Editor’s note: This article is the third in a three-part series. The plain text represents the handwriting of Greg Foss, while the italicized copy represents the handwriting of Jason Sansone.
In the first two installments of this series, we reviewed many of the fundamental concepts needed to understand credit markets, both in “normal” times and during contagion. To wrap up this series, we’d like to explore a few methods by which one might arrive at a bitcoin valuation. These will be dynamic calculations, and admittedly, somewhat subjective; however, they will also be one of many rebuttals to the claim often suggested by non-coinmakers that bitcoin has no fundamental value.
Before doing so, we want to state five fundamental principles that underlie our thesis:
- Bitcoin = math + code = truth
- Never bet against open source platforms
- Money has always been a technology to make our work/energy/time expenditures today available for consumption tomorrow
- Bitcoin is a programmable monetary energy… A store of value, transferable over the most powerful computer network in the world
- Fiats are programmed to degrade
First evaluation method: the Fulcrum index
I believe bitcoin is “the anti-fiat”. As such, it can be seen as default insurance on a basket of sovereign/fiat currencies. This concept has a value that can be calculated quite easily. We call this calculation the “fulfillment index”, and it shows the cumulative value of credit default swap (CDS) insurance on a basket of G20 sovereign countries multiplied by their funded and unfunded obligations. respective funded. This dynamic calculation forms the basis of a current valuation method for bitcoin.
Why is bitcoin the “anti-fiat”? Simply put, it cannot be downgraded. Absolute supply is fixed. Always. This is the exact opposite of the current global fiat currency regime. How, then, can it be considered “default insurance” on a basket of sovereign/fiat currencies? Basically, the value of the insurance contract increases as the risk increases, and the (credit) risk increases as the fiduciary impression continues.
Let’s use the United States as an example calculation. The federal government has over $30 trillion in outstanding debt. According to usdebtclock.org, as of this writing, it also has $164 trillion in unfunded liabilities in Medicare and Medicaid obligations. Thus, the total of funded and unfunded obligations is $194 trillion. This is the amount of fiat that must be insured in the event of default.
At the time of this writing, the five-year CDS premium for the United States is priced at 0.12% (12 basis points, or bps). Multiplying this by the total debt obligations ($194 trillion) yields the value of CDS default insurance of $232 billion. In other words, based on CDS market data, this is the amount of fiat that the cumulative total of global investors are expected to spend to purchase default protection in the United States over the next five years. .
If five-year CDS premia widen to 30 basis points (match in canada at the time of this writing), the value jumps to $570 billion. Note: This calculation uses a fixed term of five years. That said, the weighted average outstanding obligation is greater than five years, due to Medicare and Medicaid, and therefore we decided to extrapolate to a 20-year term. Using a duration calculation, the implied 20-year CDS premium for the US is 65 basis points. In other words, just using the US as a component of the G20 basket, we have a valuation of $194 trillion times 65 basis points = $1.26 trillion.
If we now expand to a broader view, our calculation of the current G20 support index is over $4.5 trillion.
Anyway, according to this methodology, the fair value of bitcoin is around $215,000 per bitcoin today. Note: This is a dynamic calculation (since the input variables are constantly changing). It’s somewhat subjective, but it’s based on valid benchmarks using other clearly observed CDS markets.
At a current price of around $40,000 per bitcoin, the fulcrum index would indicate that bitcoin is very cheap at fair value. As such, since every bond portfolio is exposed to sovereign default risk, it would make sense for every bond investor to have bitcoins as default insurance on that portfolio. My view is that as sovereign CDS premia increase (reflecting increased default risk), the intrinsic value of bitcoin will rise. This will be the momentum that allows the Pivot Index to continuously revalue bitcoin.
Second Valuation Method: Bitcoin Vs. Physical Gold
Bitcoin has been called “Gold 2.0” by some. Arguing for this is beyond the scope of this article. Anyway, the market capitalization of physical gold is about 10 trillion dollars. If we divide this amount by the capped supply of 21 million bitcoins, the result is approximately $475,000 per bitcoin.
