If Bitcoin becomes expensive and popular in future, should I buy some now?!

This post is a response to a question posed to me by a PhD student: Everyone seems to be predicting that price of Bitcoin will increase by a lot in the coming years and it will become popular. So should I buy some (accumulate) now?

|amp|

To answer this, let us discuss the economics surrounding bitcoins or cryptocurrencies in general. This is my 4th Bitcoin post. Previous posts are:

Three Reasons to avoid Bitcoin or any other cryptocurrency

|amp|

Bitcoin: Is it a Ponzi Scheme? A Pyramid Scheme? Or a Bubble?

Investing in Cryptocoin vs Trading in Cryptocoin

So my stand ought to be obvious: Do not “invest” in a currency, “trade” if you must and know what you are doing. If you are bitten by the crypto bug use it to fund dreams (not serious goals) – buy that i10 or that DSLR you always wanted from the gains.

Please remember a 500% return need not mean a lot of money. If you want to make a lot of money, you must be willing to “put in” a lot of money. Investing in crypto without understanding the basics of asset allocation and how to calculate it is like walking on a wire without training and a safety harness.

If you are a Bitcoin/crypto lover, do me a favour: Share this and/or the above posts in a popular cryptocurrency Facebook/Whatsapp/Telegram group and point out how stupid I am. Thank you.

Reactions to bitcoins are extreme (reactions to everything seem to be that these days). Most of the haters do not understand the technology and call it a scam. To me, most of the lovers seem to be intoxicated with the returns. Hard to differentiate a brag from fact from holier-than-thou.

I owe it to myself and my training and of course to you, the reader to be neutral with regard to cryptocurrencies. Extreme pessimism and extreme optimism can only mean ignorance – of risk or underlying tech.  Reactions to my previous Bitcoin posts have been along expected lines: “you don’t know what you are talking about”.  I am too old and too tired to react to such nonsense. I am more than happy to learn and will be first to acknowledge that I am wrong, but I need facts, and explanative opinions.

To reiterate, this is a post about bitcoin economics.

Before I sat down to write this, I got a 100 g slab of Amul unsalted butter for Rs. 47 from my neighbourhood supermarket. If that establishment were to accept bitcoins today, I would have (if I had any) paid 0.00013129 Bitcoins.

Now fast forward 20 years from now and assume butter will still be available and that the Rupee will still be around (will it?). At a conservative 10% inflation, the 100 g slab would cost about Rs. 316. Since Bitcoin is the future, we must not ask stupid questions like, “will Bitcoin still be around (in its current form)” and must assume it will be around and popular. So the question now is, “how much will the butter cost in Bitcoin, 20Y from now?”

The method to calculate is obvious – we just need to know the then INR-bitcoin exchange rate.

Now, we should be able to afford 100 g of butter 20Y from now in INR and therefore should be able to afford it in Bitcoin too.

My point is, if we view Bitcoin as a currency then the answer to:

 

If Bitcoin becomes expensive and popular in future, should I buy some now?!

is NO – you don’t need to. Bitcoin is only a piece of code that three parties must agree as valid – you the buyer, supermarket the seller and the “miners” who will validate the transaction for a fee.

Seen as a currency, Bitcoin has no value other its face value. A Rs. 500 note is more worth than Rs. 500 (unless you hold antique notes).

If we view Bitcoin as an investment then the answer to:

If Bitcoin becomes expensive and popular in future, should I buy some now?!

Can only be speculation as the question itself is one of presumptive speculation (sorry Pankaj 🙂 ). Well to be fair, there is some intelligent guesswork involved behind projections that Bitcoin will soar in the future.

The nature of Bitcoin

To understand why, we must consider the nature of the currency. Bitcoin is a child of disgust. It was born as an alternative to government-controlled currencies which can be printed at will and which no longer have an underlying asset value (in gold). Gold was deemed too inconvenient under conditions of economic disasters because it would prevent governments to print more money.

The currencies we use every day are inflationary in nature. That is, as goods become more expensive, we can only buy lower and lower amounts with the same denomination. Such a price inflation (at low levels) is essential to keep the economy running. Without inflation, there will be no incentive to lend money and borrowing will become expensive as there is no time value of money at play (EMIs decrease in value due to inflation)

Under extreme economic conditions – eg. hyperinflation or hyperdeflation, governments can increase or decrease the quantum of currency being circulation to restore normality. Bitcoin is based on the idea that abrupt/manipulative changes in currency volume is harmful and should be eliminated.

Therefore the number of total bitcoins that can be produced were limited to 21 million. This however meant an initial rapid increase in no of Bitcoins and decades of gradually slowing supply. Within a year of introduction 1 million Bitcoins were introduced!

total bitcoins - If Bitcoin becomes expensive and popular in future, should I buy some now?!
Source: blockchain.info/charts

Here is an interesting read on what happened to the Spanish economy due to a sudden influx of gold! Note that this does not apply to Bitcoin.

