Pragmatic approach to Bitcoin needed

By Park Chong-hoon

"If you don't understand Bitcoin, you're old." ― Leon Cooperman, billionaire investor

A few months ago, when I was asked to write about Bitcoin, I declined to do so for two reasons: first, because I did not understand Bitcoin, and second, I was restricted from commenting on it given that our bank's research did not cover it.

However, Standard Chartered Bank has recently published its first research views on Bitcoin. We recommend that investors take a pragmatic approach to Bitcoin investment, rather than simply ignoring the asset because it does not meet the standard definition of money ― i.e., serving as a medium of exchange, store of value and unit of account.

We think Bitcoin can meet each of these definitions over time, even if it does not yet. Given the tendency of markets to price an "end game" for financial assets, we believe it does not matter that Bitcoin does not yet fulfill each of these definitions.

Bitcoin defies a simple definition; it can be understood in various ways ― as a currency, it can be viewed as an asset, a payment network or software. We use the term "asset" over "currency" when considering its use cases. There were attempts to produce digital currencies before Bitcoin, including "Bit Gold" and "Hashcash." However, Satoshi Nakamoto's 2008 white paper focused on solving a particular problem: overcoming the "trust" issues associated with creating a decentralized, peer-to-peer electronic payment system.

The launch of Bitcoin in 2008 also coincided with central banks expanding the money supply of fiat currencies in order to return to compliance with national inflation targets. Quantitative easing (QE) programs were initially introduced in response to the global financial crisis; since then, money supply increases have become much more significant, for example, in response to fight against the economic impact of the COVID-19 pandemic. As a result, Bitcoin's disinflationary characteristic (via algorithms ensuring that its supply rate falls over time and that future supply is finite) attracted growing interest from economists and investors concerned about fiat currencies' store of value.

The "theory of value" in economics is a theory about price information. The fundamental question for economists in financial markets is how a financial product should be priced. As the world's leading crypto asset, Bitcoin's valuation has been the subject of heated debate, with estimates ranging from zero to $600,000.

In our Bitcoin research report, we look at its various attributes through both a structural and cyclical lens to generate metrics for its valuation. Defining Bitcoin itself has been a topic of debate; for instance, what type of asset is it? We take a pragmatic approach to this question, as we believe Bitcoin shares characteristics with currencies, commodities and equities (specifically early-stage technology companies).

We believe Bitcoin could become the dominant peer-to-peer payment method for the global unbanked population in a future cashless world ― i.e., a medium of exchange. Based on the estimated size of the global unbanked market ($20 trillion) and using credit-card companies' transactions and market valuations as a reference point, we arrive at an initial medium-of-exchange Bitcoin valuation of $50,000; at the time of writing this, Bitcoin was trading at $60,784.

As a store of value, Bitcoin enjoys a potential premium, given the slow pace of increase in its supply (currently 1.8 percent per year and set to decelerate over time). In real terms, applying "normal" U.S. M2 growth rates to known Bitcoin supply, $50,000 of Bitcoin today would be $120,000 in 2040.

We use portfolio optimization is an alternate valuation measure. Starting the optimization from the previous Bitcoin peak (around $20,000 in late 2017) gives an optimal allocation to cryptocurrencies of around 2 percent of global portfolios. We estimate that this puts Bitcoin's valuation at $175,000 if, as we expect, Ethereum's market cap catches up to Bitcoin's.

These three approaches put Bitcoin's value in the range of $50,000 to $175,000, in our view. The wide valuation range indicates that Bitcoin presents significant uncertainty as an asset. It is hard for traditional economists to accept Bitcoin, but it is also hard to ignore the market's speculative appetite. Our Bitcoin and Ethereum research reports represent our bank's initial efforts to join the new world of cryptocurrency markets, with more insights to come.

Park Chong-hoon (ChongHoon.Park@sc.com) currently heads the Korea Research Team at Standard Chartered Korea. Before joining the bank, he worked as a senior research fellow and head of telecommunication policy at the Korea Information Society Development Institute (KISDI). This article is produced with permission of Standard Chartered Bank, based on a Global Research Report originally published on Sept. 7, 2021. It is subject to the Standard Chartered Bank General Disclaimer which is available at research.sc.com/Portal/Utilities/TermsConditions