Debunking Bitcoin’s Remittance Valuation. Featuring a Lead Pipe
Author: Anshuman Mehta is a General Partner at Austere Capital, a fundamentals-based hedge fund and venture capital firm.
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Introduction
At its peak, Bitcoin has traded at a price of nearly $20k and a ‘market capitalization’ of over $300bn. If it were its own country, Bitcoin would rank 40th in the world, amongst such heavyweights as Singapore and Ireland.
That’s one mighty chilli crab and Guinness combo we’re talking.
Several thought pieces have sought to justify this price, and indeed place a higher price target, on the basis of a killer use case — the global money remittance business.
Proponents claim BTC will inexorable transform from medium of exchange to store of value, and forecast BTC price will continue to rise, or “go to the moon” as the ‘market cap’ becomes equal to the global remittance volume.
Enthusiasts of other transmission protocols, whether XRP, XLM or any other, use similar analysis to justify their own price targets.
We believe that this analysis, whether applied to BTC or any other, is fundamentally unsound. It conflates agency with ownership, and misunderstands the basics of the global remittance value chain.
Let’s take a closer look.
Medium of Exchange Becomes Store of Value
First, we must go back to a hypothesis first circulated in 2015, and subsequently repeated over and over again.
The proponents assume that Bitcoin network would capture market share in the global money remittance business. 10%, 20% or even, why not, 100% depending on the bullishness of the author.
At the conservative end, with a 10% market share of global remittance volume ($450B in 2014, projected to grow to ~$550B today), the Bitcoin blockchain would handle a remittance volume of c. $55B.
The author(s) then surmise that in order to transmit $55B, one would need to purchase $55B of Bitcoins.
Next came the critical assumption — the price of each Bitcoin would rise till the ‘market cap’ of 16M Bitcoins outstanding became equal to $55B.
Divide one number by other and you get a number.
In this case, the authors derived a ‘price target’ of ($55B / 16M) = $4K per BTC.
BTC trading under $4K would mean it was undervalued with room to grow.
Which worked great because the price at the end of 2015 was ~$430.
Of course, this was in 2015. Since then, market-share bullishness has vastly increased. The authors can extrapolate freely such that at the current annual remittance market of almost $600B+ and 16M BTC minted, BTC’s price should “to the moon”.
There’s only one problem with this analysis — it’s deeply flawed.
To understand why, let’s look at how the remittance business really works.
Alice, Bob and a Lead Pipe
Meet our friends Alice and Bob.
Alice has a gold nugget that she needs to send to Bob.
Alice can wrap the nugget in wrapping paper and hand it directly to Bob. Bob unwraps the paper and discards it.
In this scenario, the gold nugget is still worth $1 Billion. The transmission mechanism i.e. the wrapping paper is worthless.
Or Alice can also use another transmission mechanism — say a lead pipe — to keep the gold away from prying eyes. She inserts the gold into the pipe and slides it across to Bob.
For a few seconds, as the gold travels through the pipe, the pipe is worth a billion dollars. Once the gold reaches the other end, and Bob removes safely removes it and the pipe reverts to being just that — an empty lead pipe.
The lead pipe merely serves merely as the conduit. The gold nugget does not belong inside the lead pipe, nor does it belong to the owners of the pipe. (Unless, of course, the pipe owner blocks one end of the pipe and makes off with the pipe-gold combo. That’s just plain illegal.)
Not so in the aforementioned Bitcoin analysis.
The analysis assumed that because the Bitcoin blockchain would carry $55B of remittances per year, the value of the Bitcoin network (# of tokens * token price, also known as ‘market cap’) would equal $55B.
Even before we point out that the remittance volume is an annualized figure and token prices are measured at a particular point in time, or that this analysis ignores token velocity, this logic is plain wrong.
The authors confused the “medium” for the “message”, the agents for the principals.
Transmitting $55bn doesn’t make the transmission mechanism worth $55bn, no more than sliding a gold nugget through a lead pipe make the lead pipe worth the price of gold.
The remittances channeling through a protocol belong to the remitters and the receivers, not to the protocol or the token holders.
To the latter belongs only the remittance fee — the price Alice is willing to pay for the safe transmission of the gold.
And this is a small fraction of the cost of the gold nugget.
A Constant Flow of Gold Nuggets
Ah, you say, but no transmission mechanism conducts only one transaction at a time. Surely, a network that transmits $45B of remittances per year has $45B of value locked in?
To examine this point, let’s extend our Lead Pipe analogy a bit further.
Let’s assume that Alice sends 31.5M nuggets per year — quite an impressive volume.
Is the lead pipe now worth the total volume of nuggets (31.5M) it transmits?
Not quite.
31.5M nuggets a year still only equates to one gold nugget per second. Assuming our lead pipe is as efficient as the Bitcoin network, therefore each nugget only takes c. 10 minutes on average to ‘settle’ i.e. reach Bob.
And Bob promptly removes the nugget from the pipe upon receipt.
This means even with a high annual volume (31.5M nuggets), the lead pipe only has 10 minutes worth or 600 gold nuggets travelling through it at any given time.
This is an important conclusion.
By this measure, even if the entire global remittance business of $550B moved to Bitcoin network, this would only correspond to a run rate of $17.5K/sec, assuming a steady 24x7 flow of remittances.
A 10-minute transaction settlement period means the network will only ‘contain’ 10 minutes worth of value at any time. The math is simple:
$17k/sec * 60sec/min * 10min = $10.5M
This is great for the network but lousy for the BTC price.
