As some of you may be aware, the cryptocurrency space is starting to heat up again. Since the market crash in late 2017, bitcoin has began to crawl back near its all time high of $20k. Is this another bubble, or has the rise in price been justifiable? Today I will share my thesis as to why cryptocurrencies will continue to be one of the best performing assets for 2021. I will also cover my existing portfolio and why I have invested in each category. This longform analysis is mostly targeted towards individuals with interest in understanding more about the crypto space, but aren’t following the day to day activities.
Background
I’ve been an active investor and power user in the crypto space since late 2011. I started purchasing bitcoin back on the ill fated Mt. Gox when it was still trading in the single digits, and I have experienced 3 bull market cycles ($10 to $226, $70 to $1200, $200 to $20000). Since then, the entire industry has grown massively with the onboarding of institutional investors, the creation of 5000+ different altcoins, smart contract development on Ethereum and other similar blockchains, the introduction of fiat backed stablecoins, and the recent explosion of Decentralized Finance (DeFi) applications, where billions of dollars of transactions are processed without any centralized intermediary.
Historical Price of Bitcoin
People often refer to this iconic image of a bubble when describing the price of bitcoin. What most people don’t realize is that bitcoin has already experienced this cycle 4x, with higher highs each cycle. In 2011, bitcoin saw its first bubble where the price ballooned from <$1 to $31. What quickly followed was a 90%+ drawdown and a two year bear market. Then in early 2013, the price finally surpassed its 2011 high and quickly soared to over $260. Back then, Mt. Gox was the only active trading exchange, and it was filled with a host of various infrastructure issues. Unable to support the increase demand of users, the site would often crash and be unusable. This caused bitcoin to tumble back down to around $60, a 75%+ drawdown.
Within the same calendar year, bitcoin reconsolidated and experienced another bull cycle shooting to a high of $1200. Just like the iconic image of a bubble, bitcoin popped and suffered one of its longest bear markets from 2014–2017. You most likely still remember the crypto mania that followed in 2017 where bitcoin grew 100x from a low of $200 to nearly $20,000. It wasn’t until January of 2019 that bitcoin found a bottom of roughly $3500, an 80%+ correction. Yet even with this correction, the $3500 low is still 1300% higher than the previous cycle peak in the $260s.
So what does all this mean? Unlike traditional equities and index funds that grow steadily over time (excluding gaps due to earning reports), bitcoin is still in price discovery phase. In fact, bitcoin’s price growth only occurs during bubbles. There are only two phases for bitcoin. Explosive upwards growth with 10–100x growth, or multiyear bear markets where the price cools down and reconsolidates. Every single time the price of bitcoin exceeds its previous cycle all time high, it enters a new price discovery phase where heavy speculation and price growth follows.
Bitcoin and Today
As of November 2020, the price of bitcoin has nearly recovered to its previous 2017 all-time-high. Yet this time, there’s much less retail “fomo” and overall euphoria. So what has changed and why is the price increasing?
Reason 1: Decreased Supply
In May of this year, bitcoin underwent its routine halving event, where the daily production is reduced by half. There are numerous articles already covering this event, so the short version is that now there are only ~900 bitcoins created each day, whereas there used to be 1800. Assuming demand stays the same, a decreased supply should result in an increase in price.
Reason 2: Increased Demand
For years, retail bitcoin investors have touted “wait for institutions to start buying!” Well now it is evident that institutional firms, hedge funds, and publicly traded companies are buying bitcoins in large chunks. Due to the recent global pandemic and trillions of fiat currency printed out of thin air from QE and stimulus injections, bitcoin has become a primary contender to gold to hedge against dollar inflation. See just a few examples below:
- Billionaire investor Stanley Druckenmiller calls bitcoin better than gold
- Billionaire fund manager, Paul Tudor Jones, buys bitcoin as hedge for inflation
- Ricardo Salinas Pliego, 2nd richest Mexican, puts 10% liquid assets into bitcoin
- MicroStrategy, a US publicly traded company, invests $425m into bitcoin
- Square, Inc. invests $50m in bitcoin bitcoin
Interesting enough, there is now a website that tracks which companies own significant amounts of bitcoin. Remember, there are only 21m in total…and as a friend recently said, “if the 2nd richest person in Mexico is accumulating, you’re going to want to buy it before the 3rd, 4th, and 5th also start buying.”
Reason 3: Identity Crisis and Product Market Fit
In the early days, people were attracted to bitcoin for many different reasons. Some envisioned a digital currency for country agnostic payments while others saw it as the solution for international remittances. Projects such as Colored Coins tried to tie individual satoshis to real world assets such as company shares, physical property, or digital collectibles. As the market has evolved, most of these projects have moved on to other blockchains such as Ethereum, where a variety of projects are being built on smart contracts which I’ll cover later.
This leaves bitcoin with a smaller, but more focused niche of becoming a dominant reserve currency. It turns out people don’t want to spend bitcoin to buy $5 coffee. For human-to-human or human-to-machine payments, bitcoin does not provide significant improvements to existing rails such as credit/debit cards, Venmo, Paypal, etc. Instead, bitcoin is behaving more and more like a digital gold or a swiss bank account, where wealth can be parked for long term storage. One growing trend is to tokenize bitcoin onto the Ethereum blockchain via products like renBTC or wBTC. This tokenized bitcoin can then be used as collateral in DeFi products like Aave for collateralized lending. As per Dune Analytics, there are now more than $2.5B worth of bitcoins tokenized on Ethereum!
Reason 4: Bubble Expectations
As the price of bitcoin nears $20k, the all time high of 2017, people are expecting the multiyear bear market to transition into a hyper bull market filled with price discovery and rampant speculation. While previous cycle behavior cannot predict future events, it’s clear the market sentiment has shifted towards a positive note. I don’t expect the market to behave exactly the same as previous cycles, but I do expect humans to behave similarly. When prices rise and people start making money, greed takes over and the public will take notice. In the end, the price of bitcoin is the ultimate marketing campaign to attract new users. Mainstream media will only amplify this causing a hyper-extended blow off top, followed by another multi-year bear market (although with higher highs and higher lows).
As a fun project, there have been many predictions of what the future price of bitcoin might be based on previous cycle growths. One of my favorites is the bitcoin rainbow chart, but remember past performance is not an indication of future results yada yada yada.
Total Addressable Market
So we know bitcoin is still in price discovery phase, but how do we estimate its potential value? Should it be worth $0 or $1M per coin? Since bitcoin’s “use case” is becoming more and more resembling gold, we can use gold’s market cap as a proxy metric. Based on the current spot price of gold ($1800/oz) and a total supply of 244k tons, we have approximately $14T worth of gold in the world.
For reference, bitcoin’s fully diluted market cap (21m coins x $18,000) is just under $380B, or 2.7% of gold’s market cap. If bitcoin continues to prove to be a superior “digital gold”, this comparison should increase, if not, overtake in the following decades. For bitcoin to match a $14T market cap, you’re looking at a price of $600k/bitcoin.
While I don’t expect bitcoin to reach $600k anytime soon, the potential addressable market for a “digital gold” has tremendous room for growth if it continues its current trajectory. The path from $20k to $600k+ will be far easier than going from pizza to $20k.
Bitcoin Summary
- Daily supply cut in half due to halving
- Increased demand from institutional investors
- Global macro environment shift due to worldwide stimulus injection
- Sentiment shift from bear to bull market
- Bought bitcoin at $10. Still buying at $20k :)
In the next post, I will cover my thoughts on Ethereum along with how Decentralized Finance applications have evolved since 2017.
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-Ray
