Matt Hougan is the Chief Investment Officer of Bitwise Asset Management, the world’s largest provider of cryptocurrency index funds with more than $4 billion in assets under management. Before joining Bitwise, Matt held several notable positions in the financial industry, including CEO at Inside ETFs, Managing Director of Global Finance at Informa, and CEO of ETF.com. Matt also co-authored The CFA Institute’s publication on ETFs, “A Comprehensive Guide to Exchange-Traded Funds.”
Matt is a long-time Boglehead who attended the Bogleheads Conference in years past. Rick asked him for a no-spin discussion about cyber-currencies. They cover the history of blockchain technology, why cryptology is important to the blockchain, and how this led to Bitcoin, the world’s first digital currency, and eventually other digital currencies, including the digital dollar. The discussion is structured as purely educational. There is no sales hype, no recommendations for purchase or sale, and no price speculation.
• • •
This podcast is hosted by Rick Ferri, CFA, a long-time Boglehead and investment adviser. The Bogleheads are a group of like-minded individual investors who follow the general investment and business beliefs of John C. Bogle, founder and former CEO of the Vanguard Group. It is a conflict-free community where individual investors reach out and provide education, assistance, and relevant information to other investors of all experience levels at no cost. The organization supports a free forum at Bogleheads.org, and the wiki site is Bogleheads® wiki.
Since 2000, the Bogleheads’ have held national conferences in major cities nationwide. There are also many Local Chapters in the US and even a few Foreign Chapters that meet regularly. New Chapters are being added regularly. All Bogleheads activities are coordinated by volunteers who contribute their time and talent.
This podcast is supported by the John C. Bogle Center for Financial Literacy, a non-profit organization approved by the IRS as a 501(c)(3) public charity on February 6, 2012. Your tax deductible donation to the Bogle Center is appreciated.
Listen On
Transcript
[00:10] Rick Ferri
Welcome everyone to the 71st edition of Bogleheads® on Investing. Today our special guest is Matt Hougan, Chief Investment Officer of Bitwise Asset Management and the former CEO of Inside ETFs and ETF.com. Today, we’re going to be talking about the basics of cybercurrencies in a strictly educational format.
Hi everyone. My name is Rick Ferri and I am the host of Bogleheads® on Investing.
This episode, as with all episodes, is brought to you by the John C. Bogle Center for Financial Literacy, a nonprofit organization that is building a world of well-informed, capable, and empowered investors. Visit the Bogle Center at boglecenter.net, where you will find a treasure trove of information, including transcripts of these podcasts. Before we begin, I have one announcement: tickets for the 2024 Bogleheads® conference in Minneapolis, MN, are now on sale at boglecenter.net. The conference begins at 1:00 PM on Friday, September 27th, and runs through noontime on Sunday, September 29th. We’re gonna hit the ground running with a full agenda: lots of great speakers. I hope to see you there.
Our special guest today is Matt Hougan. He is the chief investment officer of Bitwise Asset Management, the world’s largest provider of cybercurrency index funds, with more than $4 billion in assets under management. Prior to that, Matt was the CEO of Inside ETFs, and the former CEO of ETF.com and the Managing Director of Global Finance at Informa.
Most important, Matt is a Boglehead®. I’ve known Matt for many years. He attended at least one Bogleheads® conference that I recall and was a diehard believer in Vanguard funds and the Boglehead® philosophy, which makes Matt the ideal person to approach this topic with because he understands a Boglehead® philosophy and also understands crypto and can join those two worlds together for us. So with no further ado, let me introduce Matt Hougan. Welcome to Bogleheads® on Investing, Matt.
[02:37] Matt Hougan
Thanks, Rick. I’m really excited to be here. This is going to be a fun conversation.
[02:42] Rick Ferri
Well, we thank you for coming on. The Bogleheads® are divided on this issue of cryptocurrency, in fact, so divided that it is banned from the bogleheads.org discussion boards. You cannot discuss Bitcoin, Ethereum, cryptocurrencies, non-fungible tokens, or anything having to do with the world of crypto assets. And there’s lots of reasons for that. I think one of the big reasons is spammers. But that doesn’t mean that we shouldn’t be discussing it on this podcast. How much money currently is in Bitcoin, let’s say what’s the value of all Bitcoin out there at the current moment?
[03:29] Matt Hougan
Yeah, it’s, it’s about a trillion and a half. It’s north of $1 trillion. So real money.
[03:34] Rick Ferri
It’s real money, and if you add up all the other cybercurrencies alone together, what’s the total ecosystem of cybercurrencies at the moment?
[03:45] Matt Hougan
Yeah, I think you’d be pushing north of $2 trillion. It’s substantial.
[03:50] Rick Ferri
So it’s time that we at least begin to learn about what this is. Now this is an informative podcast today; we’re not making any investment recommendations, we’re just talking about what this is so that we all have a better understanding about it, because I think there is a fear out there of the unknown, and this is certainly unknown to a lot of people, including me. So I want you to treat me like I’m a third grader, and you’re going to explain to me what this is all about, OK?
All right, I have an agenda, and the agenda follows the history of what’s called the blockchain, which goes back a couple of decades, and from there, the next thing we’ll talk about is how cybercurrencies, specifically Bitcoin, started using this blockchain to create the world’s first cybercurrency, and how all that works. And then we’ll talk about some of the misconceptions. And then, in the end, we’ll get into how this branches off into other types of cybercurrency.
The very last thing we’ll talk about is your business and indexing of cybercurrencies, which is interesting.
