Dispelling 7 Common Misconceptions About Bitcoin

Around 2017, while I acknowledged the well-conceived technology behind Bitcoin, I had certain concerns about the euphoric sentiment surrounding it and the potential for market dilution. I neither asserted that its value had to decline further nor held a bullish view. I chose to observe from the sidelines. 

However, my sentiment shifted in April 2020 when, at around $6,900/BTC, I became bullish on Bitcoin and took a long position in my research service. It had indeed underperformed various other asset classes from the autumn of 2017 to the spring of 2020. Nevertheless, several factors started favoring Bitcoin from that point. 

Presently, with Bitcoin priced above $15,000/BTC, it has experienced a growth of over 120% since my April pivot point and over 60% since July. Despite these gains, I maintain a bullish outlook for Bitcoin throughout 2021. However, beyond that, I anticipate a period of correction and consolidation when I will reassess its future prospects.

Throughout the summer and autumn, I have received numerous emails about Bitcoin. While I have replied to some individually, I decided to summarize the most common misconceptions, risks, and questions in a brief article. These inquiries are reasonable, and I will do my best to address them based on my perspective.

If you haven't already, I recommend reading this article on Bitcoin before proceeding.

1."Bitcoin is a Bubble"

Many individuals perceive Bitcoin as a bubble, which is understandable. Especially for those who examined the linear price chart in 2018 or 2019, Bitcoin appeared to have reached an absurd peak in late 2017 following a parabolic surge that seemed unlikely to be repeated.

To illustrate this, let’s check out this linear price chart covering the period from the beginning of 2016 to the beginning of 2019, which clearly depicts the characteristics of a classic bubble.

Chart: StockCharts.com

Maybe it is a bubble. We’ll see. However, it looks a lot more rational when you look at the long-term logarithmic chart, especially as it relates to Bitcoin’s 4-year halving cycle.

The possibility of Bitcoin being a bubble remains to be seen. However, when examining the long-term logarithmic chart, particularly in relation to Bitcoin's 4-year halving cycle, it appears significantly more rational.

Chart Source: Chart Source: PlanB @100trillionUSD, with annotations added by Lyn Alden

In the provided chart, each point represents the monthly price of Bitcoin. The color of the point indicates the number of months elapsed since the previous halving event. A halving occurs at specific intervals (every 210,000 blocks) in the blockchain, reducing the rate at which new bitcoins are generated every 10 minutes by half. These halving events are marked by the transition from blue dots to red dots on the chart.

The first cycle, known as the launch cycle, exhibited a significant percentage increase, starting from zero and reaching over $20 per bitcoin at its peak. The second cycle, from the peak price of the first cycle to the peak price of the second cycle, witnessed an increase of over 50 times, with Bitcoin surpassing $1,000 for the first time. In the third cycle, the peak-to-peak increase was approximately 20 times, with Bitcoin briefly touching around $20,000.

Since May 2020, we have entered the fourth cycle, and the coming years will determine its outcome. Historically, this phase has been very bullish for Bitcoin, characterized by strong demand and limited new supply, as a significant portion of the existing supply is held by long-term investors.

The monthly chart indicates a positive trend, with a favorable Moving Average Convergence Divergence (MACD) and a current price higher than any previous monthly closing price. The only instance where the price has been higher than the current level is on an intra-month basis in December 2017.

Chart Source: StockCharts.com

On the weekly chart, we can observe the number of occasions when Bitcoin approached near-term overbought levels and the frequency of corrections during its previous bullish run following the halving event, during which it experienced a 20-fold increase in value.

Chart Source: StockCharts.com

My role here is simply to identify assets that are likely to perform well over an extended period. While this article addresses various questions and misconceptions, there are digital asset specialists who can provide more detailed answers. However, it's worth noting that some specialists, though not all, tend to exhibit a consistently bullish bias towards their chosen asset class. This tendency is observed among gold investors, stock investors, Bitcoin enthusiasts, and others. For example, how many gold newsletters recommended taking profits around the multi-year peak in 2011? How many Bitcoin experts suggested that Bitcoin was potentially overbought in late 2017 and due for a prolonged correction?

While Bitcoin benefits from the enthusiasm of its supporters, there is still room for independent analysis regarding its bullish potential and risk assessment.

