In the past week, I’ve been asked for advice on Bitcoin by my brother-in-law, my local realtor, and close friends from as far away as Texas.
None of them cared to learn what it actually is. Or how it works. They just wanted to understand why suddenly so many folks they know are trying to buy Bitcoin hand over fist. And, of course, should they buy in now, too?
If you (or people you care about) have similar questions, this report is for you.
A Brave New World
Remember the scene from the movie Avatar, where the main character first explores the alien world of Pandora? I found that scene astonishing and beautiful. He’s encountering an entirely new and completely foreign ecosystem. Every element is fascinating and wondrous, even the dangerous elements — yet it all still follows understandable rules.
Everything is involved in either gathering sunlight or eating something else that had. Every niche is filled. Every organism has its own strategy: some light up, some fly, some run, some crawl. As entirely alien as everything is, if you understand the basics of how organisms filled their niches on Earth, you have a great starting point for understanding of the rules of life on Pandora.
Similarly, a great way to begin to understand the new world opened up by Bitcoin (and the other cryptocurrencies) is to realize that it’s an ecosystem that, at its heart, maps neatly into the universe you already understand. A few examples: payments, identity, contracts, verification, and record keeping (ledgers).
As with any ecosystem in nature, a new organism will survive and flourish if and only if it’s more efficient and effective than the prior model. For example, nothing has displaced sharks in the past 425 million years because they’re extremely efficient in their niche. To displace them, a new ocean predator would have to come along that does what they do faster, better, and (energetically) cheaper.
So the operative questions we need to keep in mind when looking at the brave new world of digital currencies are: What problem(s) are they solving?, and, Are their solutions faster, better, and/or cheaper?
These are critical questions to answer. When a new technology is first introduced, all manner of fanciful thinking can cloud people’s better judgment with dreams of easy riches. Think back to 1999: as long as “dot com” was added to the end of a business’ name, it could raise abundant funds to pursue all manner of impractical ideas. How well did that work out? Just remember Pets.com, Webvan.com and eToys.co; all certified capital destroying ideas.
Investors would have benefited from demanding clear answers to these basic questions of these companies before shoveling money into all the dot-com companies that eventually went bust. It would have prevented a lot of perfectly good capital from getting vaporized.
Over the years, Peak Prosperity has presented a number podcasts and articles explaining Bitcoin and the digital currencies. We interviewed with the chief Bitcoin architect in 2013, Gavin Andresen, and have run several lengthy reports on understanding the cryptocurrency boom. These previous works are worth taking the time to read/listen to if you’re looking to deepen your understanding of crypto technology and its value proposition.
As Charles Hugh Smith wrote for us back in January 2017 (when Bitcoin was trading at a paltry $600):
Let’s say a mere 1/10th of 1% of total global financial assets migrates into bitcoin. That equates to a price of $17,000 per bitcoin. That’s quite a rise from its current price of $580.
This is pure speculation, of course; some new scandal could emerge tomorrow that might cut bitcoin’s value in half.
The point is that value is ultimately driven by demand, and demand is driven by utility. As bitcoin’s utility increases in a world of rising financial repression, capital controls and expropriations, devaluations, etc., the demand for bitcoin will likely rise as well. (Note the rise in daily transactions in the chart posted in Part 1.)
And as bitcoin’s stability and valuation increase, the potential for a self-reinforcing feedback loop increases: as bitcoin’s value rises, it attracts more capital, which pushes prices higher, and so on.
That was a very bold call to make. But, just 12 months later, Bitcoin is now currently trading at Charles’ projected $17,000 target.
A staggering amount has happened since we started following this space in 2013. To assess what happens from here, we now need to broaden our understanding of this vast new ecosystem — with all its new entrants — that is evolving so rapidly.
The Bitcoin Value Proposition
So now that we understand how Bitcoin functions I am ready to make this claim: Bitcoin itself does not hold any value. The value in bitcoin is provided by the miners. No miners = no Bitcoin value.
The army of Bitcoin miners require a huge amount of electricity and computing capital investment to run. As long as the costs of running the Bitcoin miners is lower than the value received, then it should persist. But as soon as the puzzle-solving becomes too hard, meaning too few Bitcoin rewards are granted per solved block (currently at 12.5 Bitcoin per block) to justify the expense, then the miners will start shutting down. It’s simple cost/benefit math.
If/once that happens, we’ll begin to see blocks take longer and longer to solve. This will extend and stretch out the time to process a transaction and reduce the attractiveness of Bitcoin to merchants and holders alike.
The only thing that will keep this all working is if Bitcoin keeps increasing in value and if electricity costs do not rise faster than the returns from Bitcoin mining.