So let’s start out with the history of the blockchain.
[05:17] Matt Hougan
Mhm.
[05:17] Rick Ferri
Started out back in the early 1990s, so could you talk about what is blockchain technology, which is what all of these assets rest upon. So let’s start—we have to understand that first—so let’s start out with blockchain.
[05:41] Matt Hougan
Yeah, I love how you phrase this, Rick, because this is exactly right. I think if you understand fundamentally what a blockchain is, you can think about what value public blockchains like Bitcoin bring into the world. And you’re right that the history of Bitcoin doesn’t start in 2009, when the Bitcoin blockchain started. It starts way back. This was an area of computer science research that had gone on for decades at MIT, at Stanford, at the NSA, etc.
If I were going to boil it down, I would ask you to think about computer databases. Historically, computer databases were controlled by one entity. Your bank had a computer database. Google had a computer database. Maybe you have an Excel spreadsheet on your computer, that’s its own database, and you’re in charge of that, just like my bank is in charge of its database and your bank is in charge of its database.
Now, there are various ways that you can be networked together. The Internet was a tool for networking individually controlled databases together into a web. But what we hadn’t been able to do until we had a blockchain was to have one database that’s available to everyone, that everyone can see into, that is always accurate, but that isn’t controlled by any third party. So if you think about that bank database, let’s say Wells Fargo, they keep a record of who owns what, and they’re in charge of that record.
What a blockchain is is how do you have a database that’s accurate and updates in real time, but there’s no single person in control of it. It’s controlled by the network, by a wide variety of people. There’s no one person in control. And this ability to have one database that’s available everywhere, everyone can see into, that updates in real time, that’s always true without relying on someone to control it, lets us do a lot of new and interesting things, and that’s at the core of what it is.
[07:48] Rick Ferri
When I was researching this, this all came about through cryptology. In other words, you have a database, I have a database, and all these other people have a database, but none of us can manipulate that database because of cryptology. So this was a bunch of cryptologists. You know, World War Two: we used cryptology to send secure messages back and forth, and we tried to break the Japanese cryptology. We tried to break the German cryptology. This was created initially by cryptologists, which I find very interesting.
[08:24] Matt Hougan
Yeah, 100%. That’s exactly right. It traces its roots back to cryptology, which is a scary word, Rick. It sounds dangerous, but of course it underpins a lot of what we do today. It underpins all military communications. It underpins most point-of-sale transactions. It underpins how the Internet works.
Cryptology is a way for two parties to exchange information without other people being able to see in. So maybe I can walk through a couple of ways that that sort of the core of cryptology led to blockchain.
One is how do you have almost like a safety deposit box on the Internet that people can send to and see but that they can’t open up. The most fundamental piece of cryptology that underpins blockchain is something called the SHA 256 hashing algorithm, which allows you to have a secure place to hold something. Maybe an analogy that works for you is if you think about my house. I have a public address for my house. You can come visit my house; you could send me mail at my house; but you can’t go into my house, because I have a private key that unlocks my front door.
The fundamental piece of cryptography is actually called public-private key cryptography, where you can have a public address, and then I have a private key that allows me to unlock that address. In fact, when I hold a Bitcoin, it’s stored at my at my public address, but only I can unlock it to allow it to move, and that was the first building block of how crypto was developed.
On top of that, you had this very hard computer science problem of how do you have thousands of people maintain a database with the ability to update that database without spamming the database or entering in fake transactions, that’s the really big challenge. If you imagine 1,000 of your friends with an Excel spreadsheet, it would be complete chaos, right? That’s why we’ve always done it individually, where you control updating that spreadsheet.
But through various cryptographic advances, we figured out a way to have a Excel database that everyone could update, but that would always be true and accurate, and that was really sort of the fundamental breakthrough that the blockchain allowed.
[10:50] Rick Ferri
Again, we’re just talking here about the technology that Bitcoin sits on. Bitcoin itself is one of these blockchains, it is one of those thousands of spreadsheets. It’s the Bitcoin blockchain, for lack of a better word.
[11:11] Matt Hougan
That’s right.
[11:11] Rick Ferri
That’s what it’s called, the Bitcoin blockchain?
[11:13] Matt Hougan
That’s right.
[11:14] Rick Ferri
Well, what do you know? OK. But there’s many, many blockchains out there. I mean Vanguard uses blockchain to do trading, do they not?
[11:22] Matt Hougan
Yep, they do. There are various ways to use this fundamental technology, and each blockchain is different. That’s why there’re so many different cryptocurrencies, because they’re all optimized in different ways.
Vanguard uses what’s called a private blockchain, which has a limited accessibility. You can think of it like, if you remember corporate intranets, Rick, back in the early days of the Internet, companies would have corporate intranets. They were private internets. You can have private blockchains, or now we have a public Internet. You can have public blockchains.
Bitcoin is an example of a public blockchain. Vanguard’s trading system is an example of a private blockchain or a corporate intranet blockchain, but it’s the same fundamental technology, and the reason they’re using it is it allows you to do things like settle transactions instantly, which is something that is very hard for traditional databases to do.
[12:15] Rick Ferri
So now let’s get into using a blockchain for peer-to-peer electronic cash transfer. This was someone’s idea to create this secure method for transferring money between two spreadsheets or two people, and it became the backbone of the Bitcoin blockchain. So let’s talk about how this then evolved into using it for transferring money.
