Bitcoin (BTC) ★★★★★
April 2020 / John Hermes
Bitcoin is an electronic transaction system that does not rely on trust. The whitepaper for it was published on October 31, 2008 by an individual or group thereof operating under the pseudonym “Satoshi Nakamoto.” It is an electronic cash payment network enabling online payments to be sent directly from one party to another without the necessity of knowing each other or requiring a financial institution as an intermediary allowing for censorship-resistant transactions with low fees.
SIGNIFICANCE: The whitepaper was released during a time when banking institutions were on the brink of collapse and receiving an unprecedented bailout from their governments using freshly created “stimulus” money to stabilize the fractional-reserve banking system.
Being a decentralized peer-to-peer payment network that is completely open-source (anyone can review the code), the Bitcoin network requires no central authority to operate. Its built-in consensus mechanism allows for digital coins to be made of digital signatures, and upon creation they are rewarded to active nodes on the network processing transactions into “blocks” that are then validated by a vote of other active nodes. The clever design of the consensus mechanism solves their ability to be counterfeit, or the “double spending” problem, by providing a public record of ownership on a proof-of-work chain (also known as “blockchain”) containing the entire payment history of the network.
EXPLANATION: The BUYER in the diagram above receives the bitcoin from the SELLER once it has a set number of block confirmations accepted from the various miners and mining pools, and the HACKER attempts to “double spend” the funds that the buyer receives by giving themselves the identical amount with the same ID and timestamp but gets rejected by the honest nodes on the Bitcoin network.
These active nodes are known as “miners” who dedicate their computing power (CPUs) in the process of voting to express acceptance for blocks of validated transactions grouped together to be added to the proof-of-work chain while also rejecting invalid blocks by refusing to work on them due to some conflict. Provided that a node is the first to create a block of transactions with the correct sequential order aligning with both the transactions of the previous block as well as the next going forward with a majority of the nodes agreeing it is the correct order, the winner of that race will receive a “block reward” of a predetermined amount of newly created bitcoin that will be added to the circulating supply.
Bitcoin mining “rig.”
The supply of bitcoin is fixed at about 21 million digital coins, and they are minted on a deflationary basis with less and less going towards the block reward of the miners every 210,000 blocks or commonly known as “halving events.” According to Blockchain.com on January 1, 2020, there will be 18.136 million (86.36% of the total) mined bitcoin circulating on the network with a block reward of 12.5 bitcoins going toward the miners. The number of bitcoins in the reward will fall to 6.25 per block post the next block reward halving next month.
SOURCE: systemic bliss research
*The timing of halving events going forward are estimated under the assumption a block is mined every 10 minutes based on the state of the Bitcoin network and codebase as of April 20, 2020.
Designed to be a deflationary currency by nature, the issuance of new bitcoins decreases over time until approximately the year 2140 when the block reward per block becomes 0. The premise behind this model is centered around a predictable monetary policy with digital scarcity and transparency written into the code governing the network that changes every so often making less bitcoin over time until there is none left. If demand for new bitcoins increases while the issuance of them decreases approaching the hard cap of 21 million, they can appreciate in value and be used as a hedge against fiat currency inflation as their monetary bases increase and debase their value or, in other words, lose their purchasing power relative to bitcoin.
SOURCE: Board of Governors of the Federal Reserve System (US), Currency in Circulation [CURRCIR], retrieved from FRED, Federal Reserve Bank of St. Louis; March 31, 2020. Shaded areas indicate U.S. recessions.
The first halving event occurred at the “block height” of 210,000 on November 29, 2012 with an average price of $12.45 on that day. The second halving event occurred at the block height of 420,000 on July 10, 2016 with an average price of about $577.89 on that day. The next halving event is at the block height of 630,000 estimated to be in mid-May 2020.
SOURCE: systemic bliss research
DATA: BitcoinCharts.com Mt. Gox historical data (7/17/2010 – 4/27/2013) and CoinMarketCap historical data (4/28/2013 – 4/20/2020), shown above logarithmically.
Central banks around the world are employing their own individual monetary policy regimes to fit their nation’s needs, though it is hard to find one that isn’t engaging in “Quantitative Easing” which increases the amount of money that they have on their balance sheet as well as in reserves to encourage lending and investment by simply increasing the monetary base through printing more and more money. Bitcoin instead consists of a global network of miners operating the same algorithm using the same software with same built-in code that decreases the rate at which new tokens are created promoting saving and self-sovereignty by having a controlled monetary base of a total 21,000,000. Money can be counterfeited by criminals or devalued by corrupt politicians risking hyperinflation from printing it into oblivion, but any bitcoin generated by a malicious user not following its strict rules will be rejected by the network and thus be worthless preventing any undue liquidity injections into its market fortifying its monetary base through an antithetical process that should be termed “Quantitative Hardening.”
EXPLANATION: Scarcity can be quantified by SF (stock-to-flow), where “stock” is the size of the existing stockpiles or reserves and “flow” is the yearly production. The model shows bitcoin having a SF similar to other monetary goods like silver and gold that also have finite supplies.
Conventional currency’s root problem the level of trust that is required to make it work, and central banks also must be trusted not to debase their currency yet historically fiat currencies have been riddled with breaches of that trust. Bitcoin’s protocol at its core stands dead set against traditional fiat currencies that are intrinsically inflationary and opaquely managed without any way for the public audit them such as a blockchain. Halving events to the block reward ensure that strong economics will sustain its network for the foreseeable future.
“The Fed and the Treasury are doing everything we can to provide what you’ve described as almost unlimited liquidity.”
Steven Mnuchin, U.S. Treasury Secretary, on CNBC’s Squawk on the Street
(March 13, 2020)
Halvings reaffirm bitcoin’s fundamental value proposition that it is the most predictable, reliable, and trustworthy asset in the world. By not exceeding 21 million coins, Bitcoin is created on a more honest and sound basis than gold, silver, and the United States Dollar which collectively have never been produced more currently or held in such a high proportion on central bank balance sheets relative to their long histories. While miners continue to produce blocks about every 10 minutes, the issuance of bitcoins are set on a more transparent schedule cutting its issuance in half about every four years until meeting its predetermined limit.
CHART: World mined gold production, 1900-2014. Data from United States Geological Survey.
Bitcoin following its historical precedent usually catapultes in price during the year or so after its halving events, and the next one is leading new entrants and users to the market theorizing that it is bound to happen again for its third time. If the amount of fiat money in circulation continues expanding at accelerating rates, I expect there to be long-term effects that ultimately are disadvantageous for world reserve currency values against bitcoin’s which will soon have a lower inflation rate per annum than the Federal Reserve’s mandate of 2% for the United States Dollar and also mined less frequently as well as more predictably than both gold and silver. Bitcoin’s advantages of being censorship-resistant, decentralized, independently verifiable, immutable, peer-to-peer, and a permission-less store of value makes it a form of digital gold with a truly free marketplace reinforced by sound money principles that are unmatched by any other commodity or currency.
The easier fiat money gets, the harder a bitcoin becomes to own.
Ben Bernanke, Former Chair of the Federal Reserve, served two terms from 2006 to 2014. During his tenure, he oversaw the Federal Reserve’s response to the 2008 financial crisis. In the video above, Bernanke speaks to CBS’s Scott Pelley of 60 Minutes about the simplicity of “printing” money for economic stimulus programs without directly costing Americans their hard earned tax dollars.
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