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Bitcoin; a blunt tool or precision instrument?

Updated: Jun 6, 2018

HODLing bitcoin (“BTC”) has not been for the faint of heart. The excessive volatility since peaking in December 2017 can upset even the most iron stomachs. BTC price peaked at nearly $20k in late December settling to around $7500 at the time of writing. In the same time period, the hash rate has gone from circa 15k to 35k th/s. This means the cost of mining a BTC requires more hardware and more power. So, the cost of production has gone up but the underlying value of the commodity has gone down. This is a very difficult disconnect to reconcile. To arrive at fair valuation on pricing, we can look at (a) supply demand; and/or (b) real uses of the technology. In examining both, it is clear to us, in our capacity as investor, large scale miner, and BTC evangelists, that the pricing has bottomed out and there is now a massive directionally long bias. We attribute a target price of $25k/ BTC at year end 2018. The following paragraphs justify our position.

Basic Economics

There is a fundamental supply/demand imbalance in BTC. There will only ever be 21 million BTC produced. Full capacity is expected to be reached in the year 2140 (with the vast majority being mined by 2023). Notwithstanding the long runway for production, our best guess is that only 13m actual BTC’s are “in circulation” of the 17m that have been mined since inception. We believe a significant portion have been lost, or their keys forgotten. Of the 13 m remaining, we believe circa 5-7m are kept in cold storage and therefore only 6-8m are properly in the system to be used for buying goods, transferring value, and financial trading. Even though BTC can be reduced to 1/100 millionth of coin, when people think about acquiring a coin, naturally people don’t think of it in fractions and therefore the common practice, or goal, would be to acquire a whole coin (or something close to that if one is financially able).

BTC is now widely known and talked about, but not yet fully adopted. One must recall that BTC has only been in existence since January 2009. It has taken a phenomenal toehold in mainstream awareness in the short 9 years of its life. There are now more coinbase accounts than accounts held at Charles Schwab, one of Americas oldest stock brokers. Attending the annual Consensus conference this year, with over 8k participants (versus just a few hundred 3 years ago), and observing most of them wearing suits versus hoodies, it was a clear indicator that many minds, especially those that are financially equipped to participate in size, are at the peripheral, close to accepting BTC as either a store of value or as a functional use for payment. Either way, once they take the leap and purchase a coin, the mere imbalance of supply will drive the price up. Throughout history, the adoption of technology frequently follows a long sideway trend before an aggressive advance. Examples of this “hockey stick growth” include the adoption of the internet, email, and online commerce. In the context of BTC, when you overlay financial derivatives on top of that, the price can only continue on its parabolic journey upwards.

The Stages of Adoption

Adoption happens slowly in any sector. But to find the next trend you can’t look at what is in the mainstream, you need to look at the peripheral. We have been in crypto space for 5 years. Across most sectors that amount of time is insignificant, but in crypto, that makes us veterans. We have seen the peripheral slowly crawl to center. We have seen BTC, once only talked about in fringe publications, now being quoted daily on Bloomberg, among other mainstream publications. We believe that the value of BTC is correlated to adoption, which we think happens in four phases;

1) Early tech adopters;

2) HNWI;

3) Institutions; and

4) Sovereigns.

Our research indicates that we are in the early stages of phase three. The market began institutional adoption with the roll out of CBOE futures in BTC, but the excessive volatility since January 2018 has made Institutions wary and they are rather staying on the sidelines until they can see a short period of stability which we expect will happen by the end of Q3 This should dovetail with some degree of regulatory clarity from some of the most influential jurisdictions (US, China, UK and South Korea). We also believe that this critical timing will be aligned with some of the key Investment Banks opening up dedicated crypto desks (ie. Goldman Sachs) and solving for the key issue of custody (which also needs to be socialized and proven trustworthy to large market players). The bottom line is that there is simply too much unbanked wealth in the space for Investment Banks to ignore crypto as a workable asset class. In the fourth phase, as Sovereigns will begin to accumulate cryptos to add to their reserves (Mario Draghi publicly acknowledged that he could envisage the ECB purchasing BTC Futures as part of its ongoing strategy), the pricing should revert to a bullish trajectory and those groups that were able to withstand the nauseating price dips will benefit handsomely.

Use Cases

There is an ongoing debate as to what BTC can be used for. The crypto community is fractured with one side claiming that it can be used to buy goods and services. However, the push back has been that (1) the transaction fees are high; (2) the processing time is slow; and (3) the volatility undermines price stability for the goods and services that are bought. There are efforts being taken to address these three fundamental hurdles of adoption such as batching, the roll out of the lightning network (a second layer payment protocol that operates on top of the blockchain to enable instant transactions), and bringing in market participants to help create price stability. The facts are that over 200,000 BTC transactions are handled daily and transaction fees are now at a 7-year low! In comparison to the traditional financial system, which has had decades to work out the kinks, the BTC infrastructure is leaps and bounds ahead. A case in point; three weeks ago, our company needed to make a company payment in Asia and actioned an international transfer to settle the invoice; it took 3 days to settle. We made a similar payment in the same jurisdiction days later via BTC and it took less than 5 minutes to settle.

Like with all technologies, iterations develop positive innovation. Bitcoin 2.0 will simply be better. And when you have influencers such as Jack Dorsey, advocating on BTC’s behalf and mandating his company, Square, to adopt it and solve for its shortcomings, its chances of success of becoming the “crypto of the internet” are high.

There is another camp, championed by the likes of Peter Thiel and Steve Wozniak, who liken BTC to digital gold, and suggest it may be a store of value. Over the last year, we have seen tremendous interest from family offices and ultra high net worth individuals who now deem it prudent to hold 1% of its assets in crypto as part of a balanced portfolio. The math alone speaks for itself, if the core falls in line with the outliers who are now adopting BTC, whether it be for a store of wealth, for transaction uses, or simply as a hedge, the price can only go in one direction and that is up.

There may be better cryptos that offer better use cases but BTC is the first, and has had the best global PR campaign. It is synonymous with crypto and serves no corporate master. I wont dare predict its value or market dominance (or lack thereof) on a long term horizon. However, I will predict a continuation of BTC’s short term climb in value and adoption.

Matt Novak

Partner of All Blue Capital (“AB Capital”)

Disclosure: AB Capital is one of the world’s largest BTC miners and a direct investor in crypto assets. It holds significant BTC in its portfolio.

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