Why don’t Buffetts understand Bitcoin? Make it clear in 10,000 characters

Buffett once said publicly: Bitcoin may be the square of rat poison.

The current fiat currency and financial system is fundamentally flawed. Cryptocurrencies, and Bitcoin in particular, offer individuals and nations an interesting and potentially increasingly attractive alternative system. Perhaps the biggest challenge to encryption is not technology, but consumer behavior. The current system still works well and is hugely sticky to users, so changes won’t happen overnight.

Premise of this article

Despite the meteoric rise of cryptocurrencies since the launch of Bitcoin in 2009, most people still do not understand why cryptocurrencies exist or what their potential is. In my experience, this problem is most acute among the highly educated and relatively wealthy. Compared to other demographics, the wealthy struggle to understand how the existing financial system is deeply flawed and do not understand the value that crypto can provide. If a system works well for some people, there is no reason for them to learn about alternatives, let alone seek them out.

This article provides a brief introduction to cryptocurrencies and explains at a very high level why this new technology exists. While this article may not make you change the perception that cryptocurrencies are nothing more than a bubble, even the most ardent crypto skeptic should gain a greater understanding of the technology and potential future applications of cryptocurrencies.

If you want a more convincing argument, take my word for the fact that cryptocurrencies are the most profound innovation since the birth of the internet. Everyone should be at least familiar with why cryptocurrencies are being adopted, especially the wealthy. After all, you don’t want to be left behind, do you?

Introduction: What is a cryptocurrency?

Cryptocurrency is a specific application of blockchain technology. Blockchain technology can be thought of as a digital ledger. A “block” is a collection of data, usually a cryptocurrency transaction. According to the design of the system, each block is added to the digital ledger, the blockchain, at specified time intervals. A blockchain is literally a “chain of blocks” that maintains a recorded transaction history linearly over time.

Cryptocurrencies are blockchains used to facilitate the exchange of value. Bitcoin is the first and most famous cryptocurrency. Simply put, the Bitcoin blockchain is a digital ledger used to track who owns how many bitcoins. Bitcoin is designed to be minted at a maximum of only 21 million bitcoins, and is often considered a digital store of value or “digital gold.”

The most profound innovation of Bitcoin is its consensus mechanism – Proof of Work (PoW). Highly simplified PoW consensus is a process by which a network of computers compete for the right to validate blockchain transactions. Under PoW, each computer that verifies transactions is called a “miner.” In return for their efforts, miners receive the network’s cryptocurrency, or bitcoins in the Bitcoin network. As an open-source protocol, anyone can add their computer to the Bitcoin network and verify the authenticity of all Bitcoin transactions since its launch in 2009.

Sounds simple so far. But you might be thinking “so what?”

That’s the answer to “so what?”: Proof of Work is designed to allow a vast network of independent participants to grow. As more money enters the network, the price of Bitcoin rises and more miners are incentivized to join the network. And as more and more miners join the network, the higher the trust in the network, the more funds enter the network, and so on and so forth.

This elegant incentive mechanism creates a vast network of independently operating computers dedicated to keeping a simple ledger of Bitcoin transactions. Since its launch in 2009, the Bitcoin network has grown massively, with more than 100 million Bitcoin owners, about 1 million miners, and a combined market capitalization of about $400 billion, making it the 17th largest asset in the world. Bitcoin adoption has been so rapid that it rivals the early days of the internet.

Why Warren Buffetts Can't Understand Bitcoin  Make it clear in 10,000 characters

Comparison of the number of cryptocurrency users and the number of early Internet users

Let’s take a step back and rethink what’s going on.

Completely organically, more than 100 million economic actors have voluntarily opted into the Bitcoin network. There is no government, no coercion, and no central authority. Using only computer code and simple incentives, Bitcoin has successfully enabled a sizable group of people in the world to cooperate and coordinate with each other to voluntarily exchange value. It’s unbelievable.

Ethereum, the second-largest cryptocurrency by market cap, builds on Bitcoin’s consensus innovations but introduces programmability. Ethereum is a cryptocurrency with smart contract capabilities. Smart contracts on Ethereum enable users to enter into agreements over the internet, enforced by code. Its purpose is not only to manage the exchange of its own tokens, as Bitcoin does. For example, on Ethereum, you can borrow money on the lending platform Aave, swap one asset for another using the automated market maker Uniswap, and buy a piece of art or avatar on the NFT platform OpenSea .

