A perfect example would be Tesla today. If you look at the Tesla stock, you see some people that are adamant. I mean, passionate about why it’s going higher. Then you have another crowd of people that have the exact opposite opinion saying, “This thing is so overpriced, and their liquidity is a disaster. They’re going to have to dilute the shares.” All that kind of stuff. You’ve got really strong arguments on both sides. At the end of the day, we’re going to find out who’s right and wrong, but that’s what I love about finances. You’ve got to really step into these intellectual arguments. You can’t have surface-level comments. You’ve got to go really deep and you have to think second, third, fourth-order effects as to why something is or something isn’t.

Robert Leonard  05:16

Yeah, everyone has an opinion were those puzzle pieces go, but only one person can be right. That puzzle can only come together in one way, and whoever’s pieces fit in the right spot is going to be right at the end.

I’m excited to dive into today’s topics. We’re going to talk about Bitcoin, cryptocurrency, blockchain, and everything else related to these topics. I’m excited because they’re such popular topics, but they’re ones that I don’t personally know a lot about.

When Bitcoin first went mainstream a few years ago, I remember I bought one coin for like $1,000 or $1,500 just to try it. Then I quickly sold it like a day or two later for a small profit because I almost felt sick. It was not an investment that I could sleep easily at night owning.

But before we dive into that conversation, let’s start by first defining some important terms. What is a cryptocurrency? And then, what is Bitcoin?

Preston Pysh  06:48

I don’t know if I’m going to give you the right definition here, but I guess how I would personally describe it is when you say blockchain, I think this is important for people to understand upfront. What in the world is that? And what’s the technology behind it? This is the way I would describe the invention: If I sent you a digital picture, and you received that digital picture, you can basically copy and paste that digital picture and send it to a million people if you want to. If I would send you that digital picture through a blockchain, you are the only person on this entire planet that can own that picture. It cannot be duplicated digitally. That’s really hard for people to wrap their head around; how that’s even possible, digitally, to be able to send something and be the only copy. But that’s what blockchain does. Okay?

When you start there, and you understand that you can now send a digital scarce item to another person, and they’re the only person that can take possession of it, now people can understand how, instead of it being a picture, you could just make units or numbers, and I can send you a unit.

If I create 10 units on a blockchain, and I send you one of those units, you’re the only person that can own that one unit, and I would be the only person that could own the other nine units. That’s if you and I were the only two people participating in that. I’m dumbing this down to a really simple, easy to understand manner.

But now, imagine that happening on a global scale. There’s a fixed quantity of those units that have been created inside that protocol as it gets distributed; as they get traded amongst people. So, if you take that one unit, and you give half of that unit to your mom and the other half to your dad, now there are three people. I own nine. You own zero because you gave your one unit away, and mom and dad have half a unit. That’s pretty much what’s going on with cryptocurrency.

When we say cryptocurrency, what we’re talking about are units that are on a protocol with a set baseline. When I say set baseline, that’s the 10. You can’t create more because everyone that participates in the protocol has to agree that there should be more added. When you have something that is distributed like that, if you’re adding more units into the protocol, it doesn’t benefit anybody if they’re getting it proportionately shared amongst everybody. There’s no incentive there.

And when you talk about Bitcoin specifically, and why I would argue that the market cap on Bitcoin is so high is because it is so decentralized at this point that the incentive structure is prohibitive for people wanting to add more units to the protocol. It’s not even possible unless every node agrees that more units should be added. That’s where people will make this argument: “How can you control that there’s only going to be 21 million BTCs ever created? Can’t somebody go in there and adjust code, and there’ll be 22 million BTCs?” That cannot happen because everyone that’s running full node inside that protocol would have to agree on adding more units to the baseline of units that are in the protocol.

I’m going kind of all over the place, but in general, when you’re talking to cryptocurrency, you could basically write your own protocol. Today, Robert you could write your own protocol. You could call them Robert Coins, and if you can get 10 people to trade your Robert Coins, then you have a cryptocurrency. Now, would that have a lot of strength in the mining, or are they pre-mined? You can get all into all these other discussions, which we’ll table for now to keep the discussion pretty simple. But that was what I would call a cryptocurrency.

