Bitcoin: Reluctant Maximalism
By: Evan Feng
Tags: Messari Analyst, Cryptocurrency, Technology, Bitcoin, Investing

Introduction: Bitcoin Drives the Bus, Everything Else is Along for the Ride

There is a tendency for people to overcomplicate matters, whether because they’re unsure of their convictions, or have something they’re selling. While there are plenty of projects that have continue to design, build, pivot, and launch new features or main nets to broaden the possibilities and capabilities of the digital asset ecosystem, I’m increasingly of the belief that how Bitcoin (BTC) acts over the next 6–12 months will be the primary driver of whether cryptocurrencies take the next stepwise functions up in awareness, adoption, and yes, price, or continue to languish in relative obscurity and apathy. This will not be an article seen through rose-colored classes, but an attempt to honestly frame how the space is running short on time to deliver on the bold promises that have been made. Specifically, I’ll summarize and opine on the most common narratives from both the bull and bear camp as it relates to Bitcoin. While historically this monthly thematic overview has focused more on overarching themes as opposed to asset-level research, but I felt that now is the right time to reexamine the Bitcoin juggernaut following the recent 11th birthday of the whitepaper, and ahead of the next wave of potential catalysts. To clarify, the “maximalism” referred to in the title is not arguing in favor of a BTC-only monopoly market for cryptocurrencies, but simply my belief that what happens to BTC matters more than for any other asset for the time being, so is worth investigating most closely.

Motivation and Methodology: Time Preferences and Opportunity Costs

There’s a dichotomy between chaotic beauty and raw danger in truly free markets, like how we admire the majesty of eagles and wolves from afar but prefer to keep our distance physically. I’ve witnessed this firsthand over the course of the year as the symphonic evolution of cryptocurrency narratives and price action has driven new entrants, some exits from the space, and seat switching in both. This makes sense, as we are all optimizing to balance the potential upside reward of picking the right way to spend or time versus the opportunity cost of doing something less risky, or even fully traditional (and then allocating to cryptocurrencies on the side). More recently, we’ve seen public examples of shifts in behavior that are examples of “risking off”, or otherwise acting as if the digital asset world is less predictable and profitable than before. Examples include Circle’s winding down of its research division and then sale of Poloniex to Asian investors, expectations misses between hype and reality of new product launches, especially those geared towards institutional investors (e.g. Bakkt), as well as more personal observations where friends within the industry are either 1) joining larger projects vs. focusing on their start-up, or 2) exiting the industry entirely to return to prior career paths (although usually with the promise to re-engage).

The optimistic interpretation of these trends might be that as follows: 1) we as an industry are re-tooling for the longer-term battle for adoption, and talent is moving to the projects with the cash balances, VC funding, and brand name recognition to survive, 2) the labor market within digital assets may still suffer from oversupply (due to ideological identification, residual FOMO from 2017 etc.), and those pivoting now are alleviating the problem for the people remaining. The negative view is that 1) the smarter folks are leaving a ship that they believe to be sinking, as 2) profitable business models are still largely limited to liquidity providers like exchanges and lending desks, suggesting that 3) expectations for more robust economic systems to be built on top of blockchain and cryptocurrencies are still too high and need to be dialed back.

For better or worse, I think the juxtaposition of these two battling narratives will resolve decisively over the next 6–12 months, largely based on how BTC acts, primarily given how important the Bitcoin story and price action is for both incremental buyers and incremental sellers that remain sidelined for now. Specifically, this will revolve around interpreting datapoints to resolve some of the key debates around Bitcoin, which will then impact the trading price for the flagship cryptocurrency, which in term will affect new capital flows, business formation, and further progress in growing mindshare among the vast majority of the human population who still remain on the fence about the issue today. In the various sub-topics below, we’ll go through some of the most common bull and bear narratives in detail, and examine what the evidence suggests with respect to how closely reality follows the stories that are being told internally and externally to the digital asset community.