Although it’s still early days, with Ethereum you can see the potential of an internet-based global financial system; a system without borders, one accessible to anyone with an internet connection, and a third party without rent-seeking A system that extracts a fee for each transaction. It is worth noting that despite being more than 6 years younger than Bitcoin (Ethereum was launched in 2015), Ethereum is growing even faster than Bitcoin and has almost twice as many wallets as Bitcoin.

Why Warren Buffetts Can't Understand Bitcoin  Make it clear in 10,000 characters

Number of wallets with balance greater than 1 (millions)

Hopefully by now you are starting to see the importance of cryptocurrencies and some potential use cases such as value exchange.

To further emphasize a few key points, the decentralized public blockchains Bitcoin and Ethereum are:

  • to trust. They do not require centralized authority to coordinate between two or more different parties.
  • Anti-censorship. Hundreds of thousands of economic actors around the world independently maintain the network. Therefore, it is nearly impossible for companies, individuals and governments to block anyone with an internet connection from accessing the protocol
  • Safety. Taking Bitcoin as an example, to attack the protocol it would need to control 51% of the network, I estimate that at least $8 billion worth of equipment, billions of dollars in capital and years of necessary infrastructure would be required to reach this hashrate invest.

In a word, Bitcoin and Ethereum are public blockchains that anyone in the world can access without a gatekeeper or worry about your assets being misappropriated. This is significant because before cryptocurrencies, people always needed a government to run such a massive global system.

The wealthy are likely to have a high-level understanding of the technology and recognize that many are choosing to get involved, but may still be highly skeptical of it. They might be thinking, “The current system is working so well, what’s the point of cryptocurrencies?”

Let’s explore the current paradigm to better understand how cryptocurrencies can provide an interesting alternative to the existing financial system.

Fundamental flaws in the fiat currency system

In fact, the current fiat currency system with the US dollar as the global reserve currency and chronic deficit spending by Western governments is unsustainable. Several other alternatives will emerge in our lifetime, and currencies issued by governments with persistent fiscal deficits, including the U.S. dollar, will depreciate significantly over the next few decades. Given this possibility, it would be wise to think about how to protect yourself from currency devaluation now. Cryptocurrencies, especially Bitcoin, offer an interesting solution to this dilemma.

The U.S. federal government’s budget has been in negative territory since the Nixon administration officially ended the Bretton Woods system that pegged the dollar to gold. The petrodollar system that emerged in the 1970s made the dollar an effective global reserve currency. As the global reserve currency, the demand for the dollar does not come from the United States alone, allowing the United States to consume more than it produces without substantially depreciating the dollar. The United States took advantage of this arrangement. The cumulative deficit in the US exceeds $20 trillion, and the trend continues to widen.

Why Warren Buffetts Can't Understand Bitcoin  Make it clear in 10,000 characters

Annual and cumulative U.S. federal budget deficits

The U.S. Treasury, which is responsible for funding the federal government, sells Treasuries to pay for the federal government’s spending beyond its capacity. For most of the history of the petrodollar system, foreign governments such as China and Japan, as well as individuals and investment institutions, have been reliable demanders of Treasuries. Beginning in 2009, US government spending began to surge during the Global Financial Crisis (GFC). Since then, foreign demand for U.S. government bonds has been shrinking. As the chart below shows, the problem has been exacerbated during the Covid-19 crisis. Increasingly, other countries don’t want the U.S. government to continue profligate.

Why Warren Buffetts Can't Understand Bitcoin  Make it clear in 10,000 characters

Buyers of U.S. Treasuries: Biggest buyer during global financial crisis turned net seller in Covid-19 crisis

To fill the void left by foreign buyers leaving the U.S. Treasury market, the U.S. central bank, the Federal Reserve, began buying bonds from the Treasury in a process known as “quantitative easing” (QE). Quantitative easing can be thought of as governments printing money to finance themselves, rather than collecting more taxes or cutting spending. Printing money through quantitative easing has proven itself a more popular solution to financing government spending than the austerity measures Greece took after the global financial crisis.

The Federal Reserve, the largest buyer of U.S. Treasuries, kept interest rates very low in the wake of the global financial crisis, allowing the government to finance itself with favorable rates, or cheap debt. On the other hand, the U.S. government has no incentive to address the structural problems of the federal government budget due to the low cost of financing. Thanks to generous benefit programs like Social Security and Medicare, and as America’s elderly population surpasses its working-age population, U.S. government spending will grow faster than its tax revenue for decades to come.

