Bogleheads® Conference 2024 Does Crypto Merit a Place in Your Portfolio? with Matt Hougan

00:00:00.000 | I heard some coughing over here. I mentioned the word "crypto." What are we doing here,

00:00:14.560 | Matt? I mean, what would Jack say?

00:00:18.360 | I'm amazed you invited me. I am a Boglehead, so I feel like this is the prodigal son returning.

00:00:27.240 | Let me read your bio so that people don't throw things.

00:00:31.600 | So Matt is a Chief Investment Officer of Bitwise Asset Management, the world's largest provider

00:00:36.560 | of cyber currency index funds. They use the word "index." More than $5 billion in assets

00:00:42.860 | under management. Prior to that, Matt was the CEO of Insight ETFs and the former CEO

00:00:48.520 | of ETF.com and the Managing Director of Global Financial Informat.

00:00:54.680 | Now Matt is a Boglehead. I've known Matt for a long time. Before he had gray hair. Before

00:01:02.520 | I had gray hair. He's been to conferences before. He was a big advocate of the, I think

00:01:10.640 | you created, I forgot what it was called, the low-cost ETF portfolio. What was that?

00:01:15.680 | The world's lowest-cost ETF portfolio, yeah.

00:01:19.680 | Every year I used to go to a conference and Matt would put up there, "This is the lowest-cost

00:01:23.360 | total stock market fund, the lowest-cost international fund," and so forth. And it was kept on going

00:01:27.880 | down and down and down and down every year. So Matt is a diehard Boglehead. But he made

00:01:34.240 | this pivot to the dark side.

00:01:38.720 | So first of all, why don't you explain why you've made the pivot?

00:01:42.560 | Oh, good question. I'm a diehard Boglehead. I wrote the foreword to Eric Balchunis' incredible

00:01:50.480 | book on Jack. I operated in the ETF space for 15 years. I think ETFs were an incredible

00:01:57.760 | invention. I think they did a lot to lower costs and improve tax outcomes for investors.

00:02:03.200 | And it was really fun to see them go from something that people didn't trust, something

00:02:08.560 | that people didn't believe, but that I thought had value in the world, into mainstream apple

00:02:14.880 | pie of investing. And I think they've done a lot of good.

00:02:18.340 | And so after I sold ETF.com with my colleagues, I looked around for the next great technological

00:02:26.720 | breakthrough that I thought could bring efficiency and lower costs to the world, that I thought

00:02:32.000 | could help investors, but where the public didn't understand it and didn't like it.

00:02:37.680 | And that was crypto. So that's where I made the jump.

00:02:42.160 | I will remind everyone that there were congressional hearings about ETFs destroying the American

00:02:47.720 | dream. And even Vanguard didn't like ETFs. So I've seen technologies go from hated to

00:02:53.800 | well-understood and adopted. And although it may be unpopular in this room, I think

00:02:58.120 | crypto is on that journey as well.

00:03:00.320 | Well, just as a reminder for people, Bogleheads.org, the forum, does not allow discussions on crypto.

00:03:06.560 | There's a couple of reasons for that. You could read about it. But what happened as

00:03:10.600 | soon as people started discussing it, there was so much spam that started to hit the boards

00:03:16.440 | that the moderators were just overwhelmed with Bitcoin spammers.

00:03:21.280 | And I'm sure you've seen them. That was one of the reasons why, in addition to other

00:03:26.280 | valuation reasons, why Alex decided-- and Alex is here. You can talk with him about

00:03:31.840 | it. There he is. You can talk to him directly. He's the man. He made the decision.

00:03:35.220 | So if you're a crypto fan and you want crypto on Bogleheads, grab his ear. Talk to him for

00:03:39.680 | three hours about it. Maybe he'll change his mind. Anyway, OK, so crypto. Bitcoin. This

00:03:48.920 | has grown. I mean, how much money now is in, say, just Bitcoin? How much is in Bitcoin?

00:03:58.560 | Bitcoin's about $1.3, $1.4 trillion today.

00:04:03.480 | That's a lot.

00:04:04.480 | It's a real number.

00:04:06.040 | And if we add everything else, like Ethereum and just the cyber currencies, how much are

00:04:11.040 | we talking about?

00:04:12.040 | It's about $2.4 trillion altogether. That's the asset class, if you want to call it.

00:04:17.400 | $2.4 trillion.

00:04:18.400 | Yep.

00:04:19.400 | When I did the interview with you-- oh, it must have been only a few months ago-- it

00:04:22.680 | was just breaking two. So we've grown up 20% since then.

00:04:28.000 | It's crypto. So first we went down, and then we went back up.

00:04:31.120 | Yeah, that's the way it works.

00:04:32.120 | There's a lot of volatility in this asset class, I guess you could call it. Right? OK.

00:04:38.800 | But today, we're not talking about-- even though it says, does crypto merit a place

00:04:43.020 | in your portfolio? That's not what this is about. That's not what this discussion is

00:04:47.020 | about. I think I titled this discussion, but I titled it wrong. Anyway, it's about what

00:04:55.680 | is this thing called cryptocurrencies? And it's a very confusing term. I mean, it sounds

00:05:02.600 | like Superman, right? Was that Kryptonite? I mean, it sounds like Hollywood. And it puts

00:05:10.880 | people off, I think, just the name itself. But in fact, the name goes way back. And it

00:05:21.200 | really is the basis for what's called the blockchain.

00:05:27.120 | So start from the beginning. Talk with me like I'm a third grader, OK? And tell me,

00:05:35.600 | what is the history of the blockchain, which is what this Bitcoin and all the cyber currencies

00:05:41.600 | sit on? And a little bit about how it works.

