FG #62 Peanuts, Raisins and Tortilla Chips

The Bitcoin HODL paradox

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The HODL Paradox

We received this question from one of our Foot Guns’ subscribers:

How can HODLrs participate in crypto payments, as they want to HODL and not sell? And does this not create mental short circuit among them as they want to be excited about crypto adoption as a form of payment, yet, it means crypto selling, the opposite of hodling. 

This is a fantastic question : Does the HODL mindset hurt or help Bitcoin adoption?

One major criticism of Bitcoin’s use as a currency is the volatility which adds risk to any vendor wanting to use Bitcoin for payments. The Bitcoin maximlist’s answer to this volatility is to shout, “HODL”. They’ll admit to you that Bitcoin’s volatility is high today, but that this is because of the exponential nature of the growth of adoption of the network. The logic goes: “Bitcoin’s current volatility is needed so it can grow and eventually be less volatile after mass adoption”. However, as pointed out above if everyone adopting Bitcoin is doing so to HODL then who will use it as payments?

This would suggest Bitcoin should have two key epochs of its adoption if it is to become functional as a currency for payments. The first being the HODL epoch where early adopters are front running the perceived future value of the network knowing their coins are the ticket to ride. The HODL epoch is riddle with giant price swings and high volatility because the adoption is exponential and no one knows where the tipping point is. In this way the price swings wildly as would be HODLrs (posers) sell their coins into moments of irrational exuberance.

Only if adoption is successful and applications are built allowing a convenient user experience can Bitcoin eventually enter the Currency Epoch. In order to function as a currency the rate of Bitcoin adoption (the number of new users per day) will need to flatten. Because Bitcoin has a limited supply only when the volatility of demand reduces will the price volatility reduce. This would mean there needs to be equal buying and selling demand, i.e. there must be as many sellers as HODLrs.

Just as the Bitcoin network expands and purges itself with major events like China banning mining causing half the network hashrate to drop seemingly over night, or in 2017-18 when forks like Bitcoin Cash threatened to split the community. In order for Bitcoin to expand into a global payments system it must purge itself of the HODLers.

How is Michael Saylor helping the Bitcoin network other than making it more expensive for small players to capture even a small piece of the realestate of the Bitcoin network? Paul Tudor Jones suggested to put a small portion of your portfolio into Bitcoin as a store of value. In other words, HODL. Because the price volatility on short time frames is too high then Bitcoin wont work as a store of value unless you HODL.

With large players entering the HODL scene is it even possible for a transition to a period of low volatility where Bitcoin can become a medium of exchange?

Lending Markets

The popularity of Bitcoin lending markets has risen in the past few years. Just recently Blockfi was forced to pay at $100m fine for providing interest accounts and lending products to its customers that utilize Bitcoin as collateral.

According to Bitcoin Hodlers instead of selling your Bitcoin you can keep borrowing against it because “Number goes up”. However, this logic fails if the belief for why to HODL is to capture the value that enters the system prior to the transition to a medium of exchange. There’s no way out. Unless you have outside capital to pay the interest of the loan you must eventually sell some portion of the Bitcoin.

Crypto Payments - Lightning Strikes Hope

There are currently about 200,000 transactions per day on the Bitcoin network. This shows that there are factually already a large cohort using the network that are not HODLrs.

Using Bitcoin as a currency for daily payments is not just a matter of philosophical differences between HODLrs and others, but faces a technological obstacle of the throughput of the network. The Bitcoin Network can only process 7 transactions per second which is not even beginning to be fast enough compared to Visa’s 65,000 transactions per second. It also is somewhat costly to send Bitcoin across the main network, currently at $1.75 per transaction. Many have copied Bitcoin’s source code and tried to fix these issues by compromising security or reducing decentralization (Litecoin, Bitcoin Cash). However, a technology has been created that builds a second layer on top of the Bitcoin Network called the Lightning Network. Making Visa look slow and expensive, the Lightning Network can process nearly 1,000,000 transactions per second per channel costing $0.00004 per transactions. The Lightning network can have many channels operating in parallel and the 1,000,000 transactions per second is only limited per channel. According to Arcane Research the number of Lightning Network users is expected to grow to 700 million by 2030 and process over 1 trillion transactions per day.

The Lightning Network sounds far superior as a technology to the modern payments networks. What’s stopping adoption? HODLrs don’t seem to be helping push payments forward. Is anyone working on payments during the HODL epoch?

Enter Jack Maller and Strike.

Peanuts, Raisins and Tortilla Chips

If you’ve been around crypto for more than a year then even if you’ve never heard of Lightning or Strike, you’ve probably heard of Jack Maller. On June, 5, 2021 at the Miami Bitcoin Conference, Jack Maller gave a talk announcing that El Salvador would be passing legislation to adopt Bitcoin as legal tender. This wouldn’t be feasible without the Lightning Network.

In December 2021, Jack Mallers explained how the Lightning Network can be used for cross border payments to the IMF telling a story how he used peanuts, raisins and tortilla chips (the only props available at the time) to explain the concept in person to a money manager responsible for over a trillion USD in assets.

In the image below you see on the left how the current financial system works. Each bank, company or anyone else involved in moving money from the left most tortilla chip (person in US) to the right most (person in another country) must hold an enormous amount of liabilities compared to the funds being move. They each have to pay rents for physical locations, pay staff, pay to run servers, etc..

On the right side of the image we see the potential for a new payments system that uses Bitcoin and the Lightning network as an intermediary for transferring funds. The person is able to hold fiat in their account avoiding the volatility risk of Bitcoin and send money to another users account anywhere in the world. Jack Maller’s Strike application takes care of the conversion and sending using the Bitcoin Lightning Network. From the users perspective they are simply sending fiat back and forth as they please.

This is Bitcoin being used as a medium of exchange, but still allows individuals to use their countries fiat as a unit of account.

Who Will HODL?

HODL is an extreme mentality born out of fear of missing out. That even though you have doubled the fiat value of your account in a year you shouldn’t take profits because you would miss out on future gains. If everyone just HODL’d and no one had ever used 200,000 Bitcoin to purchase 2 pizzas we wouldn’t be talking about Bitcoin.

Gold bugs like to talk about gold having an intrinsic value being the reason it works as a store of value. That someone always will need gold in a manufacturing process. It’s this property that makes gold a good store of value. You can safely assume there will be a future buyer you can sell to.

Bitcoin can be the same. If the Bitcoin lightning network continues to expand and takes market share away from the current cross border payments market this would give Bitcoin an “intrinsic value”. As a buyer you would know there will likely be someone to sell to in the future without the fear of illiquid markets.

It’s fine to save in Bitcoin.

It’s fine to buy and sell Bitcoin.

HODL if you please.

We’ll have our cake and eat it too.