On Bitcoin as a reserve asset
No, the United States should not invest in a "strategic Bitcoin reserve"
Bitcoin was created 16 years as an innovative solution to a decades old problem of how to create a decentralized cryptocurrency, a "peer-to-peer electronic cash system" as the white paper described. The solution is clever, to be sure, and a number of folks got really excited and started playing around with. Some folks realized it could be hoarded and sold for profit, and then some other people didn't want to miss out so they bought a bunch, then a public corporation spent tens of billions of dollars hoarding it, and now, all these people want to sell it to the US taxpayers, for a massive profit.
Now you don't need someone who has studied the consensus protocol to explain how much of unabashedly self-serving grab this proposal is. Instead, I'm going to explain why the security model underlying Bitcoin is still not suitable for a global reserve currency and never will be.
For years, the main criticism lobbed at Bitcoin was that it seemed like a fad, some sort of digital beanie babies or tulips that will soon be forgotten. Critics have been predicting the price is about to collapse to zero any day now, for over a decade. And they've been wrong over and over again.
Unfortunately the focus on price has created a perception that the entire question of the viability of Bitcoin boils down to whether there are enough buyers for it to catch on. That question has been answered clearly enough; Yes, into the foreseeable future there will be buyers for Bitcoin. When it goes down there are buyers. When it goes up there are buyers. It's lasted for 16 years now, and a $2 trillion marketcap can't be wrong, right?
But none of this addresses the deeper problem that none of the folks on CNBC understand. Bitcoin's consensus model was constructed to be a scrappy low-stakes internet currency and not meant to sustain a $50 T market cap decades into the future.
To put it bluntly, Bitcoin is underpinned by an adversarial mining process that is literally designed to break if one party gains too much control over the mining equipment. This was true in 2009. It was true in 2017 and it's true today. It's silly to put massive amount of national wealth into this sort of thing.
All our trust is in poorly paid miners
Bitcoin's blockchain is maintained by miners throughout the globe. (For a longer description, see here) Without the blockchain, there is no Bitcoin. The consensus model requires that miners are in constant competition to mine the next block, which they are rewarded for by freshly minted Bitcoin. However this model breaks down when one miner or coalition of miners is able to create more than 51% of the blocks. With this power, they can freeze transactions, overwrite recent transactions, or simply trash the entire process.
Miners use ASICs (Application Specific Integrated Circuits) to produce gazillions of hashes per second, in sort of a lottery game in which the more hashes you produce, the larger chance you have to win the right to produce the next block. There are only so many of these machines, and these are produced mostly by a corporation called Bitmain, which is headquartered in Beijing. So control of the blockchain essential comes down to the ability to purchase machines that are made in China.
Now the fact that these machines are made in China could be a temporary concern, they could be developed and sold here (after some initial costs.) But this leads us to another problem, the declining reward to miners. In order to keep the total number of bitcoins produced finite forever, the number of bitcoins that are minted to give to miners is cut in half every four years. Initially, miners were rewarded 50 bitcoins when they created a block. In 2012 this number went from 50 to 25, earlier this year (2024) it went from 6.25 to 3.125. In 2044, this will be down to 0.09765625 bitcoins per block. Mining corporations are expected then to buy ASICs, install them in warehouses and spend massively on electricity and hydrocooling to fight for a dwindling slice of this pie.
Mining is set up to be an extremely competitive market; for this reason miners should expect extremely tiny profit margins. Bitcoin's price cannot geometrically increase forever, as the price stabilizes and rewards are cut in half, some miners will be forced out of business or will consolidate. At some point there will be a glut of ASIC machines. These machines will be essentially useless except for one purpose: attacking the network.
You can value an ASIC using stock or flow value. The flow value (a dollars/time unit) of the machine will be the rate at which it returns profit. If the machine is not competitive, the flow value goes to zero. The stock value should be the discounted expectation of future flows; if a machine is expected to have no flow value in the future, the stock value is its value as a paperweight. If you have a warehouse full of outdated machines, or machines that went underwater when Bitcoin's price didn't rise to compensate for the halving, you probably need to pay someone to haul them to the dump.
To bring in numbers; Today Bitcoin's marketcap is about $2T. The "security budget" that is, the amount paid to miners, is around $16B/year. Of this $16B revenue we can assume that only a small chunk of this is profits. If Bitcoin is worth $1M in 2045, then the marketcap is about $21T and the security budget is around $5B/year. So a $21T asset is secured by $5B worth of revenue; safe to say for this competitive-by-design industry, well under a $1B (if not under $100M) in profit. Now we are in a goofy place. A rogue hedge fund could, for a relatively small amount of money, commandeer and brick the entire $20T ecosystem for fun and profit.
A global adversary could slowly stockpile these machines, or even produce their own, mining Bitcoin while profitable. Then guess what, they now have the power to freeze our stash, or simply make a joke of the Bitcoin protocol. Why would they do this? Probably because it would be ROFL hilarious to watch the USA realize they just lost trillions betting on a internet currency.
Now of course, you may say, there are ways to prevent this. The US could pay miners to destroy old ASICs, or they buy the ASICs themselves, building up the stockpile. Or Bitcoin could move to a new consensus algorithm (any Proof of Stake fans out there?) But these sort of things will throw Bitcoin's equilibrium off forever. One nation owning the hash power to defend an attack means that conversely, they now possess the power to execute an attack. And owning the power to create an attack essentially gives the US veto power over the rest of the global participants, making it extremely unattractive, and kind of ruining the whole point. The US is then in the position of selling this thing that it essentially is in control of as an asset. So kind of like US Treasurys, but instead of a continuous and stable flow of debt and repaid debt, it's rocky and unstable. At this point we've left the original Bitcoin long behind and are onto something else entirely.
The system was designed to break if necessary
To quote the whitepaper
The incentive may help encourage nodes to stay honest. If a greedy attacker is able to assemble more CPU power than all the honest nodes, he would have to choose between using it to defraud people by stealing back his payments, or using it to generate new coins. He ought to find it more profitable to play by the rules, such rules that favour him with more new coins than everyone else combined, than to undermine the system and the validity of his own wealth.
The game theory of the system is based on the logic that nobody will break something that they find useful. This is great for a small community which finds Bitcoin useful; you prefer not to break it. But this doesn't apply when it becomes a global reserve asset.
The entire security model of Bitcoin is based on an "He ought to find it more profitable to play by the rules" statement.
Just to be exceeding clear. Bitcoin lacks important physical properties of gold.
Gold is different. Gold you can put in a fort. If you have gold in your fort, and some other nation has gold in their fort, you can’t touch theirs and they can’t touch yours. Nothing you do with your gold affects their gold. The worst thing you can do is sell your gold, which might lower the market value of their gold. But without some sort of physical assault, you aren’t able to touch their gold.
Bitcoin is different. Bitcoin transactions necessarily all go on the same ledger. They have to otherwise the whole things makes no sense. Everyone has to agree on a single ledger for Bitcoin to function. Without the ledger there is no Bitcoin.
And the ledger can be attacked from anywhere in the world.