As someone who is not directly involved in the digital asset industry, but possesses a background blending engineering and finance, I approach Bitcoin, and any other asset class, with an awareness of risks, rewards, bullish and bearish cycles. I remain bullish on Bitcoin.

If the fourth cycle follows a pattern similar to the previous three cycles since its inception (which is not guaranteed), Bitcoin's relative strength index (RSI) could reach extreme levels again in 2021. Here is a chart by PlanB illustrating the historical monthly RSI of Bitcoin during the bullish and bearish phases of its 4-year halving cycle.

Chart Source: PlanB @100trillionUSD

Hence, the fact that Bitcoin has surged from $6,900 to $15,000+ in a span of seven months does not prompt me to take profits at this stage. In other words, a monthly RSI of 70 does not qualify as "overbought" in Bitcoin's context, especially considering the early phase after a halving event. However, one may consider rebalancing their portfolio later in 2021.

Every investor has their own risk tolerance, conviction, knowledge, and financial goals. Managing the position size is a key approach to handle Bitcoin's volatility instead of engaging in frequent trading. If the price volatility of Bitcoin keeps you anxious, it is likely an indication that your position size is too large. Conversely, if you have a proportionate position size, it is advisable to allow the asset to grow without hastily taking profits as soon as it gains popularity and performs well.

When the sentiment towards Bitcoin becomes excessively extreme, or if it occupies an overly significant portion of your portfolio, it might be an appropriate time to consider rebalancing.

2."Bitcoin's intrinsic value is zero"

You might check this article in 2020 as a reference before continuing.

Digital assets, in general, can possess value. To illustrate, consider a hypothetical online multiplayer game played by millions of people worldwide. If the game developer introduces a rare and powerful magical sword item, of which only a few exist, and players can sell and trade these items, the price of such a digital sword would undoubtedly be exorbitant.

Bitcoin's utility lies in its ability to enable individuals to store value independently of any currency system, utilizing provably scarce units and facilitating global transfers. Its founder, Satoshi Nakamoto, solved the double-spending problem and devised a well-designed protocol that incorporates scarce and tradable units in a stateless and decentralized manner.

In terms of utility, compare the challenges of carrying $250,000 worth of gold through an international airport to transporting $250,000 worth of bitcoins via a small digital wallet, a mobile app, or even just by memorizing a 12-word seed phrase. Additionally, Bitcoin is more easily verifiable than gold in terms of being a reserve asset and collateral. It offers greater frictionless transferability and has a finite supply. It is worth noting that I also have a favorable view of gold and have held a long position in it since 2018.

Bitcoin aligns with Satoshi's vision of a digital commodity.

As a thought experiment, imagine there was a base metal as scarce as gold but with the following properties:

– boring grey in colour

– not a good conductor of electricity

– not particularly strong, but not ductile or easily malleable either

– not useful for any practical or ornamental purpose

and one special, magical property:

– can be transported over a communications channel

If it somehow acquired any value at all for whatever reason, then anyone wanting to transfer wealth over a long distance could buy some, transmit it, and have the recipient sell it.

Satoshi Nakamoto, August 2010

In comparison to all other cryptocurrencies, Bitcoin possesses an unparalleled network effect, making it the most secure in terms of decentralization and the computational power and expense required to attack its network. While there are thousands of cryptocurrencies, none of them have managed to rival Bitcoin in terms of market capitalization, decentralization, widespread adoption, robust monetary policy, and network security combined.

While some alternative tokens may introduce innovative privacy features or smart contracts that can disrupt various industries, none of them pose a significant challenge to Bitcoin as an emerging store of value. While they can coexist effectively with Bitcoin, they cannot replace it.

Bitcoin excels in its designated role, especially in a world where developed markets experience negative real interest rates and emerging markets face currency failures. The crucial question is the extent of its utility.

The value of Bitcoin's utility is best understood by considering the entire protocol, which consists of 21 million bitcoins (each divisible into 100 million satoshis). This protocol encompasses the asset itself, as well as the means of transmitting and verifying it. The value of the protocol increases as more individuals and institutions utilize it for storing, transmitting, and verifying value, and it can decrease if fewer people use it.

