Bitcoin price may have hit a multi-year high, but numerous fundamental factors signal that even better days are ahead.
The end of 2020 has been lighting up crypto-centric subreddits and feeds of Bitcoin hodlers as the appetite for the digital bullion reaches an all-time high.
The explosion has been accelerated via the adoption of the network by PayPal, along with the long-sought out stamp of approval from respected figures like Michael Saylor, Jack Dorsey, and Paul Tudor Jones.
The corresponding price appreciation and mainstream awareness from the likes of Maisie Williams and the most recent institutional buy-in from MassMutual continue to buoy the price and sentiment surrounding Bitcoin (BTC).
The tide continues to rise as the work-from-home dynamic drives digital transformation and it increasingly appears that 2021 will be an action-packed year for the next chapter in the evolution of the Bitcoin network.
Let’s take a look at some of the key areas to keep an eye on in 2021.
Bitcoin miner valuation and the comparison to gold
Bitcoin mining has many fundamental similarities to gold mining; however, there are key differences to explore in the complex task of valuing Bitcoin miners’ operations. We will focus on Riot Blockchain as an example, which is a U.S. Bitcoin miner headquartered in Colorado.
Riot began mining in 2017 and has recently released plans for increasing their hash rate with a delivery of mining hardware expected this spring of 2021. Currently, Riot has a hash rate of 1.5 exahashes per second, which accounts for approximately 1.11% of the Bitcoin network’s total current hash rate of 135 EH/s.
The company mined 224 BTC, according to their Q3 earnings released on Nov. 9, which is in the ballpark of $4.1 million in revenue at $18,500 per BTC.
Considering the figures above, investors will wonder: How can a company justify a market cap of $670 million with just $8 million in revenue and massive operating (electricity) costs?
Even with over 1,000 BTC listed on its balance sheet, which is $18.5 million at the current BTC price, the valuation is very stretched, to say the least.
Here’s where two considerations come into play that could justify a much larger Riot market cap along with other crypto miners, assuming the network moves further into a bull market.
The expectation for future price appreciation
One does not have to dig deep before finding a wide range of optimistic targets for Bitcoin’s price one year from now. The range extends from Mike Novogratz’s $65,000 estimate to PlanB’s $288,000 based on the popular stock-to-flow model.
Meanwhile, CitiBank has recently called for $318,000; the Winklevoss twins have suggested $500,000, and Ark Investment CEO Catherine Wood appears to agree with the latter.
These price targets are the reason why miners have stuck around through the bear cycle of 2018 and operated at a loss at times. They expect the network to be around for the foreseeable future. Miners also know that there is power in serving as the validators of network transactions, and the continued rise in the network hash rate shows that Bitcoin is becoming more secure and competitive every day.
Those paltry 224 BTC that Riot mined in Q3 would expand its revenue stream to a larger, more ambiguous number if the upper limit of Bitcoin’s price is undefined. This means that Riot’s profit estimation would be unbound if BTC undergoes another parabolic rally, even if the present-day valuation does not make sense for the “lifting cost” to mine one Bitcoin and the quantity of mined BTC.
Lack of mining hardware
Worrisome aspects about getting behind a Bitcoin miner are the low barrier to entry and the massively efficient and competitive proof-of-work network which Michael Saylor described as a nest of “cyber hornets”.
Anyone can dedicate their computing power to mining Bitcoin, albeit with a very low probability of successfully mining a block and being the first to solve the hashing algorithm.
As the hash rate increases, miners band together in pools, using increasingly powerful hardware to have the best chance of successfully mining a block. While anyone could theoretically start mining, you won’t get far unless you have the latest Antminer S19 from Bitmain, which won’t be available in stock until April 2021.
The last time Bitcoin went parabolic, which was in 2017, there was a shortage of ASIC chips and other mining hardware, and suppliers, such as AMD, Nvidia and Bitmain, couldn’t keep up with the demand.
