I actually had to create a separate post category, Speculation, for this article as I didn’t want to lose credibility and be labeled as an uninformed investor who pitches an ‘asset’ which produces no cashflow, has limited adoption, and an extremely high chance of being worth zero.
However, I think bitcoin has a very interesting risk profile and is worth discussing:
1) Store of Value
There is a cap on the number of bitcoin that will be created (21 million), thus making it a deflationary “asset”. Given the current protocol, fractional reserve banking does not apply to bitcoin and new bitcoin cannot be created by banks to lend which are not known by the blockchain. In this respect, bitcoin is similar to Gold - it should be treated as a store of value rather than a currency.
While gold has been the standard store of value for millennia, bitcoin actually has some potential benefits. It is cheaper to store, easier and cheaper to exchange, and can potentially carry additional information. Gold has other use cases as well (such as jewelry and electronics) and bitcoin is not without risks (gov. intervention, hacking, limited adoption, other crypto-currencies to name a few), however there is a real scenario in which bitcoin could become a defacto store of value in 10-20 years. I am by no means saying that bitcoin is equal to gold as an asset, but with a total value of $7bn outstanding vs $10 trillion for gold, bitcoin is less than 1/1000th of the value of gold. Would it be crazy to imagine an edge-case scenario where bitcoin has gained widespread adoption in 10-20 years, and the price of bitcoin has increased to 1-10% of gold’s price?
Given the 100+ fiat currencies in the world, what is the probability that one will experience hyperinflation this year? What about in the next 10 years? I estimate the cumulative probability is high (most likely over 50%), which could result in extremely large upward pressure for bitcoin given the extremely thin trading volume.
3) Capital Flight
Building on the previous point, many countries have fixed currencies or restrictions limiting capital exiting the country. Chinese citizens have been major buyer of bitcoin through 2015 and 2016 (along with many other non-registered assets such as Vancouver real estate), driving the price up. Additionally, many migrant workers use bitcoin to send money back to family members in other countries, as transaction fees are very low 0.1%-1% vs. potentially 10% with Western Union.
4) CS / Developers
The bitcoin protocol was a real breakthrough in computer science and one of the first somewhat practical solutions to the B.G.P. The blockchain has some of the smartest minds in many different industries (finance, tech, payments) working on different uses cases to leverage the power of the blockchain. The ability to clear transactions and store public records on the blockchain instead of with a bank or third-party or reduce transaction costs from 2-3% on credit cards to less than 1% is very exciting. Holders of bitcoin are levered to all of this innovation.
5) Network Effect
Bitcoin use creates a positive feedback loop: he more people who use Bitcoin, the more valuable Bitcoin is for everyone. In a very asymmetric ‘asset’ with real catalysts, any one catalyst hitting can increase adoption to kick off this positive feedback loop.
6) Exogenous Risks
Bitcoin would most likely increase in price in a wartime environment, as governments backing traditional fiat currency become less stable. Additionally, governments are historically levered on a debt / GDP ratio - less faith in government-backed fiat currency could be very beneficial to bitcoin.
7) Uncorrelated Hedge
Bitcoin is very uncorrelated to the overall market, and in fact, in a large downturn, could potentially rally significantly. In a large selloff, capital usually will flee to low risk assets such as treasuries and less so to stores of value such as gold. However, given that trillions of government securities are already negatively yielding instruments, value stores could see a disproportionate share of buying. Given bitcoin has a total value of less than 1/1000th that of gold and is much less liquid, it is not unrealistic to think btc could outperform gold in a risk-off environment.
There are still many, many risks involved with bitcoin, the largest being that I do not believe it will ever become a currency. Other risks include: other protocols, securities risks, and government intervention to name a few. The probability that bitcoin has any value in 15-20 years is very low, probably less than 10%. However, as with many asymmetric “assets”, I do not think btc can linger forever in the semi-accepted range with a total amount outstanding of $1-10bn. It will either fail or slowly become more accepted as one or more of the above catalysts are realized, potentially increasing the value of bitcoin by orders of magnitude.
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