Then, I would describe Bitcoin as being the most decentralized cryptocurrency out there that does not run into conflicts of interest of a single person thriving the dominance of the governance that’s taking place. It’s completely distributed amongst millions and millions of people.

Robert Leonard  10:43

One of the things that stood out there that you said was the Bitcoin’s market cap. When I heard that, it seemed interesting to me. We talked about this before the show. I don’t know much about Bitcoin either, so I’m learning along with the audience, but when I hear “market cap”, I think of stocks. I think of equities. You don’t usually think of a currency. I don’t think of the US dollar having a market cap. What does that mean in relation to Bitcoin? How is there a market cap around a currency?

Preston Pysh  11:10

If we’re talking stocks, market cap is a really common terminology, right? All it is is that you’re taking the share price. Let’s say that there is a $10 share of a stock, and there are 10 shares of that stock. The market cap is just the number of shares outstanding, which is 10; and the per-share price is just $10. Multiply those two numbers together, and you get the market cap, which in this case would be $100. Now, if you’re talking Apple or one of these other companies…I mean, for Apple, you have like a trillion-dollar market cap. When you take all the shares outstanding and multiply it by the share price, you get the market cap.

So, when you are talking about a currency, and I guess the reason that it doesn’t really make any sense anymore is because it’s pretty much all these central banks are printing fiat currency. When I say fiat, that means it’s backed by nothing. They can just print more of it if they want to. That’s what makes something a fiat currency. It’s really hard to understand that because the baseline is constantly changing, and there’s no fixed amount.

But with Bitcoin, you have a fixed supply that will cap at 21 million BTC. Today, it’s at 18 million BTC. We can talk about how that is slowly rising to 21 million BTC. But today, the current number of units that are out there on the Bitcoin protocol, there’s 18 million BTC.

I think this is really important for people to understand. There’s 18 million BTC, but you can go beyond the decimal point. You can buy .1 BTC or you can buy .001 BTC. The decimal point goes out the ten to the negative eighth power, so if you were going to move that decimal point to the right, you have so many units. It’s not capped at 21 million units. It’s capped that, but you can buy .1 BTC or further down till ten to the negative eighth. So, there’s plenty of units to be distributed globally amongst all people in the world. But to come up with this market cap figure, what you’re doing is you’re taking that current supply, which is 18.2 million BTC. You’re multiplying it by the current price. 1 BTC, if you’re going to buy one bitcoin today, is worth $10,211. When you multiply those two numbers together, you get a market cap of $186 billion. That’s the market cap.

Robert Leonard  13:19

As that 18.2 million BTC gradually increases to its cap, at that point, do you expect the price to rise dramatically because of supply and demand?

Preston Pysh  13:30

You have to ask yourself, what are you comparing that to? So, yes, you have inflation. That’s actually happening in Bitcoin. We could argue that, but for simplicity’s sake, we’ll just say that there’s inflation. What I’m talking about is that people lose their bitcoins, which they can actually do. If they lose their private keys, they can lose bitcoins. I could maybe make the argument that the number of people that are losing their private keys is similar to the inflation rate today. Maybe. It’s hard to say. Anyway, that gets into a technical conversation, which we don’t want to have right now.

There’s a little bit of inflation, because you’re at 18.2 million BTC today, and you’ll get to 21 million BTC in the future, which isn’t going to happen for…you don’t hit 21 million BTC for I don’t know what the date is, but it’s close to 100 years from now. That is how long it’s going to take the protocol to eventually get to 21 million BTC. So, the inflation rate is that small. Today, it’s about 4%, and then that’s going to be cut down to about 2% or 1.5% here, coming up in May time frame. You go through what’s called a 4-year halving cycle. And so then, it’s going to be putting more bitcoins onto the market even slower. That happens every four years. The protocol limits the amount of bitcoins that are being paid to the miners that are securing the blockchain.

