Where Bitcoin’s Critics Are Wrong (BTC-USD)

Mahatma Gandhi, India’s famous independence leader, once said of his movement’s chances of success: “They ignore you, then they laugh at you, then they fight you, then you win.”

This, I believe, is the path of Bitcoin (BTC-USD). When it emerged in 2009, it was largely ignored. Nobody had heard of it; it was hopelessly complicated and you barely use it to even buy a pizza.

As it improbably grew and thrived, despite inevitable challenges, crises and missteps, Bitcoin entered the second phase, that of ridicule: “Probably rat poison squared.” said famed investor Warren Buffett in a 2018 Business interview.

After the long Bitcoin winter of doldrums from 2018 to 2019, following its meteoric rise in 2016 from $16 billion to $266 billion in market cap, Bitcoin was again on the move and had survived another round of multiple 80% drops since its inception in 2009.

With the recent run up to $67,000 in late 2021, Bitcoin was shedding the phase of ridicule. Its market cap had reached $1.2 trillion, or about 3% the size of the entire US economy. More and more former critics recognized the potential of Bitcoin and global bankers knew it was a force to reckon with.

Now we’ve entered the period of “then they fight you”. Over the last three years the US government began cracking down on all cryptocurrencies. US regulators prohibited the launch of Initial Coin Offerings – designating these as illegal security offerings. Pressure was put on foreign crypto companies to prohibit them from catering to US investors. Governments across the world mobilized to put limitations on crypto currencies. The government of China took the most extreme measures, banning all crypto miners and crypto trading in 2021, with tight criminal enforcement against violators.

Bitcoin is Too Good For The Government To Allow It

One of the most heard criticisms about Bitcoin centers around the power of governments to ban it: Bitcoin, the argument goes, would be immediately suppressed by all governments if it ever achieved even a modicum of success.

Let me respond to that criticism, because it’s based on a true assumption. Governments do view all cryptos as a threat to government authority, and Bitcoin as well.

Why would governments want to fight cryptos or Bitcoin? Simple. Governments derive their power from the ability to control the national currency. This is especially true of the United States. This is because the dollar is the de-facto global monetary standard. As such, the US government derives a tremendous amount of political power from its ability to control the dollar, and that power extends well beyond its national borders.

Unlike most other cryptocurrencies, Bitcoin is a form of money that is founded on the very principle of being non-manipulable by governments and non-inflationary once it achieved a pre-determined maximum supply of 21 million coins.

In fact, when it was launched by its mysterious founder, Satoshi Nakamoto – in 2009, Bitcoin was deliberately intended to be the very antithesis of fiat currencies. The protocol was brilliantly devised to be rigorously and programmatically controlled by an immutable algorithm, not by any individual or group of individuals.

As is commonly known, all fiat currencies in the history of mankind have been inflated by governments to serve their financing needs. The effect has been that all fiat currencies inexorably go to zero over time.

Bitcoin adherents – and I count myself among them – are deeply aware of this weakness of fiat currencies, and therefore so passionate in their embracement of Bitcoin. They view Bitcoin as an asset that cannot be arbitrarily manipulated by governments or special interests, whose limited supply will ultimately cause it to hugely increase in value as awareness of it spreads.

If Bitcoin catches on and more and more individuals can opt out of the national currency, exchanging into fiat currency only to settle their tax payments, this would represent a tremendous decrease in the power of central governments.

Governments are made up of individuals, and those individuals cherish their positions of power and influence. They will not relinquish their monopoly over the currency without a fight.

So the critics are dead right about the government’s incentives to repress Bitcoin.

Where they are wrong, I believe, is in overestimating the government’s power to do so. Governments around the world are already battling Bitcoin, to varying degrees and with varying approaches – but in the long run, they will ultimately fail.

For one thing, for governments to successfully suppress Bitcoin, they would all have to agree to do so. If only one government accepts Bitcoin and the mining of Bitcoin, that would allow the propagation of new Bitcoin to continue from that country. Once created, Bitcoin knows no borders, and can skip across the world in the time it takes to hit a keyboard key.

