• The Grayscale Bitcoin Trust is often discarded as a potential investment because it carries a premium over its bitcoin holdings. However, I don’t think this should discourage investors.
• Ultimately, any investment in GBTC or Bitcoin will depend on whether or not it’s trading below its intrinsic value.
• Modeling the value of Bitcoin is challenging. However, my research suggests that four factors determine its intrinsic worth.
• In my view, all of these four factors point towards a much higher price for Bitcoin (and GBTC by extension).
• I believe that for these reasons, investors should consider adding Bitcoin (either directly or through GBTC) to their portfolios.
The Grayscale Bitcoin Trust (OTC: OTCQX:GBTC) is a trust that only holds Bitcoin (BTC-USD), and is probably the fastest way stock investors can use to gain exposure to this cryptocurrency. This is because regulators still haven’t approved an official Bitcoin ETF. As a result, GBTC is the best alternative we have for Bitcoin as stock market investors. In this article, I’ll make a case for GBTC (and by extension Bitcoin) as a potential investment.
GBTC is mostly correlated 1 to 1 with the price of Bitcoin. It’s worth noting that there are some minor differences here and there due to a fluctuating premium (and 2% management fees). Nevertheless, it’s evident that over the long term, GBTC and the price of Bitcoin correlate almost perfectly. One could argue that GBTC is a leveraged play on Bitcoin. This is because when Bitcoin starts rallying, investors bid up GBTC’s premium, which helps the shares increase even more than Bitcoin itself. Conversely, GBTC’s Bitcoin holdings haven’t traded at a discount.
Historically speaking, GBTC’s premium fluctuates from 20% to 40%. However, when Bitcoin peaked in December 2017, investors were willing to accept a 100% premium. So ideally, as long as you get into GBTC when its premium is at roughly 30% or less, you should be fine. Moreover, if GBTC ever trades at an outrageous premium like it did at its last all-time high, then you should probably consider taking some profits and merely transferring them to an actual Bitcoin wallet (it’d be mostly an arbitrage of sorts).
When thinking about investing in GBTC we must first answer the question about whether or not Bitcoin itself can be a viable investment. For this, I think we have to remember that all intelligent investing is at its heart value investing. In other words, sound investing occurs when we pay a price that’s below the assets’ intrinsic value. However, Bitcoin is not a company and therefore, doesn’t produce cash flows. Thus, we can’t run a DCF model on Bitcoin or any other traditional valuation model. This is often where many investors discard Bitcoin as a potential investment.
However, I’ll ask the reader whether or not buying $1.00 at $0.50 would be a good investment? If you only look at the USD’s cash flows, you’d have to discard this obvious investment as well. After all, for you to profit from this, you would have to find a “greater fool” to buy it from you at its fair value. In fact, we could point out that the dollar doesn’t have any intrinsic value (i.e., not backed by anything else other than the government’s word).
Still, I think anyone reading this would happily pounce on the opportunity of buying the hypothetical dollar at $0.50. Obviously, this is an extreme example. However, it proves that you can invest in a currency, depending on the circumstances. Thus, under what conditions could Bitcoin potentially become a good investment?
How to think of Bitcoin’s “intrinsic value”
There have been many attempts at modeling Bitcoin’s fair value. However, this is not an easy task. After all, it’s a unique asset. Still, from what I’ve researched so far, most analyses converge on the following points:
• The extent to which Bitcoin fulfills the classic traits of money
• The number of people holding Bitcoin in one way or another.
• The amount of value being transacted on Bitcoin.
• Bitcoin’s scarcity.
Bitcoin’s money traits
The first item is the easiest to prove. After all, Bitcoin exhibits many of the critical traits (if not all) of sound money.
As you can see, we could argue that Bitcoin is superior to “traditional” money. Bitcoin even scores higher than gold itself on key traits like portability, divisibility, security, and scarcity (more on this later). Additionally, Bitcoin happens to be the first type of asset that no government or entity can control. In my view, this last trait is what makes it truly unique, because no government in the world can shut down, confiscate, track, or otherwise exert any tangible control over the Bitcoin protocol. Even if governments were to declare Bitcoin illegal, the reality is that there are no concrete ways of enforcing such a ban (see Morocco for example).
Estimating Bitcoin’s user base
It’s straightforward to have a rough estimate of the number of people using Bitcoin. For this, we can use the number of addresses in the network. As of Jun 2019, there are roughly 40 million Bitcoin wallets.
As you can see, the number of wallets is consistently trending higher. However, the average user has more than one Bitcoin wallet. Therefore, the number of people holding Bitcoin is probably less than what the graphic above would imply. Thus, here’s where we have to make an educated guess. In my view, it’s reasonable to say that there are roughly 13 million to 20 million people who own Bitcoin. This is assuming the average user owns 2 to 3 addresses. Since this estimate coincides with other assessments, I’m comfortable with this range.
