The Bullish Case for Bitcoin

Copyright © 2021 by Vijay Boyapati

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ISBN 978-1-7372041-2-1

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 TABLE OF CONTENTS

Foreword
Prologue
Prometheus
The Gordian Knot
The Breakthrough
1. Genesis and the Origins of Money
Genesis
The Origins of Money
2. The Attributes of a Good Store of Value
Durability
Portability
Fungibility
Verifiability
Divisibility
Scarcity
Established History
Censorship Resistance
3. The Evolution of Money
Path Dependence
4. The Shape of Monetization
Hype Cycles
Gartner Cohorts
The Effect of the Halving
The Entrance of Nation-States
The Transition to a Medium of Exchange
5. A New Monetary Base
Common Misconceptions
Is Bitcoin a Bubble?
Is Bitcoin Too Volatile to be a Store of Value?
Is Bitcoin Too Expensive to Invest In?
Are Transaction Fees Too High?
Does Bitcoin Consume Too Much Electricity?
Will Bitcoin Be Overtaken by a Competing Cryptocurrency?
Are Forks a Threat to Bitcoin?
Is Bitcoin Really Scarce?
Real Risks
Protocol Risk
The Risk of State Attack
The Risk of Miner Centralization
Custodial Risk
The Risk of Federal Reserve Policy
The Risk of Rehypothecation
The Risk of Imperfect Fungibility
Conclusion
Epilogue
The Great Debate
The Immutability of Protocols
The Schism
Denouement
Acknowledgments
Disclaimer
About the Author
To Addie, Will, and Vivi, for whom I fervently believe
Bitcoin will bring about a better world
T HE PANDEMIC OF 2020 UPENDED THE ECONOMY OF THE WORLD , FORCING
10 years of digital transformation into the span of months. Pure digital
offerings exploded in popularity and many conventional brick-and-mortar
services came to a halt. Millions of businesses and billions of people found
themselves caught amid the greatest disruption of their lives.
During the second quarter of 2020, our business scrambled to adapt to the
new constraints of a post-COVID world. The result was a streamlined
enterprise software company with half a billion in cash and more on the
way. Our immediate business challenge was resolved, but a larger threat to
our survival loomed in the distance.
The United States government’s policy response to the pandemic was to
triple the rate of monetary inflation. In essence, the cost of capital exceeded
20 percent, while the returns we could expect from any conventional
treasury investment strategy were 0 percent. This made our cash stockpile
and future cash flows a weight around our neck. A stable, profitable value
stock growing substantially slower than the rate of monetary inflation does
not serve as a store of value and rapidly loses the support of the investment
community.
This problem had existed for a decade leading up the pandemic, albeit at
a lower level of intensity. From 2010 through 2019, the rate of monetary
inflation was approximately 7 percent and investors relentlessly pressured
CEOs and CFOs to grow their cash flows in excess of this rate by any
means necessary. That often meant taking on debt and using all free cash
flows to buy back stock or to enter into serial acquisitions with a
combination of debt and equity in order to keep revenues and expected
income growing faster than this hurdle rate. The acquisitions were generally
dilutive over the long term, and as management teams struggled to integrate
acquisition targets, they lost focus on their core business. When each
business became fully leveraged on debt, or when there were no more
acquisitions to be had, it reached the end of the line.
 The 7 percent hurdle rate resulted in a 99 percent mortality rate during
the 20 years after our firm became public, driving one corporation after
another to reach beyond their fingertips, impairing their balance sheet with
too much debt and convoluting their profit and loss statements with too
many disparate business units. When the hurdle rate tripled in the second
quarter of 2020, it became clear that we could no longer “soldier on” with
this inflationary burden hanging over our head. If we continued with
business as usual, then the value created by millions of activities from
thousands of employees each year would be significantly undermined by
the decision of a few central bankers to print more money. The road to
serfdom consists of working exponentially harder for a currency growing
exponentially weaker.
The solution to our problem presented itself in the form of a K-shaped
recovery. In essence, Wall Street recovered quickly due to monetary
stimulus, while Main Street continued to deteriorate. The key to economic
vitality in times of great monetary inflation is a large balance sheet of assets
that appreciate faster than the rate of currency debasement. Accordingly, we
set off on a search for the right asset mix to place on our balance sheet in
lieu of cash and treasury bonds. It was during this search that we discovered
Bitcoin and this wonderful thesis crafted by Vijay Boyapati.
The Bullish Case for Bitcoin, first published as a long-form article,
represents an intellectual tour de force delivered with elegance and
prescience by a polymath well-versed in mathematics, computer science,
economics, philosophy, politics, and engineering. After March of 2020, it
was evident to me that the world needed a new money based on technology.
However, in February 2018, when Boyapati first published his paper, this
insight required much greater perspicacity, courage, and conviction.
In a clear and concise manner, Boyapati presents the theory of money, the
anatomy of Bitcoin, the reasons it is superior to the gold and fiat standards
that came before it, and the promise that it offers to human civilization. He
describes path dependence and the trajectory of a newly monetizing asset in
terms the layman can understand, and he addresses the concerns that most
commonly arise as newcomers struggle to comprehend the essence and
significance of this first digital monetary network. I was immediately
captivated by “The Bullish Case for Bitcoin” when I first read it and made
it part of the recommended reading for all the officers and directors of my
firm as we educated ourselves on Bitcoin and considered the logical path
forward. In this book Boyapati updates and significantly expands on the
ideas presented in his original article.
In the third quarter of 2020, MicroStrategy decided to adopt Bitcoin as
our primary treasury reserve asset, becoming the first publicly traded
company to convert to a Bitcoin Standard, and we eventually acquired
billions of dollars’ worth of Bitcoin. We recommend The Bullish Case for
Bitcoin to any of our employees, shareholders, or constituents wishing to
understand the premise and promise of Bitcoin, both as a digital treasury
asset and as the world’s first digital monetary network. I hope you benefit
from this work as much as we did.
Michael J. Saylor,
Chairman and CEO MicroStrategy
Miami Beach, Florida
March 27, 2021
 PROMETHEUS
T HE MYSTERIOUS ORIGINS OF B ITCOIN SEEM TOO IMPROBABLE TO BE REAL .
While the full details may never be known, we know they went something
like this: on January 3, 2009, an unidentified person in an unknown location
tapped a key on a computer keyboard and initiated one of the most
important programs in history. The computer began searching for a
particular pattern known as a hash, a digital needle in a haystack, that would
secure the first block in a ledger of financial transactions now known as the
blockchain. Within a few minutes or hours—no one knows for sure how
long—the first hash was found, thereby completing the genesis block and
bringing to life the world’s first truly decentralized digital currency.
Remarkably, the identity of the enigmatic figure who created Bitcoin
remains unknown, even to this day. All we know is their pseudonym:
Satoshi Nakamoto.
Barely two months earlier, on October 31, 2008, Nakamoto had
announced a technical specification for Bitcoin to the cryptography mailing
list, an email list for people interested in the study of codes and code-
breaking.1 Many of the members of the list referred to themselves as
cypherpunks and were determined to reshape society and liberate it from
the state using the privacy-enhancing tools of cryptography. Nakamoto’s
email was his very first post to the list, and it received little fanfare and
general skepticism after it was posted. Even among this group, steeped in
the history of attempts to invent a digital currency, few understood the
significance of Nakamoto’s email announcement. One exception was Hal
Finney, a gifted cryptographer and computer scientist who had devoted
much of his career to the creation of a digital currency and who was
familiar with the inherent difficulties of doing so. Of the announcement of
Bitcoin, Finney later recounted:
 When Satoshi announced Bitcoin on the cryptography mailing list,
he got a skeptical reception at best. Cryptographers have seen too
many grand schemes by clueless noobs. They tend to have a knee
jerk reaction.2

Finney tragically passed away on August 28, 2014 from complications of

Lou Gehrig’s disease. He had made numerous important contributions to
the development of a digital currency, especially to Bitcoin.
 THE GORDIAN KNOT
Ever since Tim May, a retired Intel scientist and founder of the cypherpunk
movement, had presented The Crypto Anarchist Manifesto to a small
gathering of like-minded radicals in Silicon Valley in 1992, cypherpunks
had understood the critical importance of developing a digital, stateless
form of money. As May wrote in his manifesto:

Computer technology is on the verge of providing the ability for

individuals and groups to communicate and interact with each other
in a totally anonymous manner. Two persons may exchange
messages, conduct business, and negotiate electronic contracts
without ever knowing the True Name, or legal identity, of the other.3

Yet for business to be conducted, money is required. Money is the most

important good in any developed economy because it acts as the foundation
for all trade and savings. Gold, the ancient and venerable precious metal,
had served this role for millennia, but its physicality was an Achilles’ heel
that made it vulnerable to centralization, confiscation, and state attack.
Gold’s status as global money was eventually repealed during the twentieth
century as the state came to dominate the issuance and management of
money. With a desire to facilitate anonymous payments and to overcome the
vulnerabilities of gold, cypherpunks hoped to develop a digital currency
that would be immune to the coercive power of the state.
In 1983, American computer scientist David Chaum published a design
for eCash, which was the first attempt to create a system that protected the
financial privacy of its users with cryptography. In 1989, Chaum founded a
company called DigiCash to commercialize his invention, but it was never a
financial success. Moreover, because eCash was tied to the company that
created it, it suffered from the problem of centralization: if money is issued
by a central authority, then that authority represents a single point of failure.
And, indeed, the eCash system was shut down when DigiCash went
bankrupt in 1998. Thus, the creation of a digital form of money that had no
central authority was a key challenge occupying some of the most talented
cryptographers and cypherpunks during the 1990s.
While meaningful progress on the development of digital currency was
made by cypherpunks such as Adam Back, Nick Szabo, and Wei Dai during
the late 90s, a crucial problem remained unsolved: how can digital scarcity
be maintained when there is no central authority to enforce it? It had been
recognized as early as the sixteenth century by the Spanish School of
Salamanca that money’s value derives from its scarcity. However, in the
digital realm, where data can be cheaply copied and transmitted, scarcity
had so far only been possible through the use of state power, as in the case
of intellectual property.
British cryptographer Adam Back’s HashCash system, invented in 1997,
contributed a key concept that was necessary to the development of a
workable system of digital scarcity: proof-of-work. Originally intended to
mitigate the increasingly expensive problem of email spam, Back proposed
a system whereby a computer sought for a hash that could only be found by
an exhaustive search, requiring energy to be expended, hence costing
money. Once produced, a hash could quickly and cheaply be verified as
authentic and used as a measure of how much energy had been expended
and at approximately what cost. A hash was, in essence, a cryptographic
proof that work had been done. Under Back’s scheme, email senders would
be required to attach a unique hash to each email to prove that some
negligible cost, such as a hundredth of a penny, had been incurred. The cost
would not affect regular usage but would make the ability to send spam
emails en masse cost-prohibitive. Unfortunately, HashCash was not
commercially successful and was missing essential elements that would
allow it to function as money. Proof-of-work, however, would prove to be
crucial in allowing for the coordination of untrusted parties in a
decentralized system.
In 1998, American computer engineer Wei Dai proposed a system known
as b-money that addressed the critical flaw of Chaum’s eCash: its
centralization. Instead of requiring a central authority to maintain a limited
supply of money, Dai envisaged a distributed system where participants in
the network would each separately maintain a ledger of how much money
each participant currently had so that state coercion of any particular
participant would be ineffective. Dai’s proposal was impractical, however,
in assuming that communication channels remain near-instant, connected,
and untamperable. His system was never implemented.
The same year that Dai proposed b-money, American polymath Nick
Szabo designed another system for digital money known as bit gold. As
with b-money, bit gold was never implemented, but Szabo’s system made a
critical leap forward by reframing the problem of scarcity not as the dearth
of a physical substance, but as the quality of being verifiably expensive to
produce. His neologism for this quality was “unforgeable costliness.”
Szabo’s bit gold built upon Adam Back’s proof-of-work insight and allowed
users of the system to mint tokens by providing a hash whose unforgeable
costliness would act as a limiting factor to the increase in money supply.
Ownership of such tokens would be tracked by a registry distributed across
many computers known as a property club, somewhat resembling Dai’s b-
money but differing in its functional details.
Although tantalizingly close to a solution for decentralized money,
Szabo’s design suffered some important drawbacks. First, as computers
continued to improve in processing power, a hash produced in the past
would be easier to produce in the present, meaning that hashes produced at
different points in time would not be equivalent in perceived value,
breaking an important property of money called fungibility. Thus, bit gold
would create a digital commodity more akin to diamonds—irregular in
shape and quality and not easily interchangeable with each other—than to
gold. Secondly, the concept of an ownership registry was vulnerable to
Sybil attacks that would subvert the system by creating numerous fake
property-club members who could then report false balances, crediting the
attacker with money they did not have. While Szabo devised solutions to
these problems, they were complex, and bit gold remained only theoretical.
As one century gave way to the next, hope dwindled in the cypherpunk
dream for a decentralized digital currency. Hal Finney, who had paid close
attention to each of the attempts to create a stateless form of money,
attempted to resurrect the dream in 2004 when he designed a system known
as RPOW (Reusable Proofs of Work) that was a simplified version of
Szabo’s bit gold. Unlike Szabo or Dai, Finney implemented a working
prototype of his system, but RPOW suffered from a similar problem to
Chaum’s eCash by relying on a central authority. Finney attempted to
mitigate the problem of centralization by replacing the central authority
with an untamperable hardware device that could remotely attest to the
correct balance information for users in the system. The hardware device
would be more trustworthy than a coercible company, but it could still
easily be turned off.
By 2008, as the world plunged into the worst economic crisis in
generations, most members of the cryptography mailing list had concluded
that creating a decentralized digital currency was probably impossible.
Accordingly, when Satoshi Nakamoto confidently announced that he had
solved the problems of decentralized money, very few members of the list
took him seriously.
 THE BREAKTHROUGH
A few weeks after the announcement of Bitcoin, Hal Finney began
peppering Satoshi Nakamoto with questions about his new invention.
Finney had quickly recognized the brilliance of Bitcoin and the ingenious
imaginative leap Nakamoto had made to create a new form of digital money
with no central point of authority. None of the component ideas of Bitcoin
were new, nor was any of the cryptography novel, but Nakamoto had
arranged the system in a perfect balance of economic incentives and
cryptographic guarantees.
As part of his design, Nakamoto had solved a fundamental problem of
computer science, first posed in the late 1970s, known as the Byzantine
Generals Problem: how can disparate parties that do not trust each other and
may even be antagonistic coordinate to achieve a shared goal, without
relying on a mutually trusted intermediary? As Nick Szabo explained in
2011:

Nakamoto improved a significant security shortcoming that my

design [of bit gold] had, namely by requiring a proof-of-work to be
a node in the Byzantine-resilient peer-to-peer system to lessen the
threat of an untrustworthy party controlling the majority of nodes
and thus corrupting a number of important security features. Yet
another feature obvious in hindsight, quite non-obvious in
foresight.4

It was a major technical breakthrough, and although it was not

immediately obvious to most members of the cryptography mailing list on
October 31, 2008, Satoshi Nakamoto’s invention would eventually change
the world.
W ITH THE MARKET CAPITALIZATION OF B ITCOIN SURPASSING A TRILLION
dollars, the bullish case for investors might seem so obvious that it does not
need stating. Alternatively, it may seem foolish to invest in a digital asset
that is not backed by any commodity or government and whose price rise
has prompted some to compare it to the tulip mania or the dot-com bubble.
Neither is true; the bullish case for Bitcoin is compelling but far from
obvious. There are significant risks to investing in Bitcoin, but, as I will
argue, there is still an immense opportunity.
 GENESIS
Never in the history of the world had it been possible to transfer value
between distant parties without relying on a trusted intermediary such as a
bank or government. In 2008, Satoshi Nakamoto, whose identity remains
unknown, published a nine-page solution to a long-standing problem of
computer science known as the Byzantine Generals Problem.5 Nakamoto’s
solution and the system he built from it—Bitcoin—allowed, for the first
time ever, value to be transferred quickly and at great distance in a trust-
minimized way. The ramifications of the creation of Bitcoin are so profound
for both economics and computer science that Nakamoto should rightly
qualify for both a Nobel Memorial Prize in Economics and the Turing
Award, a dual distinction only one other person, Herbert Simon, has
received.
For an investor, the salient fact of the invention of Bitcoin is the creation
of a new scarce digital good—bitcoins. Bitcoins are transferable digital
tokens created on the Bitcoin network in a process known as mining.
Bitcoin mining is roughly analogous to gold mining, except that production
follows a fixed, predictable schedule. By design, only 21 million bitcoins
will ever be mined, and most of these already have been; approximately
18.7 million bitcoins have been mined at the time of writing. Every four
years, the number of bitcoins produced by mining is halved, with the
production of new bitcoins scheduled to end completely by the year 2140.
 Bitcoin’s inflation schedule

Bitcoins are not backed by any physical commodity, nor are they
guaranteed by any government or company, which raises the obvious
question for a new Bitcoin investor: why do they have any value at all?
Unlike stocks, bonds, real estate, or even commodities such as oil and
wheat, bitcoins cannot be valued using standard discounted-cash-flow
analysis or by demand for their use in the production of higher-order goods.
Bitcoins fall into an entirely different category of goods, known as
monetary goods, whose value is set game-theoretically. That is, each market
participant values the good based on their appraisal of whether and how
much other participants will value it. To understand the game-theoretic
nature of monetary goods, we need to explore the origins of money.
 THE ORIGINS OF MONEY
In the earliest human societies, trade between groups of people occurred
through barter. The incredible inefficiencies inherent to barter trade
drastically limited the scale and geographical scope at which trade could
occur. A major disadvantage with barter-based trade is the double
coincidence of wants problem. An apple grower may desire trade with a
fisherman, for example, but if the fisherman does not desire apples at the
same moment, the trade will not take place. Over time, humans evolved a
desire to hold certain collectible items for their rarity and symbolic value
(examples include shells, animal teeth, and flint). Indeed, as Nick Szabo
argues in his brilliant essay on the origins of money, the human desire for
collectibles provided a distinct evolutionary advantage for early man over
his nearest biological competitors, Neanderthals. Szabo writes, “[t]he
primary and ultimate evolutionary function of collectibles was as a medium
for storing and transferring wealth.”6
Collectibles served as a sort of proto-money by making trade possible
between otherwise antagonistic tribes and by allowing wealth to be
transferred between generations. Trade and transfer of collectibles were
quite infrequent in paleolithic societies, and these goods served more as a
store of value rather than the medium-of-exchange role that we largely
recognize modern money to play. Szabo explains:

Compared to modern money, primitive money had a very low

velocity—it might be transferred only a handful of times in an
average individual’s lifetime. Nevertheless, a durable collectible,
what today we would call an heirloom, could persist for many
generations and added substantial value at each transfer—often
making the transfer even possible at all.
 Early man faced an important game-theoretic dilemma when deciding
which collectibles to gather or create: which objects would be desired by
other humans? By correctly anticipating which objects would have
collectible value, a tremendous benefit was conferred on the possessor in
their ability to conduct trade and acquire wealth. Some Native American
tribes, such as the Narragansetts, specialized in the manufacture of
otherwise useless collectibles simply for their trade value. It is worth noting
that the earlier the anticipation of future demand for a collectible good, the
greater the advantage conferred to its possessor; it can be acquired more
cheaply than when it is widely demanded, and its trade value appreciates as
the population demanding it expands. Furthermore, acquiring a good in
hopes that it will be demanded as a future store of value hastens its adoption
for that very purpose. This seeming circularity is actually a feedback loop
that drives societies to quickly converge on a single store of value. In game-
theoretic terms, this is known as a Nash Equilibrium.7 Achieving a Nash
Equilibrium for a store of value is a major boon to any society, as it greatly
facilitates trade and the division of labor, paving the way for the
advancement of civilization.
 The Silk Road

Over the millennia, as human societies grew and trade routes developed,
the stores of value that emerged in individual societies came to compete
against each other. Merchants and traders would face a choice of whether to
save the proceeds of their trade in the store of value of their own society, the
store of value of the society they were trading with, or some balance of
both. The benefit of maintaining savings in a foreign store of value was the
enhanced ability to conduct trade in the associated foreign society.
Merchants holding savings in a foreign store of value also had an incentive
to encourage its adoption within their own society, as this would increase
the purchasing power of their savings. The benefits of an imported store of
value accrued not only to the merchants doing the importing, but also to the
societies themselves. Two societies converging on a single store of value
would see a substantial decrease in the cost of trading with each other and
an attendant increase in trade-based wealth. Indeed, the nineteenth century
was the first time when most of the world converged on a single store of
value, gold, and this period saw the greatest explosion of trade in the history
of the world. Of this halcyon period, Lord Keynes wrote:

What an extraordinary episode in the economic progress of man that

age was … for any man of capacity or character at all exceeding the
average, into the middle and upper classes, for whom life offered, at
a low cost and with the least trouble, conveniences, comforts, and
amenities beyond the compass of the richest and most powerful
monarchs of other ages. The inhabitant of London could order by
telephone, sipping his morning tea in bed, the various products of
the whole earth, in such quantity as he might see fit, and reasonably
expect their early delivery upon his doorstep.8
W HEN STORES OF VALUE COMPETE AGAINST EACH OTHER , SPECIFIC
attributes determine which are likely to out-compete others at the margin
and win increased demand over time. Historically, many goods have been
used as stores of value, and time has shown that an ideal store of value will
excel in the following ways:

Durable: the good must not be perishable or easily destroyed. Thus,

wheat is not an ideal store of value.
Portable: the good must be easy to transport and store, making it
possible to secure it against loss or theft and allowing it to facilitate
long-distance trade. A cow is thus less ideal than a gold bracelet.
Fungible: one specimen of the good should be interchangeable with
another of equal quantity. Without fungibility, the coincidence of wants
problem remains unsolved. Thus, gold is better than diamonds, which
are irregular in shape and quality.
Verifiable: the good must be easy to quickly identify and verify as
authentic. Easy verification increases the confidence of its recipient in
a trade, making it more likely the trade will be consummated.
Divisible: the good must be easy to subdivide. While this attribute was
less important in early societies where trade was infrequent, it became
more important as trade flourished and the quantities exchanged
became smaller and more precise.
Scarce: As Nick Szabo termed it, a monetary good must have
unforgeable costliness. In other words, the good must not be abundant
or easy to either obtain or produce in quantity. Scarcity is perhaps the
most important attribute of a store of value as it taps into the innate
human desire to collect that which is rare. It is the source of the
original value of the store of value.
 Established history: the longer the good is perceived by society to
have been valuable, the greater its appeal as a store of value. A long-
established store of value will be hard to displace by a new upstart,
except by force of conquest or if the arriviste is endowed with a
significant advantage among the other attributes listed above.
Censorship resistant: a new attribute, which has become increasingly
important in our modern, digital society with pervasive surveillance, is
censorship resistance. That is, how difficult it is for an external party
such as a corporation or state to prevent the owner of the good from
keeping and using it. Goods that are censorship resistant are ideal for
those living under regimes that are trying to enforce capital controls or
to outlaw various forms of peaceful trade.

