BTC 001: Bitcoin Common Misconceptions w/ Robert Breedlove

This is a summary of the TIP podcast where I share some of the best takeaways in an easy to understand format.

Main Podcast Themes:

• What is the fundamental problem Bitcoin intends to solve?
• What is sound money?
• Will governments not allow it?
• How is Bitcoin’s supply actually fixed?
• Is the price too volatile?
• What is the Stock to Flow model?
• Why does Bitcoin need to use so much energy?

Bitcoin is a non counter-party insurance policy on the legacy technology of central banking. It is a barometer for the debasement of the legacy fiat system.

An important principle of Bitcoin to understand, especially if you do not understand a lot of finance or economics, is that Bitcoin is trying to solve for the lack of truly sound money. If security, scarcity and proof of work are not top priority, then you aren’t really solving the main problem. This is what gives Bitcoin the edge over all other crypto currencies. This is what other coins neglect when offering lower transaction fees. It comes at the price of sacrificing the soundness of the money for cheapness. If you cannot run your own node on the protocol and need to trust somebody else, then we are no longer decentralizing the protocol. Don’t trust, verify.

Bitcoin core software is a very simple piece of code. It doesn’t have a lot of features, and the developer community doesn’t add a lot of features. It is not trying to be faster, cooler, or better, it is trying to optimize for preserving the supply cap to maintain absolute scarcity of 21 million coins.

What is the fundamental problem Bitcoin intends to solve?

Inflation — Why is inflation bad? At first it may seem good. My house goes up, stocks go up, wages go up. By increasing the supply of money, not only are you disturbing price signals, but you are confiscating value away from those who hold the currency. This value is reallocated to those that receive the new money first or already own assets. There is no inflation with Bitcoin. There are only 21 million coins available. They are slowly mined at an exponentially decaying rate until the last coin is mined in 2140.

Censorship — People who are expressing their freedom of speech around the world are defunded by the local government monopoly on money (e.g. protestors in Hong Kong). This inhibits a free market. Bitcoin is censor free.

Legal Monopolies — Legal monopolies are monopolies that are created by the government. The Federal Reserve has an exclusive right to counter the currency at the expense of the market participants. Bitcoin does not permit a central, legal monopoly of money.

There are 5 key properties of money:

• Divisibility — money can transact at varying scales
• Durability — money will persist over time
• Portability — money can be easily moved across space
• Recognizability — you can verify the authenticity of money (not counterfeit)
• Scarcity — limited supply; resistant to supply inflation

What is sound money?

When gold was used as money, it was not very divisible or portable. Gold backed currencies emerged as a result. Soon fractional reserve banking allowed for more certificates than gold to be printed, leading to paper money that was not backed by hard assets (where we are today).

When we were taken off the gold standard we externalized the costs of inflation onto the broader society and siphoned its gains towards those that the central bank selected. The system through which we communicate is prices. When the medium, or money, of the price system is corrupted, it disrupts the communication network that pricing brings. When you introduce supply manipulations, you can’t tell what percentage of that price signal is noise and what percentage is signal.

Bitcoin satisfies the 5 properties of money in the following ways:

• Divisibility — Can be infinitely divided if needed, but currently 1 BTC = 100 million Sats
• Durability — The Bitcoin protocol is run across thousands of nodes that store the entire blockchain ledger. It is everywhere and nowhere. It cannot be destroyed or altered
• Portability — It is pure information and travels at the speed of light. Highly secure with multi-signature wallets or collaborative custody
• Recognizability — Cannot be counterfeited because all nodes are checking transactions
• Scarcity — Perfectly scarce with 21 million coins

Will governments not allow it?

There is a supreme court precedent from the PGP (Pretty Good Privacy) case. It declared that open source code is protected under the First Amendment. If they wanted to overturn this and outlaw Bitcoin, it would be impossible to completely ban since it is a lightweight software client. There is no central authority you can shut down.

A common argument is that they will just shut down exchanges. China has shut down several exchanges before. If you shut it down nationally, you miss out on the global market for Bitcoin. People around the world are still buying it and prices will continue to increase. If you are a government that shuts down exchanges you incentivize other governments to pick them up.

How is Bitcoin’s supply actually fixed?

Bitcoin is purely informational. It is pure digital money. Each Bitcoin is divisible by 100 million units called Sats. Even if you divide it further, there are still only 21 million Bitcoins, just like market capitalization in a stock split remains unchanged.

It is programmed into the Bitcoin protocol for there to be only 21 million coins. Path dependence helps solidify this. Path dependence is complex, but in simple terms it means that history has inertia. The order of events which lead to an outcome has relevance to that outcome. The protocol already has momentum behind it in the form of network effects. There is no attack surface left in the concept of money for a competitive technology to come in and disrupt it.

Is the price too volatile?

Bitcoin is the highest volatility, highest return asset in history. The asset is only 12 years old and is competing for a 100 billion plus market cap. The volatility comes hand in hand with the current level of asset maturity. Volatility is a natural function of price discovery. If you have something against volatility, Bitcoin is not for you. Any intelligent investor would say the answer to volatility is position-sizing. Decreasing the position size in your portfolio will decrease volatility in your portfolio, and vice versa. There is no such thing as ‘too volatile’, it’s just too volatile for your positioning.

Bitcoin runs countervailing to inflationary economics. Every four years, the supply contracts and the newly issued supply shrinks by 50%. This is an exponential decay function for money supply growth. Looking at the price action of Bitcoin, there are huge peaks followed by blow off tops and huge troughs. There is a pattern of new all time highs about 18 months after the halving. The most recent halving was May 2020, which puts a new ATH at roughly Q4–2021.

What is the Stock to Flow model?

Stock to flow is a calculation made on scarce assets. It is 1 divided by the supply inflation rate. Gold has an annual supply inflation of 1.8%. To calculate gold’s stock to flow it is 1 / 1.8% = 55. The lower the supply of inflation (or the higher the stock to flow) the more scarce the asset. Gold historically has been the truth of money, which is why the free market naturally selected it.

Stock to flow in Bitcoin price modeling was made popular by PlanB in his article Modeling Bitcoin Value with Scarcity. For more a deeper dive, check out his article.

Why does Bitcoin need to use so much energy?

In short, the high use of energy ensures settlement insurance. Every block of transactions is allocated an amount of security budget. This means that if there have been 6 blocks since your transaction, it is so deeply buried under all of this expenditure of energy that it’s impossible to unwind the chain. Other currencies would take hundreds or thousands of blocks to get the same level of security. Bitcoin is giving you the assurance of settlement finality in the lowest amount of time by allocating the maximum amount of energy per block relative to other currencies available.

Gold is energy money as well. The reason it had value in the marketplace was because the energy necessary to extract gold gave us assurance of its supply limitation and scarcity in the market. Bitcoin is monetized energy. This is part of the game theory of Bitcoin for miners and users alike. Energy and money are always necessary for economic production. Bitcoin has fused the two. This fusion is called proof of work.

Resources

Robert Breedlove’s Twitter handle — @Breedlove22

Preston Pysh Twitter handle — @PrestonPysh

Podcast Links: Apple | Spotify | The Investors Podcast