Everything You Know About Bitcoin Is Wrong

[NOTE: this was an article I wrote for the Financial Times a few months ago. Due to the relentless editing from their team, I pulled it. I am publishing it here in response to their constant negative and unbalanced reporting on Bitcoin].

Presidential guards standing to attention in pristine uniforms with bayoneted rifles lined the corridor leading to a suite of the Presidential House (Casa Presidencial) in San Salvador. This place is everything you expect it to be, regal, ordered, imposing - an explicit expression of power. I took my seat and waited anxiously. 

I was about to record an exclusive interview with the 40-year-old President of El Salvador, Nayib Bukele, about his decision to make the Bitcoin legal tender in his Central American Country. 

Bitcoin, Bukele, and I are an absurd combination. A convergence of emergent disruption that would have been unimaginable even just a few years ago: Bitcoin was only launched in 2009; Bukele started his political rise in 2012; I set up a Bitcoin podcast as a hobby 5 years ago. Yet here we are, about to discuss what many stakeholders believe to be one of the most important events in El Salvador’s and Bitcoin’s history.

Bitcoin - The Innovation

Bitcoin was created by a mysterious pseudonymous person calling himself Satoshi Nakomoto. It evolved from various attempts over decades by informal and obscure groups of libertarian computing experts to make private and secure digital money. Since then, it has slowly and then suddenly gained interest from ever wider groups in waves. Recently, the growth in popularity has been astonishing, outstripping the rates of adoption seen with other recent technology improvements, resulting in the coin's value appreciating to eye-watering levels.  

Why has this happened? Each wave of adoption has seen a wider pool of exposure to Bitcoin. And those who investigate the design of Bitcoin become bewitched by its innovation and elegance: it's the Lindy effect on speed. This is because it ticks more boxes than any other previous asset. As a store of value, it has all the attributes of traditional physical assets like gold: it is scarce, unforgeably costly, durable, and fungible. However, it also improves on gold: it is divisible, portable, and resistant to confiscation. 

Most importantly, it is 100% verifiable in the digital context, not by a centralised individual or committee, but by a decentralised and distributed community of anonymous entities. You don't even have to trust them; the protocol fixes that issue. Mike Novogratz, an enthusiastic financier in this space, stated it succinctly at a recent conference "[Satoshi} created the first digital signature you couldn't counterfeit… he allowed Bitcoin to be unique".

But there is more; it is designed to be used as a medium of exchange. This is already occurring in various parts of the world. So it is both digital gold and digital cash.  It allows anyone with an internet connection to engage in a transaction that cannot be altered or stopped, with an asset that cannot be seized without requiring a trusted middleman such as a bank.

And all of this was set out in a 9-page white paper!  

Bitcoin - The Myths       

It is more than fair to state that not all of those who've been exposed to Bitcoin and undertaken the same research are either fans of it or believe it will change the world. This includes many pre-eminent economists, financial experts, and policymakers. The history of money is as old as the history of civilisation. Store of value, currency systems, intermediaries, and governance structures have evolved throughout that period. Gold has been a reliable store of value for over 5,000 years. In either coin or paper form, currency dates back to around 700 BC. Modern banking systems date back to the 12th Century. Practices and habits have gained confidence through being tried, tested, and refined.

As a result, we end up at an impasse, as the proponents declare Bitcoin’s virtues with precious reverence and energetically defend its reputation against all attacks. The critics decry these attacks as being 'toxic' and the underlying arguments false. Unfortunately, a series of myths and untruths regarding Bitcoin linger and cling to the subject.

One such myth is that Bitcoin's volatility makes it unsuitable as a currency. It is true to state that Bitcoin is volatile, but this is an expected phenomenon during a period of rapid adoption. Bitcoin has a maximum supply of 21 million coins and a rigid supply schedule that can't shrink or expand to respond to demand. Further, as Bitcoin undergoes a rapid monetisation process, few know how to evaluate it. Therefore, volatility is a short-term feature necessary to take it from being worth zero 12 years ago to its current market cap of over $1 trillion, placing it as the world's 6th largest currency, and who knows where in the future. 

Further, when someone says that Bitcoin is "too volatile", we should ask "for whom?" It might be too volatile for Americans who have access to stable currencies and investment vehicles. But it might not be too volatile for the Lebanese or Venezuelans. Without underplaying the seriousness of this volatility on those who own the asset, the history of volatility in Bitcoin is up and is forecast by many observers to remain so over the short to medium term. Many Bitcoin owners in struggling economies happily trade Bitcoin's volatility for currencies they're otherwise forced to use that experience frequent rapid devaluation. 

