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Bitcoin: If you love it (like Twitter CEO Jack Dorsey and ex cryptobull Steve Wozniak), hate it (like Bill Gates and Warren Buffett), trade it as a tacit political protest, a proxy for Beanie Babies, for Tesla shares , see him as the bastard child of “gold and the Internet” or a potential environmental catastrophe, he is a financial chimera for the changing times.
And it’s up 90% year to date, trading over $ 13,663 per unit, up from an all-time high of $ 20,000 in 2017.
But can it also be a valuable investment, and at what value? A hedge … and if so, against what?
Brian Estes, Chief Investment Officer at Off the Chain Capital, a $ 40 million long-only bitcoin hedge fund that has outperformed all other crypto funds, bitcoin’s spot price and the S&P 500 over the past three years, sees bitcoin as a combination of many (if not all) of the above: as a scarce resource (such as gold) with at least the same intrinsic value as the US dollar (i.e., as the St. Louis Fed did, none), and which could be ready for a higher run in the next year.
“What led me to bitcoin initially was the fact that I’m very libertarian, so the idea of sovereign money was important to me, and the fact that for thousands of years before we had fiat money, we had solid assets like money, we had gold and silver for 3,500 years, “he says, adding that while Bitcoin remains an important article of faith for libertarian leanings, its appeal transcends Republican-Democratic lines.
In addition, it increasingly bridges the Wall Street-Silicon Valley gap. Estes began his career in conventional Wall Street circles at broker-dealer AG Edwards, then retired from asset management in the endowment and foundation family office segment, ranking in the 0.1% of Morningstar’s top equity managers among 2004 and 2014.
After selling his business to Wells Fargo Advisors, Estes moved into the emerging cryptocurrency space, where he helped finance and scale several blockchain companies worth over $ 10 billion. He also invested as a general partner in Polychain Capital, which became the first $ 1 billion crypto fund in 2018.
Today, his fund invests in Bitcoin through a long-only value lens: acquiring bitcoin assets at a fair value discount from troubled and unleveraged sellers.
What is fair value?
While Bitcoin, to date, is officially regulated as a commodity and still struggles to gain traction as a fungible currency in a limited number of use cases, Estes says a conservative way to value it is as a network, with no correlation to traditional assets. .
His fund relies on several models to arrive at what they consider a fair valuation for bitcoin. The former is based on a ten-year price history for bitcoin, plotted on a logarithmic scale, with a linear regression line in the middle to indicate whether it is over or underestimated: a model that correlates with 87% of its historical action on the prices. Under this simplistic model, Estes says Bitcoin is expected to be worth $ 35,000 at the end of 2020 and $ 95,000 at the end of 2021, compared to the current price in the $ 13,000 range.
A second model, devised by Thomas Lee of the boutique consulting and research firm Fundstrat, is based on Metcalfe’s law in the financial valuation of networks. Basically, the number of network users is squared to determine the value of the underlying network, multiplied by the value of the transactions flowing through the network. From late 2014 to late 2017, when U.S. regulators allowed traders to start short selling bitcoin using futures contracts, Estes says the model had a 97% correlation with the price of bitcoin and today. indicates that Bitcoin has a fair value north of $ 40,000.
Finally, he notes, there is the scarcity-based stock-flow ratio devised by the enigmatic “Dutch institutional investor” PlanB, which is based on the valuation model for a commodity mined such as gold. The ratio is the proportion of the stock that has already been mined, the flow or amount of new resource mined each year. According to this report, gold is the scarcest resource on earth with a market value of many billions of dollars, but bitcoin is the second smallest and yet its market capitalization of $ 200 billion is about one sixtieth. the size of gold.
And, according to Brian Estes, bitcoin is within range of overtaking gold for scarcity. This is because bitcoin’s source code limits its one-time supply to 21 million coins, mined at a rate of 6.25 bitcoins every 10 minutes, or around 900 bitcoins per day. This amount is “halved” at each threshold of 210,000 blocks, which is hovering around once every four years, putting bitcoin on track to become the rarest asset in the world at the next halving in 2024.
Yes, geopolitics
The scarcity of Bitcoin does not simply come down to the time intensity of doing complex calculations. The computing power required to “mine” bitcoin is expensive. According to Brian Estes, the cost of mining a bitcoin comes to $ 7,000, including the cost of electricity, cooling, hardware and labor. Chief among these inputs is electricity, so production gravitates to foreign jurisdictions where cheap energy can be accessed.
Where can you access cheap energy? Numbers from the University of Cambridge’s Center for Alternative Finance indicate that 65% of global hash power (or total mining of bitcoin) is done in China. The US is a distant second, extracting only a small fraction of that amount. Three and four on the list are Russia and Kazakhstan. So is Bitcoin geopolitical? Could be.
No matter where it is mined, bitcoin drains energy. According to the Cambridge Bitcoin Electricity Consumption Index (which is updated every 30 seconds), Bitcoin currently uses 5.6 gigawatts of the world’s electricity to produce. Over the summer, Norwegian energy giant Equinor was reported to have begun converting natural gas (or waste) runoff from its operations at the Bakken oilfield in North Dakota into electricity for cryptocurrency mining. It is unclear whether other energy and utility companies will follow suit.
Institutions still wary
Estes started Off the Chain Capital in 2016 to manage his family’s assets and decided to open the fund a year and a half ago to external investment from funds and foundations. He pitched bitcoin to this group of investors as an unrelated asset, indicating his fund’s relatively low-risk approach as a value investor. And while the largest university endowments, including Harvard, Yale, Stanford and MIT have made allocations to cryptocurrencies, smaller institutions have been extremely wary of the reputation and career risk associated with investing in a new asset class.
“To date, I don’t see much demand from foundations, funds and large institutional investors, but things are changing. The conversations we had a year ago are completely different from the conversations we have today, ”Estes says.
A five-year shock
While this may indicate that trustees related to concealment are slowing the switch to crypto assets, Estes says this will take time. And the next five years are likely to lead to a massive shock across the coin space, with few winners, many losers, but bitcoin is likely to remain as the “reserve currency of the internet”.
Another weak point? Estes notes that Bitcoin’s memory size is not large enough to support a large number of transactions and is slow, only clearing once every ten minutes. Online transactions using cryptocurrency will need something faster and bigger: one such transactional layer could be Venmo (a blockchain application owned by Paypal), it could be Facebook’s Libra, or something like the US Fed Coin. or the Chinese digital yuan which will be interoperable with the blockchain public like Bitcoin. So Bitcoin will need a transactional partner, which means that at least one other crypto payment method will emerge.
A third “survivor” in space could be a cryptocurrency for trading smart contracts. Ethereum is the leader in this space, but it has several rivals, including its newcomers Tezos and Tron.
“After the shakeout phase over the next 5 years, there will be very few winners. Bitcoin will be one, [there will be] one transactional level and one or two smart contract levels and the others will go to zero, “he says.
