Bitcoin: A Framework for Its Potential
If someone tells you with great conviction that Bitcoin is a bubble, stop listening. They’ve lost credibility. If someone tells you with great conviction that Bitcoin is the currency of the future, stop listening. The truth is no one knows.
Bitcoin today is a speculation. Some speculations, however, can be attractive wagers. For example, playing Blackjack with perfect card counting is a succession of speculations where the odds are stacked (slightly) in your favor. How then should we think about the Bitcoin bet?
What Is Bitcoin Worth?
Here is a simple framework for estimating the odds of Bitcoin’s success. Optimists see Bitcoin as a future currency (or store of value) that one day supplants the government’s monopoly of the money supply. Yet, for that happen three things must go right for Bitcoin:
(Please note: Just to give Bitcoin the benefit of the doubt, we will err on the side of being generously optimistic. We believe the real odds of the following are a good bit lower.)
1. Cryptocurrencies must become widely adopted.
By widely adopted, we mean that your uncle who still uses an AOL email address uses cryptocurrency to buy shaving cream at Walgreens. From what we’ve read and observed, the odds appear high that future transactions will be consummated using some form of blockchain technology. There is, however, risk that some “new & improved” version of blockchain tech ultimately renders today’s architecture obsolete. Let’s be optimistic and assume a 50% probability that cryptos (in Bitcoin’s present form) could be successfully mass adopted.
2. Governments must tolerate independent cryptocurrencies.
Governments like having their own currencies because they can print them and pay for things they owe. Governments don’t like currencies they cannot control because they reduce the value of the ones they do control. When people start preferring an alternative currency, it creates a problem for the government. This is what happened to gold. In 1933, during the depths of the great depression, people began to prefer gold over U.S. dollars. The U.S. government responded by making it illegal to own gold and required citizens to surrender their gold.
A country with a mountain of debt cannot afford to give up its monopoly on inflation. When there is another crisis (let’s face it, there always is), the U.S. government is liable to lose patience with cryptocurrencies. Chances are it would follow its old 1933 playbook with gold and outlaw these modern rogue currencies as well. Odds are very low that Washington will tolerate an end to the monopoly status of the US Dollar. My hunch is that the odds are close to 0%, but let’s be generous and give it a 10% probability.
3. Bitcoin must maintain leading share.
There are over 1,327 different cryptocurrencies. Bitcoin has over 50% market share, but up and comers like Ethereum and Litecoin are eating away some of its lead. What are the odds that Bitcoin maintains its dominant share? For arguments’ sake, let’s say it’s a 50% probability.
Each of the above things must happen for Bitcoin to succeed on a grand scale. Even though we assigned optimistically high odds to each of them occurring, we end up with a mere 3% probability of success (50% x 10% x 50% = 2.5%).* If Bitcoin were to reach the value of the US M2 money supply, that would imply a price of $652,000. Yet, given the mere 2.5% probability of getting there, it suggests a wager above ~$16,000 makes no sense (2.5% of $652,000). Buying Bitcoin at today’s price of ~$16,000 is thus a speculation with uninspiring odds – even assuming what we believe are optimistic probabilities. Keep in mind too that we’ve benchmarked Bitcoin’s ultimate success to M2. If we instead consider gold as a more sober benchmark, these odds suggest substantial downside from today’s Bitcoin price.**
Bitcoin may ultimately prove to be successful as an alternative currency. But that doesn’t make it a good investment.
In short, Bitcoin has no margin of safety. What is its intrinsic value? What will its price be if the government outlaws it? Your guess is as good as ours.
*Another demonstration of the risk of not understanding the need to multiply probabilities. Most folks have forgotten the lessons of their college stats class. Even if the odds are high for each progressive branch (event) in your probability tree, the odds can be very low of arriving at any final branch (event) on the tree.
**Gold held by individuals and central banks, not including gold in the form of jewelry.
Disclaimer: While the information presented herein is believed to be accurate, Fielder Capital Group LLC (Fielder) makes no express warranty as to the completeness or accuracy, nor can it accept responsibility for errors appearing in the document. Fielder is under no obligation to notify you of any errors discovered later or of any subsequent changes in opinions. Nothing herein should be construed as a recommendation to buy or sell any of these securities. It should not be assumed that any of the securities, transactions, or holdings discussed will prove to be profitable in the future or that investment recommendations or decisions Fielder makes in the future will be profitable or will equal the investment performance of the securities discussed herein. Fielder or its employees may have an economic interest in securities mentioned herein.