What is Paper Bitcoin?
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The world is quickly waking up to Bitcoin, and the world’s biggest game of musical chairs is well under way. There are only 21 million seats, and with over 97% of the supply already mined, most have already been taken.
When fiat money dies and the music eventually stops, a lot of people are going to wish they had sat down a lot sooner.
The good news is that most of the seats that are already occupied were taken by humble plebs. Most of Bitcoin’s supply is still currently held by private citizens who have been front running Wall Street and their Governments for over a decade.
Now that we’re seeing increasing demand from nation states, pubcos, and all other manner of buyers with very deep pockets, things look set to get extremely interesting.
With Bitcoin in such limited supply, how will these wealthy buyers (some with access to infinite money printers) lure plebs into parting with their stacks? Will they be able to do it with huge piles of government coupons? Or will they need to find more creative ways to get a seat at the table?
However they go about it, they’re sure to play fair right?
If all participants in the market did ‘play fair’ then this tidal wave of new demand combined with an inelastic supply, should result in a dramatic increase in price. That’s just basic economics.
But some would argue that despite the huge rise in demand from ETFs, a growing cohort of Bitcoin treasury companies, and even nation states, the impact on price has been relatively underwhelming.Especially when you consider that when adjusted for true inflation (assuming a real rate of 15%) Bitcoin arguably hasn’t even surpassed its previous ATH of $69,000 in 2021.
So what gives? Is something afoot here, or is this demand really being absorbed by enough willing sellers to have next to no impact on price?
It’s an interesting question with no definitive answer. But it does have a lot of people asking the question….
“Are people selling ‘Paper Bitcoin’?”
Paper Gold & Fractional Reserve Banking
Paper Bitcoin? But I thought it was digital!
If you’re wondering what on earth paper Bitcoin is, then the simplest way to understand it is to first look at the origins of ‘paper money’, and the subsequent emergence of fractional reserve banking.
The Origins of Paper Money
Before paper money, the world relied predominantly on precious metals to measure, store and transmit value. The fact that they’re scarce, durable, and difficult to forge resulted in them being used as a sound form of money for thousands of years.
Unfortunately, they do have some significant drawbacks.
Precious metals are good at storing value but are too cumbersome for use in day-to-day trade. Both large and small transactions are impractical, and you need a smelter if you want to break it down into smaller units. While great at storing value, they’re not so great at moving it.
It was this friction that would ultimately lead to the creation of paper money.
People soon realised that if they traded pieces of paper that represented a claim to precious metals instead of using the metal itself, money could be made far more divisible, and trade would be infinitely more efficient.
In many ways it’s quite an elegant solution. Instead of dealing with cumbersome metals, people can just transact in IOUs instead and could settle-up later once all the transactions are completed.
On paper it makes a lot of sense….
(Bad pun… I know)
The Emergence of Fractional Reserve Banking
Unfortunately, this solution has a fundamental flaw.
Any system that relies on trading paper IOUs that only represent value, instead of having any value themselves, requires a trusted third party to make everything work. A central authority is needed to store the gold, make sure it’s accounted for, and then issue standardised paper notes that represent a claim to it for people to trade with.
For this system to work, it needs a bank. Its fundamental flaw is that everything is completely reliant on trust.
The problem with creating a system reliant on trust is, it won’t take long for greedy bankers to break it. They soon realise there is an easy way to fiddle the system.
Bankers would soon notice that most people are happy to trade in paper notes and very rarely come to the bank for final settlement in physical gold. Even if some people do, it’s very unlikely that everybody comes to withdraw their gold at the same time.
This allows the banks to start creating more claims to the gold on paper than actually exists within their vaults. So long as there isn’t a run on the bank where everyone tries to withdraw their gold at once, nobody will ever notice and they can get away with it.
Bankers call this ‘fractional reserve banking’. You and I would call it counterfeiting.
By 1971 this process led to fiat currencies becoming separated from precious metals entirely, and they are now backed by little more than blind faith. Legalised counterfeiting has been allowed to run rampant, and money has become completely detached from reality, leaving us with an abomination of a monetary system.
Some people believe the solution to our problem is to go back to a gold standard, but the same process will only end up repeating itself. How would you verify that your government actually has the gold they claim is backing their currency?
It’s been a while since we heard about that Fort Knox audit….
Historically, gold has been a great store of value, but it fails as a medium of exchange and any IOU based system built upon it will ultimately end up being corrupted.
Sure, you can store wealth and hold physical gold to avoid having to trust anyone, but when you want to use it, you’re back at square one facing the difficulty of using precious metals as money. It just isn’t practical for widespread global commerce.
Are Companies Selling ‘Paper Bitcoin’?
