The Breakdown - How Bitcoin Gets to $100,000

Episode Date: November 29, 2020

On this edition of The Breakdown’s Long Reads Sunday, NLW reads a recent piece by Hong Fang, CEO of OKCoin.  In it, Fang provides a set of valuation models and scenarios that plausibly lead to bitcoin achieving a significant $100,000 value over the course of 2021.

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by crypto.com and nexo.io and produced and distributed by CoinDest. What's going on, guys? It is Sunday, November 29th, and that means it's time for Longreed Sunday. So because of the holiday, I'm recording this earlier in the week, I apologize. in advance if anything crazy has happened between now and then. But I thought it would be fun for this holiday weekend to read some delicious red meat for you bitcoiners out there.

This is called the complete case for 100K Bitcoin and is by Hong Fang. Hong is the CEO at OK Coin. She has been on this show talking about their investment, their grant to a Bitcoin core developer. And I thought that this piece was a really good follow up to my episode with BJ Boy potty from a couple weeks ago, it was all about valuation frameworks for Bitcoin, different ways of understanding what the price of Bitcoin might be based on the mental models we have for it. This puts some more numbers around that in a way that I think you guys will appreciate,

and it's a fun little piece. So without any further ado, here is the complete case for 100K Bitcoin. What a year. A global pandemic, a wavering stock market, rising numbers of unemployed people, and continued uncertainty in global markets. Yet we saw the Bitcoin price recover from 5,300 in March to almost 18,000 at time of writing. That's almost a 240% return within nine months. For regular investors, the burning question is whether Bitcoin is becoming overpriced. Is it too late to buy? If we put aside short-term volatility and take a long-term perspective, there is a reasonable path for the price of Bitcoin to reach over $500,000 in the next decade. To go even further, I think Bitcoin is likely to hit,

100K in the next 12 months. Significant upside has yet to play out for Bitcoin. Bitcoin is a store of value. When we talk about the valuation of an asset, the first step is to understand the fundamental economics. Equities, bonds, and real estate, for example, often derive their value from generating cash flows. Therefore, valuation of these assets involves projecting future cash flows. Commodities, on the other hand, are more utility-based, and therefore their prices are anchored by industrial supply and demand. Before, Taking any action on Bitcoin, I suggest asking yourself, what is Bitcoin for? Use this as a baseline to form your own view on the value of Bitcoin and its fair price range in a given time horizon.

Here's my take as a hoddler. Bitcoin is sound money and the first native internet money in human society. It is scarce, 21 million fixed supply, durable, digital, accessible, blockchain is 24-7, divisible one Bitcoin equals 100 million Satoshes, verifiable open source Bitcoin core, and most importantly, censorship-resistant encrypted. With these superior monetary qualities in one asset, Bitcoin is a great store of value. Once it reaches a critical mass of adoption as a store of value, Bitcoin has huge potential to grow into a global reserve currency, and universal unit of account too over time. The history of money shows us that natural forms of money generally go through three phases of evolution. First as collectible, speculation on scarcity, second as investment store a value, third as a money, unit of account and payment medium of exchange. As Bitcoin goes through different phases,

its valuation scheme varies too. In my view, Bitcoin is currently in the early stage of phase two. What follows is a short summary of the two phases Bitcoin has been through and respective value implications. Bitcoin as Collectible Between its inception in 2009 and 2018, Bitcoin was a short summary of the two days. Bitcoin was in its collectible phase. Only a small cluster of cypherpunks believed in Bitcoin as future sound money. It was hard to come up with a valuation scheme for Bitcoin that matched its fundamentals. It was also too early to tell whether Bitcoin could succeed in building consensus around its store of value superiority. Bitcoin is built as a basic utility and doesn't generate cash flow,

so there is no way to forecast its price based on cash flows. Its circulating supply was easy to calculate, but it was really hard to estimate demand given the fickle nature of speculative trading. When speculative demand surged and drained out of the system, particularly around the initial coin offering boom of 2017, we saw Bitcoin's price explode from $900 in early 2017 to $19,000 by the end of the year, and then down to $3,700 by the end of 2018. Bitcoin's opponents usually attack Bitcoin's price volatility as a bug, but I believe that Bitcoin's price volatility is a unique and smart self-marketing feature. It was key to its survival in the early days.