Why Warren Buffetts Can't Understand Bitcoin  Make it clear in 10,000 characters

U.S. budget deficit with no end in sight

Over the past decade, the Fed has become the largest holder of U.S. Treasuries, holding about 40% of long-term Treasuries. Recently, the Federal Reserve was forced to reverse its quantitative easing policy to control inflation caused by extreme money printing during the Covid-19 crisis, when the U.S. government increased the money supply by about 40%. The process of “quantitative tightening” (QT) is the opposite of QE: the Fed stops buying Treasuries and the money supply decreases. The Federal Reserve began signaling to the market that QT was coming in November 2021, leading to a sharp rise in Treasury yields and a sharp sell-off in risky assets such as cryptocurrencies.

The U.S. government and the Fed face a serious problem from here. If the Fed relies on the free market to finance the U.S. federal government’s deficit, interest rates on government debt are likely to be much higher than what the U.S. has enjoyed for most of the past decade. Remember, the Fed buys about 40% of the federal government’s outstanding long-term debt. At least 40% of the demand for Treasury issuance has to be replaced, and one of the biggest sources of demand — foreign governments — doesn’t want to fund U.S. government spending. These are huge demand gaps that need to be filled.

Higher interest rates will have a doubly negative impact on the government’s ability to fund projected spending. First, higher interest payments lead to larger government deficits (and thus more bond issuance). Second, and more perniciously, higher interest rates lead to lower taxes as the cost of debt rises and the economy slows. A slowdown is a major no-no for a debt-driven and rising indebted society. At the very least, through 2032, the federal government will have to finance a deficit of $1.5-2.0 trillion a year. The problem gets worse with higher interest rates and lower economic growth.

Why Warren Buffetts Can't Understand Bitcoin  Make it clear in 10,000 characters

America has a huge deficit problem; with rising interest rates and slowing economic growth, the problem will only get worse.

Essentially, with a lot of debt to be issued over the next decade and the U.S. government unable to afford excessively high interest rates, the Fed will likely need to re-implement quantitative easing at some point in the next few years, if the U.S. economy enters a recession, Then the day will come sooner. Quantitative easing means continued money printing and dollar devaluation.

This U.S. government’s system of chronic deficits imposes considerable costs on ordinary Americans. As the government gains more control over U.S. spending power, more and more ordinary Americans will spend more on politically favored industries such as health care, education and housing.

Why Warren Buffetts Can't Understand Bitcoin  Make it clear in 10,000 characters

Selected U.S. consumer goods, services, and wages data from 2000 to 2020

In addition, declining asset prices and the purchasing power of the middle class have led to a growing share of wealth held by the wealthiest Americans. With ordinary people competing for an ever-shrinking pie, governments and the wealthy have little incentive to change the existing systems that govern the country.

Why Warren Buffetts Can't Understand Bitcoin  Make it clear in 10,000 characters

US net wealth distribution

While U.S. finances are troubling, many foreign countries are worse off.

Japan’s finances today may be the United States of the future. The Bank of Japan (BoJ) owns nearly 50% of its own bonds. The Japanese government seems determined to fund its economy as much as possible before yen holders discover that the yen is not scarce and worthless.

Why Warren Buffetts Can't Understand Bitcoin  Make it clear in 10,000 characters

Developing countries such as Turkey, Argentina and Venezuela do not benefit from a strong economy or reserve currency status and spend more than they can afford, they suffer from alarmingly high inflation and a persistent currency crisis, and their citizens are increasing year-on-year. poorer year after year.

For billions of individuals subject to irresponsible government monetary policies, Bitcoin offers a potentially compelling alternative to increasingly unstable fiat-based systems.

Most prominently, Bitcoin provides the certainty of scarcity. Bitcoin is designed so that only a maximum of 21 million bitcoins can be minted. Because the blockchain is decentralized, no one can change the amount of bitcoin, and no government can reduce an individual’s purchasing power in bitcoin. It’s easy to see why someone would choose to hold a provably scarce digital asset like Bitcoin, rather than their local currency depreciating by double or even triple digits every year.

In fact, cryptocurrency adoption is strongest in developing countries. According to Statista, Nigeria, Vietnam and the Philippines are the three countries with the highest cryptocurrency adoption rates, with 32% of Nigerians using or owning cryptocurrencies. Over the past decade, Nigeria has reported inflation between 10-20%. To put it bluntly, the purchasing power of a Nigerian is declining by 10-20% every year. At the same time, the purchasing power of Bitcoin has increased by thousands of percent over the past decade. If it were you, which system would you choose?