00:05:47.760 | Great. Yeah, I think it's both really easy to understand and understood by very few people

00:05:54.640 | because it's wrapped in so much spam and nonsense. What crypto or blockchain is about is about

00:06:02.380 | a technological advance in actually in computer database design. And it's not an idea that

00:06:11.600 | popped out of nowhere. It was something that people worked on for 50 years at the NSA,

00:06:16.600 | at Stanford, at MIT, that links back to cryptography and its use in the military. This was like

00:06:23.520 | a series of technological breakthroughs trying to make a jump in how computer databases work.

00:06:29.720 | And that jump is called the blockchain. And here's the way to conceive of it. It's actually

00:06:33.460 | very simple. The way computers have always worked from when they're first designed to

00:06:39.440 | today, the vast majority of them work as individual nodes. So we talk a lot about crypto and finance.

00:06:45.680 | So I'll use a finance example to make this clear. JP Morgan has a database of their customers

00:06:52.200 | and how much they own. Bank of America has a database of their customers and how much

00:06:56.000 | they own. Wells Fargo has a database of their customers and how much they own. And any computer

00:07:01.040 | architecture that you look at looks like that. It's a series of individual databases. All

00:07:06.480 | a blockchain is, all this 50 years of work, is how do you build one database that's available

00:07:13.520 | everywhere in the world, that everyone can see into, everyone can contribute to, that

00:07:18.860 | updates in real time and is always true, but that's not controlled by any single entity.

00:07:26.280 | So if you think of JP Morgan's database, JP Morgan controls that. Wells Fargo database,

00:07:30.480 | Wells Fargo controls that. What a blockchain is, is a solution to a computer science program.

00:07:36.640 | How do you have one database that's available everywhere in the world, everyone can see

00:07:40.100 | into, updates in real time, but that no single party controls, that's controlled by the crowd.

00:07:47.880 | And the reason that's interesting, and we can get into this, is you can do things with

00:07:52.760 | this decentralized database, that's the buzzword people rap into it, that you can't do with

00:07:58.760 | a centralized database. And I'll make just one example. I think it's the least interesting

00:08:03.220 | thing crypto does. So I don't want to get hung up on this. I don't think this is what

00:08:06.680 | crypto is about, but it makes the point. You know that the Bitcoin blockchain is pretty

00:08:11.160 | incredible in that it can move money faster than JP Morgan, which is just a fact. Like

00:08:19.100 | if we wanted to send money today, somewhere around the world, JP Morgan could get it done

00:08:24.680 | on Monday. The Bitcoin blockchain could move a billion dollars in 10 minutes. How does

00:08:28.800 | it do that? Well, if you think about it, the core problem with moving money between JP

00:08:34.120 | Morgan and Bank of America is that there are two databases. So if I send you money, I'll

00:08:38.640 | write you a check from my JP Morgan account, and you deposit it at Bank of America, Bank

00:08:43.320 | of America has to check with JP Morgan to make sure I have the money, because they can't

00:08:46.640 | see into that database. If we all have one database that we're all operating from, and

00:08:52.360 | I say I want to move money from my account to Rick's account, it's trivially easy to

00:08:57.040 | update it. It's like updating an Excel spreadsheet. It can happen in seconds. So all crypto, and

00:09:03.160 | we can talk about the use cases, but when you hear crypto, when you hear blockchain,

00:09:07.960 | think about a computer science problem, which is how do you have one database that's available

00:09:12.820 | everywhere in the world, everyone can see into, updates in real time, is always true,

00:09:17.580 | but there's no single person or entity controlling it. It's decentralized. That's what it's actually

00:09:24.020 | all about, and I think it's the most important financial technology breakthrough of the last

00:09:31.200 | 40 years.

00:09:33.160 | So where does the idea of crypto or cryptology come into all of this? So yes, you can give

00:09:40.140 | money to me, I can give money to you through this decentralized control database, but why

00:09:47.800 | can't people just go in and just make false transactions and take everybody's money?

00:09:52.460 | Yeah, that's exactly right. So where the crypto comes from, and I think crypto is a terrible

00:09:57.240 | name, like crypto sounds dangerous and sounds bad and sounds scary and sounds like criminals,

00:10:03.000 | but where it comes from is cryptography, and cryptography really emerged out of the military

00:10:10.080 | during the world wars in a way to send encrypted messages, and basically the way it works is

00:10:17.680 | something called public private key cryptography, but the easy way to think about this is I

00:10:23.480 | have a house, you could look up my address, but you can't come into my house because you

00:10:29.440 | don't have the key to my front door. Cryptography is the same way to do that electronically,

00:10:34.400 | sort of how can I have an address?

00:10:35.560 | But you can actually look in my windows, you can see everything I have, correct? You know

00:10:39.680 | everything I've got in my house, you can see everything, you just can't take it.

00:10:43.880 | That's exactly right, and so how do you apply that into a digital setting? How can I have

00:10:48.960 | a digital address that everyone can see into, but they can't access it? And the answer is

00:10:55.400 | something called RSA or public private key cryptography, which for what it's worth is

00:11:00.640 | not a new idea. All military communications uses the same cryptography as Bitcoin. All

00:11:07.360 | point of sale transactions, when you bought a coffee downstairs, how Visa communicates

00:11:12.000 | is the same cryptography as crypto. The way the internet works is the same thing. This

00:11:18.400 | is a fundamental technology, but people just stacked a few other innovations on top of

00:11:24.040 | it to create the blockchain, and that's where we are today.