[12:51] Matt Hougan
Yeah. Well, first of all, let’s talk about why it’s interesting. You know, if I have $20 in cash, I can give you $20 in cash, and you instantly have it. And we didn’t have to rely on a bank to do that; I can just literally hand you the cash.
[13:07] Rick Ferri
Yep.
[13:09] Matt Hougan
But most of our money is digital, and today, every time I want to send you money digitally, it has to go through an intermediary. It has to go through a bank, it has to go through PayPal, it has to go through an intermediary.
[13:21] Rick Ferri
And my credit card…
[13:22] Matt Hougan
Exactly.
[13:23] Rick Ferri
I have to pay that stupid 2.8% fee. Somebody—it’s ridiculous how much money it costs to do a credit card transaction in today’s day and age.
[13:31] Matt Hougan
It’s ridiculous, and it’s also ridiculous how slow it is, right? Like, if I pay Billpay, it takes five days to hit my account. If I wanna wire money to London, it takes two days. Uh, Visa, as you mentioned, charges a 2 or 2.9% fee.
So the reason for this goes back to that database example. If I have a bank, and you have a bank, and I send you a payment from my bank, let’s say $100, your bank isn’t going to let you withdraw that money until it checks with my bank to make sure. I actually have those $100. Right, it’s going to verify that it’s a good transaction. That process of checking is what makes it slow and part of what makes it costly—not all of what makes it costly, but part of what makes it costly. That’s why international wire transfers take multiple days and why money doesn’t move over the weekend: because the banks are slow, they can’t communicate and check between new databases. But think about what happens when you have one database that everyone can use. All of a sudden you can move money as fast as you can change the line on an Excel document.
Right, like if I go into my Excel document, I can update a line instantly. On the Bitcoin blockchain, the same thing is true, because we’re all using the same shared record of who has what money. We don’t need to check with anyone else to move a billion dollars. This is why, and this is an incredible fact.
You can send $100, a million dollars, $10 million on the Bitcoin blockchain and have it settle within 10 minutes 24/7/365 with 100% uptime over the last decade, and that’s faster than any bank in the world can do that. And that’s despite the fact that Bitcoin has no employees, no offices—and it can move money. and it’s just this, it’s this database thing. So that’s where the peer-to-peer cash. It allows you to move money to someone else like it’s cash instantly, at very low cost, faster than the quote-unquote modern financial system.
[15:41] Rick Ferri
So the very first Bitcoin transaction that actually took place was buying a pizza, if I understand, for ?14,000, is that how it worked?
[15:55] Matt Hougan
Two pizzas, but yes. [Laughs]
[15:57] Rick Ferri
Ohh. Two pizzas. OK.
[15:59] Matt Hougan
Two pizzas.
[16:00] Rick Ferri
Must have been really good pizza.
[16:02] Matt Hougan
That’s right, $100 million pizza.
[16:04] Rick Ferri
So you had to have two people, then, you had to have a person who had created these Bitcoin, and we’ll get into the creation of Bitcoin and mining and all of that in a little bit, but somebody had to create this Bitcoin, and then somebody else had to accept it as payment.
[16:19] Matt Hougan
Yeah.
[16:20] Rick Ferri
But was that accurate? I mean, was it ?14,000 bought two pizza?
[16:24] Matt Hougan
There was something like that, yes, yeah.
[16:26] Rick Ferri
That happened in, I believe, 2014.
[16:32] Matt Hougan
2010: May 22nd, 2010.
[16:36] Rick Ferri
Fourteen years ago.
[16:37] Matt Hougan
Yep.
[16:38] Rick Ferri
So this happens, but it happens between two people. You know, you have somebody who created the Bitcoin and somebody who accepted it.
How did it get to be so big, I mean, how did it grow? It’s tough to conceptualize this, you know. I mean, why did so many people decide to come on this blockchain and start using Bitcoin in transactions, mining Bitcoin, which we’ll get to in a little bit, and kind of collecting Bitcoin. I mean, what was the incentive?
[17:12] Matt Hougan
Yeah, it’s a great question because it’s really hard to start a new currency and have it grow to a trillion dollars. It seems so unlikely. I think the answer is they’re two halves to the answer. So part of it, Rick, was speculation.
People were betting that in the future more people would want this apolitical, digital version of gold that you could store wealth in and that therefore the price of Bitcoin would go up, so they were willing to do things like deliver two pizzas, right? Which the guy had to pay for with U.S. dollars in order to get Bitcoin or mine in order to get Bitcoin. So speculation was a big piece of it.
And then, like any disruptive technology, what you find is utility on the edges. So there was some utility for people who were trying to do things initially that weren’t accepted in the traditional financial system. A reality of Bitcoin, which is no longer true today but was true in 2011, 2012, 2013, was that a lot of the use was for illicit purposes. Why would someone use it for illicit purposes? Because at the time—again, this isn’t true anymore—at the time, it was hard to track.
And it was hard to trace. And so there was some sort of jumpstart of use around sort of illicit or gray market activity and then it just kept building upon itself. And now we have a spot Bitcoin ETF and BlackRock owns Bitcoin and the state of Wisconsin owns Bitcoin and people are doing, you know, billions of dollars of transactions a day. But that’s the answer. It started as speculation and as sort of gray market utility, and then it just compounded and built from there.
[19:11] Rick Ferri
Often when we talk about the Federal Reserve and creating currency, we say the Federal Reserve creates money out of thin air, where they’re creating dollars from nowhere, using those dollars to buy treasury bonds that banks are holding, thereby getting currency or more currency into the system.