The total market capitalization of gold is estimated to be over $10 trillion. It remains uncertain whether Bitcoin could reach 10%, 25%, 50%, or even parity with that value. I prefer focusing on one Bitcoin halving cycle at a time, maintaining a four-year outlook and adjusting the analysis based on current circumstances.

3.“Bitcoin Isn’t Scalable”

Regarding the criticism that "Bitcoin isn't scalable," it is commonly argued that Bitcoin's network can handle a relatively low number of transactions per 10 minutes compared to centralized systems like Visa's data centers, limiting its suitability for everyday transactions such as buying coffee. This issue played a significant role in the 2017 hard fork between Bitcoin and Bitcoin Cash, where proponents of Bitcoin Cash advocated for increasing the block size to process more transactions per unit of time.

However, there is always a trade-off between security, decentralization, and speed in any payment protocol. It is impossible to maximize all three variables simultaneously. For instance, Visa prioritizes speed to handle numerous transactions per minute but sacrifices decentralization by operating as a centralized payment system dependent on government fiat currency. Bitcoin, on the other hand, prioritizes security and decentralization at the expense of speed. By maintaining small block sizes, Bitcoin enables individuals worldwide to run their own full nodes, contributing to decentralization and continuous verification of the blockchain.

Bitcoin Cash may increase transaction throughput through larger block sizes but at the cost of reduced security and decentralization. Moreover, it still falls significantly short of Visa's transaction throughput, failing to maximize any variable effectively.

The dispute between Bitcoin and Bitcoin Cash revolves around whether Bitcoin should serve as both a settlement layer and a transaction layer, albeit imperfectly in both roles, or whether it should primarily function as a settlement layer while allowing other networks to optimize transaction speed and throughput. Bitcoin is best understood as an ideal settlement layer, combining a scarce currency/commodity with transmission and verification features, backed by substantial security from its high global hash rate.

In contrast, the global banking system faces scalability challenges at its foundational level. For example, wire transfers often take days to settle, which is why they are not suitable for everyday transactions. However, additional layers of scalability, such as paper checks, electronic checks, credit cards, and PayPal, have been built on top of these settlement layers. Consumers utilize these faster payment systems for smaller transactions, while the underlying banks settle larger, more secure transactions less frequently. Each payment method represents a trade-off between speed and security.

Similarly, protocols like the Lightning Network and other smart contract concepts have been developed to enhance Bitcoin's scalability. The Lightning Network enables numerous quick transactions between parties, which are then reconciled with Bitcoin's blockchain in a single batch transaction. This approach reduces fees and bandwidth limitations associated with small transactions.

Source: Lightning.Network

I cannot predict with certainty which scaling systems will dominate in the future as there is still ongoing development in this area. However, it's important to understand that while Bitcoin has limitations in terms of transaction volume per unit of time, it is not limited by the total value of those transactions. The value that Bitcoin can settle within a given time frame is limitless and depends on its market capitalization and the implementation of additional layers.

To illustrate this, let's consider a scenario where the Bitcoin network is limited to 250 transactions per minute, which is relatively low. The average value of each transaction can vary, ranging from $100 to $1 million or any other amount. If the average transaction value is $100, then the total transaction value performed per minute would be $25,000. However, if the average transaction value is $1 million, then the total transaction value performed per minute would be $250 million. As Bitcoin becomes more widely used as a store of value, the transaction fees and inherent limitations prioritize the larger and more significant settlement transactions.

Additional layers built on top of Bitcoin can facilitate an arbitrary number of transactions per minute and settle them in batches on the actual Bitcoin blockchain. This is similar to consumer layers like Visa or PayPal, which can process numerous transactions per minute while the underlying banks settle larger transactions less frequently.

The market has already demonstrated its preference for Bitcoin over other cryptocurrencies like Bitcoin Cash. Since the 2017 hard fork, Bitcoin's market capitalization, hash rate, and number of nodes have significantly outperformed Bitcoin Cash. This observation alleviates the concerns I initially had about the protocol's risk assessment three years ago.