So, to answer your question, which was supply and demand based. You’ve got something that is systematically inflating at a relatively small rate, especially when you account for lost coins. Okay? And what you’re comparing it to is fiat currency and all the other central bankers in the world that are issuing currency. Let me tell you, they’re issuing it a whole lot faster than that.

And so, when you talk about the value of a currency, you have to look at what you are comparing it to. Are you comparing it to the price of gold? Are you comparing it to the Euro? To the Yen? So, what I would tell you is relative to the other fiat-based currencies, Bitcoin is rock solid as far as the inflation rate.

Robert Leonard  15:27

You also mentioned that I could, technically, create my own coin. I’ve heard many other companies even like Facebook with Libra, and just other people or organizations that have created other coins. Why are there so many coins out there right now? What is the purpose of that, and how are we going to define a clear winner?

Preston Pysh  15:46

This is a really popular question for people as they’re looking at this. If you go to coinmarketcap.com, what it does is it keeps track of every cryptocurrency out there, the market cap, and how the price has changed. It also shows you how the price has changed relative to other cryptocurrencies and other coins. What I would tell you is that a person who doesn’t understand why, in my personal opinion, Bitcoin is the clear winner and is going to continue to be the clear winner, is that they don’t understand how network effects work.

Let me give you an example of a network effect that I think everyone can understand. Do you have an iPhone? Or do you have an Android?

Robert Leonard  16:21

iPhone.

Preston Pysh  16:22

I have an iPhone as well. When you send a text to another iPhone user, what color does the text come up as versus if you send it to somebody that doesn’t have an iPhone?

Robert Leonard  16:32

iPhone is blue, and not iPhone or not Apple products is green.

Preston Pysh  16:37

That’s right. When you send that, you’re sending it over the data stream, and it’s completely free because you’re operating on their network. What they’re trying to do is to build a network effect amongst all the users to convince all their friends tho own iPhones because, “Robert’s, my best friend, and he has an iPhone and every time I text with him, I get the green bubble.” What they’re doing is they’re deriving a network effect. What you eventually get is total market dominance, when you’re dealing with a communications channel, because there’s an incentive for all the participants to use the same instrument over that communication channel.

You have a very similar thing happening in the cryptocurrency protocol space where, because Bitcoin has so many users on it, and the price of bitcoin keeps going up, now you’re driving a network effect for engineers to work on solutions to make the spendability of Bitcoin easier. They’re building apps like the Green app. It’s something you can download straight onto your phone, and then you can send Bitcoin straight into your iPhone, and you can transact with a friend.

When you look at some of these other coins, let’s say, Robert, you create your own cryptocurrency. Your barrier to entry is, “How in the world are you going to convince everyone in your neighborhood and everyone in your county, and then everyone in your state and everyone in your country to start using Robert Coins?” It is extremely hard. There are PhD-level classes that you can go take at any business school or college that specializes just in this idea of network effects.

What I would tell somebody who is looking at this and saying, “All right, which one of these things are going to win?” I would tell you to pay very close attention to all the different network effects. And if you are trying to understand the Bitcoin network effects, I would tell you to look up a guy. His name is Trace Mayer. Just type in: “Trace Mayer network effects.” Maybe we can put a link in the show notes for some of this, but Trace talks about I believe he has eight different network effects, and how they’re reinforcing specifically towards Bitcoin versus some of the other protocols, and how those eight network effects are absolutely driving the adoption and the adoption rate towards Bitcoin dominance in the long run.

Something else that I would tell people is that when you start studying adoption rates over a communications channel, you get into a thing called Metcalfe’s law, which is this exponential adoption rate. When you look at how Bitcoin’s price action has performed over the last 10 years, what you’re going to see is Metcalfe’s law to a tee.

In fact, there’s a person who goes by: @100trillionUSD. That’s his Twitter handle. He’s a quant and runs a billion-dollar quantum fund out of Europe. He loves statistics, and he has done a model on Bitcoin based on the price action based on the stock-to-flow ratio.