The table below grades Bitcoin, gold, and fiat money (such as dollars)
against the attributes listed above and is followed by an explanation of each
grade:
 DURABILITY
Gold is the undisputed king of durability. Most of the gold that has ever
been mined or minted, including the gold of the Pharaohs, remains extant
today and will likely be available a thousand years hence. Gold coins that
were used as money in antiquity still maintain significant value today. Fiat
currency and bitcoins are fundamentally digital records that may take
physical form (such as paper bills). Thus, it is not their physical
manifestation whose durability should be considered (since a tattered dollar
bill may be exchanged for a new one), but rather the durability of the
institution that issues them. In the case of fiat currencies, many
governments have come and gone over the centuries, and their currencies
disappeared with them. The Papiermark, Rentenmark, and Reichsmark of
the Weimar Republic no longer have value because the institution that
issued them no longer exists. If history is a guide, it would be folly to
consider fiat currencies durable in the long term—the U.S. dollar and
British pound are relative anomalies in this regard. Bitcoins, having no
issuing authority, may be considered durable so long as the network that
secures them remains in place. Given that Bitcoin is still in its infancy, it is
too early to draw strong conclusions about its durability. However, there are
encouraging signs that, despite prominent instances of nation-states
attempting to regulate Bitcoin and years of attacks by hackers, the network
has continued to function, displaying a remarkable degree of anti-fragility.9
 PORTABILITY
Bitcoins are the most portable store of value ever used by man. Private keys
representing hundreds of millions of dollars can be stored on a tiny USB
drive and easily carried anywhere. Furthermore, equally valuable sums can
be transmitted between people at opposite ends of the earth almost instantly.
Fiat currencies, being fundamentally digital, are also highly portable.
However, government regulations and capital controls mean that large
transfers of value usually take days or may not be possible at all. Cash can
be used to avoid capital controls, but then the risk of storage and cost of
transportation become significant. Gold, being physical in form and
incredibly dense, is by far the least portable. It is no wonder that most
bullion is never transported. When bullion is traded between a buyer and a
seller, it is typically only the title to the gold that is transferred, not the
physical bullion itself, providing a weaker assurance of ownership for the
buyer. Transporting physical gold across large distances is costly, risky, and
time-consuming.
 FUNGIBILITY
Gold provides the standard for fungibility. When melted down, an ounce of
gold is essentially indistinguishable from any other ounce and gold has
always traded this way on the market. Fiat currencies, on the other hand, are
only as fungible as the issuing institutions allow them to be. While it may
be the case that a fiat banknote is usually treated like any other by
merchants accepting them, there are instances where large-denomination
notes have been treated differently than small ones. For instance, India’s
government completely demonetized their 500- and 1000-rupee banknotes
in an attempt to stamp out India’s untaxed gray market. The demonetization
caused 500- and 1000-rupee notes to trade at a discount to their face value,
making them no longer truly fungible with their lower denomination sibling
notes. Bitcoins are fungible at the network level, meaning that every bitcoin
when transmitted is treated the same on the Bitcoin network. However,
because bitcoins are traceable on the blockchain—a public record of all
transactions that have ever taken place on the Bitcoin network—a particular
bitcoin may become tainted by its use in illicit trade and businesses may be
compelled not to accept such tainted bitcoins. Without improvements to the
privacy and anonymity of Bitcoin’s network protocol, bitcoins cannot be
considered as fungible as gold.
 VERIFIABILITY
For most intents and purposes, both fiat currencies and gold are fairly easy
to verify for authenticity. However, despite providing features on their
banknotes to prevent counterfeiting, nation-states and their citizens can still
potentially be duped by counterfeit bills. Gold is also not immune from
counterfeiting. Sophisticated criminals have used gold-plated tungsten as a
way of fooling investors into paying for false gold.10 Bitcoins, on the other
hand, can be verified with mathematical certainty. Using cryptographic
signatures, the owner of bitcoins can publicly prove they own the bitcoins
they say they do.
 DIVISIBILITY
Bitcoins can be divided down to a hundred millionth of a bitcoin and
transmitted at such infinitesimal amounts (network fees can, however, make
transmission of tiny amounts uneconomical). Fiat currencies are typically
divisible down to pocket change, which has little purchasing power, making
fiat divisible enough in practice. Gold, while physically divisible, becomes
difficult to use when divided into small enough quantities to be suitable for
lower-value, day-to-day commerce.
 SCARCITY
The attribute that most clearly distinguishes Bitcoin from fiat currencies
and gold is its predetermined scarcity. By design, at most 21 million
bitcoins can ever be created. This gives the owner of bitcoins a known
percentage of the total possible supply. For instance, an owner of 10
bitcoins would know that at most 2.1 million people on earth (less than 0.03
percent of the world’s population) could ever have as many bitcoins as they
had. Gold, while remaining quite scarce throughout history, is not immune
to increases in supply. If it were ever the case that a new method of mining
or acquiring gold became economical, the supply of gold could rise
dramatically (examples include sea-floor mining11 or asteroid mining12).
Finally, fiat currencies, while only a relatively recent historical invention,
have proven to be prone to constant increases in supply. Nation-states have
shown a persistent proclivity to inflate their money supply to solve short-
term political problems. The inflationary tendencies of governments across
the world leave the owner of a fiat currency with the likelihood that their
savings will diminish in value over time.
 ESTABLISHED HISTORY
No monetary good has a history as long and storied as gold, which has been
valued for as long as human civilization has existed. Coins minted in the
distant days of antiquity still maintain significant value today.13 The same
cannot be said of fiat currencies, which are a relatively recent anomaly of
history. From their inception, fiat currencies have had a near-universal
tendency toward eventual worthlessness. The use of inflation as an
insidious means of invisibly taxing a citizenry has been a temptation that
few states in history have been able to resist. If the twentieth century, in
which fiat monies came to dominate the global monetary order, established
any economic truth, it is that fiat money cannot be trusted to maintain its
value over the long or even medium term. Bitcoin, despite its short
existence, has weathered enough trials in the market that there is a high
likelihood it will not vanish as a valued asset any time soon. Furthermore,
the Lindy effect suggests that the longer Bitcoin remains in existence, the
greater society’s confidence that it will continue to exist long into the
future.14 In other words, social trust in a new monetary good is asymptotic
in nature, as is illustrated in the graph below:
 If Bitcoin exists for 20 years, there will be near-universal confidence that
it will be available forever, much as people believe the Internet is a
permanent feature of the modern world.
 CENSORSHIP RESISTANCE
One of the most significant sources of early demand for bitcoins was their
use in the illicit drug trade. Many subsequently surmised, mistakenly, that
the primary demand for bitcoins was due to their ostensible anonymity.
Bitcoin, however, is far from an anonymous currency; every transaction
transmitted on the Bitcoin network is forever recorded on a public
blockchain. The historical record of transactions allows for later forensic
analysis to identify the source of a flow of funds. It was such an analysis
that led to the apprehending of a perpetrator of the infamous MtGox heist.15
While it is true that a sufficiently careful and diligent person can conceal
their identity when using Bitcoin, this is not why Bitcoin was so popular for
trading drugs. The key attribute that makes Bitcoin valuable for proscribed
activities is that it is permissionless at the network level. When bitcoins are
transmitted on the Bitcoin network, there is no human intervention deciding
whether the transaction should be allowed. As a distributed peer-to-peer
network, Bitcoin is, by its very nature, designed to be censorship-resistant.
This is in stark contrast to the fiat banking system, where states regulate
banks and the other gatekeepers of money transmission to report and
prevent outlawed uses of monetary goods. A classic example of regulated
money transmission is capital controls. A wealthy millionaire, for instance,
may find it infeasible or risky to transfer their wealth to a new domicile if
they wish to flee an oppressive regime. Although gold is not issued by
states, its physical nature makes it difficult to transport, making it far more
susceptible to state control than Bitcoin. India’s Gold Control Act is an
example of such regulation.16
Bitcoin excels across most attributes listed above, allowing it to
outcompete modern and ancient monetary goods at the margin and
providing a strong incentive for its increasing adoption. In particular, the
potent combination of censorship resistance and absolute scarcity has been
a powerful motivator for wealthy investors to allocate a portion of their
wealth to the nascent asset class.
T HERE IS AN OBSESSION IN MODERN MONETARY ECONOMICS WITH THE
medium-of-exchange role of money. In the twentieth century, states have
monopolized the issuance of money and continually undermined its use as a
store of value, creating a false belief that money is primarily defined as a
medium of exchange. Many have criticized Bitcoin as being an unsuitable
money because its price has been too volatile for it to be used as a medium
of exchange. This puts the cart before the horse, however. Money has
always evolved in stages, with the store-of-value role preceding the
medium-of-exchange role. One of the fathers of marginalist economics,
William Stanley Jevons, explained that:

Historically speaking … gold seems to have served, firstly, as a

commodity valuable for ornamental purposes; secondly, as stored
wealth; thirdly, as a medium of exchange; and, lastly, as a measure
of value.17

Using modern terminology, money always evolves in the following four

stages:

1. Collectible: In the very first stage of its evolution, money will be

demanded solely based on its peculiar properties, usually becoming a
whimsy of its possessor. Shells, beads, and gold were all collectibles
before later transitioning to the more familiar roles of money.
2. Store of value: Once it is demanded by enough people for its
peculiarities, money will be recognized as a means of keeping and
storing value over time. As a good becomes more widely recognized as
a suitable store of value, its purchasing power will rise as more people
demand it for this purpose. The purchasing power of a store of value
will eventually plateau when it is widely held and the influx of new
people desiring it as a store of value dwindles.
 3. Medium of exchange: When money is fully established as a store of
value, its purchasing power will stabilize. Having stabilized in
purchasing power, the opportunity cost of using money to conduct
trade will diminish to a level suitable for use as a medium of exchange.
In the earliest days of Bitcoin, many people did not appreciate the huge
opportunity cost of using bitcoins as a medium of exchange, rather
than as an incipient store of value. The famous story of a man trading
10,000 bitcoins (worth approximately $480 million at the time of this
book’s writing) for two pizzas illustrates this confusion.18
4. Unit of account: When money is widely used as a medium of
exchange, goods will be priced in terms of it. That is, the exchange
ratio against money will be available for most goods. It is a common
misconception that bitcoin prices are available for many goods today.
For example, while a cup of coffee might be available for purchase
using bitcoins, the price listed is not a true bitcoin price; rather, it is the
dollar price desired by the merchant translated into bitcoin terms at the
current USD/BTC market exchange rate. If the price of Bitcoin were to
drop in dollar terms, the number of bitcoins requested by the merchant
would increase commensurately. Only when merchants are willing to
accept bitcoins for payment without regard to the bitcoin exchange rate
against fiat currencies can we truly think of Bitcoin as having become
a unit of account.

Monetary goods that are not yet a unit of account may be thought of as
being partly monetized. Today gold fills such a role, being a store of value
but having been stripped of its medium-of-exchange and unit-of-account
roles by government intervention. It is also possible that one good fills the
medium-of-exchange role of money while another good fills the other roles.
This is typically true in countries with dysfunctional states, such as
Argentina or Zimbabwe. In his book Digital Gold, Nathaniel Popper writes:
 In America, the dollar seamlessly serves the three functions of
money: providing a medium of exchange, a unit for measuring the
cost of goods, and an asset where value can be stored. In Argentina,
on the other hand, while the peso was used as a medium of
exchange—for daily purchases—no one used it as a store of value.
Keeping savings in the peso was equivalent to throwing away
money. So people exchanged any pesos they wanted to save for
dollars, which kept their value better than the peso. Because the
peso was so volatile, people usually remembered prices in dollars,
which provided a more reliable unit of measure over time.

Bitcoin is currently transitioning from the first stage of monetization

(collectible) to the second stage (store of value). It will likely be several
years before Bitcoin transitions from being an incipient store of value to
being a true medium of exchange, and the path it takes to get there is still
fraught with risk and uncertainty. It is striking to note that the same
transition took many centuries for gold. No one alive has seen the real-time
monetization of a good (as is taking place with Bitcoin), so there is precious
little experience regarding the path this monetization will take.
 PATH DEPENDENCE
In the process of being monetized, a monetary good will soar in purchasing
power. Many have commented that the increase in purchasing power of
Bitcoin creates the appearance of a bubble. While this term is often used
disparagingly to suggest that Bitcoin is grossly overvalued, it is
unintentionally apt. A characteristic that is common to all monetary goods is
that their purchasing power is higher than can be justified by their use-value
alone. Indeed, many historical monies had no use-value at all. The
difference between the purchasing power of a monetary good and the
exchange-value it could command for its inherent usefulness can be thought
of as a monetary premium. As a monetary good transitions through the
stages of monetization (listed in the prior section), the monetary premium
will increase. The premium does not, however, move in a straight,
predictable line. A good X that was in the process of being monetized may
be outcompeted by another good Y that is more suitable as money, and the
monetary premium of X may drop or vanish entirely. The monetary
premium of silver disappeared almost entirely in the late nineteenth century
when governments across the world largely abandoned it as money in favor
of gold.
 Monetary premium of different monetary goods

Even in the absence of exogenous factors such as government

intervention or competition from other monetary goods, the monetary
premium for a new money will not follow a predictable path. Economist
Larry White observed that “the trouble with [the] bubble story, of course, is
that [it] is consistent with any price path, and thus gives no explanation for
a particular price path.”19
The process of monetization is game-theoretic; every market participant
attempts to anticipate the aggregate demand of other participants and
thereby the future monetary premium. Because the monetary premium is
unanchored to any inherent usefulness, market participants tend to default
to past prices when determining whether a monetary good is cheap or
expensive and whether to buy or sell it. The connection of current demand
to past prices is known as path dependence and is perhaps the greatest
source of confusion in understanding the price movements of monetary
goods.
When the purchasing power of a monetary good increases with
increasing adoption, market expectations of what constitutes “cheap” and
“expensive” shift accordingly. Similarly, when the price of a monetary good
crashes, expectations can switch to a general belief that prior prices were
“irrational” or overly inflated. The path dependence of money is illustrated
by the words of well-known Wall Street fund manager Josh Brown:

I bought [bitcoins] at like $2300 and had an immediate double on

my hands. Then I started saying “I can’t buy more of it,” as it rose,
even though that’s an anchored opinion based on nothing other than
the price where I originally got it. Then, as it fell over the last week
because of a Chinese crackdown on the exchanges, I started saying
to myself, “Oh good, I hope it gets killed so I can buy more.”20

The truth is that the notions of “cheap” and “expensive” are essentially
meaningless in reference to monetary goods. The price of a monetary good
is not a reflection of its cash flow or how useful it is but, rather, is a
measure of how widely adopted it has become for the various roles of
money.
Further complicating the path-dependent nature of money is the fact that
market participants do not merely act as dispassionate observers, trying to
buy or sell in anticipation of future movements of the monetary premium,
but also act as active evangelizers. Since there is no objectively correct
monetary premium, proselytizing the superior attributes of a monetary good
is more effective than for regular goods, whose value is ultimately anchored
to cash flow or use-demand. The religious fervor of participants in the
Bitcoin market can be observed in various online forums where owners
actively promote the benefits of Bitcoin and the wealth that can be made by
investing in it. In observing the Bitcoin market, Leigh Drogen comments:

You recognize this as a religion—a story we all tell each other and
agree upon. Religion is the adoption curve we ought to be thinking
about. It’s almost perfect—as soon as someone gets in, they tell
everyone and go out evangelizing. Then their friends get in and they
start evangelizing.21

While the comparison to religion may give Bitcoin an aura of irrational

faith, it is entirely rational for the individual owner to evangelize for a
superior monetary good and for a society to standardize on it. Money acts
as the foundation for all trade and savings, so the adoption of a superior
form of money has tremendous multiplicative benefits to wealth creation
for all members of a society.
 HYPE CYCLES
W HILE THERE ARE NO A PRIORI RULES FOR THE PATH A MONETARY GOOD
will take as it is monetized, a curious pattern has emerged during the
relatively brief history of Bitcoin’s monetization. Bitcoin’s price appears to
follow a fractal pattern of increasing magnitude, where each iteration of the
fractal matches the classic shape of a Gartner hype cycle, as illustrated in
the chart below.

In his article “Speculative Bitcoin Adoption/Price Theory,” Michael

Casey posits that the expanding Gartner hype cycles represent phases of a
standard S-curve of adoption that was followed by many transformative
technologies as they became commonly used in society.22
Each Gartner hype cycle begins with a burst of enthusiasm for the new
technology, and the price is bid up by the market participants who are
“reachable” in that iteration. The earliest buyers in a Gartner hype cycle
typically have a strong conviction about the transformative nature of the
technology they are investing in. Eventually, the market reaches a climax of
enthusiasm as the supply of new participants who can be reached in the
cycle is exhausted, and the buying becomes dominated by speculators more
interested in quick profits than the underlying technology.
 Following the peak of the hype cycle, prices rapidly drop, and
speculative fervor is replaced by despair, public derision, and a sense that
the technology was not transformative at all. Eventually the price bottoms
and forms a plateau where the original investors who had strong conviction
are joined by a new cohort who were able to withstand the pain of the crash
and who appreciated the importance of the technology.
The plateau persists for a prolonged period and forms, as Casey calls it, a
“stable, boring low.” During the plateau, public interest in the technology
will dwindle, but it will continue to be developed, and the collection of
strong believers will slowly grow. A new base is then set for the next
iteration of the hype cycle as external observers recognize the technology is
not going away and that investing in it may not be as risky as it seemed
during the crash phase of the cycle. The next iteration of the hype cycle will
bring in a much larger set of adopters and be far greater in magnitude.
Very few people participating in an iteration of a Gartner hype cycle will
correctly anticipate how high prices will go in that cycle. Prices usually
reach levels that would seem absurd to most investors at the earliest stages
of the cycle. When the cycle ends, a popular cause is typically attributed to
the crash by the media. While the stated cause, such as an exchange failure,
may be a precipitating event, it is not the fundamental reason for the cycle
to end. Gartner hype cycles end because of an exhaustion of market
participants reachable in the cycle.
It is telling that gold followed the classic pattern of a Gartner hype cycle
from the late 1970s to the early 2000s. One might speculate that the hype
cycle is a social dynamic inherent to the process of monetization.
 GARTNER COHORTS
Prior to the launch of the MtGox exchange in July 2010, no hype cycles
were discernible in Bitcoin’s minuscule market. The market was dominated
by a coterie of cryptographers, computer scientists, and cypherpunks who
were already primed to understand the importance of Satoshi Nakamoto’s
groundbreaking invention and who were pioneers in establishing that the
Bitcoin protocol was free of technical flaws. Prices were set either by direct
exchange or by barter transactions, such as the purchase of two pizzas for
10,000 bitcoins by Laszlo Hanyecz. Bitcoin’s price in these early days
remained well below $1.