Granted, governments could declare transactions in Bitcoin illegal. But to actually enforce those new laws, a government would need to adopt totalitarian controls on all internet transactions. You cannot stop all internet transactions in any modern economy. That’s economic suicide.

So the alternative would be for the government to inspect all internet packets as they are transmitted, to ensure compliance.

But then people would resort to using encrypted data. So then governments would have to ban all forms of cryptography as well. Either that or provide the government a backdoor denied to others. But cryptography experts know that that is tantamount to not having any cryptography at all, given how leaky most governments are. Yet cryptography not only protects cryptocurrencies, it also ensures corporate privacy, military security, legal privacy and the smooth functioning of most banking and stock exchange transactions.

Eliminating cryptography would be extremely deleterious to a modern information economy. It would represent an enormous tax on every citizen in the economy, and be an enormous drag on economic growth. Just ask Soviet Russia or North Korea.

Apart from the economic disadvantages, I really can’t visualize most Americans accepting this degree of government repression of basic liberties. “We may be sheeple, but we’re not stupid, you know.”

Nor, for that matter, would the majority of people in most countries of the world I’ve lived in. They would quickly overthrow the governments trying to impose them.

Such governmental controls exist today in China, and Russia, and other authoritarian states, but it remains to be seen how long those regimes will last.

In fact, the shocking fact is how difficult it is to suppress Bitcoin miners even in a state considered to be among the most authoritarian today. Despite the official banning of Bitcoin mining, the hashrate of China continues to represent 21% of all global mining. This is a huge reduction from the 60-odd percent of pre-ban periods, but it’s still a lot of illegal bitcoin mining continuing to take place.

If an authoritarian government like the Chinese Communist Party has such a difficult time suppressing the usage and mining of Bitcoin, just imagine how difficult this would be in the US.

But wait, you say, if all governments have an incentive to bolster fiat currencies and hamper Bitcoin, can’t they all collude and together suppress it?

I would say no, there’s little chance of that happening. I’m far more convinced that we’re entering a new geopolitical phase of a breakup into at least two, and most likely three, political alliances. (See a discussion of that in my SA article on ASML.)

When you have three different competing blocks, it’s difficult to get an agreement on crypto policies, or for that matter, any other issues like global warming or nuclear arms control.

And surely enough, after first cracking down on Bitcoin and cryptos in 2020, Russia reversed its stance in early 2022. Perhaps Russians expected to encounter economic reprisals from the US for their impending invasion of Ukraine. This would be one way of countering those measures, while ensuring that Russia could more easily circumvent US banking controls.

“The Central Bank does not stand in our way of technological progress and makes the necessary efforts to implement the latest technology in this area,” Putin stated in a Jan 2022 meeting with members of the Russian government, addressing the divergent opinions held by the government body and the central bank.

In fact, Russia has risen to the third spot in the list of countries with the highest share of hashrate in the Bitcoin network last year after China banned the asset and its underlying mining industry in the summer of 2021.

In a world of over 300 countries, there will always be jurisdictions that will refuse to follow the diktats of the major countries, or will implement any globally imposed restrictions with less-than effective rigor.

Moreover, in the US itself, Bitcoin has already overcome its regulatory hurdles and been declared a legal asset governed by the same regulations as commodities like gold or iron ore. It will be difficult to reverse these decisions.

Any reversal would be certain to be juridically appealed by Bitcoin miners and Bitcoin investors, and the issue would likely need to be adjudicated at the level of the Supreme Court.

Bitcoin backers – myself included – argue that Bitcoin should enjoy the protection of the 1st Amendment. The legal case is certainly subject to debate. My point is that any change to the legal treatment of Bitcoin as a commodity in which Americans can legally transact will not occur easily, and will be bitterly fought in the courts.

That said, the US governments successfully banned gold in 1932, setting an important precedent. Similarly, they banned the use of alcohol in the 1920’s, a great restriction of personal liberties, under the guise of being a danger to public health.