So, anyone who’s familiar with trading commodities, they’ll understand that there’s a thing called stock-to-flow ratio. The stock is the amount of coins in existence. If we were doing the stock-to-flow on gold, the stock would be the amount of gold that is currently in existence, and then the flow would be the amount of gold that’s mined annually. The numerator is the stock, and the denominator is the flow. When you look at that ratio, it’s going to give you a number. Right? The higher that you have a stock-to-flow ratio, the more scarce that commodity is, and therefore, the more valuable that commodity is.

What he had started to do was an analysis of stock-to-flow, then he modeled it. And anyone who’s conducted a model, especially with *inaudible* directed at Metcalfe’s law; whenever he modeled that stock-to-flow, he came up with a 95% R-squared value. So, anyone that’s done Excel and plotted a bunch of dots down on the graph, and then you run an equation over those dots to see what the best fit is. Then, you do a thing called an R-squared value. You determine how good the fit is to those dots you plotted. A 95% R-squared value is pretty much unheard of.

Then, what he did was he conducted a co-integration test, which is a statistical test that you can conduct. So, you get into this debate of causation versus correlation. To remedy that, you can do what’s called a co-integration test. The co-integration test came back as being confirmed that it is co-integrated, which proves that the stock-to-flow ratio to price is correlated. You have a correlation there. This has been completely modeled and has been right within that variance. When you plot all this out, you get Metcalfe’s law.

What’s really fascinating about the stock-to-flow model is we’re really going to see whether it holds true because here in May, we’ll go through the next four-year halving on Bitcoin, specifically, and the stock-to-flow price is $100,000. “Is it going to go straight to $100,000 in May?” Absolutely not. Typically, it’s taken about a year to a year and a half after the halving event for price to reach that projected stock-to-flow price of $100,000. We’re going to see probably by December of 2021, whether that model continues to be valid. It appears like it will be, but time will tell.

Robert Leonard  22:02

I’ll definitely put links to Trace Mayer’s work in the show notes. I think we’re probably going to have a lot of different resources in the show notes from this episode. That’ll be one of them. I’ll also put a link to Plan B’s Twitter profile in the show notes. You guys can go check that out as well.

I think a network effect that the audience will probably be most familiar with is social media. If you have a social media platform that your friends aren’t on, nobody’s going to use it. But if all your friends start joining a new platform like when Instagram first started; you started seeing all your friends’ posts there. You know, all these great photos. So, then you wanted to join, and then more people saw that and kept joining in. I think today social media is one of the best examples of the network effect for the millennial generation to consider.

Preston Pysh  22:45

It’s way better than the example I gave.

Robert Leonard  22:48

Hey, everyone knows iPhone too, so I think that works.

We’re talking about all these different coins, right? And so, you mentioned coinmarketcap.com, so I pulled that up. I’m looking at the list of the coins. I see three that stood out really quick, and those were Bitcoin, Bitcoin Cash, and Bitcoin SV. Again, I am not an expert by any means. What is the difference between these three coins? Are they related? Or is someone kind of using the Bitcoin name and creating another coin? Or what is going on with those three different coins, if you will?

Preston Pysh  23:19

What’s really fascinating is you’ll find people that…remember how I was talking about level one thinking, level two thinking, and level three thinking, and digging way deep into something? So, what you’ll have is people that will say, “There’s no way on the planet this is ever going to work on a global scale, because just look. I just pulled up CoinMarketCap and there’s like five coins listed with Bitcoin in the title. I have no clue which one to buy. How in the world are my mother and father going to be able to buy this? This is nuts!” That’s your level one thinking, unfortunately. I say that because…and I can’t say this is by design, but I would tell you that the greatest strength for Bitcoin is that so many people have that opinion.

I’ve been dealing with Bitcoin since 2015, and I’ve been hearing these arguments for five years now. What happens is that because your main finance people that work on Wall Street and manage money professionally would look at that, and say, “This is ridiculous!” What has happened is that you’ve had total entrenchment of Bitcoin into the existing financial rails; payment rails, okay? So, when I bought my first bitcoin back in 2015 for $220, there were no derivative markets for Bitcoin. There’s none of that stuff. I mean this was like if you talked to anybody about this stuff, they’d think you were nuts. Stig and I recorded a conversation from 2015 of us talking about Bitcoin, and we thought it was nuts, but at the end of the episode, I said I bought some. Right?

