting.” – Richard Branson (Founder of the Virgin Group and Billionaire investor)

“Bitcoins are the most important invention since the Internet itself. They will change the way the entire world does business.” – Roger Ver, (early Bitcoin investor)

“There will be a future where people will use Bitcoin, and they won’t even know they’re using it.” – The Winklevoss Twins (early investors in Facebook & Bitcoin)

“The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts.” – Satoshi Nakamoto (Founder of Bitcoin)

“Cryptocurrency is such a powerful concept that it can almost overturn governments” – Charles Lee (Creator of Litecoin, ex-Director of Engineering at Coinbase)

“I like it” – Jeff A. Wang (the person writing this post and might have no idea what he’s talking about)

Bitcoin Adoption

The largest hurdle for Bitcoin right now I believe is adoption and awareness of the potential that exists. In my class of 13 business students at Villanova, I was the only person to own any Bitcoin. I asked several of my friends if they knew anything about Bitcoin, and all of them replied “no.” Most of them have never even heard of the term “Blockchain”, which, if anything, has more potential than Bitcoin as a platform. Think of blockchain as the internet, and Bitcoin as one specific website, maybe like Amazon. Although Amazon is the greatest website, much like how Bitcoin is the dominant cryptocurrency, the “internet” (blockchain) still controls everything as the platform. If the internet doesn’t exist, neither would Amazon.

Wide adoption and awareness of Bitcoin solves many of the inherent red flag issues of Bitcoin.

If more people accept Bitcoin, than the better medium of exchange Bitcoin becomes. The very definition of currency is the usability as a means of payment. If people don’t accept Bitcoin for your eggs, than it’s not that great as a functioning currency.

If more people adopt Bitcoin as a store of value, much like we have done with gold, than the price volatility decreases. Instead of people mass buying and subsequently mass selling their Bitcoin, causing the price to fluctuate, we simply hold and store it as value. I mean, you don’t see mass people getting rid of their gold bars at the open market; people want to hold their gold, expecting it to rise in value. It is a society mentality.

If more people begin to understand blockchain and Bitcoin, even at a basic level, more people will be keen to use it. Not many people truly understand the internet, but at its core, the internet is a network of networks, much like what blockchain and Bitcoin is trying to accomplish. Those who do understand it can help grow this industry both at an adoption level as well as a technological level.

If you’d like to join this network, do not hesitate to get in contact with me. I am only 18, and still learning about this industry myself. I do not claim to be an expert, and I hope that those who finish reading to this point also get the feel that I am not trying to impose myself in any way, but rather explain the fundamentals of money in the way that I see it. There are many benefits of the current money system we have right now, but likewise, there are many flaws. What I believe Bitcoin and the cryptocurrency industry is trying to accomplish is to simply improve on what we have. Humans constantly seek improvement. Different people will disagree and I expect that. The most important aspect as I mentioned is adoption of blockchain and Bitcoin, and everyone starts with 0 knowledge. To some people, I may sound like a genius; to many other experts in this industry, I sound like a bumbling baboon. But to advance this technology, we need new ambitious people, regardless of expertise, to join this network of networks.

I want to finish by saying a disclaimer, I do own a good amount of Bitcoin and Ethereum (another type of blockchain and cryptocurrency) and several other cryptocurrencies, as I do believe that the potential is very possible. I may also be biased about the future of blockchain, as I just spent 2 months working for one of the top FinTech companies focused on adoption of this technology. However, I do believe that right now, we all the opportunity to take part in changing an entire industry. Much like with the advancements of AI, self-driving autonomous cars, drones, robots, blockchain and cryptocurrency has now been added to that list.

I will end by saying a few prediction statements (holding myself accountable and will be fun to look back at this post!)

1. Blockchain will disrupt the financial industry and the way that global trade is conducted within the next 10 years.
2. Cryptocurrency will continue to exist in the next 10 years. Bitcoin will surpass $20,000 by 2025.
3. Ethereum will surpass Bitcoin in market cap by 2025.
4. Many large tech companies such as Amazon, Facebook, will all have their own blockchain development team by 2020, if they don’t already have (I presume that all three of these companies are exploring this technology but are not publicly advancing it nor implementing it yet. Microsoft Azure is already partnering with IBM with blockchain initiatives.)
5. China will publicly announce implementation or adoption of blockchain/cryptocurrency in some aspect by 2020.

 

Thanks for reading. To the moon!

 

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I do not offer professional advice, and you should always do your own research before making financial decisions. However, I can share my own experiences and what has/hasn’t worked for me. As always, with any investments in the cryptocurrency space, please tread with caution. This is a very volatile market, and you could one day 10x your money, but you can also lose half of your money just as quickly. In the long run, I do expect a huge uptrend. Be warned about this short-term risk.

If you’d like to start investing in Bitcoin, BCash, Etheruem, or Litecoin, you can’t beat the Coinbase app. It’s simple and great for beginners and advanced alike. If you use this link, we both get $10 free of Bitcoin.

Binance is also a Japanese exchange. Use this exchange if you want to purchase other types of cryptocurrencies (100+!). This is my referral link.

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WTF Explanation Series:

• WTF is Compound Interest?
• WTF is an ETF?
• How the F do I start Investing?

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Disclaimer:

I am not a professional financial advisor or planner as much as I’d like to be. All thoughts on the DTF Website are strictly my opinions unless otherwise stated. I understand there may be errors in my writing. My articles are not meant to be offered as professional advice, as I am currently learning a lot about finance myself. Please always do your own research and due diligence when it comes to financial decisions. Money is very important! I may own some stocks discussed in this article.

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