Bitcoin is The Shitcoin

In early 2014, I wrote a big research piece for subscribers titled “Why You Should Invest in Bitcoin and How”. At that time Bitcoin had just burst on the scene after the bank crisis in Cyprus and had its first major bull market. The technology was about 5 years old and was just getting started in getting public recognition. Like many at that time I considered whether I should take the plunge and reorient my business toward Bitcoin, but for many reasons I decided not to. However, I did take a risk on Bitcoin as an investment with relatively small amounts of money. Undoubtedly, Bitcoin has turned to be my best investment ever and with Bitcoin’s big bull market in 2017, I ended up turning my small investment into another home. Fairy dust digital money turned into real world stuff. If you haven’t read my 2014 research, you need to read it in order to understand the potential scope of this new digital money industry. My bet on Bitcoin in 2014 was a bet on the growth of the decentralized digital money industry and that has come to fruition over the past 6 years just as expected.

However, today is 2020, not 2014 and the digital money industry has changed a lot. I think it has come time to issue a warning to prospective Bitcoin buyers just as Bitcoin appears to be gaining adoption between professional investors. We had none other than hedge fund legend Paul Tudor Jones declaring that he is investing in bitcoin a couple of months ago. And he is not alone. Many other hedge fund titans are pitching bitcoin as a potential beneficiary from the Fed balance sheet expansion. While PTJ is no doubt an investing genius, he is hardly a technology genius which could be a problem when you deal with investments that require technology savvy like Bitcoin. Technology investing in general is brutal because there is always a competitor lurking around the corner that has the ability to take it all. Another issue with Bitcoin is that investors aren’t buying Bitcoin at $250-$500 dollars like I was in 2014 and 2015. Bitcoin is near $10,000 now and represents a massive dollar investment and as such carries substantial investment risk. The current Bitcoin price discounts many future developments such as big network expansion which may not come to fruition.

I have NOT bought a Bitcoin since 2015 and sold all my Bitcoins (with the exception of the collectibles) in 2018. I have invested the remaining proceeds (less the house down payment) in other crypto-currencies during this crypto bear market. I am not going to make a case for other cryptocurrencies here since that is a paid service I provide at VIXCONTANGO. However, I do want to make this blog post as a public service to educate prospective Bitcoin investors on the major investment risks they are undertaking today.

Classic Business Risk

The first major risk that Bitcoin carries now is classic business risk. When you go into a business, competitors may replicate your business and do it better than you and steal your clients. 90% of companies in the world fail and they fail because of competition. Other companies come up with a better product, better technology or have better salesforces and pound the pavement harder. Ironically, with Bitcoin building a better a product is easier than ever since it is “open source” software. Everybody in the world can “steal” the Bitcoin code and improve it. And that is what in fact many have done such as Charlie Lee with Litecoin, Roger Ver with Bitcoin Cash or Craig Wright with Bitcoin Satoshi Vision. Every alt-coin in existence is a better coin from technology perspective than Bitcoin. They have made improvements on the code and are faster to transmit and easier to store. There are other projects that reimagine digital money from the ground up and take completely different approaches that are not based on the Bitcoin code at all. Bitcoin today has many legitimate alternatives that have been around for at least 5-6 years and which have substantial network effects of their own. The important thing to understand here is that investing in Bitcoin today is like investing the 1^st version of the Apple iPhone in 2020 instead of 2007. Not investing in Apple, but in its iPhone 1 which today nobody would buy because much better phones have been made since then. This is a very important thing to understand: Bitcoin is now an archaic 12 year old technology. If you want to invest in something in the crypto space, invest in something that has a better technology than Bitcoin.

Halving is Systematic Network Reduction

When it comes to investments like Bitcoin, the technology is not the only consideration. The size of the network is very important as well since it is a “winner take all” world. “Mindshare” is super important. If everybody uses Bitcoin for payments who cares if there are other payment networks. The payment network of choice is whatever the world decides to use. However, Bitcoin faces huge long term problems as a viable payment network given to how it is designed.

One of the core features of Bitcoin is “halving”. Every 2-3 years or so, Bitcoin halves the rewards for bitcoin miners. That is a brutal financial event which means that after halving day, bitcoin miners get paid half for mining a bitcoin. Mining a bitcoin is competitive computer process and a certain dollar amount of electricity has to be spent to mine a Bitcoin. Halving means that miners have to spend double the amount of electricity to mine a bitcoin. And that process happens every 2-3 years. Imagine you hold Gold and you are told every 2-3 years it is worth half the price. Not very appealing. That means that Bitcoin has to go up in price constantly to be able to offset the halving and reward miners justly. In order for that to happen the money flowing into the Bitcoin network has to offset the amounts of money miners are spending on electricity. If the price of bitcoin is less than the production cost, miners have to sell their bitcoins at a loss and eventually go bankrupt. What happens with each halving cycle is that more and more miners go bankrupt and only the most efficient operators survive. While libertarian anarchists and unregulated capitalists admire the “only the strong survive” ethos of Bitcoin, that is a huge problem for the Bitcoin network in the long run. The bitcoin network systematically reduces its network effect. It systematically purges its miners which are the main participants in the network. At the end if you don’t have miners, you don’t have a network. Some of the alternative cryptocurrencies today don’t have this design problem and have taken a radically different approach – their incentive schemes ensure that their network rewards participation and as such their network effects get bigger over time instead of smaller.