Moreover, there is a strong correlation between the number of wallets and the price of Bitcoin. However, it’s worth noting that even though these two factors correlate with each other, the resulting model isn’t handy for predicting Bitcoin’s price with precision. The only conclusion that we can draw from this particular analysis is that as Bitcoin’s price and the number of wallets in the network tend to rise in tandem.
Still, it’s unclear whether the number of wallets follows the price of Bitcoin or vice versa. After all, when Bitcoin rallies, the number of people interested in the cryptocurrency increases as well. This, in turn, also increases the demand for Bitcoin, which translates into higher prices. So even though these two factors correlate with each other, it could be that the number of wallets is a lagging indicator rather than a predictive variable.
Nevertheless, I think it’s fair to say that if the number of wallets keeps growing, then it’s likely that Bitcoin’s price will also increase overall. Intuitively speaking, this makes sense because more people using Bitcoin should translate into higher demand and higher prices.
The value being transacted on Bitcoin
As I previously mentioned, the average value being transacted on Bitcoin is another key metric that we should keep in mind. Naturally, for practical purposes, this figure will be measured in USD. The basic idea here is that, in theory, a higher transaction value likely implies that Bitcoin is more useful as a store of value. This, in turn, should indicate a higher price for Bitcoin.
Bitcoin’s average transaction value has increased from roughly $20 in 2011 to almost $60K as of recently. Therefore, the average Bitcoin transaction value has grown at 140% CAGR. This is another excellent indicator of the Bitcoin’s tremendous growth. However, most importantly, it’s trending even higher. As a result, this should also imply higher prices for Bitcoin. Still, it’s important to mention that this indicator in particular probably follows the price of Bitcoin itself.
Another factor to consider is that a high average transaction value indicates that Bitcoin isn’t being used for small daily transactions (like cups of coffee, for example). This is because if bitcoins were being used for small daily transactions, then the average transaction value would be much lower. Instead, it seems like it is being used as a store of value. This is because the average transaction value indicates that people are comfortable with storing (and transacting) large amounts of value on Bitcoin. This is why Bitcoin is often referred to as digital gold. So again, the average transaction value is probably is more of a lagging indicator, rather than a predictive variable. Nevertheless, it’s worth keeping an eye on it. After all, it’s self-evident that higher transaction values are preferable for a currency that’s primarily used as a store of value.
However, this would also imply that eventually, we’ll need a cryptocurrency designed for smaller daily transactions. This is a topic for another article, but it’s vital to realize that people are still working on ways of making Bitcoin more convenient. For example, developments like the lightning network (which allows a higher number of transactions per block) and atomic swaps (this facilitates a seamless transition between cryptocurrencies). Once these two technologies are fully implemented on various platforms, then I think that Bitcoin will be ready for day-to-day use. Another way of thinking about Bitcoin is like the internet in its early days. In this example, Bitcoin still is in the dial-up stage. However, Bitcoin over time will probably become much more convenient, which in turn will facilitate widespread adoption. In my view, this should translate into higher Bitcoin prices as well.
Bitcoin is an extremely scarce asset
In my view, this is the most critical factor that makes Bitcoin valuable. You see, what ultimately gives any currency/commodity a higher value is its scarcity. After all, if gold were as common as water, then its practical applications alone wouldn’t make it as valuable as it is today. After all, what can be more useful than water? Thus, scarcity is clearly a determining factor for any currency’s intrinsic value.
Another great way of measuring Bitcoin’s scarcity is with the stock/flow ratio. This ratio can be applied to any commodity out there and also correlates with its price in the market. According to the Bitcoin protocol, its flow will half roughly every four years, and thus its SF ratio doubles each time this happens.
As you can see, there are fundamental factors that suggest a much higher price for Bitcoin. None of these are based on wild speculation or the “greater fool theory.” The reality is that Bitcoin is a unique asset that has the potential of changing the way we transact value as a society, and we’re still in the very early stages of such transition. In my view, as long as these four factors keep trending higher, then Bitcoin’s price should also continue rising as well. Moreover, this price appreciation potential is due to 1) Bitcoin having all the necessary traits of sound money, 2) its value (or usefulness) to society growing as more people adopt it, 3) more value being transacted on it, and 4) becoming scarcer over time.
As a result of all this, I can envision Bitcoin going much higher than its current price today. As crazy as this might sound, I honestly think that a $100K to $1M Bitcoin is entirely possible eventually (assuming these trends continue). Furthermore, I believe that we can make a reasonably good case for Bitcoin being below its fair value simply by using its SF ratio (not to mention the other factors). Thus, I think that investors should consider adding Bitcoin (in this case, GBTC) to their portfolios. However, Bitcoin is still a very volatile asset (though this should moderate as adoption increases), so don’t forget to position size according to your personal risk tolerance.