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Welcome to Episode 54 of Special Situation Investing where we fast track your investment research with short actionable investment write-ups and insights.
(Listen to the audio for more commentary on the list below.)
1. Bitcoin has the first mover advantage in digital peer-to-peer payments. The advantage will likely endure as crypto is an open source ecosystem. In closed source systems like internet search providers another company can invent the proverbial better mouse trap and take market share from whichever company dominates the industry but in crypto technological improvements can simply be incorporated into the already dominant network thus strengthening the already dominant network.
2. Metcalfe’s Law describes the exponential growth of a networks value as a function of the networks arithmetical expansion. Metcalfe’s law is expressed in the formula n(n-1)/2 and is commonly illustrated using the example of a telephone network where the value of one phone is 1(1-1)/2=0. Once a second phone is created the network value is 2(2-1)/2=1 and by the time you reach five phones the network value has expanded to 5(5-1)/2=10 and the networks value continues to expand exponentially with every additional phone that joins the network. Similarly, the bitcoin network grows exponentially in value with each new user who joins the network.
3. Gresham’s Law theorizes that good money drives out bad. The law is named after Thomas Gresham who theorized that when two coins with equal face value but consisting of different commodity metals circulate together the more valuable coin, in commodity terms, would disappear from circulation. Gresham was addressing government debasement during the Tudor Dynasty but the law transcends the limited conditions under which it was first described and lends credence to an eve increasing bitcoin value given its fixed supply limit over an ever expanding supply of fiat money.
4. Bitcoin offers inviolable security to those who self-custody. The best safe is eventually cracked, the best bank eventually fails, and the great empires along with their currency fade away. Bitcoin is in fact so secure that many of the coins are permanently stranded and unusable. At some point along the way some of the private keys were lost and the coins can no longer be accessed. This characteristic is often highlighted as a limitation by bitcoin critics but looked at through the lens of security it demonstrates the bitcoiner mantra “not your keys, not your coins” better than anything else could. Even the pharaohs couldn’t take their treasure with them to the afterlife and saw it stolen by tomb raiders where as bitcoin once properly taken into possession is secure.
5. Bitcoin provides open access for all who wish to participate. With no central authority it offers users a global monetary network in which to store value and transact business that is instant and border-less. The barriers eliminated by the network are difficult to overstate when you consider the permissions required to join existing monetary networks along with the multiple points where access to the network can be capriciously denied.
6. Eliminating the perverse incentives of money creation outlined by Richard Cantillon in the early 1700s further enhances the fairness of the bitcoin network. Cantillon explained the inequity of money creation by stating that in essence, the closer you are to money creation the more disproportionality you benefit from that creation. This is because the first person to receive the new money, and not pay a price for it, is able to spend the new money with pre-inflationary purchasing power where the last person to receive the new money spends it after prices have already risen in response to the increased money supply. Because bitcoin miners expend energy and money to “mine” new coins they do not get the same free rider benefit from the newly created currency that those close to the printer receive in a fiat money system.
7. Bitcoins total supply is capped by the protocol at 21 million coins with the last being issued in the year 2140. Because the supply is fixed and because the total number of goods and services in the world are always increasing the value of each bitcoin relative to all purchasable goods must continue to increase. Compare this to a monetary system where the supply of money is always increasing and prices increase to keep up with the money supply. In such an inflationary system, participants are encouraged to spend and discouraged from saving, they’re made to work longer and harder for the same purchasing power rather than making lasting economic progress.
8. Bitcoin mining costs are in continual decline due to technological improvements. As the machines that validate transactions and compete for block awards improve, power and maintenance costs required to obtain any given block reward go down. The secondary effect of this technological improvement is that old equipment becomes obsolete as running it comes with the a power and maintenance cost that is unlikely to be repaid by receipt of a block reward. The number of coins awarded to a miner per 10 minute block are halved every four years and this also effects the profitability of bitcoin miners as the value of their mining rewards will be cut in half every four years. A bitcoin miner must be profitable after taking into account the continued replacement of old equipment and the reduction in profitability resulting from the four year reward having cycle. The bitcoin price at which a miner can profit after accounting for these variables sets an effective floor on the bitcoin price.
For further information on this topic I recommend the Bitcoin White Paper, The Denationalization of Money by Fredrich Hayek, the Essay on the Nature of Trade in General by Richard Cantillon, any of the papers or talks of Murray Stahl, and finally the Michael Saylor Series of interviews on the What is Money Podcast.
That concludes Episode 54. We hope you got something out of that look into some of the ways you can value Bitcoin. We also hope you are getting value out of the show, if you are consider supporting our work via the ways listed below. We’ll see you again next week.
Eight ways to value bitcoin