Bull Narrative: Halving & Stock-to-Flow

A decisive catalyst for 2020 will revolve around whether bitcoin’s price appreciates in a manner consistent with the stock-to-flow model. Originally popularized by a European-based pseudonymous research named PlanB via a popular Medium article published in March 2019 has seen a fair amount of follow-up academic work fleshing out some of the tests for statistical validity. The beauty of the model is tied to its simplicity, in identifying a meaningful relationship between the historic rate of inflation and bitcoin’s market capitalization, acting as a growing body of evidence that bitcoin is indeed taking on commodity money properties and commanding a monetary premium (consistent with other metal-based monies like gold and silver which also follow their own respective stock-to-flow models) as its consistent block-reward disinflation schedule continues to chug along. The dream-the-dream scenario for bulls results in bitcoin reaching ~$100k sometime before the end of 2021, if the model is proven right, subject to some subtle nuances (debates around whether the market will adjust more gradually or all at once after the step-wise reduction in the mining block reward actually occurs).

Conversely, the pervasiveness of discussion and expectation of the model within the broader bitcoin and cryptocurrency community suggests there will be increasing risk that optimism is already baked in, increasing downside price risk immediately following the halving itself. At this point, it remains too early to ascertain whether investors in the space are “too” optimistic about the S2F model, since currently prices are not that far outside the band, and remain nominal from the perspective of other on-chain valuation metrics (MVRV, SOPR), making me cautiously optimistic that the model likely can hold through at least 1 more halving cycle, since BTC’s stock-to-flow ratio will double from 25 to ~50, close to gold’s at 62. While it remains unclear what the upper bounds of the model are (a fully scarce asset with no new inflation doesn’t necessarily take on infinite value in its market capitalization), I’m comforted that bitcoin’s next step down doesn’t necessarily challenge the existing norms, though there will be a question of how many people get nervous about the 2024 halving immediately after 2020, or if the market will take its time to digest any nervousness later down the line.

More generally, there are critics that argue that the supply dynamics are so well-known that they shouldn’t affect market clearing price, but I think there’s nuance in realizing that a successful step-down of inflation may actually increase confidence in the long-term ability for Bitcoin to keep on the path towards its SOV thesis, thereby increasing investor demand, while also feeding into a positive feedback loop from a psychological perspective. Ultimately, I think there’s more potential for the halving to be a positive catalyst, so long as we haven’t breached new all-time-highs on price before then, since historically the event itself hasn’t been a discrete daily outperformance driver, though typically has occurred towards the beginning of the a multi-year rally upward.

Bear Narrative: Slow Adoption and Scaling

Bitcoin critics point to continued lack of meaningful adoption on scaling bitcoin in a way more meaningful for day-to-day commerce. Data points include the still-buggy deployment of Lightning (including a recent node operator losing 4 BTC), and public node and channel counts remain flat or down versus peaks achieved earlier this year. At the same time, median transaction fees on BTC remain in the ~40–50c range which suggests that congestion is still not really an issue on the base layer when compared to 2017, though it remains unclear what the negative impact would be on user experience if blocks were to fill up as much during the next wave of new onboarding. My own view is that the risk is much lower given greater exchange adoption of batching functions, SegWit, and other tech-based solutions. Overall, it looks like the consumer-facing custodial wallets that will enable more frictionless purchases aren’t going to be coming online or with the right retail partnerships until 2020, including the ICE / Starbucks collaboration as an example.

Thus, this bear criticism is actually quite fair, though not an Achille’s heel for BTC. The ability to pay with it clearly exists, but it appears that the largest usage for BTC is still a mix of speculation, international asset transfer, and value storage. I don’t expect the day-to-day medium-of-exchange thesis to be as important in the near-term, though to be clear, do think there needs to be the ability for BTC to be exchanged for goods and services eventually. This is an important point, where nobody should expect to “HODL” forever, but rather have a framework for when they would be reducing size of exposure. For now, the lack of everyday usage isn’t a big problem in my mind, as I now think adoption will result from more scaled / centralized services (wallets, points-of-sale, marketing campaigns, loyalty programs like Lolli etc.), and those are slowly rolling out. There are also signs of greater adoption internationally as compared to the US markets; for example, Italian newspaper La Stampa recently reported that Bitcoin-based online payments in Italy actually rank third, behind PayPal and PostePay, but ahead of credit card networks like American Express, Visa, and Mastercard for national e-commerce.

