Uncovering the Intrinsic Value of Bitcoin and other Crypto Assets
The macro fundamentals that support the thesis of crypto investments
This paper highlights the macro fundamental narratives and the intangible intrinsic value that support the accelerated growth and investment thesis for crypto assets. We look at Bitcoin and the blockchain revolution from three key perspectives — technological, financial, and political — and use historical patterns to project possible future outcomes.
Those who have been following crypto developments for a while may have noticed that crypto market narratives change in different cycles. The last bull market cycle in 2017 was all about tokenization and fundraising through ICOs. Since mid-2020, NFT, DeFi, and CBDC developments have dominated the current market sentiments. These narratives highlight the newly discovered applications of blockchain technology, but oftentimes the market participants overreact on the technology’s potential while underestimating the actual execution risks. Thus we can see short-term hype and abnormal gains on many newly launched projects, and they are always followed by severe price correction when the crypto sentiment cools down.
In reality, crypto investing is much more than just chasing hypes and price actions. There are fundamental narratives that should remain valid through the test of time. This essay identifies three macroeconomic theses to uncover the true intrinsic value of crypto assets. Through examining the perspectives from a technological, financial, and political angle, we reveal what lies deep beneath the market hype.
Technological Perspective: Bitcoin is a technology
Whenever bitcoin is brought up, most people intuitively relate to its price and volatility, but it is much more than a speculative asset. Bitcoin is a peer-to-peer electronic payment protocol that is fully decentralized and censorship-resistant. The coin itself is an incentive and a security feature for the network participants to maintain the publicly distributed ledger. The emphasis should not be on the coin price, but on the network effect and the potential impact it can make to the world of finance.
Let’s take the Internet as a reference. It is essentially a piece of communication protocol (TCP/IP) that has changed almost all industries in the past 20 years. The fundamental business models of many industries have been entirely disintermediated by this protocol, whether it be commerce, media, entertainment, gaming, communication…etc. A gigantic social media industry has also been created and is now dominating the ways in which people interact with each other. All these changes started with the invention of the internet, which is simply a piece of universal communication protocol.
Interestingly, the Internet has not sparked a fundamental change to the financial industry. There are many fintech firms that have made finance more accessible through seamless user interface and easy-to-use features, but the plumbing of the traditional financial infrastructure has not been upgraded for nearly 50 years. Invented in 1973, the S.W.I.F.T. (Society for Worldwide Interbank Financial Telecommunication) network that enables banks worldwide to send and receive information about financial transactions is still being used today. Cross-border transactions usually take many days to settle, with high remittance and foreign exchange fees ranging from 3–7% [1]. With the introduction of Bitcoin, a value transfer protocol, there is finally a technological roadmap that can possibly transform the legacy financial status quo for the better.
The blockchain demonstrates a distributed ledger technology (DLT) that can be used to facilitate peer-to-peer value transfer without the involvement of centralized parties. This same concept is now being tested at the enterprise level — J.P. Morgan led the initiative in 2017 to start an interbank information network (IIN) that involved over 400 financial institutions and corporations across 78 markets globally. It was recently rebranded as Liink. Although this is not a permissionless public blockchain, this project utilized the DLT concept and is well on its way to replace the half-century-old SWIFT system.
Value transfer is merely the first apparent application of the blockchain technology. The emerging borrowing and lending activities created a fixed income market for crypto assets; stablecoin and CBDC initiatives enabled links between fiat money to its digital form, and tokenization paved the way for the digital securitization of assets. The possibilities seem limitless as DeFi (Decentralized Finance) protocols have started to facilitate transactions that could only be executed by financial institutions in the past. At the peak of the early 2021 crypto rally, the market capitalization of Bitcoin and Ethereum protocols unprecedentedly exceeded many traditional banks. Although the short term price volatility still exists, when we focus on the technology potential and its long term investment returns, it is apparent that the trend of adoption has been growing exponentially.
Financial Perspective: Keeping up with inflation and the monetary base expansion
Inflation has been a worry for many investors, especially since the 2008 global financial crisis, when governments around the world started to stimulate the economy by rapidly increasing the money supply, as well as implementing artificially low interest rates. Inflation depends on 1) money supply growth and 2) the velocity of money. Inflation rates can usually be observed through changes in consumer prices, financial assets, and the size of the monetary base [2].