Why are Bitcoin investors confident?

The idea is if the total no of Bitcoins is limited, as demand increases, the Bitcoin value will increase. This is why Bitcoin investors sound so sure of themselves and welcome it with a chuckle each time a new party wants to transact in Bitcoin. As more people join the party, Bitcoin price is expected to soar.

So that it is it then? Should I drop everything and buy some bitcoin?

Hang on a bit.

A world with only Bitcoin

Imagine a world with Bitcoin as the only currency, our monthly salaries will not increase each year. Well, it need not increase as there is no inflation. The cost of goods will also remain the same. So will the cost of manufacture and profits.

With the same salary, we will be able to maintain our standard of living. Since the demand for goods will not drop, there will be an incentive for manufacturers to maintain production.

In order to maintain production, they will have to borrow capital. Since there is no inflation, the interest rate can be zero. The lender is also not deprived because there will always be people to give money to. As I mentioned before, it is a perfect form of communism. Everyone will live happily ever after.

If wars and human greed are thrown into the mix as possibilities, then this smooth cycle will get disrupted. How will a Bitcoin society handle that?

Is there a flaw in this picture? There could be, I am not an economist. If so, please correct me.

Even if flawed, there is one underlying assumption here which cannot be wrong: For people to be paid salaries, for them to purchase goods; for manufacturers to borrow and lenders to lend, there must be a free movement of Bitcoin. This is, of course, a necessary requirement of any currency.

A real currency: The situation in India

Now consider for a moment the situation here. According to an RBI press release dated Oct 11th, 2017, as on Oct 6th 2017, the currency with the public is 51.8% of the total reserve money.

|amp|

The currency in circulation = currency with public + total deposits with RBI  is 75.90% of the total reserve money. This is how liquid “real money” ought to be! See RBI definitions here

Would you believe that re-monetization abruptly removed about 86% of the currency in circulation as legal tender! Regardless of that being a failure or a success, we should be proud of each other, proud of the nation that we weathered that storm without panicking and revolting.

The trouble with Bitcoin

Bitcoin is an awesome idea and it will work in a world without human beings. Be it banks, corporations or the government or Bitcoin investors, there are Humans all round and they will muck up things one way or another.

According to Bitcoinprivacy.net,

There are 1,593 addresses with more than 1000.0 bitcoins, totalling 6,351,331 BTC, 38% of all existing bitcoins.

Two addresses have BTC >100,000

Another 116 addresses with BTC > 10,000

The remaining 882 addresses in the top 1000 had BTC >1,000

So clearly it is a case of few holding many. Is this a case of human beings exploiting a well defined algorithmic feature (limited coins => increase in demand = increase in price)? Or is a case of early miners holding most of the early coins knowing that their reward could drop and mining will become difficult in time?

While for a normal currency, regulation is centralized and holding is decentralized, for Bitcoin, as on date, regulation is decentralized and holding is fairly centralized.

A reasonable guess is that these guys expect the price to shoot up (and it has) as demand increases. So they are probably waiting to make a killing. Or they are Bitcoin idealists who prefer to transact only in a Bitcoin world. Or maybe they like the idea of buying drugs easily?! Your guess is as good as mine.

Bitcoins returns - If Bitcoin becomes expensive and popular in future, should I buy some now?!
Created with https://imgflip.com/

One thing is clear: Bitcoin was designed as a Peer-to-Peer Electronic Cash System. If you see Bitcoin forums, the “investors” argue that it is a commodity + currency and not a currency. I would like to think that the lure of returns has distorted the goal of bitcoin. After all, where there is a human, there is greed.

The biggest enemy of Bitcoin is not the Bitcoin hater, not the Bitcoin transactor, but the Bitcoin hoarder – make that hodler. HODLing is the new slang for hoarding.

For a currency to be successful, liquidity is essential – trillions of dollars are exchanged each day!

Bitcoin holding pattern cannot be so centralized if we want to buy regular stuff with it. How this holding pattern changes as the number of transactions increases will determine how successful Bitcoin works as a currency. As its value increases, new entrants will buy lesser and lesser units of Bitcoin (called Satoshis).

Then there is the thought of Wall Street wanting a piece of the Bitcoin pie, or in other words, large sums of a deflationary currency being purchased with an inflation currency make me quite uncomfortable. It feels like a trap!

Just before publication, I came to know of Aswath Damodaran’s viewpoint on Bitcoin:

The Bitcoin Boom: Asset, Currency, Commodity or Collectible? In this, he argues

bitcoin is not an asset, but a currency, and as such, you cannot value it or invest in it. You can only price it and trade it.

