What a year – a global pandemic, a wavering stock market, rising numbers of unemployed people and continued uncertainty in global markets. Yet, we saw the bitcoin price recover from $5,300 in March to almost $18,000 at time of writing. That’s almost a 240% return within nine months.
For regular investors, the burning question is whether bitcoin is becoming overpriced. Is it too late to buy bitcoin?
Hong Fang is the CEO at OKCoin, a U.S. licensed, fiat-focused cryptocurrency exchange headquartered in San Francisco. Hong spent eight years at Goldman Sachs, leaving as VP of Investment Banking. She is a graduate of Peking University in Beijing, China, and has an MBA from the University of Chicago’s Booth School of Business.
If we put aside short-term volatility and take a long-term perspective, there is a reasonable path for the price of bitcoin to reach over $500,000 in the next decade. To go even further, I think BTC is likely to hit $100,000 in the next 12 months. Significant upside has yet to play out for bitcoin.
Bitcoin is a 'store of value'
When we talk about the valuation of an asset, the first step is to understand the fundamental economics. Equities, bonds and real estate, for example, often derive their value from generating cash flows; therefore, valuation of these assets involves projecting future cash flows. Commodities, on the other hand, are more utility based and therefore their prices are anchored by industrial supply and demand. Before taking any action on bitcoin, I suggest asking yourself, “What is bitcoin for?” Use this as a baseline to form your own view of the value of bitcoin and its fair price range in a given time horizon.
Here’s my take as a HODLer:
- Bitcoin is sound money and the first native internet money in human society.
- It is scarce (21 million fixed supply), durable (digital), accessible (blockchain is 24/7), divisible (1 bitcoin = 100 million satoshis), verifiable (open-source Bitcoin Core) and most importantly, censorship resistant (encrypted). With these superior monetary qualities in one asset, bitcoin is a great store of value. Once it reaches a critical mass of adoption as a store of value, bitcoin has huge potential to grow into a global reserve currency (and universal unit of account, too) over time.
- The history of money shows us that natural forms of money generally go through three phases of evolution: first as collectible (speculation on scarcity), second as investment (store of value), third as money (unit of account) and payment (medium of exchange). As bitcoin goes through different phases, its valuation scheme varies, too. In my view, bitcoin is currently in the early stage of phase II. Below is a short summary of the two phases bitcoin has been through and respective value implications.
Bitcoin as collectible
Between its inception in 2009 and 2018, bitcoin was in its “collectible” phase. Only a small cluster of cypherpunks believed in bitcoin as “future sound money.” It was hard to come up with a valuation scheme for bitcoin that matched its fundamentals. It was also too early to tell whether bitcoin could succeed in building consensus around its “store of value” superiority.
Bitcoin is built as a basic utility and doesn’t generate cash flow, so there is no way to forecast its price based on cash flows. Its circulating supply was easy to calculate, but it was really hard to estimate demand given the fickle nature of speculative trading. When speculative demand surged and drained out of the system, particularly around the initial coin offering (ICO) boom in 2017, we saw bitcoin’s price explode from $900 in early 2017 to $19,000 by the end of 2017, and then down to $3,700 by the end of 2018.
Bitcoin’s opponents usually attack bitcoin’s price volatility as a bug, but I believe that bitcoin’s price volatility is a unique and smart self-marketing feature. It was key to its survival in the early days. Bitcoin operates as a decentralized global network. There is no coordinated marketing team out there promoting bitcoin’s utility to the world. It is the dramatic price volatility that has continued to attract attention from non-followers, some of whom were later converted into believers, thus driving the continued momentum of bitcoin adoption.
Bitcoin as investment
Bitcoin went through an identity crisis as “sound money” before it graduated into the second stage as an investment vehicle. Starting with the scalability debate in 2017, when the network became congested with historical high volume and transaction costs surged, its community had serious controversies (some called it “civil war”) involving the future path of bitcoin.
See also: Bitcoin 101
As a result, on Aug. 1, 2017, the bitcoin blockchain was hard forked to create the Bitcoin Cash (BCH) chain to allow larger blocks as BTC stuck to a block size limit with SegWit adoption to enable a second-layer solution. On November 15, 2018, the BCH network forked again into Bitcoin Cash and Bitcoin Satoshi’s Vision (BSV).