Why Warren Buffetts Can't Understand Bitcoin  Make it clear in 10,000 characters

It is clear that individuals are choosing cryptocurrencies. There are also growing reasons to believe that, in the near future, perhaps entire nations will consider alternatives to traditional assets to protect their wealth.

In February, the US cut off Russia’s access to the SWIFT system. The Society for Worldwide Interbank Financial Telecommunication is a global payments network that facilitates trade between international financial institutions. The U.S. has effectively cut Russia off from the main technological infrastructure of global trade. Adding to the pressure, news this summer that the European Union is exploring a ban on gold imports to Russia.

Historically, the US-led Western financial system has been the most trusted due to its relatively stable government and robust legal protections. Gold has always been the gold standard for reserve assets: scarce and ostensibly without counterparty risk (gold itself does not go bankrupt). Recent events have highlighted to the world the risks inherent in storing wealth in systems controlled by Western democracies. Major countries are increasingly looking for alternatives. Several properties of Bitcoin make it an interesting alternative to traditional reserve assets such as paper money, sovereign bonds, and gold.

Bitcoin is sovereign. There is no counterparty risk. The Bitcoin network is a collective of tens of thousands of networks operating independently in dozens of countries around the world. All a country needs is a node and an internet connection, and they can immediately use their wealth. Countries no longer need to fear that an increased supply of dollars will devalue their assets or that adversaries will take away their access to their property by cutting off Russia’s access to the SWIFT system, as the United States has done.

The current fiat-based paradigm is plagued by human causes. Mathematically, the problem of long-term currency devaluation could get worse. This puts individuals at risk of accelerated loss of real wealth. At the same time, countries are increasingly aware of the risks posed by participating in a U.S.-controlled monetary system. Cryptocurrencies, and Bitcoin in particular, offer individuals and nations an interesting and potentially increasingly attractive alternative to current fiat currencies.

Now that we understand the inherent unsustainability of the fiat currency system and its currencies, let’s explore the underappreciated issues in the financial system, especially by the wealthy who think the existing system is better.

Fundamental flaws in the financial system

Most people can feel the appeal of Bitcoin and “digital gold” as the general perception of currency devaluation has increased in the wake of quantitative easing. The potential of Ethereum and Decentralized Finance (“DeFi”) as an alternative to the existing financial system is where the technology really struggles for the wealthy to understand. The existing system already works for most people, so what could be improved?

Modern financial systems are designed around the idea of ​​a trusted third party or parties. You save your money and apply for a mortgage from a bank like Chase. You deposit your stock with an online brokerage like Schwab. You pay for groceries and other essentials with your Mastercard credit card. You use financial apps like Cash App or Venmo to pay bills or your friends. You send money to loved ones overseas through money transfer providers such as Western Union. This usually all goes smoothly. But have you considered the price you paid for it?

Think about what you need to provide just to access these services. You need to provide every detail about yourself. Need to wait a few days for approval. If you have bad credit, they can reject you. If you are not a US citizen then good luck. Assuming you are able to sign up, you may also only be able to access services during specific, narrow hours, such as a bank (9-to-5, and only on weekdays) or a brokerage (market hours).

Then there’s resistance. Want to change one? Think about how painful it is to switch brokers. If you’re leaving the country, your bank or broker will most likely see you as a terrorist (to be clear, it’s not their fault, as the government asks them to). If you’re a merchant, it can take days or even months to finally receive funds for a transaction. Not ideal if you’re a small, cash-strapped company.

Last but not least is the cost. Banks offer a 2-3% spread in order to hold your money. They pay you 0% and then lend it out at 3%, 4% or even 5%. OK Brokers like Charles Schwab make a fortune on the mutual funds they sell to you or the securities you hold. Credit card issuers like Capital One and payment processors like Visa take 2-3% of any debit or credit card transactions you make. Money transfer providers like Western Union make a staggering 5%+ profit on the privilege of sending money outside the United States.

Why does it all cost so much money? Because of the combination of rent seeking and trust. Banks benefit from insurance subsidies from the FDIC, essentially ensuring that they will be the primary place to store your cash. With the help of banks and governments, payment processors monopolize the technological rails we use to move money. Various government regulations and technical standards make sending money between countries complicated and expensive, especially for small transfers. We believe that these systems emerged out of habit and have never questioned the necessity or cost of such arrangements.

What if we could create a system that has all the trust of an existing system, while eliminating the rent-seeking problem?

With Ethereum and other blockchains that support smart contracts, we can.

