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On Wednesday, March, 3rd — Swissquote, Switzerland's leading provider of online financial and trading services, hosted a webinar session with the 21Shares team on how to value Bitcoin in the short term as well as the long term in front of 300+ participants.

In a nutshell, this panel was organized to answer these questions:

  1. What are the metrics which we should use to track short-term Bitcoins price movements to assess investor sentiment?
  2. And what are the frameworks that best indicate and prove long-term value investing signals for market participants?

You can watch the full episode here.

This article will zero in on the second question —valuing bitcoin in the long term and we'll dive into three main valuation methods for Bitcoin that we find intuitive.

  • Market Sizing
  • The NUPL ratio standing for Net Unrealized Profit and Loss
  • The Technology adoption lifecycle of Bitcoin
  • And we'll leave a final word on the potential price appreciation of Bitcoin in this cycle

Important to note that this is a non-exhaustive list of valuation frameworks.

There are other key elements to consider such as strong network security and decentralization preventing attacks, and the growing use of renewable energy sources for mining Bitcoin just to name a few.

Market Sizing

It's been documented and established that Bitcoin shares many characteristics of gold and for this reason, Bitcoin is usually described as digital gold. As such, by relying on the market-sizing method, we can get an estimation of the total addressable market (TAM) for Bitcoin, which in this specific case is the market capitalization of gold valued at approximately $10 trillion dollars.

In theory, if Bitcoin reaches the market value of gold, the price per bitcoin will be more than $500,000. To be more specific, by dividing the market cap of gold by the outstanding number of bitcoins ever created — hence 10 trillion divided by 18.6 million, we get a Bitcoin price of roughly $535,000.

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At 21Shares we believe that Bitcoin has the chance to exceed the market value of gold. In fact, Bitcoin is a digital native asset, accessible anywhere in the world with an internet connection. The asset has a fixed, predictable supply of 21 million units ending in approximately 119 years, which since inception is programmatically-declining every four years (ie, the halving). More importantly, in the context of social distancing, closed borders, and fear of virus transmission — unlike gold, Bitcoin is easily transferable like emails and billions of dollars worth of BItcoin could be stored in a USB key also called storage in the industry (though as a rule of thumb, it’s recommended to wait an hour or roughly six blocks, added to the blockchain roughly every 10 minutes, to make sure a transaction is confirmed). Finally, the Bitcoin blockchain is tamper-resistant, open-source, and can be verified by anyone, give it a look here.

All the aforementioned points make the case as to why Bitcoin is better than gold. Note this analysis does not take into account the incredible innovations atop of Bitcoin such as the Lightning Network and Stacks, which could expand the potential total addressable market by orders of magnitude and also the use cases documented by the Human Rights Foundation, proving that Bitcoin serves as an alternative and censorship-resistant monetary system to protect human rights.

Gold unlike Bitcoin is shiny and benefits from the test of time with thousands of years under its belt. Also, gold has significantly more liquidity and is less volatile than the cryptoasset due to the fact Bitcoin is an emerging store of value that has increased by more than 5 billion percent ever since. For the record, the first-ever exchange rate recorded was about $0.0009 per Bitcoin by Martti Malmi, an early Bitcoin developer, who transferred $5.02 for 5,050 BTC via PayPal to seed a then bitcoin exchange called New Liberty Standard.

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Net Unrealized Profit And Loss (NUPL)

Now let’s delve into the second valuation framework, the NUPL ratio standing for Net Unrealized Profit and Loss. The beauty of the blockchain as we covered in the market-sizing section is the fact that it's an open-source ledger, though transactions are pseudonymous, timestamps and transaction values are visible and humanly readable. As such, this certainly helps shed light on the potential psychology of bitcoin investors based on their P&L and as mentioned in a book authored by Morgan Housel, called The Psychology of Money, "investing is not the study of finance. It’s the study of how people behave with money."

The NUPL ratio, in simple terms, measures the P&L of bitcoin investors and this metric has been instrumental to evaluate investor sentiment and identify the tops and bottoms for the price of Bitcoin over the past decade. To begin, market capitalization is an imperfect metric to measure how investors individually value bitcoin as they have different time horizons to sell the asset. So here comes realized capitalization — inspired by Pierre Rochard and created in late 2018 by Nic Carter and Antoine Le Calvez, which is the aggregate cost basis of each bitcoin not yet sold. Using the vocabulary of the crypto industry, this is the aggregate value of all unspent transaction outputs (UTOXs) priced by their value when they last moved.

