My Rejoinder to: "Bitcoin is a bubble, a way to speculate and not the future of money" by Vivek Kaul (14th January, 2021)

Link to Vivek's piece: https://vivekkaul.com/2021/01/14/bitcoin-is-a-bubble-a-way-to-speculate-and-not-the-future-of-money/

Dear Vivek,

I'am a keen follower of your frequent analysis and was very happy to see you writing an elaborate piece on Bitcoin. While it would be counter-intuitive to see a 'believer' be glad about the points you make, it gives me a starting point to address the discussion/ fears around Bitcoin in a systematic way. Thanks to the articulate way you always choose to take around any topic. So I'll skip the general opening discussions in your piece and move straight to the aspects I think are relevant to your pointwise examination: 

1. Argument: Bitcoin doesn't pass the 'Store of value' test. 

I agree with you that the price fluctuations in bitcoin do not make it seem like a store of value. The amount of bitcoins it takes today to buy a loaf of bread, after a week may buy you two or maybe half. But hasn't that happened to many of the paper currencies also in the past? Hyperinflation have hit poorly managed economies equally badly at times. In fact those are the countries where the adoption of cryptocurrencies is fastest. Venezuela is a recent example. The ability to pump up the money supply (as a response to economic distress) without the onslaught of hyperinflation is a tool available only to a handful of strategically important economies. It's still early days of adoption for bitcoin and unless we reach a steady state for its adoption this volatility will continue. It will take some time for Bitcoin to reach a steady state when the the new adopters are relatively small compared to its exiting users. In that journey the secular trend should be upward, short term volatility will continue as speculators jump in from time to time.  

2. Argument: Failure as a means of exchange; low adoption in 12 years.

Bitcoin is slightly different from a UPI app that we use. It takes much more time to confirm a transaction due to multiple confirmations on the blockchain and limitation of number of blocks being able to be confirmed in a given timeframe. While UPI has a central authority to confirm transaction, the ambition of bitcoin to be decentralised requires confirmations to come from multiple miners. In its early days bitcoin transactions have been largely happening on the main chain which seems to be inefficient and time consuming. However, this is the exact reason why the Bitcoin blockchain is trusted among of a large set of stakeholders. This prevents the double spend problem at a security level that's difficult to manipulate. 

Having said that, there are solutions now coming around this problem that make the transactions much faster. You can have bitcoin payments providers that confirm transactions between users and transfer the net bitcoin settlements at day end. Users get instantaneous confirmations during the day and the balance in their actual bitcoin wallet appears on periodic basis, this also brings down transaction cost drastically. Paypal and Square have started allowing users to convert their balances in bitcoins. Adoption may have been slow for the first 12 years, but we have to also be mindful that its all organic and despite it being much more technical to understand. 

Some of the interest could be for speculative motives, but I would not paint all of it in that colour. 

3. Argument: Free market money is a bad idea; example: Shitcoins 

The reason why Shitcoins are 'Shit', is BECAUSE THEY CHANGED THE CODE. The Bitcoin users don't loose their BTCs they owned because someone decided to fork the chain and/or create a Shitcoin. It has only strengthened the belief in the main chain. I really couldn't understand what really was your point here. It's not about the best money wins, its about whether Bitcoin (or any other cryptocurrency) is a meaningful way of exchanging value. 

My evolving assumption about your understanding of bitcoin is that your think the only success story of bitcoin will be if it replaces the fiat currency. It doesn't need to do that in my opinion. A later point covers this.  

4. Argument: Code can be changed to increase supply beyond the present limit

I think its the same as previous point. 

5. Argument: Government Control and Taxes doesn't allow Bitcoin to be the alternate currency

I completely agree that there will be Government resistance to allow Bitcoin to be a parallel currency. There will always be a requirement to pay your taxes in fiat currency and therefore there is no escaping the fiat currency. So there are 2 scenarios of government position on this and what they achieve from it:

Scenario 1: Government regulates crypto currencies and imposes the norms (like KYC, Capital gains etc.) as with investing in any other asset class.

This is a scenario where both fiat currencies and Bitcoins co-exist (which I believe is a more likely scenario). Government can access to the KYC info of the investors, have access to the transactions in case there is unlawful activity suspected and earn taxes from gains made by people through investing.

Scenario 2: Government bans crypto exchanges and makes it illegal to deal in cryptocurrencies.

Less likely, but significantly probable. There will be rush through the door gates for exiting bitcoin positions and it will crash. But does it really take away its ability to serve as medium of exchange? My fear is this will then become the most preferred medium for exchange of currency for the most unwanted use cases. Illegal stuff both within the country and across borders. It will become a medium for exchange of illegal cash. By regulating it, government has the advantage that even if the initial exchange of bitcoins is in unknown wallets, the chain of subsequent transactions has a very high probability of leading to the source. By completely shutting it out, we stand to create absolute anonymity in this space. The shutting it out works effectively only if all governments around the world make it illegal simultaneously and also enforce it with sincere intent. Less likely and least probable. 