Another downside effect of halving is that since China has the lowest electricity costs, basically all mining is now done in China. As such the Chinese government can at any point seize all the mining equipment and perform a 50%+1 attack on the Bitcoin network and change the owner of bitcoin wallets. The Ethereum Classic network experienced 2 such successful attacks recently and I think those attacks are a training ground for a larger attack on the Bitcoin network whose codebase is weaker and less secure than the Ethereum Classic codebase.

The Bigger Bitcoin Gets, The More Centralized It Becomes

As Bitcoin grows in usage, its blockchain grows as well. The blockchain database contains all the transactions on the Bitcoin network from the beginning of time. As Bitcoin network usage grows exponentially so does its blockchain database. Every node on the Bitcoin network is supposed to be able to hold the entire bitcoin blockchain database. The current size of the Bitcoin blockchain is more than 250 GB. As the blockchain gets bigger, fewer and fewer computers will be able to hold it. Bitcoin already can only be mined by specialty firms with specialty equipment. Bitcoin’s promise of “decentralized finance” simply isn’t true. The bigger Bitcoin gets, the more centralized it becomes. In the future, when the Bitcoin blockchain gets big enough, only organizations with massive technology resources such as Google, Amazon, NSA and the Chinese or Russian governments will be able to run Bitcoin nodes and be able to validate transactions on the Bitcoin network. Now tell me, is that what anti-government hackers and cypherpunks are so passionate about?!?

Bitcoin Mining is Bad for the Planet

I am far from a passionate green advocate, but who doesn’t want to live in a nice natural world with clean waters and air? The problem with the electricity consumption of the Bitcoin network is that it is now massive. Bitcoin network now consumes as much electricity as Israel, Greece or Switzerland. Entire countries with $200 billion in annual GDP. And the bigger Bitcoin grows, the more it will consume as the algorithms to mine a bitcoin become ever more competitive and energy hungry. There are better, greener coins out there. There are ways to make fast digital payments on trustless digital networks in a much more energy conscious fashion. At some point, users and governments will demand a more green networks be used for money transmission. I think there is a high probability in the future that bitcoin is banned by the government precisely because of its big carbon footprint. Or at the very least, there will be a carbon tax applied on bitcoin mining. Either way, the massive bitcoin network energy footprint will not be left unaddressed by governments forever.

Conclusion

Now, is it possible for Bitcoin to go up 10x again from here? Sure. If somehow money flows into the Bitcoin network at a rate higher than its total mining costs, that can happen. And it is totally plausible and feasible. Could it happen in the next couple of years? Sure. I don’t know what the investing future holds. But I do know what the technological future holds. The reality today is that there are better, greener decentralized digital payments networks with better incentive schemes and it is only a matter of time before they gain mind-share and supersede Bitcoin. Bitcoin is technologically the worst crypto currency in existence and it has gotten big enough to where its technological limitations present an investment risk. A winner-take-all network usually doesn’t suffer from scalability issues. Unfortunately, in 2020 for a lack of a better word, Bitcoin is The Shitcoin. Invest in crypto and in decentralized finance, but not in Bitcoin. The glory days of being a Bitcoin Hodler are over. Once capital decides to abandon the Bitcoin network for better crypto currency alternatives, the investment losses in Bitcoin will be massive and quick. Don’t be the last one hodling the Bitcoin bag. Be prudent and diversify your crypto exposure. Over the long run, Bitcoin’s dominance will be smaller and smaller.

Sell Bitcoin, Buy Altcoins.

Sell Bitcoin, Buy Altcoins

My Independence Day Constitutional Wish List

The US Constitution has 27 amendments. The last amendment was passed in 1992 and nobody knows what it is about. The last major constitutional amendment to pass was in 1951 when the 22^nd Amendment limited the number of times a person can be elected President to two. Before that in 1920 the 19^th Amendment allowed women to vote. In 1913, the 17^th amendment established the direct election of US senators by popular vote and the 16^th amendment allowed Congress to levy an income tax. In 1870, the 15^th Amendment allowed people of color to vote.

