FIDELITY’S ‘BITCOIN FIRST’ REPORT MISDIRECTS INVESTOR FOCUS

A recent report from financial services behemoth Fidelity recognises Bitcoin as a distinct asset class, but fails to recognise its true potential.

Fidelity published “Bitcoin First: Why Investors Need To Consider Bitcoin Separately From Digital Assets” on January 18, written by Director Of Research Chris Kuiper and Research Analyst Jack Neureuter.

Many in the space saw institutional recognition of bitcoin as a distinct entity from what is commonly referred to as “crypto” as a net-positive for Bitcoin. Fidelity should be commended for this recognition, as well as its efforts to understand bitcoin as a digital asset in its own right. This report, however, demonstrates that institutional education still has a long way to go.

‘WHICH ONE IS IT?’

“Once investors have decided to invest in digital assets, the next question becomes, ‘Which one?'” the paper begins.

Fidelity presents an articulated outline to guide its investors on a path of digital scarcity in the report’s aptly chosen title. Fidelity makes the following points in the outline: -“Bitcoin is best understood as a monetary good, and one of the primary investment theses for bitcoin is as the store of value asset in an increasingly digital world. -Bitcoin is fundamentally different from any other digital asset. -There is not necessarily mutual exclusivity between the success of the Bitcoin network and all other digital asset networks.

Fidelity moves on to the first point after defining the outline: defining bitcoin as a monetary good.

 

WHAT IS BITCOIN? 

Fidelity distinguishes between Bitcoin, the network, and Bitcoin, the asset, which is commonly represented by capitalising the “B” when referring to the network. The authors then start talking about bitcoin as a monetary good and as a network.

On page five, they discuss how bitcoin has a (roughly) 1.8 percent calculable inflation rate that is inherently finite and tied to a fixed amount of 21 million coins. This programmatic issuance ensures the first and only manifestation of digital scarcity as it relates to monetary goods — this scarcity drives the value of bitcoin in an unrivalled way. Why can’t it be duplicated?

According to the Fidelity report, “Because Bitcoin is currently the most decentralised and secure monetary network (relative to all other digital assets), a newer blockchain network and digital asset that tries to improve upon bitcoin as a monetary good will necessarily have to differentiate itself by sacrificing one or both of these properties.”

According to Fidelity, this is due in part to the understanding that a database “can only deliver on two of three guarantees at the same time: decentralisation, security, or scalability.” This necessitates a sacrifice in order to attempt to replace Bitcoin, which ultimately ensures its failure.

When referring to the network’s ability to overcome unforeseen obstacles, they provided a list of events in Bitcoin’s history that Fidelity considers negative, but which were ultimately overcome. Here is a list of them:

Some of these events were net positives for Bitcoin rather than negatives.

First, the anonymous creator was critical to the network’s success. The lack of a target, political associations, or beliefs attached to the protocol allowed it to become an opt-out form of money that returns money sovereignty to the individual. Satoshi Nakamoto knew that a leader or creator assigned their identity’s system of beliefs to the network, which is why they remained anonymous.

 

Second, the “civil war,” also known as “the blocksize wars” in the space, established a true ethos to a programmatic and decentralised form of money, asserting that the amount of data stored within Bitcoin blocks should remain small enough to allow participation in the network with relatively easy hosting of nodes, a critical aspect of Bitcoin’s decentralisation. This was a testing ground and an important part of the Bitcoin story, a tale of vision and consensus that would ultimately shape the protocol.

After discussing the “civil war,” the report’s authors move on to hard forks (when protocol consensus splits, resulting in the creation of a new token) that were created in the name of scalability. Why is scalability important for a digital asset?

 

SCALING OF BITCOIN

“Scalability has notably been the Bitcoin network’s Achilles heel, as it maximises decentralisation and security while having one of the slowest transaction throughputs.”

–Fidelity

This is an inaccurate depiction of the Bitcoin network. As Fidelity mentions several times in this paper, Bitcoin prioritises decentralisation and security over all else. This entails a slow-moving base layer that is designed to be slow and not scaled. Off-chain scaling was always intended for Bitcoin.

