Imagine investing $5,000 in some little-known digital currency you heard about in 2011. You forget about it for about 6 months and finally decide to check on what’s going on. You are delighted to learn you are now a millionaire from that initial $5,00 investment. Those of us watching from the sidelines missed out on what seems like a once in a lifetime opportunity. I have been following Bitcoin since April of 2011 and began buying in 2015.

In this post I make the argument that there are issues with our current monetary system which will lead to turmoil in the currency markets for which Bitcoin and other cryptocurrencies are a good hedge. I break this argument into three parts 1) What is Money? 2) Why Would People Seek Out Alternative Forms of Money? and 3) What is Bitcoin and why Might This Be Seen As A Good Alternative?

1) What Is Money?

Money arose from the need to have a ledger that keeps track of debts in a community. Before money, humans walked around with mental debt ledgers to try to remember who owed who what. For example, let’s say, during the Paleolithic era, Steve kills a buffalo and Bob would like some meat. Steve would give Bob meat and try to remember that Bob “owes him one.” Steve, in this instance, is keeping a mental ledger.

Eventually, someone came up with the idea of using “money” as a way to keep track of debts so that people no longer had to remember who owed debt. The system worked by exchanging tokens to indicate who was owed a debt by the community. Throughout history gold was often chosen because of its scarcity, portability, and divisibility. It was primarily considered valuable because of trust in the money system, not because you could melt it down and turn it into something. Thinking money must be intrinsically valuable is a common misconception that often is used to discredit bitcoin.

The three basic functions that a trusted monetary system serves are:

Store of Value (Saving) – Gives people the ability to save up purchasing power for future use.

– Gives people the ability to save up purchasing power for future use. Payment Mechanism (Paying ) – Allows people to exchange goods and services. For this you need widespread adoption of the money system.

) – Allows people to exchange goods and services. For this you need widespread adoption of the money system. Unit of measure (Pricing) – People price things in terms of the money system. i.e. A gallon of milk costs $3.

Money systems typically arise in this order. First people save using some asset. Once enough people have this asset, there is a network effect which allows this to become an accepted payment method and finally people begin to speak in value in terms of the money system. If any of these functions are undermined, it can lead to a loss of trust in the monetary system. You can see these functions in use with the US dollar system.

2) Why Would People Seek Out Alternative Forms of Money?

The 2007 financial crisis woke up some people to the cracks in our current monetary system. The world has recently entered the twilight zone that is negative interest rates. There is currently ~$12 trillion in sovereign debt in negative yield territory where one pays borrowing governments for the privilege of lending them money. With over 5,000 years of monetary history in the books, there is no precedent for negative interest rates. This is truly a first.

It’s best to think of interest rates as a price on the premium I’m willing to pay today to have money now rather than in the future. If interest rates are at 5%, it means that the market is willing to pay a 5% premium on money today vs a year from now. Negative interest rates are only made possible by central bank manipulation because they are nonsensical. A negative rate of interest implies that people are willing to pay a premium for the privilege of lending someone money.

Negative interest rates undermine the core function of a monetary system as a Store of Value (Saving). People will seek out alternatives to holding government currencies as central banks continue to destroy the purchasing power of our currencies. An asset that yields 0% is relatively favorable when compared to one that yields less than 0%.

3) What Is This Alternative Asset Bitcoin You Speak of?

The layman’s way to understand bitcoin is that it is a globally distributed decentralized ledger system. Anyone in the world with access to the internet can download bitcoin and have access to this ledger that is updated in real time. If Bob sends 20 bitcoins to Alice, this globally distributed ledger is updated to reflect this (-20 Bob, +20 Alice). As previously noted, money arose out of the need for a ledger.

Bitcoin is the best ledger (and thus money) the world has seen. Bitcoin is completely open source meaning that anyone can view the source code behind the system and see exactly how the system operates. It is a mathematical certainty that there will be 21 million bitcoins ever created because it is built into the source code. Bitcoin has the characteristics of scarcity, divisibility, and portability. Interest rates are determined completely by the market. I link to some good resources on how the system works in the notes below.

Contrast this democratic system with our current central banks system in which monetary decisions are made by a few elites about monetary policy and economy which have been proven wrong more than right as of recent. We have no guarantee of how currency creation will work in the future. The fed could announce tomorrow that they are starting a new cycle of quantitative easing and the purchasing power of our dollars could drop. The term typically used to describe this phenomenon is inflation. The technical definition for inflation is an increase in the money supply. It just so happens that this almost always is accompanied by a rise in prices.

Figure 1: Recalling Facebook: Blockchain Wallet Users

Source: “Recalling Facebook” Jim Grants Interest Rate Observer, graph blockchain.info

Conclusion: Bitcoin as A Hedge Against Monetary Disorder

Murray Stahl, chairman and chief investment officer of Horizon Kinetics and publisher of The Devil’s Advocate Report Compendium was recently interviewed by Grant’s Interest Rate Observer on using Bitcoin as a hedge. To paraphrase the argument being made in the article:

“If Bitcoin were to be equal to the value of all government bonds with negative yields, the increase in value would be 1,111.11 times. If a portfolio having a 1% position experiences a 1,111.11 times appreciation over five years and all other investments that make up the remaining 99% become worthless, this portfolio’s rate of return would be 61.86%. Talk about a hedge!”

To put that in dollar terms, a $600 investment (approximate price of coin at the time of writing), would increase to $666K if it experienced a 1,111.11 times appreciation.

Anyone with noteworthy financial credentials wouldn’t recommend someone save a significant portion of their money in Bitcoin & crypto-currencies. I believe it can be used as a hedge in an emerging asset class and a speculative bet on monetary disorder. Bitcoin either fails and becomes worthless or is widely adopted and increases significantly in value. This is a very asymmetric bet.

Disclaimers: Throughout this post I use “Bitcoin” as my subject. I am actually speaking about crypto-currencies in general. This is meant to be a layman’s guide and focusing on Bitcoin makes it easier for people to conceptualize. In actuality the space is more complex and there are other well positioned crypto currencies.

These opinions are my own and do not constitute financial advice. I am not a financial planner. These opinions are not meant to reflect those of my employer.

Further Reading:

Bitcoin.org

More on Why Bitcoin?:

How To Buy Bitcoin?

Coinbase – How I buy bitcoin and probably the easiest for people new to the space.

For Techies:

What is The Future Going to Look Like: