Posted over at Mish Talk, Mike brings up some good points and outside-the-space perspective. Time will tell how things unfold. One thing that does overlap that I see, is a further tightening over KYC on-ramps. Currently, the KYC enforcement for low-dollar purchases with bitcoin ATMs is rather soft (in the US.) I can see that getting tightened when an account ID or scan of a drivers license or gov’t ID in order for a transaction to even process. (On that note, see this recent piece by Bitcoin Magazine on KYC-free bitcoin options.)
Be well, Everyone.
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Why Bitcoin Won’t Reach Mass Adoption Ever: A Three Generations Theory Rebuttal
Let’s take a look at an interesting theory regarding mass adoption of Bitcoin as money. I also review an excellent article by Lyn Alden that is pro-Bitcoin. In all, I present three views.
The Three Generations Theory
Bitcoin Magazine author Aleksander Svetski writes explains The Three Generations Theory: How Bitcoin Reaches Mass Adoption In 60 Years.
I picked the story up via ZeroHedge. The idea is interesting and well presented.
Whether Bitcoiners like it or not, large-scale Bitcoin adoption is not coming this decade or next. It’s simply going to take a number of generations to filter into society.
Bitcoiners are notorious for their over-estimation of how quickly Bitcoin is going to “take over the world” and become “widely adopted as money.” I’ve sat squarely in that camp for a long time now, but have come to think differently of late.
People are very quick to project technology adoption curves onto Bitcoin. But the problem is that Bitcoin is not just a technology.
It’s not just a smartphone, or a computer, or a social network, or a new stock or security, or a new payment method, or a search engine, or a messaging platform, or any other new product, app or service.
Bitcoin is an entire techno-socio-economic transformation. It’s a reinvention of money from the ground up, incompatible with any prior primitives.
These are both real hurdles and necessary to recognize. You can’t just close your eyes and ears, tweet that “Bitcoin fixes this” and pretend it’s all going to be OK because NgU always happens. No.
Large-scale, socio-economic shifts take generations to settle in and normalize. The old guard needs to die, so to speak, so that those born into the new paradigm can lead.
Each generation is a paradigm shift in and of itself, and each successive such change brings with it a completely new understanding of and relationship to Bitcoin.
There is at least one major flaw in those paragraphs. Did you spot it?
To give you some time to think about it, and before my answer, consider the three stages of the generation view.
Three Generation Stages
- The Infection Stage
- The Infrastructure Stage
- Mass Adoption Stage
You might be thinking, “No man. It will happen faster because look at all the tech that’s going to be built by then.”
I leave it to the reader to investigate those stages as proposed by Svetski in the preceding link.
Three Generation Theory Flaw
“It’s a reinvention of money from the ground up, incompatible with any prior primitives,” says Svetski.
Bitcoin is not a reinvention of money and it currently isn’t money at all.
What is Money?
In What Has Government Done to Our Money? Murray Rothbard explains “Money is a commodity that differs from other commodities in being demanded mainly as a medium of exchange.”
Money has three properties, unit of account, store of value, and medium of exchange. But the key idea is “demanded mainly as a medium of exchange.”
That was the original idea behind Bitcoin. In practice, the main use of Bitcoin is speculation.
Nothing is priced in Bitcoin. And because of government mandates, Bitcoin needs to be converted to fiat to be spent.
Historically, gold, when it has been available, was the preferred money. Government mandates changed that.
I believe in a free market in money. And if the market accepted Bitcoin, who am I to object? But we don’t have a free market in money, and likely will not again.
I believe, but cannot prove, that a free market would adopt tangible gold, not electrons and an algorithm as money, given a choice.
That is what thousands of years of history suggests.
Money Substitute
Bitcoin is not money but rather a relatively liquid money substitute. One cannot use Bitcoin directly except in rare cases of barter.
Realistically, Bitcoin is money in the same sense that shares of Apple are money.
One has to find a buyer for shares of Apple, then those shares for money. Similarly, one has to find a buyer for Bitcoin to use it as money.
In both cases, buyers are easy to come by. The difference is Bitcoin trades 24×7, but it still has to be exchanged for money to use it as money.
I frequently read stories how people avoid dollars and transact in Bitcoin. But except in rare barter instances where Bitcoin is held by the seller of goods and services, Bitcoin requires conversion to fiat to use.
