Bitcoin Cross the Chasm: Libra pushes it over

After 10 years of existence, and having increased in price by a factor of a million or so even while supply increased by a factor of seven, Bitcoin has crossed the chasm. Ironically, Facebook supplied the final push when they announced their Libra plans on June 18th.

Bitcoin’s high value is founded on two very strong attributes: security and scarcity. In addition it is highly divisible, fungible, and easily and rapidly transportable across the world. But there are thousands of cryptocurrencies that have those latter attributes. Yet they each have a small fraction of Bitcoin’s value. In fact about 2/3 of the value of all cryptocurrencies combined ($300 billion, approximately) is found in Bitcoin alone, at roughly $200 billion.

How can the price increase in a decade by a factor of a million even as supply went up? Because hashing rate, that drives up security, has increased even more, around a factor of a trillion. This made Bitcoin much more desirable to hold as a store of value. 

The growth in hashing power for the Bitcoin blockchain, logarithmic scale (Chart from blockchain.com)

Security

Security comes from hashing power applied to the mining process. Cryptocurrency mining via Proof of Work is the most effective consensus algorithm to maximize security for a decentralized accounting ledger. This computational hashing power is in the form of specialized ASIC hardware specifically designed for rapidly calculating the Proof of Work algorithm.

Bitcoin has steadily grown to an enormous 70 Exahashes of hashing power deployed around the world. That is 70 million trillion hashes per second. The hash rate has grown by a factor of 1000 in the past five years, with more mining pool nodes and better hardware. 

The coin with the second position in hash rate, Bitcoin Cash, a clone or hard fork of the original Bitcoin, has only 3% as much hash rate.

There is that much computing power directed toward solving the cryptographic puzzle, and with the winner claiming the current block reward of 12.5 Bitcoins each 10 minutes or so. Some $19 million is mined per day, at the current price of $10,750 thus it is worth throwing lots of compute power into the solution.

Security can be measured by how much it costs to mount a 51% attack on Bitcoin.  It costs around $1 million to rent enough compute power for an hour of mining; this would allow a counterfeiter to double spend, but the value of double spent coins would be less than the rental expense.

A 51% attack would not invalidate ledger entries that contain your Bitcoin received yesterday or five years ago, just as a new counterfeit dollar does not replace your existing one. The clever design of the Bitcoin blockchain means that each ten minute block added after a particular block increases the security of that particular block exponentially.

The more hash rate, the more security.

While some have criticized Bitcoin’s electricity consumption, roughly equivalent to Ireland’s needs, the conversion of electricity to secure information is at the heart of what provides Bitcoin value. The electricity is not wasted, energy is encapsulated as value; electrons are turned into secure bits. The electricity used in Bitcoin mining should be compared to the much greater use of electricity and energy in gold mining, for example, or in the offices and computational facilities of the banking system.

Furthermore, 74% of Bitcoin’s electricity is from renewable supply, especially  hydropower. 

Scarcity

The world has never seen a form of money with scarcity as great as that of Bitcoin. To be money, one requires divisibility for a standard unit of account, and stability in the supply.

Gold coins and silver coins have been used in the past because of the relative scarcity of these precious metals, formed only in supernovae. Gold, unlike silver, does not increase in quantity much each year since most gold ever mined is still around in the form of jewelry or bars or coins. The supply rate increase is around 1.6% per year. Historically, large new discoveries made a difference, but those days seem to be behind us. Asteroid mining of gold is decades into the future.

The yearly increase in supply depends on how the price for gold moves, mining discoveries and development, and the cost of energy and other inputs to the mining process. But the supply increase is rather stable. There are total above-ground stocks of around $8 trillion. One-quarter of that, some $2 trillion, is held by central banks around the world.

Governments have moved away from the gold standard during the last century, and all government issued money is now fiat fractional reserve currency, issued as debt. The supply is influenced by (and sometimes more directly controlled by) committees at the central bank through monetary policy. The increase in supply of dollars currently runs at over 4% per annum. Consumer price inflation is lower, around 2%, due to productivity increases in the economy.

Bitcoin new supply each day and each year is not determined by committees of Ph.D. economists and bankers, as in the case of fiat, nor influenced by its price, as in the case of gold! If the amount of hashing power drops in response to a price drop, the Bitcoin mining difficulty that is embedded in the algorithm automatically decreases and there is still one new block issued every 10 minutes on average, containing the equivalent of 12.5 shiny new Bitcoins.

Bitcoin’s supply increase is all baked into the Nakamoto consensus: there will be at most 21 million Bitcoin ever issued, and that final number is not reached for another 120 years. However, current supply is already at 17.8 million Bitcoins, so there are only 3.2 million more that will ever be created.

