The 2018 Bear Market Came Because Bitcoin Was Misunderstood. It won’t happen Again.

For years, Bitcoin was misunderstood and misused. Early adopters thought it was just a convenient instrument to make rapid internet payments and send each other money without dealing with governments and banks.

Those who came later tried to impose their ideology on the Bitcoin network and push for changes that would directly reflect specific agendas: banking the unbanked, demanding for transactions to be “instant” (aka mined in the next block) and “cheap” (in relative USD terms, as compared to Visa or PayPal), as well as establishing foundations and advocacy groups that would deal with governments and trans-national corporations (The Bitcoin Foundation).

But after years of doing Scaling Bitcoin conferences and starting internet debates for the purpose of establishing the future of the network, it all came down to a simple dilemma: are we going to keep the Bitcoin network decentralized and build layers on top of it, or change it so that all transactions happen on the base layer?

In the end, we ended up having multiple forks and the free market decided that decentralization is much more important. Not only that investors found actual use in putting their cash savings in bitcoin to avoid inflation and taxation, but the network also developed a healthier system of incentives as increasing fees make up for the halving mining rewards. This dynamic has proven that Bitcoin works best as digital gold and the miners can carry on with their security service for years to come, without worrying much about profitability.

The fact that today’s news are about hedge funds and companies allocating a percentage of their cash holdings into Bitcoin instead of praising how another payments processor or major store accepts BTC payments only proves that the network has matured. After 12 years of existence, the network has finally found its best use case as a store of value.

Bitcoin Will Soon Transition From Store of Value to Mean of Exchange

Even if the base layer will always have small blocks (1-2 megabytes) which only fit 2-3 thousand transactions each, this doesn’t mean that there will be no commerce or retail on the Bitcoin network. As the bidding for block space is much more intense and there is more demand than ever for transactions to get included in Bitcoin blocks, sidechains and second layers emerge.

At the same time, even the block space management has gotten better. Today we have better tools to understand Bitcoin fees and adjust time preference accordingly. The mempool.space website is just an example of a visual representation that makes it easy to approximate transaction costs and the time required to get Bitcoin network confirmations.

Also, the wallets have gotten better at recommending fees and the blockchain explorers have become more user-friendly. Even while using the base layer, it’s easier to understand what’s going on and what happens with a transaction over time.

The exchanges have also gotten better at managing funds. For internal transactions, they keep separate ledgers which minimize the instances when transactions on the Bitcoin network are required. Custodians such as BitGo and Bitfinex even go as far as creating pegged (or wrapped) tokens that can be transferred back and fourth with smaller costs.

For outgoing transactions, exchanges have sidechains such as Blockstream’s Liquid. Xapo, Bull Bitcoin, Bitfinex, BitMEX, Hodl Hodl, OKCoin and Huobi are only a few examples of exchanges that make settlements through this Bitcoin sidechain.

And then there’s the Lightning Network: the second layer which fulfils all the dreams of early adopters (instant transactions with great privacy and scalability) and also adds the extra intricacies found in Ethereum (smart contracts, tokens and client-side file sharing).

Lightning is the best way to send small transactions that otherwise wouldn’t make sense to be transferred on the base layer due to high fees (why move 500 satoshis on-chain if you’re going to pay just as much for the fee?). At the same time, it also enables participants to open large channels that instantly transfer entire bitcoins in a matter of seconds.

As of January 2nd 2021, ACINQ has used almost 110.000 BTC to open a total of 1207 channels, while Bitfinex has also allocated appoximately 132.000 BTC just for various Lightning channels. Which means that 2 Lightning companies have put together more than 1.15% of the total supply of bitcoins.

There’s definitely enough liquidity for large transactions, and it’s only a matter of time until Lightning gets to show the entire world that it’s ready to handle most of the retail economy that happens in Bitcoin. So far, there wasn’t much activity on it due to the relatively low costs of transacting on the base layer. But as adoption grows, operations are expected to move to either on a sidechain or on Lightning.

Lesser known (yet competitive) sidechains such as Paul Sztorc’s DriveChain and Ruben Somsen’s StateChains are also catching up with the increasing Bitcoin activity. They are focused on both scalability and privacy, so it’s going to be interesting to see how much traction they get in the future and to which extent users embrace sidechains over second layers.