It is a shame that our generation hasn’t been able to add its input to the US constitution. The US Constitution is far from a perfect document and needs to be improved over time. The Trump presidency showed how much the US constitution depends on the President being an honest and honorable person. There are many practices that US Presidents have followed that are norms, but not laws. But Trump happened and we can no longer assume that future US Presidents will be honest and honorable. Voters can make mistakes and in the age of direct social media and reckless demagoguery, voters will make even more mistakes in the future.  More safeguards are needed to make American democracy more resilient. On this 4^th of July when America celebrates its birth, I want to propose a series of constitutional amendments to strengthen American democracy in the future:

1. A Senator needs to represent at least 1 million people

The US constitution says that House Congressmen have to represent at least 30,000 people and I think a similar requirement needs to be made for Senators. As populations have grown over the years, the disparity between rural and urban states have grown dramatically. A new type of state has emerged – the suburban state – and it is drastically underrepresented in the Senate. Rural states have acquired a disproportionate power in the Senate and rural interests often run roughshod over suburban interests. It doesn’t make any sense for states like Alaska and Wyoming with less than a million residents to be sending 2 senators. A small state like Connecticut has 3 suburban counties – Fairfield, Hartford and New Haven – which each have higher population than the entire state of Alaska or Wyoming. It is not fair for suburban states to be under represented like this. As such we need a requirement that a state needs to have at least 2 million people to send 2 senators. States with sub 2 million populations should send only 1 senator. This type of rule ensures that rural interests still are represented in the Senate but not overrepresented.

• Direct election of Attorney General

The Trump presidency has revealed a critical weakness in the US constitution – the President can’t be held accountable for crimes he commits while in office. The main reason for that is because the President can appoint and fire the Attorney General at will. If an investigation gets close to the President, the President can fire the Attorney General and put a person who can shut down all the investigations. This makes the US governance system extremely vulnerable to a dishonest President like Trump. There is not enough checks and balances inside the executive branch. We can’t have Congress run impeachments constantly because the Attorney General’s office can’t function properly. Congress should be busy writing laws instead of administering justice. Administering justice is the job of the Department of Justice.

As such, the major parties need to nominate an Attorney General that will be elected together with the President. The name of the AG needs to be right there next to the President and VP. The position of Attorney General effectively dictates US social policy and this is an extremely important position. Americans often have no idea who their next AG will be. The Attorney General needs to be more independent of the Executive Branch and take his power from the people. People need to know who they are voting for AG when they go to vote. Many states already allow the direction elections of state AGs. The President shouldn’t be able to fire the AG. If for some reason the AG resigns or is impeached before his 4 year term ends, the President can appoint a replacement with Senate confirmation as is the current procedure. There should be also a 2-term limit for how long a person can be AG just like there are for a President.

• Direct election of Federal Reserve Chairman

Presidents currently have way too much sway over monetary policy. Monetary policy powers are granted to Congress by the Constitution. Congress in turn has delegated them to semi-independent agency like the Fed since the economy often runs into trouble faster than political consensus can be built in Congress for a bailout. The Fed needs to have even more independence and in particular, the President shouldn’t be able to fire the Fed chair mid-term. Also it will be helpful to voters if a party outlines its economic policy and its choice for Fed chair before the election instead of after. Many Americans often are very surprised by actions of the Fed. Monetary Policy is extremely powerful and often more powerful than Fiscal Policy in addressing issues in the US economy and it is unconscionable that American voters don’t have a bigger say in who their Fed chair is. In some respects, the Fed chair is a more powerful person for the US economy than the President. The name of the future Fed chair should be right there on the ballot together with the President, VP and AG.

• Impeached President can’t be Commander-in-Chief

In 2020, we witnessed the sordid spectacle of Trump turning the US military against the American people after a legitimate impeachment failed to remove him from office earlier in the year. Currently, an impeachment by the House is simply a political spectacle and carries no actual loss of power for the President. And a removal is often considered to be too drastic an action. As such Presidents have become more brazen over the years and break the laws with increasing frequency. They can’t be prosecuted by the Department of Justice and with enough political heft in the Senate, they can avoid removal from office. This is a pattern that has gotten worse since Nixon and we need to modify the Constitution so that an impeachment is an act that does remove some powers from the President. President need to be more mindful of Congress and its impeachment powers.

Trump showed that the President can abuse his Commander-in-Chief powers after an impeachment. As such those powers need to be taken away from the Presidency. If a President is impeached, the Vice President automatically becomes a Commander-in-Chief. This way a President who is collapsing politically can’t turn the military against the American people.

• Allow states to run budget deficits in recession

About 50% of government spending in the US is done by state and local governments. State and local governments are big participants in the domestic economy on par with the Federal government. They provide critical government services such as police, fire, transportation and public education. One of the biggest economic problems that we have discovered in the US over the past 40 years is that state and local government actions to balance their budgets in a recession exacerbate the recession. They have to fire staff because of budget cuts and raise taxes to balance spending and tax revenues. 50% of the US government can’t run Keynesian stimulus in a recession and that in turn has led to longer and longer recessions and weaker and weaker recoveries over the years. We need to change that system so that state and local government can run a deficit like the Federal government automatically for as long as their local economies are in recession.