The limited supply does not restrict Bitcoin’s use as a medium of exchange since each Bitcoin can be subdivided into 100 million units of Satoshis (sats). Thus even if Bitcoin reached $1 million in price, each sat would be worth just a penny.

Approximately every 4 years the supply issuance rate is cut in half by means of cutting the block reward in half. These quadrennial events are called Halvings (or ‘Halvenings’). That means inflation decreases continually as (a) the stock grows, and (b) the rate of new coin issuance decreases. At the next Halving the block reward (block subsidy, formally) will decrease to 6.25 Bitcoins from the current 12.5 reward. At the Halving after that it will decrease to 3.125 Bitcoins per block.

While in its early years the supply increase rate was quite high for Bitcoin, now it is at a reasonable 3.8%, less than the US dollar supply increase of over 4%. And at the next Halving in May 2020 it will be cut to 1.8%. (The rate drops more than by half since the existing stock is growing every 10 minutes as well). By 2024, the inflation rate will drop under 1% and it will continually decrease inexorably toward zero.

Bitcoin supply gets tighter and tighter, unlike fiat currencies with continued variable inflation and the risk of inflation getting out of control.

PlanB has built a very nice model of Bitcoin price vs. scarcity, using stock-to-flow ratios, which represent the inverse of the annual percentage supply (flow). Existing stock refers to the total number of Bitcoin ever mined. Flow is the new supply rate. Thus stock-to-flow is the number of years’ of supply, at current rates, that would be required to double the outstanding stock. 

Bitcoin will never, ever, double its outstanding stock, because stock-to-flow keeps tightening in the hard-coded Bitcoin supply algorithm. In the PlanB model, price correlates very well, at 95%, with a high power of the stock-to-flow variable, roughly the cube of that ratio. Bitcoin’s stock-to-flow will double, and be close to gold’s as of next year.  And since market cap (value of all Bitcoin) has correlated with such a steep power law, this is a big deal.

Double feedback loop

The beauty of Bitcoin’s design is that security and scarcity work together in a self-reinforcing pair of cooperating feedback loops as shown in the figure below. 

In the upper loop, we are indicating that Bitcoin is already scarcer each year relative to increasing dollar supply, and as of next year’s Halving, it will be continually scarcer relative to all fiat currencies and match gold as well. This increased scarcity drives price higher. 

In the lower loop, we are indicating that higher prices encourage more mining power, more hashing power, and that increases security. Increased security drives prices higher. 

And thus scarcity increases security. And increases in both work to increase the price. 

The long term outlook is excellent. Volatility is high at present due to a relatively thin market compared to gold, currencies, and Facebook or Apple stock. It will decrease with time as more value is captured into Bitcoin.

Both scarcity and security work in concert to drive Bitcoin price upwards. Copyright 2019, MoneyorDebt

Asset or debt?

All fiat currencies represent debt. Fiat currencies are issued in exchange for debt of individuals, corporations, or governments.

Facebook’s Libra is a debt-based token. It is a so-called stable coin backed by a basket of fiat currencies, which themselves represent debt. Money Creation 101: a bank makes a loan and new money is created; a central bank buys a treasury bill and new money can be created. There is no limit to the amount that can be created (apart from likely regulatory restrictions); it will be created and destroyed relative to demand.

Libra has a model of centralized security, managed by an Association of some 28 companies, and it has no scarcity other than that of the reserve basket of fiat currencies that back it. Libra cannot increase in value, rather its value inflates away along with the Dollar, Euro, Yen, and Pound components of the basket. Bitcoin is an asset, a pure asset with no associated debt. Like gold it comes into existence by a mining process, but mining occurs on computers rather than from the ground. If there is a debt crisis or banking crisis, Bitcoin is not affected, in fact, it would be sought after. Bitcoin was created by Satoshi Nakamoto in 2008/2009 in large part as a response to the debt crisis that brought on the Great Recession a decade ago.

Store of value or medium of exchange?

Money must be a store of value, a medium of exchange, and a unit of account. The default unit of account around the world is the US dollar, but the other main currencies such as the Euro, Pound, Yen, and Yuan are major units of account.

All of the over 100 fractional reserve currencies score highly in the medium of exchange category, at least within their own borders. They do not store value for the long term, losing half their value every decade or two or three depending on the strength of the particular currency and varying inflation rate.

Bitcoin is designed, like gold, first and foremost as a store of value, with its very constrained monetary supply. Its monetary policy is even superior to that of gold, and completely defined in advance.

No other money has ever had its monetary policy for the next hundred and even thousand years laid out in advance. Gold was the closest, but new mine discoveries always added major supply increases.