Valuation method 3: Bitcoin as a percentage of global assets
As I recall, the Institute for International Finance estimated total global financial assets in 2017, including real estate, at $900 trillion. If bitcoin captured 5% of this market, we could calculate $45 trillion divided by 21 million to find a value of $2.14 million per bitcoin, in today’s dollars. With a 10% market share, that’s over $4 million per bitcoin.
Fourth Valuation Method: Expected Value Analysis
Based on the expected value, bitcoin is also cheap, and with each day the bitcoin network survives, the left side (towards zero) of the probability distribution continues to decrease while the skew on the right side is maintained. Let’s do a simple analysis using the figures calculated above. We will formulate a distribution that has only five outcomes, with arbitrarily assigned probabilities.
|Evaluation method||Approximate assessment||Probability|
Bitcoin versus physical gold
5% of global assets
10% of global assets
The expected value result for this example is greater than $150,000 per bitcoin.
Given bitcoin’s recent price levels, if you thought this was in line with your calculating expected value, you would buy with both hands. Of course, there is no certainty that I am right. And this is not financial advice to run and buy bitcoin. I am simply presenting an evaluation methodology that has served me well over my 32-year career. Do. Your. Own. Research.
For the record, my base case is significantly higher than that, as I believe there is a real chance that bitcoin will become the reserve asset of the global economy. The tipping point of this event is when bitcoin is adopted as the global unit of account for trading energy commodities. I think it makes sense for countries that sell their precious energy resources in exchange for worthless fiat to switch from US dollars to bitcoins. Interestingly, Henry Ford foreshadowed it when he said a long time ago that it would replace gold as the basis of money and substitute in its place the imperishable natural wealth of the world. Ford was a Bitcoiner before Bitcoin existed.
Digital monetary energy stored on the world’s largest and most secure computer network in exchange for energy to power power grids around the world is a natural evolution based on the first law of thermodynamics: conservation of energy. ‘energy.
These are huge numbers, and they clearly show the possibilities for asymmetric returns from the bitcoin price curve. In reality, the probability/price distribution is continuous, bounded at zero with a very long tail to the right. Given its skewed return distribution, I think having zero bitcoin exposure is riskier than having a 5% portfolio position. If you’re not long in bitcoin, you’re irresponsibly short.
If you are a fixed income investor today, the math is not in your favor. The current yield at maturity of the “high yield” index is about 5.5%. If you factor in expected and unexpected losses (due to default), add in a management expense ratio, and then factor in inflation, you end up with a negative real return. Simply put, you are not earning an appropriate return on your risk. The high-yield bond market is heading for a major balance sheet.
Don’t think about it too much. Reduce your time preference. Bitcoin is the purest form of monetary energy and is portfolio insurance for all fixed income investors. In my opinion, it’s cheap on most rational expected value outcomes. But again, you can never be 100% sure. The only certain things:
- Fiat debasement in progress
- A fixed supply of 21 million bitcoins
Study math…or end up playing silly games and winning silly prizes. The risk comes quickly. Bitcoin is the hedge.
It would seem that everyone should understand the basics of the credit-based monetary system on which our governments and countries operate. If we want to defend the ideals of a democratic republic (like Lincoln said“…a government of the people, by the people, for the people”), then we must demand transparency and integrity from those of us whom we have chosen as leaders. It is our duty as citizens: to hold our leaders accountable.
But we can’t do that if we don’t understand what they’re doing in the first place. Indeed, financial literacy is sorely lacking in the world today. Unfortunately, it appears to be by design. Our public education systems have 12 years to teach and so allow us to think critically and challenge the status quo. It is through this process of empowering society that we strive to achieve, and collectively realize, a better future.
Yet it is the same process by which we remove the centrality of power. And that, make no mistake, is a threat to those at the top of the system. Often this power is concentrated in the hands of a privileged few (and the rest) due to a disparity in knowledge. Thus, we find it tragic that an article like this even needs to be written… However, perhaps Satoshi’s greatest gift to the world was rekindling the fire of curiosity and critical thinking in each of us. That’s why we bitcoin.
Never stop learning. The world is dynamic.
This is a guest post by Greg Foss and Jason Sansone. The opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.