In-depth analysis of Bitcoin's value potential: Why is it the best-performing asset of the past decade?
The market value to heat value ratio chart shows that Bitcoin is still quite far from the bubble zone.Original Title: "2021 Bitcoin Investment Research Report", Authors: Louis Liu and Joe Burnett, founders and research directors of Mimesis Capital
The fundamental problem with traditional currency is the total trust required for it to function; central banks must be trusted not to devalue the currency, but the history of fiat currency is filled with breaches of that trust.
--- Satoshi Nakamoto, February 11, 2009
Bitcoin, a decentralized digital currency, was discovered by Satoshi Nakamoto on January 3, 2009, when unknown developers pieced together the original source code. Satoshi mined the first Bitcoin block and received a reward of 50 BTC. After that, a decentralized crypto network was born, and it began to grow and spread worldwide like a virus.
For most of 2009, the price of a single Bitcoin was $0.00, and no one in the world (at that time) was willing to trade Bitcoin for fiat currency. As the year progressed, more people began mining Bitcoin online, and its inherent scarcity gradually became apparent. When people started to be willing to exchange their dollars for the most scarce currency in history, the exchange rate began to develop; at one point, it was 1 dollar for 1,309.03 BTC. In other words, on October 5, 2009, 1 Bitcoin was worth $0.00076.
Since the birth of Bitcoin in 2009, its price has been a cause for concern, from being valued by only a handful of people to millions around the world buying and saving Bitcoin, including some of the world's top investors like Bill Miller, Paul Tudor Jones, Stanley Druckenmiller, and Larry Fink. One of the more fascinating aspects behind the rise of Bitcoin is its inherent nature; Bitcoin has no CEO, no central organization, and no marketing department, yet it has grown into an asset with a market value of hundreds of billions of dollars. The purpose of this report is to delve into why Bitcoin is the best asset of the decade and our outlook for 2021.
The History of Bitcoin Over the Past 12 Years
Today, when most people hear about Bitcoin, they think of huge bubbles and price crashes. What the average person may not know is that the bubble in Bitcoin in 2017 was not the first; Bitcoin has experienced many bubbles in its 12-year history.
The first notable Bitcoin bubble occurred on November 7, 2010, when the price of Bitcoin surged from $0.01 to a peak of $0.36, then crashed back down to $0.19 on December 10, 2010, marking a 36-fold increase and a -47% drop.
The second significant Bitcoin bubble occurred in June 2011, when the price of Bitcoin rose from $0.19 to a peak of $30, then crashed back down to $2.30 in December 2011, representing a 157-fold increase and a -92% drop.
The third significant Bitcoin bubble occurred in April 2013, when the price of Bitcoin rose from $2.30 to a peak of $250, then crashed back down to $62 in July 2013, marking a 108-fold increase and a -75% drop.
The fourth major Bitcoin bubble occurred in December 2013, when the price of Bitcoin surged from $62 to a peak of $1,150, then crashed back down to $154 in January 2015, representing an 18-fold increase and a -86% drop.
The fifth major Bitcoin bubble occurred in December 2017, when the price of Bitcoin rose from $154 to a peak of $19,700, then crashed back down to $3,140 in January 2019, marking a 127-fold increase and a -84% drop.
You can see that Bitcoin inherently exhibits extreme bull and bear markets; this price volatility can be seen as part of the early adoption process.
The impacts driven by bull markets in the network include: technological development (developers), investment (ICE and Fidelity), and security (miners). Bear markets, on the other hand, drive away all those who do not truly understand the essence of Bitcoin, and they will deeply regret selling.
In the repeated bubbles of Bitcoin, you will consistently find that the price lows at each "burst" continue to rise, as the foundation formed by true Bitcoin adopters keeps growing.
Why Does Bitcoin Have Value?
Some very smart people still find it difficult to cross the threshold of why Bitcoin generates value; they simply label Bitcoin as a "bubble" and assume there is no reason for anyone to want to hold Bitcoin, which is a significant mistake.
Bitcoin is a monetary commodity, and throughout history, monetary commodities have included gold, the dollar, silver, salt, stone money, shells, glass beads, and many other items.
A monetary commodity is a unique type of commodity; its value depends on everyone else. Unlike simple commodities, such as fishing rods, which can have value regardless of whether you are alone, most commodities do not require reliance on other humans to have their utility.
While it is true that Bitcoin's value depends on other people, this does not mean it is a bubble based on "collective illusion."
Bitcoin has accumulated hundreds of billions of dollars in value because it is the focal point of the monetary game theory for individuals. Due to Bitcoin's unique monetary attributes (as listed in the table below), individuals are motivated to adopt Bitcoin as a way to preserve their wealth, as doing so will yield rewards from the market over time.
Compared to gold, fiat currency, and all other previous monetary commodities, Bitcoin has at least 100 times more improvements, making it the only way for humanity to preserve wealth over time and space without being diluted.
