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A Primer On Digital Assets, Part 1: Bitcoin

Updated: Mar 31, 2020

Within the digital asset ecosystem, colloquially referred to as cryptocurrency, there exists four primary asset classes: bitcoin, stablecoins, security tokens, and real estate tokens. Digital asset classes are distinguished by characteristics and market structure, as are their traditional counterparts. This four part primer explores the characteristics, market structure, and growth potential of the four primary digital asset classes. Part 1 of this primer will focus on bitcoin, part 2 will focus on stablecoins, part 3 will focus on security tokens, and part 4 will focus on real estate tokens.

Part 1: Bitcoin

Bitcoin is the oldest and most established digital asset class. It can most simply be described as a digital upgrade to traditional hard commodities. Similar to hard commodities, new bitcoin are digitally mined along a fixed supply schedule using specialized computer hardware. Anyone can purchase and operate this computer hardware, however operating at a profit requires access to low cost electricity. Unlike hard commodities, bitcoin has a built-in payment system which enables its users to digitally send and receive the asset. This means no third parties are required to send and receive bitcoin, although there are third parties which offer digital asset storage at enterprise scale.

There are multiple digital assets that have been created in an attempt to replicate bitcoin, often with added features, however these digital assets suffer from reliability and centralization issues. Litecoin and ethereum are the most well known of bitcoin alternatives and are utilized for testing new features that may later be added to bitcoin. For features not able to be added to bitcoin’s core codebase without causing network disruption, additional technology layers are built on top of bitcoin’s core codebase that are opt-in for users of these features.

Over $3.3 trillion was transferred using bitcoin’s built-in payment system throughout 2018. Its growth in this regard lags behind previous years, though still signals a healthy amount of usage for payments. Bitcoin’s transfer volume is comparable to mainstream alternative payment systems and currently dwarfs transfer volumes of other digital asset classes. Custodial bitcoin transfer services are mostly regulated under existing money transfer regulations. While the technology for storing, sending, and receiving digital assets, colloquially referred to as ‘wallets’, is most advanced for bitcoin, concerns are often shared among the community in regards to its lack of intuitive user experiences and interfaces. Improvements in user experiences and interfaces of bitcoin wallets as well as meaningful increases in the quantity of merchants accepting bitcoin for payment will set the stage for further growth in bitcoin payments.

Exhibit 1: Transfer Volumes of Bitcoin & Traditional Payment Systems

Sources: Satoshi Capital Research, Wall Street Journal, Company Self-Reporting

The value of yearly bitcoin trading volume exceeded $2.2 trillion in 2018. It is primarily traded on online exchanges which enable real-time buying and selling of the digital asset using traditional currencies. It is mostly traded spot or as futures contracts. Growth in trading volumes at bitcoin exchanges has been meteoric over the past few years, with international exchanges, particularly in Asia, leading the way. It is worth noting that there is also a burgeoning OTC market for bitcoin, in which billions of dollars worth of the asset is traded directly between buyers and sellers, without exchanges. Satoshi Capital Research estimates more than $100 billion in bitcoin was traded OTC in 2018. While the bitcoin OTC market is relatively similar to the OTC market for traditional commodities, it is not as liquid. Buying and selling hundreds of millions of dollars worth of major traditional commodities, such as oil or gold, OTC is common and a fairly simple process that adheres to established procedures. However, buying and selling hundreds of millions of dollars worth of bitcoin is currently a relatively arduous effort, prone to high transaction costs, meaningful market impact, and lack of process standardization. Bitcoin trading is regulated in most markets by existing banking regulations, with a few jurisdictions launching digital asset-specific regulations. Integration of bitcoin into traditional trading and custodial processes will set the stage for further growth in bitcoin trading.

Exhibit 2: On-Exchange Trading Volumes of Bitcoin & Traditional Commodities

Sources: Satoshi Capital Research, World Gold Council, Reuters, Business Insider

Bitcoin currently has a market value (MV) of $88.5 billion, comparing well with most other hard commodities. Satoshi Capital Research estimates this can eventually grow to $17 trillion. To estimate the growth potential of bitcoin’s MV, Satoshi Capital Research created a simple methodology to determine a total addressable market (TAM).

TAM = MV of gold + MV of negative yield bonds

TAM = $7.7 trillion + $9.3 trillion

TAM = $17 trillion

To explain this methodology further, the MV of gold is included as gold is the commodity most widely utilized as a store of value. In an increasingly digital world, the utility of gold as a store of value due to its scarcity and shininess will likely be diminished as it can be replicated in labs as even shinier objects and it offers no value to digital transactions over alternatives. We see the value currently stored in gold transitioning to bitcoin over time, as its utility as a store of value diminishes due to artificial supply growth (i.e. lab grown gold) as well as potential long term supply shocks (e.g. asteroid mining). The MV of negative yield bonds is included as bonds are the asset most broadly associated with long term storage of value. The utility of bonds as a store of value is greatly diminished with negative yields, as negative yields indicate a cost on capital to investors as opposed to the expected return on capital. While bitcoin does not offer a yield to investors based on interest rates, it offers yield in capital appreciation due to its inherently deflationary nature. Bitcoin is inherently deflationary as there is a known and limited total supply that is being introduced to the market at a known schedule, yet there is variable demand that trends upwards over time. Therefore, the deflationary nature of bitcoin offers investors utility as a source of reliable and predictable yield over the long term that is increasingly competitive with negative yield bonds. Improvements in quality to bitcoin markets and transfers will set the stage for further growth in traditional investor appeal.

Exhibit 3: Current Market Values of Bitcoin & Traditional Commodities

Sources: Satoshi Capital Research, David Davis, JM Bullion, Visual Capitalist

There is clearly a long road still ahead for the oldest digital asset class. However, should it realize full potential, there exists trillions of dollars in business opportunities that are already creating the world’s next great enterprises.



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