Answering the Question: What is Bitcoin Worth?

There are fewer things in the world more divisive than Bitcoin - you either love it or hate it. People that are indifferent are that way because they know almost nothing about it. Anyone who has taken the time to read up on this new currency/commodity would be hard-pressed not to have an opinion on it. There are those people (like Warren Buffett) who say it is absolutely worthless. It has to be said in defense of Bitcoin, Buffett does not have a great track record when it comes to valuing new technology having missed the early rallies in every single technology stock! There are others (Bitcoin maximalists like Michael Saylor) who say it is worth millions. The objective of this blog is to try to find a rational valuation for Bitcoin - although it has to be said from the outset that I lean more toward the side of Michael Saylor than Warren Buffett.

Current Sentiment

The mood in the crypto market is still super negative with few people buying into the current rally. Technicians are calling for a massive retracement. Gareth Soloway is the biggest bear calling for Bitcoin to go back below $10,000. I am not big on technical analysis, but he is seeing death crosses, hail marys, and double tops on every graph. Fundamental bears are saying the current rally is a dead cat bouncing with short sellers covering their shorts. Maximilaists like Raoul Pal from Real Vision and Cathie Wood from Ark Invest take a more macro approach. They do not buy into the view that structurally high 1970s-style inflation is what we are currently experiencing. Raoul Pal highlights that 1970s inflation was called by a massive demand shift brought on by the Baby Boomers entering the job market, and current inflation is driven by supply shocks on account of the Ukraine war which is affecting the delivery of key commodities like oil, gas, metals, coal, and grains. He thinks we could soon go back to a deflationary environment which would require the Fed chairman Powell to quickly toss away his Paul Volker inflation-beating bazooka and grab his cage of doves and try getting them to coo in unison, as he is forced to cut rates and inject liquidity into the system. This would be infinitely favourable for Bitcoin.

Cathie Wood focuses more on comparing the current environment to the 1920s when we saw the convergence of key technologies. She recently tweeted: if inflation is unwinding, as we believe, then we could be heading back to the future, the Roaring Twenties, the last time several general purpose technologies evolved at the same time: telephone, electricity, and the internal combustion engine. The setup is remarkably similar". Cathie Wood is saying that we are seeing a similar convergence of technology in the form of blockchain, robotics, and artificial intelligence.

Current Valuation

So how do we value Bitcoin? Metcalfe's Law was originally presented in 1980 by Robert Metcalfe stating that the value of a telecommunications network is proportional to the square of the number of connected users. This law has been used to value Facebook. What separates crypto from social networks is that the asset being valued is also the technology being adopted. A Bitcoin user is a stakeholder in the system whereas most users of Facebook are not Facebook shareholders.

So let's put this into action. Bitcoin has between 700,000 and 1 million daily active addresses. If we use the low end of the range, bitcoin is valued as such using Metcalfe's Law:

700,000 × 700,000 = 490 billion. There are 19.1 million bitcoins in circulation which means that each Bitcoin is worth $25,700.

If we use the upper end of the range, Bitcoin would have a market capitalization of $1 trillion each Bitcoin would be worth around $52,000. So Metcalfe's law would place the fair value of the crypto at roughly between 25 and 50 thousand dollars per bitcoin.

With Bitcoin trading at around $21,500 at the time of writing this, you want to start accumulating at these levels. Timing a market like Bitcoin is almost impossible, so you want to dollar cost average. As the adoption increases, so too will the fundamental value increase with every indication that we could find ourselves north of $30k by the end of 2023 indicating there could be a 50 percent upside from current levels.

Alt Coin Market Stinks

One of the many things that the collapse of FTX taught us is that not all cryptos were created equal. You need to draw a close distinction between coins that are mined and verified through proof of work, and coins that are issued and/or verified through proof of stake. It is this distinction that the SEC is grappling with on a daily basis because it goes to the heart of whether the crypto asset is a security or a commodity. If it is a security it needs to be subject to similar rules to the issuance of a stock and therefore needs to be regulated by the SEC. If it is a commodity it needs to be regulated by the CFTC (Commodities Futures Trading Commission). Either way, few Bitcoin bulls would argue against regulation. Sure, the initial dream of Satoshi was to create an alternative peer-to-peer payment system that was separated from the current financial system which was almost brought to its knees thanks to the actions of a few bad actors like Lehman Brothers in 2008. In order for Bitcoin to realize its full potential as a financial asset class and compete for a position in institutional investment portfolios alongside bonds, equities, real estate, and commodities, it needs to be regulated. For Bitcoin to move out of the fringe and into the mainstream, regulation is non-negotiable. SBF and FTX did a great job in sucking the oxygen out of the altcoin market which means we are seeing a flight to quality. Crypto money is moving into high-value assets like Bitcoin (some Bitcoin maximalists go so far as to say that even Ethereum is a shitcoin, but that is another discussion).

Hardware Market

It is impossible to analyze Bitcoin without looking at what is happening in the hardware market given that mining is such an important part of Bitcoin’s value. During a Bitcoin cycle bust, GPU hardware gets flooded back onto the market, and the main reason miners dump the semiconductors is because of the over-production of coins, and instead, they’d rather sell the hardware and buy the BTC at a discount, which is why the GPU makers are going through the per-usual secondary market flood of GPU boards causing the price of tapped out silicon to drop at this point in the cycle.

Bitcoin turned the semiconductor market into an exhaustible commodity, so when Bitcoin network demand for hardware drops, so does the computer hardware market. So, we’re starting to see signs of stress across semiconductor names, which is also indicative of a cycle bottom in Bitcoin, because if the hardware starts to improve, it’s because the miners noting a sudden price reversion in Bitcoin will inevitably buy up global semiconductor chip supply again.

Summary

There are five quick reasons you want to be accumulating Bitcoin at current levels:

1) Even on the most conservative average daily user numbers Metcalfe's Law gives us a fair value of $25k per BTC which means, at $21.5k it is trading at a 15 percent discount. Daily average users have been buoyant over this 15-month crypto winter which means that as we find the bottom, user numbers, and adoption are likely to increase exponentially.

2) Sentiment is changing. The bad news on Bitcoin is getting so stale. Not even the most violent critics of Bitcoin can come up with any original arguments. Jamie Dimon continues with his one-liner jabs but we are all starting to see through the bravado and see the true pain and anxiety that lies beneath. JP Morgan is all too aware that crypto is going to eat its cross-border wire transfer lunch. How is it possible that in 2023 the quickest way to move $10,000 from Singapore to Los Angeles is by buying an airline ticket? If you watch any Bitcoin debate on YouTube, the detractors will quickly quote Mt Goix, FTX, Terra Luna, Three Arrows Capital as reasons to keep away from Bitcoin. This is preposterous - it is like quoting Bernie Madoff and Lehman Brothers as reasons to stay away from the stock market. The FTX collapse was actually good for Bitcoin, because it highlighted the dangers of issued shitcoins and speeded up the need for crypto regulation. Bitcoin is a beneficiary of both. Gandhi is quoted as saying "First they ignore you, then they laugh at you, then they fight you, then you win”. I get the impression that we are in the process of transitioning from phase three to four.

3) The macro environment is turning. The inflation dragon seems to have been tamed and we could be heading back to deflation, which would require a pivot from the Fed and potential rate cuts in 2024. Given that markets are discounting mechanisms that discount events six to twelve months in advance, this could provide seeds for a Bitcoin rally in the next few months. Regardless of how hard you try to argue that Bitcoin is a low-correlated asset class, it has been moving in line with risk assets over the last 15 months. Increased liquidity in the market is good for risk assets like stocks, and Bitcoin.

4) Regulation is coming. I am not a complete anarchist - rules are good as long as they are smartly phrased and applied. Since Lehman Brothers, regulators have not bathed themselves in glory. They have not formulated good bank regulations. Dodd-Frank killed off the small banks with their compliance burden, but you live in the hope that this time is different. Gary Gensler understands crypto better than most, and he is the most powerful man in the crypto space at the moment. I believe that bad rules are better than no rules, and if Gensler can formulate some rules that are closer to mediocre, we are off to the races.

5) Other assets are severely overvalued. Stocks, bonds, and real estate are pricey. The trailing 12-month PE ratio on the Standard and Poor's index is 22 which means you need to wait almost a quarter of a century to recoup the price paid for stocks from their trailing earnings. That is still expensive. Fifty basis points on a Japanese 10-year bond, 138 bps on Swiss, and 374 on US 10-year treasuries is not much to get excited about especially when global inflation is trending around 6 percent.

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