Why Bitcoin is Undervalued

Why Bitcoin is Undervalued

Disclaimer: Your capital is at risk. This is not investment advice.

ByteTree Market Health Update; Issue 59

There are two reasons that spring to mind as why Bitcoin is undervalued. The first is based on ByteTree’s live metrics, which see its worth just under $40,000 today. The second is where it is going. Having studied Bitcoin since mid-2013, I was always bullish that great things would eventually happen. I’m not just pointing to the rising price, but the real-world applications. Since this subject is 10x more important than the recent price dip, and therefore buying opportunity, I’ll cover it first.

Back in 2013, Bitcoin was clunky, and in many ways still is. It can only transact 7 times per second (3 million per week see fees explode) in contrast to Visa, which is widely quoted to handle 65,000 transactions per second. Being decentralised has limited Bitcoins ability to scale, as the miners have to perform complex tasks to verify each and every transaction. That takes time and energy, and the miners are handsomely rewarded for it. Being Visa is easy in comparison, as they don’t need to prove a thing; they just log it.

One reason I have remained a bull over the years is because every problem Bitcoin has faced has been overcome. It is an open-source project, which has attracted some of the finest minds in the world. This leads to continuous improvement, which means an infinite number of applications lie ahead. The massive development effort has centred around Bitcoin, as opposed to other cryptos, because it dominates the ecosystem and faces the power laws behind the network effect. Why would a sharp mind focus on something else? In that sense, crypto has become a one-horse race.

Developing a system takes time. The internet was pretty awful in the 1990s but look at now. I asked our chief dev and co-founder, Mark Griffiths, to remind us of the history of the internet as he recalls it. He has highlighted the layers that he felt were most important, and some examples of applications that followed. He might not have witnessed events in the 1960s, but certainly has since the late 1980s once he came of age.

The history of the internet according to Mark

Year What happened Description Led to
1960s ARPAnet/Hypertext The concepts of connected, structured digital information (Hypermedia) and wide area networking were born, if unrelated at the time. Ted Nelson Project Xanadu
1987 Commercial Dial-up internet Modems brought connectivity to enthusiasts outside education for the first time. Available services were a convoluted mess. CIX, Compuserve, AOL, Demon Internet
1993 Hypertext transfer protocol (HTTP)/The Web All online services could now use a single, coherent view with a simple and consistent address scheme. The internet became accessible with a mouse… and could have pictures. Tim Berners-Lee httpd/NCSA, Marc Andreessen Netscape
1996 The Interactive Web Javascript and plugins allowed the browser to move from “text & pictures” to more fully interactive and searchable media. Audio on the web became possible. A very experimental phase of the web’s development. Internet explorer, Macromedia Shockwave, Yahoo!, AltaVista
2000 eCommerce and Web 2.0 With internet porn showing how to take money, new digital retailers arrived, and users could contribute content and ‘comment’ on websites for the first time. Commerce drives the establishment of faster, better networks and video on the web becomes a practical possibility. Google, Amazon
2001 Peer-to-Peer File Sharing While they ended up mired in copyright infringement lawsuits, these new class of network apps introduced the whole idea of decentralised networking, and put the foundations in for how Bitcoin could work in future. Napster, Limewire, BitTorrent
2007 Social Media User content becomes the content. MySpace, Facebook, YouTube, Reddit
2009 Mobile Hypermedia in your hands. App Store, Android
2010 Cloud computing and microservices Smaller, faster and scalable. AWS, Azure, Google, Node.js
2017 Streaming bandwidth Global peering arrangements boost the planet’s bandwidth and hypermedia finally arrives at home. Netflix, Amazon Prime

The internet didn’t land overnight. It took years of development and today, there is more content and creative destruction than ever before. The technology sector is on fire, largely because many disciplines of science have converged. No longer are chemists, biologists, mathematicians, engineers and computer scientists separate profession as the cutting edge demands they be combined. The world wouldn’t be raining in Covid-19 vaccines if that were not true. It would take years to develop them if the old ways still applied. At the centre of this lies computational power and advanced software.

I have long said that Bitcoin, in addition to being a monetary asset, has been a tech stock. It is so much more than electronic gold, which is merely an added bonus. No doubt it helped in the early days to cement Bitcoin’s credibility, as an infinite supply would have been a detractor, but as we move forward, that job is done. With just 2.4 million Bitcoins left to mine, out of 21 million, that is no longer driving value. As we have consistently been saying, Bitcoin’s main driver is the network effect which is why ByteTree has been built around that.

I would recommend Andy Edstrom’s book, “Why Buy Bitcoin”. I quote (with permission):

“Today, there are several additional layers being built on Bitcoin. The most developed is the existing set of exchanges and custodians, including Coinbase, Kraken, BitGo, Xapo and others [Fidelity]. These companies allow transfers between accounts similarly to the way the banking system allows transfer of dollars between account holders at the same bank. The system is less secure than settling transactions directly through the Bitcoin network, but it is faster…
Perhaps the best known and most promising new layer being built on Bitcoin is the Lightening Network. This system allows users to open and close direct and multi-leg payment channels among participants. It facilitates huge increases in transaction volumes (potentially allowing hundreds of thousands or even millions of transactions per second) by only settling occasionally through the Bitcoin network. It is analogous to the second and third layer systems that exist on top of the U.S. dollar today… the Lightening Network is functional, and the amount of software development talent drawn to it seems to be growing quickly.”