Even altcoins find themselves in the middle of a battle to offer competitive Bitcoin services – from locking and tokenizing BTC amounts for the purpose of transacting with lower fees, to providing greater transactional privacy. It’s clear that Bitcoin has won the war of internet currency standards, and right now everybody is trying to incorporate it in their product or service.

The store of value function results from very rational reasons: if the Bitcoin network can only handle a small number of transactions and it costs more to bid for space in the next block, then it makes more sense to rationalize the number of operations; and since the price of bitcoin has greatly appreciated against fiat money, it makes more sense to save bitcoins on the long term than to spend them like a fiat currency.

Therefore, it’s safe to say that Bitcoin became a store of value thanks to economic incentives – parties involved in a transaction did not desire to pay lots of fees, while users found rationality in HODLing. But it doesn’t mean that BTC will never become a currency for payments and the base layer’s limitations will definitely not stop innovation from taking place permissionlessly in layers and stacks.

In a very near future, there will be lots of instant, scalable, and private bitcoin payments, except that it will happen via Lightning or sidechains. Just like bank notes helped gold become more portable and fungible, Bitcoin’s layers will serve a very similar function of providing convenience and extra features with a security tradeoff that should be understood and mitigated by the parties.

Except For Gold, Bitcoin Has No Competition

During this bull market, Bitcoin has the potential to match its “digital gold” nickname by equaling or even surpassing gold’s market cap. And even though gold has time, tradition, and industrial use on its side, bitcoins are easier to verify, audit, and hold in self-custody and carry around while crossing borders.

The fact that Bitcoin transitions towards becoming a mainstream commodity like all precious metals means that its price discovery will lead to new highs that will feel less slippery and volatile. If more seasoned investors add BTC to their portfolios for long-term holding, the speculation factor is greatly lowered. And if community members truly understand the unique qualities of their bitcoins and treat them as multi-generational assets, then we’re bound to see fewer negative swings in relation to fiat.

This means that during this cycle, Bitcoin can also attain the long-term stability of gold. After the weak hands get shaken off and the coins end up in custody of people who understand the value proposition of what they’re holding, there will be a lot less volatility. And if the governments keep on inflating their fiat currencies, the incentive to swap hard money for a devaluing currency gets lower.

Soon enough, the price of bitcoin will mostly get measured against gold – the only other hard asset which finds itself in the same league for preserving wealth and purchasing power. Fiat valuation is only a short-term metric.

Does This Mean That Bitcoin Will Have No Bear Market?

Absolutely not. Even though the maximum supply is known at all times, it’s hard to predict and maintain a high demand. Some speculators will dump, the weak hands will follow, and the strong hands won’t always have the money or disposition to buy all the bitcoins. The enthusiasm can also fade over time, as it’s likely for Bitcoin to become absolutely boring and uninteresting in the next couple of decades. But we’ll always see price cycles and various market phases.

The point of this article is to argue that the price action we’re seeing today is driven by much more than retail speculation. We don’t find ourselves in the middle of the same bubble we saw in 2017, we don’t have the same uncertainties, and Bitcoin doesn’t have any kind of identity crisis that’s driven by disparate scaling philosophies.

Bitcoin is better understood today, as more people treat it as a savings mechanism than as a currency to spend at Starbucks. And if participants are rational and their actions match their expressed conviction, then the dips will be less painful and the length of bear markets will greatly diminish.

The closer we get to the Bitcoin standard where BTC is global reserve currency, the fewer people are going to sell their hard money for something that’s infinitely inflationary. In fiat terms, there’s almost infinite increase potential for bitcoins. But when a Big Mac costs $10.000, it will make very little sense to sell your BTC for a few hundred million. By then, you will most likely be able to buy the same Big Mac for a more stable and predictable amount of bits or satoshis.

Disclaimer: while this article is optimistic about the future trends in Bitcoin price, it is not by any means financial advice. You should always make your decisions based on your own judgment and/or the advice of an expert. Also, don’t get reckless and invest more than you’re willing to lose.

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