In fact, not all bitcoins have the same cost basis. To give you an example, 2 Bitcoins allocated to a wallet sometime in January 2017 will have a cost basis of about $1,000 each as Bitcoin traded at that price, so a total value of $2,000. As such, the formula of the NUPL ratio is the following: realized cap minus market cap divided by market cap. The ratio ranges between 1 for 100% of the investors in profit and the negative territory for the losses.

Remember, investing is also the study of how people behave with money. Depending on whether we are in a bull market or a bear market, the level of the NUPL ratio categorizes investor sentiment in 5 brackets as you can see at the bottom of this chart: capitulation in red, hope or fear in orange, optimism or anxiety in yellow, belief or denial in green and euphoria or greed in blue. Let me give you a concrete example.

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Last year in mid-March there was a market crash due to the pandemic, the price of Bitcoin nosedived from the high $7,000 down to $4,000. A week later, the price jumped to over $6,000.

By investigating the bitcoin blockchain as you can see on the chart below when the price of bitcoin dropped, the coins shifted hands from short-term traders that bought Bitcoin less than 6 months ago at that time to long-term investors that held bitcoin for more than a year. And this explained the rapid recovery back to previous levels. To use the analogy of the NUPL ratio, when short-term traders capitulated and closed their positions, long-term investors found hope to buy bitcoin at a discounted price.

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The Technology Adoption Lifecycle

Now let's dive into the last valuation method: the technology adoption lifecycle. With this one, we want to show you why we are still in the early innings of crypto adoption.

First, let's answer this question "how many people own cryptoassets?". According to the University of Cambridge, there are more than 100 million crypto users. This is 2.5% of the entire internet population of 4.6 billion people, the reason we refer to the internet population as a realistic total addressable market, in this case, is that anyone needs an internet connection for accessing cryptoassets.

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For those new to the concept, the technology adoption lifecycle is a sociological model describing the acceptance of an innovation. The process over time looks like a bell curve as you can see below. This method categorizes different cohorts adopting a product or a service based on demographic and psychological attributes. It indicates that the first group of people to use a new product is called "innovators" followed by "early adopters". And then the early majority and late majority, and the last group to eventually adopt an innovation are called "Laggards".

Back to the context of cryptoassets, 2.5% of the entire internet population means that we have not crossed the chasm for mainstream adoption yet. In fact, we are still in the innovator stage. But, the appeal to the crypto industry is significant, especially coming from conventional finance, a few leaders have been both brave and ahead of the adoption curve — such as Paul Tudor Jones, Ruffer, and the endowments of Yale and Harvard University.

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12 years since the creation of bitcoin and a lot of people think that this is too late, but now you understand that this is just the beginning of the adoption lifecycle. To put things in perspective to compare with other technological advancements, in 1997, the Internet had roughly 100 million users, which is the equivalent of 2021 for the crypto industry.

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Source: right-hand side slide, SkyBridge

The last point on the adoption lifecycle is regarding wealth management, according to a survey composed of 620 private bankers and financial advisors who manage more than US$3 trillion of private client wealth, as much as 1% of the portfolio of high net worth individuals was invested in crypto assets. This is not as much as gold standing at 3%, which we believe bitcoin could exceed in the long run. Bear in mind that wealth management is a gigantic market estimated at $89 trillion of global assets under management according to the Boston Consulting Group. In addition, note that the combined AUM of institutional-grade investment vehicles such as exchange-traded products is only about 2.5% of the whole crypto market, so it represents a small fraction.

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Final Word

Last but not least, Ark Invest pointed out that if this bull market is as disruptive as the last bull market in 2017, then the price of Bitcoin could increase by 20x from its previous all-time high and reach as much as $390,000. You must be wondering why 20x? Well, Bitcoin experienced two cycles before this one — in 2013 and 2017. In 2017, bitcoin traded at more than $1,000 and exceeded the highest level in 2013 by 20x to reach $19,000. Obviously, this is still a question mark and only time will tell. At 21Shares, we will closely monitor what the future holds.

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