And depending on how much money they create out of thin air and what’s going on with the economy and how fast the economy is going, whether the economy can accept this money or not, it could add too much new currency to the system, and it could become inflationary. But this is all being decided by the Federal Reserve.
[20:04] Matt Hougan
That is correct—by 12 people in suits.
[20:07] Rick Ferri
By 12 people in suits, OK. And this happens not only in the United States, but all around the world; all the central banks are doing the same thing.
[20:13] Matt Hougan
This is right.
[20:14] Rick Ferri
They’re all creating currencies out of thin air. They do to support the economy. If you don’t create currency, then the currency that you do have in place as the economy grows would appreciate in value, because there’s only a limited supply, so you have to create currency; you have to. But if you create too much of it, it can be inflationary.
[20:34] Matt Hougan
That’s right.
[20:34] Rick Ferri
So it’s the Federal Reserve. It’s the banks that are controlling the creation of new currency. With Bitcoin, it’s not the banks, it’s the miners, the people who are mining the blockchain.
Now there’s a whole lot there that I just said: miners mining the blockchain. We need to go over all of this: Bitcoin creation through mining. What is mining? What are they doing? Why does it take 10 minutes to process a transaction? I’m going to task you now. We’re talking about miners, mining, and the creation of new Bitcoin.
[21:15] Matt Hougan
Sure, absolutely glad you brought up inflation as well. By the way, a lot of the catalyst of how Bitcoin grew from nothing to a lot was we saw a lot of abuse of the traditional financial system, money printing post-the financial crisis, money printing post-COVID, the Cyprus bank seizures, etc. So all that played into the growth. But let’s talk about mining.
I’m going to go back to that analogy of a bank. Rick. Think about what a bank does. It processes transactions. It stores your wealth. And for that it charges you a fee. That’s how it stays in business. That’s obviously a gross oversimplification, but let’s go with it. If you think about the Bitcoin network, what does it do? It processes transactions and it secures Bitcoin, but there’s no one to pay the fee.
[22:00] Rick Ferri
When we say about processing transactions, this is if I decide to send you Bitcoin.
[22:06] Matt Hougan
That’s right, yeah.
[22:07] Rick Ferri
That’s a transaction, but it needs to be processed so it goes into a block, correct?
[22:14] Matt Hougan
That is right, yeah.
[22:15] Rick Ferri
With a lot of other transactions, and about every 20 minutes, these blocks get approved, which is what the miners are doing, they’re approving the block.
[22:25] Matt Hougan
That is right. So if you think about it, let’s say you want to send a Bitcoin transaction and I want to send a Bitcoin transaction and lots of people want to send Bitcoin transactions. They post a message that says I wanna send point-two Bitcoin to Johnny. And all those messages go into what’s called a mem pool. So you can think of this as like a holding tank for proposed transactions.
And then every roughly 10 minutes—it varies a little bit depending on how many people are doing it—but roughly every 10 minutes, these miners, which are computers around the world validate transactions and take a group of validated transactions that go from a real address to another address and have the right amount of Bitcoin and put them into a block and settle them. And when they’re settled every 10 minutes, everyone who has a copy of this Excel database of who owns what Bitcoin updates their records, and that’s how the Bitcoin database updates.
Now, there’s this famous thing about these complex math problems that all these different miners are solving.
[23:39] Rick Ferri
And this is the cryptology part of it all right here.
[23:41] Matt Hougan
Yeah, that is right. Let me tell you how that happens and why it happens.
Only one miner can settle a block of transactions every 10 minutes, and for what it’s worth, Rick, it’s called a blockchain because each block follows the next block, so it’s a chain of blocks.
So you have all these miners. Let’s say it’s 100,000 computers. They’re all racing to be the one who gets to settle a transaction, because if you settle it, you’re issued new Bitcoin.
Right now, every time you settle a block of transactions, if you’re the lucky miner who gets to do it, you get 3.125 Bitcoin, which is like 200 grand, right. So you really want to do it
[24:28] Rick Ferri
These are never split between the other miners. I mean, one lucky miner gets it, that’s it?
[24:33] Matt Hougan
One lucky miner gets it. Yes, now sometimes miners pool together and agree to share rewards. But yes, one lucky miner gets it. Only one person can settle each block. So what happens is there is this arbitrary math problem that’s effectively like guess a number, and it’s a really big number.
[24:54] Rick Ferri
Yeah.
[24:54] Matt Hougan
It’s the equivalent of finding one piece of sand in the world, right, find this piece of sand. It’s that kind of hard thing.
[24:59] Rick Ferri
It’s really beneficial to have a very fast computer.
[25:03] Matt Hougan
Yes. Yeah, yeah, yeah.
[25:04] Rick Ferri
And it burns a lot of power. I would imagine this fast computing.
[25:07] Matt Hougan
And it burns a lot of power. These are computers that are sitting in cooling liquids that are overclocked, that are usually near hydro sources, but they’re racing [makes illustrative noise], and then one of them solves it, and then what happens—and I’ll explain why they do this in a second—they say, hey, I’ve solved it. Here is the block.
Everyone else checks it, and then they all update their copy of the database to reflect these changes, and the reason they updated it is because you can’t solve the next riddle without knowing what the next the previous block is, so they’re incentivized to update it.
The reason they have them do this math problem is because one of the big problems that cryptologists ran into in developing this idea of a decentralized database is it’s free to try to fake it.