Bitcoin operates as a decentralized global. network. There is no coordinated marketing team out there promoting Bitcoin's utility to the world. It is the dramatic price volatility that has continued to attract attention from non-followers, some of whom were later converted into believers, thus driving the continued momentum of Bitcoin adoption. Bitcoin as investment. Bitcoin went through an identity crisis as sound money before it graduated into the second stage as an investment vehicle. Starting with the scalability debate in 2017, when the network became congested with historical high volume and transaction costs surged, its community had serious controversies, some called it a civil war,

involving the future path of Bitcoin. As a result, on August 1st, 2017, the Bitcoin blockchain was hard forked to create the Bitcoin cash chain to allow larger blocks, as BTC stuck to a block-sized limit with Segwit adoption to enable a second-layer solution. On November 15th, 2018, the BCH network forked again into Bitcoin Cash and Bitcoin Satoshi's vision. Fortunately, Bitcoin, BTC in this case, survived its growing pains and the industry-wide bear market and thrived thereafter. It is also through such public disputes and price performance after hard forks that BTC's support and dominance has been further solidified, with an increasing number of addresses holding BTC and decreasing volatility. Then came 2020. This year has been extraordinary in many

aspects, but it is truly a milestone year for Bitcoin. The coronavirus pandemic has brought emotional and economic stress to many people on a global basis. On top of that, 12 years after the 2008 financial crisis and the publication of the Bitcoin White Paper, we are reminded how easily our economy could be flooded with new money printed out of thin air. Three trillion in new money was created in just three months in the United States, about 14% of US GDP in 2019. The US was not alone. In 2020, it has been extremely hard for responsible savers to find reliable real yields to preserve their hard-earned wealth. American middle-class families have either had to accept zero or negative interest rates at banks and debasement risk or bet in the all-time high equity market when the

real economy struggles, not knowing when the music will stop. In other countries, people must fight an uphill battle every day to simply preserve the earning power of their salaries. These macro themes are too strong for anyone to ignore. In contrast, the Bitcoin network had its successful third having on May 11th, 2020, highlighting the beauty of having monetary discipline pre-written into code and executed by the global network smoothly ever since. As a result, more investors in traditional finance, Wall Street institutions included, have started to realize that Bitcoin has a unique hedging capability against long-term inflation risk, with a risk-reward profile better than its closest monetary cousin, gold. Different from its 2017 ride, Bitcoin's current run-up is

characterized by more vocal institutional endorsement. Square and micro-strategy allocate treasury cash into Bitcoin. The office of the comptroller of the currency allows U.S. banks to offer crypto-asset custody, PayPal enabling crypto buying and selling, Fidelity making a case for a 5% asset allocation and doubling down on crypto engineering recruiting, well-established traditional asset managers, including Paul Tudor Jones and Stanley Druckenmiller, announcing public support for Bitcoin. The mainstream momentum is building up. For the first time, since its historic inception, Bitcoin officially entered mainstream media as digital gold, a legit and credible and liquid alternative asset to consider for both individuals and institutions. The earlier comparison to Dutch tulip

media starts to fade. As more people educate themselves about what Bitcoin is and start to embrace it, not as a speculative trading asset, but as a long-term asset allocation option, we can now look at its fundamentals and anchor price ranges with a simple supply and demand math. What follows are three scenarios used to triangulate Bitcoin's potential one-year trajectory. Scenario 1.1-2% U.S. household wealth allocation. According to the Federal Reserve, U.S. household wealth reached 112 trillion by June 2020, with the top 10% owning two-thirds of the wealth. 1 to 2% of 112 trillion equals 1.1 trillion to 2.2 trillion to 2.2 trillion potential demand. Fidelity's most recent report actually recommends 5% target allocation.

Current total circulating BTC is around 18.5 million. To keep it simple, let's assume 21 million max supply are all up for sale. Divide the potential demand by max supply, we get a price range of 56,000. to 112,000. This scenario does not account for the rest of the world, which has 400 trillion more in global family wealth, according to a Credit Suisse wealth report. If we assume one to two percent allocation of global family wealth, we will be looking at 228,000 to 456,000 price range. Would this happen in the next 12 months? Likely not. Can this happen within the next decade? I think that's very possible. This episode is brought to you by crypto.com, the crypto super app that lets you

buy, earn, and spend crypto all in one place and earn up to 8.5% per year on your Bitcoin. Download the crypto.com app now to see the interest rates you could be earning on BTC and more than 20 other coins. Once in the app, you can apply for the crypto.com metal card, which pays you up to 8% cashback instantly on all purchases. Reserve yours in the crypto.com app today. Many investors want to be a part of the next bull run. Others seek to build their dream home, Finally launch that startup or fund their education, try NXO's instant crypto credit lines and borrow against any major cryptocurrency with no minimum or maximum withdrawal amounts, no fees whatsoever, no credit checks, and flexible repayment. Not to mention the APR starts at just 5.9%. Stay on top of your investment game with nexo.io.

