RenMac: Bitcoin Is No Better than Bearer Bonds



Key takeaways

If bitcoin is to be more than a bandwagon, it has to have utility as a medium of exchange or store of value. Given our view that it is not advantaged in either, we think Warren Buffett’s comments on gold are timely for bitcoin: “the rising price has on its own generated additional buying enthusiasm, attracting purchasers who see the rise as validating an investment thesis…as ‘bandwagon’ investors join any party they create their own truth – for a while.”

As a medium of exchange

As a medium of exchange, bitcoin does not, and cannot, support real-time payments. Verifications are almost instant, but a recipient gains access to funds only after a transaction is confirmed, which typically takes up to an hour, or longer if the network is congested. The delay is built into the protocol unlike the delay in bank transactions, which can be mitigated (by an intermediary taking settlement risk in a “good-funds” model) so that, for example, PayPal has announced it will leverage Visa and Mastercard to offer instant bank transfers. We regard the parity market cap of BTC and MA as an example of mispricing in MA’s favor.

As a store of value

As a store of value, bitcoin faces a security challenge that can be addressed only by offline management of the private keys necessary for coin access, and so suffers from similar limitations to bearer bonds. This could be mitigated by an institutional structure for private-key depositaries as exists for registered securities and gold, but the resulting “banked” bitcoin is arguably self-defeating and, anyway, functionally equivalent to existing banks and depositaries implementing private chains (where access rights are controlled as opposed to bitcoin, which is a public chain with open access) for back-end settlement activities. We see Ripple and the related Inter-ledger Protocol as more likely candidates for this backbone and prefer XRP over BTC.

The broader issue is block-chain governance and, in particular:

  • the incentives faced by customers (e.g. leverage chain utility), developers (e.g. increased value of token holdings), and “miners” (e.g. increased fees for confirming transactions)
  • coordination mechanisms, which in the case of bitcoin, are off-chain through Bitcoin Improvement Proposals

Governance disagreements can lead to chain forks where a subset of the community begins working on a branch of the chain that expresses a minority view. This occurred on August 1 for bitcoin, which forked into bitcoin and bitcoin cash with the latter using larger block sizes to reduce confirmation times.

We do not believe the same chain design works equally well for both applications of a currency, medium of exchange and store of value, since different implementations involve different trade-offs among the key criteria of:

  • correctness: distinguishing between honest and fraudulent transactions
  • agreement: maintaining consensus on an internally consistent set of confirmed transactions in the face of distributed accounting
  • utility: reducing latency, so increasing settlement speed

Given the built-in latency, bitcoin design favors store of value over medium of exchange, and the governance structure seems unable to adapt.

Bitcoin: no better than bearer bonds

The optimistic case for bitcoin is typically framed in terms of limited supply, and its consequent ability to function as a currency that is not subject to debasement by central banks. In setting his PT of $40,000 by the end of 2018, Michael Novogratz, a crypto investor who could “hear the herd coming” in October and predicted the current price, cites this absence of a supply response. The premise is that bitcoin is advantaged as a currency as distinct from, say, vintage marbles, which are in finite supply but not viewed as a practicable hedge against loose monetary policy.

Beyond the importance of demand (hence utility), as well as supply, to price the notion of finite supply is simply false. On August 1, bitcoin forked to bitcoin cash effectively doubling coin-supply, and the next fork will likely involve bitcoin gold.

The cautious case is made by Warren Buffett: “you can’t value bitcoin because it is not a value-producing asset … people get excited from big price movements, and Wall Street accommodates.” This was prescient given that two days later, on October 31, CME announced the launch of bitcoin futures. Of course, Buffett makes the same case against gold: “gold gets dug out of the ground in Africa or someplace…then we melt it down, dig another hole, bury it again and pay people to stand around guarding it…it has no utility [beyond some limited industrial and decorative applications].”

The counter is that gold is a store of value that protects against inflation even if it is not value-producing, and that bitcoin can also act in this capacity, as digital gold. This is Peter Thiel’s perspective: “it’s like a reserve form of money, it’s like gold, and it’s just a store of value…you don’t need to use it to make payments.” In short, the sustainability of bitcoin as a valuable asset depends on its utility as a medium of exchange or store of value. In our view, it is disadvantaged in both cases even if supervisory hurdles can be overcome. And we agree with Buffett’s prognosis: “I don’t believe in this whole thing at all. I think it’s going to implode.”

RenMac: Analyzing macro factors that impact the investment world.

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