Bull Narrative: Risk-Off Macro Hedge, “Digital Gold”

The bull narrative of bitcoin as a risk-off asset is only somewhat true, and substantially weaker on a short-term basis, though may still be valid over longer timeframes. Earlier in 2019, there were greater instances of BTC prices following an inverse relationship with RMB. However, more recent price patterns, especially during periods of stress in traditional markets, tend to see behavior in cryptocurrency markets indicative of de-risking and forced selling, as opposed to hedging-related purchases.

For now, there remains tension between the fundamental characteristics of bitcoin that should be free from monetary policy distortion that affects traditional financial markets, and the reality of bitcoin now having grown large enough to slowly make its way into the existing world, thus being subject to some of the whims of traditional market participants who might only have a small allocation of bitcoin yet remain subject to risk parameters driven by their equities book. However, I think it’s important to acknowledge that even when Bitcoin is trading more like early-stage equity than like gold, that’s more a reflection of the particular market psychology at that point in time, since the fundamental characteristics of bitcoin don’t change on a whim. While “digital gold” is a convenient narrative, my own view is Bitcoin already has shown it doesn’t like to neatly fit in a box, and I don’t think it’ll necessarily conform to our existing expectations, even in the fullness of time, and may continue to oscillate between a risk-on and risk-off asset for quite some time — though this does not preclude the absolute return generation potential.

Bear Narrative: Lack of Fundamental Value Means No Buyers of Last Resort

This was more fully covered in my article on the problems associated with the simplistic Greater Fool Theory, but being charitable to the bears, there is a more sophisticated point of contention on the lack of buyers of last resort due to the difficulty in identifying fundamental metrics of value for bitcoin. In contrast to the world of traditional assets where there are special situation funds and distressed debt investors who specialize in identifying and conducting diligence to find value in the hairiest situations, there’s a narrative about the lack of buyers of last resort in bitcoin, and in fact the presence of mining rewards and miners having fixed fiat costs result in a market structure where there’s greater incremental supply, at least initially.

However, I think this is actually incorrect, since Bitcoin’s unique supply schedule and network dynamics also require contemplation of active holders (those who choose not to sell). Bitcoin researcher and recent addition to the Kraken team Pierre Rochard went through an exercise listing potential sources of incremental buying support, including employers that pay in bitcoin, recurring, windfall, and opportunistic buyers. This particular bear point is one of the weaker ones, for two primary reasons:

The universe of incremental buyers (likely new money) is continuing to expand with greater mainstream awareness, specifically those willing to be opportunistic during shorter-term price corrections, even if they have not yet committed to entering the market. The universe of incremental sellers at a given price decrease over time, assuming progression in the money-ness of Bitcoin, as evinced by greater SOV usage, means of exchange on layer 2 (once bugs are fixed). Interestingly, interviews of miners at industry events show greater consensus around holding (instead of selling) at lower prices, assuming they have scale to remain profitable, manage fiat payable accounts, and let competitors get shaken out.

Overall, the above dynamics suggest net upward price pressure as being more likely over the long term versus depreciation (barring catastrophic challenges to the unique attributes of BTC), as the fixed supply schedule coming from primary production (mining) means the behavior of existing holders also matters a great deal. Publicly available analysis of the on-chain behavior of UTXO sets suggests that the majority of long-term holders (3–5 year and 5+ year) continue to believe in higher valuations for BTC, despite some short-term volatility driven by shorter-duration speculators.

Bull Narrative: Chinese Blockchain Push

With President Xi of China formally leading a shift in tone towards favoring blockchain innovation as an arena for global technology leadership, the stakes have been raised even higher than before. To be clear, I believe the bigger positive impact on Bitcoin and other public chains may be from the United States’ response, as opposed to expectations of Chinese adoption of the existing coins over new, fully-approved and supported government-based implementations. It would be overly simplistic to expect that Chinese citizens will ultimately prefer and buy bitcoin once they are introduced to using the DCEP, especially since existing private market payment systems like AliPay already offer best-in-world convenience and security.

However, I believe that the renewed focus and government-level promotion and funding of blockchain start-ups, education, and focus as a new battleground (see China’s policy-driven AI leadership) likely will subsidize and generate new best practices for development and implementations of blockchain tech that can then be ported over to the public open protocols that the rest of the world would use. We’ve already seen the internet bifurcate into China vs. Rest-of-World, and I expect this to happen for cryptocurrencies as well, especially once the digital RMB starts more aggressively getting exported out of China.

