Bitcoin: an investment like no other

If its volatility continues to fall, bitcoin could quickly become a genuine store of value, according to Yves Choueifaty, founding chairman of the TOBAM asset management company, who expects the price to exceed €1 million.

Before any consideration of investing in bitcoin, and given the specificity of bitcoin in this regard, it is worth starting by addressing the risks. Bitcoin is an extremely risky asset, its three-month rolling volatility has often exceeded the 100% volatility level, which is unparalleled among widely held assets.

However, the level of risk in itself is irrelevant when deciding whether to invest in an asset. One million euros invested in an asset with 10% volatility is much riskier than €2,500 invested in an asset with 100% volatility.

For an investor, the percentage risk is not relevant, it is the risk in euros that is. The decision to invest must be made by considering the investment thesis; risk considerations, for their part, will determine the size of the investment. In short, you cannot rationally rule out an asset by saying "this asset is too risky for me"; if you thought that, you would simply buy less of it.

Investment thesis

A possible investment thesis for bitcoin is that it has fundamental and empirical qualities that could potentially make it a new yardstick for measuring value.

The most important word is "potentially". With an investment thesis, it is not a matter of stating a proven fact, but a potential, not yet realised: if there is a thesis, there is an antithesis.

Bitcoin is not today a standard for measuring value. In fact, that's what makes it a potentially attractive investment. If it were already one, it would probably be worth a lot more than it is today and it would be much less attractive to buy it than it is today...

The search for the standard

A standard is a unit used in a normative measurement. Whether we are measuring length, mass, duration, temperature or anything else, it is necessary to define a standard.

The history of economics has been accompanied by a long search for a standard to measure value. One of the earliest yardsticks, in the days of hunter-gatherers, were flint arrowheads; piles of them have been found, which are hard to explain by motivations other than hoarding.

Flint arrowheads were difficult to make, owning a few allowed you to exchange them for desirable goods. When, as a result of technological advances, flint arrowheads became easier to make, it was necessary to change the yardstick; this was the era of agricultural yardsticks, and then agricultural goods in turn became easier to produce. When users have the impression that the monetary standard is easier to produce, it is necessary to change it.

This was the era of metallic standards: first iron, then bronze, silver and, when silver production became too easy, gold. It is interesting to note that for a long time, the role of the State was limited to that of certifier and not really issuer.

The sovereign did not produce silver metal and then gold, but transformed it into coins, thereby certifying its weight, with the initial aim of facilitating trade. The State affixed its seal to the coin, thereby certifying its weight. The etymology of the pound sterling says it all... (sterling meaning pure silver metal and the pound being a unit of weight).

The fluted character of a coin's edge is, again, an anti-abrasion device intended to contribute to the constancy of its weight.

The qualities of bitcoin

What are these fundamental qualities that give bitcoin its potential to become a standard for measuring value? We can start by listing six fundamental characteristics of bitcoin:

👉 it is unalterable;

👉 it is unfalsifiable;

👉 it is difficult to seize;

👉 it is non-manipulable by a central authority ;

👉 it is, eminently, exchangeable;

👉 its supply is limited, it is non-inflationary.

We will not dwell here on demonstrating these properties, but will merely try to facilitate an intuitive understanding of them. The first five qualities come from blockchain technology. Bitcoin is digital, robust, decentralised, peer-to-peer.

It was on 31 October 2008 that Satoshi Nakamoto introduced both blockchain technology and bitcoin. He would implement the technology and the first bitcoin (the first 50 in fact) was mined on 3 January 2009. Bitcoin was born.

The blockchain

What is the blockchain, intuitively? It's a chain of blocks. A decentralised register made up of pages, or "blocks", recording all the transactions between virtual "safes". Imagine a gigantic collection of safes, each of which can be accessed in two ways.

If you have the public key to one of the safes, this allows you to find out how many bitcoins are in the safe and possibly slip additional bitcoins inside the said safe;

If you have the private key, you will be able to seize all or some of the bitcoins in the safe and send them to another safe. In order for this system to operate in very secure conditions, it needs to be allocated computing power. The people who "lend" computing power to the system are called "miners".

Remunerating miners

In order to motivate miners to allocate computing power, Satoshi has devised a lottery and transaction fees for the benefit of miners. Statistically, every ten minutes (publication of a "block", a page in the register) a miner, determined by chance, receives a fixed number of new bitcoins.

The first miner received 50 bitcoins and, every 10 minutes, following the publication of a new block, a new page in the register, a further 50 bitcoins are allocated to a randomly chosen miner. And this is done 210,000 times because, every four years, every 210,000 blocks, the bitcoin protocol divides the reward by 2, this is known as halving.