Fortunately, bitcoin (BTC in this case) survived its growing pains (and the industry-wide bear market) and thrived thereafter. It is also through such public disputes (and price performance after hard forks) that BTC support and dominance has been further solidified, with an increasing number of addresses holding BTC and decreasing volatility.
Then came 2020.
This year has been an extraordinary year in many aspects, but it is truly a milestone year for bitcoin. The coronavirus pandemic has brought emotional and economic stress to many people on a global basis. On top of that, 12 years after the 2008 financial crisis and the publication of the Bitcoin white paper, we are reminded how easily our economy could be flooded with new money printed out of thin air; $3 trillion in new money was created in just three months in the United States, about 14% of U.S. GDP in 2019. The U.S. was not alone.
In 2020, it has been extremely hard for responsible savers to find reliable, real yields to preserve their hard-earned wealth. American middle-class families have had to either accept zero to negative interest rates at banks and debasement risk or bet in the all-time-high equity market when the real economy struggles, not knowing when the music will stop. In other countries, people must fight an uphill battle everyday to simply preserve the earning power of their salaries.
These macro themes are too strong for anyone to ignore. In contrast, the Bitcoin network had its successful third halving on May 11, 2020, highlighting the beauty of having monetary discipline pre-written into code and executed by the global network smoothly ever since. As a result, more investors in traditional finance (Wall Street institutions included) have started to realize that bitcoin has a unique hedging capability against long-term inflation risk, with a risk-reward profile better than its closest monetary cousin, gold.
Different from its 2017 ride, bitcoin’s current run-up is characterized by more vocal institutional endorsement: Square and MicroStrategy allocate treasury cash into bitcoin; the Office of the Comptroller of the Currency (OCC) allow U.S. banks to offer crypto asset custody; PayPal enabling crypto buying and selling; Fidelity making a case for 5% asset allocation and doubling down on crypto engineer recruiting; well-established traditional asset managers including Paul Tudor Jones and Stanley Druckenmilller announcing public support for bitcoin. The mainstream momentum is building up.
For the first time since its historic inception, bitcoin officially entered mainstream media as “digital gold,” a legit and credible (and liquid) alternative asset to consider for both individuals and institutions. The earlier comparison to “Dutch tulip mania” starts to fade. As more people educate themselves about what bitcoin is and start to embrace it not as a speculative trading asset but as a long-term asset allocation option, we can now look at its fundamentals and anchor price ranges with a simple supply-and-demand math.
Below are three scenarios used to triangulate bitcoin’s potential one-year trajectory.
Scenario 1: 1-2% US household wealth allocation?
- According to the Federal Reserve, U.S. household wealth reached $112 trillion by June 2020 (top 10% owns two-thirds of the wealth).
- 1%-2% of $112 trillion = $1.1 trillion to $2.2 trillion potential demand (Fidelity’s most recent report actually recommends 5% target allocation).
- Current total circulating BTC is about 18.5 million. To keep it simple, let’s assume 21 million max supply are all up for sale.
- Divide the potential demand by max supply, we get a price range of $56,000-$112,000. This scenario does not account for the rest of the world ($400 trillion global family wealth, according to Credit Suisse Wealth Report 2020). If we assume 1%-2% allocation of global family wealth, we will be looking at a $228,000-$456,000 price range. Would this happen in the next 12 months? Likely not. Can this happen within the next decade? I think that’s very possible.
Scenario 2: 2%-3% of global high-net-worth individual allocation?
- According to Capgemini World Wealth Report 2020, global HNWI wealth stood at $74 trillion by end of 2019 (~13% alternative, 14.6% real estate, 17% fixed income, 25% cash and cash equivalent, 30% equity).
- 2%-3% of $74 trillion = $1.48 trillion-$2.22 trillion potential demand.
- Divide the potential demand by max supply, we get a price range of $70,000-$105,000.
- This scenario does look at global data, but only accounts for high-net-worth individual (HNWI) allocation, assuming that this segment has more assets to invest and investment decisions are more driven by institutional asset managers and advisers. I am also assuming a higher range of allocation here because HNWI are generally better positioned to take on more risks in search of higher risk-adjusted return.