If you don’t make it expensive to spam the network or try to propose a fake transaction like: oh, actually Rick sent all his Bitcoin to me when you didn’t, then you’ll have scammers that are constantly trying to do illicit things with the blockchain and do fake transactions and steal, so you have to make it costly. What this math problem does is it makes it expensive to guess and so you can’t guess until you solve this math problem.
And so you have to spend this computer energy before you can guess and as a result, you don’t have people spamming the network. And a remarkable fact about the Bitcoin network is, you know, we’re 15 years in, there’s never been a false transaction processed.
[26:50] Rick Ferri
Hmm.
[26:50] Matt Hougan
Think about that, like, imagine a bank saying there’s never been a forged check—ever.
[26:58] Rick Ferri
Oh, no, no, I have a lot better. I’m—how many times have I had to get a new credit card number because somebody stole my credit card number?
[27:06] Matt Hougan
Exactly, exactly. And here you have this Bitcoin blockchain with no employees, no CEO, you know, that some people are skeptical of—it’s never happened in 15 years. This system just works beautifully because everyone is incentivized to do it right, and they’re punished to try to do it wrong. And it’s a really elegant computer science solution.
[27:29] Rick Ferri
I just want to confirm: so I solved the block; I get to create three Bitcoin, which I can sell, and that’s my…that’s how I get paid.
[27:42] Matt Hougan
That’s right. Yeah, it’s ?3.125 right now.
[27:46] Rick Ferri
3.125, I’m sorry.
There’s other fees as well, correct? I mean when you do a Bitcoin transaction, when I send you money, you send me money, Bitcoin, I mean we…I have to pay a transaction fee. And does the miner get that also?
[28:00] Matt Hougan
Yeah, yeah.
These blocks are only so big, so they can only hold let’s arbitrary number. This is not the number, but let’s say they can hold 100,000 transactions. What if there are 120,000 transactions in that pool? How do you make sure that yours is processed first? The way you do it is you append a transaction fee or tip that says, if you process my transaction you also get a dollar…
[28:27] Rick Ferri
Ohh.
[28:28] Matt Hougan
…and so what Bitcoin miners do is they get this reward, which is called the Coinbase reward. That’s where the company Coinbase got its name.
[28:35] Rick Ferri
Hmm.
[28:36] Matt Hougan
And then they also get these transaction revenues.
[28:39] Rick Ferri
What’s the transaction revenue typically of a block if you solve it? I mean, you know, you get ?3.125, but what else do you get?
[28:48] Matt Hougan
Right now it’s around 10% of the revenue. So if the ?3.125 is 200 grand, you can think of like 20 grand of transaction fees.
[28:56] Rick Ferri
Oh, OK.
[28:57] Matt Hougan
It’s real. The reason they’re important, Rick, is the amount of Bitcoin you get falls in half every four years. So it actually started at 50, then 25, then 12 ½, 6.25, 3.125.
[29:09] Rick Ferri
And what’s the purpose of that?
[29:11] Matt Hougan
Yeah, Bitcoin states that it will only ever be ?21 million that exist. That’s something you can trust. Unlike dollars: it’s infinite dollars, only ever gonna be 21 million; if you think about when Bitcoin started, there were zero Bitcoin. This is the way Bitcoin is created: Bitcoin is riding an asymptotic creation curve, meaning that the creation is slowing down. And in 2140, 116 years from now, we’ll get to 21 million, and there will be no more.
The idea of it falling in half was twofold. One was Bitcoin would become more valuable so the amount you get for doing this should fall. And the other was that over time you want to see the value of the Coinbase reward go down and the value of the transaction revenues go up to balance it out, right, so the system becomes self-sustaining and doesn’t need this Bitcoin, ‘cause eventually there’s no more Bitcoin, you have to have the transaction fees. So this decay function was preprogrammed in with the idea that if Bitcoin worked, it would become self-sustaining with these transaction fees, and so that’s why it falls in half.
[30:26] Rick Ferri
Incredible.
[30:27] Matt Hougan
It’s really remarkable, yeah.
[30:30] Rick Ferri
- So it continues to get cut in half: it started out at 50 and then I went to 25 in 2014, and now it’s down to 3.125, and in four years it’ll be cut in half again. So it makes it more and more and more expensive for miners to mine because they’re getting now half of what they were getting at the beginning of the year. So, but their energy costs have not gone down, have a lot of miners left the industry because the reward for mining a block just was cut in half. What’s the incentive to continue to do it?
[31:13] Matt Hougan
Yeah, there are two answers to that question. One is it’s an efficient market, right? So the miners know that this is happening. It’s not like they’re surprised. This is preprogrammed in…
[31:23] Rick Ferri
OK.
[31:23] Matt Hougan
…and so you don’t see a cliff of miners leaving. What you see is sort of a slope; usually about 10% of the mining power leaves the network around the halving. Mostly it’s older computers that can no longer compete.
[31:39] Rick Ferri
Right. I got it. Yeah, that would be obvious, I believe. Yes, as we discussed a little bit ago, yeah.
[31:45] Matt Hougan
The other really brilliant thing, you know, as you dig into Bitcoin—you realize that the design in 2009 was so smart in so many ways—is that the system automatically adjusts, and what I mean by that is…if you…the goal of Bitcoin is to process transactions every 10 minutes, but that depends on people solving this math problem, and how fast they solve the math problem depends on how many people are doing it, how much computer power is going towards it.
