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January 17, 2020

Bitcoin – The Bitcoin Economy?

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Bitcoin is sizzling in South America. Northern winters are helping to cool miners and create new incentives for renewable energy. Rumors are swirling about social-media giant Twitter introducing micropayments. Blockstream’s Liquid sidechain is ready to roll out. And while the world’s first digital currency remains a pariah in many circles, the question is are we on the verge of a Bitcoin economy?

When Bitcoin first rolled off the digital printing presses a little over 11 years ago, only a handful of people noticed. The notorious ‘cypherpunks’ who were on the infamous mailing list were able to test the still-unknown Satoshi Nakomoto’s version of a decentralized digital currency. It had been tried before, but never in a way that enabled stateless control, permanent immutability, and -digitally-verifiable records of each and every transaction. V1, for argument’s sake, worked very well. Not flawlessly, but well enough for a seemingly valueless digital asset to be trading at over $1,000 per coin within 5 years.

In the era of the 1st major boom-and-bust cycle in Cryptocurrency, we saw several new versions of the decentralized currency – branded as Bitcoin 2.0 – come to the forefront. Led by Ethereum, these challengers would employ code that enabled ‘smart contracts,’ a re-engineered blockchain to reduce the environmental footprint, and a Keynesian inflation model that would enable thousands of early-stage backers to get rich in the process through a pre-mine model known as the ICO (Initial Coin Offering). This wave brought with it a massive bubble that saw several digital assets (including Ethereum) appreciate by more than 10,000% in a single year. It culminated in a massive bursting of the bubble in January 2018 and billions of dollars in capital evaporated within just 12-18 months of that famous peak.

2018 – Crypto Rout

What has ensued since then is a reckoning of sorts. While many ICOs were nothing more than an elaborate scam, many talented and well-meaning entrepreneurs believed that they were on the verge of making history, only to be on the other end of angry phone calls and scathing emails from would-be investors whose ‘assets’ disappeared virtually overnight. At the valuation most ICOs raised at during the peak, it’s unlikely most investors will ever get any of their money back let alone see a significant return for their risk. It was a trader’s market driven by a boiler-room mentality that made Wolf of Wall Street look like a high-school drama.

MMT and The Bitcoin Thesis

Perhaps the most spectacular observation of the Crypto Bust of 2018 is that nothing of substance really came out of it. There were a lot of socialist ideas about how the blockchain could be used to redistribute wealth. There was a lot of posturing about how people in Africa would be transformed by a blockchain or two, and the unbanked would suddenly be banked. Worst of all was the idea that Bitcoin’s proof-of-work blockchain – a major innovation in and of itself – could be replaced by a proof-of-stake blockchain that would use virtually no energy and have zero security tradeoffs.

Many ideas, but a few years later we can see that the vast majority of these ideas were developed in an ivory tower by armchair economists and software developers. Yes, there are some good ones and the ‘long-term’ context still holds for certain teams that wanted to push the boundaries. But the central tenet of many of these ideas was that a group of people (ie. the founding team) could effectively issue an unlimited amount of a security, distribute as if it is a currency, and then if they run out of money in experimentation mode, just ‘print’ more.

Conveniently, this philosophy is exactly the same as the Modern Monetary Theory (MMT) where a sovereign body can print unlimited sums of its currency and will NEVER default on its debt.

The most important conclusion reached by MMT is that the issuer of a currency faces no financial constraints. Put simply, a country that issues its own currency can never run out and can never become insolvent in its own currency. It can make all payments as they come due.” As a result, “for most governments, there is no default risk on government debt.

WSJ – Gregory MANKIW on MMT

As this realization dawned on ‘the market,’ it became clear that the technological innovation that underpinned Bitcoin (ie. the blockchain) was nothing without an anti-inflationary, anti-MMT monetary policy to accompany it. While Ethereum’s killer app to date has in fact been the ICO, Bitcoin’s killer app has been a secure and reliable protocol for transferring value where the supply is fixed at 21 million. That means that unlike the vast majority of tokens on the market (where it functions as a security, but brands itself as a currency), Bitcoin cannot simply be issued and distributed at will to increase the capital available for experimentation.

