May 21, 2021
Bitcoin Price Predictions— Part Two
Driving Forces in the Bitcoin Universe: External Factors and Macro Environment
Article by Lesia M.
… Continued from ‘Driving Forces in the Bitcoin Universe: Internal Factors’
External Factors
1. Institutional Adoption
Bitcoin has 12 years of proven performance track record, reaching $1T in market capitalization over this period, beating the performance of such Tech giants as Google, Facebook, Amazon, Apple and other. The main difference between the current bull cycle and the one in 2017, is that nowadays we see much more global institutional investors entering the market. The surge in interest to crypto assets flags high probability of mainstream adoption in the foreseeable future. With increasing adoption across investors, corporates, financial institutions and governments, the probability of a global digital transformation towards cryptocurrencies grows higher.
Bloomberg Intelligence provides colour on acceptance of cryptocurrencies as a payment method: global crypto payments leaped towards $1.6B in Q1 2021, signifying a rapid adoption of crypto payments to merchants in everyday life. To minimize distortions from Covid-19 lockdowns that began about a year ago, Bloomberg Intelligence shows the four-quarter average increase about 60% to just over $1B from $640 million in Q1 2020. They believe crypto payments reflect a shift toward digitalization with the outbreak of the pandemic.
Below graph shows the total value of cryptocurrency payments to merchants in 2020 of around $3B, which is only around 0.40% of the global cards and payments market, and only 0.15% of the global payments revenues in 2020. Given the steep rise in crypto payments received by merchants in USD in Q1 2021, we see a growing opportunity for crypto payments in the years to follow.
Figure 1. Crypto payments received by merchants in USD
General view on the crypto market is that the rapid adoption of Bitcoin will continue in future, magnifying its acceptance as the global digital-reserve asset. Visa, Goldman Sachs, and Morgan Stanley have all taken noteworthy steps in acknowledging the digitalization of money.
In March, Visa Inc has come out with a statement that it will allow transactions in USDC. Many other big finance firms, such as BNY Mellon, BlackRock and Mastercard have taken steps for further adoption of cryptocurrencies as both payment methods and investments.
April 2021 seems to be the month when all U.S. mega-banks decided to make their entrance into the crypto market. Thus, Goldman Sachs is offering a wide range of bitcoin investments and other digital assets to its wealth management clients. Investment options will include physical bitcoin, derivatives and other traditional investment vehicles. Morgan Stanley is allowing qualified investors to access three of external crypto funds, two of which are run by Galaxy Digital and the third one by both IS Investments and NYDIG. Finally, on April 27th news came out that JP Morgan will allow its clients to invest in a bitcoin fund provided by NYDIG, being the latest U.S. mega-bank to change its position regarding crypto. According to sources, the fund is planned to kick off in summer. JP Morgan accepting bitcoin investments is a notable change in tone, as the CEO, Jamie Dimon, has been knows to heavily criticise bitcoin in the past.
Other than wide adoption by companies and financial institutions, BTC has a strong case to be accepted by general public through the possible launch of a U.S. Bitcoin ETF. Securities and Exchange Commission is currently reviewing applications for a Bitcoin ETF submitted by Galaxy Digital, NYDIG, Fidelity Investments, SkyBridge Capital, VanEck, WisdomTree and others.
Crypto and blockchain solutions trigger interests in the political arena as well. In particular, New York City comptroller candidate calls for more blockchain innovation in NYC. In the details of her plan, NY retirement systems will have up to 3% of their funds in crypto exposure, and the city itself would invest in blockchain to support start-ups in this field. Another candidate running for the Mayor of NYC joined the hype, claiming he would ‘invest in making the city a hub for BTC and other cryptocurrencies’.
Another exciting announcement came out on Apr 19th, when China’s central bank called crypto assets an “investment alternative”. This label signifies a softening stand on cryptocurrency trading in China, while stressing that cryptos do not compete with the country’s digital currency — digital yuan. Industry participants have taken this statement rather positively, hoping for progressive shift of cryptocurrency trading in China and watching out for potential regulatory changes. Discussing crypto and blockchain opportunities on the political arena is an important stepping point for the technology, as both public and politicians contemplate over potential future applications.
2. Network Effect
As you dive deeper into the subject of bitcoin valuation, you will most probably notice there are multiple studies that examine bitcoin in terms of its adoption, the so-called network effect. As explained earlier, bitcoin adoption seems to be growing every day. Comparing this growth to some of today’s Tech giants, it is obvious that at one point of time, Apple, Amazon and Google gained such an amount of users, that no other firm was able to replicate their success.
Network economics looks at adoption rates over a communication channel. One of the most successful network models used for valuations of FAANG technology-based entities, as well as the internet usage, is the Metcalfe’s Law. This model is based on the connectivity amongst users that can be described as n (n — 1)/2, where n is the number of users on the network. Simply speaking, in a network of 5 users, 10 different connections can be established; in a network of 12 users this number grows to 66. This model technically explains the business concept of the ‘network effect’.
This valuation can be applied to any firm which creates a network of users. Fax, Emails, and social networks all followed the same trend — if there hadn’t been a common agreement between users to switch to these communication channels, their value today would have been around zero.
