Cryptocurrency is that just a digital currency or something more? Should it be considered as a currency? Will it replace USD or other currencies?
To my understanding the word “Cryptocurrency” is a misnomer, Bitcoin is a “Crypto Asset”. Don’t think Bitcoin as a currency for doing transactions. Bitcoin is not going to replace regular currencies of the world.
Think Bitcoin as an asset. You invest in this asset to diversify your portfolio. A normal currency like USD or INR can be printed by Government. In year 2020 US government injected more than $9 trillion into the market. It is estimated that 22% of Dollars in circulation is printed in 2020. This is purportedly done to save the Wall Street.
Debasement
When you suddenly increase the amount of dollar in circulation, debasement or decrement of the value happens. When you have 20% more USD in market it can be considered that overall dollar value too has reduced proportionately. Say you had $1M in the beginning of 2020, current value is reduced to $800K due to debasement. USD is a fully fiat currency since 1971 and Government can easily bring down value of investment by printing more dollars to bail out Banks, Wall Street when they screw up things. This is a hogwash, because if you think of it by printing money intrinsic value of the money is getting lost due to debasement.
Bitcoin
Bitcoin is completely deregulated, the protocol sets a limit of 21M coins that can be minted in total for eternity, which means after 21 million bitcoins no more fresh coins can be produced. The protocol is designed in such a way that every year the number of bitcoins generated in the system is reduced and it is getting halved every four years.
Now let us look Bitcoin as an asset. As the number of coins is going to be limited, as more people onboard to buy bitcoins the price of bitcoin is going to go up. If we consider an asset like say Gold, miners can dump more gold when prices are soaring which can reduce the price. Even though there may be a limit to gold reserves technically it looks a long way and lots of gold is kept as jewels so even if we run out of reserves people will melt jewels and dump gold.
Most of the assets have some regulatory body which controlling the prices. Regulations are always a double edged swords, even though people may argue regulators help investors by protecting prices, more often they manipulate the system and reward the corrupt business or politicians (like famous bail out banks after financial crisis, everyone lost money except the banks, bank executives got their bonuses and perks, common man who had mortgages lost his home). In Bitcoin world as it is completely decentralised no one can manipulate the system (like lowering interest, printing more money putting more tax etc.)
Analogy
If we want to understand Bitcoin better, let consider the example of a city which has 21M blocks. Today we have around 18M blocks ready for sale or in circulation. Today (Sep-2021) each block today costs around INR 36,00,000/-. As most people won’t be able to afford to buy a block (or coin), blocks are sub-divided for as low as INR 10/- we can own a tiny portion of a block/coin. Eventually all the 8 billion people can vie for chunks of blocks in the city from the total 21M blocks/coins up there for taking. As more people on-board price is going to increase.
Exit Strategy
Ok considering we decided to go ahead with investing in Bitcoin, when do we exit? Right now Bitcoin mean annual return is 400%. But this doesn’t come with stability, it goes through wild swings and whole capital can we wiped out in these swings. But given that it has far superior returns and as more people invest the volatility would stabilise and we can keep Bitcoins as a long term asset. So coming to exit strategy — there is no exit strategy. Today no other instrument gives this superior returns, so why would you sell it? If you need cash, put Bitcoin in mortgage take a loan, pay interest and close it. That would be better strategy for today.
It is like owning a prized art work like Van Gough painting, there is very small limit of 1 for an original painting so always there is scarcity and prize is going to keep going up based on the demand. But if you buy an art work you have take care to protect it, protect from theft, fire, water etc. An asset like Bitcoin resides in a digital wallet which we can carry around in our phone, it is secure and it is easily transferrable to other parties or other countries
Should I or should I not?
Considering the volatility, lack of laws etc. a small portion can be kept aside to Bitcoins to diversify the asset allocation. We don’t want to miss the ride and definitely Bitcoins look like a great asset for future. So test the waters with small amounts which we can take some risk to play with.