After the establishment of the first exchange-traded price in 2010,

Bitcoin’s market has witnessed four major Gartner hype cycles. With
hindsight, we can precisely identify the price ranges of previous hype
cycles in the Bitcoin market. We can also qualitatively identify the cohort of
investors associated with each iteration of prior cycles.
$0.06–$30 (July 2010–July 2011): The first cycle attracted a steady
stream of ideologically motivated investors who were dazzled by the
potential of a stateless, digital money. Libertarians such as Roger Ver and
Ross Ulbricht were attracted to Bitcoin for the anti-establishment activities
that would become possible if the nascent technology became widely
adopted. The cycle reached its climax just a month after Gawker published
a widely read article covering Bitcoin and its use in a website known as Silk
Road that had been created by Ulbricht. Silk Road facilitated the purchase
of illicit substances using bitcoins and was an early source of demand for
the digital currency.
$30–$1,154 (August 2011–December 2013): The second cycle saw the
entrance of the most intrepid of investors, such as the Argentinian Wences
Casares, who were willing to take a chance on the iconoclastic and
unproven technology. Casares saw in Bitcoin a potential cure for the
economic ravages of the hyperinflation he had experienced as a child. A
brilliant and well-connected serial entrepreneur, Casares is known to have
evangelized Bitcoin to some of the most prominent technologists and
investors in Silicon Valley, and he came to be known as patient zero for
spreading the so-called “mind virus” in this way.
The Winklevoss twins, who had tussled with Mark Zuckerberg about the
founding of Facebook and had received a large settlement from the
company, were also participants in the second hype cycle. Having received
a large payout from Facebook, the Winklevoss twins were celebrating in
Ibiza when a chance encounter with investor David Azar first exposed them
to this new investment opportunity. They were immediately intrigued by
what they heard and eventually used their newfound capital to invest in
Bitcoin.
Investors in Bitcoin’s first and second hype cycles were willing to brave
the arcane and risky liquidity channels from which bitcoins could be
acquired. The primary source of liquidity in the market during this period
was the Japan-based MtGox exchange that was run by the notoriously
incompetent and malfeasant Mark Karpeles, who later received a prison
sentence for his culpability in the collapse of the exchange.
 $1,154–$19,600 (January 2014–December 2017): The third hype cycle
attracted the first major influx of investors without an ideological affinity to
the cypherpunk ethos that gave rise to Bitcoin. In terms of the S-curve of
adoption, these new investors could be recognized as “early adopters”.

An analysis of blockchain and exchange data from this period by Willy

Woo suggests that the cohort of new entrants was dominated by retail
investors and that global usage grew from approximately 1-2 million
investors to over 14 million.23 The cycle ended with a speculative fervor
driven by the launch of a legion of alternative cryptocurrencies (alt-coins)
competing with Bitcoin for market dominance. The vast majority of these
alt-coins have since faded into obsolescence.
It is worth observing that the rise in Bitcoin’s price during the
aforementioned hype cycles was largely correlated with an increase in
liquidity and the ease with which investors could purchase bitcoins. In the
first two hype cycles, MtGox was the primary source of Bitcoin’s liquidity
and obtaining and securing bitcoins from this poorly run exchange
remained too complex for all but the most technologically savvy investors.
Furthermore, many who did manage to transfer money to MtGox ultimately
faced loss of funds when the exchange was hacked and later closed. By the
beginning of the third hype cycle, competitors to MtGox began to emerge.
However, even after MtGox’s collapse and replacement by more competent
competitors, significant hurdles remained for investors seeking to invest in
Bitcoin. Banks were often reluctant to deal with exchanges and exchanges
such as Coinbase were unable to keep their service consistently available
under heavy usage. The newly emerging financial infrastructure remained
rickety at best.
It was only after the end of the third hype cycle and a two-year lull in the
market price of Bitcoin that mature and deep sources of liquidity were
developed; examples include OTC brokers, regulated exchanges that
improved their reliability and futures markets such as the Chicago
Mercantile Exchange. By the time the fourth hype cycle began in 2020, it
was relatively easy for retail and institutional investors to buy and secure
bitcoins.
$19600—? (January 2018 – ?): At the time of writing, the Bitcoin market
is undergoing its fourth major hype cycle. As sources of liquidity have
deepened and matured, major institutional investors can now participate and
indeed several prominent wealth managers such as Paul Tudor Jones and
Stanley Druckenmiller have allocated a portion of their funds to Bitcoin.
Along with wealth management funds, public companies Tesla,
MicroStrategy, and Square have apportioned part, or all in the case of
MicroStrategy, of their corporate treasuries to Bitcoin, setting a precedent
for other large corporations to do the same.
With the maturation of Bitcoin’s market, institutional demand is likely to
play a powerful role in the current hype cycle. As Philip Gradwell, CEO of
blockchain analytics firm Chainalysis, wrote in a note to clients:

The role of institutional investors is becoming ever clearer in the

data … Demand is being driven by North American investors on fiat
exchanges, with greater demand from institutional buyers.24

A study produced by the University of Cambridge Center for Alternative

Finance concluded that, by the third quarter of 2020, there were “a total of
up to 101 million unique crypto asset users” globally.25 It appears that
during the current hype cycle, Bitcoin is poised to shift from the “early
adopters” phase of the S-curve of global adoption to the “early majority.”
The availability of a regulated futures market paves the way for the
eventual creation of a Bitcoin ETF, which will then usher in the “late
majority” and “laggards” in subsequent hype cycles.
Although it is impossible to predict the exact magnitude of the current
hype cycle, it would be reasonable to conjecture that in the current cycle
Bitcoin attains some significant fraction of the market capitalization of gold
—its closest cousin in the global family of financial assets.
 THE EFFECT OF THE HALVING
Bitcoins are produced by a competitive process known as mining that
requires the expenditure of computational energy. The Bitcoin production
schedule is predetermined by its protocol and, by design, approximately
every 10 minutes a new block is mined by a miner (a computer participating
on the Bitcoin network). Each time a miner successfully mines a block it is
awarded a fixed number of bitcoins, and this reward is known as the block
subsidy. The block subsidy is the original source of all bitcoins produced on
the Bitcoin network.
Approximately every four years or, more precisely, once every 210,000
blocks, the Bitcoin block subsidy is halved in an event known as the
halving. For the first four years of Bitcoin’s existence, each block carried a
reward of 50 bitcoins. For the next four years, the block subsidy was 25
bitcoins. In the current epoch, which began in May 2020, each block
rewards miners with just 6.25 bitcoins. By the year 2140, or thereabouts,
the block subsidy will decline to zero and no new bitcoins will be produced
by mining. An important question for investors is what affect Bitcoin
halvings have on its price level and whether this quadrennial supply shock
can be adequately “priced in” by the market.
Bitcoin’s protocol specifies that the amount of computational energy
required to mine a block is adjusted periodically to maintain a relatively
consistent output of bitcoins during each halving epoch. If the
computational resources devoted to mining increase, the difficulty of
mining is adjusted upward, and it becomes more costly to mine new
bitcoins. This difficulty adjustment tends to make miners into marginal
producers. That is, the profit from mining tends toward zero over time. Due
to the marginal nature of the mining business, miners typically need to sell
most of the bitcoins they mine to cover the continuing costs of running their
operations, which are dominated by electricity costs. Thus, miners provide a
constant downward pressure on Bitcoin’s price level. When the Bitcoin
halving occurs, the downward selling pressure of miners is approximately
halved in magnitude.
All things being equal, if demand for bitcoins were to remain constant,
the halving would result in an excess of demand over supply, causing the
price to rise. Given the predetermined timing of each halving, it seems that
it should be possible for market participants to anticipate the event and
price it in. Yet historically, it is clear that Bitcoin halvings have not been
adequately priced in and that Bitcoin’s price seems to rise dramatically after
each halving. Indeed, it may be speculated that Bitcoin’s halving is the
precipitating cause of Bitcoin’s periodic hype cycles.
As we saw earlier in this chapter, when a Bitcoin hype cycle ends, the
price drops precipitously until it finds an equilibrium where demand from
buyers with strong conviction matches the supply from speculators seeking
to exit the market and miners selling to cover their cost of production. The
halving disrupts the eventual equilibrium, and the supply of bitcoins that are
tradeable on the market is slowly but surely transferred to the hands of
long-term holders. As the pool of tradeable bitcoins diminishes, the market
price of Bitcoin begins to drift upward, and the apparently inexorable rise in
price seems to trigger a classic “madness of crowds” phenomenon and the
parabolic phase of the hype cycle ensues.
A potential reason that prior halvings have historically not been priced in
is that when a halving triggers a new hype cycle, it is unclear how large the
cohort of participants reachable in that hype cycle will be, and to what
extent members of the cohort will be willing to allocate their savings to
Bitcoin. Complicating matters are the complex feedback loops involved in
monetization. We have already noted that when some investors decide to
save in Bitcoin they not only act as passive investors, but also become
active evangelizers for the superiority of Bitcoin as a means of saving to
others. The extent to which this evangelization enlarges a cohort is perhaps
not measurable.
 THE ENTRANCE OF NATION-STATES
Bitcoin’s final Gartner hype cycle will begin when nation-states start
accumulating it as a part of their foreign currency reserves. The market
capitalization of Bitcoin is currently too small for it to be considered a
viable addition to reserves for most countries. However, as private sector
interest increases and the capitalization of Bitcoin approaches that of gold,
it will become liquid enough for most states to enter the market. The
entrance of the first state to officially add bitcoins to their reserves will
likely trigger a stampede for others to do so. The states that are the earliest
in adopting Bitcoin would see the largest benefit to their balance sheets if
Bitcoin ultimately became a global reserve currency. Unfortunately, it will
probably be states with the strongest executive powers, such as
dictatorships like North Korea, that will be the earliest to accumulate
bitcoins. The unwillingness to see such states improve their financial
position and the inherently weak executive branches of the Western
democracies will cause them to dither and lag behind in accumulating
bitcoins for their reserves.
There is a great irony that the United States is currently one of the
nations most open in its regulatory position toward Bitcoin, while China
and Russia are the most hostile. The U.S. risks the greatest downside to its
geopolitical position if Bitcoin were to supplant the dollar as the world’s
reserve currency. In the 1960s, Charles de Gaulle criticized the “exorbitant
privilege” the U.S. enjoyed from the international monetary order it crafted
at the Bretton Woods conference of 1944. The Russian and Chinese
governments have not yet awoken to the geo-strategic benefits of Bitcoin as
a reserve currency and are currently preoccupied with the effects it may
have on their internal markets. Like de Gaulle in the 1960s, who threatened
to reestablish the classical gold standard in response to the US’s exorbitant
privilege, the Chinese and Russians will, in time, come to see the benefits
of a large reserve position in a nonsovereign store of value. With the largest
concentration of Bitcoin mining power residing in China, the Chinese state
already has a distinct advantage in its potential to add bitcoins to its
reserves.
The United States prides itself as a nation of innovators, with Silicon
Valley being a crown jewel in the U.S. economy. Thus far, Silicon Valley
has largely dominated the conversation on the position that regulators
should take vis-à-vis Bitcoin. However, the banking industry and the U.S.
Federal Reserve are finally having their first inkling of the existential threat
Bitcoin poses to U.S. monetary policy if it were to become a global reserve
currency. The Wall Street Journal, known to be a mouthpiece for the
Federal Reserve, published a commentary on the threat Bitcoin poses to
U.S. monetary policy:

There is another danger, perhaps even more serious from the point
of view of the central banks and regulators: bitcoin might not crash.
If the speculative fervor in the cryptocurrency is merely the
precursor to it being widely used as an alternative to the dollar, it
will threaten the central banks’ monopoly on money.26

In the coming years, there will be a great struggle between entrepreneurs

and innovators, on the one hand, who will attempt to keep Bitcoin free of
regulatory control, and the banking industry and central banks, on the other,
who will use their influence to promote Bitcoin regulations in order to
prevent disruption of their industry and money-issuing powers.
 THE TRANSITION TO A MEDIUM OF EXCHANGE
A monetary good cannot transition to being a generally accepted medium of
exchange (the standard economic definition of money) before it is widely
valued, for the tautological reason that a good that is not valued will not be
accepted in exchange. In the process of becoming widely valued, and hence
a store of value, a monetary good will soar in purchasing power, creating an
opportunity cost to relinquishing it for use in exchange. Only when the
opportunity cost of relinquishing a store of value drops to a suitably low
level can it transition to becoming a generally accepted medium of
exchange.
More precisely, a monetary good will only be suitable as a medium of
exchange when the sum of the opportunity cost and the transactional cost of
using it in exchange drops below the cost of trading without it.
In a barter-based society, the transition of a store of value to a medium of
exchange can occur even when the monetary good is increasing in
purchasing power because the transactional costs of barter trade are
extremely high. In a developed economy, where transactional costs are low,
it is possible for a nascent and rapidly appreciating store of value, such as
Bitcoin, to be used as a medium of exchange, albeit within a limited scope.
An example is the illicit drug market, where buyers are willing to sacrifice
the opportunity of holding bitcoins to minimize the substantial risk of
purchasing the drugs using fiat currency.
There are, however, major institutional barriers to a nascent store of value
becoming a generally accepted medium of exchange in a developed society.
States use taxation as a powerful means to protect their sovereign money
from being displaced by competing monetary goods. Not only does a
sovereign money enjoy the advantage of a constant source of demand, by
way of taxes being remittable only in that form, but competing monetary
goods are taxed whenever they are exchanged at an appreciated value. This
latter kind of taxation creates significant friction to using a store of value as
a medium of exchange.
The handicapping of market-based monetary goods is not an
insurmountable barrier to their adoption as a generally accepted medium of
exchange, however. If faith is lost in a sovereign money, its value can
collapse in a process known as hyperinflation. When a sovereign money
hyperinflates, its value first collapses against the most liquid goods in the
society such as gold or foreign money like the U.S. dollar, if they are
available. When no liquid goods are available or their supply is limited, a
hyperinflating money collapses against real goods, such as real estate and
commodities. The archetypal image of a hyperinflation is a grocery store
emptied of all its produce as consumers flee the rapidly diminishing value
of their nation’s money.