It is important to note that Bitcoin does not necessarily need billions of people to use it to continue functioning as the best monetary commodity. If Bitcoin simply maintains its existing base of savers, it will still be the best monetary commodity in the world. However, Bitcoin is the best monetary commodity in the world because of its unique attributes, and we know that individuals are incentivized to adopt the best monetary commodity due to its superior value storage function. Therefore, we can be confident that Bitcoin's price will continue to grow exponentially as the number of people adopting Bitcoin as a primary monetary commodity increases.
The Increasing Algorithmic Scarcity of Bitcoin
The Bitcoin protocol has an algorithmically built supply schedule, which means the number of Bitcoins issued to miners will decrease over time. This protocol is executed in a decentralized manner, meaning no individual, bank, or government can influence Bitcoin's reliable and established monetary policy.
As shown in the above image, Bitcoin's monetary inflation is halved every 4 years (210,000 blocks). Regardless of how many new miners join the network or how high (or low) the price of Bitcoin is, the number of Bitcoins that can be mined each year cannot be changed. The most recent halving (the third halving) occurred on May 11, 2020, when the number of Bitcoins produced per block was halved from 12.5 to 6.25. There will always be a total of 21 million Bitcoins, and they are becoming scarcer every day.
Three Types of Exponential Network Effects
Mining Power (Moore's Law)
Bitcoin is a currency network that grows exponentially; as more miners join the network, they enhance the security of Bitcoin and the certainty of transactions. We measure Bitcoin's mining power by its hash rate.
Since the Bitcoin network went live in 2009, the hash rate has been growing exponentially. When new ASICs (Application-Specific Integrated Circuits) are created, produced, and launched, the mining network effect of Bitcoin grows, leading to an increase in Bitcoin's hash rate, making the overall network more secure and the accounts more immutable. As the network becomes more secure, it incentivizes individuals to store more wealth in Bitcoin, which feeds back into more ASIC research and development, and more ASICs are purchased and used by the public. This massive positive feedback loop accelerates global adoption of Bitcoin.
The growing mining power of Bitcoin is directly related to Moore's Law, which states that the number of transistors in dense integrated circuits (ICs) doubles approximately every two years. This means that miners upgrading to new ASICs will significantly increase the productivity of Bitcoin output. In fact, since Bitcoin halves approximately every four years, the number of Bitcoins that new ASICs can mine is about four times that of previous miners, which helps alleviate the selling pressure after halving, as previous miners can no longer profit and are forced to stop their machines until prices rise. A significant reason for price increases after halving is that the profits generated by using new ASICs are significantly higher, so when those high-cost producers leave, the selling pressure in the market decreases significantly. In summary, the market dynamics caused by Moore's Law help increase scarcity and reduce selling pressure during Bitcoin halving.
As Bitcoin's hash rate continues to grow exponentially, the blockchain becomes more secure, and Bitcoin users can be more confident that they are transacting on an immutable blockchain. As more miners from around the world join the network, it becomes increasingly expensive and impractical for potential attackers to attempt a 51% attack to overwrite the end of the blockchain. As you can see, Bitcoin's hash rate has been growing rapidly, and the cost required to conduct a 51% attack (which requires 51% of the hash rate) could reach billions of dollars. Starting from scratch would take years of attempts and require an unimaginable amount of energy from many different sources.
Virtual Networks (Metcalfe's Law + Currency Gravity)
Like Facebook (social network), Amazon (retail network), Netflix (television network), Apple (computer network), and Google (search network), Bitcoin also grows and rises under Metcalfe's Law, which states that the effect generated by a telecommunications network is proportional to the square of the number of users connected to its system (n²).
Unlike the other networks mentioned above, Bitcoin is the world's first decentralized (decentralized) limited-supply scarce currency network. Saylor's Law is a good way to envision the currency network gravity of Bitcoin, meaning that as more capital is allocated to the network and more users join the network, the gravity of the currency network increases. When more capital is allocated to Bitcoin, the price rises, and when the price rises, Bitcoin becomes more attractive to investors. This is because the size of Bitcoin (market capitalization) is similar to the mass of a planet; the larger the planet's mass, the stronger its gravitational pull. As Bitcoin as a whole becomes larger, the gravitational pull generated by its market capitalization becomes stronger.
Due to the non-replicability of decentralized currency networks, Bitcoin cannot be copied, and because of Saylor's Law, it has the most powerful network effects among all known networks. In the growth chart of the number of addresses below, we can clearly see that as more users join the network, the price grows exponentially (note that the price indicated on the y-axis is on a logarithmic scale). While the growth in the number of addresses is not a perfect indicator, analyzing the growth of addresses on the Bitcoin blockchain can help us verify that more people adopting Bitcoin is correlated with Bitcoin's price, and it provides us with statistical evidence to support our theory that Bitcoin is the best monetary commodity, which helps drive adoption and price.