If this situation occurs again with Bitmain and MicroBT, then any miners who currently own the next-gen equipment will have an advantage until more hardware enters the fight.
Conversely, gold miners have a proven source of the metal beneath the ground. Gold miners need both the proper drilling and excavating equipment and rights to the land, which serve as barriers to entry for mining gold.
Should the price of gold double to $4,000 per ounce, prospecting would increase, and the rate at which gold is extracted from the earth would increase. This would, in turn, break down the activation energy for entry and bring the supply and demand into equilibrium, consequently lowering the price if supply overshoots demand.
However, no matter how much the mining hardware arms race continues, Bitcoin cannot be mined faster than 6.25 BTC every 10 minutes thanks to the supply schedule and difficulty adjustment that Satoshi Nakamoto built into the protocol. This heavily impacts the supply-and-demand dynamics of Bitcoin, something which I’ll touch on a bit later.
GBTC versus Bitcoin
Grayscale’s Bitcoin Trust (GBTC) trades over the counter and allows investors to gain exposure to the underlying digital currency in common brokerage accounts, like a closed-end fund.
Each share represents 0.00095346 Bitcoin after subtracting the annual 2% fee and premium of GBTC. Below is a comparison of the performance of GBTC vs. Bitcoin over the past four months.
As shown by the narrowing gap between the asset prices during the end of September, GBTC tends to do slightly worse than BTC during a period of price consolidation.
GBTC performs slightly better than the underlying asset as the premium expands, and increased market demand tampers with the inefficiencies of the OTC investment vehicle versus the real-time price of the underlying asset.
This can be seen in the widening gap during the price increase over the past two months.
The chart below shows even greater detail regarding GBTC’s premium over the past 12 months, in addition to the Net Asset Value in comparison to share price.
The premium bottomed out at approximately 10% in times of bearish BTC price action (in April, July and September) and expanded to as high as 30% to 40% during the rapid price increases that occurred in February and August.
The recent Bitcoin price acceleration to $19,000 from $11,000 is increasing the premium in accordance with this trend. It remains to be seen what competitor closed-end funds offering Bitcoin exposure would do to GBTC, as it is the sole product of its kind in the U.S. marketplace.
On Nov. 25, VanEck launched a Bitcoin exchange-traded note trading on Germany’s Böerse Xetra exchange, and with SEC Chairman Jay Clayton stepping down in December, there may be an increased likelihood of a U.S. exchange-traded fund approval if the newly appointed SEC chairperson is more favorable toward the asset.
Supply and Demand
Buckle your seat belt. Every 10 minutes, a block is mined, and 6.25 new Bitcoin come into existence as the block reward compensation.
To put this into perspective, every hour, 37.5 BTC is mined. That equates to 900 new BTC per day. Before the May 11 Bitcoin halving, this figure was 12.5 BTC every 10 minutes, and in 2024, it will dwindle further to 3.125 BTC.
The daily addition to the Bitcoin market cap is approximately $16.7 million of newly minted coins at current prices. GBTC itself reported a daily inflow of $115 million on Nov. 12, which is an 11x increase from the $50 million weekly in the previous month.
This demand is 6.9x the new supply, and to quantify demand from Square, PayPal and exchanges across the world. Thus, it is clear that there is an increasingly large gap between the demand for Bitcoin and the newly mined coins entering the market. Historically, this dynamic has appeared in the year or so following a block reward halving.
Last time, in the four-year cycle, it led to the 2017 run that put crypto briefly in the eyes of mainstream retail investors, as the price had appreciated 20x from $1,000 in January to $20,000 by the end of the year.
If Bitcoin were to liken to gold’s status as a global store of value, the $9 trillion gold market is the benchmark that investors have on their radar.
This would mean a 25-fold increase from the current Bitcoin market cap, assuming the two can co-exist amicably.
While we continue to digest this rapidly changing digital ecosystem at our own unique paces, the Bitcoin network buzzes along and gains further traction, taking no prisoners in the process.
What developments will 2021 bring for us to grapple with and discuss next?
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