So if too many people leave the network, Bitcoin slows down. The transaction speed extends from 10 minutes to 11 minutes or 12 minutes or 13 minutes. When that happens, what the system does is it makes the math problem easier. So it sort of dynamically adjusts…
[32:33] Rick Ferri
Uh. Interesting.
[32:42] Matt Hougan
…so that it gets back to this 10-minute cadence and as a result, you know, generally speaking mining should be almost a commodity business, but in such a volatile market you can make profits if you manage your cap table well, but it’s been sustained for 15 years. It’s worked really well.
[32:52] Rick Ferri
So let’s ask the $69,000 question, which happens to be around the price of ?1 today…
[33:00] Matt Hougan
[Laughs]
[33:01] Rick Ferri
…and that is that the price of Bitcoin has to be at least equal to the amount of money I have to expend as a miner in energy cost and equipment cost and other overhead taxes to mine. If energy costs go up, I can’t make money mining Bitcoin anymore, because it’s just costing…
[33:32] Matt Hougan
Yep.
[33:33] Rick Ferri
…me too much money. So I mean, I’m trying to begin to understand why the price of a Bitcoin has gone from basically .01 cent—?14,000 to order two pizzas—up to $69,000.
[33:49] Matt Hougan
Yeah.
[33:49] Rick Ferri
And it has something to do with what you’re talking about, correct?
[33:53] Matt Hougan
A little bit, but I actually have a different theory on the price, which I’ll share. To talk one more second about the sustainability of mining, if mining becomes unprofitable, as we talked about, some miners drop out, and as a result, if you’re still in the game, your probability of winning that reward goes up, right, because there are fewer people playing the game, and that’s why the system is sort of dynamically self-adjusting and doesn’t go away. Sometimes it does become unprofitable to mine, but then you see miners shut down and other people get a bigger share of the winnings.
My thesis on Bitcoin’s value is actually really simple and a lot of people struggle with this. A lot of my investing heroes actually struggle with this. Warren Buffett struggles with this because it has no cash flow. How does it have any value? I think Bogle would have struggled with it for the same reason and a lot of smart people struggle with it.
But here’s my thesis, Rick: Bitcoin provides a service. The service it provides is the ability to store wealth without a government or a bank and the ability to move money in a peer-to-peer fashion. You may not want that service, but a lot of people do: people who don’t trust the dollar or people who don’t trust their local currency, etc.
If you want to store money in a digital format without relying on a bank or a government, Bitcoin’s your only choice.
But you can’t pay a fee to access that service. You can’t pay a $10 a month subscription. You can’t pay a software as a service sort of subscription seat model. The only way to access that service is to buy Bitcoin. If more people want that service, the price will go up. If fewer people want that service, the price will go down.
I think the reason Bitcoin went from a penny to $69,000 is: A) more people want that service today, because of rising distrust in governments, banks, currencies, and then, B) more people believe that Bitcoin will be around and matter in 15 years than they did before, because now BlackRock is the space and it’s in the regulatory setting.
So you know any service, if more people want it, the value goes up; if fewer people want it, the value goes down. And that’s how I think of Bitcoin. It’s just a service, but you can access it only through buying Bitcoin.
[36:21] Rick Ferri
An investor in Bitcoin is—can be—very different than a user of Bitcoin. In other words, if you now have a Bitcoin ETF, one of the largest Bitcoin ETF’s out there and the lowest cost, which is very Boglehead® ish anyway, but can’t spend Bitcoin ETFs. It’s not like having a wallet, which is where you would hold your Bitcoin that you bought directly and you wanted to go out and buy a candy bar with it or something. I mean, you can’t do that with an ETF.
[36:58] Matt Hougan
That’s right, similar in that sense to a gold ETF or, like a currency index ETF like DXY, it is an investment, pure and simple, yeah.
[37:09] Rick Ferri
So Bitcoin was the first one out of the gate with a cybercurrency, but the technology does go back, as we said, 14 years, I mean, with the advent of newer technologies, isn’t there better things coming along than Bitcoin that will replace Bitcoin, and, if so, what will that do to the value of a Bitcoin?
[37:33] Matt Hougan
Yeah, it’s a great question. Now you’re speaking my indexing language…
[37:37] Rick Ferri
OK.
[37:38] Matt Hougan
…and there are different things, and they may challenge Bitcoin, you know, that’s why we created the first crypto index fund.
I had a Betamax growing up and a BlackBerry and now I have an iPhone. I think it’s hard in any disruptive technology to know what the ultimate winners are, and so many investors will pick and choose one, and that’s valid, but I think for a lot of people the best approach is, if you want exposure to it—which not everyone needs to, but if you want exposure—is to diversify and own an index. I mean I think the same lesson is true here that was true in Internet stocks. The argument against this, Rick, is that crypto is a network-effect business.
The bigger your asset is, the more liquid it is, the more places you can exchange it for traditional currencies, the bigger the regulatory moat, the more secure the blockchain is. And network-effect businesses are sticky, right? Facebook is not the slickest technology, but it’s not going anywhere, because it has a big network effect.
[38:44] Rick Ferri
Right
[38:44] Matt Hougan
So Bitcoin has a big network effect. But I do think a humble investor would take an index-based approach to the space, because you just don’t know how it will turn out.
[38:57] Rick Ferri
There are other cybercurrencies, and I’m just going to stick with cybercurrencies. I’m not getting into things like non-fungible tokens which include I call them a zombie type. Pictures of people that are being sold for whatever on the Internet, but I’m not gonna get into that here today. I’m just talking about cybercurrency. So the next probably significant one is Ethereum. You talk a little bit about what the difference between Ethereum and Bitcoin is.
