What will be the value of one Bitcoin in 10 years? A value investors view point.
The attitude of a value investor is to buy assets or securities below intrinsic value and sell when the price is above the intrinsic value.Cryptocurrencies and Bitcoins are the new talks of the town in the investing world. It becomes imperative as an investor to have a look at this investment alternative.
Although I don’t consider myself an expert on currencies, in this research paper, I will attempt to value Bitcoin as an investment. Please do note that my views should be taken with a pinch of salt as cryptocurrencies are a highly risky and speculative investment.
I also have as always tried to make the report as simple as possible so you as the reader can find it easy to understand. Please do ask as many follow up questions in the comments section below.
Because Bitcoin is a digital currency and not a stock we will have to approach the valuation from what I call the first principles approach.
Here are a few Facts About Bitcoin which will be the basis of the evaluation and discussion going forward.
There will only be 21 million Bitcoins ever to exist, and the last Bitcoin will be generated in the year 2140.
In the next ten years, the total number of Bitcoins will be close to 17 Million; the supply can not be increased or decreased.
It is a decentralized currency, and no government owns or controls it.
Bitcoins are considered the most secure digital currency ever to exist and based on mathematical principles and a new technology called Blockchain.
Bitcoin is designed to be a deflationary currency as against other currencies which are inflationary.
As a forex instrument, it is significantly cheaper to do transactions using Bitcoin. For example, it cost 3-7% for an Indian to transfer money abroad, however, with Bitcoin the costs will be close to 10-25 cents.
Bitcoin is faster, and it takes close to 10 minutes compared to 3-5 days in traditional banking methods of transferring money.
What is the definition of value?
Value is the amount of discounted cash an asset will produce over its lifetime.
In the case of a company, we have always maintained that the per share value of the company is the per share amount of cash the company will generate over its lifetime. We discount this total amount of cash and discount it to present value.
However, Bitcoin being a digital currency is different, and one needs to understand what need it serves before one values it. The need Bitcoin serves, or the problem it solves will drive demand for the currency and thus result in a higher value.
How is Bitcoin different and What drives its value?
There are many factors which affect the price of the currency. However, currency prices in my view are primarily determined by three things.
The acceptance of the currency and daily transactions.
The balance of payment (trade deficit) and financial condition of the country issuing it.
The policies of the central bank and government of the country to which the currency belongs.
Bitcoin is decentralized and thus it is not owned or subject to any government intervention. Further to this, Bitcoin is designed to be a deflationary currency which means its value will increase over time instead of decreasing as is the case with traditional fiat currencies.
As a currency, the acceptance and amount of transactions or daily volume are what will drive the value of Bitcoin in the future. Thus the value of Bitcoin depends on the mass adoption and its value proposition of lower transaction charges.
Bitcoin is not governed by any government or backed by any assets, thus just like in the case of Facebook and Whatsapp, it depends on its users to drive demand and value. However, in the case of Facebook or Whatsapp, they generate money or have potential to do so from advertising or data, in the case of Bitcoin it is an increase in its utility and need for people to transact with each other in a faster, low cost and secure which will drive its value.
Assumption 1: The number of transactions increases due to mass adoption and it will increase the demand for Bitcoins 10 folds in the next ten years.
The way I see it Bitcoin is two things :
A way to do forex transactions and transfer money which far cheaper than banking methods.
A digital currency which can be used to buy and sell products.
This implies that Bitcoin is mainly targeting the forex market and will also act as currency which can be used online.
Bitcoin and the Forex market
The first point and use case for Bitcoin is pretty straightforward. People or institutions in the coming future will use bitcoin to do forex transactions as it is significantly cheaper. The use case is much higher in developing economies as compared to developed economies.
The forex market is currently valued at 5.5 trillion USD each day. If we were to assume that Bitcoin will capture 10% of the market share, then it comes 550 Billion of Bitcoins traded every day each day.
Assumption 2: Bitcoin will capture 10% of the Forex market in 10 years.
Whats the competitive moat of Bitcoin?
