A new asset class might be growing up right before your eyes
A controversial pregnancy.
bitcoin’s genesis block by all accounts entered the world in January 2009, less than 12 years ago.
No one has yet admitted to being its parent (or parents) and I guess that adds to the intrigue of who or what Satoshi Nakamoto is or might have been, and the speculating surrounding who or what might be holding a mother lode of coins.
It makes for a great story.
After its difficult pregnancy with hacks, rampant speculation, ‘bitcoin Jesus’ and claims that bitcoin was being used to finance body parts on the dark web (yup), 2017 turned out to be a massive year for bitcoin and other crypto assets.
And, following a massive four month run between September 16, 2017 and December 17, 2017, bitcoin peaked at around US$19,600 per bitcoin. But almost precisely a year later it bottomed out at around US$3,300. ouch.
Most of us missed out and were happy to do so because before a breakthrough store of value can become a fully-fledged asset class (if it ever does) it typically experiences some major highs and gut wrenching lows - or it just disappears.
But having recovered from those lows, bitcoin in particular has been well supported within a range of US$7,000 to US$9,300 of late, and over the past two weeks it has started to break out to the upside, hitting US$12,315 as I write.
Is this simply a risk-on move because equities and gold are too expensive, and bond yields are really low?
Does its finite supply (assuming the majority does not decide to change that) mean it can become a real store of value if enough people believe in it, even though it is a virtual asset?
Is it that different to fiat? It too is accepted within its own ecosystem purely ‘by edict’.
Are we seeing that troublesome baby grow into a promising child? Maybe. I think so.
Growing up can be messy.
It’s fair to say that there have been lots of problems with bitcoin.
I’ve found that it’s really clunky to buy, it’s difficult to store offline and re-inject if you want to swap or trade it, and the spreads can be massive. It’s a shallow market compared to traditional asset classes and there are ongoing exchange hacks and shenanigans playing out, plus there are still problems with the theory that it cannot be corrupted - 50% of the hashing power can change the rules, but the reason they don’t is rooted in self-interest, and trust.
Wait. Trust? Isn’t the blockchain meant to be trustless? Well, yes, as long as it’s de-centralised gatekeepers say so. Same with Ripple - validators run the code and the network, and may be able to collude, plus it’s a centralised system. Getting rid of the actor in the middle hasn’t been entirely possible.
The reality is that there is still a lot of trust required to believe in the integrity of these systems, and no two blockchains and supporting ecosystems are the same.
There is also the question as to whether a fork (or the birthing of a new blockchain from an existing blockchain usually due to a philosophical difference in manifesto) is actually like printing money. Sure, call it something else, like bitcoin cash, but isn’t that really a form of dilution to the existing chain?
Then there are the continual arguments over what is ‘consensus’ and what sort of consensus model should be used, and how much energy it will take to generate said consensus. Does it really have a good ES&G scorecard?
Power hungry, addictive with potential for social disruption, and no standard governance? If it was a company or a stock it could be thought about like big tobacco was.
Name risk? Not so great, and in many cases this is a result of get rich quick bandits and digital boiler rooms promoting dodgy ideas through a procession of initial coin offerings, token generating events and inspiring, yet unproven ideas.
Then there are the crypto money shops and self-professed experts, who offer a service that no one really understands in an asset class that can’t be tracked, valued or forecast. Great job guys, you’ve got the world totally confused.
If you don’t believe me - go ask one of them how bitcoin actually works - let alone some of the other assets.
Oh, and before I forget, shutting down your crypto shop front and sending a ‘good bye, so long, farewell and thanks for the shekels’ photo of yourself with an exotic panorama in the background is NOT how you go about starting a serious asset class.
But as an investor that’s happy to take a few arrows, if you can make it through to the other side, it can be incredibly satisfying. And, think of all the theater you get to enjoy on the way.
An adolescent, looking for acceptance.
So yes, there are still issues. But there are always problems with nascent technologies. But platforms evolve and either get sufficient traction or they wither.
Remember the internet navigator called Netscape (kind of sort of morphed into Mozilla)? Remember old amazon? It invented the cloud and now it’s new amazon.
Early problems, but almost always solutions once you give it some time.
In the meantime, you get what is known as ‘information discount’.
It’s a discount for imperfect information. A lower price, if you will, because there is no uniform way of doing anything, i.e., no standards, no commonality between hundreds of alternative coins/tokens/assets, and certainly no way to factor in accurate future growth metrics. In most crypto cases there are no underlying stores of value or earnings, making it foreign to many of those used to investing in stocks and bonds.
Plus you can’t see or touch it and you never get it, just a key to an address.
The price we are currently paying for bitcoin might seem expensive, but if it is an information discount because of a lack of purpose, large bid-ask spreads, limited ways to trade it, security issues and other items already discussed, maybe it’s really cheap.