Bitcoin Accepted Here
“Bitcoin Accepted Here” in practice, really means the merchant will immediately sell that Bitcoin to someone else willing to trade money (dollars, euros, yen, etc.) for Bitcoin.
In general, to buy anything with Bitcoin first requires another buyer willing to trade money for Bitcoin. It’s important to understand that selling Bitcoin for fiat to buy things places negative price pressures on Bitcoin.
Carried to 8 decimal places, the percentage of people paid in Bitcoin per hour is zero percent. Due to volatility it will stay that way.
Some trivial and meaningless number of people believe they receive payment for services in Bitcoin, but mostly they don’t in practice. Except in extremely rare case, a person paying someone Bitcoin first exchanges fiat for Bitcoin.
There is not enough of this kind of activity in Bitcoin to matter.
Importantly, it will stay that way until some major government demands taxes to be paid in Bitcoin.
Please let that sink in because ultimately that is what will determine whether or not Bitcoin will ever be money.
Reasons Against Bitcoin As Money
- Bitcoin will never be money because no significant governments will ever adopt it. At best, Bitcoin will will remain a money substitute.
- Bitcoin is too volatile to be used as money.
- Volatility makes Bitcoin perfect for speculation.
- Bitcoin is also a great mechanism for fraud and money laundering.
- Taxes
Point one is a sufficient reason why Bitcoin will never be money.
Points two, three, four, and five are practical matters, irrelevant due to point one.
Many will argue that Bitcoin fraud is tiny, and they are correct.
But the percentage of illegal transactions in Bitcoin is undoubtedly higher with Bitcoin than US dollars. Taxes are a case in point.
Taxes
Selling Bitcoin is a taxable event. If a person sells Bitcoin to buy something, those gains are taxable.
The tax setup makes it very unfriendly to use Bitcoin as money in routine transactions.
How many have sold Bitcoin to buy something or just to take profits? What percentage of people paid taxes on their gains?
Failure to do so is tax evasion.
Supply of Bitcoin
The supply of Bitcoin is not falling. It increases every day at a known decreasing rate.
There were 19,276,325 bitcoins in existence as of Jan. 29 2023. The maximum total is 21 million. That means there are 1,723,675 left to be mined before the limit of 21 million bitcoins is reached. That will happen in the year 2140.
The above numbers from the Investopedia article What Happens to Bitcoin After All 21 Million Are Mined?
If Bitcoin in 2140 largely serves as a store of value, rather than for daily purchases, then it’s still possible for miners to profit—even with low transaction volumes and the disappearance of block rewards. Miners can charge high transaction fees to process high-value transactions or large batches of transactions, with more efficient “layer 2” blockchains like the Lightning Network working in conjunction with the Bitcoin blockchain to facilitate daily bitcoin spending.
Starting in 2140, there will be no more mining profits. To maintain the integrity of the blockchain, miners will have to make a go of it on transaction fees.
This will further preclude using Bitcoin as money or a money substitute.
I rather doubt this is a workable setup, but we will not find out until late in the game, assuming the game lasts long enough.
Futures and Derivatives (Paper Bitcoin)
Bitcoin is supposedly impervious to manipulation. But what about futures and derivatives?
Chart Notes
- The most recent data shows open interest at 19,060 contracts. That represents 95,300 Bitcoins worth $2,191,900,000 at $23,000 per Bitcoin.
- There are 7,278 leveraged short contracts.
- There are 5,639 leverage long contracts.
In the futures world, at least on US exchanges, there is a long for every short.
Some of the positions are hedged. Hedging bitcoin is relatively simple but with some slippage.
For example, if you buy 5 Bitcoins and are short one contract you have a near perfect hedge except for contract rollover costs.
What is the Real Long-Short Position?
I do not know. Nor does anyone else because the CME position is just a fraction of the data.
Please consider this snip by the U.S. Commodity Futures Trading Commission article Who Trades Bitcoin Futures and Why?
Crypto assets have been one of the most discussed investment topics of the last few years. Starting with Bitcoin in 2009, the volatility in this investment vehicle has intrigued both finance professionals and retail traders. However, still little is known about who actually invests in the most famous cryptocurrency, Bitcoin. Part of the reason for that is because most of Bitcoin trading happens on unregulated exchanges and there is no disclosure of counterparty identities.