Bitcoin faces competition from hundreds of other copycat digital currencies. However, it has a massive first mover advantage and enjoys the benefit of “networking effect.” Just like is the case with WhatsApp and Uber the value of the digital currency is derived from its users and the acceptance.
Bitcoin also has a massive community of investors, merchants, and miners who have widened its competitive moat as a cryptocurrency.
However, just like with all technology products it can always be disrupted by something better.
Assumption 3: Bitcoin has a first mover advantage in the cryptocurrency market and has a competitive advantage in the form of a networking effect.
What are the risks involved with Bitcoin?
Lack of acceptance or bans from the governments:Governments around the world have expressed concerns about Bitcoin being a way and means to do illegal transactions this can result in future of a ban from most governments or regulation on b Bitcoin transactions. This can impact the value proposition of the digital currency.
Quantum computing and other technologies in future are a threat to Bitcoin as they can make it less secure or people may be able to hack the Bitcoin network, this may result in Bitcoin becoming of zero value.
Bitcoin faces competition from other crypto currency and in future, there is a possibility that a new digital currency, perhaps better than Bitcoin may take away its market share and render bitcoin useless.
Assumption 4: There is a 50% probability of Bitcoin failing due to competition or technology changes.
To arrive at a value for Bitcoin value we need to take into account the 1) Daily volume increase, 2) the market share Bitcoin will capture in the forex market and 3) Limited circulation in the number of bitcoins.
As discussed before a 10% market share of the forex market is 550 Billion USD. The current daily traded volume of Bitcoin is 250 million. If the volume traded of Bitcoin rises ten times. Then we get a valuation of 5.5 trillion. Further to this, there will be a total of 21 million bitcoins only by the year 2140.
In the next ten years, we will have close to 17 million bitcoins in circulation. If we divided 5.5 trillion by 17 million. We get a valuation of 323,529 USD.
Now that we have received the valuation of 323,529 USD, however, we still need to incorporate the change of failure and margin of safety.
In my view, the probability of failure of Bitcoin stands at 50% (however as things evolve this estimated should be changed upwards or downwards).
This probability of failure of 50% gives us a value of 161,764 USD per Bitcoin.
Further to this just like in all our valuation we need to incorporate a margin of safety.
The current price of Bitcoin is close to 2500 USD vs. a valuation of 161,764 USD which gives us a margin of safety of 98.45%. In other words, if the facts and assumptions made in this report are correct then the market is telling us that there is a 98.45% chance of Bitcoin Failing.
Scenario Analysis and Target Price.
After incorporating the above assumption, it will be prudent to conduct a scenario analysis by assigning a range to each assumption we discussed above. However, I must warn you again that Bitcoin is a highly speculative investment in a nascent market of crypto currency. The scenario analysis is based more on imaginative thinking rather than cold facts; I would prefer the latter any day.
Here is the list of Assumption and Ranges used in the scenario analysis.
Increase in usage and daily transaction of Bitcoin in next ten years will be in the range of 100% to 1000% or 1 to 10 times.
Bitcoin will capture between 1% to 10% of the Forex market share.
The probability of failure is at 50%
The margin of safety is 50%.
Based on the range of these two assumptions we get a range of 6720 USD to 657,163 US per Bitcoin. The mean value per Bitcoin is 80,882 USD.
Recommendation for Bitcoin:
The current market price of 2600 USD as against the valuation of 80,822 per Bitcoin.Therefore we feel that Bitcoin is –undervalued valued by close to 96.7% which is a decent margin of safety as a value investor.However, because Bitcoin is not accepted by governments or is not yet proven to be an investment vehicle, it is a high-risk investment. In conclusion – A long term investor can start buying at current levels of 2600 USD and keep adding if the Bitcoin price goes down in the short run, that being said one should allocate the very little value of their portfolio and also expect to lose all their money if things go south. The time horizon will be ten years. Please remember the cryptocurrency space is constantly changing due to the fast moving technology and not all risk are covered in this short report.
The jury is still out and only time will tell. Whats your view on Bitcoin’s future??