Thursday, May 19, 2022

The Bitcoin Scam

The fundamental thesis behind owning Bitcoin is that it is a inflation hedge that protects holders from excessive government money-printing. The logic behind this is fairly straightforward: it is desirable because it can be used functionally as a currency without traditional banking intermediaries (Note: this is true on a micro basis but NOT at scale) and because there will only ever be 21 million created, it will be in scarce quantity relative to government fiat currencies, thus its price will go up.

While this is intellectually intoxicating, particularly for hard-money, Austrian/libertarian types, it is nonetheless built on false premises. The most obvious flaw in this thesis is that there are real costs (particularly capital costs) that Bitcoin miners need to incur in order for the Bitcoin network to remain intact. Bitcoin exists on computers, and computers are real capital equipment that degrade over time and therefore must be replaced. The replacement cost of these computers will inevitably rise over time with inflation. Therein lies the scam - as long as there are enough suckers to buy Bitcoin from the miners at prices in excess of their cost of capital, they will make money. And given there are guardrails built into the Bitcoin code against rapid market share accumulation, the only way for Bitcoin miners to increase their profits is to pump up Bitcoin's price. More on this below:

Bitcoin mining used to be a lot more profitable than it is today, because early adopters had less competition. See below:

Miners could generate a higher ROIC, because they could accumulate and sell more Bitcoin per unit of capital employed (i.e. computers needed for mining).

As mining became more crowded, ROIC collapsed. Given that miners have high fixed costs ($10k computers need to be replaced after 2.5yrs, current b/e estimates around $32k), they went on a massive marketing/propaganda campaign. They needed the price of Bitcoin to be higher because otherwise they burn cash. If everyone is burning cash, then eventually they run out of money and the network collapses. So, they need to pump up the price in order for their operation to remain profitable. Hence, they created the inflation narrative/meme.

To reiterate: the business model of Bitcoin is to purchase computers to do the mining work, then creating a narrative and selling it to suckers. There are built-in protections that make it more difficult to accumulate Bitcoin as more miners enter the market and compete. This is a system design to ensure the quantity of Bitcoin mined sticks to the cadence set forth by its creator. So, it is impossible for someone to come in and grab a ton of market share at a rapid rate. Without the ability to grab market share, the only alternative for increasing profits is to hype up Bitcoin so that you can sell it at the highest price possible. As long as its price doesn’t drop below b/e rate, miners can stay in business. That’s literally the business model.

The capital intensity of such a business makes the “inflation hedge” narrative complete nonsense. Bitcoin only has value if its network is running, which by definition requires miners to incur real capital costs. Those costs will go up over time with inflation - that much is guaranteed. What is uncertain is whether the price of Bitcoin will continue to go up.

This fact is crucial when considering Bitcoin as a “store of value.” Families may retain precious stones or metals like gold as heirlooms to honor and respect their ancestors. We see this all the time when people want to build a new engagement ring with their grandmother’s stone. The chemical properties of those materials ensures they will still be around in 500 years, which makes them desirable possessions. The likelihood of the Bitcoin network being around 500 years from now is close to 0%. One can’t reasonably pass it down as a family heirloom, so it is actually an inferior store of value to something like gold.

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