But this is where it’s really interesting. People would say that’s the biggest liability, whereas I would flip that on its head and I’d say, “I think that might actually be one of its strongest assets.” It has totally duped so many people for so long that now you have all these engineers that have done…I mean, you can do atomic swaps from a USB-tethered coin that tracks the price of the dollar down to a tee. Straight into bitcoin, okay? In the blink of an eye, you get immediate clearance of payments. If you took cash from Bank of America and routed it over to some exchange, it might take you three days. It’s totally crazy in terms of what’s happening as far as the engineering that’s going on to allow exchanges to integrate into this protocol.

I would argue that all that was possible because the adoption rate is, in my humble opinion, a timed Trojan horse. We can talk about that later if you’ve got questions about why I think that. I can get into all the details why. And from an engineering standpoint, how the protocol was constructed.

The naming and the forks that have happened off of Bitcoin and all these other coins are just confusing to the masses that have allowed the entrenchment into the financial rails. To answer your question more specifically, you said Bitcoin Cash, Bitcoin SV, all these other things, what has happened is other people said, “Oh, I think that we should have bigger blocks. I don’t think that they should be 1-megabit blocks, I think they should be 8-megabit blocks,” meaning the blocks that are being mined should be able to handle larger transactions. One group of people said, “That’s going to be really bad for security because not everybody can run a full node off of their home computer.” Then, you had another group that said, “Well, that doesn’t matter. There should just be big nodes that download the full blockchain and run this.” There are security implications associated with that, so no one could agree.

The people that had the opinion that you should go to 8-megabit blocks, they forked the protocol, meaning they took that source code, and they started running it right next to the other source code, but they changed it to 8-megabit blocks. Then, what you had were all the people that are mining it, which are most importantly, the people that are running full nodes. This gets into a little bit of a technical conversation. You have people running full nodes, and then you have miners that are mining it. They started taking sides as to which one of those two protocols that they wanted to participate on. And lo and behold, look at the price, and the price tells you who won. So, you got Bitcoin Cash, which is at $472. You got the regular bitcoin that’s at $10,211. 

What you have happening, and the reason why this is so different than what we saw before like when the internet was stood up, and you had the Internet Protocol, and you had transfer control protocol, TCP, right? That rides on top of the Internet Protocol. It’s a second layer. These protocols were designed just like Bitcoin, and they were adopted just like Bitcoin, and they’re now being used globally.

I mean, if you’re on the internet, you’re using the Internet Protocol. You’re using TCP. You’re using trasmission control protocol. You’re using the Hypertext Markup Language. You’re using all of these things. These are universal, and the markup language is more for the code, but they’re the protocols that I was discussing before are being universally adopted by everybody because of a network effect. And so, in my humble opinion, you have the exact same thing happening, but you’re having it for money now, and you’re having this big giant fight at a protocol level as to what is money. And so far, your winner by quite a bit is Bitcoin.

Robert Leonard  28:31

We’ve talked about how the network effect is driving this, and you were just talking about the different prices. I want to talk about that a little bit more. And of course, like you said, the network effect is a huge component of this. But outside of that, why would someone pay say, $10,000 for a bitcoin, when they could just pay maybe $0.25 cents, $0.30 cents for a Ripple.

Preston Pysh  28:51

This all goes back to the scarcity of the units. When you look at Ripple, for example, these are all pre-mined coins, meaning you didn’t have to do any work to create them. I’m going to say this word, and I’m going to make some people mad, but for me, this is a scam because the person who created it said, “Oh, well, I’m going to create.” They have 43 billion XRP, okay? And if they wanted add more because it was…let me just start off with creating it. So they’re pre-mined. They literally created all 43 billion units, and if they wanted to keep 10 billion of them, and then put the rest of them onto the market, they could do that. And they did do something like that. Now that the remaining units are on there, what they can do is they can put more of that supply in the market when they want, and they can take some of that off of the market if they want. And so, when you have that many units, 43 billion units versus Bitcoin at 18 million units, one’s way more scarce than the other, and one is used way more than the other; and therefore, the value is extremely higher than the other.