The Crypto Currency Debate: Future of Money or Speculative Hype?

Crypto currencies, with bitcoin and ether leading the pack, have succeeded in financial markets by attracting investors, and in the public discourse by garnering attention, but they have not succeeded (yet) as currencies.

Any resemblance to my viewpoints is purely coincidental and accidental!

There is one issue I would like to disagree upon: He says Bitcoin supporters think of it as a currency and detractors think of it as a collective. I think that the evidence suggests that many supporters think of Bitcoin as a collectible and as currencyThat is, they perceive value in holding it.

My Stand

Just to reiterate, I strive to maintain a neutral stand as it the only way to learn more about fascinating blockchaining without bias.

DMuhSZwUQAASXYm - If Bitcoin becomes expensive and popular in future, should I buy some now?!

Source:  World Economic Forum: 5 questions about central banks and digital currency

I am not against Bitcoin. I think it is secure, solid technology and has the potential to revolutionalize the way we transact. There are better alternatives like Ethereum available too. I am not against Bitcoin trading either.

I am against Bitcoin hoarding: buy and holding as much as possible so that it can be sold when 1BTC = 1 Billion USD. That, I believe can (and has?) muck(ed) up a wonderful idea. There is still chance that some form of crytpo may turn out successful as a pure currency.

Which bring me to: If tomorrow, 1 BTC = 1 Billion USD and liquidity is reasonable, volatility will come down dramatically and therefore so will returns. You can still buy BTC. Just that 1 Satoshi will cost 10USD.

How will the miners behave?

I have always felt that there is something off about mining.  There is always cost involved in every model. If the cost of inflationary currencies is manipulation by governments and banks, what is the cost of decentralization?

I will place my money on the cost of mining and validating transactions. Already there are articles about how unprofitable bitcoin mining is and then there is this: The electricity required for a single Bitcoin trade could power a house for a whole month.

It is my insignificant opinion that the cost of decentralization could well be the Achilles heel of decentralization.  The incentive to ratify transactions should be money and not creating new money! When the supply dries up in one currency, the already rich miners could either call it a day or shift to a newer currency. The entry cost for new miners would then too high.

This control that miner can and do exert is a possible danger and couple with hoarding can prevent Bitcoin from ever realizing its true purpose (if ever there was one).

If a crytocoin enthusiast has bothered to read up to this point, your opinion please: the model of Ripple seems to be much better suited as a currency than as an investment. Ripple has a model in which some amount of coin is destroyed as a fee in each transaction. It is, however, a centralized currency and therefore trust will be lower.

Forget all this blah blah: should I invest?

Many readers may prefer to scroll right to this section. Well, if you are regret-monger and feel bad when your friends or contacts talk about the returns that they have made, buy some crypto for the sake of your health and peace of mind. If you are going to buy fractions of a cryptocoin (say BTC, ETH) it really means nothing to your wealth. If you are going to buy whole units of those (even gradually), then I hope you understand what you are doing and what you are getting into.

Hail Hydra!
1ry3cu - If Bitcoin becomes expensive and popular in future, should I buy some now?!

I welcome criticism with an explanation of where and how I am wrong. Will not take blanket statements seriously.

 


Also published on Medium.

Create a "from start to finish" financial plan with this free robo advisory software template


Free Apps for your Android Phone

Install Financial Freedom App! (Google Play Store)
Install Freefincal Retirement Planner App! (Google Play Store)
Find out if you have enough to say "FU" to your employer (Google Play Store)

About Freefincal

Freefincal has open-source, comprehensive Excel spreadsheets, tools, analysis and unbiased, conflict of interest-free commentary on different aspects of personal finance and investing. If you find the content useful, please consider supporting us by (1) sharing our articles and (2) disabling ad-blockers for our site if you are using one. We do not accept sponsored posts, links or guest posts request from content writers and agencies.

Blog Comment Policy

Your thoughts are vital to the health of this blog and are the driving force behind the analysis and calculators that you see here. We welcome criticism and differing opinions. I will do my very best to respond to all comments asap. Please do not include hyperlinks or email ids in the comment body. Such comments will be moderated and I reserve the right to delete the entire comment or remove the links before approving them.

6 thoughts on “If Bitcoin becomes expensive and popular in future, should I buy some now?!

  1. Also, with Quantum Computers around the corner, I wonder if the SHA-256 encryption used currently will be able to hold up against a brute-force attack.

  2. “When the supply dries up in one currency, the already rich miners could either call it a day or shift to a newer currency.”

    Yes, they can always do that and satoshi knew it would happen and that is why the difficulty adjustment algorithm is built-in. As more and more miners join in mining, the difficulty keeps increasing and after a point of time, mining will become unprofitable as costs are too high at which point, some miners will drop out and the difficulty will adjust itself downwards and lower the costs to make mining profitable for everyone. Mining was never meant to be a get rich quick scheme. However given the costs associated with Proof of Work, it is entirely possible that Bitcoin may switch to Proof of Stake in future if the majority deem it necessary as Ethereum will be doing soon.