6. Argument: Paper money and Democracy are intertwined 

I completely agree with your point here. Paper money gives immense control to governments to take immediate action. It provides the liquidity to institutions in times of economic distress and prevents a complete collapse. I would want this mechanism to be present even if it requires something like Bitcoin to not exist. But I don't think we need to make that extreme choice. 

I loved how you pointed out that people with savings will always prefer Gold standard as it maintains their lead in wealth accumulation. In the post Bretton Woods era a large section of people have been pulled out of the poverty and a middle class has developed in countries like India and China. But essentially this has been possible largely due to the fractional lending system. You can still have a fractional reserve system with a gold standard. USA saw an explosion of growth both in times when there was a Gold Standard and when they were off the Gold standard. Its more to do with productive circulation of money. What moving away form a gold standard enables is that the governments or central banks have more options to manage liquidity in case of a financial recession or support currency supply requirements in periods of strong growth. I think it would be interesting to also examine how much the computerisation of banks and private banking helped the velocity of money and its contribution of strong period of growth post the 90's.

I have been a regular reader of your articles and I think you also feel how the middle class' savings are in a precarious situation since depositing it in a bank yields real negative return and there is no option but to look at risky investments to at least protect the purchasing power. So, haven't we again reached a stage again where the people with money are frontrunning the average person in wealth accumulation? This year gave us a new shape of recovery, "K". Is the paper money continuing to work for the people it is intended to benefit?

Interestingly, I was going through the balance sheets of the biggest banks just before I read your article. The average balance with RBI on their balance sheets is roughly 3-5% of the deposits they hold. You know what I'm hinting at. That's something Bitcoin takes care of. For the amounts one invests in bitcoin (and holds it in their bitcoin wallet), the holder themselves are the true custodian of their own savings/ purchasing power.

7. Argument: Control of Chain by miners

I think this concern of yours is the one I agree most with. It is true that controlling the majority of mining capability gives China more control over the blockchain. But controlling most mining power doesn't mean owning the most Bitcoins. But let's assume that they also own most of the Bitcoins. This has been a big concern for the community and there is progress on both diversifying the mining power as well as technological changes that prevent any disruption from such gain of mining power. 

But I still agree there is immense chance of disruption to the blockchain if in future the Chinese government enforces a control on all miners at the same time and compromises the chain. However, I don't understand what they'll achieve out of it except destroying the acceptability of Bitcoins and its values temporarily. Will it be worth the backlash from the rest of the world, I really don't know. But I agree with this point of yours and see this as a real threat in bitcoins journey to mainstream adoption. 

8. Argument: There is no freedom from middleman

"....but trading it without a third party was cumbersome unless the user was expert in cybersecurity". I'd recommend you to download and create a bitcoin wallet for yourself to see how much of this is true. Apart from the time it takes to get a confirmation of your transaction, with many of the modern wallet apps, the experience is hardly any different from a QR code based transfer you would do for UPI payment. 

The exchanges come into picture if you want to convert it into fiat currency. Presently, there is no freedom from the middleman if you are buying and selling it for fiat currency. The promise of eliminating the middleman is when you are transacting only in Bitcoins. 

Frankly, I don't understand why we need to eliminate every kind of middleman for Bitcoin to be successful. The middleman that was intended to displace was the Central Banks, I guess, not the exchanges or any payment apps. 

9. Argument: Media doesn't cover the more pertinent points

All this has been in discussion in multiple forums, may not be in the mainstream media. But we also don't get the kind of analysis like yours in the mainstream media. I don't know who to blame for this, the laziness of the media or the laziness of the reader who doesn't want to put efforts in research before investing. 

10. Argument: Surge in Bitcoin price is because of investors looking for returns in times of low interest rate

I agree much of the surge is because of the search for returns. But I don't see it as a negative. The more attention bitcoin gets the more people make an attempt to understand it. I strongly belief that the concept of Bitcoin has very strong foundations. It doesn't mean I think it can't tank tomorrow. It can surely do. But lets ask our self also why have we been hearing about a surge in bitcoin interest every few years. 

Instead of taking this "The current surge seems to have been spurred by interest from the financial establishment, most of which had long scorned it." to mean that there is a diabolical plan to create a ponzi scheme through Bitcoin, lets make an attempt to understand what they are saying and if it makes sense. If a cash generating listed business like MicroStrategy Inc. decides to convert their entire treasury (about USD 450 million) into bitcoins, what is their rationale?. There is an element of speculation in Bitcoin's surge, no doubt, but its not all about that I believe. 

I don't recommend that people invest in Bitcoin, unless they understand it. Speculative investing in Bitcoin can be a disaster. Only if one understands the technology and the nuances around what affects it, they can decide the risk they can comfortably take in it. There are some big assumptions in Bitcoin's journey to mainstream use.   

I see a future with co-existence of both paper money and crypto currencies, similar to co-existence of paper money and gold. I see it as a switch to a more efficient and accessible scarce asset. The origins of paper money lay in the physical challenges around using a commodity as exchange of value as transaction size becomes bigger. Bitcoin's core proposition is in solving that. Whether the world goes back to this as the only medium of exchange, or settles somewhere in the middle, only time will tell.

- Bitcoin Pappu

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Disclosure: The writer has purchased/ invested Bitcoins in the past.