Bitcoin Series #5: Bitcoin isn’t Backed by Anything!
In our Friday series, we take a deep dive into different asset investments. The first asset we’re covering - which we will stick with over the next several weeks - is Bitcoin (BTC). Our goal with this weekly series is to familiarize readers with BTC and to address common anti-BTC arguments. For full disclosure, Brandon and Daniel are strong believers in Bitcoin and both have allocated portions of their portfolios to BTC (HODL baby).
Let’s get physical
A common criticism of Bitcoin - and cryptocurrencies in general - is that it exists only digitally (online) and has no physical presence (“you cannot hold a bitcoin”) or backing. On its surface, this criticism is attractive and seems obvious, as nearly everyone has held physical currencies (a U.S. dollar, a Canadian “loonie,” etc.) and expect that any valid currency should resemble the status quo. There is also psychological comfort in having your store of value in your hand (or wallet, safe, etc.) - you can see it, touch it, know that it’s there. Bitcoin is not physical; it is a digital asset. But before diving into Bitcoin, it’s important that we briefly cover traditional currencies and their “backing.”
The gold standard
For brevity, and to remain within our circle of competency, we will focus our attention primarily on the U.S. dollar. In 1900, the Gold Standard Act was passed in the United States, establishing gold as the only standard for redeeming paper money (U.S. dollars or USD). Essentially, every dollar in circulation was backed by a specific allotment of gold. The gold standard is meant to protect citizens from hyperinflation and abuses of monetary policy - for example, the government could not print more representative paper money than their gold stores could back. In 1971, in a move known as the Nixon Shock, President Richard Nixon removed the USD from the gold standard and established the fiat-based system that we currently use.
According to Investopedia: “Fiat money is government-issued currency that is not backed by a physical commodity, such as gold or silver, but rather by the government that issued it. The value of fiat money is derived from the relationship between supply and demand and the stability of the issuing government, rather than the worth of a commodity backing it as is the case for commodity money.”
Monetary systems that use fiat currencies can be abused by the governments and/or central banking agencies (in the U.S., the Federal Reserve) that oversee the system. A particularly harmful abuse of this system is over-printing, which adds money to the system and devalues the circulating currency. This is known as inflation and, when done to excess, can cause hyperinflation.
Unfortunately, the U.S. appears to be on the fast track to hyperinflation. The COVID-19 pandemic brought the economy to a screeching halt. Many businesses were forced to close and unemployment skyrocketed, reaching ~15% nationwide. In response, the government passed a series of stimulus bills, including the CARES Act (~2T USD) and the Consolidated Appropriations Act (nearly 900B USD). This stimulus money was created out of thin air. And it does not appear to be stopping anytime soon. In fact, Jerome Powell (16th chair of the Federal Reserve) said that they will do “whatever it takes” (including printing a massive amount of money) to delay a recession.
The long winded point is this: If you criticize BTC for not having a physical backing, wait until you find out about the USD. Unfortunately, many are not taught that your hard earned money is at the complete mercy of the Federal Reserve - and they really don’t seem to care about your money keeping its value.
What makes a good store of value?
A currency is usable when it can reliably maintain its value over time without depreciating. In other words, a usable currency is one that should serve as a solid store of value. One important characteristic of a reliable store of value is scarcity. The gold standard was meant to fortify the relative worth of the USD and stop the government from reducing scarcity of USD. Unfortunately, those days are gone. And it shows. Massive stimulus packages and continuous deficit spending are devaluing USD - it’s only a matter of time until it fails to serve as a usable currency. This is causing many investors to search for a better store of value.
According to Investopedia, successful currencies meet six key criteria:
So, we know the USD is falling short in at least one of these characteristics. But does Bitcoin meet the criteria? We believe it does:
Scarcity: Bitcoin has a hard cap on number of coins that will ever be created.
Divisibility: Each coin can be divided into 100,000,000 Satoshis; 0.00000001 Bitcoin is a single Satoshi (for comparison, a U.S. dollar can be divided into only 100 cents).
Utility: The blockchain tech underlying BTC make it an incredibly reliable and safe way to store and/or transfer money.
Transportability: While time is needed to improve transactional technology for retail payments, online exchanges and wallets make it relatively fast, easy, and (because of the blockchain ledger) safe to transfer money.
Durability: While paper money can wear over time, a bitcoin will always live on the ledger.
Counterfeitability: BTC runs on a massive, distributed, decentralized, and encrypted network, making it extremely difficult to hack/counterfeit coins.
But, but, but...is Bitcoin physically backed by anything?
The short answer is no, Bitcoin is not backed by anything physical. You cannot hold a Bitcoin or create a physical one. However, a physical presence is not what drives value. A U.S. dollar is a physical object, but it can depreciate (and is). It’s only backing is the U.S. government, who continuously mismanages federal funds and engages in deficit spending. BTC on the other hand, is backed by a large, distributed, decentralized, opensource, and encrypted network. BTC-derived technologies are being developed by some of the smartest people in the world. And, as described above, BTC meets the 6 key criteria for serving as a reliable currency, despite its lack of a physical presence. At the end of the day, this is just one more example of the same old, recycled FUD that the BTC opponents trot out every time the price dips. Don’t fall for it.
As we said in our introduction, we plan to address several arguments against BTC, one at a time, over the next several weeks. We hope that our weekly posts will encourage readers to learn more about this emerging technology.
Common arguments against BTC:
Be sure to check out our previous articles explaining Bitcoin and subscribe to get the new topics straight to your inbox!
BTC is not physically backed by anything
BTC is used primarily by criminals for illegal activity
BTC is not a transactional currency (cannot be used to buy everyday items)
Governments will not allow it or will heavily regulate it
It’s easy to lose access to BTC wallet
Happy Friday everyone - get after it this weekend!
Brandon and Dan
Disclosure: The authors of this writing hold positions in cryptocurrency mentioned in this article. That cryptocurrency is Bitcoin. The article was written by Daniel Kuhman and Brandon Keys, and it expresses the author's own opinions. They are not receiving compensation for it. The information presented in this article is for informational purposes only and in no way should be construed as financial advice or recommendation to buy or sell any stock or cryptocurrency. Brandon and Daniel are not financial advisors. We encourage all readers to do further research and do your own due diligence before making any investments.