And remember, it's your crypto, your credit, your choice. Get started at nexo.io. scenario two, two to three percent of global high net worth individual allocation. According to Cap Gemini's World Wealth Report 2020, global high net worth individual's wealth stood at $74 trillion by the end of 2019. That was allocated as 13% alternative, 14.6% real estate, 17% fixed income, 25% cash and cash equivalent, 30% equity. 2 to 3% of $74 trillion equals $1.48 trillion to $2.2.2.3% of $7.4 trillion to $2.2.3%. billion of potential demand. Divide the potential demand by max supply, and we get a price range of

70,000 to 105,000. This scenario does look at global data, but only accounts for high net worth individuals, assuming that this segment has more assets to invest and investment decisions are more driven by institutional asset managers and advisors. I'm also assuming a higher range of allocation here because high net worth individuals are generally better positioned to take on more risks in search of higher risk-adjusted return. Scenario 3, catching up with gold. There's been a long-standing argument that Bitcoin would catch up to gold and market cap once it is widely accepted as a digital and superior version of gold. Current gold market cap is $9 trillion. That is about 2% of total global wealth and 12% of global high net worth individual wealth. 100% of gold market cap means $428,000 price

point for Bitcoin. Can we get there in 12 months? Probably too aggressive an assumption. Can Bitcoin rise to 20 to 25% of gold in 12 months, aka 2.4% to 3% of global high net worth individual allocation? Possibly. That would give us a price range of 80,000 to 110,000. There are additional factors that could add more upside to Bitcoin. Given that we are still in the early stage of mainstream adoption, I don't want to overemphasize them, but I want to lay them out there just to keep the perspective. Potential allocation from corporate treasury management. We are already seeing early signs of this Swiss Square and MicroStrategy.

Square recently allocated about 1.8% of its cash balance to buy 50 million in Bitcoin. Sizing up corporate demand for Bitcoin is tricky, though. Each company has its own cash flow and growth profile, which will affect its risk appetite in asset allocation. Potential allocation from foreign exchange reserves of all sovereign states. According to the IMF, the global foreign exchange reserve was $12 trillion by June 2020. With the top three reserve currencies in US dollars, $7 trillion at 58.3%, euros, 2 trillion at 16.7%, and yen at 650 billion, 5.4%. Is it possible to see sovereign countries allocate some of their Forex reserves into Bitcoin? I believe that trend will emerge over time when Bitcoin's superiority in store of value further plays out in the next 5 to 10 years. Assuming 25% allocation, 3 trillion,

a little more than euro allocation, that is another $140,000 of upside. Bitcoin catching up to the U.S. dollar as a dominant global currency reserve could take a long time to materialize, if at all, but it is not impossible to see Bitcoin among the top three list. Not 100% of Bitcoin's max supply would be available for trade. There is about 18.5 million in circulation. About 10% of that has been dormant for over 10 years. It's tricky to estimate how much of the total Bitcoin in circulation will actually be up for sale at different price points. None of the above account for the dollar's inflation rate in the years to come, which is about 2% to 3% annually as a baseline. Neither do these scenarios account for the network effect of Bitcoin, the possibility

of Bitcoin becoming more ubiquitous and reliable as a unit of account. What could go wrong? A one-sided investment case is never a good one. It is prudent to play devil's advocate and assess downside risks. What are the major risks that may derail a Bitcoin bull run? Protocol risk. The biggest risk always comes from inside. Bitcoin has inherent value only because it has the unique characteristics of sound money, scarce, durable, accessible, divisible, verifiable, and censorship-resistant. If any of those qualities are compromised, the foundation to its investment case will be eroded or gone. Such protocol risks were high in its first few years, but after two major controversial hardvorks and three successful halvings, it seems that protocol-level risks are somewhat contained.

The Bitcoin ecosystem has been consistent in independent developer support. According to Electric Capital's developer report, the Bitcoin developer ecosystem has maintained 100-plus independent developers every month since 2014. Additionally, we've also seen an increase in commits to the Bitcoin Core codebase in 2020, reaching a peak in May around the time when the third having happened. It's also encouraging to see major development milestones emerging on the Bitcoin Core network, including the merger of Signet, Schnorr-tap route, and increasing focus on fuzz testing, to name a few.

These protocol-level developments continue to enhance the privacy and scalability of the network, boosting Bitcoin's technical stability as a currency. To ensure a healthy and safe future for Bitcoin, it is cool. critical to ensure that Bitcoin core developer community remains independent in decentralized and continues to make steady improvements in critical areas like security and privacy. This is also why we have been passionate about providing no-string sponsorship to Bitcoin core developers and projects at OKCoin. Investing in Bitcoin development helps reduce the protocol risk.