Why? Remember, almost 16M BTCs have been minted. All those free-float BTCs fighting to carry only $8.5M of value every 10 minutes — that can’t be good.
The LeadCoins Obfuscation
Our analogy is great for understanding the divide between the Principal (or the owners of the remittance i.e. Alice and Bob) and the Agent (or the transmitter of value i.e. the lead pipe).
Remittances (gold nuggets) are not the channel (lead pipe). Remittance beneficiaries (Alice and Bob) are not transmitters (the owners of the lead).
This analogy is also imperfect.
In crypto-currency implementations, distinctions can become blurred. In order to remit money through the Bitcoin network, one must purchase Bitcoins.
A closer approximation then is if Alice needs to convert her gold nuggets to a crypto-currency, let’s call it LeadCoins, minted and controlled by Charlie who owns the lead pipe.
So how does our analysis evolve? We call it The LeadCoin Obfuscation.
In this scenario, Alice trades her gold nuggets for LeadCoins and transmits them to Bob. She willingly pays a small fee for the transmission of gold.
At the other end, Bob receives LeadCoins and exchanges them for gold nuggets.
As before, neither Alice nor Bob have any off-pipe use for LeadCoin. We also assume that Bob exchanges all LeadCoins for gold nuggets. To the extent Bob leaves LeadCoins in the pipe, whether for speculation or future use, the value of the pipe may rise by the equivalent of gold nuggets not redeemed.
One could argue that the act of buying a gold nugget ‘worth’ of LeadCoins would cause one LeadCoin to rise in value. And in the short term, this relationship probably holds.
But the underlying economics are unmistakable. Alice and Bob are in the gold business, not the LeadCoin business. So long as they are able to purchase and sell LeadCoins for the purpose of transferring their gold, at predictable prices and in the right amount, the LeadCoins may as well not exist for them.
Similarly, the global remittance business accomplishes a transfer of fiat money for end-user requirements, not to build crypto-currency positions or inflate token prices.
When evaluating the intrinsic value of a payment network token, what matters is how much revenue Charlie is able to collect from Alice for the use of his LeadCoins. Printing 1B, 10B or 100B LeadCoins only serves to dilute the per-coin ‘share’ of revenues that is attributable to each token.
An increase in network value caused by high token issuance volume is short-lived and unsustainable.
As someone once said, mo’ tokens, mo’ problems.
But Wait, There’s More
Our analysis above makes clear that a very large headline number ($550B remittance volume) breaks down into a fairly manageable constant volume ($17K/sec or $10.5M per settlement cycle).
We also make clear the difference between principals and agents.
So, what do the agents earn? If the entire global remittance volume were transmitted on the Bitcoin blockchain, what would that mean for BTC holders in terms of fees and revenues?
For that, let’s go back to the real world for a moment.
The World Bank estimates that c. 10% of global remittance is eaten up in fees. That’s a scandalously high figure and must be reduced. We sincerely hope that distributed ledger technologies will move us towards a seamless, legal and inexpensive way to transmit this value.
But for now, we need to work with this constraint — any disruption to the status quo only makes sense if it delivers a fee load lower than 10% of value transmitted.
Bear in mind that for the pure messaging piece, the value is much lower. For instance, in 2016, the inter-bank SWIFT network transmitted nearly 6.5B messages annually in 2016, handling information related to the direct transfer of nearly $5T per day (!) and earning c. $900m in revenues with operating profits of c. $50m.
The rest of the value chain involves building a to-consumer solution, finding and onboarding end-users and institutions, fulfilling know-your-customer requirements, complying with anti-money-regulations etc.
Again, we are not speculating on whether these activities can or cannot be disrupted (read: delivered cheaper) by deploying distributed tech. We are merely clarifying that the transmission aspects of remittances are but a fraction of the bigger equation.
So even assuming the Bitcoin manages to capture $55B of global remittances and the revenues of the entire value chain magically “moves to the blockchain”, and this move delivers no incremental efficiency over current infrastructure, only 10% or $55B is captured as revenue.
That’s $5.5B. Not $55B. The remittance fee, not the remitted value. The price for using LeadCoins, not the gold.
But at least we have a revenue figure. We just need to plug in the number of tokens around and hey presto! We Have A Price Target. Right? Not quite.
Circularity Circularity
Determining a price target is a more complicated analysis, convoluted by the fact that BTC has a traded price determined by the open market.
For BTC, as with any other such transmission mechanism with a token trading price, circularity ensues as both the independently set trading price and remittance-revenue based ‘fair value’ jostle for supremacy.
How? Brace yourself.
BTC’s trading price determines how many tokens are required to transmit $55B of remittances. The market share in turn determines revenues earned by the network as a whole, and using the number of tokens calculated above, the per-token revenue. The per-token revenue is in turn used to calculate the token target price given an investor’s return requirements. This token-price would re-set the number of tokens we’d need to remit the $55B of market share captured, altering the revenue per token. And on and on.
We delve into this circularity at the heart of crypto-valuation in a future piece.
Conclusion
The Lead Pipe analogy is a powerful tool for analysing any transmission protocol. The difference between principals and agents must be recognized, and therefore returns priced accordingly.
This framework is first in a series of pieces that we will publish in the coming weeks. Our mission is to foster the creation of token design best practices and the issuance of high-benchmark tokens in any distributed context.
We believe this work is imperative if the distributed ledger ecosystem is to thrive.
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