7 Lessons I learned About Investing in Bitcoin

This is a republication of the notes, slides, and video of my Dec 7, 2013 presentation at LabitConf Buenos Aires.

Originally Presented Dec. 7, 2013 at laBITconf Buenos Aires

Over the last two years, I spent eight months living in Argentina and Chile, and actually, it was here in Buenos Aires that my friends taught me about Bitcoin. They called it ‘La Moneda del Futuro’, and it was their great passion that infected me with the ‘Bitcoin virus.’

Actually, the true meaning of this Bitcoin-revolution only recently started dawning on me, and that is that Bitcoin marks the end of monetary apartheid. Let me repeat that: Bitcoin marks the end of monetary apartheid. It is the end of financial discrimination and segregation based on nationality and political privilege.

In the economy of Satoshi Nakamoto, there are no artificial barriers to entry, you are not asked for any papers, there are no unnatural restrictions preventing mutually beneficial transactions. Basically, if you’ve got value to offer, you’re in business!

This process of value creation has been happening for nearly 5 years now- and how far have we come in such a short period of time!

Since I started recommending Bitcoin as an investment, in late 2011, there was one single question people kept asking me again and again: “why the hell should I invest in Bitcoin?”

However, with the tremendous growth we’ve seen and ever more opinion leaders expressing their admiration for this technology, the mentality is clearly changing, and the main question that I get now, is “Please tell me, how in the world can I invest in Bitcoin?” And that’s exactly the question that I’ve been asking myself for all this time.

So in this presentation I’ve boiled down some of the insights that I think are useful into a couple of lessons. Please don’t take them as the ten commandments, but rather a humble starting point for discussion. That said, I think they have merit and it’s these ideas that inform my own investment strategy.

1. First, and most importantly: Do Your Homework

If you consider investing in Bitcoin, do your very best to deeply understand what you are dealing with.

To invest in Bitcoin without understanding it, is like being in the middle of the ocean on a boat and not understanding your position and what the currents are. — Bitcoin is not just a vehicle for speculation, — it’s not just a currency, — it’s not just a commodity, — it’s not just a better version of paypal or western union, — it’s not just a cheaper way of transacting financially, either … Bitcoin is all of the above, and more The best way to describe Satoshi Nakamoto’s value proposition is probably to say that we are dealing with a:

…globally distributed… …digital protocol… …for trustless and easily verifiable… …information synchronisation and… …property allocation.

Let’s go over this definition word by word:

• “global” means that anyone in the world can use it;
• “digital” means that it’s super fast and nearly free;
• “protocol” means that it is carefully constructed and approved by many;
• “trustless” means that it’s extremely reliable & not dependent on third parties;
• “information synchronisation” means that it can host and secure any type of contract imaginable;
• and “property allocation” means that you can use it to determine your ownership of money or economic goods, and that you can use the network to transport property to anyone you want at any time.

So this is Satoshi’s gift to the world, an amazing network and community for the storage and exchange of value. And the only way to transact on that network, is by making use of digital currency units called “bitcoins”, of which there will only ever be 21 million in circulation. That is what makes these bitcoins so very special as an investment.

And this is why, when you become familiar with the Bitcoin culture, you’ll bump into phrases like “one never sells all of his bitcoins”, or: “To the moon!” — pointing out the enormous long term potential of this technology.

Indeed, people who have a profound understanding of Bitcoin, realize that their decision to start acquiring some coins might very well be the most important investment they will ever make.

2. Don’t make things too complicated: first and foremost, focus on acquiring some coins

As I said, the real value of Bitcoin lies in the size and quality of its network. Sure there are many other decentralized digital currencies around nowadays, but the one with the largest and most sophisticated community surrounding it, by a clear mile, is Bitcoin itself.

