In investing, what is comfortable and easy to do is rarely profitable. One of the most challenging aspects of investing for investors is taking that leap to step out of their comfort zone. In my interactions with friends on the topic of bitcoin, the biggest challenge I observe is a mental barrier and a lack of imagination; on the possibility that an alternate finance system (the bitcoin system) can co-exist alongside the current financial system.
There is a psychological barrier that prevents people from accepting the fact that a new asset class cannot only co-exist with the current system but can completely exist digitally. The average investor is used to the physical investment world, we see the real estate we buy, we watch Netflix and buy $NFLX stocks, we use iPhones and buy $AAPL stocks.
Investors usually extrapolate on current trends and miss out on the bigger long term picture. In the course of human history monetary systems have risen and fallen with different ages. There was a time when it was inconceivable to think of metals as a form of currency or a monetary system. In the metal age(iron/bronze), it was unthinkable to have processed trees (paper) as currency(monetary system).
Society moves on from a given age or monetary system before that system becomes unavailable or worthless. We moved on to the bronze age before stone became extinct, we moved on to the gold money era before grain (salt) became extinct, we now see that the global economy will move on to other energy sources than fossil fuels way before we will run out of fossil fuels.
Investors attempting to understand how, why and if digital currencies like bitcoin can co-exist with the current financial system should analyse the fundamentals and technology independent of the current system. To understand bitcoin and crypto-assets, you need to expand your imagination and think out of the box.
Monetary & Intrinsic Value
Monetary Value (MV) is the amount of currency that would be exchanged for the sale of a good or service. It is commonly understood as the worth in cash that something has in the free market. Goods with monetary value include artwork, precious metals like Gold, Diamond, Silver, state-backed fiat currencies and Bitcoin.
MV can be considered as the value that exists despite an economic good not having intrinsic value. Intrinsic value is an umbrella term which can mean the price a rational investor is willing to pay for an investment considering all levels of risk, it could also mean an investor’s perception of the inherent value of an asset. Goods with intrinsic value include fixed income, crude oil, real estate, etc.
Bitcoin Growth Path
Several valuation models are being used in determining the potential growth of bitcoin and other digital assets. We will focus on them in detail in subsequent articles and will take a brief look at the stock to flow (S2F) model here. The S2F model is a way of measuring the abundance and amount of a resource held in reserves divided by the amount produced annually. The S2F model is mostly applied to natural resources. The model predicts a bitcoin market capitalisation of $1 trillion after the third halving in May 2020 (which happened 5 days ago), which broadly translates to a bitcoin price of $55,000 between 2020 and 2024.
Digital Scarcity
The Bitcoin halving is a 50% block reward reduction that occurs every 4 years after every 210,000 blocks mined. This reduces the number of bitcoins mined, increases the efficiency of the mining process and reduces the inflation of Bitcoin. After the third halving, bitcoin will have an inflation rate lower than that of Gold. The bitcoin money supply is fixed and publicly known. There will only be 21 million bitcoins to exist ,nothing more, nothing less. A fixed amount of bitcoins are released every 10 minutes and on every 210,000 blocks, the supply is cut by half.
Before the first halving 50 bitcoins were released, then 25 bitcoins, this was further reduced to 12.5 bitcoins after the second halving in 2016. The third halving occurred 5 days ago and now the reward is 6.25 bitcoins.
When supply reduces, whiles demand remains the same, ceteris paribus, price will most likely appreciate . In the case of bitcoin, the single biggest source of sell pressure, the miners now receive much fewer bitcoins, hence a huge reduction in sell pressure. The graph below indicates the effect of the bitcoin halving on the bitcoin price.
The first two halvings indicated that after each market top (All Time High), prices decline rapidly as it enters a bear market. Bitcoin has historically bottomed 459 days before its next halving, after this bottom, the first accumulation phrase begins and buyers accumulate at bargain prices.
We witness the first expansion which is usually retail-driven. Prices then stay in the next accumulation phase (2nd accumulation) as we prepare for the next halving. The halving paves the way for a final stronger bull phase that leads to the next market top (ATH). Historically, post halving rallies take an average 446 days from the halving to the peak of the cycle. Investors should note that in bear markets, the price goes way lower than you’d expect and similarly when in bull markets, the price goes way higher than you’d expect.
The first halving reduced the outstanding bitcoin supply by 15%, the second halving by 5.1% and the third halving will lead to a 2.2% reduction. The first halving led to a 9,212% rally in 2012 and the second halving led to a 2,910% rally in 2016, this third halving in 2020 should lead to at least a 1,000% rally. With this in mind, we estimate the impending bitcoin rally due to the third halving should lead to a market top (ATH) at $100,000 in Q3 2021.
Conclusion
Bitcoin is the first truly global bubble whose magnitude and reach is limited only by the desire of citizens of all countries to protect their hard-earned savings from the vagaries of government economic mismanagement and irresponsibilities.
We believe having a reasonable exposure to Bitcoin is an asymmetric investment bet anyone across the globe can participate in. Everyone across all religious, cultural, socio-economic backgrounds have equal exposure to bitcoin. Having a long term view, the potential of bitcoin and the entire digital-asset market is simply unlimited.
Chart of the Week
The Bitcoin Profitable days indicator represents the number of days in Bitcoin’s traded history where Bitcoin has been profitable relative to todays price. The chart highlights the aggressive growth of Bitcoin’s adoption curve overtime, which is reflected in the price. Supply is limited, as demand grows, the price appreciates. The chart shows Bitcoin has been profitable 95.0% of its existence.
Disclaimer:
Investors must have the financial ability, sophistication and experience to bear the risk of an investment. This article is intended for those with an in-depth understanding of the high-risk nature of investments. This article is not to be considered as investment advice and tax advice. Talk to your accountant and your investment advisor. Do your research before making any investment decision.