We argue that there are two main types of traders in the BTC markets, those who almost exclusively invest in Bitcoin futures (concentrated traders) and those who hold Bitcoin futures to diversify their large futures portfolio (diversified traders). Second, we show that the composition of the BTC market, in terms of the percentage of diversified and concentrated investors, has changed over time. Specifically, we observe that this shift takes place around mid2020. Third, we analyze the futures market portfolios of the BTC traders to understand.
Previous papers have analyzed other aspects of the Bitcoin futures market. Many of these focus on whether price discovery occurs in the CME BTC futures market or elsewhere. Baur and Dimpfl (2019) find that the majority of price discovery occurs in Bitcoin spot markets. Despite using similar data and methods, Karkkainen (2018) find the opposite, that BTC leads price discovery. Alexander and Heck (2020) find that price discovery occurs primarily on unregulated (not CME) futures markets.
Alternatively, Corbet et al. (2018) show that introduction of Bitcoin futures has increased spot volatility of Bitcoin and claim that Bitcoin futures are not an effective hedging tool.
The CME listed for trading a Bitcoin futures contract regulated by the Commodity Futures Trading Commission (CFTC) in December 2017. The contract is settled in cash rather than delivery of actual Bitcoin with a contract size of five Bitcoin.
The CME listed Bitcoin options in January 2020 and micro Bitcoin futures in May 2021. Micro Bitcoin futures have a contract size of 0.1 Bitcoin but are otherwise identical to the original CME Bitcoin futures.
In addition to the regulated contracts listed by the CME, there exist numerous unregulated Bitcoin derivatives that are listed on various cryptocurrency exchanges, including Binance, BitMEX, Kraken, and others.
The most common unregulated Bitcoin derivative is the perpetual swap (also called a perpetual future or perpetual contract) which, unlike ordinary futures contracts, has no specified expiration date. Perpetual Bitcoin swaps differ from CME Bitcoin futures in several other ways, including the settlement mechanism, the denomination, the amount of leverage, regulation, and availability to U.S. persons.
Perpetual contracts have no specified expiration date and positions can be held indefinitely. While ordinary futures contracts ensure convergence to the price of the underlying asset via either physical delivery or cash settlement at expiration (CME Bitcoin futures use cash settlement as discussed above), perpetual contracts instead have a funding mechanism (referred to as the funding rate) whereby long position holders and short position holders exchange payments as the Bitcoin price fluctuates to ensure that the futures price reflects the cash Bitcoin price. Such payments are typically made at set intervals, often multiple times per day.
The exchanges listing perpetual contracts generally offer far more leverage than CME futures contracts, sometimes as much as 200 to 1, meaning a user need only post margin of 1/2 of 1% of the notional value of a position. With this much leverage, a relatively modest adverse price move may result in an exchange forcing a position holder to liquidate at a loss.
What About Whales?
In addition to the above, one needs to factor in whales and super-whales.
Here is the description from WorldCoin: Cryptocurrency whales, or crypto whales, are individuals or entities that own large quantities of a specific cryptocurrency. Generally speaking, a crypto whale is an entity that holds enough digital currency to significantly influence market prices by trading significant amounts of coins and tokens.
Whales buying and selling large numbers of contracts perhaps holding derivative options as well can greatly influence the price causing price cascades.
How much purposeful manipulation happens by whales is uncertain.
In addition, there is always the strong likelihood of a whale amassing so much Bitcoin wealth that he or she decides to cash out for gold, real estate, or other property.
The higher the price, the bigger the incentive to diversify. Price pressures in this regard are immense.
Speculation Drives the Price
While we do not know the current futures position or what whales may do, it’s easy to see that speculators control the market.
Rapid winding and unwinding of contracts with leverage as much as 200-1 and actions by whales and hedge funds are what sets the price.
Absurd Price Targets
The widespread notion that people in Africa, El Salvador, or even the US, buying 1/10,000 of a Bitcoin over the course of time will drive the price is nonsensical.
This also means the $1,000,000 price targets based on mass adoption or Bitcoin use as money are also nonsensical.
The wild fluctuations in price makes Bitcoin unusable as money but a great tool for speculation.
Premise Revisited, Looking Forward
“It’s a reinvention of money from the ground up, incompatible with any prior primitives.”
It’s not money and won’t be simply because no major government will ever adopt it.
But what about the second half of that sentence, “incompatible with any prior primitives”?