Bitcoin has been criticized on the medium of exchange front, but it is improving in that regard as well. First, remember that it is subdivided into a hundred million sats, so small quantities are not a problem. Fees are sometimes high, but trivial if you are moving large amounts, and much less expensive than the costs of bank wires or moving gold. Transfers are much more rapid, occurring within an hour for sufficiently secure confirmation.

The Lightning network and other second layer solutions such as wrapped Bitcoin (ironically using Ethereum ERC20 tokens) are making Bitcoin more accessible for small purchases by allowing transactions to be handled off-chain and later settled in bulk back to the Bitcoin blockchain. 

Government reaction to Libra

Theannouncement of Libra by Facebook and the group of companies known as the Association in mid-June has thrown governments into a tizzy. In the US, the Federal Reserve chair, the SEC chair, the Treasury Secretary and even the President all weighed in with their opinions. The net-net of comments were that Libra needs to be closely regulated, certainly with respect to KYC/AML (know your customer and anti-money laundering), and President Trump, presumably at Secretary Mnunchin’s urging, said they ought to be required to obtain a banking license. Secretary Mnunchin expressed the usual money laundering concerns.

Hearings before Congress were quickly scheduled and took place in the Senate and House mid-July. David Marcus, who leads Libra development at Facebook’s Calibra subsidiary, testified. He was not especially forthcoming on whether Facebook will be able to restrict some users from access to the Calibra wallet, and had limited information about the Association. The other members of the Association have only signed letters of intent; the charter is not yet ratified.

Congressperson Waters, who chairs the House Financial Services committee, has called for a pause in development until reviews can be completed. Marcus declined to commit to this, or to a preliminary sandbox environment working in conjunction with regulators. A bill has been introduced in Congress that would outright ban Libra, but this seems unlikely to pass.

The IMF, European Central Bank, and other central banks are almost panicking at the prospect of a competitive global currency. The UK Parliament will schedule hearings. The French Finance minister said Libra must not be allowed. India is foolishly trying to outlaw cryptocurrency completely. The Chinese central bank has announced they will develop their own central bank digital currency; they also just published a guide to Bitcoin.

Now what is interesting is that in the US, the Administration, the Fed, and Congress are beginning to draw a clear distinction between Libra, which is corporate money, and one might argue a shadow banking system, and Bitcoin, which is private money, with no centralized control.

It is encouraging for Bitcoin that some Congresspeople get the difference. In fact Congressman Patrick McHenry stated “I think there’s no capacity to kill bitcoin. Even the Chinese with their firewall and their extreme intervention in the society could not kill bitcoin.”

Regulation is already generally in place in the US for Bitcoin and cryptocurrencies more broadly. The SEC is restricting and regulating new cryptocurrency token offerings ICOs and are looking at Bitcoin ETF proposals. The SEC have stated that Ethereum and Bitcoin are not under the purview of ICOs, essentially recognizing the private money nature of the way they were created. (Ethereum is more problematic since they wish to move to Proof of Stake in the future). The CFTC has approved futures trading in Bitcoin. The IRS has been treating cryptocurrencies as assets taxable for capital gains purposes.

So there is no prospect for banning Bitcoin in the US and probably not in most Western countries or Japan and Korea. A Chinese court upheld property rights for holding Bitcoin in July. Although some mining restrictions have been placed in China, this seems more about managing electricity usage and even theft rather than an outright ban on cryptocurrency mining. Iran has recently legalized cryptocurrency mining.

In sum, the reactions of the US government and other governments toward the Libra announcement indicate a desire to closely regulate this corporate money style of ‘cryptocurrency’. This is especially the case since Libra is from a large social media company already under fire for data privacy breaches and whose scale of billions of potential Libra users could pose a systemic threat to central banks’ management of their national currencies.

As Libra is slowed down by regulations in various nations, Bitcoin is unimpeded. As governments recognize the difference between a corporate money (with Libra being a product an association of corporations) and Bitcoin’s private money nature, Bitcoin benefits.

One can argue that all of the attention given to Libra with the announcement and to cryptocurrency more broadly, along with the realization that Bitcoin cannot be stopped,has provided a push of Bitcoin across the Chasm, with Libra’s help even though Libra itself is is not scheduled for release until 2020. 

Bitcoin on a log scale, starting late 2013. (source: Coindesk)

Chasm is crossed by Bitcoin: 20 reasons

1. Bitcoin has been around for 10 years, since early 2009, and has increased in price by six orders of magnitude since April 2010, even as supply increased seven times.

2. Bitcoin has been through two Halvings; the next is only 10 months from now; this is the fundamental driver of scarcity with fully predictable inflation headed under 2% and then under 1% . Supply is now tight and only getting much tighter.

3. Bitcoin suffered through the crypto winter of 2018 and bounced back by a factor of over three times in price since the start of 2019. It has moved back above $10,000 with prospects for $50,000 plus within the next year or so due to the forthcoming Halving (PlanB model of stock-to-flow projection yields the future price estimate).

