Bitcoin Adoption Thesis
Everyone knows that the early adopters of Bitcoin who played the game right have made extraordinary returns over the past ten years. Unlike institutions or corporations, these early adopters were generally everyday people interested in computer science or economics.
Bitcoin is still far from mainstream, however. As cryptocurrency grows as an asset class, a new wave of "early adopters" will emerge from traditional establishments. This is starting now because a lot has changed. Players were once dissuaded from the bitcoin markets for three reasons:
For the longest time, no large institution was willing to take the reputational risk of being wrong for acquiring such an unproven and speculative asset.
Just a few years ago, there was insufficient infrastructure to acquire tens of billions of dollars of bitcoin. The size of the bitcoin market was simply too small for a meaningful position without absorbing all the available liquidity.
The regulatory environment was unclear, making the acquisition of bitcoin a potential catalyst for legal and regulatory scrutiny.
But that was then. Today, the environment has drastically improved, and large institutions have taken steps towards acquiring and holding large amounts of bitcoin safely and legally. Microstrategy and Tesla, for example, have led the way in the corporate world. Still, I believe the time has come for pension funds and nation states (more specifically, central banks such as the Federal Reserve, European Central Bank, Bank of Canada, etc...) to join the early majority.
This phase could take years, if not decades, but I believe there's still room to grow before the first-mover advantage expires. The process of refining consumer hardware and UI for full-scale adoption will decide for the late majority what's valuable and what's not.
It might sound crazy to suggest that a central bank would purchase such a volatile asset, but their incentive is clear and based on the ballooning debt.
Nearly every central bank in the world holds massive amounts of government debt on its balance sheet. In the US, the Federal Reserve is, in fact, the single largest holder of US Government Debt. Since fiat currencies are no longer redeemable for gold, they're effectively "backed" by this debt. The fact you can lend out your US dollars back to the government and earn a return on your investment is a massive factor in the dollar's perceived value. Belief in USD ultimately comes from the fact that the government can tax the strongest economy in the world to pay back its debts.
The problem
Since the great financial crisis, government debt has massively outpaced real economic growth, creating a gap between the government's outstanding debt and its ability to pay it back. Every year, it becomes more and more difficult for the government to repay its creditors, making it increasingly likely they'll default on their debt. They're trying to solve this problem through quantitative easing, where central banks print money and use it to reduce the amount of outstanding government debt. This was a clever solution to the great financial crisis, but it can only work for so long because the supply of dollars will eventually become so great that they become worthless.
A possible solution to this broken cycle would be for the Federal Reserve to grow its balance sheet faster than the government issues debt. The Fed could then reduce outstanding government debt without printing more money, thus closing the gap between the debt and the economy. This would require the central bank to purchase an asset that rapidly appreciates relative to its own currency. Which asset has this potential? Bitcoin.
Central banks are hesitant to buy their own stock markets as it distorts private valuations, which could negatively affect future economic growth. But Bitcoin is decentralized and therefore void of any connection to national agendas. It's also wholly neutral, fundamentally exogenous, and guaranteeably scarce. Critically, unlike anything else a bank could buy (like bonds, stocks, or gold), the supply of bitcoin cannot expand to meet an increase in demand.
Why Bitcoin makes sense
Imagine, for example, if the Federal Reserve announced it would start acquiring Canadian government bonds. The Canadian government would be incentivized to issue more debt since they know a guaranteed buyer is on the other end. The same goes for stocks – if the Fed started buying shares of Apple, Apple would eventually start issuing more shares to meet demand. And Gold? If there's a guaranteed buyer, it's no longer risky for gold mining companies to explore new mines, purchase new equipment, and build massive quarries to expedite production.
In contrast, the supply of bitcoin is pre-determined and will never increase to match the new demand created by central banks. A prominent central bank acquiring Bitcoin would signal to other central banks that they're engaging in the bitcoin strategy. This would validate Bitcoin as an investable asset and force other central banks to adopt the same method. Since the supply of Bitcoin is utterly inelastic to price, it would trigger a race to acquire as much bitcoin as possible. This has not happened yet, so I believe there is still significant upside left for bitcoin despite its already impressive rise.
Besides serving as a reserve asset for central banks, Bitcoin can act as a strategic resource to be acquired for national security. Under this lens, Bitcoin is nothing more than a network for moving wealth, and access is granted by holding bitcoins. Bitcoins are a medium for the transfer of wealth in the same way air is a medium for the transfer of sound.
Owning bitcoins means owning a piece of the underlying network, which will eventually, it looks like, be classified by nation states as a critical infrastructure alongside energy, transportation, and communication. And since the supply is fixed, owning 1% of the Bitcoin network today guarantees the same relative ownership in the future. This is not the same for other resources such as oil, gold, or military power, where the total outstanding supply can increase disproportionally among countries.
First come, first serve
Market entry dynamics create significant first-mover advantages for the first nation state to acquire bitcoin.
The cost of acquiring a fixed percentage of the Bitcoin network will grow exponentially with adoption, meaning the first nation to purchase the asset will capture most of the upside.
Counterintuitively, this makes adopting Bitcoin less risky in the early stages of adoption. If you're the last one to buy, there's a greater risk of other players cashing out and dropping the price on you.
On the other hand, being the first to buy with size (like Tesla and Microstrategy) means having larger control over the network, narrative, and price. Since the bitcoin market is already illiquid, only so much capital can join the network without significantly raising the price. This creates strong incentives for nation states to buy and lock up bitcoin as early as possible. Alternatively, nations may engage in an "arms race" to increase their control of the total mining power, which would have different implications and is something to explore in future research.
These views are obviously highly speculative and the process of any government or central bank purchasing any type of digital asset is likely decades away. But even a corporation like Tesla purchasing bitcoin seemed ludicrous in 2020. And during periods of instability (like what we see now in a slowing economy and high inflation), governments are more willing to take risks and deviate from the status quo. If the US dollar does start to hyperinflate, the Fed will need to act fast, and by then, Bitcoin may be the only lifeline they have left.
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Many thanks,
Tijo
“Buy right, sit tight.”