Fiat currencies would be like this if the central banks manage the monetary baseline, and then inflate currencies. You’d have the exact same thing happen if they take money. You see this in the markets. You can see this right now, where they’re conducting quantitative easing in which I take cash. I drop it into the bond market, and I basically buy those bonds off the market, and I pump all this liquidity into the system. When I add that liquidity into the system, it has this effect of supply and demand and scarcity. That drives the value of it and whether it goes up or down.

Robert Leonard  30:27

In your explanation you said “they” a couple times. Who is “they”?

Preston Pysh  30:32

When I’m referring to what?

Robert Leonard  30:34

Ripple. They released these coins. Who is “they”?

Preston Pysh  30:38

For Ripple specifically, there’s a Ripple Foundation. I don’t know who’s the CEO of Ripple. Full disclosure, it is not something that I own or would recommend somebody own because I think it’s very centralized. I think it’s absolutely manipulated because they have the amount of units that they collected from the start. More importantly, they’re not using a proof of work mechanism, which is driving the price higher, which in effect pauses a network effect. That’s a whole big, long technical conversation. But “they” is actually a group of people in a foundation that’s actually managing that protocol. 

They’ll tell you that they’re completely decentralized from the protocol at this point, but when they founded it, it was not. They’ll probably argue that extensively, but everyone can argue something as much as they want, but the reality of it is that they are absolutely manipulating the monetary baseline of that protocol. So, that’s not something that I would recommend anybody participate in. The whole issue with fiat right now is the manipulation of the monetary baseline. So in my humble opinion, the protocol that’s going to win in the long run is the protocol that never manipulates their monetary baseline and demonstrates a super hard, easily transferable, immutable ledger like Bitcoin.

Robert Leonard  32:00

Based on what you just said, I’m assuming there’s no Bitcoin foundation with a CEO running it, right?

Preston Pysh  32:06

Bingo.

Robert Leonard  32:07

So all of this conversation leads to an even bigger question, “Why do we even need a new form of money? Why do we need a new currency? What’s wrong with what we have? Or just the US dollar?”

Preston Pysh  32:20

You wouldn’t believe how many people do not ask that question or understand that question, so I’m thrilled you asked that because at the heart of everything, it all comes down to that question, “Why in the world do we need to have Bitcoin, when I can go to Starbucks and spend dollars? And they spend very easily.” This is not about going to Starbucks and having an easier transaction by using bitcoin. This is not about that. What this is about is, globally, no currency is paid anything.

This is going to turn into a little bit of a history lesson.

So when you go back to 1944 there’s a thing called Bretton Woods. What Bretton Woods was it was taking the US dollar, and it was pegging it to gold. If you went to the bank and you said, “Here’s my $1. Give me however many ounces of gold that is associated with that.” You should be able to collect that many ounces of gold. The reason you use gold as a peg is because it’s a scarce commodity. It’s a scarce rock. It’s not something that can be created in a lab, and that’s why it’s held the test of time of being money for eons.

When they went through the Bretton Woods, the US said, “We’re going to peg the USD to gold.” Not only did that happen, but all these other nations that participated in Bretton Woods back in 1944 also pegged their currencies to the dollar. As they pegged themselves to the dollar and the dollar was pegged to gold, you had what was a fixed monetary baseline, or what we thought was a fixed monetary baseline that couldn’t be manipulated.

Where this really comes into play is when you’re conducting trade with another nation, you have this balance of payments event that occurs whenever you do not live up to your monetary baseline. If you’re printing it will, what you’re doing is you’re devaluing your currency and the country that has pegged currency is going to take advantage of that situation.