When it comes to measuring inflation, people intuitively think of CPI (Consumer Price Index). However, consumer price has been kept reasonably low in recent years compared to the pace of monetary base expansion (money printing). This is mainly due to technological advancement, a strong deflationary force that makes consumer goods cheaper over time. The other key reason is that the previous rounds of quantitative easing have mostly been used to bail out financial institutions in order to maintain financial market stability; thus, the excess money supply was trapped in the financial system, driving up financial asset prices instead of consumer prices. The most recent COVID stimulus programs, however, sent funds directly into the hands of the consumers. As a result, the velocity of money increased and inflation started in the consumer sector; the year-over-year CPI numbers have already shot up over 5% since June 2021 [3].
Monetary base inflation is the increase of broad money supply. Taking the U.S. dollar for example, the monetary base had been rising steadily in a linear fashion since 1960, but it has since turned into an exponential curve, starting from the 2008 Global Financial Crisis. As shown on the chart, the U.S. dollar monetary base increased by over 660% in the past 13 years. The latest number published in October 2021 is at $6.38 trillion, from $840 billion in June 2008.
What should investors do when they see such an exponential increase in the money supply? Will they be able to maintain their dollar purchasing power? The large-scale quantitative easing program is not just happening in the U.S. alone; ECB, Bank of Japan, People’s Bank of China and many other countries are launching aggressive stimulus packages to keep their economies afloat post-COVID. If investors do not own assets that outperform the increasing pace of broad money supply, their purchasing power can diminish rapidly over time. The traditional inflation hedge such as commodities, real estate, or gold does not seem to deliver a return that can beat the rate of monetary base inflation, which is at a shocking annualized rate of 16.9%.
Even the broad equity market index is not able to keep up the pace with the rapid expansion of the Fed’s balance sheet. In the chart above, we can only count on those technology giants to deliver outsized returns. Nevertheless, when it comes to bitcoin, this new digital asset simply outperforms every traditional asset class and tech company. This is why many asset managers have started to allocate bitcoin and crypto assets in their investment portfolios, and consider it as a fiat currency inflation hedge and a new digital store of value.
Another interesting market phenomenon is the sudden behavioral change of foreign (non-U.S.) governments such as China or Japan that are major U.S. exporters, which hold massive amounts of dollars through trades. In the past, these sovereign states had always used their dollar reserves to purchase U.S. treasury bonds. However, this usual behavior has started to shift in 2020. As top hedge fund manager Stanley Druckenmiller pointed out, in the past 20 years, there has been a constant $500 billion inflow into U.S. treasuries until the spring of 2020, where foreign governments slowed down the purchase of low-yield treasuries, and bought more U.S. equities instead [4]. One interpretation is that foreign governments might also be conscious about preserving their dollar purchasing power. This occurrence also made the Fed a major purchaser of treasury security bonds, which further accelerated the abnormal monetary expansion of the U.S. dollar.
The institutional adoption of cryptocurrency started with macro hedge fund managers, as they were the first ones to observe this monetary expansion trend and the need to hedge against the fiat currency system. Many traditional asset managers and corporate investors also followed this investment thesis and added crypto assets into their portfolios. As El Salvador makes bitcoin the legal tender in June 2021, it is only a matter of time that crypto becomes a reserve asset for central banks and sovereign entities.
Political Perspective: Political support for the crypto dollar is a positive tailwind
Bitcoin may be the first cryptocurrency, but it is no longer the most traded one. The most widely used stablecoin USDT, or Tether, exceeded the trading volume of bitcoin in April 2019. The trading volume peaked at nearly $300 billion per day in the month of May 2021. As discussed in a previous essay on the rise of crypto dollars, the U.S. dollar continues to dominate nearly 90% of all bitcoin trades today, as the most widely used international settlement currency.
Governments around the world take very different approaches toward the crypto sector. Take the two largest economies for example; China, on one hand, takes a serious stance to crack down on domestic crypto exchanges and mining activities; meanwhile, the U.S. allows a crypto exchange to go public, and bitcoin futures and options are traded in CFTC-approved exchanges. These are just two extreme examples of government approaches to crypto assets. With the exception of El Salvador, which already made Bitcoin a legal tender, the majority of sovereign regulators sit between the two ends of the spectrum and have yet to decide the most appropriate policies. Regardless of policy directions, those who prohibit the growth of this innovation will eventually miss out the potential economic benefits that come with it, which can be quite substantial.