    The beauty of Bitcoin lies in the fact that it is not under anyone’s control. Nobody can create more Bitcoins on their whims and fancies and neither can anyone change the algorithm without majority consensus. Infact it is even better than democracy as the minority voice is not ignored as it happens in a democracy. If a minor section of people do not agree with how Bitcoin works, they can fork it and make their own altcoin but of course it will have lower value due to lower demand.

    I believe this centralized control that the government has over the monetary supply has to stop. We cannot allow the government to print money whenever it pleases or demonetize notes whenever it wants and cause mass inconvenience to people. Printing money out of thin air is akin to making everyone poorer without actually taking money out of your pockets. This is legal robbery. People are being pacified with higher salaries but it is merely an illusion as the higher salary is negated by rising price of goods and services. High inflation rate is a constant struggle and it encourages people to live in debt by borrowing money rather than save money and live within their means. Look at where the American economy is and this is the path we are heading towards. Very soon we will all be living in debt and will be at the mercy of our banker overlords. This is what the government wants.

    “There are 1,593 addresses with more than 1000.0 bitcoins, totalling 6,351,331 BTC”

    I also want address the issue of early investors holding a lot of Bitcoin. I am sure you agree with the risk vs reward fundamentals right? It applies to every financial instrument and Bitcoin is no different. People who invested when Bitcoin was $10 were taking on an enormous amount of risk. Did they know Bitcoin would be successful back then? No, but they took the risk and I believe they deserve to be rich because of that. Obviously people investing now are taking far lesser risk as Bitcoin is proven and will get far lesser value. Similarly, people who invest 10 years later will get even lesser value as their risk will be non-existent. You can very well invest $100k in some random coin today with just $100k market capitalization and become a billionaire if it takes off but you won’t do that since the risk is too high. Bitcoin was in the same spot in 2008.

    We all have our issues with the 1% ers who have all the money in the world, like the Ambanis and Tatas. Bitcoin will be no different in that regards and it’s wrong to expect that. Bitcoin was never created to solve the inequality that exists in society. It does not promote socialism.

    I also believe that Bitcoin can finally put an end to the ridiculous overhead costs that the baking industry has imposed on us by slotting themselves in as the middle men. Just think of the trillions of dollars in fees spent every year on overseas remittance and foreign exchange fees. Then add to that the 2% merchant fees that goes to the bank on every purchase via cards. Bitcoin has no such overheads. I believe developing countries and underdeveloped countries stand to benefit a lot out of Bitcoin because their fiat currencies are unstable. People of Venezuela, Zimbabwe, Greece and many other countries have been financially ruined due to their worthless fiat currencies. Bitcoin as a global currency can not only help these countries but also prevent such destabilization from happening in future.

    I think the benefits of Bitcoins and other altcoins are too many to ignore at this point. Bitcoin is a response to the global recession we suffered in 2008 thanks to the bankers, which devastated people financially. The wheels have been set in motion for a better future and there is no going back now.

    Sorry for the lengthy post but I feel it was necessary to write this since you seem opposed to Bitcoin without any rhyme or reason even though it aims to make our lives better in every possible way. The government propaganda machine will try to sway our opinion against Bitcoin in the coming years but I know the truth. Bitcoin is not an investment to me. I support the very idea and premise it is built on and I care about that more than the returns it gives.

    1. Thanks for the lengthy post, but I find it amusing that you found it necessary to write this “since I seem opposed to Bitcoin without any rhyme or reason”.
      How many times should I mention “I am not against Bitcoin. I think it is secure, solid technology and has the potential to revolutionalize the way we transact. There are better alternatives like Ethereum available too. I am not against Bitcoin trading either.”?

      Distribution of wealth is not the same as the distribution of currency!! I have already considered the issue of
      “I also want address the issue of early investors holding a lot of Bitcoin. I am sure you agree with the risk vs reward fundamentals right? ” I have no issue with their wealth. What I would like to see is how Bitcoin behaves as circulation increases (not the same as wealth)

      Let us please not assume every possibility and eventuality about the fate of Bitcoin was already written down by Satoshi!

  3. Nice article. Basically I am already following what you said in the last couple of lines. I have invested a not so-small amount into it, just to get rid of my FOMO. If it fails, I will be sad for few days, and if it succeeds, I will feel good for few days(I won’t become a millionaire). But at least, in the present, I am not stuck at “should I” or “should I not” loop. I have put a hard line that I won’t invest any more now, whether it goes up or down. This gives me a peace of mind, and I can concentrate on more important things. 🙂

Do let us know what you think about the article