So if you think the technology developed by Satoshi is something worth investing in, go out there and simply buy some bitcoins, or some millibitcoins, as they are called these days. Apart from the coins itself, it is also possible to invest in the ecosystem that is developing around Bitcoin: exchanges, merchant services, mining companies, escrow services, and more. It is definitely true that there are many brilliant entrepreneurs active in this ecosystem by now, and some of them created businesses that are growing very fast. However if you plan to invest, keep in mind that the Bitcoin network is designed to be a super lightweight, very open environment allowing people to transact directly with one another. That’s the essence of a peer to peer currency: it cuts out the middle man, reducing overhead to almost zero. So in other words, if you go out and invest in too many Bitcoin middle men, you might end up empty handed, or at least with less than if you had just invested in coins. It is very hard to outperform an average growth of +1000% per year, so by all means consider these periphery investments, just don’t go crazy on them.

3. Security, security, security

I’m going to keep this one very brief. If you invest in an asset with low third party risk, the implication of that is that nobody is taking care of you. You are responsible for the safe storage of your coins, and nobody else. So do your research and take some time to set up a secure way to store your investment for the long run.

4. Don’t overestimate the impact of politics

In every practical sense of the word, Bitcoin is a global and nongeographical phenomenon. From the perspective of governments, it is like water: try to grasp it in your hands, and it flows to another place out of your reach. That’s why in general, political events will be overestimated in their eventual impact.

We’ve seen the seizure of the Silk Road for example, which caused BTC to drop from $125 to $85 overnight. Well, 3 days later the price was back up — the heist turned out to be a non-event. Given that many people (especially in the West) are very fearful of government and tend to overestimate its actual reach, I think that negative political shocks affecting Bitcoin are actually buying opportunities.

5. Mass Psychology : understand and ride the wave

To keep with our sailing analogy, there are fundamental currents that drive the Bitcoin ship, but there are also waves and wind, which have a strong short term impact.

When Bitcoin experiences a series of positive shocks (maybe a celebrity endorsement, like the one of Richard Branson recently, or a major retailer deciding to accept it), that leads to a lot of media exposure and usually a big rally in the price.

The rapid growth in price however, eventually puts stress on the bitcoin ecosystem, and inevitably a sort of crisis develops. The new investors panic, and the cycle enters the ‘bust’ phase. (This is the phase where Bitcoin ignoramuses triumphantly shout from all the rooftops: ‘The Bubble has popped!’.)

In order to survive the volatility in Bitcoin, it’s very important to be aware of this dynamic of mass psychology. Map out a strategy for yourself and try to stick with it, in order to avoid being swept away by the emotion of the moment.

6. Understand the interaction of all things Crypto

Recently there was a lot of news about the huge rally in Litecoin and the other alternative cryptocurrencies. And then when Bitcoin went down a bit, the altcoins dropped much more in percentage terms. Someone on reddit said “when Bitcoin sneezes, the altcoins catch a cold”.

Well I think there is a logic to the madness, and it looks a little like this:

This diagram is a model of how liquidity flows through the Bitcoin ecosystem. On the left there is a huge tank of Fiat money. When the sentiment around Bitcoin is positive, money flows from the Fiat-tank into the Bitcoin ecosystem.

First, people spend fiat money to buy bitcoins and the value goes up. If it looks like that they can make more money by buying mining equipment, they will also spend dollars buying Bitcoin mining rigs. As the rally continues, the new adopters are bummed out that they have to buy bitcoins at such a ‘high price’ and they start buying litecoin, peercoin, terracoin and the other alternatives to Bitcoin.

In that sense, we could say that the altcoin markets serve as a pressure valve for Bitcoin.

The same happens with the mining market: when bitcoin prices rise, the cost of mining equipment expressed in bitcoin drops, and bitcoin savers buy more mining rigs. When that happens, mining hardware manufacturers are given the signal to speed up production.

