Bitcoin is pristine collateral

“The difference between assets that are someone else’s liabilities, and assets that are nobody’s liability, probably got a lot clearer to people in recent weeks.” – Lyn Alden

We are at the inception of seeing companies post bitcoin as collateral to borrow fiat currencies. One such example is MicroStrategy which recently borrowed $205 million by posting $820 million of bitcoin as collateral, representing a 25% loan-to-value, at a floating rate plus 3.70% from Silvergate Bank.

It’s important to remember that Silvergate Bank has its deposits insured by the US Federal Deposit Insurance Corporation (‘FDIC’), so this is effectively the US banking system underwriting bitcoin-backed loans.

More companies are entering this space, including a listed US REIT, SL Green Realty Corp, which announced in its 2021 Annual Institutional investor day presentation that it has made a $10 million investment in a bitcoin fund as they “believe in the future of Bitcoin as a means of transacting business even in real estate”.

Adam Reeds, the co-founder and CEO of Ledn, a financial services platform for holders of digital assets, introduced the idea of borrowing against bitcoin holdings. This would work with lenders using verifiable bitcoin holdings (also known as proof of reserves) as the asset the lending would be against, instead of allowing borrowers to borrow against their future earnings which represents their ability to repay their loans.

This would be done through bitcoin-backed loans, instead of mortgage-backed securities, as it allows bitcoin holders to maintain ownership of their bitcoin without having to sell the asset, and be able to utilise their bitcoin to finance real estate asset purchases. This adds to the growing narrative that bitcoin is pristine collateral.

While mortgage-backed securities continue to be heavily regulated in the market, the regulatory framework for bitcoin-backed loans is still a work in progress according to Josip Rupena, the founder and CEO of Milo, the crypto mortgage platform.

What is bitcoin?

Bitcoin is the world’s first global, private, digital, rules-based, monetary system, and is increasingly considered to be digital real estate. If bitcoin’s fixed supply of 21 million units represented the surface area of habitable land on Earth, each unit of bitcoin would be the equivalent of 750 acres of land.

Bitcoin has grown organically since its creation, with no venture capital money, no CEO, no marketing department and it is not going away anytime soon. The Lindy Effect (a theory that the future life expectancy of specific non-perishable items, like a technology or idea, is proportional to their age (credit to Sahil Bloom for the explanation)), which when applied to bitcoin, means that the longer bitcoin survives, the more likely it will continue to exist, leads to it becoming more and more permanent in the world’s perception as valuable.

On 31 October 2008, Satoshi Nakamoto, an anonymous person/group, released the bitcoin whitepaper. On 3rd January 2009, the first bitcoin was mined and embedded in Block 0 of the Bitcoin blockchain, the coinbase of this block included the text: “The Times Jan/03/2009 Chancellor on brink of second bailout for banks.”.

A bitcoin is created by the process of “mining” i.e. bitcoins are introduced to the supply at a fixed rate, with blocks mined every ten minutes. Therefore, the production takes place on a designed, predictable schedule, with its scarcity programmed, provable and transparent. Bitcoin is 24/7 and operates like clockwork.

At any given point in time, anyone can verify how many bitcoins are in existence. Every 210,000 blocks, the number of bitcoins that can be mined, per block is halved, as follows:

Period Block Reward

2009 – 2012 50

2012 – 2016 25

2016 – 2020 12.5

2020 – 2024 6.25

2024 – 2028 3.125

2028 – 2032 1.5625

On May 11, 2020, the reward halved to 6.25 bitcoin. This equates to a production of 900 bitcoins a day. Based on the above halving schedule, the final bitcoin is projected to be mined in 2140.

Bitcoin has since gone on to represent different things to different people, and in particular, solving the issue of unsound money to people globally.

While Nakamoto’s white paper may have intended for peer-to-peer transactions, to compete with fiat currencies such as the US Dollar, Euro and Yen, bitcoin does not have to replace the everyday cash transactions in global finance. In the developed world, very few people are paying for everyday items with bitcoin, such as coffee. In legacy financial world parlance, this would be the equivalent of purchasing coffee with US Treasury bonds (which represent the safest way to store dollars), which represents the store of economic energy. If this money is to be used, it needs to be converted into a currency like the US Dollar for consumption and usage.

In the legacy financial world, US Treasury bonds and gold (until 15th August 1971, when Nixon unpegged the US Dollar from gold) are considered to be the main tool to store long-term wealth. Bitcoin is competing with this by addressing the devaluation of fiat currency, enabled through the actions of governments, over time.

We must consider and understand the difference between currency and money. Currency is a medium of exchange, a unit of account. It is portable, divisible, durable and fungible (interchangeable). Money is the same, and also provides the function of being a long-term store of value and maintaining its purchasing power over long periods.