If you want to do a thought experiment, I would tell you to do it like this. This is the best example I can give you. Imagine there’s four of us, and we’re playing a game of Monopoly. It’s just the four of us playing on our Monopoly table, and the banker is adding more and more money into the game. We just keep adding more and more every time we go around GO. We just keep adding more and more money into the game. What’s gonna happen to the price of everything in that game as we play it? And as we trade properties? As I go over, I say, “Hey, I want to buy that property from you.” You’re going to bid the price because there’s more money in the game. Now, if you had a deflationary currency, they’re taking money off the board. Every time you go around GO, the banker’s clawing money back out of the game. This is how the real economy works, where the central banker is adding money in, and then they’re taking money out. 

Now, I want to do another thought experiment with you. Imagine that there are two other tables with four people sitting at these two other tables, in addition to our table, and they’re also playing a Monopoly game. There are 12 people total playing Monopoly on three different tables, and we can now trade amongst those tables. So, we have X, Y and Z tables. I can go from the X table, where I’m playing, and I can go over to the Y table, and I can buy properties with my currency. Right? Now, what I want you to imagine is one of those tables, let’s say the table you and I are playing on, we have a banker that we’re in cahoots with, and that banker is adding money into our game, and all the other players, all the other tables are keeping their money, sound and fixed. But the banker we’re playing with, he just keeps slipping us hundreds. Guess what happens? We have an advantage. We have a huge advantage to go over to those other tables and start buying up all their properties. If we do it slow enough, we do it super slowly, those other tables aren’t going to realize what in the world is going on.

This is exactly what happened, whether people want to believe it or not. This is exactly what happened from 1944 up until 1971 in the United States. I have a chart that I can send you. The way it was done was through the money multiplier. That’s another thing that you can put in the show notes. What the money multiplier is. People can learn what that is and how banking is. Basically, it’s a multiplier the banks have to have so much money on hand based on the exchange rate back in the gold. So, what happened was that the US kept adjusting their money multiplier from 1944 to 1971. The banker was adding more cash into the game until it got to a point where there was so much cash into the game that if the players went back to the banker and started demanding the gold, guess what? There wasn’t enough gold there to swap with the currency that supposedly it was backed by.

So in ’71, the US comes off the gold standard. So, if we come off the gold standard, and we had this Bretton Woods system that everything was basically tied to the dollar, while everyone else comes off the gold standard altogether. Now, you have this global event where money is not tied to anything. What you’ve had effectively, and I’ve heard Ray Dalio call this, “The US basically defaulted back in ’71, when they came off the gold standard.” What you’ve had is this-slow motion default, because interest rates even went further after ’71.

When you got to 1981, you had the 10-Year Treasury at around 16.1% or 16.2% because there was so much interest in the country, where all this manipulation of the baseline currency had been taking place for literally decades, that the inflation was skyrocketing because there was so much demand for this booming economy that was happening. How did the central bankers deal with this up until right now? Well, they keep adjusting the interest rates. They do that through the bond market. They do this through the supply of money.

Originally, they did that through the federal funds rate, which is your short-term money. As that came clear down and eventually hit zero after the 2008 crisis, the federal funds rate was pegged at zero. Now they have to start going into the long tail of the bond market, where they’re doing longer duration bonds, and there’s now buying that up. What you’ve been having since we’re really 1971 is you’ve had a slow-motion default. Where currencies fail, in the end, is when the interest rates go to zero percent and they can’t go any lower. You’re not there yet in the US. Well, you are on some portions of the bond yield curve. When you go to Europe or Japan, they have negative interest rates, especially when you look at it from a real basis, instead of a nominal basis. They’re in negative interest rate territory. Here in the US, on a real interest rate scale, you’re in negative interest rates. 

This is a really, really long answer to your original question, but I think you have to understand all this to understand why Bitcoin. So, back to where I was.

If you have negative interest rates, what you actually have is a deal a contract between two parties that guarantees the loss of capital. So, if I go up to you, and I say, “Hey, let’s do a deal, Robert. You buy this negative-yielding bond, give me $100 today, and then next year, I guarantee you I will give you back $99. I promise. I swear to God, I will do it. I will give you $99 back.”