Bitcoin doesn’t suffer from the same drawbacks as precious metals. It’s divisible, it’s a good store of value, it’s easy to keep secure, and can be transmitted globally within minutes.
Bitcoin has all the requisite properties of sound money just like gold, but is much more practical to transact with and look after yourself. Unlike gold, Bitcoin doesn’t require a paper-based IOU system to be built on top of it to be useful as day-to-day money, and you don’t need to use a third-party to look after it for you.
Despite this, there are still people buying ‘paper Bitcoin’ rather than controlling their own UTXOs in their own Bitcoin wallet. Millions of people still leave their coins on exchanges, purchase Bitcoin ETF shares, and buy stocks in Bitcoin Treasury Companies instead.
The harsh reality that a lot of these people are likely to face is that they do not actually own any Bitcoin. Like people trading in paper that represents gold, all they own is a paper promise that represents some Bitcoin.
Bitcoin Exchanges
For transparency some exchanges show ‘Proof of Reserves’ that gives you some confidence that they do hold all the Bitcoin they claim to. But most don’t. The balance you see when you login to your exchange account is nothing more than a user interface with a number on it. It isn’t proof of anything. Just like with fractional reserve banking, everything is based on trust.
How can you ever be sure that the exchange truly has all the Bitcoin required to honour all customer deposits? Do you think if everyone tried to withdraw from the exchange at once that they would be able to?
Bitcoin Treasury Companies
Similarly, a lot of people are attempting to get exposure to Bitcoin by buying stocks in Bitcoin Treasury Companies. While it's true that people buying stocks were never buying Bitcoin in the first place, it’s almost certain that they buy these stocks because they believe these companies do hold Bitcoin. Once again, a lot of this is reliant on trust.
Michael Saylor recently announced that his company Strategy will not be providing proof of their Bitcoin reserves. Instead, shareholders will simply have to trust Michael and his board that they hold all the Bitcoin they claim to.
Strategy’s dubious reasoning for not offering proof of reserves centres around ‘security concerns’. But this is a weak position. All Bitcoin in circulation is always visible on the blockchain, and the company regularly announces their purchases publicly anyway. Revealing which UTXOs belong to Strategy specifically would not make their wallets any less secure.
(We would never recommend private individuals do this as it will compromise their privacy, but shareholders in a public company should perhaps expect more transparency).
Bitcoin Rehypothecation
And then of course there is the ever-present risk that any Bitcoin you leave with a third party gets rehypothecated and lent out to multiple other parties to invest and speculate with. If your Bitcoin goes through multiple steps of rehypothecation then this can result in multiple people holding paper claims over your Bitcoin.
This is exactly what happened when FTX rehypothecated user funds and commingled them with money used by their sister hedge fund Alameda Research, which used them to gamble on shitcoins. Of course, when these ridiculous trades went south, Alameda Research lost all of FTX’s customer funds that they had been using to gamble with and the exchange became insolvent.
Whenever you leave your Bitcoin with a third party you always run the risk that they will play games like this, lend your Bitcoin to other people creating multiple claims to it, and ultimately create more IOUs than they have Bitcoin to back it up.
You need to carefully read the T&Cs of any third party you deal with, or better still, only hold your Bitcoin in full self-custody to avoid the risk all together.
All the scenarios described above are what we would call ‘trust me bro’ situations. In our experience, these are best avoided.
Own Real Bitcoin – The Bitcoin Way
So, are companies really selling paper Bitcoin?
Some people are certainly speculating that it might be happening as they attempt to explain why Bitcoin’s price hasn’t exploded despite huge institutional demand and nation state FOMO.
But for the time being at least, it remains just speculation. The truth is there’s no way to be sure. We typically only find out these types of shenanigans are going on once something breaks and things go south in dramatic fashion.
Thankfully, companies selling paper Bitcoin tend to get found out quickly. It’s difficult to verify whether gold inside a secure vault is truly there or not, but Bitcoin’s public ledger makes it easy to account for all the Bitcoin in circulation.
If multiple entities claim to have more Bitcoin than they really do, then it won’t be long until people notice that things aren’t adding up. You just want to be damn sure you’re not holding their Bitcoin IOUs when that day inevitably comes, because it’s very unlikely they will be honoured.
The best way to avoid getting caught up in all this nonsense is to not participate in it in the first place. Satoshi was explicit that Bitcoin was designed to be held in self-custody so that you no longer had to trust third parties or rely on IOUs.
When you’re ready to opt out of a world based on paper promises we can make sure you have the skills needed to own Bitcoin in 100% self-custody with zero counterparty risk and no chance of being rug-pulled by an untrustworthy 3rd party.
Stop running the gauntlet, book a call with one of our experts today, and let’s start the training you need to become financially independent.