Buy you can’t really value it. Fixing supply and tracking demand measures traction and uptake but does not explain why that demand is there in the first place, and as a result is not a way to value it in my opinion. Next, how do you explain a shrinking chain like Ripple, where tokens can be destroyed after a transaction. Honey, I shrunk the xrp? Again, temptation to say the supply is not only fixed, but it’s shrinking - but wouldn’t you rather have an estimate of the earnings being derived from the actual use cases that it powers?
It’s intriguing because it’s part philosophy, part politics, part math and part psychology and extremely difficult to explain.
In equities, a share is a share with few variants (ordinary and preference, voting and non-voting) and an ETF is an ETF. Bid-ask spreads are small as markets are deep and volume is abundant and valuation’s are pretty straightforward because earnings and multiples can be observed and directly stapled to a particular stock or bond.
While bitcoin does look like it has all of the hallmarks to be a digital reserve currency (with its 60% market share of crypto capitalisation) it’s not, and it doesn’t have a real world use case as yet.
Could it become the digital reserve currency?
Maybe. Or, in the very least, you’d have to think that digital currencies soon to be announced by various governments will be able to convert in and out of crypto – and if so, bitcoin is an obvious gateway.
The next largest asset is Ethereum and while it has a token called Ether, it sits in the application layer and offers smart contracts to instantaneously track and/or automate contracts - that is, it’s not like bitcoin. It’s effectively a decentralised platform upon which smart contracts across multiple use cases can be digitised, provenanced and automated. It’s really interesting and its currently powering a lot of the distributed, or peer to peer finance platforms that we are seeing.
Ripple moves value around the world to allow $ to move as quick as data, through its xrp crypto and application layer run by Ripple Labs. It’s a lot smaller and more volatile than bitcoin, plus it’s centralised. But, it’s way faster - 4 seconds versus up to 10 minutes for bitcoin. But it’s not really a currency, it’s an enabler.
But perhaps the renewed interest in crypto is all about finding assets that are not correlated to shares, bonds and other traditional assets? That is, something to provide a hedge against QE Infinity’s debasing of fiat money and also an asset which can prosper during deflation, reflation or inflation.
As the largest (and first) player, bitcoin has been benefiting. It’s like the amazon of crypto.
Regardless, it has been breaking out of late and if it’s not just going up with everything else, perhaps it’s a sign that we are in the early days of asset class creation.
And if that is correct, maybe it is as undervalued as amazon was for all of those years. In other words, cheap, and impacted by multiple information discounts.
So, how early might we be?
Many orders of magnitude needed before it’s all growed up.
Asset classes are big things, by value. They include shares, bonds, cash, real estate, precious metals, derivatives and other big gorillas. These are key categories you generally get to allocate, or have allocated for you, when dealing with your investment portfolio and/or superannuation.
How big are the popular asset classes?
It depends, but here are two popular ones.
Global shares are currently worth ~US$95 trillion as an asset class. You can get further detail from the World Federation of Exchanges.
Global bonds, or let’s say debt securities, are worth ~US$120 trillion and you can get some interesting splits by reading the Bank of International Settlements’ Quarterly Review, June 2020.
What about crypto? The total asset class has a capitalisation of US$368 billion, of which bitcoin accounts for $218 billion, or 60% of class. Tiny!
Ethereum and Ripple make up a further 15% of the space, and all three account for 75% of the total space.
OK, let’s do the math - $100 trillion divided by $368 billion = 271 times.
But let’s look at bitcoin alone. bitcoin would have to increase by 458 times to hit the $100 trillion mark.
That’s a serious amount of potential headroom.
But before it gets there, it would first need to pass US$1 trillion – and if it does, that’s already 4.5x.
Then, onto US$10 trillion, which would mean 45x from today and I think at that point it looks and feels like a real asset class, i.e., around 15% of 'GDP, albeit still in its teenage years.
From there it can grow. But by that stage it is likely that a lot of the information discount would have been wiped off and various standards would be in place - no longer frontier stuff, so the discount disappears and the exponential value growth slows.
I am intrigued to see whether it can find a purpose and tear into adulthood.
So, before discounting bitcoin and crypto because it sounds too hard (or dodgy) perhaps consider whether you think it could develop into a fully-fledged asset class, given a little more time and help from key central banks, major global corporations and a lot of pretty smart people looking for a solution to 75 years of fiat.
Best wishes,
Mike.
NextLevelCorporate is a leading independent corporate advisory firm with a multi-decade track record in designing, originating and completing transformative M&A, IPO, growth capital and strategic corporate advisory solutions, in and out of Australia.
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Image attributions: Nickelodeon.