May 10, 2021

 

For the last several years, I’ve been an agnostic when it comes to Bitcoin. Scratch that. For the last several years, I’ve been an atheist when it comes to Bitcoin, and a pugnacious one at that. Much like St. Paul’s persecution of Christians prior to his conversion, I was on a similar warpath, but against Bitcoin. I was convinced it was a “scam” or “pump and dump scheme”; I took every opportunity to discredit its worth and undermine any potential role it could play in the financial markets; and I vowed, both publicly and privately, that I would never own it. But St. Paul eventually saw the light on the road to Damascus and I too have had my own “Damascus Moment”. Over the last several months I’ve researched Bitcoin more intensely than ever before: reading books and articles, listening to podcasts, watching videos, etc. and I’ve concluded that it does indeed have a viable and vital role in the future of the financial world.

 

After St. Paul’s conversion, he wrote over a dozen letters that are now included in the New Testament canon; I will not write a dozen letters. I will write only one letter – this letter – detailing my own “Bitcoin conversion”. I doubt that it will be added to any official canon, but at the very least, this letter will give you an honest account of my journey from being a Bitcoin atheist to a Bitcoin convert. 

 

 

When I first began to entertain the idea of Bitcoin’s financial merit (albeit reluctantly), it caused me to question my own preconceived ideas of money: What is it? How has it developed over history? Why is it necessary?  What did the earliest forms of money look like? Naturally, these questions brought me back to the universal properties of money:

 

If a currency fails to meet any of these tests, its viability as money is nonexistent. Take the U.S. Dollar for instance: We’re able to divide it into smaller increments (quarters, dimes, nickels, pennies); it’s fairly durable, unlike seashells (circa 1200 B.C.); thanks to its distinct color and texture, our dollars are recognizable; our wallets and checkbooks attest to its portability; and unlike grains of sand on the beach, the supply of the U.S. Dollar is limited (or so we’re told). On the surface, the U.S. Dollar seems to be a viable form of money; but upon further investigation, the dollar fails to pass one crucial test.

 

For much of its history, the dollar was backed by gold since gold is the scarcest of monetary metals. Like all countries, the U.S. inevitably abandoned this gold-based monetary system and adopted a fiat system where the value of money exists simply because the government says so. This is a common thread in the history of governments and their responsibility concerning their currency. Unfortunately, this allows the government to create and issue money whenever it deems fit. Exhibit A: the 25% growth in the U.S. monetary supply in 2020. Geniuses aren’t needed for this math: for every dollar that was in my wallet at the beginning of 2020, I lost 25 cents in purchasing power by the end of the year. Taken to the extreme, if this pattern persisted for five years, my dollar would lose 75 cents of purchasing power even though it never left my wallet. This is serious problem. 

 

On a macro level, reckless money printing is a reverse robin hood: stealing from the poor to give to the rich. As more dollars are released into the financial system, prices increase. Whether it be common household goods or stocks, bonds, and other financial assets, prices will increase. For the wealthy who have the ability to own these assets, they’ll see nothing but asset appreciation. For those who lack the financial wherewithal to hold such assets, they’ll see nothing but higher price tags while the value of their hard-earned dollars crumbles within their wallets. I would like to think that the government will eventually abandon this pattern of reckless money printing, but as the deficit continues to grow and the Fed continues to use quantitative easing as their tool of choice, it’s inconceivable to believe that the money supply will ever stop growing. Long story short: the dollar is not scarce. 

 

This is where I began to understand the utility of Bitcoin as money: as it’s purely digital, Bitcoin can be divided into 100,000,000 units (known as a Satoshi); its durability is ensured as long as one computer exists; as it’s just information, Bitcoin can be transported at the speed of light; due to the nature of Bitcoin’s blockchain network, it cannot be frauded or counterfeited; and given that Bitcoin’s protocol caps its supply at 21 million, Bitcoin perfects the property of scarcity. In short, Bitcoin is better money. Pure and simple. 

 

Once I understood Bitcoin’s monetary viability, I began to question the nature of our financial system and its reliance on the dollar. Why don’t we use other currencies? Who’s to say that we have to use banks? What’s special about the U.S. dollar? These questions led me to discover the world of decentralized finance. 

 

As it stands today, our current financial system is entirely centralized. From banks to brokerages, exchanges to investment firms, these institutions house our accounts, protect our assets, and create payment channels that allow us to buy the goods and services we want. On the surface, these institutions seem to benefit society, and for many decades they have; it wasn’t until the 2008 financial crisis that we learned the cracks in our centralized financial system were much deeper than surface level. As the government injected billions of dollars to keep the financial system afloat, Bitcoin’s promise of a decentralized currency gradually gained traction and the world began to understand the power of blockchain technology. 