The case of Prohibition, and the more recent relaxation of drug laws decriminalizing marijuana, are cogent cases that show the ineffectiveness of government enforcement of the law, even when a practice is deemed illegal.

If China – able to lock up millions of Uighurs in concentration camps for failing to culturally assimilate – is unable to stop Bitcoin, how can one possibly view the relatively democratic US governments successfully banning all Bitcoin transactions? This would require draconian measures only really enforceable in the Orwellian police states that prohibit the use of all forms of encryption unless the government has backdoor access to the encrypted data.

The United States is not there today, nor are most other countries of the world. Thus Bitcoin will not be stopped even though it’s an inconvenient thorn in the side of Big Government.

Bitcoin Is Nothing Special – It’s Easy To Copy So It Has No Value

It’s amazing how time and again, I hear the argument made that while Bitcoin itself is limited to 21 million coins in all eternity, that does not make it a scarce asset.

These critics say it’s perfectly trivial to copy the entire Bitcoin protocol, and commit exact carbon copies of the original Bitcoin. Bitcoin II, Bitcoin III, Bitcoin IIIIICCCVVVVV.

So how can Bitcoin possible be scarce? So goes the argument.

The argument is deeply flawed. Let me be brief in my counterargument: Mona Lisa. The last time I looked, that picture was trading for some $3.4 million.

I don’t want to know the talents of Leonardo da Vinci, but I’d venture to say that the average art student with a few years of art study under his/her belt could knock out a decent copy of that famous painting in just under a couple of weeks.

Why don’t they? Because they’d never get anywhere near the value people are willing to pay for the original. People value the first one because it was the first, and because a rich history and lore surrounds the painting that people are willing to pay to associate themselves with.

Similarly, there is only one Bitcoin. People have tried to do knockoffs, and improvements, to Bitcoin, which are called forks. The list is in the thousands. Guess what? None of them ever caught on with the public, despite possible minor improvements to the original Bitcoin protocol.

A great part of the reason why has to do with a principle called Metcalfe’s law. This principle proposes that the value of a telecommunications network is proportional to the square of the number of connected users of the system. So the larger a network already is, the easier it is to grow even faster.

Cryptocurrencies, by their social nature, are subject to the growth metrics defined by Metcalf’s Law. The more people that adopt any given cryptocurrency, the more attractive it is for other people to use it. And the more other people use it, the more attractive it is for merchants to adopt it. And the more merchants adopt it, the more valuable it becomes for the original users. Repeat ad infinitum, or at least until all humans are using it.

So let me ask you. Would you prefer to own Bitcoin, even a fraction of it, knowing you can immediately sell it to 190 million other people in the world, instantly?

Or instead, please buy my new “BetterBitcoin” coin. Nobody’s using it yet, but trust me they will.

What do you think most people will choose? Thought so.

Ok, you say, but what about the twenty-thousand odd cryptocurrencies that you’ve heard are out there?

Well, those do temporarily distract people away from the original Bitcoin. And for a while, they will slow down Bitcoin’s growth and hence the steepness of the exponential network curve.

But then there’s another law that governs monetary instruments: Gresham’s Law. Gresham’s law is a monetary principle stating that “bad money drives out good.”

Bitcoin is by far the superior money. Bitcoin was not the first cryptocurrency (see eCash), but it was the first to be endowed with just the right mix of characteristics to guarantee its success. And once it achieved a certain size, Metcalf’s Law ensured that it would become much more secure and robust than other crypto’s also based on the similar proof-of-work protocols.

Unlike fiat money issued by governments, Bitcoin is not susceptible to government greed and profligacy. Unlike Gold, Bitcoin, is eminently divisible, measurable, and transportable. Unlike Litecoin (LTC-USD), Bitcoin is more secure, since its network is much larger, making it more immune from 51% attacks. Unlike Ethereum (ETH-USD), Cardano (ADA-USD), Solana (SOL-USD), or Avalanche (AVAX-USD), to name just a few other popular cryptocurrencies, Bitcoin is more decentralized, and thus less susceptible to private manipulation or government repression.