Eventually, when faith is completely lost during a hyperinflation, a

sovereign money will no longer be accepted by anyone, and the society will
either devolve to barter or the monetary unit will be completely replaced as
a medium of exchange. An example of this process was the replacement of
the Zimbabwe dollar with the U.S. dollar. The replacement of a sovereign
money with a foreign one is made more difficult by the scarcity of the
foreign money and the absence of foreign banking institutions to provide
liquidity.
The ability to easily transmit bitcoins across borders and the absence of a
need for a banking system make Bitcoin an ideal monetary good for those
afflicted by hyperinflation. In the coming years, as fiat monies continue to
follow their historical trend toward eventual worthlessness, Bitcoin will
become an increasingly popular choice for global savings to flee to. When a
nation’s money is abandoned and replaced by Bitcoin, Bitcoin will have
transitioned from being a store of value in that society to a generally
accepted medium of exchange. Daniel Krawisz coined the term
hyperbitcoinization to describe this process.27
 COMMON MISCONCEPTIONS
M UCH OF THIS BOOK HAS FOCUSED ON THE MONETARY NATURE OF B ITCOIN .
With this foundation, we can now address the most common
misconceptions about this revolutionary monetary good.

IS BITCOIN A BUBBLE?
Bitcoin has a monetary premium that gives rise to the common criticism
that Bitcoin is a bubble. However, all monetary goods have a monetary
premium. Indeed, it is this premium (the excess over the use-demand price)
that is the defining characteristic of all monies. Thus, in a sense, money can
be said to always and everywhere be a bubble. Paradoxically, a monetary
good is both a bubble and may be undervalued if it is in the early stages of
its adoption for use as money.

IS BITCOIN TOO VOLATILE TO BE A STORE OF VALUE?

Bitcoin’s price volatility is a function of its nascency. In the first few years
of its existence, Bitcoin behaved like a penny stock, and any large buyer,
such as the Winklevoss twins, could cause a large spike in its price. As
adoption and liquidity have increased over the years, Bitcoin’s volatility has
decreased commensurately. When Bitcoin achieves the market
capitalization of gold, it should display a similar level of volatility. As
Bitcoin surpasses the market capitalization of gold, its volatility will
decrease to a level that will make it suitable as a widely used medium of
exchange. As previously noted, the monetization of Bitcoin occurs in a
series of Gartner hype cycles. Volatility is lowest during the plateau phase
of the hype cycle and highest during the peak and crash phases of the cycle.
Each hype cycle has lower volatility than previous cycles because the
liquidity of the market has increased.

IS BITCOIN TOO EXPENSIVE TO INVEST IN?

A common complaint among investors new to the Bitcoin market is that an
individual bitcoin is too expensive to purchase. This complaint is often a
result of the mistaken belief that bitcoins can only be purchased in whole
units rather than in smaller fractions. In fact, the divisibility of Bitcoin
allows investors to purchase trifling sums of the currency, such as a single
dollar’s worth. In other instances, the desire to own a whole bitcoin is the
result of a human psychological tendency known as unit bias. Unit bias is
the desire to complete a task or fulfill some objective in its entirety, and
research has shown it is a potential factor in the human proclivity to
overeat.28
The desire to own a whole unit of a cryptocurrency leads many investors
to mistakenly believe that competing cryptocurrencies are more affordable
because individual units of those currencies have a lower price. However,
the cheaper unit price of many of Bitcoin’s competitors is due to their much
higher unit supply, which is arbitrarily chosen and not in itself indicative of
the value of the currency. Investors should not focus on the price of an
individual unit, but rather on the market capitalization and liquidity of the
whole currency; the much larger capitalization and significantly deeper
liquidity of Bitcoin is a reflection of its stronger network effect and utility
for storing value.
An associated apprehension is that most of Bitcoin’s financial returns are
in the past rather than in the future, due to its previous meteoric rise,
leaving many new investors with a sense that they have missed out. While it
is true that the earliest owners of an economic good in the process of
monetization will see the greatest financial gains (assuming they are able to
hold over the long term) this does not imply that latecomers will not enjoy
good returns. The rate of financial returns will diminish over time as the
pool of savings entering a new monetary good slows and eventually
dwindles. But for Bitcoin, the addressable market encompasses the entire
market for storing value, which amounts to hundreds of trillions of dollars
in value and includes the gold market, government bonds, real estate, and
fine art. Bitcoin clearly has not reached full market saturation. Even in an
outcome where Bitcoin becomes the world’s reserve currency and the
inflow of savings to it stabilizes, owners will still see financial returns
proportional to the productivity of the global economy in which it has
become the unit of account.

ARE TRANSACTION FEES TOO HIGH?

A recent criticism of the Bitcoin network is that the increase in fees to
transmit bitcoins makes it unsuitable as a payment system. However, the
growth in fees is healthy and expected. Transaction fees are a cost required
to pay bitcoin miners to secure the network by validating transactions.
Miners are compensated by the sum of transaction fees plus the block
subsidy, which is an inflationary payout borne by current bitcoin owners.
Given Bitcoin’s fixed supply schedule—a monetary policy that makes it
an ideal store of value—the block subsidy will eventually decline to zero,
and the network must ultimately be secured with transaction fees. A
network with “low” fees is a network with little security and one prone to
external censorship. Those touting the low fees of Bitcoin alternatives are
unknowingly describing the weakness of these so-called alt-coins.
The specious root of the criticism of Bitcoin’s “high” transaction fees is
the belief that Bitcoin should be a payment system first and a store of value
later. As we have seen with the origins of money, this belief puts the cart
before the horse. Only when Bitcoin has become a deeply established store
of value will it become suitable as a medium of exchange. Furthermore,
once the opportunity cost of trading bitcoins reaches a level at which it is
suitable for use as a medium of exchange, most trades will not occur on the
Bitcoin network itself, but rather on second-layer networks with much
lower fees. A second-layer network allows parties to exchange bitcoins off-
chain—that is, without broadcasting every transaction to the Bitcoin
network—with final settlement eventually occurring on the blockchain. The
use of a second-layer network facilitates a much higher volume of cheap,
fast transactions than would be possible on-chain.
Second-layer networks, such as the Lightning network, provide the
modern equivalent of the promissory notes that were used to transfer titles
for gold in the nineteenth century. Promissory notes were used by banks
because transferring the underlying bullion was far more costly than
transferring a note representing the title to the gold. Unlike promissory
notes, however, the Lightning network will allow the transfer of bitcoins at
low cost while requiring little or no trust of third parties such as banks. The
development of the Lightning network is a profoundly important technical
innovation in Bitcoin’s history, and its value will become apparent as it is
developed and adopted in the coming years.

DOES BITCOIN CONSUME TOO MUCH ELECTRICITY?

The energy expenditure of Bitcoin’s network, required for the purpose of
mining, has been a cause of criticism among many anti-Bitcoin activists
who fault the potentially negative impact it may have on the Earth’s
environment. A common refrain is that Bitcoin’s network consumes more
electricity than some small nation, implying that this is an indictment of
Bitcoin in and of itself. According to the Cambridge Center for Alternative
Finance, at the time of writing, Bitcoin’s network consumes approximately
105 terawatt-hours of energy annually. Concerned investors may
legitimately question whether societies will tolerate such a significant
expenditure in the future and whether this may pose a political threat to
Bitcoin’s continued existence.
Policy-makers and investors must go beyond tendentious sound-bites
when performing a critical analysis of Bitcoin’s energy consumption.
Nuances that should be considered in an impartial analysis include the
source of Bitcoin’s energy consumption and whether it is environmentally
harmful, whether the energy consumed displaces other uses and, most
importantly, the utility provided to society made possible by such energy
usage. In this section, I will endeavor to consider these nuances through a
comparative analysis of Bitcoin with its main competitors. As a system for
storing and transmitting value, Bitcoin’s nearest competitors are gold and
the various fiat monetary systems used globally.
A 2014 survey of peer-reviewed studies on the environmental impact of
gold mining by Hass McCook concluded that the annual energy expenditure
of gold production was approximately 475 gigajoules or 132 terrawatt-
hours.29
 The environmental effects of gold mining are harsh and obvious

Although it superficially appears that the energy consumption of Bitcoin

and gold are similar, the environmental impact of gold mining greatly
exceeds that of its Bitcoin counterpart. A study published in the
International Journal of Environmental Research and Public Health by
Fashola et al. explains that “[gold] mining activities can lead to the
generation of large quantities of heavy metal-laden wastes which are
released in an uncontrolled manner, causing widespread contamination of
the ecosystem.”30 In contrast, Bitcoin mining only requires the operation of
computers on which Bitcoin’s mining software runs, often housed in large
data centers similar to those used by Google, Facebook, and Microsoft.
Furthermore, unlike gold mining, which must take place near the source of
the gold ore being mined, Bitcoin mining can take place in any location
where there is a power source and an Internet connection. Combined with
the ease and cheapness with which bitcoins can be transmitted, Bitcoin
mining gravitates toward sources of power that are overbuilt and produce
excess electricity that would otherwise go to waste. A prominent example of
overbuilt electrical capacity is the hydroelectric dams in Sichuan province
in China, one of the largest centers of Bitcoin mining. David Stanway, a
senior correspondent for industry and environment at Thomson Reuters,
explains that “Sichuan underlines the case. Total hydropower reached more
than 75 GW in 2017, greater than the total in most Asian countries. It was
also more than double the capacity of the province’s power grid, meaning
lots of wasted power.”31

A Bitcoin mining farm

Given that excess energy can only be transported limited distances, due
to decay over power lines, Bitcoin mining essentially rescues wasted energy
and transforms it into a digital good that can be easily transmitted around
the world. In this way, Bitcoin mining can be thought of as a means of
unlocking stranded energy that would be otherwise uneconomical to
produce or would go to waste due to limited usage in its geographical
location. Furthermore, many sources of excess energy are renewable in
nature and do not meaningfully contribute to global carbon emissions.
Examples include the aforementioned use of hydroelectric energy in China
and geothermal energy used by Bitcoin mining facilities in Iceland. Thus,
Bitcoin can be viewed as a force for environmental good by making
renewable energy producers more profitable and increasing the incentive
for investment in future production. A 2019 study by CoinShares Research
concluded that “a conservative estimate of the renewables penetration in the
energy mix powering the Bitcoin mining network [is] 74.1%, making
Bitcoin mining more renewables-driven than almost every other large-scale
industry in the world.”32
When comparing the environmental cost of Bitcoin mining to fiat
monetary systems, one must recognize that it is not simply the financial
infrastructure that should be accounted for, but also the political cost that
gives the monetary system enough credibility that a citizenry would place
their trust in it. History is littered with examples of nation-states whose
money and monetary systems collapsed when they were conquered or
splintered into factions. Without a military to enforce geographical
boundaries and a police force to enforce property rights, no sovereign
monetary system could survive. It is here that Bitcoin truly excels. Where
sovereign monies require an apparatus of coercion to exist (i.e., the state),
Bitcoin provides the foundation for a new monetary system where property
rights do not need to be maintained by a sovereign. An individual who owns
bitcoins can be thought of as having a “super property right”: ownership in
a valuable good that can easily be held and transmitted without the support
or sanction of the state.
Ultimately, the energy consumed by the Bitcoin network will be
proportional to the demand from the world’s citizenry to use a
permissionless system for savings and exchange and the utility that system
affords them. As Satoshi Nakamoto explained, “[t]he utility of the
exchanges made possible by Bitcoin will far exceed the cost of electricity
used. Therefore, not having Bitcoin would be the net waste.”33
For those living under oppressive regimes, Bitcoin’s utility is more than
theoretical and may be a matter of life and death. In a New York Times
opinion piece, Venezuelan economist Carlos Hernández explained that
owning Bitcoin allowed him to weather the ravages of hyperinflation and
allowed his brother to escape Venezuela without having his savings
confiscated.