A second and related myth is that Bitcoin has no real value. Proponents of this myth suppose that if something has no intrinsic value, it has no value at all. 

However, government-issued currency (fiat currency) also has no intrinsic value: it is not backed by any physical commodity. Simply put, government cash is worth something because, firstly, the government promises to honour its value and allow taxes to be paid using the cash they issue.

Fiat currency is not a 20th-century invention, but its modern use goes back to 1971, when US President Nixon took the US off the gold standard. Since that time, fiat currencies have enveloped the world. Despite its detractors, this process has largely worked for the traditional finance centres. Since 1971 there has been no default by a modern western economy (although Greece was late in paying back an IMF loan in 2015). This breeds confidence that the system works whilst providing the flexibility to deal with shocks to the system (i.e. 2008 financial crisis and the pandemic). 

Yet, more than 150 million Bitcoin users agree that its unique properties justify its price, with many more on the sidelines seeking to gain exposure. The original 'Bitcoiners' were cypherpunks developing censor-resistant money. However, these are increasingly being joined and swamped by a new and varied range of investors. So who are they?

Broadly, current Bitcoin buyers fall into five categories:

• First, people who lack better alternatives. Whilst fiat currencies have worked relatively well for those living in western democracies, 1.3 billion people live in countries plagued by double or triple-digit inflation, and more than half the world's population lives under authoritarian regimes. Unsurprisingly, Bitcoin is widely used in these places — think Turkey, Nigeria, Venezuela, and Argentina. 

• Second are those looking for a hedge against loose monetary policy, inflation, or geopolitical risk. The obvious example is Venezuelans using Bitcoin to counter the impacts of hyperinflation. But, it also increasingly includes people in traditionally stable western democracies. For example, the money supply in the USA has increased by 36% since Jan 2020, and inflation is now starting to play catchup. As Milton Friedman stated in 1956: "Inflation is always and everywhere a monetary phenomenon". 

• Third are those who engage in international commerce — small companies with international employees, online purchasers of goods from other countries, or individuals sending payments to other individuals (such as remittances) that currently incur significant fees for settlement that takes days. Bitcoin enables secure real-time payment from anywhere to anywhere with no transaction fees. It is that revolutionary.   

• Fourth, people buy Bitcoin as a means of portfolio diversification, just as they buy gold or silver. This includes a growing list of major blue-chip financial companies such as Tesla and Square, family offices, hedge funds, pension funds, and potentially sovereign wealth funds. Such investments have seen Bitcoin's price reach an all-time high in October. Bitcoin is closing in on the market capitalisation for silver of $1.3 Trillion. However, investors are piling in on predictions Bitcoin could catch gold's capitalisation of $11.3 Trillion. 

• Finally, we are in a period where nation-states are buying Bitcoin to act as an additional reserve currency may be upon us. The CEO of BitMEX, a digital currency trading platform, predicts another five countries in 2022 that will follow El Salvador. 

Bitcoin - The National Currency

Back in Casa Presidencial, President Bukele set out to me why he decided El Salvador needed to make Bitcoin legal tender alongside the US dollar. Nearly a quarter of the population lives and works abroad, mostly in the US. These people send money back to their families. In 2020 these remittances were over $6 billion, representing an eye-watering 23% of GDP. These remittances are also vital in offsetting the growing trade deficits, which reached $4.5 billion in 2019. Yet, the costs and means of making such payments are punitive: Western Union will charge around 10% for such services (they charge a flat fee for the service and make a margin on the currency exchange), and such payments will take days. 

Now, using innovations built onto the base layer of Bitcoin, people can send money home instantly at no cost and, importantly, without any risk associated with Bitcoin price volatility. The direct benefits are 2 fold: the associated cost saving is retained, but the efficiency of the process incentivizes more frequent remittance payments: suddenly sending $5-$10 home isn't cost-prohibitive.  

More broadly, the introduction of Bitcoin will enable millions of people to gain access to the financial system. It is estimated that 70% of El Salvadoran adults don’t have bank accounts. As part of the launch, Each Salvadoran has been given $30 of Bitcoin in a country whose per capita income was $3300 in 2020. This will enable huge numbers of families to save for the first time using a financial instrument that can accrue value. They can also convert the Bitcoin into dollars, transact, or add to their balances as the Bitcoin is provided to them in a digital wallet called Chivo.