So just as the US dollar will drive out the official bolivar in today’s Venezuela – as the “better” money, Bitcoin will eventually drive out most of the other 20-some thousand crypto-competitors.

Before the advent of cryptocurrencies, there were a few “global” currencies and hundreds of national currencies. In the future, there will be probably be one major crypto-currency – Bitcoin – and very likely a half-dozen other global cryptocurrencies more attuned to solving unique economic tasks or attuned to the unique political and social mores of its users.

Will Quantum Computing Kill Bitcoin?

Quantum computing is a rapidly-emerging technology that harnesses the laws of quantum mechanics to solve problems too complex for classical computers.

Computer engineers estimate that these machines could emerge as a viable mass technology within a period of 10 to 20 years.

The first proven quantum computers that exist today do not have that power. However, within 1 or 2 decades, security experts believe quantum computers could harness such computing power as to break the encryption protocols fundamental to the security of the Internet that we have today.

These security protocols lie at the heart of Bitcoin security, and almost all other cryptocurrencies. Most cryptos use a hashing methodology deploying 256-bit encryption to secure Bitcoin from hackers. If this encryption can be easily broken by quantum computers, then the security of Bitcoin could be compromised by an attacker and the entire Bitcoin blockchain network could be irrevocably compromised.

These claims are accurate, and they are a real danger that threatens Bitcoin. However they also threaten the entire modern economic system of the internet, including all banking and brokerage transactions.

But the danger is overblown. Because as quantum computers become more common and more powerful, so too will the technologies evolve in order ensure continued security.

The National Institute of Standards and Technology (NIST) is taking quantum computing’s threat to cybersecurity very seriously. As early as 2015, NIST has been seeking new encryption algorithms to replace those that a quantum computer could potentially break. Already, NIST had identified the best algorithms out of a shortlist of 7 finalists and 8 alternate candidates.

Bitcoin’s unique decentralized mining system makes any changes to the protocol difficult to adopt, because it requires buy-in from a majority of miners and users with widely varying incentives, needs, budgets and jurisdictions. This is a source of Bitcoin’s strength: new ideas are robustly debated and scrupulously examined. But it can also be a source of Bitcoin weakness, since important or desirable changes to the protocol take longer to occur.

However, when faced with a threat to their very livelihood, I have no doubt that the new, more secure algorithms will be adopted. After all, everyone loses if Bitcoin is hackable.

We may even see one or two forks of Bitcoin occur, with various of the new algorithms being adopted by differing “camps” of Bitcoin investors. But just as in nature’s law of natural selection, the better solution will eventually be adopted by more people and thrive, while the lesser solution will shrivel and eventually fall into disuse.

Bottom line, though, Bitcoin will survive quantum computing. So will most cryptocurrencies, and so will the internet.

Bitcoin Will Die Because Miners Lose Their Financial Incentives

Another common criticism leveled at Bitcoin is that the protocol will become insecure once all future Bitcoin have been mined and the currency enters into its deflationary phase.

This will be approximately in the year 2140, so 118 years from today. Right now, each miner is paid a certain amount of newly minted Bitcoin (created out of thin air) as a reward for verifying and securing a specified block of Bitcoin transactions.

This stops when all 21 million coins have been minted. At that time, miners will only be paid a smaller transaction fee for their activities.

Because that could be a big drop in rewards, critics argue that many miners would cease their activities. That in turn, would mean that there would be fewer miners globally verifying transactions.

According to this reasoning, that would make it easier for one single very large entity to gain control of more than 51% of all the computing power on the Bitcoin blockchain. Since there would be far fewer Bitcoin miners, requiring far less computing power, it would be less expensive to corner the market by buying a majority of Bitcoin miners and maintaining that majority.

Once that dominant position is established, that miner could essentially “recreate real history” to its own financial benefit, by altering the amounts of transactions and the real identities of buyers and sellers.

Because it would control the majority of the outputs on the blockchain, this would become the “accepted” version of truth. This is akin to a Congress deciding who owns a given asset or right, but all members of the Congress being fully controlled by one individual. There goes democracy.