This is how the reward goes from 50 to 25, then to 12.5; today it is 6.25 bitcoins every 10 minutes; this quantity will be reduced to 3.125 in April 2024. Each Bitcoin is divisible 100 million times, the smallest fraction of a Bitcoin is called a satoshi, and there are 100 million satoshi in a Bitcoin. The last satoshi is expected to be mined in 2140, by which time 21,000,000 bitcoins will have been mined.

Non-inflationary currency

This brings us to the fifth property: bitcoin is the first candidate device to be a currency of which there is a limited and known number in advance. Bitcoin is eminently non-inflationary. This is the fundamental difference between bitcoin and previous currencies. The yardstick for measuring value is currently the US dollar; the US Federal Bank's balance sheet stood at 500 billion dollars in 2002; it will be 8,000 billion dollars in August 2023. The Roman denarius, the currency of the empire, originally contained 4g of silver per coin, ending up at 0.1g of silver per coin towards the end of the empire.

Gold itself is highly inflationary. It is estimated that 190,000 tonnes of gold have been extracted from the earth's subsoil since the beginning of mankind. The Earth contains some 6+15 tonnes of gold. Mankind has mined 0.00000000318151% of the gold on Earth. There is gold everywhere in the universe, whereas we will never find a bitcoin on the Moon or on the planet Mars...

For Milton Friedman, inflation is not the rise in prices, it is the failure of money: "inflation is always and everywhere a monetary phenomenon; it is and can only be produced by a more rapid increase in the quantity of money than in production".

An invasive state

Bitcoin has its origins in the thesis that any centralised monetary policy is, sooner or later, doomed to failure.

The thesis is that, once a group of people has a monopoly on issuing money, sooner or later it will abuse it. The central bank's mission is price stability. A well-managed central bank mechanically accumulates immense power, so it is very tempting to use this power for purposes other than price stability.

When the central bank assigns itself, or is assigned, rightly or wrongly, a mission other than price stability (defending the banking system, impecunious states, the energy transition...), this new mission is necessarily accomplished at the expense of the initial mission. This is unorthodoxy.

According to Milton Friedman, inflation is probably the most important factor in this vicious circle whereby one type of government action makes government control increasingly necessary. For this reason, all those who wish to stop the drift towards ever greater state control should concentrate their efforts on monetary policy. Bitcoin's value proposition is that it is digital, unalterable, decentralised, trades peer-to-peer and there are 21,000,000 of them.

There will be no monetary inflation as a result of bitcoin.

Disruptive innovations

Bitcoin is nonetheless heavily criticised. This is the fate of all disruptive innovations. When any disruptive innovation emerges, a Kübler-Ross cycle is triggered.

Elisabeth Kübler-Ross was a psychiatrist who described the stages of grief: first shock, then denial, anger, depression, experimentation, decision and finally acceptance.

A disruptive innovation is one that claims to be able to change things; so when it emerges, you have to mourn the loss of the world before. But the old world had at least two qualities: it worked and we knew it. Every disruptive innovation at some point triggers anger, anger against electricity, against running water, against the train, the car, the atom, the internet or the mobile phone... There are then four drivers of anger.

The engines of anger

The first engine is passion or ideology; it consists of judging innovation not by checking whether it works or whether it doesn't, but by the yardstick of right and wrong.

We won't ask whether bitcoin works or doesn't work, we'll then say: bitcoin is bad, as if a technology could fall under good or evil.

The second driver is conflict of interest; asking a candle maker what he thinks about the light bulb is like asking a central banker what he thinks about bitcoin.

The third driver of anger is ignorance. Human psychology is peculiar in that it is easier to criticise what it does not understand than what it does understand. At the root of much of the criticism of bitcoin is ignorance.

The fourth driver of criticism is reason. In the case of a truly disruptive invention, the answer to most reasonable criticism is the creation of an overlay. The car is a disruptive innovation; a reasonable criticism of the car is that, if the brakes are suddenly applied, the passenger is thrown against the windscreen... and that doesn't only have advantages.

The answer to this reasonable criticism is the creation of an overlay to the car: the seatbelt. This overlay does not detract from the disruptive innovation but, on the contrary, reinforces it. A car with a seatbelt is still a car, it's even a better car, it works better that way...

We can observe that most of the reason-driven criticisms of bitcoin find or will find their answer in the development of an entrepreneurial, financial, regulatory, IT overlay, which will stand between the risk-taker and the blockchain.

Original article published in the magazine of the Polytechnic School, "La Jaune et la Rouge", n°792 February 2024.

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