 

At the risk of treating this letter like a term paper, I’ll refrain from describing the intricate details of blockchain technology for two reasons: 1) I assume you already have a fairly good idea of what’s involved and 2) I don’t know the intricacies of Bitcoin’s blockchain. What I do know is that because Bitcoin operates off of a blockchain, governments can’t manipulate it, hackers can’t attack it, authorities can’t confiscate it, and by virtue of its open ledger, every transaction is transparent while maintaining its privacy behind complex computer encryption. Centralized systems require hours of man-power and millions of dollars to even come close to ensuring the privacy and security the public demands. Bitcoin doesn’t require any of that. By its very nature Bitcoin is the most private and secure money ever invented. This privacy and security is ensured by the thousands upon thousands of Bitcoin miners all over the world who validate and confirm Bitcoin transactions. As a result, the risks part and parcel to our current financial system (monetary censorship, corruption, dependence on central authorities, government manipulation, etc.) are virtually nonexistent in the Bitcoin network. 

 

By the time I understood Bitcoin’s viability as money and its superiority as an alternative to our current financial system, only one question remained: how to value it? How can you value what is arguably the best asset ever created? How does one value an asset that’s nothing but lines of computer code? As it turns out, the answer is not as complicated as I thought. 

 

 

As a student of Warren Buffett, my approach to the valuation of any asset consists of a detailed analysis of its free cash flow in relation to the cash outlay. I’ll admit that I struggled to conceptualize any possible value of Bitcoin simply because the asset in and of itself doesn’t do anything: it doesn’t collect rents; it doesn’t produce crops or livestock; it doesn’t pay a dividend, etc. Unlike productive assets (apartment complexes, farm ground, businesses, etc.), Bitcoin doesn’t kick off any cash flow. I treated these objections as a mental crutch. This allowed me to ignore Bitcoin as it didn’t conform to my preconceived ideas of traditional valuation. This was an error in my thinking – not an error in Bitcoin. 

 

The more I delved into this space, I learned that non-productive assets are not without hope. Their value is simply a function of their scarcity (sound familiar?). Take DaVinci’s Mona Lisa, van Gough’s Starry Night, or any of Pollock’s splatter-painted works of art: in and of themselves they produce nothing but dust; yet, they still have value. Why? Because they’re scarce. It’s their scarcity that gives them value and the passage of time has only underscored this point. The same is true of Bitcoin. Granted, Bitcoin hasn’t existed for 500+ years like the Mona Lisa, but over the course of its short lifespan, Bitcoin has proved its resilience time and time again. Moreover, unlike rare works of art, Bitcoin actually has utility and I dare say much of its utility has yet to be realized. Utility combined with scarcity is a rare and beautiful combination.

 

Now let’s get down to the numbers. In full disclosure, I haven’t the faintest idea how to value Bitcoin. Like I mentioned above, I’ve been schooled in the art of valuing productive assets like farms, real estate, and businesses, not non-productive assets, like Bitcoin. But one investment lesson holds true regardless of the asset’s productivity: when a scarce asset is held over a long-term time horizon, the price today is virtually negligible as long as that asset remains in demand. Call me a cockeyed optimist, but it’s hard for me to envision a future where Bitcoin isn’t in demand, and history has proved as much. That being said, I will never advocate the use of borrowed money to buy Bitcoin. In its short history, Bitcoin has experienced several 50%+ crashes (usually over the span of one or two months). For the individual investor who uses borrowed money to buy Bitcoin, a drop of that magnitude could easily wipe out their position and still hold them indebted to their creditor. But if you use your own money to buy Bitcoin and hold it over a long-term time horizon, I believe it’s safe to say that you’ll come out on top.

 

 In short, when it comes to scarce assets, the name of the game is accumulation. The more you accumulate, the better off you’ll be. Valuation plays an important role – there’s no doubt about it – but if Bitcoin is the best asset ever created – and I believe it is – it does more harm than good to lose the forest for the trees. 

 

 

St. Paul’s conversion changed the world for billions of souls. My conversion will not have the same effect. At the very least, I hope that this letter served as an honest account of my reservations regarding Bitcoin and my enlightenment as I educated myself on its merits. 

 

As a newcomer to the crypto universe, I’m far from an expert on crypto currencies as a whole, especially other crypto currencies: Litecoin, Ethereum, Dogecoin, etc. A ruthless crypto critic might slaughter me upon the altar of any number of these cryptocurrencies, claiming that I don’t understand the flaws of Bitcoin that these altcoins claim to have remedied, and this may be true. Nevertheless, I believe that I have a sufficient understanding of Bitcoin’s fundamental characteristics as they relate to the financial world, and, if my conclusions are correct, I like what I see. 

 

Lastly, no one likes a man who’s willing to “talk the talk” while neglecting to “walk the walk”; in an effort to avoid this characterization, I’ve invested a significant portion of my net worth in Bitcoin so as to truly “eat my own cooking”. As with all investments, there are risks – and plenty of them – but I believe that Bitcoin’s rewards significantly outweigh the risks. Could I be wrong? Sure - that’s all part and parcel to investing. It takes time to measure the success of investment decisions, but until that time comes, Bon Appétit!

Yours

John Kanel