00:11:29.000 | So when we talk about blockchain, just to confirm, there's not just one big blockchain

00:11:35.680 | out there that controls everything, right? I mean, there's individual blockchain, there's

00:11:41.720 | private blockchains, there's public blockchains.

00:11:46.840 | That's exactly right. So you can architect a blockchain in a bunch of different ways.

00:11:52.000 | So you mentioned private versus public blockchain. Vanguard uses a private blockchain to settle

00:11:56.280 | transactions internally. The right way to think of a private blockchain is it's like

00:12:02.200 | corporate intranets. If you remember the early days of the internet, I do, the internet was

00:12:07.280 | terrible and it was scary and you weren't supposed to go on it and no one trusted it

00:12:10.960 | and Wikipedia would never be anything. In the early days of the internet, everyone thought

00:12:15.160 | corporate intranets were the future. Why? Because they were safe, secure, and controlled.

00:12:21.760 | Your company could have an intranet and you could trust the information on it, but you

00:12:25.800 | wouldn't go into the wilds of the public internet. There be dragons.

00:12:31.080 | The same thing is true in crypto. You can have a private blockchain that only five people

00:12:35.800 | can work on, and J.P. Morgan uses a private blockchain to move money from Department A

00:12:41.600 | to Department B within the bank, because it's the most efficient way to do it. As I mentioned,

00:12:46.560 | Vanguard uses a private blockchain for certain securities transactions. And a lot of people

00:12:51.880 | have been excited about private blockchains. My sort of base case is that just like with

00:12:57.800 | the internet, it's actually the public open blockchains that are the valuable one. And

00:13:03.680 | we can get into this. There are many different blockchains, even publicly. There's Bitcoin,

00:13:07.680 | there's Ethereum. They do different things. They're good at different things. And they

00:13:11.960 | have different use cases in the world.

00:13:14.040 | So you take something like Bitcoin. Bitcoin is just one blockchain that everyone can access.

00:13:23.680 | It's a public blockchain, correct?

00:13:26.200 | Yeah.

00:13:27.200 | And if you have another type of cyber currency like Ethereum, that's a separate blockchain.

00:13:33.000 | But it's just all ledgers. It's just all spreadsheets in a way.

00:13:35.440 | Yeah.

00:13:36.440 | So we can all have access to all of this. We can all see it. But to actually make a

00:13:40.140 | transaction and get it to work, something has to happen where if you're going to give

00:13:45.720 | me money or somebody in this room, we're going to transact and we're going to give each other

00:13:50.880 | money on this blockchain. It has to be verified in some way. So talk about the verification

00:13:58.360 | of all these transactions.

00:13:59.360 | Yeah. Let's sit with Bitcoin. We can do Ethereum later because it's actually a more complex

00:14:03.800 | story. It's actually going to appeal to more of you because Ethereum has cash flow and

00:14:08.200 | Bitcoin doesn't. But you're right. If you think about what a bank does, a bank secures

00:14:14.040 | your money and processes transactions. And for that, they charge you a fee and you pay

00:14:17.520 | them in cash or they take your interest income depending on the bank.

00:14:23.000 | In a blockchain, Bitcoin blockchain, same thing. It processes transactions and it secures

00:14:28.200 | the blockchain. But there's no one person doing it. So how does it work? The way it

00:14:35.160 | works is what you've heard called mining in the Bitcoin space. And what mining is, is

00:14:42.800 | all these computers around the world. Anyone can run one of these computers. You could

00:14:47.520 | run one of these computers, Rick. And these computers work to verify transactions and

00:14:53.240 | then settle them on the blockchain and secure the blockchain. So to use your specific example,

00:14:58.840 | if I put in a ticket, if you want an order to send you a Bitcoin or half a Bitcoin or

00:15:05.080 | a third of a Bitcoin, it goes into a pool. And then these computers around the world,

00:15:11.840 | they take all the people who want to send Bitcoin from person A to person B. They check

00:15:16.480 | to make sure that I have the Bitcoin that I'm trying to send to you. That's a valid

00:15:21.520 | transaction. They package a bunch of them together into what's called a block. That's

00:15:25.880 | where the word blockchain comes from. And then one of them gets to settle that block.

00:15:32.240 | And then that enters and is sort of formalized in the ecosystem. And the way mining works

00:15:37.400 | is everyone's racing. One person gets to settle a block. Those transactions are finalized

00:15:42.240 | and then they do it all again. And every 10 minutes, a new block is processed. But it's

00:15:46.680 | the same thing banks are doing. It's just in a different way.

00:15:49.360 | So you've got all these transactions all over the world that are happening with Bitcoin.

00:15:53.800 | They're kind of adding all up in this block. And then at a certain time or a certain capacity

00:15:59.520 | of this block, then the miners go in and they try to solve some key. They try to figure

00:16:07.480 | out what the key is to verify all of these things. And if they're actually the winner,

00:16:15.960 | and by the way, this takes a tremendous amount of power, a tremendous amount of computing

00:16:19.480 | power. These are not simple transit, simple keys, if you will, that they have to figure

00:16:23.720 | out. Anyway, they then verify that yes, all of this is correct. And when a miner verifies

00:16:33.280 | that it's all correct and they find the key, they're the ones who get to the key first

00:16:40.120 | because there's all these competing miners out there trying to get to that same key.

00:16:44.280 | They get the key. What happens after that?

