We’ve stepped into 2021 and Bitcoin looks like it’s just getting started. In a year in which the world has stepped into a paradigm shift brought about by the spread of a novel virus, institutions and individuals alike are catching on to the benefits of crypto’s leading asset. If you’ve read any of our other content on Bitcoin in 2020, then you know that we’ve been tracking the case for it as a safe haven for both institutions and the average investor. Since December 7th, when we last posted on the subject, that case has only gotten stronger.
First and foremost, institutional adoption continues to rise as current HODLers accumulate and new HODlers climb aboard. The number of publicly traded institutions that have announced the usage of Bitcoin as a treasury reserve has progressed to 15, with numerous others buying in indirectly using methods such as Grayscale’s Bitcoin Trust and the New York Digital Investment Group. Though the bulk of this adoption occurred this year, what these stats indicate is that it’s still quite early yet. The number of publicly traded institutions that hold gold, for example, lies in the thousands if not more. On top of this, gold is the world’s most popular hedge, but over the course of 2020 in particular, Bitcoin has begun to look more and more ready to challenge that.
Nailing down why is easy if you understand both Bitcoin’s general value proposition as well as the current situation that investors of all classes now find themselves in. Worldwide, the virus has engineered a major loss of confidence in traditional portfolio models. With that, the driving narrative for Bitcoin adoption across investor classes has become “Bitcoin is a life raft away from the traditional financial system.” While this may appear to be true on the surface, in our last Bitcoin update on December 7th, we discussed how this is only the start of developing an accurate value proposition for crypto’s leading asset. Through adding in its correlations with other traditional markets like stocks, gold, and bonds, you will find yourself faced with a fuller picture to use going forward whether you plan to trade Bitcoin or simply “HODL” it.
If you’re already an NBX client, then you can simply stick with us to follow all of Bitcoin’s correlations as they develop over time. In any case, with this overall thesis in mind, we can now zoom in on what 2020 has meant for Bitcoin adoption in the case of institutional investors, then retail investors as well.
What 2020 Has Told Us About Institutional Investors and Bitcoin
From Square kicking off the bull market that’s been supercharging Bitcoin’s growth in 2020, to Blackrock and Marathon adding fuel to the fire most recently, institutions have quite literally been leading the charge into Bitcoin. As we’ve discussed above and in previous posts, the key value proposition for them continues to be that it is a more portable, provably scarce gold-alternative, i.e., digital gold. According to JP Morgan analysts via Bloomberg and others, Bitcoin continues to compete for gold for institutional in-flow, which, if it continues as a trend, may result in Bitcoin outpacing private institutional investment in gold. That, is, of course if and when its market cap reaches $575 billion or more, for which, only time will tell.
In any case, as the year comes to a close, there are two key signals to pay attention to that will shed light on just how powerful this institutional rally becomes over the long-term. First, while Bitcoin’s correlations with traditional assets have begun to break away significantly in 2020, what will be more important is whether they can continue to do so as the global economy recovers from the effects of COVID-19. If that turns out to be the case, then crypto’s leading asset will truly be on its way towards proving its viability as a powerful safe haven. Following this, it will also be important to track whether the thesis that Bitcoin’s price rises with its hash rate proves to be true. If, over the next year, both measures move in tandem or close to it, then it might be reasonable to conclude that hash rate in fact, is a macro-indicator for Bitcoin’s future bull markets.
As you can see above over the course of the past year, price did generally follow hash rate, though not completely. This is because hash rate cannot drive Bitcoin’s price up alone. As with any asset in existence, for bull markets to occur, there has to be demand, which is always driven by a wide collection of factors. Even so, in Bitcoin’s case, the increased demand for it can be boiled down to a single case, i.e., that of it being digital gold. Nearly all of the public institutions that have purchased Bitcoin in 2020 have admitted this to be the key driver behind their efforts.
What 2020 Has Told Us About Retail Investors and Bitcoin
What about, however, retail investors(non-institutional investors)?