4.“Bitcoin Wastes Energy”

One common criticism of Bitcoin is its energy consumption. The Bitcoin network currently consumes a substantial amount of energy, which raises environmental concerns, especially as its usage grows. However, it's important to note that other valuable commodities, like gold, also require significant energy input. The process of gold mining involves exploration, mine development, rock processing, purification, minting, and transportation, which collectively consume a substantial amount of energy. The value of gold is derived from the energy and effort invested in obtaining and refining it, making it a dense store of value that does not erode over time.

Unlike gold, fiat currencies such as dollars, euros, or yen can be created limitlessly by banks with the stroke of a keyboard. Additionally, industrial metals like iron are abundant and readily available. In contrast, gold is rare and requires extensive energy and time investment for extraction and purification. Despite the energy-intensive nature of gold mining, central banks, institutions, investors, and consumers find value in it due to its scarcity and various applications.

Similarly, Bitcoin's energy consumption is high because it relies on a significant amount of computing power to secure its protocol, ensuring decentralization and resistance against attacks. While Visa consumes less energy than Bitcoin, it achieves this at the cost of complete centralization and relies on an abundant fiat currency. Other cryptocurrencies like Litecoin also consume less energy than Bitcoin but may be more vulnerable to attacks by well-capitalized entities.

The question then arises whether Bitcoin justifies its energy usage and adds enough value. The current market indicates that it does, and I agree with this assessment. Bitcoin provides a decentralized digital monetary system that operates independently of any sovereign entity. It follows a rules-based monetary policy and exhibits inherent scarcity, offering individuals worldwide a choice to store value and transmit it to others. While individuals in developed markets with stable currencies may not perceive an immediate need for Bitcoin, those in emerging markets who have experienced severe inflation understand its value proposition more readily.

Chart Source: Statista

Moreover, a notable portion of the energy consumed by Bitcoin could otherwise go to waste. Bitcoin miners actively seek out the cheapest available sources of electricity worldwide, often tapping into energy that is currently underutilized or surplus to requirements. For instance, this includes excess capacity in certain hydroelectric dams in specific regions of China or stranded oil and gas wells in North America. Bitcoin mining equipment is mobile and can be deployed near these low-cost energy sources to capitalize on them, effectively repurposing and giving value to otherwise stranded energy production. By converting the output of such inexpensive and underutilized energy sources into something of monetary value, Bitcoin mining plays a role in reducing wastage.

5.“Bitcoin is Too Volatile”

While Bitcoin is promoted as both a store of value and a medium of exchange, its price history has been highly volatile. This volatility leads investors to question its suitability as a reliable store of value or medium of exchange, suggesting that it fails to fulfill its primary intended function.

To some extent, these concerns are valid. Bitcoin is not the asset you would typically rely on for emergency funds or saving up for a near-future expenditure like a down payment on a house within the next six months. It is still a relatively young store of value, having emerged approximately 12 years ago, and as such, it carries a significant degree of growth and speculative characteristics. Over time, its market capitalization has been expanding, capturing a portion of the market share from other established stores of value and growing into a noteworthy asset class. Whether Bitcoin will continue this trajectory or reach a point of stabilization and potential stagnation remains to be seen.

In order for Bitcoin's market capitalization to increase from $25 million to $250 million, $2.5 billion, $25 billion, and eventually surpassing $250 billion as it stands today, volatility is a necessary component, particularly upward volatility, even though it comes with accompanying downside volatility.

6.“Governments Will Ban Bitcoin”

Another valid concern raised by individuals is the potential for governments to ban Bitcoin, especially if it proves to be successful. Some governments have already taken such measures. Therefore, this concern falls more into the category of risk rather than misconception.

Historical precedent exists for government bans on certain assets. For example, in the United States, owning gold was illegal for Americans from 1933 to 1975, except in small amounts for jewelry and collectibles. This example demonstrates that even in a country known for its freedom, there was a period where individuals could face imprisonment for possessing gold coins and bars due to the perceived threat it posed to the monetary system.

The provided chart illustrates the interest rate of 10-year Treasury yields in blue, with the orange bars representing the annualized inflation-adjusted forward rate of return for purchasing a 10-year Treasury bond and holding it until maturity over the subsequent 10 years. The green square indicates the time period when owning gold was prohibited.