00:16:48.040 | Yeah. So when they solve this math problem, and then I want to explain why there's this

00:16:52.320 | math problem, because I think people think it's just a waste. When they solve this math

00:16:56.440 | problem, they raise their hand and say, "I've solved the math problem. Here are the 10,000

00:17:01.880 | transactions that should be settled." Everyone checks their work and it's finalized. And

00:17:06.240 | then that miner receives a reward from the Bitcoin network of new Bitcoin. So right now,

00:17:13.920 | these blocks are settled every 10 minutes. And the reward you get is a couple of Bitcoin.

00:17:19.520 | So a few hundred thousand dollars. And that's why everyone races to do it.

00:17:23.360 | What is it? 3.125?

00:17:25.200 | That's right. Yeah. So about 200 grand. And then you might be wondering, so why this complex

00:17:31.160 | math problem? And the reason is, you need to make it costly to propose a solution to

00:17:38.520 | the network and say, "I've settled these transactions." Because otherwise, everyone would spam it

00:17:44.640 | with fake transactions, right? They would just spam it because it would be free. If

00:17:49.020 | you make it costly, then the only people who are going to raise their hand and say, "I

00:17:52.560 | did this," are people who have processed valid transactions. And then the network adopts

00:17:58.120 | it, and then they run the race again. The incredible thing about this system...

00:18:02.800 | One thing about it. Once the network adopts it, everybody out there gets an update, correct?

00:18:08.160 | That's right. And the incredible thing about the system... Remember what I tried to explain

00:18:12.200 | earlier, which is it's the first decentralized database that updates in real time and is

00:18:16.000 | always true. The reason it updates in real time is in order to run the next race, you

00:18:23.360 | have to have the information that was just settled in this block.

00:18:27.520 | So if you think about how do you solve this problem of getting a million computers around

00:18:31.920 | the world to update in real time, the way it's solved is they all want to run this next

00:18:37.680 | race. And they can't run this next race until they update their database. And this is what

00:18:43.240 | allows it to work over time. And here's an incredible fact that's just true. Bitcoin

00:18:49.200 | blockchain has been working for 15 years, has 99.99% uptime. It has better uptime than

00:18:55.440 | the Swift network, the Visa network, or any major bank. And it's never processed a fraudulent

00:19:01.000 | transaction. It's an amazing result. And it's this mining algorithm that keeps people

00:19:08.080 | doing that.

00:19:09.640 | So a couple of questions there. There's money involved for the miners. The first thing,

00:19:15.200 | if they solve this equation and they beat everybody to solving the equation, they get

00:19:18.720 | 3.125 Bitcoin for doing it. Where does that Bitcoin come from?

00:19:25.280 | Yeah, it's issued. So we started with zero Bitcoin.

00:19:27.640 | It's created out of thin air.

00:19:30.920 | Well, Rick.

00:19:34.200 | Kind of like the Federal Reserve in a way, right?

00:19:37.760 | Yes. Yeah. With limits. I mean, it's created from the energy consumed. But yes, yes. We

00:19:44.040 | started at zero Bitcoin. There will only ever be 21 million Bitcoin. The way we get to 21

00:19:48.160 | million Bitcoin is through this process of mining. It follows an asymptotic curve. So

00:19:53.880 | the amount of Bitcoin you receive falls in half every four years. If you heard the halving,

00:19:58.960 | that's why they call it the halving. Crypto loves to make up fancy terms. And eventually

00:20:03.600 | there'll be no more Bitcoin in 2140.

00:20:05.960 | Well, there'll be a limited amount of Bitcoin, but it would all be issued.

00:20:09.080 | It'll all be issued.

00:20:10.120 | But I just want to confirm. I mean, there's not like this bank of Bitcoin sitting over

00:20:15.280 | here that's underlined by gold or anything, correct? That they just issuing 3.12. I mean,

00:20:21.280 | it is literally created and... No?

00:20:25.480 | Yes. Yes. So it's created like most things.

00:20:32.520 | By who?

00:20:33.520 | By the people. It's the people's money. Now, let me go straight into this.

00:20:39.080 | Sounds like our government.

00:20:40.960 | No, hold on. Everyone, this is sort of the fundamental question that I know you are asking,

00:20:47.720 | which is, why does Bitcoin have any value?

00:20:49.960 | Well, we're not there yet, but I just want to say.

00:20:52.880 | We'll get there in a minute.

00:20:53.880 | You've got me pinned in this theoretical place. I want to make sure I get there.

00:20:57.680 | I'm going to let you up for a minute here. So the miners get 3.125. So that's their incentive.

00:21:04.400 | Yes.

00:21:05.400 | At least for the next hundred years until all the Bitcoin are issued, correct? And it

00:21:08.520 | keeps halving. So it gets less and less and less.

00:21:10.840 | Correct.

00:21:11.840 | It's more and more expensive for them to do this. But also, if I was going to send you

00:21:15.120 | my money through the blockchain, the Bitcoin blockchain, I have to pay a little bit of

00:21:19.680 | a fee too, correct?

00:21:20.920 | You can pay a fee. So there's a tip or incentive fee. The way to think of it is these blocks

00:21:25.800 | can only process so many transactions. If there's more than that, if you want to jump

00:21:30.080 | to the head of the queue, you append a tip. I'll give you like a dollar, I'll give you

00:21:34.240 | two dollars.

00:21:35.240 | Is that a tax-free tip?