Truthfully, the answer is the same as what we’ve discussed above, at least on a basic level. In a world where it’s becoming increasingly clear to everyone that all traditional assets can be manipulated by centralized entities, and achieving a reliable return on investment is increasingly hard to do, Bitcoin’s a powerful hedge. Because its’ supply is fixed and its governance is decentralized, it will always exist outside of the traditional global financial system and consequently, it’s likely that its correlations with traditional assets will continue to break down over time, as we have indicated before.
All in all, it’s becoming more clear over time that the world needs digital gold, especially when the ROI from most other sectors can disappear at a moment’s notice due to economic crises.
The Importance of the HODL to all Investors
In the end if there’s one thesis that applies above all, it’s that with Bitcoin, history speaks to HODLers winning out. With companies like Paypal and Grayscale reportedly buying up the equivalent of more than 100% of the available supply of Bitcoin on a long-term basis, if such behavior continues, we will see a shortage or a supply-shock. That, in turn, will likely lead to an even more powerful bull market than we’ve experienced this year, provided that demand stays consistent.
If you’re wondering why, it’s simple. When demand increases, available supply decreases, and HODLers start to proliferate compared to short-term traders. The historical relationship between total supply held by long-term holders(HODLers) and Bitcoin’s price shows just how this plays out in practice.
In a nutshell, what the above data shows is that in the short-term, the two variables are quite imperfectly correlated, but in the long-term, an increase in HODLers follows an increase in price and vice-versa. One particular theoretical framework that sheds some light on this relationship is the idea that Bitcoin is “a living example of Metcalfe’s Law, but in trust,” which Raoul Pal shared with us over the course of the past year.
To break down what this truly means, it’s important to understand first what Metcalfe’s Law is, then how it relates to Bitcoin and finally, how Bitcoin redefines trust.
What is Metcalfe’s Law?
Metcalfe’s Law is the basis for network effects, which was originally introduced by Robert Metcalfe in 1980, then improved upon for the internet and internet-connected networks in 1993 by George Gilder.
At face value, what it says is that the value of a network can be approximated by its total nodes squared. So, if a particular cryptocurrency network has 13,000 nodes, that would mean that its overall value is 169,000,000. Typically, valuation via Metcalfe’s Law is denominated in US Dollars.
How does Metcalfe’s Law relate to Bitcoin?
Before Bitcoin, Metcalfe’s law was most commonly used to value technology platforms such as Facebook, Amazon, and Netflix with their users being represented as the “nodes” in the previously mentioned formula.
Though Bitcoin is a decentralized cryptocurrency network and the first of its’ kind, it still stands to reason that it can and should be valued using Metcalfe’s Law. The question is however, how to determine that value and whether once determined, it truly reflects the overall worth of the entire Bitcoin ecosystem.
Related to the first point, current research indicates that one way of approaching Bitcoin’s value with Metcalfe’s Law is to take the number of active Bitcoin wallet addresses and square them. While this does provide a sort of value for crypto’s leading network, it simultaneously shows that Metcalfe’s Law can’t determine Bitcoin’s value alone. To understand why, it’s important to first understand how Bitcoin redefines trust for the better.
How does Bitcoin redefine trust?
Consider the structure of the Bitcoin network.
Fundamentally, it allows for anyone to send Bitcoin to anyone else, anywhere, any time, regardless of if they’ve ever met them in person and without the help of any bank or other centralized entity. For this reason, it’s been said by several different tech insiders that Bitcoin introduced “trustless trust” to the world.
If we understand this as synonymous with introducing decentralization to the global financial system for the first time, then it can also be concluded that Bitcoin’s users and its’ redefinition of trust are two key elements of its’ overall value proposition.
So, Metcalfe’s Law and “Trustless Trust” = Bitcoin’s Value?
In short, not quite.