Data Sources: Robert Shiller, Aswath Damodaran

During the four-decade period spanning from the 1930s to the 1970s, holding money in banks or sovereign bonds did not effectively combat inflation. In other words, the returns from these paper assets, as represented by the orange bars, were negative when adjusted for inflation. Consequently, savers experienced a decline in their purchasing power if they relied on these assets.

This situation was primarily due to two decades of inflation: one in the 1940s and another in the 1970s. Although there were intermittent periods, such as the 1950s, when cash and bonds performed reasonably well, over the entirety of this four-decade period, they resulted in a net loss when adjusted for inflation.
Given this context, it is not surprising that gold emerged as a refuge for investors during this specific period. Gold demonstrated strong performance and preserved its purchasing power in the face of currency devaluation. The government, perceiving hoarding as a threat to national security, enforced a ban on gold ownership, effectively compelling people to invest in paper assets that lost value or other economically productive assets like stocks and real estate.

It is important to note that this ban on gold ownership occurred during a time when the U.S. dollar was backed by gold. The U.S. government aimed to retain ownership of the majority of gold and limit citizens' ability to acquire it. However, unlike gold or Bitcoin today, gold was backed by a tangible asset, and hence, there was a greater incentive to impose such a ban.

Enforcing the ban on gold ownership proved to be challenging, with only a few prosecutions despite severe penalties on paper. Bitcoin, on the other hand, utilizes encryption technology, making it difficult to confiscate except through legal means. However, governments can still ban cryptocurrency exchanges and make it illegal to possess Bitcoin, resulting in institutional investors withdrawing their investments and driving Bitcoin into the black market.

Nevertheless, the current landscape makes it highly challenging for major capital markets such as the United States, Europe, or Japan to ban Bitcoin. With a market capitalization exceeding $250 billion and major publicly traded companies like MicroStrategy (MSTR) and Square (SQ) owning Bitcoin, along with various other public and private entities, institutional investors, and influential individuals, attempting to ban it would be detrimental to the balance sheets of corporations, funds, banks, and investors who hold it. Additionally, such a ban would not be popular among the millions of voters who own Bitcoin.

While regulatory hostility remains a risk, particularly while Bitcoin's market capitalization is below $1 trillion, this risk can be managed by adopting an appropriate position size based on individual financial circumstances and goals.

7.“Where to Buy Bitcoin”

Moving on to this question. the ideal platform depends on an individual's goals and geographical location. The first consideration is whether one intends to be a trader or a saver. This determines whether a long-term Bitcoin position will be established or if it will be bought with the intention of selling it within a few months, or a combination of both.

The second question relates to custody preferences. One can choose to self-custody Bitcoin using private keys and a hardware wallet or a multi-signature solution, which provides a higher level of security but requires a learning curve. Alternatively, one can opt for a custodial service where someone else holds the Bitcoin, offering simplicity but involving counterparty risk.

Bitcoin can be accessed through publicly traded funds like the Grayscale Bitcoin Trust (GBTC), which trade at a premium to their Net Asset Value (NAV) and rely on counterparties. While such funds can be useful for diversifying portfolios within an Individual Retirement Account (IRA) due to tax advantages, they may not be the most efficient way to establish a core Bitcoin position.

Bitcoin is also available on major exchanges, allowing users to transfer their holdings to a private hardware wallet or other storage solutions. It is important to exercise caution when using platforms that do not permit Bitcoin withdrawals, such as Robinhood. Personally, I purchased my core Bitcoin position through an exchange in April when I became bullish and subsequently transferred a significant portion to personal custody.

Additionally, I started dollar-cost averaging through Swan Bitcoin, which provides the option to store Bitcoin in cold storage or transfer it to personal custody. Swan specializes in Bitcoin and offers low fees for those who prefer dollar-cost averaging. It is primarily a platform for savers rather than traders. As an advisor to Swan Bitcoin and knowing several members of their team, including their CEO, it is my preferred method for accumulating Bitcoin.

In summary, a good combination is having access to a cryptocurrency exchange, a dollar-cost averaging platform like Swan, and a personal custody solution such as a hardware wallet or a multi-signature solution. For those in the early stages of learning, keeping Bitcoin on an exchange or in custodial storage is also acceptable, and as one becomes more knowledgeable, the option to self-custody can be pursued if suitable for their situation.