Today, believe it or not, in the entire world there is $15 trillion of negative-yielding bonds that are that exact contract structure of people guaranteeing themselves, signing up for a guaranteed loss $15 trillion worth today. When you start getting into that situation, the incentive structure changes to people saying, “Hey, you know what, I’m just going take the cash. I’m going to put it in a safety deposit box. And then next year, instead of getting $99, I’ll still have my $100.” That’s where you’re at. And so, you’re at this point where the bond market’s going to break because no one wants to sign up for these deals.

The only reason I would argue that you’re seeing these deals is because central banks and states are mandating that they have a buyer of these deals in the issuance of these deals, so it’s getting crazy. And that dynamic is not going to last. What you are now seeing are central bankers printing at unstoppable levels. And as they continue to use quantitative easing as their insertion point, which I would describe as inserting the liquidity into the top of the economy, and the top earners and the one-percenters that own those billion-dollar bond tranches.

When you know you have somebody that is guaranteed to buy that billion-dollar bond tranche, well, guess what? The price is going to go up, and it’s going to go up, and it’s going to go up. You’re going to continue to get the liquidity, then you’re going to buy stocks, and you’re going to buy back your shares, and you’re going to bid the price of equities even higher and higher because equities function as a scarce…somewhat they operate very similar to gold, where there’s a scarce amount of shares that you can buy for that same amount of equity that you own in the operating business.

That’s why you’re seeing the stock market getting big like hyperinflation right now. It’s because of the fact that the liquidity insertion point continues to be at the top, and they’re not doing something like universal basic income. I’m not promoting either one of these courses of action because both of them lead to the same road, which is inflation at a ridiculous scale.

Bitcoin that has a fixed monetary baseline, in my humble opinion, is going to do extraordinarily well against something like this. It’s equivalent to going back into the 1922 Germany Weimer Republic. When you look at what happened there, and you saw gold just hold its valu; its buying power. It held its buying power, and they couldn’t print the money fast enough. You’re seeing that digitally now. You know, back then they didn’t have digital money, so what would that look like today? Well, it looks like what you’re seeing in the stock market. It’s going bananas.

Robert Leonard  42:25

So that was going to be my exact next question: Is Bitcoin today’s gold? So, when people were back then adding a portion of their portfolio into gold to hedge some of their risk, should people now be doing that in Bitcoin, rather than gold?

Preston Pysh  42:40

My opinion? Absolutely. You could get somebody else on here. You could get an academic, and they’ll tell you, “Oh, it’s crazy. It’ll never replace gold. Gold’s been around for 10,000 years.” They’re going to use these really top level, in my opinion, surface-level deep arguments. But when you get into the fact that I can send you a bitcoin right now, and we can settle a billion-dollar transaction right now if you just put a QR code up on your screen. I could scan it, and if I had a billion dollars in my account, I could send it to you right now, and my fees would be $3. We could settle that right now. How is that worse than gold, where you need a truck, 40 armed guards, and then a transport plane, depending on where you’re at; and a delay of 15 days for coordination, and then a high-end security structure in order to house it, keep it and maintain it? It’s laughable. 

Then you get into this. Here’s another argument: How do you know that the gold bars are pure? You’d have to melt them down and do an analysis of the chemical composition of all the gold. With Bitcoin, you can just run a full node and test the purity of the billion dollars I just sent you in a second, which is nuts!

Robert Leonard  43:55

All right guys, so that’s it for part one of my conversation with Preston all about Bitcoin, blockchain, and cryptocurrencies.

Now that you’ve heard the first half of the conversation, I hope you can see how all the things I mentioned in the intro are true. It’s very heavy with technical information, so you might need to go back and listen to it a couple of times. I know I did. But it’s incredibly fascinating, and it’s going to be a lot of fun to watch play out over the next few years. If you know anyone that wants to learn more about Bitcoin from a beginner’s perspective, be sure to share this completely free episode with them. And next week, Preston and I will pick up right where we left off, and continue our conversation in part two of this episode. I’ll talk to you all then.

Outro  44:36

Thank you for listening to TIP. To access our show notes, courses or forums, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decisions, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.