In the above image, we compare Bitcoin's price with the total number of addresses holding more than 1 BTC.
By performing linear regression on the selected data range, dating back to 2010, we can find an R² coefficient of 0.93, indicating that the growth in the number of addresses explains 93% of the changes in Bitcoin's price. This is statistically significant evidence suggesting that part of Bitcoin's early exponential returns can be attributed to the growth in the number of users.
To reiterate, what drives the increase in Bitcoin's user base? It is the growing understanding of Bitcoin's inherently unique attributes that make it the best monetary commodity in the world, combined with its increasing scarcity, which drives people to adopt Bitcoin.
The Function of Price and Liquidity
As a currency network, price is the ultimate indicator of Bitcoin's exponential growth. Psychological factors and liquidity also impact Bitcoin's price. Bitcoin is the only liquid asset that benefits from its price increase; when the price rises, it attracts more attention, more market confidence, more news, and more potential buyers.
The most important rule in the Bitcoin economy is that investment creates liquidity, and liquidity creates value.
--- Daniel Krawitz
Modeling Bitcoin's Exponential Growth
What drives Bitcoin's price is difficult to determine, but extensive research indicates that Bitcoin's increasing scarcity is a good historical explanation.
A simple calculable metric based entirely on Bitcoin's diminishing supply schedule is the so-called stock-to-flow ratio.
Stock refers to the existing quantity of Bitcoin (already mined); flow refers to the annual production of newly mined Bitcoins.
In the model shown above, you can see that Bitcoin's price is highly correlated with its increasing scarcity. In fact, Bitcoin's stock-to-flow ratio (its scarcity) can explain 94.7% of Bitcoin's price changes.
Our research confirms that Bitcoin's price is driven by two key factors.
Continuously increasing scarcity (stock-to-flow ratio)
Society's understanding of Bitcoin's significance
The supply schedule in Bitcoin's programmed algorithm helps to distribute Bitcoin as widely as possible to all (potential users) while keeping the price low enough to ensure it can be established within the existing financial system.
Due to the pre-written halving schedule in Bitcoin's programming algorithm, Bitcoin's stock-to-flow ratio will double every four years. What you can see is that these halving events can explain 94.7% of Bitcoin's price changes, but without the understanding of most capital in the world, Bitcoin's price would not be rapidly driven up. If only a few people were trying to buy as much Bitcoin as possible, its price would inflate excessively until the selling pressure from mining exceeded the capacity of these few individuals.
This is why Bitcoin's price is influenced by both its scarcity and society's understanding of its significance, interacting with each other. Halving events statistically do drive price increases, but halving events cannot be operated in advance by a few people, as these few cannot purchase the newly mined Bitcoins that miners are forced to sell at astonishingly high prices (to cover costs), leading to a final price equilibrium between scarcity and global adoption levels.
Since Bitcoin's price is driven by these two key factors, if both continue to increase over time, Bitcoin will continue its journey of exponential price growth.
It has existed for 13 years, and over time, it has increasingly stabilized into a brand.
--- Stanley Druckenmiller
Potential Opportunities
As Bitcoin has provided a unique solution for individuals to transfer wealth over time and space, it is likely to capture market share from existing inferior assets used for value storage.
Gold
The price and market value of gold come from its utility as a monetary commodity. Since gold is an inferior monetary commodity compared to Bitcoin, and currency has powerful network effects, Bitcoin is likely to quickly absorb the entire market value of gold.
Money Supply and Global Debt, Stocks, Real Estate
M2 (broad money) / global debt is Bitcoin's second major target. Compared to Bitcoin, fiat currency itself is an inferior monetary commodity. Additionally, all global debt is denominated in fiat currency. We know that all central banks are competing to devalue their currencies to directly impact the purchasing power of broad money and all global bonds (which is simply the future debt claims of fiat currency and a small increase in returns due to bearing additional counterparty risk).
Warren Buffett famously referred to Bitcoin as "rat poison." He might be right; Bitcoin could be rat poison, and that rat is fiat cash.
--- Bill Miller, CFA
Stocks
The value of stocks is based on their estimated discounted cash flows, meaning companies that increase their cash flows over time will have a higher value than those that do not. In today's world, with the increasing production of fiat currency, it is relatively easier to increase cash flows year by year, which means that if the money supply remains constant (like Bitcoin), many existing companies may not increase their cash flows. If their cash flows do not actually increase, then the value of these existing companies is greatly overestimated, especially compared to the opportunity cost of simply holding Bitcoin.
Moreover, when discounting future cash flows of stocks using the 10-year Treasury bond, also known as the "risk-free" rate of return, the trading price of the 10-year Treasury bond is less than 1%, meaning cash flows are almost not discounted. This is another indicator showing that the value of stocks is severely overestimated compared to Bitcoin.
