Bitcoin, by many measures, is a digital form of gold.
The key driver behind Bitcoin’s price is – just as for gold – faith in instrument.
Assuming faith in Bitcoin gains in strength to the level of that of gold, $500,000 per Bitcoin is not unreasonable.
While $30,000+ per Bitcoin seems expensive, given BTC’s valuations over the past couple years, we cannot rationally call the BTC rally a bubble.
I’ve been a stock and options trader for the better part of a decade. On occasion, those in my personal life will ask me some investing advice or stock tips. I can always provide some info, whether it be general lesson or an individual stock analysis.
More recently, however, I have been increasingly likely to encounter a new group of investors. These investors are, like me, (relatively) young, which makes them stand apart from those asking me for stock advice. As you can guess, I’m talking about Bitcoin (BTC-USD) investors.
These Bitcoin aficionados – upon learning I’m a trader – typically ask me my thoughts about the Bitcoin market. Until now, I’ve been at a loss for words. “I know nothing about the Bitcoin market,” I would say, to their disappointment.
But the number of Bitcoin investors around me has seemed to grow exponentially over the last couple years. And recently, many of my followers are asking about the “Bitcoin bubble,” so to speak. I’ve decided I have had enough.
So, earlier this month, I spent a good part of each day studying Bitcoin –its construction, utility, and the market itself. I feel now that I have enough knowledge to give some thoughts on this market and – most urgently – whether $30,000+ per Bitcoin is an overvaluation. This will be my first article on Bitcoin but perhaps not my last.
Bitcoin Is Digital Gold
In my opinion, to understand the valuation of Bitcoin you first have to understand similar investment vehicles. Some consider Bitcoin a commodity; some a currency; some a hedging instrument. I think the closest analogy is gold, which is similarly considered all three.
But before we get to Bitcoin itself, we should review a bit of history – specifically that of the dollar and gold. This history is important because of the idea of “valuation.” While a stock can be valued via its price-to-earnings or other ratios, gold and the dollar (and Bitcoin) cannot.
It wasn’t always like that, though. The dollar used to be redeemable for gold, at $35 per ounce of gold, pegged. Gold determined the value of currency roughly 50 years ago.
Everyone knows this, but not everyone knows why the USD became the world’s go-to currency. The reason the dollar became so standard was due exactly to the USD-to-gold peg. The USD was seen as a surrogate for gold because the United States held 75% of the world’s gold in its reserves; if the USD is pegged to gold and the US controlled most of the world’s gold, it was nearly equivalent to peg your currency to the USD as it was to gold, and it was easier from a financial standpoint.
During the great depression, in an attempt to control inflation, President Nixon redefined the value of the dollar in terms of gold twice, effectively devaluating the dollar against the metal. Of course, this led to panic: Your dollar is getting weaker against gold – so to trade your dollars in for gold is the logical move. Well, that created a run on the gold reserves, and Nixon wasn’t having any of that – hence the removal of the gold standard.
The result was gold and the dollar becoming separate markets. But the dollar’s global dominance was already in place. Global markets did not redefine their currency valuations against gold but kept their faith in the USD.
“Faith” here is an important word. Without gold behind the dollar, the valuation of the dollar is simply whatever dollar users consider it to be. We no longer have a fundamental valuation for dollar, but faith in the Fed and US government keeps the dollar strong.
Side note: Many goldbugs will say they do not have faith in the US government or Federal Reserve, which is fine, but they still spend, save, and invest with the USD. The dollar’s valuation is thus implied: As long as it is accepted as a useful currency, it will remain a useful currency.
Gold works the same way. We have no way of truly attaching a hard value to an ounce of gold, and it is not used as a currency. However, faith in the metal itself keeps it valuable – the value of gold is in the minds of those trading it.
This brings us to the Bitcoin-gold analogy. Bitcoin is valuable because those trading Bitcoin consider it to be valuable. As with gold, this valuation is not entirely imagined: Both are of limited quantity; both are considered a hedge; both are seen as an anti-fiat currency.
In addition, the supply of both gold and Bitcoin is partially determined by their present values. Gold miners are less likely to create new mines if the price of gold is low, as the production of new gold cannot be a profitable endeavor if the production costs outweigh the revenue gained from selling the mined gold. Bitcoin miners, likewise, are less willing to dedicate their resources to mining the decreasing number of mineable Bitcoins as the cost of Bitcoin falls.
In many ways, Bitcoin seemed to be designed – whether intentionally or not – as a virtual form of gold. While neither have any hard value (with the exception of a small, rather negligible percentage of the world’s gold supply being employed in technology and jewelry), both are rare, secure, and orthogonal to currencies. When you equate Bitcoin to gold, things get interesting, as now we can see some important differences.