Venezuelan military personnel at the borders have a reputation for

seizing the money of people who want to leave, but Juan’s, being in
Bitcoin, was accessible only with a password he had memorized.
“Borderless money” is more than a buzzword for those of us who
live in a collapsing economy and a collapsing dictatorship.34

WILL BITCOIN BE OVERTAKEN BY A COMPETING CRYPTOCURRENCY?

As an open-source software protocol, it has always been possible to copy
Bitcoin’s software and imitate its network. Over the years, many imitators
have been created, ranging from ersatz facsimiles such as Litecoin to
complex variants like Ethereum that promise to allow arbitrarily complex
contractual arrangements using a distributed computational system. A
common criticism of Bitcoin is that it cannot maintain its value when
competitors are easy to create and are able to incorporate the latest
innovations and software features.
The fallacy in this argument is the assumption that cryptocurrencies
compete on their technological attributes; rather, they compete on their
monetary attributes. Technology has value only insofar as it gives
credibility to the monetary attributes of a cryptocurrency, such as scarcity.
In this sense, boring, well-tested, and stable technology is preferable to
cutting-edge innovation.

Furthermore, the scores of Bitcoin competitors that have been created

over the years lack the network effect of the first and dominant technology
in the space. A network effect—the increased value of using Bitcoin simply
because it is already the dominant network—is a feature in and of itself. For
any technology that possesses a network effect, it is by far the most
important feature.
The network effect for Bitcoin encompasses the liquidity of its market,
the number of people who own it and the community of developers
maintaining and improving its software and brand awareness. Large
investors, including nation-states, will seek the most liquid market so that
they can enter and exit the market quickly without affecting its price.
Developers will flock to the dominant development community that has the
highest-caliber talent, thereby reinforcing the strength of that community.
Also, brand awareness is self-reinforcing; would-be competitors to Bitcoin
are always mentioned in the context of Bitcoin itself.

ARE FORKS A THREAT TO BITCOIN?

A trend that became popular in 2017 was not only to imitate Bitcoin’s
software, but also to copy the entire history of its past transactions (the
blockchain). By copying Bitcoin’s blockchain up to a certain point and then
splitting off into a new network, in a process known as forking, competitors
of Bitcoin were able to solve the problem of distributing their tokens to a
large user base.
The most significant fork of this kind occurred on August 1, 2017, when
a new network known as Bitcoin Cash (BCash) was created. An owner of N
bitcoins before August 1, 2017 would then own both N bitcoins and N
BCash tokens. The small but vocal community of BCash proponents
tirelessly attempted to expropriate Bitcoin’s brand recognition, both through
the deceptive naming of their new network and a campaign to convince
neophytes in the Bitcoin market that BCash was the “real” Bitcoin. These
attempts failed, and this failure is reflected in the relatively minuscule
market capitalization of the BCash network. However, for new investors,
there remains an apparent risk that a competitor might clone Bitcoin and its
blockchain and succeed in overtaking it in market capitalization, thus
becoming the de facto Bitcoin.
 A fork in the road

An important rule can be gleaned from the major forks that occurred with
both the Bitcoin and Ethereum networks. Most of the market capitalization
will settle on the network that retains the highest-caliber and most active
developer community. Although Bitcoin can be viewed as a nascent form of
money, it is also a computer network built on software that needs to be
maintained and improved. Buying tokens on a network with little or
inexperienced developer support would be akin to buying a clone of
Microsoft Windows that was not supported by Microsoft’s best developers.
It is clear from the history of the forks that occurred in 2017 that the best
and most experienced computer scientists and cryptographers are
committed to developing the original Bitcoin and not any of the growing
legion of imitators that have been created from it.

IS BITCOIN REALLY SCARCE?

While the supply of bitcoins within the Bitcoin network is limited to no
more than 21 million, some have contended that because Bitcoin’s software
can easily be copied and its blockchain forked, the creation of new tokens
on several copycat networks implies that Bitcoin’s scarcity is illusory. By
this flawed logic, each copy made of the Mona Lisa dilutes the singularity
of the original. Rather, each copy of Da Vinci’s masterpiece just serves to
illustrate that there is only one real Mona Lisa. Similarly, each copy made
of Bitcoin illustrates that there is only one network with a dominant
network effect, brand recognition, and monetary scale that allows billions of
dollars in value to be transferred each day.
 REAL RISKS
Although the common criticisms of Bitcoin are misplaced and based on a
flawed understanding of money, there are real and significant risks to
investing in Bitcoin. It would be prudent for a prospective Bitcoin investor
to understand and weigh these risks when considering an investment in
Bitcoin.

PROTOCOL RISK
The Bitcoin protocol and the cryptographic primitives on which it is built
could be found to have a design flaw or could be made insecure with the
development of quantum computing. If a flaw is found in the protocol or if
some new means of computation breaks the cryptography underpinning
Bitcoin, faith in Bitcoin as a store of value may be severely compromised.
Protocol risk was highest in the early years of Bitcoin’s development when
it was still unclear, even to seasoned cryptographers, that Satoshi Nakamoto
had truly found a solution to the Byzantine Generals Problem. Concerns
about serious flaws in the Bitcoin protocol have dissipated over the years as
numerous attempts to break it have failed and real flaws have been found
and fixed. Furthermore, protocol developers have been aware of the risk of
quantum computing for years and have researched potential solutions if the
use of such computers becomes feasible.35 However, given the
technological nature of Bitcoin, protocol risk will always remain, if only as
an outlier risk.

THE RISK OF STATE ATTACK

The threat of a state attack has hung over Bitcoin like a baleful pall since
early in its history and it remains the gravest and most present risk that
investors should weigh today. In a post to the Bitcointalk forum in
December 2010, Satoshi Nakamoto fretted that Wikileaks, a website known
for publishing state secrets, was considering collecting donations using
Bitcoin. Nakamoto explained that the attention brought by Wikileaks’
potential usage of Bitcoin was unwanted because the embryonic system he
had created was not yet resilient enough to withstand a concerted state
attack. Nevertheless, the decentralized and permissionless nature of Bitcoin
attracted usage for proscribed purposes early on, including the drug
marketplace Silk Road that opened in February 2011. It was Silk Road that
first drew the attention of members of the U.S. Congress to Bitcoin,
including West Virginia Senator Joe Manchin, who publicly appealed to
Federal regulators to ban Bitcoin in 2014, writing:

Due to Bitcoin’s anonymity, the virtual market has been extremely

susceptible to hackers and scam artists stealing millions from
Bitcoins users. Anonymity combined with Bitcoin’s ability to
finalize transactions quickly, makes it very difficult, if not
impossible, to reverse fraudulent transactions.
Bitcoin has also become a haven for individuals to buy black market
items. Individuals are able to anonymously purchase items such as
drugs and weapons illegally. I have already written to regulators
once on the now-closed Silkroad, which operated for years in
supplying drugs and other black market items to criminals, thanks in
large part to the creation of Bitcoin.36

Manchin mistakenly believed that Bitcoin was ideally suited for illicit
trade because it was anonymous. In reality, Bitcoin’s blockchain is public
and open, allowing law enforcement agencies to employ blockchain
analytics software to trace transactions years after they have taken place.
The development of blockchain analytics and its employment in
prosecuting several prominent criminal cases has muted the charge that
Bitcoin is anonymous and is predominantly used for criminal activities.
Over the years it has become apparent that the overwhelming source of
demand for Bitcoin is as a means for savings and investment rather than for
illicit trade. Yet it is precisely Bitcoin’s usage as a store of value that
undermines a key sovereign power of any nation-state: control over the
nation’s money. The concern for loss of control over monetary policy will
provide continuing motivation for many states to contemplate an attack on
Bitcoin.
A state attack on Bitcoin could take many forms ranging from onerous
regulation of its usage, such as forcing users to report the identity of the
recipient of sent bitcoins prior to sending them, to making mere ownership
criminal or even attempting confiscation. While the threat of confiscation
may seem far-fetched, there are precedents for states attacking the property
rights of their citizens in this way. In 1933, President Franklin Roosevelt,
ostensibly attempting to mitigate the Great Depression, issued Executive
Order 6102, ordering U.S. citizens to relinquish their gold and making its
ownership illegal. Due to the difficulty of transporting, securing, and
assaying gold, there was a tendency for owners of it to keep their holdings
with financial institutions, creating a more centralized and coercible target
for the U.S. government.
 Executive Order 6102

In contrast, being digital and decentralized in design, Bitcoin has shown a

remarkable degree of resilience in the face of numerous attempts by various
governments to regulate or ban its use. However, the exchanges where
bitcoins are traded for fiat currencies are highly centralized and susceptible
to regulation and closure. Without these exchanges and the willingness of
the banking system to do business with them, the process of monetization of
Bitcoin would be severely stunted, if not halted completely. While there are
alternative sources of liquidity for Bitcoin, such as over-the-counter brokers
and decentralized markets for buying and selling bitcoins, the critical
process of price discovery happens on the most liquid exchanges, which are
all centralized.
Mitigating the risk of exchange shutdowns is jurisdictional arbitrage.
Binance, a prominent exchange that started in China, moved its
headquarters to Japan and then Malta after the Chinese government halted
its mainland operations. National governments are also wary of smothering
a nascent industry that may prove as consequential as the Internet, thereby
ceding a tremendous competitive advantage to other nations.
Only with a coordinated global shutdown of Bitcoin exchanges would the
process of monetization be halted completely. The race is on for Bitcoin to
become so widely adopted that a complete shutdown becomes as politically
infeasible as a complete shutdown of the Internet. One hopeful sign is the
increasing adoption of Bitcoin among financial institutions and
corporations, both of which are generally more adept at lobbying
governments than retail investors. Furthermore, the largest U.S. exchange,
Coinbase, recently listed as a public company commanding a valuation of
100 billion dollars at the time of writing. Policy-makers are likely to be
cautious when enacting policies that could destroy billions of dollars of
market capitalization and potentially harm millions of retail investors.
Finally, the process of political capture, whereby politicians and their
constituents have an increased ideological affinity for Bitcoin simply
because they own it, is steadily increasing and provides a natural bulwark
against hostile policies.
The possibility of a global shutdown of exchanges is still real, however,
and must be factored into the risks of investing in Bitcoin. As was discussed
in Chapter 4, national governments are finally awakening to the threat that a
nonsovereign, censorship-resistant digital currency poses to their monetary
policies. It is an open question whether they will act on this threat before
Bitcoin becomes so entrenched that political action against it proves
ineffectual.
THE RISK OF MINER CENTRALIZATION
Bitcoin miners are computers on the Bitcoin network that serve the purpose
of validating and establishing a temporal ordering of transactions submitted
to the network. An important risk that investors should consider is the
possibility that the computational resources devoted to Bitcoin mining,
referred to as hash power, become too centralized. If control of the hash
power of the network were concentrated in too few hands, it might become
possible to attack the network, either politically or economically in a
process known as double spending.
Double spending occurs when a mining firm or cartel with a majority of
the total hash power exchanges bitcoins for something valuable, such as
dollars, and then uses their mining resources to reorganize the blockchain so
that the original transfer never occurred. Double spending is a costly
endeavor fraught with risk; the reorganization of the blockchain is not
guaranteed to succeed and, even if it did, a successful purloining would
undermine confidence in Bitcoin itself so that the attacker would be
harming their own savings. Satoshi Nakamoto anticipated the threat of
double spending from the very beginning, observing in his original
whitepaper that Bitcoin was designed in such a way that potential attackers
had a greater incentive to mine honestly than to double spend:

If a greedy attacker is able to assemble more CPU power than all the
honest nodes, he would have to choose between using it to defraud
people by stealing back his payments, or using it to generate new
coins. He ought to find it more profitable to play by the rules, such
rules that favour him with more new coins than everyone else
combined, than to undermine the system and the validity of his own
wealth.
 When first published in 2008, before Bitcoin’s network even existed,
Nakamoto’s claim was still only a theoretical contention and based on the
assumption that attackers were economically rational. Recent research by
Savolainen and Ruiz-Ogarrio has corroborated Nakamoto’s claim in
practice:

We conclude that the historically observed [mining] pool

concentration does not indicate a higher risk of double spending
attacks. … Hence, our result directly contradicts the common belief
that concentration is harmful. This result demonstrates the well-
known economic insight that feasibility does not imply
desirability.37