[39:26] Matt Hougan
Yeah, there are two primary differences. The first comes to how programmable it is. By that I mean one of the unique things about having a crypto or cybercurrency is you can program it to do things like only send this Bitcoin to Rick if he says Matt is fantastic on his podcast.
[39:49] Rick Ferri
[Laughs]
[39:49] Matt Hougan
Right. You can do those sorts of if-then statements.
[39:52] Rick Ferri
Ohh.
[39:53] Matt Hougan
Bitcoins, I mean not that exact example, but you can imagine examples, right? Like, if you imagine an escrow statement right now if you’re buying a car or a boat or a house.
[40:02] Rick Ferri
Yeah.
[40:02] Matt Hougan
You have to put a legal document around that. In crypto land you could just put a smart contract around it that only releases it once the escrow agreement is reached.
[40:13] Rick Ferri
And this is Ethereum [you’re] talking about: If-then…
[40:16] Matt Hougan
That’s right.
[40:16] Rick Ferri
…rather than I’m sending you one Bitcoin and you’re going to send me one Bitcoin, that’s how the Bitcoin blockchain works. But Ethereum it’s: I’ll send you some money, but all of these different things have to happen before it gets sent.
[40:31] Matt Hougan
Yeah.
[40:32] Rick Ferri
It’s already a contract. It’s already written into the agreement…
[40:35] Matt Hougan
That’s right.
[40:35] Rick Ferri
…and I at that point it’s automated as these things occur and verified they’ll have occurred, then it will send you the money. Is that an accurate description?
[40:50] Matt Hougan
Yeah, that’s right. You can program it to do exactly that. And there are really interesting examples of things that are going on; there are crypto brokerages that trade billions of dollars a month that are just software programs with no employees. So like Coinbase competitors or the crypto equivalent of Charles Schwab that process trades immediately and instantly without any corporate overhead and do billions of dollars of trades a month. That’s a program called Uniswap, which is built on Ethereum.
[41:22] Rick Ferri
Hmm.
[41:22] Matt Hougan
There are lending programs where you can get collateralized loans instantaneously from other users with no corporate middleman like you would at a bank or a prime broker just by using this smart contract—as it’s called—programmability. So Ethereum can do all that. Bitcoin really just can be sent or held or stored. You might say, “Matt, it sounds like Ethereum is better than Bitcoin.”
What it is is more flexible. The trade-off for that flexibility is it’s less secure…
[41:59] Rick Ferri
Oh.
[41:59] Matt Hougan
…and that’s why people talk about Bitcoin as digital gold, because if you have gold, you really care about security. When you make a computer program more complex—which Ethereum is more complex—it inherently becomes a little bit less secure, and so that’s the difference between those. The other difference is how they’re mined. Ethereum uses a process called proof of stake that’s much more energy efficient.
[42:28] Rick Ferri
Oh.
[42:28] Matt Hougan
It uses about 99% less energy than Bitcoin. That’s the other difference between those two.
[42:35] Rick Ferri
And is there a limit to the amount of Ethereum that can be created?
[42:40] Matt Hougan
No, good question. No, it’s on a continual inflation schedule about 1% a year. The flip side is when you use Ethereum to program those sorts of activities, you burn some, so it removes it. So it has a different inflation cycle than Bitcoin. It’s not as fixed or reliable as Bitcoin.
[43:02] Rick Ferri
How long has Ethereum been around?
[43:05] Matt Hougan
Started in 2015, so nine years now.
[43:09] Rick Ferri
Nine years?
43:10] Matt Hougan
Yeah.
[43:09] Rick Ferri
OK, let’s go to 2024. Is something new coming along that even goes beyond that?
[43:22] Matt Hougan
Yeah. The other asset people are really excited about is Solana.
Solana, Rick. Take—it takes—this is going to get a little bit technical, but I’ll try not to get too deep.
[43:32] Rick Ferri
Ohh, this hasn’t been technical already? OK.
[43:35] Matt Hougan
[Laughs.] It takes a different design to Ethereum to make it faster and cheaper to use. And it makes certain trade-offs in order to achieve that. It has less uptime; it is more centralized.
But it’s trying to compete with Ethereum by being faster and cheaper. It’s new tech—it’s a good example of what you raised. It’s new tech, it’s massively parallel processing as opposed to Ethereum, which takes a different approach.
It’s a competitive space. This is a disruptive technology where we’re 10 years in, so we shouldn’t be surprised that the technology is evolving, right? If you…I remember when we used to search for things on Ask Jeeves and Yahoo before we all went to Google, and now we’re moving to ChatGPT, right? So technology evolves. The same is true in blockchains as well.
[44:32] Rick Ferri
I do want to ask about one more before we move on to the last topic, the digital dollar. Now here it’s a digital version of the US dollar being explored by central banks, including the Fed. How does that differ from other cybercurrencies? Talk about that if you can.
[44:58] Matt Hougan
Yeah, you know this efficiency of blockchain-based systems could be used to speed up transactions of dollars, and dollars right now, as you and I just discussed, are slow and costly and not very modern, right? Things settling in days or multiple days with high fees attached. So central banks around the world are looking at how do we move from our existing system, which is really based on traditional cash currency, into a digitally native system likely built on blockchain, which many people call central bank digital currencies. There are both great things to be excited about about central bank digital currencies in terms of speed and efficiency and many things to be worried about, because theoretically, if poorly designed, the government would have complete oversight of every transaction and the ability to seize assets at will, and I think many people are uncomfortable with that.