Paradoxically, this has increased its value over time relative to everything else on the market. It is now seen as a closer competitor to Gold than to other Cryptocurrencies. Its scarcity is almost impossible to replicate in the same way, meaning that if someone copies exactly the same script as Bitcoin they will be required to compete against a decade of trust in the brand it has established for itself within the global community.

No, you can’t run into 7-11 or Tesco’s and pay with Bitcoin today – and quite frankly, why would you need to, VISA works fine. But the Bitcoin Thesis has begun to emerge as a phenomenon in places where their local currencies have hyper-inflated, and where capital controls reign. This could be a signal that a true Bitcoin Economy is about to begin, and with it, a commercial layer that facilitates cross-border commerce in ways we have never seen before.

The Bitcoin Economy

Let’s leave countries at the very bottom of the economic barrel – ie. Venezuela – out of the equation and look at countries with a fairly modernized economy and infrastructure, and a well-educated, talented population. Let’s look at Argentina.

Argentina has a history of currency crises, capital controls, and corrupt governance. Despite this, the quality of life there has remained relatively high and cities like Buenos Aires and Mendoza continue to be hubs for global tourism.

Local Bitcoins Volume – Argentina

Bitcoin is booming in Argentina. The above graph shows volume from Local Bitcoins, effectively tracking the P2P (peer-to-peer) volume in the country. If you zoom in, you will see that there was a downtrend in early 2018 (when the global Crypto market began its collapse), yet current weekly volume (~$30 million) is roughly 10X higher than it was in Q1 2018. The only way to explain this graph – which has almost zero correlation to price – is that people in Argentina see the utility in Bitcoin. Despite sustained efforts by the government to effectively ban Bitcoin, the people continue to buy while the Peso continues to collapse.

XE.com – 5 Year Forex Chart

None of this is to say that Bitcoin is good or bad, or that its value will go up or down. It simply shows the correlation between the amount of volume being moved between locals in a country where you have a national currency devaluing at a rapid pace. It’s simply Game Theory in action, where you know that on one hand, you are buying a highly-volatile digital asset rapidly depreciate at any moment, but on the other hand, you know that the value of your hard-earned Pesos (in this case) lose double-digit purchasing power every year. Not that we would expect people in Argentina to start converting all of their capital to Bitcoin, but it is obvious enough that we would expect a certain percentage of the population to convert some.

And this is how the Bitcoin Economy begins. Slowly people accumulate the underlying digital asset for its core anti-inflationary properties, some in certain regions more than others. As that accumulation progresses, the underlying technology and infrastructure improve, thus bringing in more people from developed regions who buy it for a specific, non-essential purpose (ie. a digital alternative to gold). Suddenly, new applications emerge across the global economy that incentivizes entrepreneurs to implement Bitcoin. That’s where we are now, and from here on out we will see whether the Bitcoin Economy is more sizzle or steak.

Energy, Liquid and Twitter

While Bitcoin gains traction in regions with unstable national currencies, one may be wondering what’s happening in the Western World where currencies have been relatively stable and trust in the banking system reigns.

Energy

On the energy front, you have major investors like Peter Thiel getting behind Bitcoin Mining Startups that are trying to transform the energy equation for proof-of-work and compete against China for mining capacity.

San Francisco-based Layer1 announced it has raised $50 million from billionaire Peter Thiel and others to move forward with its plan, which includes running its own power sub-station and purchasing solar and wind energy produced on the plains of West Texas.

FORBES – LAYER1 Raises $50 Million

Given the magnitude of the problem, there are several layers to Layer1’s plans.

According to industry research, over 60% of Bitcoin’s hashrate and 100% of Bitcoin hardware production are located in China. Less than 5% of Bitcoin’s hashrate and 0% of hardware production are located in the United States.