So my conclusion here is that a Bitcoin itself has no value. A Bitcoin and an intact and functioning mining operation has value. So to invest in Bitcoin, you should really be familiar with the state of Bitcoin mining, and what sorts of challenges and risks it might face.
A Gigantic Rip(ple)-Off
For anyone interested in getting better grounded in this exciting and transformative world of digital assets such as Bitcoin, Ethereum, and SelfKey, Peak Prosperity is hosting a webinar on the topic with our resident digital assets expert, Mark Rees, this coming Sunday January 7th at Noon EST.
In addition to the promise of this new ecosystem, we’ll also warn folks of its risks — and we see a big one with of the recent crypto darlings: Ripple (coin trade symbol = XRP).
XRP is on an epic bull run. It’s up over 1,000% in just the last month alone, and 30,000% in 2017. It now has a market capitalization of over $120 billion and is now the #2 coin after Bitcoin in market cap. It’s fair to say that practically nobody who is speculating in XRP has the slightest clue about what it is, what problems it is solving, or even how many there are in circulation.
Complicating the story is that Ripple is a company offering a new payment platform to banks and financial services companies, while XRP is a coin they’ve also offered. The platform is called xCurrent and it’s really a glorified messaging platform.
Here’s how that’s doing:
In terms of interbank payments, many people mention Ripple as a promising way to transfer money between banks.
Over the last 30 days it processed two billion dollars (as of this writing) worth of interbank and interpersonal transactions — about 40 seconds’ worth of volume on the SWIFT interbank network — after three years of being available to banks to trade 90% of the world’s high-volume currencies.
This is like the proportion of US GDP comprised by toothpick sales.
Why haven’t banks preferred this new technology? The answer is thatsetting up a Ripple Gateway isn’t actually much different than using the existing corresponding-account system — except that a lost password or security token can lead to much larger and more instant actual losses — which, as a reminder, has happened to more leading bitcoin exchanges than have managed to avoid it.
The same features that make the banking system attractive to end users also make it attractive to banks. They already have ledgers, and don’t need to distribute them, anonymize them, encrypt them, publish them, and make them irreversible.
The associated coin, XRP, has no relationship to the platform. Unlike Bitcoin, XRP does not come into being as a valuable mining operation is performed, they were simply coded into existence by Ripple. How many and where are they?
Many investors new to the cryptocurrency space might not be aware of where all the XRP actually exist. Unlike bitcoin and many other cryptocurrencies, XRP isn’t created on a particular timeline through mining – or the act of securing decentralized networks.
Instead, the 100 billion XRPs (the cryptocurrency’s coded limit) are already available, with most under the control of Ripple itself. Ripple currently controls about 61 billion XRP, although in May (where the price ranged from 5 cents to 41 cents) the company announced it would move to lock up 55 billion XRP in escrow, to be released at a rate of 1 billion a month for at least four and a half years.
So there are 49 billion (with a “b”) XRP coins out there, with another 5 billion for ready use by the company and another 1 billion per month ready to hit the streets. Contrast that with around 16.5 million (with an “m”) Bitcoin out there, and a coded maximum of 21 million once they are all mined.
In other words, there are 3,000 times as many XRP coins out there as Bitcoin, and XRP coins have no mining function attached to them! It’s entirely unclear what their value proposition is here.
But people are afraid of missing out (FOMO) and so they are piling into XRP without any clear understanding of the value proposition. They see XRP going up in price and they want in. In other words, it’s bubble time.
According to people familiar with the space, including the digital asset expert who will be providing the insights at our cryptocurrency webinar, XRP is a useless and therefore worthless coin.
Digital assets are exploding. And they promise to transform the way the world works.
Of course, there will be many twists and turns along the way. There will be big winners and big losers. If you’re interested in potentially putting some of your investment capital into this space, you deserve to be as well educated as you can be.
Given the massive wall of liquidity that the central banks have unleashed, and the increasingly cumbersome and intrusive banking regulations nations have passed, it’s entirely appropriate for people to seek ways to store their wealth outside of today’s grotesquely-mismanaged fiat money system.
However, these new digital technologies are not easy to understand. Remember: the essence of being a good investor is understanding your investments intimately.
It might indeed make sense to simply put a portion, say 5%, of your investable wealth into digital assets. Just make sure whatever amount you invest goes into a carefully selected portfolio — don’t just select willy-nilly from the exploding variety that are out there.
As with any exciting new technology, what we currently have is a rush into the space by hordes of entrants, many of them unsophisticated and simply hoping for a quick buck. That works for a precious few; most simply get burned.
Such is the way of bubbles. People rush in; most get trapped.
But that shouldn’t dissuade anyone who is willing to do the work, develop an understanding of the space and its key players, and determine for themselves the answer to these questions: What problem(s) is (are) being solved?, and, Does this new technology solve things faster, better and/or cheaper?