$500,000 BTC: Not Absurd
Consider the market caps of gold and Bitcoin. Gold has a market cap of $10T. Bitcoin has a market cap of $500B. When you divide these market caps by the value of these instruments, you’d see Bitcoin should be valued at nearly $500,000 per BTC, once Bitcoin’s “faith” equals that of gold, so to speak.
From this perspective, $30,000 per BTC is cheap. But you need to consider a couple extra details before you set your $500,000 sell limit order. For one, gold has been considered valuable for thousands of years, while Bitcoin is fairly new.
Again, this is faith – gold has thousands of years of realizable non-intrinsic valuation has made this metal reliable in the minds of investors. Bitcoin needs to earn such trust before a $500,000 BTC will be reasonable, but Bitcoin has an advantage that gold does not: It was designed to be reliable and is gaining investors’ trust quickly.
Faith is growing in Bitcoin. You only need look at the institutions that have pumped millions of dollars into Bitcoin, including NYSE-listed companies such as Square (SQ) and insurance companies such as MassMutual, to see that faith in this cryptocurrency is growing. The blockchain allows Bitcoin to be decentralized and thus beyond a form of centralized manipulation. And, while new, just as gold does Bitcoin has staying power if only due to it being the first successful cryptocurrency – hence why no other coin has been able to overtake it in market cap.
As Bitcoin ages, and its investors age with it, Bitcoin will be seen as less of a newfangled digital speculation and something more akin to gold. Young Bitcoin investors of today will in their older years fall back on what they know – Bitcoin, much like my grandparents, who grew up during the great depression, fell back on gold as the trusted go-to investment in their later years. While Bitcoin seems like a speculative trading instrument to much of the older investment community, that is slowly changing – and it is that growing faith in Bitcoin that will push its valuation up to the BTC-gold market cap equilibrium of around $500,000 per BTC.
Of course, the $500,000 valuation isn’t exactly correct, as we still have coins to mine. The Bitcoin hard cap is at 21M Bitcoins. Assuming all Bitcoins are mined before we reach (or surpass) the BTC-gold faith equilibrium, we should hit a price of around $400,000 per BTC. If we take that as our price target, Bitcoin is still less than 10% of its potential value at present.
Bitcoin Is Not a Bubble
And that’s pretty much my answer to whether Bitcoin is in a bubble. If faith in Bitcoin continues to grow, its value should eventually converge to its most equivalent investment vehicle, gold. That is, we need watch the trend of Bitcoin faith more so than the current dollar value of the coin, as BTC by itself – like gold – has no intrinsic value.
With large investors jumping into this game, and with young investors loyal to Bitcoin, the trend is turning upward. So, while the chart of Bitcoin looks like that of a bubble, and while $30,000 per BTC seems expensive compared to a year ago, the impetus behind the growing USD valuation of a Bitcoin seems to be a stable one. Confusing previous market bubbles, where we can value a company by its price-to-future earnings (for instance), with the rise in the price of a novel gold-like commodity will almost certainly lead to poor predictions of the Bitcoin market going forward.
In short, my thesis on Bitcoin is to treat it as “convergent gold.” If you must attach a dollar value to BTC, equate the market cap to gold first and “divide by faith.” Of course, the entire picture is much more complex (such as faith in BTC being correlated to faith in the dollar and thus faith in gold), but this should give you a general idea of the potential worth of a single Bitcoin, which – at this point – is significantly lower than its present value.
In other words, no, I don’t think $30,000 BTC is absurd.
Still, BTC is not without risk. The two major risks are not impending at the moment. But you should watch these two developments to get a feel of whether BTC is in danger of losing the public’s trust:
The major inherent risk of going long BTC on my thesis is also one of faith. For now, that risk looks quite low, as faith is on the uptrend. However, we have seen big financial players take anti-Bitcoin stance, such as China banning its financial institutions from making Bitcoin transactions, and an accumulation of such actions could damage trust in the coin. But on the other side of the coin (pun not intended), governments taking anti-Bitcoin stances could ironically foster more trust in the coin as an anti-fiat investment.
The other clear risk is a new technology that supplants Bitcoin as the top cryptocurrency. For now, Bitcoin has the market lead and staying power, due to its design and being a household name. More public knowledge about cryptocurrencies could lead to a shift to another coin, devaluing Bitcoin against it. This, nevertheless, does not seem too likely in the near future. Even the features that Bitcoin lacks relative to newer coins are generally still “doable” with Bitcoin: For example, if you want to run smart contracts on the Ethereum blockchain, you need only convert your Bitcoins into RenBTC, which are pegged to the price of BTC, and now you essentially have converted your Bitcoin to an ERC-20 coin with which you can run smart contracts.
In short, these risks are not immediate issues for Bitcoin, but a smart Bitcoin investor should keep up-to-date with these two possible risk factors.