LAYER1 CEO – MEDIUM

But what makes this so compelling is that if you study the incentives, you can see that Bitcoin Mining actually creates an incentive for renewable energy production, a key tenet of Layer1’s plan in Texas. Furthermore, it helps convert stranded energy assets (ie. stranded natural gas) into capital that can be deployed into more innovation on energy infrastructure. The net effect is that innovation between Bitcoin Mining infrastructure and the Energy Grid go hand in hand, and now with companies like Layer1 and others dedicating themselves to North America, it creates a large volume of potential Bitcoin transactions in the future.

Liquid

Next, you have the introduction of the Liquid sidechain, which when combined with Elements and other server-side software will make Bitcoin much more scalable at the core.

Liquid is one of Blockstream’s flagship products that is an inter-exchange settlement network that exists as a Bitcoin sidechain. It connects numerous exchanges to provide better liquidity through faster Bitcoin transactions, and users can even issue their own assets. It has a native asset, L-BTC, which is pegged to Bitcoin via the sidechain.

Blockstream – Liquid

While the impact of the Liquid sidechain in the market may be a bit hard to predict at this moment, it does create a much faster mechanism for market makers, exchanges and financial institutions to trade and settle large BTC transactions. For so long, the major advantage of other comparable blockchains is that they were faster and cheaper. However, as discussed above, this came at the sacrifice of the unit of account, which for most other blockchains was a security masquerading as a currency. In the case of Liquid, it enables new assets to be created, but it keeps Bitcoin as the core unit and doesn’t require an exotic token to operate.

Yes, there are potential centralization tradeoffs and other considerations. Blockstream is a private company and Liquid is a Layer 2 solution that is in effect a consortium. Someone with a more advanced technical background would have to compare the tradeoffs here; however, Liquid is launching and that will increase liquidity in Bitcoin, a pre-requisite for it reaching critical mass.

Twitter

Founder of Twitter @jack has long been a proponent of Bitcoin. His other company Square has seen a huge surge in Bitcoin volume on its Cash App in the United States over the last several quarters.

Cash App by Square
The Block Crypto – Square BTC Volume

As of Q2 2019, Square had 15 million Monthly Active Users (MAUs). Using the same period as a reference point, Twitter has 330 million MAUs or about 20X the size. That’s why the recent news that Twitter will be launching a Bitcoin tipping feature on the social network has caused so much hype:

Twitter is currently considering a feature that will allow users to send money and value to other users … Others echoed this optimism, claiming that solutions like the Bitcoin Lightning Network, which enables BTC transactions that can be well under a dollar and can take place in literal seconds, would be perfect for this tipping feature.

Blockonomi – Twitter Tipping Bitcoin

With Bitcoin’s Lightning network entering the mainstream frey, a Twitter tipping integration could propel the Bitcoin network towards critical mass. There is a huge network of independent journalists and pundits who currently generate large amounts of Likes and RTs, which doesn’t pay the bills. Bitcoin would effectively become a new source of income with the introduction of BTC tipping, in the process creating a new business model for independent journalism.

Tying the Pieces Together

All combined, we can see that much has changed in the world of digital currencies since the 2017/18 bubble. Bitcoin is still the king. Now, a series of global events and technological innovations may propel the decentralized digital asset towards critical mass in the next year or two.

While other ventures in the Cryptocurrency and Blockchain space remain exciting, we saw the effects of too much capital rushing towards companies who didn’t have a solid monetization model. Investors will be much more sophisticated in the next wave, while governments themselves will be market actors as well. The net effect is competition will be high, and regulation will increase.

That means that despite the optimism around Bitcoin, it is too soon to say with certainty that a Bitcoin Economy will emerge. Nonetheless, many are placing their bets now, and if they are right, the price of Bitcoin will be stratospherically higher by the time it’s clear that the Bitcoin Economy has truly arrived.

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