4. Bitcoin has an enormous lead in security over all other cryptos with far and away the greatest amount of hashing via specialized ASIC accelerated computers.

5. There are some 32 million Bitcoin wallets held by perhaps 10 million people; while it now has significant presence, there is also huge room for growth.

6. Facebook’s Libra has put the Fed, Congress, Treasury Department, SEC into a tizzy. Also the IMF, ECB, Bank of China  and other central banks are more or less panicking around the challenge of global digital currency alternatives. The IMF is creating a series of papers to look at alternatives that could include holding e-money ‘stablecoin’ currency reserves at the central bank.

7. The attention on Libra seems to be leading to a view from Congress and the Administration that (a) we must regulate Libra closely, Facebook cannot be trusted and  (b) Bitcoin is here to stay. 

8. Bitcoin is already the clear global digital currency alternative from a Store of Value perspective and could challenge gold in that regard. Gold has a total market capitalization of $8 trillion of which $2 trillion is held by central banks. Bitcoin is still much smaller at 1/5 of a $Trillion.

9. In the US Bitcoin regulation is mostly in place, with taxation and KYC /AML for exchanges sorted out, a futures market established, and the next big step is retail investment products such as ETFs to ease mass adoption.

10. While volatility of Bitcoin price is high (7% per month) it is decreasing and expected to continue to do so as the market deepens.

11. Bitcoin is an asset, fiat is debt. That alone should drive adoption especially with the next recession and future debt and banking crises. Negative interest rates may be coming to the US, certainly a return to very low rates is on the horizon.

12. Central banks are looking at implementing digital currencies that they would control, but that offers minimal innovation; such a central bank digital currency would still be just the same old fractional reserve fiat, inheriting problems of instability and remaining as a poor long term store of value.

 13. Central Banks cannot resist the cryptocurrency /e-money tide. This leaves them three major alternatives: (a) accept corporate money such as Libra, even holding reserves for them, and squeezing banks as a result (b) outlaw or restrain corporate money and build their own digital currency which could mean individuals hold balances at central banks, also squeezing banks, or (c) strengthen their currencies by adding Bitcoin to their balance sheets along with their gold. They could allow banks to issue their own digital money in competition with Libra and other corporate money, and let the market sort it out with appropriate but not heavy-handed regulation and risk supervision.

14. I do not expect the US,  Japanese, European, or British central banks to add Bitcoin to their reserves any time soon. But some smaller central bank may very well, and start a Bitcoin reserve race. The central bank of central banks, the BIS, will try to slow them down by saying they cannot include any Bitcoin held as part of their reserve accounting position. But central banks might well hold anyway if they believe it will appreciate relative to gold.

15. The first Central bank to actually add Bitcoin to reserves gets a jump on all the others, and could set off a race. Bulgaria may be de facto the first, since their government has seized Bitcoin used in criminal activities that has a present value of $2 billion. This is about equal to the nation’s gold reserves. If they are smart they will not auction it off.

16. Great macro investors like Ray Dalio and Raoul Pal see a next recession coming and continued overhang of debt pushing the US toward zero and negative interest rates. More debt monetization is on the horizon in their view, and in such low interest rate environments with money printing, pure assets like gold and Bitcoin benefit from a flight to safety. With negative interest rates and even small inflation, cash is trash.

17. Libra is a gateway drug to Bitcoin, and exchanges will make a market. As new people get  introduced to crypto through Libra, they will become more aware of Bitcoin and could choose to exchange Libra for Bitcoin as a savings vehicle, while using Libra and competitors for spending purposes.

18. Fiat and Libra and e-money are payment methods, spending vehicles, primarily mediums of exchange. Bitcoin is a savings vehicle, primarily a store of value that can presumably be used for greater purchasing power in fiat or Libra terms in the future due to its stronger monetary policy. Lightning Network and other second layer solutions are enhancing the utility of Bitcoin for purchasing as well.

19. Libra has sharpened the differences in the crypto space. Bitcoin has crossed the chasm because governments in the West are now understanding the clear distinction between corporate money ‘crypto’ and the original decentralized Bitcoin. They have largely worked out their overall approach to Bitcoin regulation while struggling with what to do about Libra and other ‘stablecoins’ or corporate money. Their fear of Bitcoin has lessened as tools to track its usage in money laundering and transnational crime have been developed.

20. After a decade of phenomenal growth, and in time for the 2020s, Bitcoin is coming of age. Expect a growth spurt and many more developments.

“The world that Satoshi Nakamoto, author of the Bitcoin whitepaper envisioned, and others are building, is an unstoppable force” – Patrick McHenry, U.S. Congressman

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