The longest economic expansion ever
Following the global financial crisis in the year 2008, central banks across the world devised a number of temporary measures to arrest the impending economic collapse. These include lowering of interest rates, buying up of debt at record levels and printing of physical money. Little was done in terms of actual reforms within the banking sector and the wider economic machinery. Why? Nobody wants to swallow the bitter pill of declining growth.
The ‘Keynesian’ economic system operates in cycles of boom and bust. Therefore, a cooling period that is recessionary in nature is required. This can be thought of as the reset button before subsequent economic growth resumes. Instead of allowing unprofitable banks and business to fail in 2008, the central banking cartel of the world went on a hyper-drive to stimulate the longest economic expansion ever recorded in history.
A quick look at these charts demonstrate the insanity of ballooning asset valuations especially within the last 10 years since the crisis. Stock market indices are at all time high while companies are able to perform stock buybacks. Availability of cheap credit from central banks is enabling this misadventure. Growth cannot go on for ever and the bubble will burst. Is 2020 the year when all hell breaks loose?
Bitcoin is non-correlated to other major assets. Statistical analysis proves this and the price action confirms that Bitcoin does not appear to be affected by economic coordination of central banks. Without any controlling party except during the initial period of conception, Bitcoin has time-tested evidence to back-up this claim. Throughout 2019 for example, no correlation was found between Bitcoin to gold and the S&P 500. Bitcoin’s 94 percent gain was superior to gold’s (18% gain) and the S&P 500 (29% gain). None of this is attributable to the stimulus provided by central banks unlike that seen with stock.
Just within the first month of 2020, Bitcoin has completely outpaced other assets with more than 30% gains at the time of writing. Capital diversification into Bitcoin is now becoming the norm for major hedge funds and institutional investors with about 5-10% of portfolio allocation. Spurred by early geopolitical events (threats of US-Iran) and disease outbreak (Wuhan Coronavirus), chances are that more fund will flow into Bitcoin and cryptocurrencies in general in 2020.
The Bitcoin protocol has some very interesting properties to qualify as the hardest money known to mankind. Supply is limited to 21 million coins. The proof of work (POW) consensus ensures that value in the form of energy is spent to produce new coins at a rate of 1800 coins per day or about 0.7 million per year. Emission is rapid in the initial years with programmed decline in rate that occurs every 210,000 blocks. This takes about 4 years between emission rate reduction and is termed as the Bitcoin halving. It is a very elegant way of rewarding the early adopters. The year 2020 is special as it is the third time that block rewards are cut in half from 12.5 coins to 6.25 coins every 10 minutes. Miners who spend precious electricity to solve the complex mathematical to validate the block will have a smaller reward when the halving occurs. The following is highly important to take into consideration:
- Miners earn rewards by selling the coins that they earn. This drives down the price of Bitcoin. With the halving of rewards, there will be fewer coins on sale leading to softening of the downward price pressure.
- Scarcity of Bitcoin is real. Fewer coins will be available for adoption and fewer still left to mine. 18 million Bitcoins have been mined in the past 11 years. The remaining 15% will be mined between now and 2140. Awareness and recognition of Bitcoin’s value as a store of value and safe-haven is on the rise.
- No other cryptocurrency (even Bitcoin forks) has sufficient security through decentralization and value in the form of energy packed into each Bitcoin. With more miners turning on their ASICs each day, the hash-rate (computing power to solve the mathematical equation) has been setting record levels.
A model to guide us
Based on the above first 2 factors alone, a stock to flow model of Bitcoin has been proposed here. To describe it in a simple manner, this is the amount of coins produced over a period of time against it’s existing supply. With 18 million coins in circulation and 0.7 million currently produced per annum, the stock-to-flow (S2F) of Bitcoin is 25. We can make the following comparisons:
- Gold S2F is 62
- Silver S2F is 22
- Pre-halving Bitcoin S2F is 25.
Higher numbers signify increasing scarcity. Block reward halving will reduce production in half and increase the scarcity of Bitcoin. Post-halving S2F of Bitcoin will be 55 which is close to gold. Still having doubts about Bitcoin’s moniker as digital gold?
Scarcity also relates to market value in interesting ways. The S2F model has a high degree of correlation with market value as shown below. In fact, 95% in price variability is explained only by the S2F model (scarcity). The remaining 5% possibly relates to factors such as supply-demand relationship, technical obsolence and others.
Remains to be proven wrong
The S2F model has performed well historically but only time will tell if it holds true and for how long? Target price for 2020 based on the model is at USD 55,000 per Bitcoin and can serve as the first litmus test. It is also probable that we could see a collapse in the value of the US dollar with the extreme devaluation leading to the search for an alternative store of value that is liquid and easily transferable. A property that gold fails on multiple counts.
Ignore at your own peril
Bitcoin’s rise to dominance will begin in 2020 as it captures valuations from other asset. Within a decade, we are likely to experience a period of Hyper-bitcoinization with everything in the physical world valued in BTC or satoshis. The big question is, are you ready for it? We are on the verge of greatest wealth transfer in this new decade. How are you going to position yourself?