For the first time in human history, there is a solution that eliminates the need for a trust-based model to not only store but also exchange value through a centralised institution such as a bank, and this is bitcoin. Bitcoin exists as strings of free and open-source software code with no physical form, on the internet. The Bitcoin blockchain facilitates transactions of bitcoin (the monetary asset) allowing recipients to custody bitcoin.

Monetary properties

To appreciate why bitcoin is a monetary asset, we have to understand the fundamental properties of money:

a)     Divisibility – the ability to be subdivided as a monetary medium;

b)     Durability – the monetary asset must not be perishable and must be long-lasting over time. Throughout history, gold has proven to be especially durable as it is a non-reactive metal;

c)     Portability – the ability to move across space and time, securely, protecting it against loss and enabling long-distance trading;

d)     Scarcity – resistance to counterfeiting or supply inflation, which would devalue the existing monetary asset that remains in supply;

e)     Fungibility – an asset that is interchangeable with another of equal quantity. For instance, this can be the interchangeability of a USD$1 note for another USD$1 note, which holds the same value;

f)      Verifiable – the asset must be easy to identify and verify as authentic. Gold fails this since the only way to truly assess the purity of gold, is to melt it down.

Bitcoin satisfies each of these properties, as follows:

a)     Divisibility – each bitcoin is divisible into 100 million units, known as Satoshis, and can be used for transactions of all sizes including buying coffee, or be a settlement layer for large transactions across the world;

b)     Durability – despite the threat of hackers, and repeated attempts from nation states to regulate bitcoin, the network has continued to function as designed without ever breaking down;

c)     Portability – bitcoin can be stored in private keys or on digital wallets and be easily moved across the world. Global transactions with immediate settlement are possible between any two points connected to the digital network.

d)     Scarcity – there will only ever be 21 million bitcoins in accordance with its code and blockchain technology. The only way this changes is if consensus is achieved by 51% of the network, which would necessitate a hard fork to be activated by both miners and node operators.

e)     Fungibility – on transmission, every bitcoin is treated the same on the bitcoin network and can be traced on the blockchain.

f)      Verifiable – bitcoin can be verified using cryptographic signatures with mathematical precision and certainty, which makes it impossible to counterfeit.

As a consequence of the above monetary properties, bitcoin is the ultimate savings technology as it enables a person to store their money for the future, which represents their economic energy that cannot be devalued through the printing of additional monetary units, thereby bringing control into the hands of the holders in the form of sound money.

A centralised protocol is not able to maintain these properties as the network can be controlled by individuals or groups. Decentralisation is therefore the means, not the end. With miners and node operators increasing in numbers and spreading as widely as possible, the trust requirements are reduced as no single entity can interfere with the use of the system.

It should be remembered that Russian oligarchs who have stored their wealth in London real estate over the last 20 years have seen in recent months through government sanctions, these properties get seized. Bitcoin, therefore, presents a more robust alternative that cannot be seized if secured properly, be it cold storage or multi-sig security.

While bitcoin may be volatile in the short term, when measured in fiat currencies, it has always trended upwards in price over long durations. The only negative of bitcoin is that it has a short history, and even today the market capitalisation is hovering around $1 trillion with the asset class remaining in price discovery mode. As more sophisticated investors continue to enter the market, with incoming regulation set to provide more clarity, we will continue to see the price of bitcoin, when measured in fiat currencies continue to appreciate.

Yet it must be remembered that bitcoin itself remains very stable as it has a fixed supply of 21 million with 1 bitcoin = 100 million Satoshis.

Conclusion

Bitcoin is an alternative to owning equities, as it demonetises capital from other asset classes like bonds and public equities, which are essentially claims on future cash flows. This is because bitcoin is a decentralised asset that remains outside the system and has continued to outpace official inflation over long periods of time.

You may have heard the term ‘hyperbitcoinisation’ which refers to bitcoin as the long-term store of value and the currency for everyday transactions, and whilst hyperbitcoinisation remains possible, it makes collateralised borrowing very difficult where there is only a finite quantum of an asset available, at least until such time that the new financial world allows issuers to tokenise bitcoin.

It should be remembered that home purchases in the legacy financial world, take place under a system called fractional reserve banking, which allows banks to issue credit out of thin air and provide a mortgage against one’s future earnings, whilst paying LIBOR plus a fixed interest rate to repay the mortgage over 20 to 30 years.

In the world where bitcoin becomes increasingly recognised as pristine collateral, lenders will consider bitcoin to be the hardest form of money and consequently allow borrowers to collateralise against it for fiat currency denominated credit like the US dollar to acquire other hard assets such as real estate.