Today, you can store your wealth in a digital wallet on the Ethereum blockchain that you can access from anywhere in the world at any time of the day. There is absolutely no resistance from bank hours, national borders or other inconveniences. All you need is an internet connection and a browser.

Want to earn some income from your cash? Head over to Aave, a decentralized lending marketplace, and deposit some funds. Aave currently pays 1-2% in stablecoins (i.e. digital dollars) while earning 10-15% of depositors’ income. Good luck to the banks that will compete with Aave in the future.

Want to exchange some of your cash for another protocol’s tokens? Head over to Uniswap to buy tokens for a promising emerging project.

Want to take out a loan? Head over to MakerDAO, deposit your Ethereum, and withdraw some stablecoins (i.e. digital dollars). You might be surprised to learn that people are already borrowing their crypto assets on the internet completely without permission and buying real-world assets like pianos and even houses.

Want to pay a merchant for a cup of coffee? Pay your local barista in seconds using your Phantom wallet and USDC stablecoin on the Solana blockchain for less than a cent per transaction. No more 3% fees to credit card companies, and merchants no longer need to wait days or even weeks for money to arrive.

In all of the above examples, you can:

  • Access them in seconds from anywhere in the world. All you need is an internet connection, a browser like Chrome, and a MetaMask wallet to use these apps. No need to share your identity or wait for someone to approve you.
  • Instant settlement. No need to wait for the bank to approve your loan or the settlement of a stock trade. You can get funding in minutes.
  • Cheap. The current transaction cost on Ethereum is $1-2, making payments over $100 competitive with credit cards. On similar other smart contract platforms like Solana or Polygon, the cost per transaction is even cheaper and faster.

Bottom line: Blockchain-based systems are more accessible, have the least friction, and are much less expensive. More access, less friction, and lower costs are often a powerful combination of technologies, just as the Internet has demonstrated to traditional industries: Google’s advertising and media, Amazon’s retail, and Apple’s mobile phones.

Before we assume a utopia free from the quagmire of the traditional financial system, let’s be a little more realistic: the technology has a long way to go before it’s ready for its prime time. The current user experience is terrible. Using cryptocurrencies in the real world is almost impossible. The regulatory treatment of cryptocurrencies is still very vague.

The biggest challenge for crypto may not even be technology, but consumer behavior: the transition from using a third-party service to manage your wealth to self-custody is a huge challenge. Consumer behavior is sticky, as AOL’s 1.5 million paying customers demonstrate. I wouldn’t expect baby boomers to dive headfirst into a public blockchain-based financial system.

But like the early days of the internet, encryption represents a technological leap from zero to one compared to the existing financial system. The news is out: Thousands of software developers are pouring into the field to take advantage of this potentially once-in-a-lifetime opportunity:

Why Warren Buffetts Can't Understand Bitcoin  Make it clear in 10,000 characters

Ethereum continues to attract developers

Thousands of entrepreneurs and people who are increasingly concerned about cryptocurrencies will figure out what’s wrong with cryptocurrencies. As doubts clear, individuals may increasingly continue to opt for the crypto financial system and cut out the middlemen that dominate the existing financial system.

in conclusion

Current fiat-based systems generally work well. Billions of people are able to exchange goods and services every day, and the system is sticky. Customs and regulations such as government requirements to pay taxes in local currency make it extremely unlikely that an alternative financial system will emerge overnight.

What is more likely is that individuals continue to opt for the new internet-based economy, with digital assets such as Bitcoin and Ethereum accounting for an increasing share of global net worth. An internet-based sovereign financial system offers so many benefits compared to existing systems that cryptocurrency adoption is unlikely to stop in the next few years.

In addition, there are speculative cycles. The crypto asset class is the best performer ever. Bitcoin has grown 230% annually over the past decade. Ethereum has risen more than 2,000 times since its initial coin offering in 2014. But the transfer of wealth from the traditional fiat-based financial system is still in its early stages. The total market capitalization of cryptocurrencies is $0.9 trillion, while global assets are around $500 trillion. It’s not out of the question to think that the world could co-store 1% to 10% or more of its wealth in cryptoassets in the long term, especially as the world becomes more and more digital. Future crypto cycles will continue to push the technology forward and attract a new crop of risk-seeking adventurers (eg: me, only getting in the car in 2021).

Therefore, even if the existing system works well for you and you are a cryptocurrency skeptic, you should understand and appreciate cryptocurrency, a technology wave that may be bigger than the internet. Cryptocurrencies may only get stronger in the coming decades.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/why-dont-buffetts-understand-bitcoin-make-it-clear-in-10000-characters/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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