And this gets to my point. There is no shortage of software talent has been hard at work. Just as 2020 has seen huge improvements in the institutional infrastructure surrounding Bitcoin, the network itself is ready to take another leap forward. When I have previously described Bitcoin as a tech stock, as it follows the laws of the network effect, these layers morph it into a fintech stock as well, which will disrupt traditional finance. That is long overdue because when you enjoy a fabulous lunch in Paris, and pay by card, a banker back home just added another dessert onto your bill.

Once you have read Edstrom’s book, here’s Jack Mallers being interviewed by Preston Pysh (text is below the recording). Mallers is the 26-year-old founder of Strike, and I suspect you’ll hear more about him in the future, as he’s the type to change the world for the better. I quote Mallers:

“a really important conceptual point for what I’ve been working on for years now and what’s becoming Strike is this inherent difference between Bitcoin, the asset and Bitcoin, the network. The asset, as you’ve described, is accelerating, it’s in flying fashion and flying colors, right? You’ve got it all over mainstream TV, in large public companies allocating their reserves to Bitcoin because it protects against the asset inflation and the Federal Reserve’s desire and need to just infinitely print money.
However, Bitcoin, the network actually offers extraordinarily fascinating innovation as well. You’re talking about the very first natively digital bearer instrument that can achieve settlement globally with no permission. And it’s distributed, it’s censorship-resistant. I mean, there’s a lot of innovation within the network itself. And so the difference there is do away with the monetary policy of the asset, the price of the asset, just what the network itself accomplishes is fascinating. And I think therein lies the real difference between what Strike is trying to accomplish versus a Coinbase or a Kraken.
What Lightning accomplishes, it gives Bitcoin this natively digital bearer instrument cash finality, which is an unbelievable achievement. You can have cash finality with an asset that is natively digital, inherently global, and can achieve settlement and clearance at no variable costs anywhere in the world at any given time. The way the Bitcoin protocol in achieving settlement work prior to the Lightning Network is you relied on network consensus, and network consensus took an undefined amount of time, and it was an undefined cost. Bitcoin fees at its base layer, it’s a market, it’s a free market…
And so the results of this is I can move a physical bearer instrument anywhere in the world at no variable cost. It is cheaper, faster, more inclusive, and more global than any other monetary network in the world. And it is achieving that with real physical value. There is no credit in the Lightning Network. The money moves and settles and the value actually transports in real-time at no cost. And that is an immense achievement for money as a technology. It is an innovation and an accomplishment for humanity that we can move physical value in real time for free globally at any point 24/7.”

Did you see “no variable cost”? Free? 24/7? Read the whole interview, but Mallers isn’t just transferring Bitcoins around the world for free, but whatever you want. Dollars, pounds, euros, yen, this is it. Bitcoin is ready to challenge the financial system. Bitcoin not only gives you a fast-growing tech stock, you also get a fintech stock with a gold bar attached.

Buy the dip

Hopefully, most of you will see the recent price correction as a buying opportunity. I highlighted the heightened risks last week:

A few charts that show how Bitcoin is currently short-term over bought, although less so than last week. Volatility has also risen.

30-day volatility has risen

Source: Bloomberg. Bitcoin realised volatility over 30 days since 2013.

Put simply, volatility scares investors because it moves price in both directions. 83% volatility implies average daily price moves of 5%. That doesn’t mean it happens every day, but on average. Investors prefer calm, so expect institutional investors to back off for a few weeks until things cool down. They’ll soon be back.

Bitcoin was extended from the trend

Source: Bloomberg. Bitcoin deviation from the 30-day moving average since 2013.

Bitcoin was also extended from trend. Price exceeded $40,000 last week with the 30-day moving average lagging well behind. Great stories always become overbought, and this has already calmed significantly. Look at the old all-time high in 2017 for comparison. It touched 50% above the 30-day trend twice before the final peak. On both occasions, price corrected below trend. A dip into the 20ks is entirely possible but fear not as a new high in the spring seems more likely than not.

Having already written too much, I’ll cover valuation in more detail next week. Suffice to say, this methodology I dreamt up in 2014 still works like a treat. Once again, ByteTree is publishing the 1- and 5-week fair value numbers.

The current level of weekly on-chain transaction value is $67bn (see page main), which implies a fair value close to $40,00. This number is volatile, so please use it in context with the 5- and 12-week readings, which just like price moving averages, lag. Over 5 weeks, the average transaction value is $48bn, implying a fair value of $28k and over 12 weeks, $34bn, implying a fair value of $20k. As the market consolidates, these will once again become aligned. Don’t expect them to during a price surge.


Please send feedback to info@ByteTree.com

Who is going to adopt Bitcoin as the network grows? For mass adoption at lower value levels of translation, aren’t the barriers of high fees and technical difficulties pretty significant?

Everyone could adopt the Bitcoin network, especially the young who are comfortable with the digital world. Indeed, they are more confused by the old world. Show them a stamp or a fountain pen. As for the boom in payments, look to the new layers which will enable transactions at zero to low cost.

Once (if) BTC arrives as a gold-like asset, isn’t there the issue of the slowing of the network effect? Since Gold is typically held as a store of value, with few transactions.

You could hold your Bitcoin in one of the second- or third-layer applications. You would be saving your “electronic-gold-the-asset”, while simultaneously allowing the network to thrive. But I would remind you gold trades $150bn per day in contrast to Bitcoin’s $10bn (on chain). I suspect Bitcoin becomes many more times liquid than gold in the future.