Bitcoin as an Asset Class (Part 1)

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One important characteristic of this new type of data structure that is the blockchain is that it has a unique property, namely that the read-write operation to access that database is in the form of a token that is, by its very design, liquid, tradable and transactable. In that sense, Bitcoin has created an entirely new asset class and a novel platform model that we have not seen before.

The growing universe of public blockchain networks with their own tradable tokens that borrow the idea of a scarce native, digital asset to align incentives from Bitcoin is spawning an entire new Crypto asset class that we believe is not only there to stay but will in time become a bona fide fifth asset class that will take its place alongside established, traditional asset classes or concepts such as equity, debt, metals & commodities and real estate.

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All the properties of BTC speak to why Crypto from a financial perspective is so interesting. If we think of money as stored work energy. What we are seeing is that a lot of energy in the form of stored fiat currency units is flowing into the space/market cap of crypto at the moment. The time, attention and energy of developers is exploding. The number of apps, the number of new markets, the quantum of developers dedicating time and energy is exploding. Bitcoin and the blockchain has a lot of gravity behind it that is absorbing time, money, developer attention and outputting new markets and apps. BTC has a low measured return correlation with all other traditional asset classes. If you take a portfolio with equity and bonds and real estate and add BTC to it, then you increase return while reducing variance. This is amazing. But upon reflection, it makes complete sense when you consider what Bitcoin and the Blockchain is designed for. In the current centralization paradigm practiced by the global financial system, decisions are made by a single authority or a concentrated group of elite insiders. In BTC and the Blockchain, decisions are made by a wholly distributed group. This can be a bug or a feature depending on your perspective on decentralized versus centralized governance systems. Rather than viewing these alternative/competing paradigms in a zero sum framework, we can see them as floating on top, in parallel or orthogonal to each other. A lot of the activity that we are seeing from a financial asset perspective seems to reflect the fact that the market is seeing the decentralized governance and consensus systems in BTC and other Cryptos as a feature or a positive thing or at the very least as a hedge against the risks of the current paradigm of centralization as expressed by political manipulation of money supply. This would explain why there is low or even negative correlation.

If we take the perspective that there is economic and financial activity, and that currency units or money represent work energy. From a systems level scenario, it is good to see different scenarios representing different energy amounts/levels currently floating in particular systems, if just a fraction thereof moves into blockchain and bitcoin, then the price level of BTC of expressed in fiat currency units will reflect that. Almost all schools of economics agree on the fundamental equation of MV=PQ.

Money supply times velocity of money has to balance and equate with the price level of goods and the quantity of goods and services. That’s what we are seeing here in a beautiful, lockstep mathematical progression.

Ethereum is another important public blockchain analogous to Bitcoin. Bitcoin does one thing very, very well. It is an immutable, decentralized store of value. Ethereum and its blockchain does another thing very well – creating smart contracts to really aid in automation for many types of markets. This explains why Ethereum has received so much attention from investors, developers and the media. The media tends to take an adversarial, zero sum stance in the way it contrasts these blockchains with each other., zero sum, like TCP/IP or SMTP better or is my car better than a plane than a train.

These are perhaps not the right questions to ask. Perhaps the right framework or context to set is to acknowledge that there are multiple public blockchain systems out there. Each of these blockchains should do one thing really well. Now, let us delve into what each of these blockchains does particularly well. In the case of Bitcoin, it has proven itself as a strong, immutable store of value outside of the control of governments and corporations. This function is clearly currently regarded as particularly valuable in the market given the political volatility and uncertainty that we are experiencing right now at the global level, and the desire to store work energy in asset classes that provide a hedge against perceived growing global macro risk. In the case of Bitcoin, if you send a ping to the Bitcoin database, you can rest assured that when you get a message back it is immutable, trustable and is backed by billions of cycles of computational power/proof of work. That explains why the token in BTC blockchain has value. When you are accessing a completely public database, it is non-trivial to ensure that you can rely on all information you are getting back to be completely trustable, reliable and undoctored. Analogously, when you ping the database to store information on it, you can rely on the record you are creating to be immutable and irreversible. Inundated as we are today by a steady, relentless diet of fake, manipulated news from unreliable, vested interests it is not difficult to see why Bitcoin derives intrinsic value from its ability to function as an immutable, decentralised store of value (data) without a single point of failure and outside the control of anyone.

What we are seeing with Ethereum is that the function that it performs really well has value. In its case, that is enabling reliable smart contracts and automation. In fact, if we zoom out it is easy to see that this phenomenon is applicable in nearly all technologically complex and intensive areas. If we look at the examples of correlation between highly valuable technology stacks and returns on capital in large listed technology companies such as Microsoft, Google and Facebook, then it is easy to see that the market has rewarded the successful build-out of technology to solve valuable problems, as represented by the exponential growth rates in their stock prices. One nuance worth noting here is that since the Google IPO, there has been a fundamental shift in value capture from the public market investor to the private investor. This is a function of several things, most notably the easy availability of large amounts of private capital for the best tech companies as well as a reluctance amongst the most innovative companies to provide more regular disclosures on internal projects and engage in the short-term optimisations that a public listing would entail.

What’s interesting about Crypto is that there is no private vs public distinction. Because the token and the protocol are intertwined and inseparable, if the protocol has value then the network has value. If the protocol network has value, then access to that protocol network has value. If access to that protocol network has value, then the token providing that access has value. And this token is liquid from the outset, by design. In the old internet paradigm, of course, as we noted before virtually all the value was captured at the application layer by luminaries such Microsoft, Google, Facebook or Apple. This was because pre-Bitcoin, the foundational, enabling internet protocols such as TCP-IP and SMTP upon which these great companies were built could not be securitised and floated via a network access-providing token that behaved like equity. Today, if we look at the %age gains of public blockchain networks such as Bitcoin, Ethereum or even Monero, we find that these price gains can be explained mathematically and logically in terms of well-known methodologies for valuating network systems, such as Metcalfe’s law which states that the value of a network is proportional to the square of the number of connected devices/users of the network, or the Smith’s corollary to the Metcalfe’s law which states that the value of the network is proportional not just to the number of users within the network but also to the value of all information and knowledge shared by users in all sub-networks and within the entire network as a whole.

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While the money and currency functionality of crypto networks is an interesting aspect, it is not the only or even the most important aspect of these systems. In fact, it is the most obvious aspect about Crypto in the same way in which email was not the only application of the internet, merely its most obvious one.

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