Real Estate
The real estate market holds nearly $300 trillion in wealth, and the price of real estate is also based on its estimated future cash flows, as investors purchase real estate to generate cash flow (rent). Current real estate prices are inflated due to the entire industry being subsidized by cheap debt (very low mortgage rates). Additionally, the holding costs of real estate are high; you must pay property taxes, homeowners insurance, property management, and all maintenance costs when items are damaged every year.
In contrast, the opportunity cost of not holding Bitcoin is very high compared to other financial assets. Bitcoin is both a safe investment and has unprecedented upside potential.
$500 billion is a severely underestimated (Bitcoin) market cap when the total market cap of the world's stock markets is $90 trillion, and who knows how many trillions fiat currency has.
--- Paul Tudor Jones
Outlook for 2021
Decrease in Exchange Holdings
Bitcoin is being withdrawn from exchanges at an unprecedented rate.
Currently, there are about 18.6 million Bitcoins in existence (with a cap of 21 million Bitcoins). Since March 2020, when panic over the Covid virus peaked and lockdowns began worldwide, causing market crashes, the number of Bitcoins held on exchanges has decreased at an unprecedented rate.
Before the bull market began in 2017, we saw a much smaller but similar phenomenon. In August 2016, the peak number of Bitcoins on exchanges was 1.06 million, and at the beginning of 2017, there were still 940,000 Bitcoins on exchanges, indicating that 120,000 Bitcoins were moved out (a decrease of -11%).
This time, the bull market seems to tell a more extreme story. In March 2020, a total of 2.97 million Bitcoins were held on exchanges. Today, there are 2.33 million Bitcoins on exchanges, indicating that 640,000 Bitcoins have been moved out (a decrease of -22%).
Data shows that Bitcoin adoption is rapidly expanding, and Bitcoin is continuously being transferred from exchanges to personal cold wallets, where they may never be sold again.
Bitcoin is the world's best store of value asset, an emerging mainstream currency network, and the answer to the value storage problem faced by 7.5 billion people and $300 trillion in capital. In this regard, it represents an unstoppable force.
--- Michael Saylor, CEO of MicroStrategy
Market Cap to Thermal Value (Safety Thermal Coefficient) Ratio
The thermal value (safety thermal coefficient) has been very helpful in determining the timing of Bitcoin's price peaks using system dynamics principles. Thermal value is the total daily Bitcoin rewards measured in dollars.
The standard under the energy currency system is to apply a quantitative energy equivalent to $1 within an hour.
--- Henry Ford
Henry Ford and Thomas Edison once had an idea about an "energy currency system," and Bitcoin is the realization of that system they discussed. Compared to using energy (mining) to create Bitcoin's price, this thermal value metric helps us visualize the timing of Bitcoin price breakthroughs.
The market cap to thermal value ratio typically presents a parabolic shape just before the end of a Bitcoin bull market. This is because Bitcoin's price rises, while a large number of other miners have not yet joined the network scale to increase production costs. As we approach the peak of this ratio, we may see inefficient miners join the network scale, raising the total production costs for all miners and increasing global selling pressure (to pay for electricity). At this juncture, the price trend becomes unsustainable and reverses, often resulting in a significant correction in Bitcoin's price.
In the market cap to thermal value ratio chart, it is clear that we are still very far from the bubble zone, and it appears that we are still in the early stages of a large-scale bull market, making 2021 a promising year for Bitcoin.
Approaching Escape Velocity
While monitoring potential top indicators like the market cap to thermal value ratio is important, this bull market may be distinctly different from previous ones.
History tells us that when a currency fails—trust is completely lost—it resembles a debt market that looks like a supernova (for credit denominated in that currency).
--- Preston Pysh, Host of The Investor Podcast
We live in a very unique macroeconomic era, where all central banks are creating unprecedented amounts of fiat currency out of thin air, while the greatest form of currency in human history was discovered over a decade ago, and as I type, it is gaining immense value. Preston Pysh, host of the Investor Podcast, refers to Bitcoin's rapid adoption and development trend as "escape velocity," which could potentially lead to the complete destruction of all value stored in dollars and other fiat currencies.
As Bitcoin's price repeatedly sets new historical highs, will people around the world continue to watch their fiat currency being diluted and devalued? Or will they fully adopt Bitcoin as their preferred value storage tool, taking advantage of Bitcoin's "digital ascent" (continuous appreciation) technology?
I might have missed something about Bitcoin.
--- Ray Dalio, Co-Founder at BridgeWater, November 2020
As we enter 2021, the world is about to awaken in this large-scale inflation orchestrated collectively by central banks in modern history, in one of humanity's greatest discoveries: Bitcoin.
Bitcoin will usher in a prosperous, wealthy, and free new global renaissance.