00:21:37.440 | It's taxable revenue, Rick. Everyone in crypto follows taxes. The elegance of this is you're

00:21:46.300 | probably wondering what happens in 120 years when all the Bitcoin's gone. Well, the idea

00:21:51.540 | is that this tip revenue takes a bigger and bigger portion of the stack. And that's in

00:21:56.480 | fact true. When it started, it was 100% this issuance, which by the way, is called a Coinbase

00:22:01.800 | award if you want to know where Coinbase got its name from. This issuance of new Bitcoin

00:22:06.320 | is called a Coinbase award. The amount of tip revenue is zero. Now it's about 3 to 10%,

00:22:13.320 | depending on the day. And the idea is that in 2140, it'll be 100%. So it's a self-sustaining

00:22:18.600 | ecosystem of fundamental value.

00:22:21.240 | Let's go way back to the first Bitcoin transaction, which I believe was 2010?

00:22:33.200 | The first commercial transaction, yes, of buying something, yep.

00:22:36.720 | Where it took 14,000 Bitcoin to buy two pizzas, correct?

00:22:42.800 | Yep, something like that, yeah.

00:22:44.920 | We've had some inflation in Bitcoin, have we not?

00:22:48.760 | It's the best way to hedge yourself against inflation. They look like pretty good pizzas.

00:22:54.200 | I'm not going to lie. No, look, yeah. Originally, Bitcoin wasn't worth very much, which has

00:23:01.880 | to be true. If you're inventing a new store of value, it has to start at zero and eventually

00:23:06.800 | become very valuable. It has to start with high volatility and eventually become low

00:23:13.240 | volatility. That's actually exactly what's happened in Bitcoin. It's gone from zero to

00:23:17.760 | 1.2 trillion dollars. Vol has fallen by more than 60% over the last 14 years in Bitcoin.

00:23:25.200 | So yeah, some guy bought a Bitcoin, a pizza for what amounts today to like $400 million,

00:23:33.840 | which seems bad. It sounds like a lot, however good it was.

00:23:39.280 | It's a good pizza.

00:23:41.640 | But the reality is, it's unlikely he would have held that Bitcoin until today.

00:23:47.200 | So it's interesting. So these two people decided they're going to do the first transaction

00:23:51.080 | and it's going to be a couple of pizzas and it's going to cost 14,000 Bitcoin. But then

00:23:57.640 | other people started just adopting this. And not only did they, by the way, this first

00:24:05.160 | took place in California, this transaction.

00:24:07.480 | I think the transaction, yeah, it was U.S. based.

00:24:09.960 | Okay, so it went through the U.S. and now it's all over the world. And now we have millions

00:24:15.160 | of people on this, which is kind of amazing if you think for this private currency that

00:24:21.560 | this is going on.

00:24:22.560 | Now, so tell us why other, say other countries like Ghana or Libya, whatever, why would they

00:24:28.400 | like to adopt this? It's not because they think it's going to go up in value. They're

00:24:31.560 | using it actually for currency, correct?

00:24:33.360 | Well, I mean, they're using it to store wealth in economies where they have terrible currencies.

00:24:41.040 | You don't have a great one. As Bill mentioned on the last panel, the government inflated

00:24:45.760 | away about 25% of the value of the dollar over the last handful of years. That's not

00:24:50.400 | great, but it's certainly the cleanest shirt around the world. If you're in another economy

00:24:57.480 | and you can't gain access to dollars, Bitcoin appeals to a lot of people.

00:25:04.800 | My starting point is that it's not physically impossible for a new store of value to emerge

00:25:10.740 | in the world. It's not impossible for there to be a digital store of value, and it appears

00:25:16.280 | as if Bitcoin is filling that role. So yes, in these countries around the world, people

00:25:19.720 | are using it to store value. Some people are using it for payments, although I think the

00:25:23.800 | primary use is store value, and it's gaining adoption.

00:25:28.200 | Okay. Oh, by the way, if you have questions, we'll collect them, and we'll get to your

00:25:36.960 | questions. We've got about a little over 15 minutes left in this discussion. Now, your

00:25:45.960 | company is not a miner. No, your company has created products. You were one of the first

00:25:58.000 | exchange-traded funds. In fact, the least expensive, if you want to look at fees, being

00:26:02.320 | in Boglehead, to hold Bitcoin. So it seems to me, in the world, there are two types of

00:26:11.760 | people who buy Bitcoin. There are people who want to buy it as an investment or a store

00:26:19.200 | of value, and there are people who are using it for transactions, correct?

00:26:25.080 | Yeah. And the people who are using it for transactions, say, in the United States, it's

00:26:30.360 | a little difficult, right? I mean, if I buy Bitcoin to buy a car or buy something else

00:26:38.520 | with it, this is treated by the IRS as an asset. So on my tax returns, even if I buy

00:26:47.520 | a pack of gum for $2, I have to actually list that on my tax return. Do I not talk about

00:26:54.040 | this? Yeah, it's terrible to buy stuff. I've never

00:26:57.760 | bought a coffee with Bitcoin, but I've never bought a coffee with gold either.

00:27:02.960 | Well, it's true. You would have had to do that.

00:27:05.680 | And it'd be a lot easier to send you a little piece of Bitcoin than it would be to like

00:27:09.200 | shave a bar of gold. So, you know, look, it is not used for... Again, I think the primary

00:27:17.200 | value of Bitcoin is to be a store of value, a way to store wealth outside of the fiat

00:27:22.560 | system in a digital format. I think more people will want to do that in the future than do

00:27:27.000 | that today. But in the US, it's not a great transactional tool, and I doubt it ever will

00:27:32.280 | be. I mean, we have the dollar. Dollar's great.

00:27:34.720 | Okay. So if you're going to store your value in Bitcoin, when you're going to buy something,

00:27:41.960 | you convert it to dollars and you use dollars to do it. It's a lot easier to just to convert,

00:27:46.520 | say, a big block of Bitcoin than it is, you know, each little individual transaction.