While this initially will come under the guise of settling payable balances related to the Belt-and-Road Initiative (BRI), I expect there may also be additional areas of focus for acceptance of China’s DCEP, such as international retail in European and American cities where Chinese tourists tend to go (for example, a lot of flagship retail stores on 5th Avenue in Manhattan proudly display badges alerting of acceptance of Alipay, UnionPay etc.) or as part of global trade settlement between multinational corporations, especially in the manufacturing / technology spheres. Thus, I expect US to respond in ways that initially favor the dollar first, such as partnering more aggressively with Libra’s stablecoin shift (instead of the initial basket-based approach) as the first counter-offensive, while opening the door to greater support of global public chains as well. We’ve seen this story many times before, from private-owned infrastructure (intranet vs. internet), migrating eventually to public resources, and I believe this will play out for most of the world. Though China’s future is less certain, its actions in favor of the underlying technology (even if applied in permissioned ways) is absolutely a positive effect on the rest of the public projects, including Bitcoin.

Bear Narrative: Blockchain, Not Bitcoin

Related to the China point above, the most pervasive commentary that bitcoin bears like to point to refers to their belief in the underlying implementation being more important from a tech perspective than the network effects, social consensus, and community hivemind that emerges around any particular cryptocurrency. This then results in criticism such as identifying a protocol that will be the “bitcoin killer” due to faster transaction speeds, or fixing other issues common to layer-1 protocols (e.g. with a “better” or more fair consensus and voting mechanism). Similarly, there are industry participants that find themselves in this camp due to having invested in the equity or tokens of some of these Bitcoin or Ethereum killers, and are also talking their book to a large degree, despite user metrics being quite low for a lot these newer projects, or nonexistent if they’ve not yet launched a main net. The dynamic here reminds me of the adage that “the perfect is the enemy of the good” — we’re running out of time for a good-enough solution to scale geographically and vertically across products and cannot afford to wait much longer.

My own view is that the “blockchain, not Bitcoin” crowd large suffers from having not thought through some key factors such as 1) what gives money its value (hint: shared belief among as many people as possible), 2) social signaling dynamics where blockchain is the more socially acceptable term within the Overton window than Bitcoin (though this is changing), and 3) mental hedging against being wrong, in the sense of diversification in case bitcoin is not a winner in the long-term. Ultimately, I continue to think that the bulk of the value generated in the next few decades will relate to cryptocurrencies, not esoteric blockchain projects, though SOME of the web 3.0 initiatives (especially ETH which has such a large developer and goodwill lead compared to other smart contract platforms) will ultimately make their way into and replace the existing traditional internet infrastructure.

Conclusion: Risky, but Rewarding

As an investor focused exclusive in digital assets, my most valuable asset is my time. Since bitcoin is already the biggest asset in the space and a meaningful driver of price performance for all other altcoins, and has a unique 2020 catalyst via the halving, I think it deserves the bulk of time, focus, and investment capital decision-making consideration for the near term. If this whole experiment with decentralized and permissionless digital bearer assets ends up working out, Bitcoin will be a major participant, while most other assets remain thinly-traded distractions that require incredibly greater diligence and care to evaluate despite offering minimal opportunities for incremental upside (when adjusted for volatility and greater operational, custody, and trading risk). To be clear, I believe there will very likely be a handful of unique protocols that will outperform against fiat and BTC ratios despite these factors — it just might not be worth your time and sanity to comb through to find them for yourself.

In conclusion, I hope outlining the most prominent bull and bear themes related to Bitcoin today helps with your own thought process and where you see things going, as we all have to decide on our own what risks matter more, and act in the market to express our views on the timeframes most appropriate to our own appetite. Although the Bitcoin whitepaper recently celebrated its 11th birthday, Bitcoin remains early in its lifecycle, and a consensus view of what 2020 will bring has yet to emerge, even locally among the people aware of and immersed in the ecosystem, not to mention the billions of people who have yet to seriously think through what value Bitcoin might be able to offer them in a future with more robust businesses built on top of this new base layer of money storage and transfer.