Scenario 3: Catching up with gold?
- There has been a long-standing argument that bitcoin would catch up to gold in market cap once it is widely accepted as a “digital and superior version of gold.”
- Current gold market cap is $9 trillion. This is about 2% of total global wealth and 12% of global HNWI wealth.
- 100% gold market cap means $428,000 price point for bitcoin. Can we get there in 12 months? Probably too aggressive an assumption. Can bitcoin rise to 20%-25% of gold in 12 months (aka 2.4%-3% global HNWI wealth allocation)? Possible. That would give us a price range of $80,000-$110,000.
There are additional factors that could add more upside to bitcoin. Given that we are still in the early stage of mainstream adoption, I don’t want to over-emphasize them, but I want to lay them out just to keep the perspective.
- Potential allocation from corporate treasury management. We are already seeing early signs of that with Square and MicroStrategy. Square recently allocated about 1.8% of its cash balance to buy $50 million in bitcoin. Sizing up corporate demand for bitcoin is tricky, though. Each company has its own cash flow and growth profile, which will affect its risk appetite in asset allocation.
- Potential allocation from foreign exchange reserves of all sovereign states. According to the International Monetary Fund, the global foreign exchange (forex) reserve was $12 trillion by June 2020, with the top three reserve currencies in U.S. dollars $7 trillion (58.3%), euros $2 trillion (16.7%), and yen $650 billion (5.4%). Is it possible to see sovereign countries allocate some of their forex reserves into bitcoin? I believe that trend will emerge over time when bitcoin’s superiority in “store of value” further plays out in the next five to 10 years. Assuming 25% allocation ($3 trillion, a little more than euro allocation), that is another $140,000 upside. Bitcoin catching up on the U.S. dollar as a dominant global currency reserve could take a long time to materialize, if at all but it is not impossible to see bitcoin among the top 3 list.
- Not 100% of bitcoin’s max supply would be available for trade. There is about 18.5 million in circulation. About 10% of that has been dormant for over 10 years. It’s tricky to estimate how much of the total bitcoin in circulation will actually be up for sale at different price points.
- None of the above account for the dollar's inflation rate in the years to come, which is about 2%-3% annually as a baseline. Neither do these scenarios account for the network effect of bitcoin, the possibility of bitcoin becoming more ubiquitous and reliable as a unit of account.
What could go wrong?
A one-sided investment case is never a good one. It is prudent to play devil’s advocate and assess downside risks. What are the major risks that may derail a bitcoin bull run?
The biggest risk always comes from inside. Bitcoin has inherent value only because it has the unique characteristics of “sound money” (scarce, durable, accessible, divisible, verifiable and censorship resistant). If any of those qualities are compromised, the foundation to its investment case will be eroded or gone.
Such protocol risks were high in its first few years, but after two major controversial hard forks and three successful halvings, it seems that protocol-level risks are somewhat contained. The Bitcoin ecosystem has been consistent in independent developer support. According to Electric Capital’s developer report, the Bitcoin developer ecosystem has maintained 100+ independent developers every month since 2014. Additionally, we’ve also seen an increase in commits to the Bitcoin Core codebase in 2020, reaching a peak in May (around the time when the third halving happened).
It’s also encouraging to see major development milestones emerging on the Bitcoin Core network, including the merge of Signet, Schnorr/Taproot and increased focus on fuzz testing, to name a few. These protocol-level developments continue to enhance the privacy and scalability of the network, boosting bitcoin’s technical stability as a currency.
To ensure a healthy and safe future for bitcoin, it is critical to ensure the Bitcoin Core developer community remains independent and decentralized and continues to make steady improvements in critical areas like security and privacy. This is also why we have been passionate about providing no-strings sponsorship to Bitcoin Core developers and projects at OKCoin. Investing in bitcoin development helps reduce the protocol risk.
This, to me, is the second0biggest risk to bitcoin. Bitcoin’s ethos is to empower individuals through decentralization, but the risk of concentration always exists.
