As someone that started buying BTC in the spring of 2013, last year’s run up was nothing short of spellbinding as price kept going up with little or no respite. Yet, by the end of 2017, it started to became clear that, in classic bi-polar cognitive bias, that kind of extraordinary exuberance had to give way at some point to an equal and opposite sentiment of gloom. Hence my November 28th 2017 brief op-ed titled “Bitcoin’s technicals are signaling a major correction ahead”.
As BTC was approaching $10,000, the article opined that technical analysis suggested a major retracement and a reversion to its long term trend. Two months later, BTC had managed to double and almost reached $20,000 validating even more the overbought thesis. In the same piece I pointed to an undermost support level just below $3,000. $2,941 to be precise if Bitstamp’s price series is considered. While that support level has yet to be tested as of the date of this article, it looks like the price may indeed be reached at some point in the near future.
While pundits and media are once again announcing for the umpteenth time the “death” of BTC, it may be useful to take a pause and consider possible long terms scenarios. For sake of brevity I will not restate here the investment case for BTC. I do maintain my view as the case for a sensible allocation to BTC has not changed over the last twelve months and, if anything, has become stronger. Please refer to my April 2017 “Bitcoin is on a tear but here’s why the price could go a lot higher” for further detail.
It is worth however to remind that, given the finite nature of BTC, the price is fundamentally driven by demand (e.g. adoption) along the lines of the classic “S curve” first developed by E. Rogers in 1962. According to such model, innovation goes to four stages of adoption before reaching its full potential. Given that the current number of BTC wallets is approximately 25 million at this time and that single owners typically control more than one wallet, it is reasonable to assume that BTC is currently held by anywhere between 10 and 20 million owners, be it individuals or institutions. Using any number of other store of value comparables and assuming the potential ownership for BTC at a very large number in the X00 of million, it is safe to assume that adoption is still somewhere in the “early” stage.
Using BTC’s price history over the last 10 years, what we know of the asset class and, more in general, of the life cycle for technological innovations, we can identify three base scenarios for the price of BTC:
- “The pause that refreshes” - Whilst the -80+% decline has been a shocker to most observers, it is critical to bear in mind that BTC has suffered similar/worse declines at least four other times since 2011. Past declines, no matter how severe, have always been followed by periods of consolidation and, eventually, by new highs. Yet it would be a mistake to assume that “past is prologue” as one big difference this time around may be the breadth of the adoption relatively to the previous bull cycles. As a lot more BTC newbies have been burnt and suffered significant losses, it is possible that this bear phase may end up being, if not deeper, at least much longer than the past ones. Looking at the past bear cycle, it would not be surprising if the current phase of consolidation could last well into 2020, e.g. 24–36 months. Nonetheless, at some point, the distribution of ownership from “weak” to “strong” (e.g. asset allocators) will be completed and the thinning out of selling supply may start to push prices higher once more and a re-ignite a new bull phase. As a new ascending trend is established and in light of the very finite supply, the network effect will kick in again and lead to higher and higher prices.
- “A better mousetrap”- Most intellectually honest observers would agree that the idea of using technology to store and transfer value is here to stay at this point. The question is rather of the extent of which BTC will be used for that purpose relatively to other digital assets. It is hard to imagine another crypto currency to outright steal BTC’s dominant position. The leading crypto currency has a significant moat in terms of first mover advantage and has shown tremendous resilience against a variety of hacking and other attacks over the last decade. It is possible however that a superior technology or a successful breach may significantly impair adoption and open the way to alternative crypto currencies. Furthermore, a number of possible store of value competitors may start to gain popularity in light of the fact that same technology that “powers” BTC can also be used to own and manage any variety of assets such as gold, real estate, precious art etc. Lastly it is also possible that a major central bank or financial institution may succeed in establishing their own crypto currency platform. A mitigating aspect of such scenario is that such platform may not be decentralized and, therefore, would be inherently riskier than BTC. At any rate, any major competition or substitute would impair BTC’s adoption and therefore come to bear on its price.
- “Black swan”- BTC was designed by Satoshi Nakamoto as reaction to the 2008 financial crisis and a way to protect value from the vagaries of a financial system controlled by political actors. The possible best case scenario for BTC may therefore be another major crisis, financial or else, that may prompt economic participants to seek safety in an asset class that is totally uncorrelated and uncontrolled by governments/financial institutions. Given that BTC carries no country, counter-party or custodian risks (provided the owner has controls of her wallet’s keys) at a time of great disruption BTC may become the best, if not the only, “safe” asset. In the face of “panic” demand, given the very limited supply, it is reasonable to assume very few holders would want to trade BTC for currencies of dubious value and it is entirely possible that prices may not only make new highs but also reach levels that would not even be considered possible in the current environment.
It is very difficult to assign an accurate probability to each of the above scenarios. It is however reasonable to make a few logical considerations:
- Scenarios #1 & #3 would both drive adoption and, therefore, because of the finite supply, would be positive for future price appreciation. While #1 may provide a for a slower trend, #3 would drive fastest adoption curve and price increase.
- Scenario #2 would be adverse to BTC’s price appreciation. Furthermore a better mean to digitally store value may imply further and possibly very rapid decline of BTC’s price.
- Scenario #1 is based on historical data as in not less than 11 occasions BTC has recovered from price declines ranging from 30 to 94%. On the other hand, scenarios #2 and #3, while entirely plausible, are predicated on “unknown unknowns”. It is therefore logical to assume that scenario #1 may carry a level of probability even just marginally higher than #2 & #3. Assuming #1 has 34% probability, #2 and #3 would each carry 33%.
- Based on the above reasoning, the aggregate probability of the two positive scenarios, (#1 + #3) would therefore be 67%. Even wanting to be more conservative and assigning to #2 an higher probability, the two positive scenarios would still likely be above 50%.
I suspect there are a few different ways to approach the issue and I do not expect the above logic to be exhaustive. Yet if the reasoning is fundamentally correct, at the current price levels BTC may carry a resonably attractive risk/return profile as there would be at least an above 50% probability of its price making new highs at some point in the future. While we are clearly looking at a highly speculative asset, perhaps something to consider as a hedge against “fiat” assets in the context of a well diversified portfolio allocation.
The information on this document should not be interpreted as or deemed to be a recommendation to any investor or category of investors to purchase, sell or hold any security, currency or crypto currency. Any investment decisions must in all cases be made by the reader or by his or her investment adviser. The views expressed on this email are solely those of the writer.