As a speculative tool, what precisely is Bitcoin incompatible with? Certainly not the futures market.
And what about future primitives? Remember the war between VHS and Beta?
Beta was technically superior but VHS won out. Much of the current generation of Zoomers has no idea what either of them is. Both are worthless technologies replaced by something else.
Reflections on Mass Adoption
Bitcoin isn’t money and it will not be money in 20 years or 60 years.
The price will not be set by mass adoption because there will not be mass adoption. And there won’t be mass adoption because governments will never demand taxes in Bitcoin.
Rather, the price will be set by speculators, but only as long as governments allow speculation.
Undoubtedly, Governments Can Stop Bitcoin
Bitcoin advocates promote the idea that it’s impossible to kill Bitcoin. At best they are quite naïve. Some of the advocates are charlatans or manipulators in pump and dump schemes.
All governments have to do to kill Bitcoin is ban conversion to fiat. A transaction ban by the US or EU imposed on merchants, banks and exchanges would kill Bitcoin immediately.
Yep, you still have your Bitcoin. No one will take it away. It’s just worthless because you cannot convert it to spendable money.
Q: How long will major governments allow Bitcoin speculation?
A: Until they feel threatened by it.
Perhaps that’s a year from now and perhaps it’s never. But the lower the price stays, the less likely governments will act to rein it in.
Don’t fool yourself. On grounds of money laundering, fraud, or made up excuses, governments can kill Bitcoin. And they will if threatened enough by it.
That is a statement of fact. The only part debatable is the likelihood of such an event.
I don’t know the odds, nor does anyone else. But the lower in price Bitcoin stays, the less likely the event.
Three Generations Rebuttal Conclusion
The idea that a Bitcoin mass adoption will happen over 60 years, with governments unable to do anything to stop it, even as Bitcoin sits the entire time, not as money but as a money substitute, potentially taxed to death, and potentially displaced by other technologies or better blockchain representations seems to be extremely wishful, if not outright fantasyland thinking.
That’s my base case, but here is another.
Counter-Rebuttal by Lyn Alden
The brightest person I know in the Cryptoworld is Lyn Alden. Her writing is pragmatic and well-reasoned, without any hype, ever.
In August of 2022, she mentioned many reasons for mass adoption in her take A Look at the Lightning Network
It’s a very long read and some will not understand various points. But I recommend a full read in entirety. Here are a few pertinent snips.
It’s natural for people to want to hoard something like gold or bitcoin, and spend their dollars, pounds, yen, euros, yuan, pesos, naira, and rupees. Money that depreciates in value tends to circulate, while scarce money that tends to appreciate in value gets hoarded, with much lower spending velocity.
This becomes especially true if a jurisdiction treats the harder money like property and taxes each transaction, which most jurisdictions do. If you try to use things like gold or bitcoins as media of exchange, each transaction is a taxable event compared to your initial cost basis when you originally bought that asset. The incentive therefore is to hoard the taxable gold or the taxable bitcoin, with their lower levels of supply inflation, and spend the non-taxable fiat currency on consumption, unless someone has a strong desire for bitcoin’s censorship-resistant payments properties.
For example, bitcoins have been used as a medium of exchange by girls in Afghanistan, by Russian political opposition when their bank accounts get frozen, by Nigerian merchants and protesters, by people getting capital out of China, by people getting their money out of Venezuela, Iran, Palestine, and elsewhere, by under-banked people in El Salvador, and more. It’s also used in developed markets for some natively-online services, such as Substack or buying VPNs, and many others. And yes, in the early years for people to buy drugs online and occasionally for things like ransomware attacks.
The Volatile Process of Monetization
An asset cannot monetize without volatility. By definition, an asset can’t go from being worth zero, to having a market capitalization of a million dollars, to a billion dollars, to a trillion dollars, to several trillions of dollars, without upward volatility. That upward price move due to user adoption is volatility.
With that being the case, any upward volatility of this magnitude will attract speculators, leverage, and surges of demand, and these speculators eventually get caught up and forced to sell for one reason or another, resulting in periods of sharp downward volatility.
But more broadly, one must ask, “at what point would someone want to permanently exchange their self-custodial scarce money (bitcoin) that has a 1.8% annual supply inflation rate that is exponentially shrinking, for a soft money (fiat currency) that typically has a 7% annual supply inflation rate or higher?”