Concentration risk. This, to me, is the second biggest risk to Bitcoin. Bitcoin's ethos is to empower individuals through decentralization, but the risk of concentration always exists. Within the network, the risk lies in the concentration of mining power. It is not an industry secret that 65% of the world's hash power is in China. If mining power is coalesced, a mining pool or group of miners can manipulate network transactions, creating fake coins through double spending, in turn impacting the market price. However, there is also the argument that such concentration risk is inevitable, but to some extent harmless too, given how the network

incentive has been designed for Bitcoin. In other words, the incentives in the form of new bitcoins and transaction fees should work to keep the majority of the nodes honest because it is economically costly to cheat, not because it is hard or impossible to cheat. The assumption is that the mining participants are all rational and make economic decisions. Externally, similar risk lies in ownership concentration. Investors or whales holding significant amounts of Bitcoin can influence and even manipulate the market by triggering a change in price based on their buy-sell timing. Given that an individual or an entity can own more than one Bitcoin address,

it's hard to paint an accurate picture of Bitcoin ownership. So this risk does exist. This is also why I feel very passionate about promoting financial literacy and crypto knowledge. I believe that we can build a healthier and more sustainable future if more individuals come to understand what Bitcoin is about and start to embrace it. The first institutional wave is exciting to see. But if Bitcoin ownership tilts too much towards the institutional end, we would all be defeated in our mission to building a more

inclusive and individually empowering network. Political risk. Another major risk comes from sovereign governments. Given that Bitcoin is positioned as future money, it is possible that sovereign governments ban it for fear it threatens their fiat currencies. Again, such risks were higher in earlier years before Bitcoin was able to build meaningful adoption momentum. Actually, such bans had already happened in several countries. India in 2018, for example, which was revoked in 2020. Central Bank digital currency experiments around the world could also have an impact on how Bitcoin's future plays out. This year has seen the first wave of institutional endorsement for Bitcoin, and therefore 2020 will be recognized as a milestone year in alleviating this political risk. When publicly listed

companies, asset managers, and well-known individuals start to own Bitcoin and speak in favor of Bitcoin, such a ban is going to become very unpopular and hence harder to implement in countries where popular votes do matter. I hope the momentum will continue to build, making a risk of total Bitcoin ban increasingly remote as time passes. A successful and complete ban on Bitcoin would also need to take coordinated efforts of all sovereign governments, which is very unlikely. As long as there are countries that let Bitcoin legally flow, Bitcoin will have a chance to win. A decentralized global network cannot be shut down by any single party. That being said, Bitcoin price volatility could be amplified time to time by domestic and geopolitical changes.

In my view, political risks remain the third largest risk to Bitcoin until it becomes too big to be tampered with. We are obviously far away from that point. There can also be a wider payment ban on Bitcoin while it is being recognized as an illegal financial asset. Such a risk is not totally out of the picture yet. The good thing is we are not banking on Bitcoin becoming the unit of account and medium of payment in our 100,000 to 500,000 scenario. When Bitcoin does progress to phase three, we will not be talking about Bitcoin price anymore, but instead talking about everything else's price in Bitcoin. Adoption risk. This is a timing risk. It is quite possible. possible that it may take much longer than expected for Bitcoin to go mainstream. The only way to

manage this risk is to make sure your Bitcoin portfolio is properly sized. If you invest in Bitcoin or anything else and worry about where its price would be in the next 12 months, your portfolio of Bitcoin is probably too big for you. Size it based on your own risk tolerance and conviction level in Bitcoin. Don't do more than what you can afford or believe in. I also believe the unique quality of Bitcoin will speak for itself over time. Bitcoin's price chart between 2017 and 2018 very much looked like a bubble. However, if we look at Bitcoin's full trading history, there is a clear upward trend together with growing asset holding addresses, growing active addresses, and growing network computing power. The increasing mean hash rate of the Bitcoin network

represents the security level that one would want to see in a network where people's wealth is stored. I may be on the bullish side for Bitcoin's 12-month price trajectory, but I truly believe that with Bitcoin, time will be our best friend. Looking ahead. Bitcoin is unlike any other asset we've encountered before. This is the truly sound and global wealth network that will continue to grow as the world recognizes the significance of its properties. To put things in perspective, here is a recent tweet from Michael Saylor, CEO of Microstrategy, that summarizes the relevance of Bitcoin as a utility and store of value. Michael tweets, Bitcoin is not a currency, nor is it a payment network.

It is a bank in cyberspace, run by incorruptible software, offering a global, affordable, simple, and secure savings account to billions of people that don't have the option or desire to run their own hedge fund. In a world of uncertainty, Bitcoin gives huddlers like me confidence. It has a huge network effect that can ultimately empower every individual who believes in it and uses it. I look forward to the continued evolution of the Bitcoin ecosystem and feel excited about being part of it.