But I do think eventually we’ll move toward a digital dollar of some sort. It doesn’t worry me from a Bitcoin perspective or even from an Ethereum perspective or other crypto asset perspective.
Because, just like gold doesn’t compete with the physical dollar, I don’t think Bitcoin competes with the digital dollar. They’re two different promises. It’ll compete at the edges in terms of speeding up the existing ecosystem…
[46:29] Rick Ferri
Uh huh.
[46:30] Matt Hougan
…but I don’t think that’s the fundamental value of blockchain. I think it has to do with not relying on centralized entities and the programmability of money, as we discussed, which won’t be native to a CBDC in the same way it is to Ethereum. So I think it’s inevitable, I think we should worry a lot about privacy in terms of how it’s designed, and I don’t think it will compete with crypto in a major way.
[46:57] Rick Ferri
And we could talk about this obviously for a long time because there’s an awful lot to this, but we only have a little over 50 minutes, so I do want to ask: you were heavy into exchange traded funds—total market index, total bond index, different factor-type funds, I mean, you wrote about it, you talked about it. This was your thing, and I’ve known you for many, many years. I was a little bit taken aback. You did a full pivot and went this direction to a company called Bitwise Asset Management and you began—of course staying with the Boglehead® philosophy—you decided, let’s create an index of these cybercurrencies. And so, and tell me your decision to go that direction professionally, and then what has the journey been so far?
[47:55] Matt Hougan
Yeah, I’d start with the early days of ETFs, Rick. If you remember, in the early days of ETF’s, people didn’t like them. They were a disruptive technology that were cheaper, more efficient, more tax-efficient, but a lot of people were distrustful. The Financial Times labeled them weapons of mass destruction. I remember hearings on Capitol Hill about ETFs destroying the American dream. Vanguard indeed was slow to migrate into ETFs, but it was exciting to be part of the early days of ETFs, because you knew this new financial technology could make the world cheaper and more efficient and more fair.
And it was exciting to be part of that growth. By the time I exited the ETF space, ETFs were, you know, 7 or $8 trillion of assets in the U.S. and they were accepted as the best way we have for many people to invest.
When I looked at crypto, I saw something similar. I saw technology that in my view can make the world cheaper, more efficient, more fair—that introduces really exciting new capabilities into the world, but that people were skeptical of; that there were congressional hearings that were labeled rat poison squared. You know, I saw a lot of similarities, and I really enjoyed being part of ETFs as they grew from this tiny idea into what they are today, and I saw the opportunity to do that again in crypto. And I would say, so far it’s been fantastic. I mean as a company, we’ve gone from just a few people to 65. We’ve gone from…
[49:39] Rick Ferri
Oh.
[49:39] Matt Hougan
… $0.00 in assets to close to $4 billion in assets. And then as an industry, we’ve just made such incredible progress. I think in 2017-2018 people didn’t think crypto would be around. Now with BlackRock and others in the space, people are confident that it will be, and I think we’re just at the sort of inflection point of crypto where it goes mainstream, so I see a lot of analogies between the two, and I’d make the same career shift, you know, 10 times out of 10; it’s been really exciting.
[50:15] Rick Ferri
Let me ask you one question. This is a personal question having to do with taking something like a total stock market index and putting it into a coin rather than having it in a fund or an ETF and being able to trade that 24 hours a day, seven days a week even, with transaction costs and spreads that are almost de minimis. Feasible?
[50:37] Matt Hougan
Yes, absolutely. I think inevitable. You know, what kind of world do we live in where things trade from 9:30 to 4:00 and then take the weekends and holidays off?
You know, there was a great Bloomberg headline the other day, Rick—I don’t know if you saw it—it said, New York Stock Exchange settlement to speed up to levels last seen 100 years ago. I mean, we’re still taking a day to settle trades. It’s ridiculous.
[51:03] Rick Ferri
Yeah.
[51:03] Matt Hougan
Imagine if you could only send email from 9:30 to 4:00 and not over the weekends, and it took a day to settle. It’s absurd. We need regulatory breakthroughs to be sure, and it will take a few years.
But the entire way we approach investing, I believe, is going to move on to these blockchain rails because it’s just a much more efficient 24/7, 100% uptime way for financial assets to move over the Internet, and it’s ridiculous to me that we accept the kind of latency and costs that we do in the traditional system. So that day is coming, Rick.
[51:43] Rick Ferri
Matt, it’s been great having you on Bogleheads® on Investing. Thank you so much for all of the education that you have provided to the Bogleheads® over the many, many years: first in ETF space and now in the cryptocurrency space. And we’ll see you in September at the Bogleheads® conference because we have a session together.
[52:02] Matt Hougan
That’s right. I can’t wait. And thanks for having me on. This is a real highlight for me. I love the Bogleheads® and everything you stand for. It’s a big part of what I do.
[52:14] Rick Ferri
Well, you’re part of that. Thanks again.
This concludes this episode of Bogleheads® on Investing. Join us each month as we interview a new guest on a new topic. In the meantime, visit boglecenter.net, bogleheads.org, the Bogleheads® wiki, Bogleheads® Twitter, the Bogleheads® YouTube channel, Bogleheads® Facebook, Bogleheads® Reddit. Join one of your local Bogleheads® chapters and get others to join. Thanks for listening.