Within the network, the risk lies in the concentration of mining power. It is not an industry secret that 65% of the world’s hash power is in China. If mining power is coalesced, a mining pool or group of miners can manipulate network transactions, creating fake coins through double-spending, in turn impacting the market price. However, there is also the argument that such concentration risk is inevitable but to some extent harmless, too, given how the network incentive has been designed for bitcoin. In other words, the incentives in the form of new bitcoins and transaction fees should work to keep the majority of the nodes honest because it is economically costly to cheat (not because it is hard or impossible to cheat). The assumption is that the mining participants are all rational and make economic decisions.
Externally, similar risk lies in ownership concentration. Investors, or “whales,” holding significant amounts of bitcoin can influence and even manipulate the market by triggering a change in price based on their buy/sell timing. Given that an individual (or an entity) can own more than one bitcoin address, it’s hard to paint an accurate picture of bitcoin ownership. So this risk does exist. This is also why I feel very passionate about promoting financial literacy and crypto knowledge. I believe that we can build a healthier and more sustainable future if more individuals come to understand what bitcoin is about and start to embrace it. The first institutional wave is exciting to see, but if bitcoin ownership tilts too much toward the institutional end, we would be defeated in our mission of building a more inclusive and individually empowering network.
Another major risk comes from sovereign governments. Given that bitcoin is positioned as future money, it is possible that sovereign governments ban it for fear of threatening fiat currencies. Again, such risks are highest in earlier years before bitcoin builds meaningful adoption momentum. Actually, such bans have already happened in several countries (India in 2018, for example, which was revoked in 2020). Central bank digital currency (CBDC) experiments around the world could also have an impact on how bitcoin’s future plays out.
This year has seen the first wave of institutional endorsement for bitcoin, and therefore 2020 will be recognized as a milestone year in alleviating this political risk. When publicly listed companies, asset managers and well-known individuals start to own bitcoin and speak in favor of bitcoin, such a ban is going to become very unpopular and hence harder to implement in countries where popular votes do matter. I hope the momentum will continue to build, making a risk of total bitcoin ban increasingly remote as time passes.
A successful and complete ban on bitcoin will also need to take coordinated efforts of all sovereign governments, which is very unlikely. As long as there are countries that let bitcoin legally flow, bitcoin will have a chance to win – a decentralized global network cannot be shut down by any single party.
That being said, bitcoin price volatility could be amplified from time to time by domestic and geopolitical changes. In my view, political risks remain the second-largest risk to bitcoin until it becomes too big to be tampered with. We are obviously far away from that point.
There can also be a wider payment ban on bitcoin while it is being recognized as legal financial assets. Such a risk is not totally out of the picture yet. The good thing is, we are not banking on bitcoin becoming the unit of account and medium of payment in our $100,000-$500,000 scenario. When bitcoin does progress to phase III, we will not be talking about bitcoin price anymore, but instead talk about everything else’s price in bitcoin.
This is a timing risk. It is quite possible that it may take much longer than expected for bitcoin to go mainstream.
The only way to manage this risk is to make sure your bitcoin portfolio is properly sized.
If you invest in bitcoin (or anything else) and worry about where its price would be in the next 12 months, your portfolio of bitcoin is probably too big for you. Size it based on your own risk tolerance and conviction level in bitcoin. Don’t do more than what you can afford (or believe in).
I also believe the unique quality of bitcoin will speak for itself over time. Bitcoin’s price chart between 2017 and 2018 very much looked like a bubble. However, if we look at bitcoin’s full trading history, there is a clear upward trend together with growing asset-holding addresses, growing active addresses and growing network computing power. The increasing mean hashrate of the Bitcoin network represents the security level that one would want to see in a network where people’s wealth is stored.
I may be on the bullish side for bitcoin’s 12-month price trajectory but I truly believe that with bitcoin, time will be our best friend.
Bitcoin is unlike any other asset we have encountered before. This is a truly sound and global wealth network that will continue to grow as the world recognizes the significance of its properties. To put things in perspective, here is a recent tweet from Michael Saylor, CEO of MicroStrategy, that summarizes the relevance of bitcoin as a utility and store of value.
In a world of uncertainty, bitcoin gives HODLers like me confidence. It has a huge network effect that can ultimately empower every individual who believes in it and uses it. I look forward to the continued evolution of the bitcoin ecosystem and feel excited about being part of it.