The argument also has some substance. Bitcoin mining revenues would certainly drop when new the Bitcoin mining reward is only derived from transaction fees.

However, by my estimates those fees will be enormous, since they are a percentage of the value of Bitcoin itself times the number of transactions in a block.

It’s hard to know what happens in 100 years. But the most likely scenario that I see is that Bitcoin will largely serve as a store of value (similar to Gold today). A secondary, less expensive protocol, based on the Lightning Network will be used for billions and trillions of small day-to-day instant transactions.

Every thousand to 100 thousand transactions though, the Lightning nodes will autoclose and settle on the Bitcoin network. So the average number of Bitcoin transactions will still go up over time.

How expensive could Bitcoin rise to if say half the planet is using this protocol? Well that would be 50% of humanity, up from around 4% today. So 40 times today’s price of $16 k does not sound unreasonable. That’s $640k per Bitcoin.

But that’s if it only served as a store of value. It’s value as a settlement layer for Lighting Network or other level 2 blockchain protocols that use Bitcoin to settle up will propel Bitcoin up to values many times higher.

I would be surprised if Lightning or some other level 2 protocol did not replace most credit card and bank transactions done today. In that case, we can only take a wild guess at the number of daily transactions. Let’s see. 4 billion people buy a gallon of milk or a pack of gum or top up the electricity in their (finally) flying car. That’s 12 billion Lightning transactions per day!

But since an average Bitcoin block can only fit around 2500 transactions (this is not a max but an average), and a block occurs every 10 minutes, this means that only 360,000 transactions can be done per day on the entire Bitcoin blockchain per day.

This means that Lightning nodes (or other level 2 or level 3 emerging technologies) would have to settle less frequently on Bitcoin. If they settled up once every 16 days, the Bitcoin network would be able to process all transactions within 24 hours. Every 32 days settlement to Bitcoin means average transactions would take 1/2 day.

This does not mean users of Lightning need to wait a day. Their lightning transactions would be sub-second, especially for smaller amounts where final Bitcoin blockchain recording is less critical.

If you’re selling your house, you’d want to wait out that 24 or 48 hour period before giving the new owners the keys to the house. But if you’re selling a bag of groceries for $80, you’d relinquish to goods immediately without sweating it. The likelihood of a chargeback would be infinitely small. Besides, you can expect insurance companies to fill this void and insure the transactions for both parties for small fractions of a penny.

Because the Lightning nodes would be competing for scarce Bitcoin block space, the cost of a transaction would grow exponentially, and far surpass today’s block rewards.

This back of the envelope example of mine fits in with the much more detailed analysis of the issues published recently by Blockware Solutions. I invite readers to read the report, which is excellent.

Here’s their conclusion:

In the long run, the market may naturally find an equilibrium for on-chain fees. It could reach a point where there is not much more demand for scaling technology and fees are high enough to avoid censorship after X blocks. When will this occur? Impossible to know, but it’s safe to say that Bitcoin’s long-term “security” is probable and that miners will likely experience more scaling cycles where they earn a significant amount of transaction fees as Bitcoin adoption accelerates and the use of it as a medium exchange begins

Bottom line, my conclusion is that Bitcoin is not threatened when it approaches its 21 million coin limit. Bitcoin mining will continue to be a competitive marketplace, with promising growing income for miners and a continued natural defense against security breaches and 51% attacks.

Where Does Bitcoin Go From Here?

So if I believe Bitcoin’s critics have it wrong, where do I see Bitcoin going from here? The short answer is: temporarily down, while the recent FTX fiasco plays out and drags down most of the crypto industry.

I still believe the technical analysis I published on SA last August is valid. I see Bitcoin dropping to the $10k support level, at minimum. There is even a minute chance that it can go as low as $3k though I would be very surprised.

Myself I will load the boat at $10k. Readers will think: “Wow, that’s another 60% drop”.

True, but then Bitcoin will be the proverbial Phoenix soaring from the ashes to new as yet unclaimed heights. Remember the old adage: “What doesn’t kill you makes you stronger”. That’s Bitcoin.