The market cap of Bitcoin is 8.5bn USD.
There are by many accounts only 1-2 million owners of Bitcoin. Technocrats, anarcho-capitalists, nerds, VCs, and a couple big names on Wall Street make up the large majority of those who own Bitcoin. As a currency, 8.5bn seems awfully inflated relative to the community size of 1-2 million people on this planet willing to trade in Bitcoin.
On this level, it is understandable for those outside the Bitcoin community to look at it all as one gigantic bubble waiting to pop. For many, it’s already popped - falling from a high of 1200 USD to ~400 USD with China’s apprehensions, MTGOX exchange going kaput, and a myriad of skepticism stemming from traditional institutions and asset managers.
Yet Bitcoin rose over 30% in the month of May. After sitting in the doldrums at $400, Bitcoin has risen aggressively up to $680 (As of June 1).
One major concern highlighted by skeptics is the issue of scarcity or potential lack thereof. The argument goes that while bitcoins are limited in supply, there exists an infinite amount of alternative digital currencies that can be created. However, recent price action has demonstrated the strength of Bitcoin’s network effect. Despite more than 200 alt-coins appearing all within the past 6 months, their cumulative cut of the digital currency market cap is falling precipitously. Bitcoin makes up well over 90% of the total market cap and that number is rising.
The market cap of a digital currency is extremely deterministic of the types of transactions it can facilitate. Therein lies the beginnings of the story of Bitcoin’s undervaluation.
Over recent months, many have realized that the invention, the technology underpinning Bitcoin and altcoins is capable of much more than serving as a Store of Value or Currency. It can be used for remittances, smart contracts, stock issuance and ownership, and any form of asset transfer imaginable. That’s the power of the decentralized public ledger.
With that understanding, the takeaway is profound.
For digital currencies to facilitate these activities doesn’t only require building out the infrastructure, the ecosystem and the various layers above the protocol - it necessitates that the market cap be several orders of magnitude bigger than it currently is. By extension, if Bitcoin itself needs to be several folds bigger than 8.5 bn, then you can forget about any of the current alt-coins being used for these identified purposes. That’s not because alt-coins are not limited in supply or an equal in technology to Bitcoin, but rather because it lacks the sufficient market cap and accompanying liquidity to facilitate remittances, smart contracts, stock issuance and the like.
To emphasize this point, let’s look at the various merchants that have begun accepting Bitcoin. Over the past few months, we have seen coffee shops, small individual online vendors, and some corporates such as DISH Network, Overstock.com, Fancy.com, Tiger Direct and others accept payment in Bitcoin.
The skeptics of Bitcoin including Warren Buffett argue that this development only proves that Bitcoin may be an improved form of payment - saving merchants credit card fees, eliminating chargebacks etc, but does little in the way of giving bitcoins themselves any value. They say that it doesn’t matter to the end consumer or the merchant what the price or market cap of Bitcoin is because the merchant will simply hedge out their bitcoins back into Dollars or whatever fiat currency they use. Bitcoin isn’t being used as a unit of account - just as a payment processor. By extension the conclusion goes that it doesn’t matter what digital currency is facilitating the lubrication of the payment process either - further compromising the notion that bitcoin has value.
While compelling, this view among the skeptics is short-sighted and doesn’t scale. At the current market cap of 8.5bn, if Donald Sterling accepted Bitcoin as payment from Steve Ballmer for the purchase of the LA Clippers for 2bn, Bitcoin simply does not offer the liquidity for Mr. Ballmer to acquire 2bn dollars of it without grossly increasing the price nor does it offer Mr. Sterling the liquidity to hedge out his bitcoins should he wish to without grossly slamming the price to the ground.
The number of Bitcoins ever to exist are fixed at 21 million with 13 million currently in play and about 8 million still to be mined until 2140. At the current valuation, Mr. Ballmer would have to buy up around 3 million BTC or around 25% of the coins. That would be an imprudent thing to do. It’s important to note however, that the technological benefits and efficiencies of Bitcoin should translate as well for the purchase of the LA Clippers as they do for the purchase of a cup of coffee. The market cap just isn’t significant enough at the moment to accommodate for larger use cases. The same restraints are preventing a billion dollar company from raising funds through an equity offering on the Bitcoin blockchain or a million people from doing remittances on the same day.
But it’s not the 21 million fixed supply of bitcoins that’s restricting the possibilities. Bitcoin is infinitely divisible. It’s the present day market cap that’s too low. The value of each bitcoin would have to rise sharply so that a 2bn dollar purchase equates to perhaps 30,000 BTC, not 3,000,000 BTC. That’s what is needed to facilitate remittances, stock issuances, smart contracts, replacing large wire transfers and the like.
For Bitcoin, as with any asset that has the potential to escalate in price with a significant degree of risk, human nature and animal spirits tends to ensure a volatile path.
This volatility is simply a means to an end.
We should not desire for Bitcoin’s value to stay constant and stable right now. If Bitcoin mirrored the present fluctuations of the USD, the EUR or JPY, it would mean that Bitcoin will forever stay inconsequential - stuck at 1/10,000th the size of fiat and unable to deliver on the vast potential that it promises.
If the technology can scale, then so too will the market cap.
That’s the case for why Bitcoin is grossly undervalued.