2020: The Next Phase of Bitcoin's Evolution

In May 2020, the long-anticipated halving (aka The “Halvening”) of Bitcoin’s block reward will be triggered, reducing the number of bitcoins mined from 12.5 to 6.25 per block. This will reduce Bitcoin’s inflation rate from ~3.7% to ~1.8%, below that of the US Dollar and only 0.3 percentage points higher than gold.  Bitcoin will be nearly on-par with gold as the “hardest” money in all of human history; it will become more difficult to produce a new Bitcoin than an additional unit of any other currency except gold. Unlike gold, Bitcoin is vastly more divisible, portable, durable, recognizable and highly resistant to seizure.

Within 2 to 3 years, I believe that increased market confidence in Bitcoin’s true scarcity will cause its network value (aka market capitalization) to soar from approximately $150 billion today to between $1 trillion and $3 trillion as predicted by PlanB’s stock-to-flow model. This implies a price of $50,000 to $150,000 per Bitcoin.  New demand for Bitcoin will come from a Millennial savings boom, a marginal shift in global demand from gold to Bitcoin, and investors starved for yield in a world saturated with over $15 trillion in negative interest rate debt. 

The massive flow of value into the Bitcoin Network will enrich HODLers who will use their newfound purchasing power to fund innovations that will influence the broader world.

Bitcoin-backed banking will proliferate.

As Bitcoin’s price booms, newly enriched HODLers will seek to improve their standard of living by earning interest on Bitcoin deposited into off-chain lending companies like BlockFi and Unchained Capital. For putting their Bitcoin at risk, they will earn interest far in excess of today's so-called "high-yield" accounts which offer zero or even negative real returns. They will also use their Bitcoin as collateral to secure US Dollar-denominated loans that will enable them to deploy their Bitcoin without incurring fiat capital gains tax liability from selling.

Bitcoin-backed banking will also occur onchain. 2019 was the year of Decentralized Finance, or DeFi, on Ethereum. An explosion of new decentralized finance protocols emerged including stablecoins (MakerDAO), exchange (Uniswap), savings (Compound), lending and derivatives (bZx), and synthetic assets (Synthetix). As of this writing, over $800 million is now locked in the DeFi economy from only $50 million at the end of 2017 with Ether (ETH) as its currency. 

Soon, I believe blockchain interoperability solutions like Nomic will allow Bitcoin to be transferred seamlessly across blockchains, including Ethereum. This new “Internet of Blockchains”, or Interchain, will allow Bitcoin to exploit its currency network effect as the hardest, most liquid cryptocurrency with over 60%+ of all trading volume. Like Ethereum, Bitcoin will increasingly be used as collateral in an expanding DeFi economy. Bitcoin will become the King of Collateral in this new economy as it will come to have the “lowest perceived counterparty risk on the planet”.

Decentralized Stablecoins will gain significant currency market share. 

The US Dollar is the global reserve currency and unit of account, and will remain so in the medium term as Bitcoin’s exchange rate volatility remains insanely high.  A plethora of centralized stablecoins pegged to the US Dollar have already been issued by a number of exchanges including Binance, Coinbase, and others. Tether (USDT) dominates the global centralized stablecoin market with over 96% of all stablecoin trading volume despite deep public mistrust of the company that operates it. 

In my view, stablecoins have not gained significant currency market share yet because they are either centralized (Tether, USD Coin, True USD, etc.) or overcollateralized (MakerDAO). Both of these factors severely limit the number of people who can use stablecoins as mediums of exchange. For instance, $465 million of ETH is locked in MakerDAO, but there is less than $30 million worth of DAI, the stablecoin issued after ETH is deposited as collateral.

Despite limited success so far, decentralized stablecoins issued on top of unstoppable, permissionless blockchains like Bitcoin and Ethereum will likely overcome the shortcomings of their centralized counterparts. The volatility of Bitcoin’s exchange rate with the US Dollar will decline as the Bitcoin network grows, increasing its usefulness as collateral. I believe it is likely that one or more decentralized stablecoins will gain widespread adoption in the medium-term. TradeLayer, Reserve, MakerDAO, and Facebook’s Libra are the most promising projects to watch in the space. 

The International Monetary Fund believes that the proliferation of stablecoins would likely lead many countries, especially those with high inflation or low public trust in their currency, to adopt the US Dollar as their de-facto medium of exchange. If decentralized stablecoins are successful, we should expect the number of currencies globally to plummet as an increasing number of countries become “dollarized”. 

Square will build a payments protocol using Bitcoin.

Jack Dorsey, the founder and CEO of Square, loves Bitcoin. He has repeatedly stated that he both hopes and believes that Bitcoin will be the “internet’s native currency”. Jack Dorsey’s public commitments have been followed with decisive action. Square has enabled Bitcoin buy and sell as well as send and receive functionality in the Cash App. The company has created an internal team called Square Crypto to further develop the Bitcoin protocol, and has even created an SDK for the Lightning Network. According to Square’s Shareholder Letter, Cash App generated $148 million in Bitcoin revenue in the third quarter of 2019, up from $125 million in Q2 2019 and $65 million in Q1 2019. 

Beyond Jack Dorsey’s personal enthusiasm for Bitcoin, Square is heavily financially incentivized to build their own payments protocol. Why is this? 

Square primarily makes money by making it easier for businesses to accept payments from their customers. Square receives a small percentage of the revenue for each transaction it processes on behalf of its merchants. Square charges 2.6% plus $0.10 per transaction, but in reality, only keeps a small fraction of this fee because the vast majority is passed along to the payment network that settles the transaction, usually Visa or Mastercard, in the form of an interchange fee. Interchange fees are usually a percentage of the total transaction plus some fixed amount, say 2.5% plus $0.10 per transaction. If the interchange fee is 2.5%, and Square charges the merchant 2.6% per transaction, then Square keeps 10 bps of the transaction. A $10 transaction would generate $0.01 in gross profit for Square.

Now, imagine that Square built a hyper efficient payments protocol that could settle each transaction for $0.001 instead of merely routing them to Visa and Mastercard. Square would be able to charge significantly less than 2.6% plus $0.10 per transaction, incentivizing massive transaction volumes through the protocol. Despite charging much lower fees, Square would likely have a significantly greater gross profit per transaction.

Bitcoin offers Square a path to build a payment protocol and make a killing doing it.