Bitcoin – Bull Case and Valuation (Part 2/3)

3 January, 2021
Investing; Bitcoin

Two years ago I thought that bitcoin was overhyped, buttressed by the bullish dreams of the few despite the disbelief of the many.

I thought it had no intrinsic value and scoffed at the nonsense that it was the future of money.

But in May 2020 I changed my mind.

This is part 2 in my series of posts that explains why. I recommend starting with part 1.


Broadly, two dynamics underpin the rise of Bitcoin:

  1. Robust fundamentals — a decentralised, scarce, digital asset
  2. Increasing market penetration — institutional ownership, accessibility and crossing the chasm

I’ll look at each of these in turn before turning to the ultimate question: how much should a Bitcoin be worth.

1: Robust Fundamentals

Part 1 explained Bitcoin’s value as a decentralised, scarce, digital asset.

These fundamentals offer protection against institutional corruption, inflation, monetary financing, intermediation and governmental control. This gives Bitcoin immense value.

Part 1 unpacks this in more details.

But in short, the algorithm that powers Bitcoin is one hell of an invention. The Bitcoin network, and its codification is genius. Assuming broad adoption, Bitcoin might be the most valuable invention of the modern era.

[If you want to take a deep dive on the true ingenuity behind Bitcoin, I would recommend the paper that pioneered the Bitcoin movement. It was written by the anonymous creator(s) of Bitcoin, Satoshi Nakamoto. My appendix article on Bitcoin also dives into some intriguing eccentric and philosophical theses on why Bitcoin is the way of the future.]

2: Increasing Market Penetration

In mid-2020 I became bullish on Bitcoin. At the time, I was still largely ignorant of the engineering ingenuity behind Bitcoin. But what I did recognise were a conflux of factors that would make Bitcoin more accessible and more attractive.

2.1: Increasing accessibility – Square and PayPal

In 2017, the friction of setting up a Bitcoin wallet meant that the majority of the population did not consider purchasing Bitcoin. Technical barriers to understanding Bitcoin pushed the general populace further away.

But in 2020, I believed two things had changed.

First, there were more educational resources on Bitcoin than ever before. At the same time, there were more distribution channels for Bitcoin information. You could read about Bitcoin on the web, watch a video on YouTube, or listen to a zealous Bitcoin devotee (cough, Chamath) on Spotify. The increased accessibility of information made Bitcoin less intimidating.

Second, and more importantly, Bitcoin was becoming easier to buy. And in a world where complexity is the enemy of execution, reducing friction in a purchase is key. Square and PayPal have done just that.

Square’s Cash App has 30 million monthly active users. That is 10% of the American population who could access Bitcoin. Square processed $306M in Bitcoin revenue in Q1 2020. This number is up 71% quarter-on-quarter, and 367% year-on-year.

But the real shift was when PayPal began to support Bitcoin in October 2020. PayPal allows users to buy things from its 26 million sellers using Bitcoin. The growth of this is yet to be reported but we can expect the numbers to be big.

Each day, new payment cards and methods are being created for Bitcoin. Each day that passes, trust in the currency increases, improving the odds of mass adoption.

2.2: Institutional ownership

More and more institutions are buying Bitcoin. Two multi-billion dollar public companies, MicroStrategy and Square, both own large stakes of Bitcoin.

Billionaire investors like Paul Tudor Jones, Cathie Woods and Stanley Druckenmiller own it, as do banks like JP Morgan and Morgan Stanley. Massachusetts Mutual Life Insurance purchased $100M, and Scott Minerd who manages $233B is another Bitcoin bull. His price target… $400,000.

Fidelity is involved in institutional-grade custodian services for it. Andreessen Horowitz, one of the most successful venture funds of the 21st Century, recently restructured to buy crypto. It has since launched two crypto funds with $865M under management.

Increasing institutional ownership creates a self-perpetuating cycle. Some companies start owning it, the price goes up, shareholders ask why other companies are not owning it, other companies begin to own it. Rinse and repeat.

Sound like a bubble?

You’re right. But this isn’t necessarily a bad thing, as I’ll get to in part 3.

2.3: Crossing the Chasm

In 1962 Everett Rogers pioneered the Diffusion of Innovation Theory.

Rogers found that innovation goes through five sequential stages of adoption:

  1. Innovators
  2. Early Adopters
  3. Early Majority
  4. Late Majority
  5. Laggards

Whether it was the mobile phone, the computer, the internet, or ride-sharing, innovation adoption tends to follow this pattern.

Bitcoin is still in the early adopter phase. Less than 5% of people own Bitcoin. This suggests it has much more room to grow. But first it must cross the chasm.

Empirically, the hardest threshold to cross for innovative products is the transition from the early adopters to the early majority. Studying what distinguished successful innovation from unsuccessful, Geoffrey Moore distils it down to ‘Crossing the Chasm’.

For every incremental buyer of Bitcoin, trust in the currency increases, and it gets closer to crossing the chasm. We are now reaching, or perhaps have recently reached, the critical mass of Bitcoin owners required for the asset to move from a speculative ‘trading card’ to a true store of value.

Valuing Bitcoin

It is one thing to say that Bitcoin is undergoing a structural adoption shift undergirded by sound fundamentals. It is another to determine what price is right. The ultimate question is how much a Bitcoin should be worth.

I see three ways of valuing Bitcoin:

  1. Bitcoin’s market cap as a % of gold’s market cap
  2. Bitcoin’s value if it were to replace a certain proportion of cash on S&P 500 balance sheets
  3. Bitcoin’s value based on certain levels of institutional investment

Valuation 1: Bitcoin vs Gold

Since the Bitcoin narrative is driven by its potential as a storehold of wealth, it is logical to analyse it relative to gold.

The Bitcoin devotees profess that they will hold Bitcoin until it reaches a similar valuation as gold, and only then are some likely to redistribute their money to higher growth assets.

On this basis, Bitcoin would seem to have a long way to run.

And let’s not forget, that there is an infinity of gold in space. With Musk, Bezos, and others driving space exploration, it might only be a matter of time before the ‘limited supply’ of gold is an anachronism. (Probably not for 50+ years).

Valuation 2: Bitcoin on the balance sheet

Square and Microstrategy have been the forerunners in buying Bitcoin as an alternative to cash on the balance sheet. If the thesis that Bitcoin is a viable storehold of wealth plays out, other companies are likely have an allocation on their balance sheets.

If all S&P 500 companies were to allocate 1% of their cash to Bitcoin, its price could increase by ~$40,000.

Valuation 3: Impact of Institutional Investment

Finally, it is intriguing to quantify the impact of institutional investment on Bitcoin’s price. If High Net Worth Individuals (HNWI) and the mass affluent were to allocate even small amounts to Bitcoin, the price impact could be substantial.

So that’s the bull case. At least how it was in December 2020 when I wrote this article. While it may seem like a rosy picture, Bitcoin is not without existential threats. Part 3 will look at some common threats and misconceptions to Bitcoin. A bonus part 4 will then unpack some existential threats.

See you there.