Then there are the national advantages to diversifying a reserve currency, particularly where you don't have a sovereign currency. El Salvador is one of eight sovereign nations that use the US dollar as legal tender. There are obvious benefits to this in terms of price stability. However, El Salvador is also beholden to US monetary policy, without any of the benefits that come with the US being able to change its money supply. Irrespective of any price appreciation of Bitcoin, having an additional reserve currency diversifies El Salvador's currency risk. 

Lastly, and perhaps most importantly, what El Salvador has done is prove that such a system works for both other countries and multinational firms. Salvadorans can use Bitcoin to buy services and products across the country, including multinational firms such as McDonald's and Starbucks. Payments are instant and can be converted to the dollar, enabling these companies to avoid the transaction costs associated with the incumbent payment systems. Such fees can represent up to 3% of additional cost, so don't be surprised if multinational firms wake up to this cost-saving and push themselves for greater geographic adoption of Bitcoin's technology. 

President Bukele has hailed the initiative to be a success. In early October, Bukele announced that more people had signed up to use the official digital wallet in the first 3 weeks than had bank accounts. With Bitcoin currently valued at $61,000, its value has grown by over 20% since it was made legal tender in early September, an incredible experience for those previously unbanked Salvadorans. A couple of weeks ago, Bukele stated that more money was flowing into the Chivo system than was being withdrawn, and remittance payments using the wallet were up to $3million per day (around 19% of total remittances). 

At a national level, the country has bought Bitcoin held in a trust fund. Through the appreciation in its value, the trust fund has the confidence to continue investing: it currently has 1,120 Bitcoins. Profits are beginning to be used for capital projects: in early October, a pet hospital was to be built using profits from the fund. 

That is not to say it hasn't been without its problems. Observers are concerned about the centralised control of the Chivo wallet. More broadly, some commentators are concerned about Bukele's increasingly authoritarian leadership style: Human Rights Watch has criticised his actions that have "undermined basic democratic checks and balances." 

Bitcoin - Next Steps

Bitcoin has triggered a great global debate regarding the role of money, the state, and individuals. Forces are pushing for either greater distributed freedom or greater centralised control. This debate is welcomed. It focuses on fundamental issues that will need to be grappled with over the next decade, most notably who should have sovereignty over money. It means, perhaps for the first time, ordinary people across the globe have a chance to shape the structure of the financial systems that surround us.  

Let's not fool ourselves to think that wide-scale adoption of Bitcoin is inevitable or even certain to dominate our economic systems. There will certainly be further bumps in the road. The ideology of Bitcoin pushes against the freedom nation-states have had to dictate monetary and fiscal policy. Resistance to this is a natural reaction, and the resultant friction will rightly test what Bitcoiners mean when they state it will support a new economic paradigm. Currently, all eyes are on whether the US will implement greater regulatory control or greater restrictions on Bitcoin. There are powerful camps building to support and resist such measures, with previous presidential candidates taking positions on both sides. The outcome will go a long way to determining the future of Bitcoin.

Yet, whatever happens, Bitcoin can't be stopped. Bitcoin has long passed a tipping point whereby its global adoption means it can not be 'hacked' or controlled by a bad actor. This was all part of Satoshi's grand design. This means China's increasingly draconian measures (that have effectively banned digital assets not controlled by the state) have not affected the long-term trajectory of Bitcoin. 

The citizens of many countries with strict controls are managing to circumvent them by using TOR and peer-to-peer systems. Alex Gladstein, Chief Strategy Officer at the Human Rights Foundation, provides peerless accounts of how Bitcoin is helping those who are otherwise financially marginalised. This includes Palestinians trapped by Israeli military occupation and the corrupt Palestinian Authority. Afghans, particularly women under the new Taliban rule, get to be their own bank. Cubans use Bitcoin as a form of peaceful protest and can opt out of a broken system.

Wider restrictions may inhibit Bitcoin, but they will not destroy it.

If supported, Bitcoin can do for money and commerce what the Internet did for connecting people through an open network. Jack Dorsey, the CEO of Twitter and a significant Bitcoin advocate, stated, "The whole spirit of Bitcoin... is to provide a trusted system in a distrusted environment, which is the internet.” Dorsey believes Bitcoin will be the currency of the internet, enabling what some have termed the Internet of Value (Iov), where value can be transferred as easily as data. 

In the meantime, whether it's Venezuelans escaping hyperinflation, Salvadorans bypassing costly remittance services, western investment firms hedging against inflation, or companies using it as a new payments rail, Bitcoin adoption is showing no signs of slowing down.