While Nakamoto’s original design of Bitcoin anticipated the possibility

of double spending under the assumption of economically rational agents, it
did not account for a concerted political attack on mining firms by a nation-
state with non-economic ends. Nation-states have often acted in
economically irrational ways to further their political ends, such as waging
war on their neighbors. A nation-state might be motivated to carry out a
political attack on Bitcoin mining to prevent its citizenry from availing
itself of a means of saving and transacting outside the state’s jurisdiction.
Alternatively, a nation-state may desire Bitcoin’s demise because of a belief
that it poses a systemic threat to the state’s monetary policy. If a nation-state
were to appropriate enough of the computing resources used for Bitcoin
mining, it could potentially censor transactions that it did not approve of, or
simply deprive the network of that hash power, dramatically reducing
network security and undermining confidence in the currency itself.
Of the nation-states with a motivation to attack Bitcoin’s network, the
People’s Republic of China currently has the greatest capability. Due to its
dominance of chip fabrication and the overcapacity of energy production in
some of its provinces, China has become the global center for production of
mining hardware and the home of the largest mining operations. A 2019
study by CoinShares Research estimated that “as much as 65% of Bitcoin
hash power resides within China.”38 If the Chinese state were to nationalize
the companies producing mining hardware and those doing the mining
itself, it could pose a significant threat to the operation of Bitcoin’s
network. Although there is no way to eliminate the risk of the Chinese state
targeting Bitcoin, there is a nuclear option that could neutralize an attack in
the event it occurred: altering Bitcoin’s proof-of-work function. Before we
can fully understand this nuclear option, we must briefly explore the history
of Bitcoin mining.
Since the inception of Bitcoin’s network in 2009, the computers used for
mining have become increasingly specialized to maximize the hash power
generated per unit of electricity consumed. In the earliest days, participants
in the network used their regular computers for mining, but by May 2010
Lazslo Hanyecz had discovered that computer chips optimized for image
processing, known as GPUs, were far more efficient at mining than regular
CPUs. Hanyecz’s discovery triggered an arms race in the development of
mining hardware that ultimately led to the creation of application-specific
integrated circuits (ASICs) for Bitcoin mining. The first ASIC miners were
created in 2013 by China-based hardware manufacturer Canaan Creative,
and since then several other chip manufacturers such as Bitmain and Bitfury
have entered the highly competitive space. ASIC miners are computers
developed to do one and only one thing with the utmost efficiency: run
Bitcoin’s proof-of-work function, known as SHA256, as rapidly as possible.
By applying the SHA256 function exhaustively, a miner can find an
acceptable hash required to create the next block on the blockchain, thereby
collecting the block subsidy associated with it.
SHA256 is the fundamental building block of Bitcoin mining, and
billions of dollars have been spent in the research and production of
hardware that is optimized to run it. However, it is possible for SHA256 to
be replaced as Bitcoin’s proof-of-work function with an alternative, such as
SHA512. Replacing Bitcoin’s proof-of-work function would instantly
render obsolete the mining hardware optimized to run SHA256, devastating
the companies that produce it and the mining facilities that employ that
hardware. Such an extreme measure could potentially be used if Bitcoin
mining were to come under attack by the Chinese state, but it would be
extremely perilous. Without an overwhelming consensus of participants in
the Bitcoin network and the investors who hold bitcoins as savings,
changing the proof-of-work function could cause a fracturing of the
network and splintering of the community into factions, each claiming that
the network running their preferred proof-of-work function was the real
Bitcoin. Furthermore, without the significant capital expenditure devoted to
SHA256-based mining hardware and facilities, Bitcoin’s network security
would be dramatically lower until equivalent expenditures were made for
the alternative proof-of-work function. Thus, a change of Bitcoin’s proof-
of-work function should rightly be considered a nuclear option only to be
deployed in the gravest circumstances. Even if never deployed, the threat
that Bitcoin’s proof-of-work function could be changed is a powerful check
on any nation-state hoping to appropriate Bitcoin’s hash power for its own
ends.

CUSTODIAL RISK
Corporate and institutional buyers of Bitcoin often rely on regulated
custodians when storing their bitcoins. As its value continues to rise,
hundreds of billions of dollars’ worth of Bitcoin will be in the care of these
custodians, presenting an increasingly attractive target for hackers. Where
custodians for physical gold only need to contend with potential security
threats that are proximate to the location of the stored gold, custodians of
Bitcoin must contend with hackers that can target custodied funds from
anywhere on Earth. A successful heist of a major regulated Bitcoin
custodian may severely damage confidence among corporate and
institutional investors.
Mitigating the threat of a major hacking attack are improvements in
security practices across the entire industry and the development of tools for
managing funds without ever needing those funds to be accessible to the
Internet. While a major theft can never be fully ruled out, it appears that the
likelihood of a catastrophic heist, such as the one that felled the first major
Bitcoin exchange MtGox, is much lower than it was in Bitcoin’s early
history.

THE RISK OF FEDERAL RESERVE POLICY

During the late 1970s, the United States experienced a period of high
monetary inflation that helped trigger a bull market in gold. The decade
culminated in a crisis of confidence in the U.S. dollar that was only
resolved by the drastic actions of the Federal Reserve Chairman, Paul
Volcker, who was newly confirmed at the time. Volcker dramatically raised
short-term interest rates to an unprecedented 20 percent in 1980, which
threw the U.S. economy into a deep recession and sent gold into a multi-
decade bear market, but also tamed the rampant price inflation of the
1970s.39
Portrait of former Federal Reserve Chairman, Paul Volcker
 As a monetary good with trillions in market capitalization, gold was
vulnerable to Federal Reserve policy. If the Federal Reserve drives interest
rates high enough, the demand for gold, which has no natural yield,
transfers to dollars that can collect interest at the Federal Reserve’s short-
term interest rate. Due to its smaller size, Bitcoin’s price movements have
largely been dictated by the flow of new investors into its market, but as
Bitcoin approaches the same market capitalization as gold, it too will face
macroeconomic risks from Federal Reserve policy. If the Federal Reserve
Board were to perceive a threat to the dollar’s credibility from the continued
monetization of Bitcoin, it could attempt to thwart that process by
increasing interest rates steeply, as Volcker did in the early 1980s.
Hindering such an effort, however, is the starkly different fiscal situation of
the United States today in comparison to the late 1970s. Not since the debt
incurred during the Second World War did the United States hold a debt
position greater than 100 percent of its GDP, as it does now. In comparison,
the debt-to-GDP ratio in 1980 was less than 40 percent. Thus, while the
threat of Federal Reserve interest rate hikes exists, it would be difficult for
the U.S. central bank to pursue such a policy without making it much more
onerous for the U.S. Treasury to service its outstanding debt; pursuing an
aggressive interest rate policy in the current fiscal environment could
potentially trigger a sovereign debt crisis. Thus, the Federal Reserve may be
bound by fiscal factors to continue a policy that is favorable to Bitcoin’s
monetization, even as it approaches and surpasses gold in size.

THE RISK OF REHYPOTHECATION

Financial institutions that provide advanced investment products, such as
shorting, buying on margin or derivatives, typically require their clients to
provide collateral in the form of cash, stocks, bonds or other assets before
they are given access to these products. Collateral is used as a means of
mitigating risk when a client makes an imprudent investment that results in
a loss. For example, if a client of a brokerage firm shorts a stock and later
the stock increases in value, the brokerage can sell all or part of the client’s
collateral to cover the loss.
Rehypothecation is the practice whereby a financial institution uses the
collateral provided to it for its own investment purposes, thereby potentially
increasing its profits but also putting its clients’ collateral at greater risk. In
return for permitting their collateral to be invested or lent out, a client is
compensated in some way, such as a lower interest rate when shorting.
When done prudently, rehypothecation can allow financial institutions to
provide investment products at lower cost or even for free, and it can also
deepen market liquidity. However, when done imprudently and when the
practice is pervasive, rehypothecation can become a systemic risk to a
financial system. When collateral is lent out repeatedly and passes through
many financial institutions, a failed investment at one institution can cause
a series of cascading liquidations among many institutions, driving the price
of the collateral asset down precipitously and triggering a liquidity crisis.
Indeed, as Singh and Aitken argue in their 2010 IMF working paper,
rehypothecation played an important role in the 2008 financial crisis:
“Incorporating estimates for rehypothecation (and the associated re-use of
collateral) in the recent crisis indicates that the collapse in non-bank
funding to banks was sizable.”40
Bitcoin’s first significant use as a collateral asset came in 2014 with the
founding of a Hong Kong-based cryptocurrency exchange, BitMex.
BitMex’s clients could deposit bitcoins on the exchange and then make bets
on various derivative contracts, such as the Perpetual Swap contract. The
contracts offered by BitMex created a way for its clients to bet on the future
price of Bitcoin and to do so with leverage. By providing an exchange that
did not require deposits in fiat currency, BitMex was able to circumvent the
bureaucracies that typically regulate such markets, such as the CFTC,
allowing the company to rapidly grow its business. By August 2020, the
exchange was doing a staggering 75 billion dollars in trading volume,
turning its co-founders into billionaires.41 BitMex’s pioneering use of
Bitcoin as collateral and the financial success it enjoyed did not go
unnoticed. Many businesses have since followed BitMex’s lead, from the
venerable Chicago Mercantile Exchange, which was founded in 1898 and
now offers Bitcoin futures contracts, to BlockFi, which allows its clients to
earn interest on their bitcoins. Market commentator Raoul Pal has called
Bitcoin “pristine collateral” and there is indeed a growing recognition that it
is an ideal form of collateral due to its innate attributes and the nature of its
market:

1. Bitcoin has a global and deeply liquid market with billions of dollars
in volume trading every day.
2. Bitcoin’s markets are continually open, unlike regular stock markets,
allowing financial institutions to sell their Bitcoin collateral whenever
they perceive an increased risk to their loan portfolio.
3. Bitcoins are not the obligation of any third party, unlike bonds,
reducing counterparty risk.
4. Being digital, unlike gold, bitcoins are easy and inexpensive to take
possession of, increasing the convenience of using Bitcoin as
collateral.

With the growing recognition that Bitcoin is an ideal form of collateral,

its increasing usage for this purpose will be a major source of demand in its
monetization. Yet Bitcoin’s growing use as a collateral asset brings an
attendant risk of irresponsible rehypothecation. In an incipient industry,
investors should rightly be wary of the quality of underwriting at the
institutions that are accepting Bitcoin as collateral and subsequently
investing it. The risks of Bitcoin rehypothecation are, perhaps, even greater
than for other assets such as stocks and bonds. During a liquidity crisis, if
many financial institutions are forced to sell bonds that have been taken as
collateral, the collapse in prices will be protected by the cash flow of the
bonds. Without cash flow to provide a safety net for its valuation, a liquidity
crisis in Bitcoin could cause a disorderly collapse in its price. As we saw in
the third chapter’s discussion of the path-dependent nature of money, a
collapse in Bitcoin’s price could cause a significant shift in expectations
about prospects for its future monetization, thereby stunting or even halting
that process.
The greatest protections against the risk of rehypothecation are strong
market regulation and industry transparency about the controls used to
manage investments of collateral. Regulation is often taken to mean
oversight by a regulatory body, such as the CFTC, but in practice such
bureaucracies are slow to understand and satisfactorily supervise new and
innovative industries, often relying on antiquated regulations conceived
decades ago. By far the most important regulation is that of the market
itself; institutions that invest irresponsibly should be allowed to fail,
ensuring that poor practices are punished and will not become systemic in
the industry, as they did during the housing crisis of 2008.

THE RISK OF IMPERFECT FUNGIBILITY

The open and transparent nature of the Bitcoin blockchain makes it possible
for states to mark certain bitcoins as being tainted by their use in proscribed
activities. Although Bitcoin’s censorship resistance at the protocol level
allows these bitcoins to be transmitted, if regulations were to appear that
banned the use of such tainted bitcoins by exchanges or merchants, they
could become largely worthless. Bitcoin would then lose one of the critical
properties of a monetary good: fungibility.
To ameliorate Bitcoin’s imperfect fungibility, improvements will need to
be made at the protocol level to improve the privacy of transactions. While
there are new developments in this regard, pioneered in digital currencies
such as Monero and ZCash, there are major technological tradeoffs to be
made between the efficiency and complexity of Bitcoin and its privacy. It
remains an open question whether privacy-enhancing features can be added
to Bitcoin in a way that does not compromise its usefulness as money in
other ways.
 CONCLUSION
Bitcoin is an incipient money that is transitioning from the collectible stage
of monetization to becoming a store of value. As a nonsovereign monetary
good, it is possible that at some stage in the future Bitcoin will become a
global reserve currency much like gold during the classical gold standard of
the nineteenth century. The adoption of Bitcoin as a reserve currency is
precisely the bullish case for Bitcoin and was articulated by Satoshi
Nakamoto as early as 2010 in an email exchange with Mike Hearn: “If you
imagine it being used for some fraction of world commerce, then there’s
only going to be 21 million coins for the whole world, so it would be worth
much more per unit.”42
This case was made even more trenchantly by the brilliant cryptographer
Hal Finney, the recipient of the first bitcoins sent by Nakamoto, shortly
after the announcement of the release of the first working Bitcoin software:

[I]magine that Bitcoin is successful and becomes the dominant

payment system in use throughout the world. Then the total value of
the currency should be equal to the total value of all the wealth in
the world. Current estimates of total worldwide household wealth
that I have found range from $100 trillion to $300 trillion. With 20
million coins, that gives each coin a value of about $10 million.43

Even if Bitcoin were not to become a fully-fledged reserve currency and

were simply to compete with gold as a nonsovereign store of value, it is
currently significantly undervalued. Mapping the market capitalization of
the extant above-ground gold supply (approximately 10 trillion dollars) to
the current mined supply of bitcoins gives a value of approximately
$540,000 per bitcoin. As we have seen in Chapter 2, in terms of the
attributes that make a monetary good suitable as a store of value, Bitcoin is
either comparable or superior to gold for every criterion except for
established history. As time passes and the Lindy effect takes hold,
established history will no longer be a competitive advantage for gold.
Thus, it is not unreasonable to expect that Bitcoin will approach and
perhaps surpass gold’s market capitalization in the next decade.
A caveat to this thesis is that a large fraction of gold’s capitalization
comes from central banks holding it as a store of value. For Bitcoin to
achieve or surpass gold’s capitalization, some participation by nation-states
will be necessary. Whether the Western democracies will participate in the
ownership of Bitcoin is unclear. It is more likely, unfortunately, that tin-pot
dictatorships and kleptocracies will be the first nations to enter the Bitcoin
market.
If no nation-states participate in the Bitcoin market, there still remains a
bullish case for Bitcoin. As a nonsovereign store of value used only by
retail and institutional investors, Bitcoin is still early in its adoption curve:
the so-called early majority are now entering the market while the late
majority and laggards are still years away from entering. With broader
participation from retail and especially institutional investors, a price level
between $100,000 and $250,000 is feasible.
Owning bitcoins is one of the few asymmetric bets that people across the
entire world can participate in. Much like a call option, an investor’s
downside is limited to 1x, while their potential upside is still 100x or more.
Bitcoin is the first truly global bubble whose size and scope are limited only
by the desire of the world’s citizenry to protect their savings from the
vagaries of government economic mismanagement. Indeed, Bitcoin rose
like a phoenix from the ashes of the 2008 global financial catastrophe—a
catastrophe that was precipitated by the policies of central banks like the
Federal Reserve.
 Beyond the financial case for Bitcoin, its rise as a nonsovereign store of
value will have profound geopolitical consequences. A global,
noninflationary reserve currency will force nation-states to alter their
primary funding mechanism from inflation to direct taxation, which is far
less politically palatable. States will shrink in size commensurate to the
political pain of transitioning to taxation as their exclusive means of
funding. Furthermore, global trade will be settled in a manner that satisfies
Charles de Gaulle’s aspiration that no nation should have privilege over any
other:

We consider it necessary that international trade be established, as it

was the case, before the great misfortunes of the World, on an
indisputable monetary base, and one that does not bear the mark of
any particular country.44

Fifty years from now, that monetary base will be Bitcoin.