00:27:50.960 | Yes. Yeah. A hundred percent. Yes.

00:27:53.400 | One question came in, and I think we need to circle back to this. It has to do with

00:27:58.240 | the security of Bitcoin. So we hear a lot about it's a great platform for laundering

00:28:05.280 | money, a great platform for organized crime.

00:28:10.980 | Thanks for having me, Rick.

00:28:13.240 | Well, just tell us why things have gotten better.

00:28:18.200 | So things have gotten a lot better. The most important day in Bitcoin's history from my

00:28:24.140 | perspective was a day in 2019 when the travel rule began to be applied to all digital asset

00:28:33.440 | service providers around the world, including things like Coinbase, including things like

00:28:37.240 | finance, etc. And if you look at the leading reports of the volume of activity that's illicit

00:28:43.880 | on the Bitcoin channel, it fell from about 1.2% of transactions to about 0.3%. And today,

00:28:51.960 | even the Department of Justice says that Bitcoin does not have significant criminal use. And

00:28:57.600 | the reason for that is every Bitcoin transaction is traceable. It's synonymous, but it's traceable.

00:29:04.000 | You can go back in time for every Bitcoin forever. And what happened is they began regulating

00:29:09.720 | entities like Coinbase, which are the exit points to the traditional system. And any

00:29:15.400 | time an illicit transaction hits one of those exit points, it's seized. And I know people

00:29:24.000 | are skeptical of this, but the government itself has come out and said it's not primarily

00:29:29.600 | used for criminal activity now. There's a huge amount of regulation. Now, there are

00:29:33.920 | parts of crypto where that's not true. These things called privacy coins, which I think

00:29:37.520 | will be made illegal. These things called mixers, which are being made illegal. But

00:29:42.880 | traditional just use of Bitcoin, there really just isn't criminal use anymore. There used

00:29:51.300 | to be, but there's not. Less than for cash.

00:29:55.940 | So I'm a rogue country, North Korea. I buy a quantum computer. Now, this is way beyond

00:30:06.320 | the power of anything. It's just being created. Let's say this quantum computer, it can break

00:30:11.920 | the code of the Bitcoin blockchain and basically take everybody's money. Tell us the threat

00:30:21.500 | of quantum computing, which by the way, is an interesting area. I do follow this industry.

00:30:26.920 | It's really come a long way. What safeguards are being put in place to protect things like

00:30:32.400 | this, in a way, legacy Bitcoin blockchain, which is quite old, as we talked about, against

00:30:37.960 | new technology such as quantum computing?

00:30:40.520 | Yeah. I mean, the place I would start is that if North Korea has a quantum computer that

00:30:44.680 | breaks RSA cryptography, Bitcoin is going to be the last thing they look at. I think

00:30:49.600 | they'll look at US military communications, because they would be able to see through

00:30:55.200 | all of that. I think they would look at the fundamental functioning of the internet and

00:30:59.080 | the energy grid, all of which relies on the exact same cryptography that Bitcoin has.

00:31:05.920 | Bitcoin, it wouldn't make sense to steal people's money using quantum cryptography breaking,

00:31:13.840 | because the act of doing so would destroy the value of Bitcoin. I don't worry about

00:31:18.120 | it, because there's been huge advances in quantum resistant cryptography, because it

00:31:22.960 | is the centerpiece of how the internet and all military communications and all commercial

00:31:26.500 | transactions take place. I think quantum resistant cryptography will be solved before steady

00:31:33.120 | state quantum computing. And if we're wrong, I really think Bitcoin's the last thing to

00:31:38.960 | be worried about. I'd be worried about nuclear codes.

00:31:43.080 | Let's go on to another topic. So we have an energy shortage here, and we're trying to

00:31:53.960 | make energy more green. We have climate change and so forth, and a big discussion about that.

00:32:01.000 | And of course, there's two sides to it. But there's no doubt that mining Bitcoin takes

00:32:09.660 | a heck of a lot of energy. And as more and more and more energy is being used to do this

00:32:19.040 | mining of cryptocurrencies, I mean, isn't that sort of counterproductive to where society

00:32:24.880 | is trying to go?

00:32:25.880 | Yeah. I mean, I'd say two things. First, it uses about the same amount of money, energy,

00:32:29.880 | as video games. And I would argue that a new currency...

00:32:32.960 | A heck of a video game.

00:32:34.480 | Well, I'm saying. It's just facts. But look, this is like anything. We have gas powered

00:32:40.720 | cars and we're moving to electric cars. Blockchain started with an energy intensive infrastructure,

00:32:46.800 | and it's moving to an energy light infrastructure. So Ethereum, the second largest blockchain,

00:32:52.320 | doesn't use mining. It started out using mining. It uses a new technology called proof of stake,

00:32:58.720 | which requires people to put up collateral to guarantee their honesty in processing transactions.

00:33:04.240 | Bitcoin is still on the original version, which is called proof of work, which involves

00:33:09.000 | all these computers running things. That's because Bitcoin is, I know you'll laugh, because

00:33:15.800 | in this setting it seems ridiculous, a very conservative blockchain. Ethereum is more

00:33:20.960 | open to innovation. I think eventually we'll move to a more energy resilient system in

00:33:27.440 | Bitcoin. But it's actually the transition's happening a lot faster in crypto than it is

00:33:32.160 | in almost any other industry around the world. So I think we're going through the same energy

00:33:37.360 | transition there.