It is interesting to know what the U.S. government feels about USD stablecoins, especially when USDT, a crypto dollar created by the private sector, has become the backbone of the global cryptocurrency ecosystem. A talk given in June 2021 by Randal Quarles, a member of the Board of Governors of the Federal Reserve, seems to suggest that the central bank will likely support such private-sector innovations, as it sees “strong account of the potential benefits of stablecoins, including the possibility that a U.S. dollar stablecoin might support the role of the dollar in the global economy [5].”
Keeping the U.S. dollar as the dominant global currency has been a key objective for the U.S. government to maintain its global leadership and secure the financial health of the country. History shows that the U.S. dollar’s dominance started from the establishment of the Bretton Woods system in 1944, where the dollar was first introduced as a gold-backed global currency. However, this only lasted until August 1971, when the central bank ran out of gold reserves. Three years later, the U.S. government struck a deal with Saudi Arabia to standardize all exported oil prices in dollar terms. Since oil is the world’s most important source of energy, all nations started to accumulate dollars as a reserve currency for oil trades — thus, the petrodollar system was born. Fast forward to today, global shipments of crude oil totaled an estimated US$661.8 billion in 2020 [6]. This was a 34.5% decline compared to the 2019 pre-COVID era. Although this may seem like a substantial number, it merely represents a few days of the USD stablecoin trading volume. The crypto market today has grown much bigger than the global energy market, and this came as a nice surprise for the U.S. government. The dollar dominance is further strengthened by the heavy use of the crypto dollars, and this purely market-driven event happened without any government intervention.
Over the past 600 years, the world has seen monetary system rules change every 80 to 120 years. In international financial history, the nation state who has the most military power and holds the largest gold or silver becomes the leading international reserve currency of the world. The current dollar dominance has lasted for 77 years, first backed by gold, then by oil. As the recent COVID pandemic weakened global demand for oil and decreased the flow of the petrodollar, the crypto dollar took up the reins to sustain dollar dominance. This might be a new phenomenon that digital gold is replacing black gold to be the next dollar reserve.
Coincidentally, the most convenient place to buy bitcoin is in the U.S., where any retail investor can gain access to it through Paypal, Cash App, regulated crypto exchanges, traditional brokerage firms, and commodity futures exchanges, not to mention the wide variety of investment vehicles from public companies to private crypto funds. The regulatory dialogues on cryptocurrency have been both active and progressive on Capitol Hill. Most importantly, the institutional adoption led by top U.S.-based money managers has resulted in tens of billions of inflows into the crypto ecosystem [7]. One of the tech giants, Facebook, has quietly moved its previously-controversial stablecoin project from Switzerland back to the U.S., and has plans to issue a dollar-backed coin [8]. If this project is ever launched at scale, 3 billion people in the world would instantly be able to receive and trade digital dollars. No other fiat currencies in the world could possibly achieve such a large global distribution and circulation as the U.S. dollar.
While the U.S. progressively embraces crypto innovation, the hypothesis is that dollar dominance will continue to persist in the next 20–30 years, sustained by accelerating crypto trades and ownership. We should expect to see a growing crypto economy supported by strong political and economic interests.
Conclusion
Investing in cryptocurrencies is more than just chasing fads or profiting from short-term volatilities. Deep down beneath the price action, there are fundamental reasons that support the long-term investment thesis. Understanding these principles will help us discover the intangible intrinsic value of this innovative asset class.
It is impossible to predict what will happen tomorrow or the next year, but when we observe the change in technological advancement, financial trends, investment preferences, and political interests, we can anticipate where the future will take us in the next few decades. Many signals are indicating a major structure shift in the future of finance, monetary, and governing systems. Realizing these upcoming trends can provide us with certainty during an extremely uncertain time. This is the time for everyone to consider getting crypto exposures in the investment portfolio, it is a rather safe investment if you keep a long term perspective.
About the author: Christian Hsieh is the CEO of Tokenomy, a crypto financial services platform.
References:
- Sending money home: Transaction cost and remittances to developing countries, cege Discussion Papers, №387, ECONSTOR, 2020.
- The Ultimate Guide to Inflation, Lyn Alden, 2021.
- Inflation climbs higher than expected as price index rises 5.4%, CNBC, 2021.
- Stanley Druckenmiller says the Fed is endangering the dollar’s global reserve status, CNBC, 2021.
- Parachute Pants and Central Bank Money, by Randal K. Quarles, Federal Reserve, 2021.
- Crude Oil Exports by Country, World’s Top Exports, 2020.
- Bitcoin Treasuries, Buy Bitcoin Worldwide, 2021.
- Facebook-backed crypto project Diem abandons the Swiss license application, will move back to the U.S., CNBC, 2021.
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