Valuing Bitcoin simply based on Metcalfe’s Law and its decentralized governance would only lead to half of the first cryptocurrency’s accurate worth. What’s likely left out is what we’ve discussed above and in all of our other posts this past year. People need provable digital scarcity and increasingly inverse correlations with the traditional global financial markets. In other words, Bitcoin’s not just a decentralized currency network, it’s simultaneously also becoming a compelling macro-hedge. Until that has played out over the course of a decade or so as the “trustless trust” narrative has, all attempted valuations of the network will fall short.
The Living Example of Metcalfe’s Law, But in Trust
Despite the above, it’s still possible to use Metcalfe’s Law and a concept called a “Soros-style feedback loop,” to approximate Bitcoin’s potential value, which is what Raoul Pal and others who agree with him have spoken about on more than one occasion.
To summarize their theory in this respect, they believe that Bitcoin’s adoption cycle will continue to be driven by institutions (and retail investors) realizing its fundamentals, which will raise its market cap and price, and will in turn, cause more investors from both sectors to take on Bitcoin positions. As long as the network continues to grow and demand continues to exist, Pal and his compatriots, which number essentially all major macro-investors among others, believe that this “positive feedback loop” will continue into the long-term.
While such a theory still doesn’t leave us with a concrete value for the entire Bitcoin network, it does leave us with the idea that its digital scarcity will always be the most powerful factor driving its adoption. Additionally, it tells us not where Bitcoin will be forever, but where it is now.
What about other metrics for valuing Bitcoin?
It is true that some have taken Bitcoin’s relationship with Metcalfe’s Law and developed metrics like the Network Value to Transactions Ratio (NVT), which is used to estimate what Bitcoin’s price should be through dividing its market cap by its daily transaction volume in USD. Still, the NVT has proven inaccurate particularly during major Bitcoin rallies, including in 2020, which is illustrated below.
Truthfully, the NVT doesn’t seem to have been meant to be a simple valuation measure. Instead, it’s more accurate to think of it as something like an early attempt at measuring where Bitcoin’s baseline price is and therefore, how much over or undervalued it is compared to that price. Over time, other measures like Bytetree’s NVT-BT have surfaced to build upon the NVT’s methodology and attempt to get a more accurate picture of the same situation, though as of now, Bitcoin largely continues to carve its own path.
In the End: HODLERs Rule
In the end, if there’s one primary metric to follow that appears to call for a continuing bull market, it’s the “total supply held by long-term holders,” as shown above. This proliferation of long-term investors, put together with Paypal, Grayscale and others funneling in +100% of Bitcoin’s supply is what will lead to market scarcity, which together with Bitcoin’s digital scarcity, will likely push its growth to even further heights down the road.
Bitcoin’s Key Trends to Watch in 2021
As we move into 2021, the key overarching trend to watch will be how Bitcoin performs as the global economy starts to recover. If it manages to sustain even 1/2 of this year’s ROI, then the idea that it’s becoming the world’s greatest hedge will have been cemented even further through it continuing in its’ current positive feedback loop. As you follow this trend, keep in mind related sub-trends such as Bitcoin entering a supply shock, and HODLers outpacing short-term traders, both of which are reliable metrics for tracking the emergence of sustained Bitcoin bull markets.
If history indicates anything for certain, it’s that in the end, Bitcoin tends to eschew all predictions in favor of carving its own path. Therefore, whether you’re a Bitcoin investor or trader, think of the trends we’ve covered here as just more tools to for you to use alongside Bitcoin’s fundamentals such as its revolutionary portability and digital scarcity to better understand what sort of journey the world’s “digital gold” will take.
If you’re interested in doing all of that with us, then stick around with this blog. The ultimate goal of all of our Bitcoin-related content has always been to give you all of the necessary information so that you can confidently make your own judgments on Bitcoin’s value.
In our next post in this series, we’ll dig deeper into supply shocks and what effects they can and are having on crypto’s leading asset, together with leading expert opinions on the subject. Until then, remember that we’re here to help you. If you have any thoughts or questions about this post as well as others, reach out to us any time here, on Twitter, or on our website!