First and foremost, the purpose of this article is not to give any advice regarding the validity of investing in Bitcoin. Rather, the purpose is to provide you with a digestible article about what bitcoin is, what is block chain, does bitcoin have value, etc.
I’ve spent a lot of time in Las Vegas over the years where I have done a lot of different seminars and meetings. I am not a gambler but I do know enough about it to know that those little wooden chips that people use while they are at the tables are as good as money. If you try to touch somebody’s chips, you could easily lose a hand. This is kind of odd when you really think about it. Little wooden toy chips are so valuable??? After all, for somebody to manufacture those wooden chips, it’s easy and one can make an endless amount of those wooden chips for almost nothing. If we were to go back before casinos even existed and think that little wood chips could have value, similar to money, it would be difficult to understand. However, today when we look at those wooden chips, it is 100% reasonable because we know that there are checks and balances that have been put into place to ensure that those chips are just as valuable as cash. The main attributes that those “checks and balances” provide in order to make those little wooden chips as good as cash are:
- Scarcity: there is not an unlimited amount of chips. The casino only issues chips to the gamblers based off the amount of cash the gamblers pay for those chips.
- Divisibility: there are many different dollar amount sizes of chips that allow anybody to bet with them. Conversely, if the casino only issued chips in $100,000 denominations, the amount of people partaking in the gambling would be extremely limited.
- Easily Exchanged for Value: the casino guarantees that if you want to cash out and “exchange” your chips for cash, you can do that.
Although a valid currency (whether the US Dollar or Bitcoin) depends on more things than the above three bullet points, the simplified example of casino chips is a microcosm of the issues that consumers and policymakers analyze when they assess bitcoin. Lets discuss.
What is Bitcoin?
Bitcoin is not anything physical. Bitcoin is basically a balance that one has on a virtual ledger – known as a “blockchain”. Some may get confused about the terminology “Blockchain” but the logic around the terminology is this: The data that is on this “Blockchain” ledger is posted in “blocks” that get chained together – like how your bank statements show all of your transactions chained together in a chronological order from top to bottom, or vice versa. This blockchain’s entries are decentralized (not controlled by any one person or government), are transparent, and are irreversible. The system cannot be cheated by anyone.
Now, because of the lack of physical presence, some may dismiss Bitcoin as something that doesn’t really exist. I would argue that there are many things in life that cannot be seen and touched that have value. For example, if my best friend were to give me a promise that he will pay me every year $10,000, that promise is worth something to me! Even if it has no “physical value”. Bitcoin can certainly be viewed as more than a “promise” by somebody. Again, Bitcoin is a stored value that you own that is on a public/decentralized ledger.
How does one get a Bitcoin balance on that ledger? You either paid cash for it, sold property for the Bitcoin (like you would sell something for cash), or you “mined it”.
Without scarcity, you have no value in the Bitcoin. As an example, I played a game with my two kids where I gave them each a piece of Starburst candy. I told them to pretend that each of those Starbursts were as valuable as a large gold nugget and they can trade with one another their belongings by using that Starburst as currency. That one Starburst that each of them had was hugely valuable to them!!! Matthew could buy basically everything that Seth owned with that one Starburst because it was “scarce”. What did I do next? I dumped out the entire bag of starbursts for each of them to split. Do you think that Matthew and Seth any longer viewed any one Starburst as a scarce “gold nugget”? Nope. They each had all that they needed and therefore one little Starburst alone that Seth owned would not buy anything of Matthew’s!!! That is called inflation.
By the way, the “Starburst effect” is why many are concerned about our country’s spiking money supply. Some would say the government has been dumping out bags of Starbursts for decades. Chart below.
Back to Bitcoin… If Bitcoin was not “scarce”, then it would not have value. Bitcoin is indeed scarce. As a matter of fact, the supply of Bitcoin will never be more than 21 Million Bitcoins. A lot like the dollar when the Gold Standard existed prior to 1973, there is only a set level of Bitcoin that is available. It cannot be created out of thin air which can erode the value of the Bitcoin – like in my Starburst example.
We will not get into the semantics of “mining” of the Bitcoin, but there is currently almost 19 million bitcoin in circulation, with a little over 2 million left to be mined. Almost all of them are expected to be “mined” by 2140.
The key takeaway here is, there will never be more than a set number of Bitcoins, which follows the logic of the “Gold Standard” – where the dollar was pegged to Gold. As a matter of fact, some pundits are calling Bitcoin “Gold 2.0”. And of course, the limited quantity of Gold as well as Bitcoin is why many folks will use both as an inflation hedge as we continue to dump Starbursts out.
You may be asking yourself a couple of questions. One question may be, “If a Bitcoin is $38,000 today, do I have to buy a whole Bitcoin?” This is similar to the casino analogy of the casino having only $100,000 chips. Nobody would be able to play at that casino unless there was DIVISIBILITY of the chips to lower levels than $100k. So, if you don’t have $38k burning a hole in your pocket, you can buy fractions of a Bitcoin. As a matter of fact, Bitcoin is indeed “divisible” down to eight decimal places.
Another question you may have is, “only 21 million Bitcoins??? How is that enough for the 7 billion people on Earth?”. Again, technically the Bitcoins can be divided up as much as 8 decimal places. This means that if everybody owned .00000001 Bitcoin, then it would take 100 million people to equal one Bitcoin. So, there is plenty to go around.
Easily Exchanged for Value
One of the points of this article is to discuss if Bitcoin has value. Value can be subjective, a lot like how I used the make-believe example of my friend’s “promise” to pay me. When it comes to Bitcoin, I think the answer to that question as of today is, yes. Of course it has value because TODAY you can get value out of a Bitcoin – to the tune of 38,000 American Dollars!
Tomorrow or next month or next year? Very few can answer that question, which is why Bitcoin is not for the faint of heart.
Bitcoin possessing value over the long run depends on several things:
- How easily can Bitcoin be exchanged for goods, services, and dollar bills. Technology like “Crypto-ATMs” are popping up all over. For the fun of it, I did a Google search for “Crypto ATMS Near Me” in Des Moines, IA. Here is about half of the list.
- Oversight and Regulations: Does the government understand the “blockchain” that takes place with Bitcoin? Can the government catch money laundering like they can with cash? Have you ever tried to deposit over $10k in cash into a bank here in the US? There are Anti-Money-Laundering reports that get filed. This same system is not yet in place for cryptocurrencies.
- Legal Tender vs. Property Taxation: Even if you could use Bitcoin to purchase day-to-day items, what about taxes? Currently, Bitcoin is treated like property. If you have ever sold property, do you remember the reporting of how much you sold it for versus how much you had in it? Bitcoin is treated similarly whereas you must report the Bitcoin transactions on your tax return. This is in contrast to the dollar, whereas legal tender (dollar) is not explicitly taxed. This is a big hurdle to making Bitcoin a part of our everyday lives.
- Environmental Damage: That’s right! Bitcoin “mining” uses a huge amount of energy because of the specialized computers that are used. These computers suck an enormous amount of energy. Thus, the widespread adoption of Bitcoin does have a challenge by many environmentalists. You may have seen the CNBC news piece of Malaysia bulldozing the “Crypto-Computers” because the people that used them stole $2 million in electricity to run them. Article HERE.
- Internet technology must be vast in order to quickly process the Bitcoin transactions. This is not as much of a problem for the US as it is for smaller more primitive countries.
Clearly Bitcoin can provide value if large-scale adoption happens with countries, regulators, and policy-makers. However, I believe we have a long way to go yet before Bitcoin is considered “safe” by any account.