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Bitcoin’s Uncomfortable Price

The Valuation Problem

Asset categorization is normally a straightforward exercise: Tesla is a tech stock, gold is a precious metal, and US dollars are a currency. How would you categorize Bitcoin? A technology stock? A digital precious metal? A digital currency? All of the above? Bitcoin is difficult to place because an argument can be made for all of the above. And this why Bitcoin’s price, even for the most objective investor, varies wildly — valuation depends on how you classify it.

Bitcoin is Not a Tech Stock

Tech stocks make investors money. Its’ products and services have consumed our attention spans and wallets for the past 10 years. Our pre-existing familiarity with technology, and their stocks, lure us to categorize Bitcoin as a tech stock. In other words, categorizing a foreign technology in a familiar space gives us a sense of control, comfort, and confidence. We want it to fit within a mental model that we are experienced in to make sense of what’s new. It’s completely human. Deep down most of us don’t care what Bitcoin is but as investors we surely want to capitalize on its growth. When we don’t know what something is, our instinct is to derive price through comparative analysis. Mainstream media adds to our confusion by constantly comparing Bitcoin against technology stocks. For obvious reason it is tempting to write attention grabbing headlines like “Bitcoin Is Now Bigger Than Bank of America, Netflix, and Shopify”. While the statement is true, the comparison is misleading.

Bitcoin is not a tech stock. Bitcoin has no employees, no marketing department, no sales team, no board of directors, no dividends, provides no forward looking guidance, is not a legally registered company, and issues no financial statements. It makes no promises to shareholders and cannot be sued or held liable. The key valuation criteria that should be accounted for is that both benefit from network effects. Products with network effects compound in value with each new user; and once a critical mass is met the product becomes sticky and hard for competitors to displace.

Bitcoin is Better than Gold

Another common comparison is Bitcoin as a digital analog to gold. Ironically, most know next to nothing about gold beyond the fact that it’s shiny and valuable. Gold is used in hardware technology but the two are polar opposites from an investment basis — so what gives? Bitcoin is a technology but its design principles match the qualities that make gold valuable: scarcity, divisibility, durability, portability, fungibility, and difficult to produce. That is no coincidence. Gold is the longest surviving, most successful form of money in history dating back to 700 B.C. The transformation of gold from physical to digital is Bitcoin’s Darwinian moment. Darwin’s theory of evolution takes a battle tested base recipe and adds a new feature necessary to survive modernity: Bitcoin’s gold adaptation gives it the ability to teleport anywhere on earth instantly while preserving gold’s key valuation properties. Bitcoin follows the evolutionary map and that is what anchors maximalists’ confidence in it’s permanence. Bitcoin makes a strong case as digital gold.

Gold has an estimated market cap of $9 trillion. If Bitcoin consumes the entire market cap of gold, that puts Bitcoin’s valuation ceiling at $486,000 per coin. It is unlikely gold will go to zero so this number serves as an initial marker. Here’s where it gets interesting: Bitcoin has more to offer humanity than gold by a sizable multiple. The best analogy (credit Michael Saylor) is in building materials: wood, stone, and steel. Wood homes typically span no more than 3 stories. The Chateau de Coucy is the tallest stone castle maxing out around 13 stories. That makes stone a 4x improvement over wood. The Burj Khalifa is the world’s tallest steel skyscraper reaching 160 stories making it a 12x improvement. Wood and stone are naturally occuring. Steel is an alchemical discovery — a man made technological breakthrough. Steel enabled entire metropolises to spring into existence changing the landscape of the entire globe. Steel did in decades what wood and stone could not accomplish in centuries. Bitcoin shares this relationship with steel: both are man made technological breakthroughs. Both displace a lineage of natural competitors. Bitcoin unlocks a future that will exceed our wildest imaginations. Therefore $486,000 is not a valuation ceiling but rather a valuation floor.

Bitcoin has Currency Potential

Bitcoin as a currency sounds accurate as it is touted as high tech money. There is truth to the statement since you can send Bitcoin from person A to person B. Is Bitcoin a currency? No*. Not in its current state. And not in the modern sense. In order for money to be useful it must be widely accepted, maintain price stability, and transact instantly. Bitcoin fulfills none of these in its present form. Bitcoin’s core value is based on gold’s blueprint but there is a twist: it also inherits the best traits of software enabling it to evolve.

Can Bitcoin become a widely accepted currency with a stable price that can clear transactions instantaneously? Yes, in time. Like the Internet, Bitcoin benefits from network effects. Given time and adoption, the notion that Bitcoin can become widely adopted is completely reasonable so long as it continues to exist and provide utility. Adoption and usability upgrades lead to broader acceptance and the likelihood for things to be priced in Bitcoin. This reasoning follows the well worn path of network effects. Transaction speed at the base layer currently takes minutes to clear — far too long for normal everyday use. Fortunately, Bitcoin is software and can build upon itself. Proof of this is Bitcoin’s Lightning Network which was a completely experimental 5 years ago and available in production today. Download the Strike by Zap app. It looks and feels exactly like Venmo or PayPal, transacting entirely in US dollars. But under the hood you are using Bitcoin that clears instantaneously via the Lightning Network. The Lightning Network is just one example of the wave of innovation being built on Bitcoin. And this only scratches the surface of how Bitcoin will outcompete traditional money in terms of featureset and utility.

I expect Bitcoin to be categorized as money in the long term future but not in its present state. The day Bitcoin qualifies as currency its valuation numbers skyrocket into seven, even eight, digit valuations. The total currency in existence is estimated at $80 trillion. And that is incredibly conservative considering governments worldwide printed an estimated $20 trillion during 2020 alone. Add in “All the Money in the World” that includes cornerstone sectors like the stock market, derivative markets, and real estate; and you quickly end up in 7 or 8 digit valuation territory. Of course these valuations are pie in the sky and may take generations.

Call Options on the Future

Fortunately, Bitcoin is built to last the test of time. If we understand why Bitcoin is significant as a product, we can create valuation maps built on knowledge. If we understand Bitcoin solely based on price fluctuations we will misunderstand it, call it names, mislabel it, and fear it. It is my conclusion that Bitcoin under $20,000 is grossly undervalued. I’ve shared my valuation map with you. I welcome you to challenge what you see differently so we can build better more accurate maps.

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