In the following graph we see how the number of active bitcoin addresses and BTC price have been highly correlated in the last years. The current bull market has already exceeded the previous all-time high of active addresses in the end of 2017 — beginning of 2018.
Figure 2. Number of Active BTC Addresses vs BTC price
After the first halving event, BTC bull market reached its peak in the end of November 2013, exceeding $1K. At that time, markets had approximately 200K active bitcoin addresses. In the next epoch peak, mid-December 2017, BTC price got close to $20K, with around 1,000K active users. Between the two peaks, the number of active users went up 5x, while the impact on bitcoin price was 20x. It is bold to expect the number of active bitcoin users to go up to 5,000K in this halving epoch, bringing BTC price up to $400K. However, this would be the case if the relationship between the two previous events was linear.
Another interesting observation we can make is that up to a certain point in time, the price of bitcoin is not really correlated with the number of active users. In fact, between 2012 and 2018, the number of active accounts has a relatively stable growth trend of around 250% per year. Since the beginning of 2016, we see a growing correlation between the two indicators. This could signal that the BTC price will from now onwards fluctuate proportionally to the number of new subscribers.
In the end, bitcoin’s network effect continues to compound while its supply remains limited, creating a bullish case for the cryptocurrency’s price development.
3. Market’s Interest
Based on growing interest in cryptocurrencies trading and growing demand for more tools to manage bitcoin exposure, CME Group offered bitcoin futures on December 18, 2017, and then later added options on bitcoin futures on January 13, 2020. JKL Capital proprietary trading system uses futures to hedge against downside risks in the market. The most recent development is CME getting ready to launch micro bitcoin futures on May 3rd, 2021. These futures contracts are one-tenth of the size of one bitcoin. Their creation reflects both rising bitcoin price and growing demand from a broad range of market participants.
P. T. Jones compares the current bitcoin market to the gold market back in 1970. This is when gold was first productized as a futures instrument and entered a bull market to quadruple in price since. In the case of gold, it was a great buying point, and we are left to speculate whether bitcoin has the potential to replicate gold’s performance in the current market environment.
Macro Context
1. Inflation
A big reason of recent momentous interest in Bitcoin is, potentially, not as much the cryptocurrency itself, as the overall economic context. With governments printing money to support the post-Covid-19 economy, speculations about impending inflation crisis are spreading in the market. U.S. government alone printed $9T in 2020, which is 22% of all USD ever issued. Moreover, in August 2020 the U.S. Fed has announced that rather than shifting their policy instruments based on projected inflation, they would now change the policy only when the target level of inflation hits the trigger, thus letting the U.S. inflation run higher than the standard 2% goal. This policy change might cause serious inflation spikes, as it will take some time for the monetary policy actions to kick in after their implementation.
In addition to active money printing and a change in the Fed’s monetary policy, we also witness higher net income in the U.S. due to stimulus, combined with a pent-up demand following a long period of lockdowns and lower spending. Indeed, in the U.S. personal savings rate spiked up to 33% in 2020, compared to a historic average of around 10%. These factors strengthen the existing upward pressure on prices.
We can already see the early outcomes, with the US consumer price index up 2.6% since March 2020. At the same time, inflation-adjusted hourly earnings increased 1.5% in March from the year earlier, 1.1% less than the inflation rate. Meaning that those earners have less purchasing power.
Many economic analysts and investors believe this massive monetary expansion will cause inflation to rise over the next years to 5–10% annually, with some predicting up to 20% of annual inflation rate. In his paper “The Great Monetary Inflation”, Paul Tudor Jones describes the current state of affairs as ‘an unprecedent expansion of every form of money, unlike anything that developed world has ever seen’.
Even though we have recently witnessed some serious money printing in the U.S. and all over the world, inflationary policies are not new to this world. Almost every fiat currency backed by a central bank is designed to lose its value over time. Many bitcoin believers understand this and agitate that the recent raise in cryptocurrencies, though catalysed by the Covid-19 crisis, was not created solely by it. Even in a hypothetical Covid-free world, sooner or later, general public would understand that the current monetary systems are full of flaws. The creator of bitcoin himself was very sceptical about central banks printing money. In his white paper, Satoshi Nakamoto wrote: ‘the root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust.”
Michael Saylor, who’s company holds $4.38B worth of bitcoin, suggests viewing bitcoin as property in a quest to overcome inflation. If the fiat currency expands at 15% a year, not only does the dollar lose 15% of its value annually in purchasing power, but same awaits equities denominated in dollars. Thus, even a diversified portfolio with dollar denominated assets is likely to decrease. Saylor’s answer is to buy a property or an asset, which is not valued upon cash flows.
2. Zero Interest Rate
US Treasury yields have been progressively going down in the last 40 years. With historically low interest rate, there is a growing concern amongst investors that they are losing money in real terms when investing in bonds. Bloomberg went as far as to claim that the traditional 60/40 portfolio (60% equities / 40% fixed income) is no longer valid[1].
