A Case for Bitcoin Investment
Bitcoin is a libertarian experiment to create a sound digital money. Sound money is a prerequisite for capitalism, hence I want to see this experiment succeed. With that aim, I purchased very small amount of bitcoin, in early 2017. After riding one boom and bust cycle, I have become convinced of its robustness, enough to suggest upto 5% allocation to this emerging asset. It has successfully become a global speculative commodity, with a key advantage over other commodities for speculation purpose - its supply is rigidly finite. Not only has it become the most widely adopted blockchain, its critical governing rules have become immutable, as demonstrated by the recent failure of miners to increase block size so that they can have more transactions, and hence more fees for them, at the expense of increasing data space requirements for Bitcoin nodes. Therefore we can confidently say that it is now beyond the control of any single authority and its monetary policy is now set in stone, unlike other cryptocurrencies which are decentralised only in theory, but are controlled by a small team of developers and miners working on them.
But it is not a sound money yet. The most important property of money is its salability, it must be a commodity which everyone is willing to accept in exchange for their good or service. But due to its volatile nature, not many would want to hold bitcoin. Even if they are made to exchange their product for bitcoin, they will immediately dump it for fiat money. As such, there is no monetary demand for bitcoin, there is only speculative demand, and hence my rationale to limit the initial allocation to 5%. Rather, Bitcoin is a bet on the hope that as its value increases, as more and more people learn about it and purchase it for speculative interests, its value will become more stable, and being a conveniently tradable digital asset, it could become a unit of accounting for global trade, and a store of value, a reserve commodity, like gold. That is when its monetary demand will emerge and replace its speculative demand.
Decentralisation and fixed monetary policy are its most important features, which make it possible candidate for sound money. Since fiat currencies supply is determined by central banks, who eventually end up abusing their power and pump its supply to meet politicians promises, therefore debasing the currencies value and eroding the wealth of savers. If such a sound money alternative is available to savers, they will dump their currencies for bitcoin, and unlike gold, bitcoin cannot be forcefully seized.
But decentralisation also has its costs. Blockchain requires every node to maintain a copy of transaction ledger, which makes it very inefficient to scale. This inefficiency of blockchain technology makes it unsuitable for any application which requires a trusted third party, for example someone to enforce smart contracts in real world, because such application can be run more efficiently with a centralised solution by the trusted party. It also makes it nonsensical to have corporate or nation backed cryptocurrency, because if it is based on the trust in some corporate or nation, they might as well run a centralised payment processing system, as it will be much faster and cheaper. The only application of blockchain is to create a decentralised digital asset, whose value is not tied to any physical asset or institution, but is derived from its blockchain network, and at present bitcoin is the only truly decentralised blockchain.
With limited transaction capacity and high transaction time, blockchain will be suitable only for recording high value transactions. It will never be suitable for small transactions like buying coffee. We will still need trusted institutions to process such transactions instantaneously, however it is possible for these institutions to club these small transactions and use bitcoin blockchain for settlements and maintaining their overall balances. At present that seems to be the direction Bitcoin is taking with the development of lightning network to process payments off chain backed by the balance maintained on chain. With time, we can expect more such second layer applications built around using the first layer of bitcoin blockchain.
For more on understanding the need of sound money and economics of bitcoin, I would recommend reading “The Bitcoin Standard”.