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Bitcoin’s increased acceptance among capital market investors explains why it has surged on news that could be detrimental to other markets, such as Brexit, the surprise Trump election win, and the devaluation of the Chinese yuan.
Such a correlation implies that people are likely buying bitcoin to protect themselves from further devaluation of the yuan.
“An investment operation is one which,
upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”
As a result, more suppliers are drawn to the market, accelerating the alleviation of the shortage in classic supply and demand economics.
Speculators are the ones who first allocate money because they have the highest tolerance for risk and are always on the lookout for new information.
Single speculators, or small groups of them, typically do not destabilize markets. It is when the groups turn into crowds that the negative ramifications build.
Among the other characteristics of crowds, we must note their infinite credulity and exaggerated sensibility, their short-sightedness, and their incapacity to respond to the influences of reason.
Reality and experience have no effect upon them.
Unfortunately, when the market turns and the prestige is gone, the contagion of terror spreads just as quickly through the speculative crowd.
Cheap credit often fuels asset bubbles, as seen with the housing bubble that led to the financial crisis of 2008.
Similarly, cryptoasset bubbles can be
created using extreme margin on some exchanges, where investors are effectively gambling ...
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Speculative bubbles are particularly dangerous when there is no underlying long-term value proposition to the asset.
These times are worthwhile to examine and learn from, and it’s important to note that bitcoin has always recovered from these periods of mass speculation, a major differentiator from tulips.
Figure 10.2 Bitcoin’s history of doubling price in a one-month period Data sourced from CoinDesk
First, we will define a bitcoin bubble cycle as being recognizable on the first day that bitcoin’s price has doubled from its price 30 days prior.
Figure 10.3 Bitcoin’s price bubbles Data sourced from CoinDesk
Similar to the 1920s, in the 1990s stock analysts and investment managers rationalized the expensive markets with the claim that the old methods of valuing companies no longer applied. There were new methods that justified the nosebleed prices.32
A key indicator of the unsustainability of mass speculation is when new and inexperienced entrants stream into the markets.
The innovative investor would be wise to learn from France’s mistake and always take the time to investigate the priors of cryptoasset developers and advisors before putting money into the assets they create.
Control over the asset supply goes beyond crowdsales and founders, as it can spread to the miners or other entities required to support a cryptoasset.
The innovative investor needs to carefully examine the supply schedules and who newly minted cryptoassets are being issued to.
assets. In the traditional capital markets, an entire industry is based on this process, known as sell-side research.
In this chapter we discuss applying fundamental analysis to the founding characteristics of a cryptoasset. This includes examining: • White paper • Decentralization edge • Valuation • Community and developers • Relation to digital siblings • Issuance model
Any cryptoasset worth its mustard has an origination white paper.
As it relates to cryptoassets, a white paper is the stake in the ground, outlining the problem the asset addresses, where the asset stands in the competitive landscape, and what the technical details are.
We call this the decentralization edge. Put bluntly by Vitalik Buterin, “Projects really should make sure they have good answers for ‘why use a blockchain.’”3
The innovative investor should perform similar thought experiments with any cryptoasset under consideration and be convinced that its associated architecture will provide long-term value and isn’t simply riding a hype-wave7 with the intent of gaining funding while providing little value over time.
utility value and speculative value.
Currently, roughly 5.5 million bitcoin, or US$5.5 billion worth at the price of US$1,000 per coin, is held by the top 1,000 addresses recorded in Bitcoin’s blockchain.
Future utility value can be thought of as speculative value, and for this speculative value investors are keeping 5.5 million bitcoin out of the supply.
Since these people must buy that bitcoin from someone else, that someone else needs to be convinced to let that bitcoin go, and so a negotiation begins.
The velocity of money is the frequency at which one unit of currency is used to purchase domestically-produced goods and services within a given time period. In other words, it is the number
Currently, the velocity of the USD is a little north of 5.12
About US$500 billion is transmitted annually through the remittances market. Assuming that bitcoin serviced that entire market, then to figure out the value of one bitcoin, one would need to assume its velocity. Say bitcoin’s velocity is 5, similar to that of the U.S. dollar. Then dividing that $500 billion by a velocity of 5 would yield a total value of bitcoin of $100 billion. If, at this point, we are at the maximum of 21 million bitcoin, and this is the only use for bitcoin, then that $100 billion divided by 21 million units would yield a value per bitcoin of $4,762.
If each bitcoin needs to be worth $952 to service 20 percent of the remittance market and $11,430 to service the demand for it as digital gold, then in total it needs to be worth $12,382. There is no limit to the number of use cases that can be added in this process, but what is extremely tricky is figuring out the percent share of the market that bitcoin will ultimately fulfill and what the velocity of bitcoin will be in each use case.
For example, if someone offered to give the innovative investor $150 in 10 years or $100 now, then if there was a perfectly safe way to earn 5 percent the innovative investor should take the $100 now because $150 divided by (1.0510) equals $92 today.
If information cannot be found on the developers, or the developers are overtly anonymous, then this is a red flag because there is no accountability if things go wrong.
A frequent argument that Bitcoin Maximalists—people who believe bitcoin will be the only cryptoasset that survives—purport is that all other cryptoassets display features that Bitcoin will someday absorb.
The total planned supply of the asset is also integral to the cryptoasset’s individual units preserving value over time. If too many units will ultimately be issued, that will erode the value of the asset in the future.
Next, consider if the distribution is fair. Remember that a premine (where the assets are mined before the network is made widely available, as was the case with bytecoin) or an instamine (where many of the assets are mined at the start, as was the case with dash) are both bad signs because assets and power will accrue to a few, as opposed to being widely distributed in line with the egalitarian ethos.
The only way attackers can process invalid transactions is if they own over half of the compute power of the network, so it’s critical that no single entity ever exceeds 50 percent ownership.
In other words, miners are purely economically rational individuals—mercenaries of compute power—and their profit is largely driven by the value of the cryptoasset as well as by transaction fees.
One way to determine the relative safety of a cryptoasset is through its hash rate.
A cryptoasset’s hash rate is representative of the combined power of the mining computers connected to the network.
While hash rate often follows price, sometimes price can follow hash rate. This happens in situations where miners expect good things of the asset in the future, and therefore proactively connect machines to help secure the network.
Once it’s been ascertained that the hash rate is growing, often the best way to compare the relative security of cryptoassets is through a calculation of the equipment securing the network. Using a dollar value is helpful because it gives us an idea of how much a bad actor would have to spend to re-create the network,
Using $660 million for Bitcoin and $294 million for Ethereum, while the network values for the two cryptocurrencies are respectively US$17.1 billion and $4.7 billion, we get a range of 3.9 cents to 6.3 cents of capital expenditure per dollar secured by the network.
For example, Bitcoin is mined with ASICs, which yield the greatest hash rate per dollar spent, while Ethereum is mined mostly with GPUs.