00:33:38.560 | Okay. Well, you mentioned a few things about, and I said this too, and Bitcoin's been around

00:33:43.120 | for a while now, what, 14 years, 15 years, right? Been around for a while. And there's

00:33:48.160 | new technologies that have come along. Okay. Now, before we get to some of those new technologies,

00:33:55.840 | if out with the old, in with the new, what keeps the value of Bitcoin at $60,000 a coin

00:34:05.400 | if there's better, newer, faster, cleaner technologies that do more out there?

00:34:11.360 | Oh, this is a great question.

00:34:13.280 | I'm glad you like it.

00:34:16.400 | Finally. Let me do one minute to explain the difference between Bitcoin and Ethereum. And

00:34:22.920 | then by that means, answer that question. So every crypto asset is two things. It's

00:34:28.760 | a blockchain and an asset, the Bitcoin blockchain and Bitcoin, the Ethereum blockchain and Ethereum.

00:34:35.360 | The blockchain is just a piece of software and you can optimize a piece of software to

00:34:39.120 | be good at different things, right? Microsoft Word is a piece of software and Salesforce

00:34:44.120 | is a piece of software, but they do different things. The same thing is true in crypto.

00:34:48.080 | Bitcoin was the first blockchain. And it's very simple. All you can make Bitcoin do is

00:34:52.880 | send money, receive money, hold money. That's it. That's it. Ethereum was the second major

00:34:58.960 | blockchain. It looked at Bitcoin and said, it's amazing. You can move a billion dollars

00:35:01.880 | around the world instantaneously. What if we could program this like we program other

00:35:06.840 | features? So Ethereum is a Turing-complete programming language, which means you can

00:35:11.040 | program Ethereum to act like a bank or to do conditional things. Give Rick my Ethereum

00:35:18.640 | if he says something nice about me.

00:35:20.360 | So it can do contracts.

00:35:21.360 | They can do contracts. Now, it can do anything. You can build the New York Stock Exchange

00:35:25.600 | on Ethereum. And there are examples like that. You may wonder why is Bitcoin worth more than

00:35:29.800 | Ethereum if Ethereum can do everything Bitcoin can do and then some. And this is the answer

00:35:34.540 | to your question. In designing software, having limited capability has one big advantage,

00:35:42.120 | which is it makes your software extremely secure.

00:35:45.240 | If you think about the Bitcoin blockchain as a piece of software, it's relatively simple.

00:35:49.040 | It's been around for 15 years. It doesn't update much. There's very little chance of

00:35:52.760 | there being a bug in it. If you think about the Ethereum software, it's very complex.

00:35:57.400 | It goes through major upgrades every two years. The chance of a bug is substantially higher.

00:36:02.080 | And that gets to use case. Bitcoin is used as digital gold. If you want to build digital

00:36:07.080 | gold, the only thing you care about is it's secure. It doesn't need to sing. It doesn't

00:36:12.480 | need to dance. It just needs to be secure. Digital gold is a $17 trillion market. Bitcoin's

00:36:19.640 | penetrating that. And that's what it's rewarded for. If you want to build a new financial

00:36:24.080 | ecosystem, you need to sing and dance, etc. That's what Ethereum is doing. But it won't

00:36:29.320 | ever compete with Bitcoin because it will never be as secure as Bitcoin.

00:36:33.600 | The other reason that Bitcoin can't be surpassed for its use case of digital gold is that the

00:36:38.400 | security of a blockchain depends on how much money people spend mining it or doing proof

00:36:43.560 | of stake. And Bitcoin just has a lead. And it's hard to assail. You and I could create

00:36:50.120 | Matt Rick coin, but it would be secured only by the power of my phone. Anyone could hack

00:36:56.640 | it. It'll be hard for another asset to disrupt Bitcoin as digital gold. But other use cases

00:37:02.960 | of blockchain, you'll see a lot more competition.

00:37:06.040 | Well, we've got a couple of minutes left. Let's just get into valuing Bitcoin. I mean,

00:37:13.960 | value Bitcoin. Is that an oxymoron?

00:37:15.920 | Not at all. Bitcoin provides a service. Unlike stocks and bonds that pay cash flow or real

00:37:29.400 | estate that pays cash flow, where you could say, OK, here's a series of cash flows that

00:37:34.280 | you're going to get so we can discount those cash flows by some discount rate based on

00:37:38.920 | risk and we can come up with what the net present value of that stream of cash flows

00:37:42.640 | is out to perpetuity. Well, Bitcoin, like gold, granted, doesn't have any cash flow.

00:37:49.520 | And so you can't, by some standards, you cannot put a value on it because there's no cash

00:37:56.240 | flow. But it does have a value. I mean, it trades at a price. It trades at a price every

00:38:02.320 | day. And I asked you this question on the podcast, but I'll ask it again. I mean, it

00:38:07.760 | seems to me, and maybe I'm wrong, that if it cost me as a miner, it cost me $60,000

00:38:17.420 | or $30,000 per Bitcoin to mine, that at least should be somehow factored into the price.

00:38:24.360 | So, I mean, that might be one determinant. In other words, how much does it cost a miner

00:38:28.960 | to mine Bitcoin has some factor in determining what the price is? Does it?

00:38:38.720 | I think it has some factor in determining the price, but the amount of cost to mine

00:38:43.040 | a Bitcoin has a reflexive loop with the price of Bitcoin because the more the value goes

00:38:49.560 | up, the more people mine, the harder it is to mine, the cost to mine goes up. I think

00:38:54.960 | of it a little bit differently and pretty simply. You know that sort of thing you do

00:39:02.440 | with kids where you draw nine dots and you ask them to connect it with four lines and

00:39:05.820 | they can't do it if they stay within the parameters. I feel like people are like that with this

00:39:10.080 | cash flow thing. Bitcoin provides a service, which is the ability to store wealth without

00:39:15.380 | relying on a government or a bank. You may not like that service. I like that service.