The term “off chain” refers to the placement of applications built on top of Bitcoin that use the Bitcoin ledger for record keeping and use of bitcoin, the currency, in ways that do not require every transaction to be processed on the base layer as soon as it occurs. The Lightning Network is the most successful iteration of Layer 2 applications to date, but it only receives a brief mention in this paper, which you can find below:

Lightning is mentioned as a bystander in the conversation in the paper, but it has led to El Salvador being able to adopt bitcoin as legal tender due to its ability to scale at a nation-state level.

To say that scalability is Bitcoin’s “Achilles heel” is to wonder why gold was not capable of global instant settlement. An asset’s base layer must move slowly and securely, and systems are designed to be built on top of that base layer.

I’m sure you’re wondering why the text in the preceding image was highlighted. After discussing scalability and the iterations of Bitcoin that resulted from hard forks aimed at changing this scalability, the Fidelity report compares Bitcoin to Ethereum and discusses smart contracts.

 

BITCOIN VS. ETHEREUM

A diagram depicting the differences between Ethereum and Bitcoin is provided below. The report authors stated in the previous image referencing Lightning that this Layer 2 application was “built using smart contract functionality.”

 

The Fidelity authors paint an inaccurate picture of whether the Bitcoin network can host smart contracts in this comparison. Smart contracts have always existed on Bitcoin, but they have always been more limited than those found on other platforms. Typically, protocols such as Ethereum refer to “Turing-complete” smart contracts. This means that the code can simulate a Turing machine and is considered computationally more expressive, allowing for broader application scenarios.

Taproot, a protocol upgrade released last year, enables more widespread use of smart contracts on Bitcoin. It does not permit the use of smart contracts because smart contracts were already available on Bitcoin. This is a common misconception about Bitcoin, as many people believe that smart contracts do not exist or were not possible prior to Taproot. Taproot, in fact, expanded on existing applications.

It may appear that the purpose of highlighting this is to simply point out where the Fidelity authors are incorrect, but this is not the case because they got a lot of things right in this paper, which is primarily focused on institutional adoption. The content of this report can undoubtedly drive the narrative that Fidelity seeks to achieve.

But first, let’s go over one more important aspect of Bitcoin that you should be aware of.

 

THE PURPOSE OF BITCOIN

Fidelity, as previously stated, sees the primary reason for creation and technological innovation as a monetary good. This viewpoint makes sense as a financial services company, as demonstrated by the following excerpt: “The first-mover advantage [of Bitcoin] led to a lack of true competition for bitcoin’s primary use case as a monetary asset and a store of value, creating a drastically different return profile for bitcoin investors.”

The primary use case is not as a monetary asset, and it is worth noting that there was no value to speak of when it was created, allowing for a store-of-value use case. Bitcoin’s true primary use case is as a protest tool. This text is etched in digital stone in the genesis block, the first block mined on Bitcoin, to demonstrate this: “The Times 03/Jan/2009 Chancellor on the Verge of a Second Bank Bailout.”

Bitcoin is a direct response to the 2008 financial crisis and our centralised systems’ inability to respond appropriately. Bitcoin is an opt-out monetary good that enables users to exit the nation-state system and reclaim control over their own wealth. It is the embodiment of protest and a voice against wrongful and misguided authority.

 

WHAT CAN WE TAKE AWAY FROM FIDELITY’S VIEW ON BITCOIN?

“Traditional investors typically apply a technology investing framework to bitcoin, resulting in the conclusion that Bitcoin, as a first-mover technology, will be easily supplanted by a superior one or will have lower returns.” However, as we have argued here, bitcoin’s first technological breakthrough was as a superior form of money, not as a superior payment technology.”

–Fidelity

 

Fidelity got a lot of things right in this report, including bitcoin being considered separate from crypto, the Lindy effect demonstrating that Bitcoin grows stronger by the day, the network’s enforceable scarcity as a highlight, why Bitcoin can’t be supplanted, the struggles Bitcoin has endured, presenting bitcoin as a starting point for digital portfolios, and the risks associated with it.

It’s clear that Fidelity intended for this report to target institutional buy-in, so it stands to reason that the narrative would be tailored to entice long-term investment strategies based on the continued success of this new monetary good. But that doesn’t mean we shouldn’t always be vigilant and purposeful in our understanding of what Bitcoin is and what it’s truly capable of.

 

Disclaimer: These are the writer’s opinions and should not be considered investment advice. Readers should do their own research.

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