 THE GREAT DEBATE
W HAT IS B ITCOIN ? T HIS SEEMINGLY SIMPLE QUESTION AND THE DEBATE
that arose to answer it roiled the community of Bitcoin developers and
investors for several years, culminating in a schism in the community and a
split of the Bitcoin network on August 1, 2017. In the years after Satoshi
Nakamoto created Bitcoin, two main ideological factions emerged, each
supporting a different vision for its future. The first faction saw Bitcoin
primarily as a payment system akin to Visa or PayPal, but without a
centralized point of control. They emphasized the transactional use of
Bitcoin and believed that money is defined primarily by its role as a
medium of exchange. The second faction stressed the importance of Bitcoin
being uncensorable and warned of the dangers of ceding control of
Bitcoin’s protocol to any particular interest group. This faction envisioned
Bitcoin as a digital version of gold, emphasizing its use as a nonsovereign
store of value.
Complicating the contention between the two ideological factions was
the disappearance of Bitcoin’s creator not long after its creation. On
December 12, 2010, 772 days after first appearing online to publish the
design of Bitcoin, Satoshi Nakamoto made his final post to an online
Bitcoin forum. Nakamoto’s disappearance was of great consequence to the
incipient software project that he had founded. Without its creator, the
community of developers working on Bitcoin’s software had to continue
their work without guidance or a common future vision. One of the clearest
statements we have of Nakamoto’s aspirations for the project comes from
his seminal publication, the “Bitcoin Whitepaper,” published on October
31, 2008. Yet that short document fails to decisively answer the question of
whether Bitcoin should be thought of first as a medium of exchange or as a
store of value. Despite writing hundreds of forum posts and emails to the
community of developers working on Bitcoin, Satoshi never
unambiguously explained its monetary nature. In some of his writing,
Nakamoto emphasized Bitcoin’s similarity to gold and its use as a store of
value:

[Bitcoin is] more typical of a precious metal. Instead of the supply

changing to keep the value the same, the supply is predetermined
and the value changes. As the number of users grows, the value per
coin increases. It has the potential for a positive feedback loop; as
users increase, the value goes up, which could attract more users to
take advantage of the increasing value.45

On several other occasions Nakamoto discussed Bitcoin for use in

payments, emphasizing the medium-of-exchange role of money.
 Embryos of different species appear alike

In its embryonic form, Bitcoin appeared to embody each vision with

equal plausibility. On the one hand, Bitcoin’s network began with low
transaction fees, allowing bitcoins to be transferred at low cost around the
world, seemingly providing a comparative advantage to alternative
payments systems such as the Visa credit-card network. On the other hand,
the exchange value of bitcoins increased significantly over time, suggesting
it was a nascent store-of-value. But just as many species appear alike in
their embryonic form, imprinted in their DNA are the instructions that will
reveal their great differences in the fullness of time. Bitcoin’s DNA lay in
the consensus rules of its protocol and, as we shall see, these rules would
make it clear that only one of these visions for Bitcoin would be realizable.
 THE IMMUTABILITY OF PROTOCOLS
A protocol is a set of rules that participants in a system must abide by when
using the system. Examples of software protocols include TCP/IP, which
governs how data is encoded and transmitted across the Internet, and SMTP,
which governs email-specific Internet traffic. Protocols can also apply to
the physical world; for instance, the IEC 60906-2 and NEMA 5-15
standards for power sockets describe the shape of electrical plugs plus the
voltage and amperage of the power conducted through the sockets.

The ground slot is a backwards-compatible change to the original socket design

Protocols that are defined for use in software or hardware systems with
many participants are usually very difficult to modify once in use, for good
reason. Participants usually assume the immutability of a protocol when
building businesses or devices that rely on it. Thus, changing a protocol for
a widely used system would come at great cost to the ecosystem of
participants who depend on it. Consider, for instance, the massive cost to
North American households if the shape of power sockets were modified.
Every socket in the nation would need to be updated, and every device that
relied on the former socket shape would have to be discarded or provided
with an adapter to use the new shape. An exception to the costliness of
protocol updates are backwards-compatible changes that do not affect
systems that use older versions of a protocol. For instance, the ground slot
was invented in 1924 and provided a backwards-compatible update to
sockets that reduced the risk of electrical shocks. Older devices with two-
pronged electrical plugs were still able to use the newly designed sockets.
When Satoshi Nakamoto published the source code for Bitcoin on
January 9, 2009, he had essentially produced a protocol for value transfer
across the Internet. Nakamoto realized that once his design had come to life
in a live, functioning network, it would be very difficult, if not impossible,
to make non-backwards-compatible changes to the Bitcoin protocol.
Commenting on this on June 17, 2010, Nakamoto observed that “Once
version 0.1 was released, the core design was set in stone for the rest of its
lifetime.”46
 THE SCHISM
Bitcoin’s protocol is defined by rules that specify which messages sent on
the Bitcoin network are valid and these rules are enforced by computers on
the network that run the Bitcoin software. Computers that do not abide by
the so-called consensus rules are rejected from the network. Most famous
among the consensus rules is the rule that determines how many new
bitcoins may be minted per block. The block-subsidy rule defines Bitcoin’s
overall inflation schedule and limits the eventual total supply to no more
than 21 million bitcoins. Another important rule is the maximum size of
each block, which limits the total number of transactions that can be
processed each time a new block is mined. This rule was originally created
in 2010 as a means of hindering denial-of-service attacks to the budding
network.47
Bitcoin’s block-size rule was the main point of contention between the
two factions debating the future of Bitcoin. One faction, referred to as big-
blockers, wanted Bitcoin’s protocol changed so that the block size was
larger and could accommodate more transactions. Crucially, the proposed
change would not be backwards-compatible and would cause a split in the
network unless all network participants adopted it unanimously and at the
same time. Big-blockers viewed Bitcoin as a piece of software, such as
Microsoft Word, that should be upgraded frequently to satisfy the desires of
businesses using it primarily for transactional purposes. The other faction,
referred to as small-blockers, resisted such a change and cautioned that it
would place control of Bitcoin in the hands of the companies that were
pushing for the ostensible upgrade. They also warned that increasing the
block size would diminish Bitcoin’s decentralization by necessitating the
use of more costly hardware, driving less affluent participants away from
the network. Small-blockers viewed Bitcoin not as a piece of software but
as a protocol and emphasized the cost to the ecosystem that would come
from modifying its rules. Even more importantly, small-blockers recognized
that if it became easy to change one consensus rule, then all rules, including
Bitcoin’s block subsidy rule, would be easier to modify. Because demand
for Bitcoin as a store of value rests largely on the credibility of its fixed-
supply monetary policy, changing Bitcoin’s block size would indirectly
undermine that credibility.
The fierce debate between Bitcoin’s two factions came to a head on
August 1, 2017 when the big-blocker faction modified the software running
on their computers to accommodate larger blocks, thus making it
incompatible with the rest of Bitcoin’s network. Computers running the new
software were rejected from the original Bitcoin network and formed a
second network of their own in a process known as a fork. The second
network was known as Bitcoin Cash and had its own separate tokens that
could be traded on the market. The question of Bitcoin’s future then shifted
from a debate internal to the Bitcoin community to the marketplace where
bitcoins, using the exchange symbol BTC, and Bitcoin Cash tokens, using
the symbol BCH, would trade against each other in an economic test of
which vision would attract the greatest investor demand. In the following
years, the market overwhelmingly voted in favor of the original network
and a vision of Bitcoin as a nonsovereign store of value. The Bitcoin Cash
network faded into irrelevance, and its small community was wracked by
continued infighting and further schisms.
 DENOUEMENT
The market’s support for the Bitcoin network with its original consensus
rules made clear that Bitcoin’s value lies more in its existence as a largely
immutable protocol than as an upgradeable piece of software. As a protocol
with fixed consensus rules, Bitcoin’s block size and the number of
transactions that can be supported per block will remain limited. Growing
adoption of Bitcoin will result in increasing demand for the limited space
per block for transactions, implying that transaction fees must rise over
time. Bitcoin’s network will thus become uneconomical for small payments
such as the purchase of coffee or bread but will remain suitable for
settlement of the type of large value transfers that underpin a global
financial system. Smaller payments with bitcoins will happen on layers
built on top of the Bitcoin network such as the Lightning network or
custodial transfer layers like banks. Hal Finney, the brilliant cryptographer
who was first to recognize the potential of Satoshi Nakamoto’s invention,
wrote in 2010:

Bitcoin itself cannot scale to have every single financial transaction

in the world be broadcast to everyone and included in the block
chain. There needs to be a secondary level of payment systems
which is lighter weight and more efficient.
…
I believe this will be the ultimate fate of Bitcoin, to be the “high-
powered money” that serves as a reserve currency for banks that
issue their own digital cash.48

Finney implicitly recognized that Bitcoin would first need to be

established as a store of value, or reserve currency as he called it. Once
established, bitcoins could be used for everyday payments using higher-
layer systems. He understood that Bitcoin would not serve as a payment
system competing directly with Visa or PayPal, but as something far more
significant: a nonsovereign store of value that would function as the
monetary base for a new global financial system. This was the fate written
into Bitcoin’s DNA—its consensus rules—from the very beginning.
 ACKNOWLEDGMENTS
W HEN I BEGAN WRITING T HE B ULLISH C ASE FOR B ITCOIN AS A LONG - FORM
article in early 2017, the price of Bitcoin hovered around $1,000 and I
hoped the article might help to explain the economic importance of this
revolutionary technology to a few friends and perhaps even some Wall
Street investors. I did not anticipate that the article would eventually be read
by hundreds of thousands of people around the world and be translated into
twenty different languages by volunteers. This unexpected readership can
be explained in part by a growing demand to understand Bitcoin and its
significance, but it can also be attributed to the invaluable help I received in
crafting a text that is accessible and interesting to the layperson. In this
regard I wish to express my gratitude to those who contributed to the
creation of the original article and to the completion of this book, which it
significantly expands upon.
First, I would like to thank Michael Saylor for writing the foreword to
this book and for his generous efforts in providing free educational content
through his charity, Saylor Academy. Second, I would like to thank
@BitcoinUltras, a pseudonymous artist that I met on Twitter, who
volunteered to create the cover art and the beautiful art that adorns each
chapter. Third, I would like to thank my friend Sanjay Mavinkurve who
generously created the charts for this book, which epitomize the aphorism
that a picture is worth a thousand words. I would like to thank Daniel
Coleman, Michael Hartl, Ben Davenport, Mat Balez, and Stephan Kinsella
for the diligence they showed in editing my manuscript. Numerous people
provided feedback that improved the clarity of my writing, and for this I
wish to thank Alex Morcos, John Pfeffer, Pierre Rochard, Koen Swinkels,
Ray Boyapati, Michael Angelo, Patri Friedman, Ardian Tola, and Michael
Flaxman.
 Finally, and most importantly, I wish to thank my wife Lisa for helping
me to see this project through and for providing me with the three greatest
inspirations in my life, my darling children.
 DISCLAIMER

The views presented in this book and any errors herein are my own. This
book is for information purposes only. It is not intended to be investment
advice. Seek a duly licensed professional for investment advice.
 ABOUT THE AUTHOR
B ORN AND RAISED IN A USTRALIA , V IJAY B OYAPATI MOVED TO THE U NITED
States in 2000 to pursue a PhD in Computer Science. Instead of enrolling in
a doctoral program, Boyapati ended up at a small startup called Google
where he spent several years using his background in machine learning to
improve the ranking algorithms used in Google News. Boyapati left his
lucrative job in 2007 to work on a grassroots campaign in the 2008
Presidential election, helping to raise millions of dollars and bring hundreds
of volunteers to New Hampshire to canvass for Ron Paul. In 2011, Boyapati
discovered Bitcoin and went down the proverbial rabbit hole in a quest to
understand how a new form of Internet money, backed by no commodity
and guaranteed by no government, could have any economic value. Armed
with a background in Austrian economics, Boyapati penned “The Bullish
Case for Bitcoin” as a long-form article in 2017 to provide the layperson
with an economic framework with which they could understand Bitcoin.
Vijay Boyapati has a Bachelor of Science with first class honors from the
Australian National University, receiving the University’s highest
undergraduate honor, the University Medal. He is a husband and loving
father of Addie, Will, and Vivi. He lives with his family in Seattle,
Washington.
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32 http://bullishcaseforbitcoin.com/references/coinshares-paper-1
33 http://bullishcaseforbitcoin.com/references/satoshi-electricity-quote
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