00:39:20.320 | Millions of peoples around the world like that service. If more people want that service,

00:39:24.680 | the value of Bitcoin goes up. If fewer people want it, the value goes down. If no one wants

00:39:28.360 | it, the value goes to zero. That's actually not different from any other service. Salesforce

00:39:33.720 | provides a service. If more people want Salesforce's service, the value of Salesforce stock goes

00:39:38.700 | up. If fewer people want it, the value goes down. If no one wants it, the value goes to

00:39:42.240 | zero. The only difference is Salesforce is a centralized entity, so to get that service,

00:39:47.880 | you can pay Salesforce a subscription. There's no Salesforce. There's no centralized entity.

00:39:56.460 | You can't pay a cash flow to get this service. The only way you can get the service Bitcoin

00:40:03.480 | provides is to buy Bitcoin. The more people do that, the more value goes up. It's actually

00:40:09.840 | just the same. More people, more value. Fewer people, less value. More people, more value.

00:40:14.920 | Fewer people, less value.

00:40:15.920 | >> So it's supply and demand.

00:40:17.280 | >> It's supply and demand. I think it's going after a market that's probably $30 to $40

00:40:24.200 | trillion in size. So how much could a Bitcoin be worth? If Bitcoin captured the gold market,

00:40:30.240 | if it had the same amount of wealth in Bitcoin as is in gold, every Bitcoin would be worth

00:40:35.320 | $1 million. Right now, the market is saying it has about a 6% chance of doing that before

00:40:43.600 | you take discounts into effect. Maybe a 10% chance on a discounted basis. If you think

00:40:48.760 | it has a 20% chance or a 50% chance, then no matter what your discount factor is, the

00:40:54.840 | net present value is actually higher. So that's how I approach valuing Bitcoin. I estimate

00:41:00.080 | its chance of penetrating a market, and then I apply a discount factor to that. It's not

00:41:04.880 | that far off of cash flow.

00:41:06.920 | >> But there is this black swan risk out there, right, where the first quantum computer that

00:41:17.040 | nobody knew about breaks the code, and now nobody wants Bitcoin anymore.

00:41:22.840 | >> Yeah, or every government around the world bans it. That's why you don't put 100% of

00:41:26.920 | your portfolio in Bitcoin. I mean, at Bitwise, we talk about 1% to 5% of your portfolio,

00:41:38.480 | with 5% being the absolute max. Because above that, it makes your overall portfolio more

00:41:43.760 | volatile and subject to mass drawdowns. If you put 1% of your value in portfolio in Bitcoin,

00:41:49.920 | the most you can lose is 1%. And that's how I handle that sort of existential risk.

00:41:54.680 | >> So let's look forward. We talked about Bitcoin, we talked about Ethereum, there's

00:41:59.800 | others. What is the one really interesting new thing that's coming along that you're

00:42:06.280 | excited about?

00:42:07.280 | >> Yeah, I mean, first I should say from an investment perspective, we run a crypto index

00:42:10.640 | fund because my family had a Betamax growing up. You never know what the future of technology

00:42:16.160 | will look like. What are the applications that I'm excited about? I'm excited about

00:42:22.000 | digital gold. I'm excited about stablecoins disrupting payments. Stablecoins are digital

00:42:30.200 | dollars on the blockchain. I think it's a crime that we pay a 2.5% fee every time.

00:42:36.200 | >> 2.9%.

00:42:37.200 | >> Every time we use a Visa card.

00:42:40.600 | >> And then if a client pays me on a Friday afternoon after 4 o'clock, I don't get the

00:42:46.280 | money until Monday. And I still have to pay 2.9%.

00:42:49.880 | >> Yeah, remember when we paid a dollar a minute for long distance phone calls? To me,

00:42:54.760 | the Visa fee feels like that. It's something that we've grown to accept as reality, but

00:42:59.080 | it doesn't have to be. Today, there's about $160 billion of dollars on blockchain called

00:43:06.520 | stablecoins issued by firms like PayPal. And those can move around the world instantaneously,

00:43:13.480 | settle instantaneously 24/7, 365. And the cost to transfer them is like sub-penny.

00:43:23.040 | And that's all built on blockchain. That's all built on the Ethereum blockchain. I think

00:43:26.240 | we're going to wake up and stablecoins are going to disrupt Visa, MasterCard, and PayPal

00:43:31.520 | the way cell phones disrupted AT&T. And that could happen almost in a day. I think we'll

00:43:38.000 | get stablecoin legislation next year and it'll be a game changer.

00:43:43.360 | We've got 15 seconds left, so I'm going to leave you with the floor and final comments.

00:43:50.000 | >> I would just say thank you all for having me today. I know that crypto is outside the

00:43:55.760 | norm and really appreciate the open minds. Even though I've gone to the crypto dark side,

00:44:02.880 | as Rick said, Vogelheads remain my home. So thank you all for having me. I really appreciate

00:44:08.600 | it.

00:44:09.600 | [ Applause ]

00:44:13.640 | >> Thank you.

00:44:14.640 | >> Thank you.

00:44:15.640 | >> Thank you.

00:44:15.640 | [BLANK_AUDIO]

Bogleheads® Conference 2024 Does Crypto Merit a Place in Your Portfolio? with Matt Hougan

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