Conventional treasury strategies that rely upon short-term government bonds all have negative real yields. Thus, the dilemma lies between loosing capital in a negative risk-free rate or buying a relatively volatile asset with a tremendous return. Institutions that placed their bet on bitcoin see an arbitrage in the market, where one can borrow at nearly 0% interest rate and reinvest in an asset that has an average annualized rate of return of 230%.
3. Debt
Alongside the Great Monetary Inflation comes the worldwide growing credit. Indeed, earlier this year the US government debt hit 100% of the country’s GDP, world debt reached record high of $281T at the end of 2020, and the corporate debt continues to grow as businesses take up credit lines to fund cash shortfalls. Debt in the developing countries topped 250% of GDP amid growing pandemic stimulus.
With modern monetary theory that the debt is an infinite balance sheet, stakeholders will never be able to repay the outstanding global debt. Reading between the lines, this would also mean that the interest rates do not have a possibility to rise above zero: if a government is not able to pay out its debt, it certainly cannot afford to pay the service on it.
4. Post-crisis economy
Global pandemic created a unique macro-environment for bitcoin. According to JP Morgan report of February 2021, COVID-19 crisis accelerated the rise of digital finance. Digitalization and technological change in the financial industry is obvious as pandemic boosts demand for fast and convenient digital payment.
On the other hand, national lockdowns and controls have fueled excess saving rate amongst global population, leading to record inflows into cryptocurrency investments, particularly into bitcoin. In fact, since the beginning of global pandemic we have witnessed a rising correlation between bitcoin and equities markets, which indicates that bitcoin can no longer be seen as a perfect hedge against a downside risk in equities market.
In addition, raising debt and high inflation expectations spiked announcements of greater institutional acceptance of cryptocurrencies. COVID-19 has accelerated paradigm shifts that were already happening in the bitcoin environment, amplifying the impact of external and macro factors on the organic growth of bitcoin.
5. Regulation
Concerns regarding bitcoin regulation are the primary argument of bitcoin sceptics. They argue that as soon as bitcoin gains mass adoption, it will become a threat to governments and to local currencies, and thus will be eliminated. In addition, there are ongoing discussions regarding bitcoin being related to illegal activity. None of the applications filed for a bitcoin ETF in the US have been approved to this date by the Securities and Exchange Commission.
The outcome of bitcoin regulation is binary — it is either a global hard block of cryptocurrencies (which, in reality, would be quite difficult to implement due to internet connectivity and technological advancement), or a slowly evolving regulatory environment which will raise trust in digital assets.
Conclusions
Price rally of the current bitcoin bull run is not as much the excellence of the cryptocurrency itself, as the combination of external factors and the macro environment in the bitcoin universe. All these aspects are interconnected, creating synergies for organic bitcoin growth. Bitcoin’s scarcity — its internal characteristic — creates value for bitcoin in the macro-environment driven by inflation. Institutional adoption of bitcoin — an external factor — has a high impact on bitcoin’s internal traits, such as liquidity and trustworthiness.
It is interesting how nowadays many economic experts turn to bitcoin, being rather bullish about its role in the macroeconomic environment. We are finding ourselves in a situation, where markets have an urgent need for wealth-storing assets, but only a limited number of options. When we examined internal characteristics of bitcoin, we saw how this asset class possesses many of gold’s traits, thus making it into a potentially viable solution to protect one’s worth against a rising inflation. Bitcoin also offers a decentralized solution, whereby no central bank or government can dictate its development.
In the last year, BTC has indeed shown a strong negative correlation with weakening US dollar. However, at JKL we believe it is early to claim that bitcoin is a hedge against inflation. If the annual inflation expectation in the near-term is around 7%, a good store-of-value asset would have an annual return of 15–20%. Not 230%. Anything above the inflation hedge is a target for speculation.
Figure 3. JKL Trading Strategy Performance vs Bloomberg Dollar Spot Index
Our fund sees the potential terminal value of BTC as an extensive range, making its outcome rather binary. Best-case scenario of this projection will take place if Bitcoin sees a wide institutional adoption. At the point where Bitcoin stands now, it would be irrational to rely solely on best-case scenario predictions. JKL Capital sees the long-term investment in Bitcoin as a bet on the future, where this asset acquires all features of ‘digital gold’ and is widely accepted as such. Until then, bitcoin is a hypothetical storehold of wealth, rather than a factual one.
At JKL we see bitcoin price surpassing $100K in the current bull run, peaking around $140–160K before entering the bear market to later stabilize around $110K, which would be its ‘fair price’ according to the Stock-to-Flow Model. We expect Bitcoin price to peak between the end of September and mid-November 2021.
Finally, JKL proprietary trading system develops its models to predict short-term price movements, with usual holding periods varying between one hour and a couple of days. Therefore, none of the long-term views stated in this article reflect the position of our quantitative strategy. Since going live in September 2018, JKL strategy has generated a proven track-record of taking profits out of digital assets’ volatility, regardless of whether the underlying market had a bullish or bearish trend.
[1] Bloomberg Wealth (2021). Death of 60/40 Portfolio Makes Returns Harder for Funds.
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