PMC Weekly Review - November 4, 2019

A Macro View: The Fundamentals of Bitcoin Investing

Last Friday, October 25, was a big day for bitcoin, rallying as high as 42% and closing out the day up almost 30%. This was the third-largest, single-day run-up in bitcoin’s history! The strong price appreciation came on the back of comments from Xi Jinping, president of the People’s Republic of China, on the potential of blockchain technology, stating that China needs to “seize the opportunity… and accelerate the development of blockchain technology…” 1

In light of the recent price movement and renewed interest in the blockchain technology, assessing the Bitcoin network’s health may be useful. Around 720,000 daily active addresses now transact on the network, marking a 30% increase since the beginning of the year. And each address paid a small fee when it sent bitcoin to ensure that the transaction was included in the blockchain. As of this week, bitcoin users pay an average of $330,000 dollars a day in fees, and cumulatively, since the network’s inception, they have paid more than $1 billion. This all suggests a growing use of the Bitcoin network.

Hash rate, a measure of the total processing power of the Bitcoin network, is another important indicator of network health. The processing power is used to secure the Bitcoin network and is a proxy for measuring its overall security. Hash rate has more than doubled this year, as miners continue to add computing power, making the network the most secure it has ever been.

As the market infrastructure around the Bitcoin network continues to be developed, more and more investors are evaluating the prospects of adding bitcoin to their portfolio. In considering such a move, it is helpful to contrast and compare the fundamentals of an equity investment to that of a bitcoin investment.

A share of equity is a portion of corporate ownership. This principle is the foundation for equity investing analysis. To quote Benjamin Graham, the father of financial analysis, “A stock is not just a ticker symbol or an electronic blip; it is an ownership interest in an actual business, with an underlying value that does not depend on its share price.”2  If a business is profitable, the owners have a claim on its profits, and the value of their equity increases; conversely, if the company is unprofitable, the owners’ equity value decreases. For this reason, successful equity investors go to great lengths to analyze and understand the drivers of corporate profitability before investing. If during the research and due diligence process investors find a peculiarly profitable company, they would have an incentive to acquire more shares to have a larger claim on the profits.

Bitcoin, on the other hand, is not a company. It does not have profits or losses, cash flows, or a management team, so analyzing it requires different approaches. Bitcoin is many things to many people, but central to its design is an open source network, letting participants interact in new ways. In short, Bitcoin is a network that allows its participants to interact with one another by storing and communicating value over the internet.

According to Metcalfe’s law, a network’s value is derived from the number of its participants and is proportional to the square of that number. As the size of the Bitcoin network grows, bitcoin’s value, or market cap, increases—the healthier the Bitcoin network, the higher the value the market ascribes to bitcoin.

Although it might be appropriate for an equity investor to buy 25% of an individual company to maximize portfolio value, the same action in bitcoin may reduce or limit the total number of network participants, lessening the health of the network and leading to a lower market cap for bitcoin.

In our view, there comes a point for Bitcoin investors when the overall purchasing power of the position will increase more by investing additional capital in the growth and development of the network than by simply buying more bitcoin. As investors begin to embrace the Bitcoin network, they would do well to remember this and avoid applying an equity investing mindset to bitcoin. Failure to do so may weaken the network and reduce the purchasing power of their bitcoin positions in the long term.


Scott Keller

Portfolio Manager

1Foxley, William, Coindesk, October 25, 2019.

 2Graham, Benjamin. The Intelligent Investor, Harper Collins, New York, 1949.

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