Takeaways from Grayscale's 2020 Making sense of Bitcoin's value report. Part 1 & 2 encompasses the key extracts from the report, while part 3 includes some personal afterthoughts.
Part 1 - Hedge against inflation
“It’s an insurance policy in case inflation comes back again as it did in the 1970s. I would say that if that’s a sensible thing to do, then, certainly to have 1 to 2% of your assets in Bitcoin makes great sense here.” – Bill Miller
We believe demand for a scarce monetary asset like Bitcoin grows as global monetary inflation accelerates.
a. In 1971 when US abandoned the gold standard, asset prices increased while wages stagnated. This necessitated further expansionary policies by increasing money supply, and lowering interest rate to combat for decreasing economic demand. As illustrated below:
b. Thus, loose monetary policy incentivised the market to take on more debt to purchase assets. As a result, money was fuelled into financial assets instead of the general economy as intended. Increasing the disconnect between equity market and the economy. As illustrated, US debt to GDP has nearly doubled since 2008, and the velocity of M2 monetary supply (rate which money moves around) declined as newly distributed money made its way into financial assets rather than the economy.
c. As illustrated, federal reserve printing more money and faster than ever. While US dollar remains strong relatively to other currencies, the ongoing quantitative easing (monetary policy whereby a central bank purchases at scale government bonds or other financial assets in order to inject money into the economy to expand economic activity) have caused wary of monetary inflation.
Part 2 - Ways to evaluate bitcoin's value
Since its not a cash generating asset, can't apply discounted cash flow to model the present value.
a. Relative valuation
In may 2020, fames investor Paul Tudor Jones. examined different store of value - financial assets, cash, gold and bitcoin. gave a score based on purchasing power, trustworthiness, liquidity and portability
Although bitcoin scored the lowest. what's surprising is that BTC had a score 60% of financial assets, but a market cap of only 1/1200th of that. BTC scored 66% of gold as a store of value, but market cap is only 1/60 of that. This framing illustrates the massive addressable market, despite its challenges like adoption, trust and regulation.
b. Supply & demand
With bitcoin's supply fixed at 21M, several supply side and demand side metrics serves as a reference of BTC's price direction. Note that significant activity occurs off-chain which may slowly decrease the efficacy of these metrics.
Supply-based metrics:
Active Coins: Coins that have not moved for 1 - 3 years labelled as holder, while coins moved in the last 90 days labelled as Speculator. Trend of increasing number of hodlers and decreasing speculator.
Stock-to-flow model: calculated by dividing the existing supply of a commodity by that commodity’s annual production growth. Current trajectory points upwards, just like how stock-to-flow is usually modelled after scarce commodities such as gold or silver.
Bitcoins held on exchanges: A large amount of exchange supply may be bearish and a low supply may be bullish.
Demand-based metrics:
Daily active addresses: doesn’t properly encompass all users, as majority of holders store their assets on exchanges, but it nonetheless gives investors a view of network growth.
Whale index: unique Bitcoin addresses with balances over 1,000 Bitcoin, which has been increasing steadily despite price fluctuations.
Part 3 - Personal thoughts
Bitcoin's valuation methods are still fuzzy, since traditional discounted cash flow analysis do not apply to non cash generating assets.
The above mentioned methods merely serve as references rather than offering a definitive answer.
Limited usefulness of the metrics as 1) more activity occurs off chain 2) majority of crypto holders still rely on exchanges which dilutes the ability to identify unique users, or aggregated users storing in an aggregated wallet.
Demand side metrics above should be taken with a grain of salt as user demand does not equate to intrinsic value. Think tulip bubble in 1600s where the rarest tulip bulbs traded for as much as six times the average person's annual salary.
With that being said, it is undeniable that fiat currency is greatly susceptible to inflation, especially given global expansionary policies amidst the covid pandemic.
If adoption crosses a threshold and there is sufficient use-case, there might be utility in the fixed supply argument.
It's still early days. If there was a clear valuation method, there would be less arbitrage opportunities, crypto probably would not generate as much fanfare, and we would not be reading about it.
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