The answer for many people, is never, as long as the Bitcoin network is still working.
Instead, they want to hold and accumulate bitcoins until enough merchants accept them, at which point they could spend some of them, especially if there is enough critical mass for them to become legal tender in more jurisdictions by that point.
When understood that way, risk analysis regarding the Bitcoin network should focus on questions like, “What events could potentially derail its monetization process? What events could make the majority of users want or need to sell their bitcoin, stop viewing it as good long-term savings, and instead hold something else? What threats could censor the network, disable the network, or otherwise disrupt its ability to serve as a tank-like medium of exchange and self-custodial portable savings?” Those are the right questions to ask, in my view.
With that last paragraph, Alden, unlike most Bitcoin advocates, admits the concerns I discussed are plausible.
For many paragraphs following, Alden discusses the Lightning Network.
She returns to my concerns with ….
Most people living in the US or Europe or Japan do not have problems making payments or getting bank accounts on a regular basis. They may wonder why Lightning is relevant at all.
However, a significant portion of the world is unbanked, while a free open source software app that makes use of the Lightning network can give them payments capability. A large portion of the developing world suffers from persistent double-digit inflation, and most people in developing countries have experienced major currency devaluations/resets in their lifetimes, which eradicates savings.
Additionally, approximately half the world lives in countries that are classified as authoritarian or semi-authoritarian. They face arbitrary bank account freezes for basic things like protesting or speaking too freely. Technology like the Bitcoin/Lightning stack is an asymmetric technology for them.
It’s hard to say exactly where this leads. Peer-to-peer global transfers of liquid value is a Pandora’s box that has now been opened. Certain governments do not want it open, and pass various laws against it, but here it is, with free open source software. It’s much harder for governments to enforce payment rules on millions of individual persons, than on just thousands of highly-regulated banking institutions. If people don’t need to go through banks to transact inside or outside of their local area, that opens a new set of possibilities.
On the other hand, governments are working towards central bank digital currencies. Some of them, like China, got a head start and already have implementations in the field. Most other governments, however, are way behind, and are only in the research phase for how they might want to go about constructing a digital currency.
Governments have to get rather authoritarian if they want to nearly-completely deter the use of such open and decentralized technology and then maintain that deterrence perpetually.
Instead, the main ways that policymakers can control the industry are via on-ramps, taxation, and regulation. They can block fiat bank connections to digital asset exchanges, or regulate their usage with strict KYC AML compliance checks in and out of large digital asset exchanges combined with blockchain surveillance to track addresses. They can make it hard to serve as a custodian for digital assets, or make it hard for users to withdraw coins from custodians. There are ways around this, but all of these are frictions and control points for large pools of capital.
That ending paragraph above is the risk I detail in my rebuttal to the three generations theory.
In short, don’t compare failed attempts in backward countries to block Bitcoin to what would happen in the US if the Fed were to impose rules on banks and the government were to impose rules on exchanges or place big taxes on transactions.
The lightning network in general seems to have long-term application with or without Bitcoin.
Indeed, the European Central Bank published a report this month that examined the Bitcoin/Lightning stack among several potential methods for global cross-border payments, and took the network pretty seriously in their analysis.
Let’s make some friendly assumptions to see where this all heads.
Friendly Assumptions
- No government ban.
- No volatility
- No tax consequences of holding or buying things in Bitcoin
- Global merchant acceptance
- Governments collect taxes in Bitcoin
What is Bitcoin Worth As Money?
Let’s assume all of those things happen. What’s Bitcoin worth? A million dollars in a few years? A million dollars in 10 years? What?
I don’t know. Nor does anyone else.
But I do know that every one of those assumptions seems highly unlikely individually and collectively. Meanwhile, speculators will set the price.
Competing Views
There you have it, three competing views.
What I especially like about Lyn Alden is she does not pretend to know where this is all headed. No one else does either.
She does present a good case why Bitcoin is being adopted where it is.
Liquidity and Final Thoughts
Finally, it’s important to note the Fed and central banks are now decreasing liquidity at a rapid pace.
Bitcoin’s entire existence until now has been in an ocean of increasing liquidity and falling, even negative interest rates, by central banks.
Wherever Bitcoin is headed, don’t expect it to be impervious to Fed actions, central bank actions in general, liquidity, global recessions, US and EU government crypto policies, and whales cashing out.
This post originated at MishTalk.Com.
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