At some point however, the sentiment around Bitcoin begins to turn again, and the value of Bitcoin stagnates or declines. Because the markets for the altcoins hardly have any US dollar-liquidity, people exchange their altcoins for bitcoin, leading to a very quick decline in value in the altcoin markets. And in the bitcoin mining sector, at some point investors will figure that the massive investments in extra capacity have put a lot of pressure on the profitability of individual machines. Enthusiasm drops, and the stream of investments dries up — to stay with our diagram: the bucket starts overflowing and no longer seems to reward new investments.

However this perception can be misleading, because, like what happened in september and october this year, the market did not take into account that Bitcoin might actually rally again, bringing the yield of mining machines back into positive territory.

So what is the investor to make of this dynamic?

A possible trading strategy based on this model is to basically be a contrarian:

• When do you invest in Bitcoin mining? When nobody thinks it is profitable anymore.
• When do you diversify into altcoins? When Bitcoin is entering a new hype phase in the media and the price starts rising.
• When do you sell your altcoins for Bitcoin? Well, when these are hyped as well, and are breaking records valuations compared to Bitcoin.

Personally I recommend trading with very conservative amounts, because you are exposing yourself to a lot of risk by moving in and out of these currency exchanges.

7. Invest what you feel comfortable with

Despite the attention that Bitcoin is getting in the media, it is clear that we are still in early phases of Bitcoin adoption. Merrill Lynch estimates that today not even 3 million people are to some extent savers in Bitcoin. That’s about one in every 1000 internet users, and one for every 1500 mobile phone users. And the market cap of Bitcoin is now around $10 billion. That’s a small fraction of every market that it could potentially disrupt.

To give an idea: the size of the remittance market is $500 billion; the e-commerce market is $1000 billion large; the US financial services industry alone is $1300 billion in size, the money supply in high inflation countries (+6%) is over $4000 billion, the value of all paper money banknotes is about $4500 billion; the size of the physical gold market is some $7000 billion; foreign currency reserves (which Bitcoin could replace) are also $7000 billion; … you get the picture.

These are all market places that Bitcoin technology has the power to completely disrupt, and each time this happens it will put rocket fuel under the price of the Bitcoin currency.

What does this mean for the investor?

Well, that we shouldn’t be afraid of estimating the future potential value of one bitcoin in the range of $100,000 to $1 million. In other words, the risk/reward ratio of Bitcoin is still extremely positive.

Yes, there are scenario’s thinkable in which Bitcoin as a currency would fail — but the potential upside if it keeps growing like it does today is simply spectacular.

That’s why I recommend investing with a conservative amount of one’s portfolio: say 1–10%, depending on your risk profile and on how much volatility you can stomach.

In conclusion: no need to bet the farm on Bitcoin, feel free to invest with what you personally feel comfortable with.

Closing remarks

— That’s it, these are my seven lessons on how to invest in Bitcoin.

In closing here, I just want to express why I’m so very optimistic about Bitcoin in Latin America.

Everywhere I go in Europe or the US I feel many young people suffer from a phenomenon called ‘pronoia’ — they believe in a conspiracy of people, especially politicians, aimed at helping them. Young people tell me: “I’m not too worried, the state will surely find a solution for the debt problem.” They tell me: “Politicians will secure our deposits, they will find a way to contain inflation and keep the banks open. And the government will also find a way to keep paying for our pensions, our health care, my children’s education, etcetera.”

I find that the young people of Latin America suffer a lot less from this pronoia disease. They instinctively know that the answer to the question of their economic well being lies not in the decision of some government official, but in their own entrepreneurship, in their own imagination, in their own effort and initiatives.

Talking about this country in specific: right now things may look pretty bleak, but I think Argentina has amazing potential for economic prosperity. Yes, the old days can come back, when Buenos Aires was on equal footing with Paris and New York, and in many ways actually, life can become much better than it was then.

There is a tremendous amount of value in this country, that’s just obvious, and I think Bitcoin, which is the first truly global language of finance, Bitcoin will play an important role in helping to unlock that value.

Thank you.

Post Scriptum: Here’s a short interview I did for ElBitcoin during the conference, who then published it on their website.