Bitcoin recently hit a market cap of 1 trillion USD – Yes with a “T” a single coin was worth more than USD 57,000 as recently as 21-Feb-21

I have been a firm critic of Bitcoin using largely below rationale

 

 

but is there something that I am missing?

Most of the stuff on internet/twitter is very price driven, the day price appreciates the more noise is made that day without any meaningful analysis on this phenomenon.

After some digging came across a really useful piece that analyses the crypto landscape with data and objectively

CFA Institute has put a very detailed report on Crypto Assets for Investment Professionals while the whole report is fantastic, I will share some of my key learnings from the report. You can access the full report here

1. Whether we like it or not – Crypto is here to stay 

As the cryptomarket enters its second decade, one thing is clear: Crypto and blockchains are not going away. 2 major financial institutions, such as Fidelity Investments and CME Group, are heavily involved; large endowments, such as those of Harvard University, Yale University, and Stanford University, are investing, alongside such hedge fund legends as Paul Tudor Jones II; the crypto efforts of leading companies, such as Facebook, PayPal, Visa, and Square, are frontpage news; and central banks, from the US Federal Reserve to the People’s Bank of China, are discussing how to develop blockchain enabled digital currencies of their own.

2. Bitcoin is first among Equals

Just like we have Silver, Platinum and other more rare metals but Gold is Gold, Similarly when it comes to Crypto currencies Bitcoin is first among equals

Between the time this paper was published and today(Feb’21) the third highest market cap has been taken up by Cardano which was launched just three years ago just pointing out to innovation that has been taking place in this space

For Bitcoin – The simplicity, security and its first mover adoption has created a massive network that is unlikely to be toppled

What is important to understand is that the value of each cryptoasset-powered blockchain is less a patent-worthy secret technology and more the network that emerges around each one.

3.  We are really really early in evolution of crypto assets

Gold has found multiple uses over the course of its long history – Store of value, Coinage / Currency, Jewellery, Medicinal use etc. I think same will have with Crypto assets

As in the early days of the internet, the public blockchain space can feel bizarre and even hazardous for the unversed. And again similar to the internet, the disruptive possibilities created by public blockchains have opened up windows for fraud and bad actors in its early years. But only public blockchains advance fundamental breakthroughs, such as digital scarcity, and in our opinion, this is likely the area where the largest leaps forward will happen.

4. Valuation is tricky

Gold prices remained flat for 100 years before jumping 10X in space of 20 years. The paper uses a variety of methods to value Bitcoin

a) TAM method – Replaces gold entirely as store of value, then a coin becomes worth ~ USD 600,000 and if does only 10% then ~USD 60,000. Another theory is if replaces 5-10% cash and bank balance held by companies then again it could be ~ USD 200,000 per coin

b) The Equation of Exchange (MV = PQ)

As an easy example using round numbers, let us assume bitcoin will process 100 billion transactions (Q) of $100 each (P) per year. Then P × Q = 100 billion × $100 = $10 trillion per year. If on top of that we assume that bitcoin has a velocity of 5 (in other words, on average, one bitcoin changes hands five times per year), we arrive at a potential market capitalization of $10 trillion per year/5 per year = $2 trillion. If we divide this number by the fully diluted amount of bitcoin outstanding (21 million), it yields a price target of $2 trillion/21 million, or $95,238 per bitcoin. If we assume further that this level will be achieved in five years, we can discount this amount by an appropriate rate and arrive at an estimated present value.

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c) Valuing Cryptoassets as a Network – This is to me is the most interesting valuation framework to be used for valuing Bitcoin or other Cryptoassets

The Metcalfe valuation method makes intuitive sense, given that daily active users are a proxy for interest in and adoption of a cryptocurrency.

some smart folks like Shaan puri are calling this out and eventually if institutional money moves in then value of network would be multifold

5. Does it deserve a place in portfolio ?

To date, bitcoin has been a rare asset, combining the return characteristics of a classic alternative asset with the liquidity characteristics of publicly traded equities. The key question is whether it will retain these key characteristics in the future

For instance, a 1% allocation to bitcoin added 5.3%, on average, to the portfolio’s return and boosted the Sharpe ratio by 0.19, whereas a 5% allocation to bitcoin added 28.1% to the portfolio’s return and boosted the Sharpe ratio by 0.69, on average.

6. Low correlation to other asset classes 

The drivers are very different for Bitcoin the below exhibit from report points this out very well

therefore future correlation is also likely to very similar and remain low correlated

7. Risk of regulation may become boon

While outright ban like proposed in India on these currencies can hurt them badly but Prof Bakshi and Charlie Munger have taught me to think from multiple angles on a situation. Like weed if regulation is brought in then these currencies would become legit and there would be framework and laws of operation

in my opinion the bigger risks are

a) Bitcoin becoming currency of crime – already happening and its a watch items

b) Bugs – Its a software and even the best software can be attacked with sophisticated bugs, Imagine a billion dollar hole in you pocket as wallet was not able to protect your coins from an attack

c) Outright ban on use like one proposed by India

Overall I like how the report has summarised the phenomenon

One thing is for certain: The emergence of a new asset class and financial ecosystem is a rare event, and the potential for cryptoasset-powered blockchains to move the world forward is exciting.

Edit 2021 Sep >> Invested in Bitcoin

Share in comments or Facebook group if you have more interesting reading material on Bitcoin

some interesting reads

on energy waste

on USD losing its status

on Mis conceptions regarding Bitcoin