Bitcoin in 10 Objects, Part 2

In yesterday’s note we reviewed the first part of our recent conference presentation about bitcoin, outlining real world objects that can help explain its rise and relevance. In case you didn’t see it, here is a brief summary:

  • Over the last 15 years the global popularity of high denomination paper currency notes has grown at an impressive clip. There are currently $1.2 trillion in $100 bills in circulation around the world and $686 billion in 100/200/500 euro notes.
  • Central banks have resisted calls to reduce or eliminate such notes. For example, the European Central Bank has been replacing all the 500 euro notes it promised to pull with an equivalent amount of 100 euro notes.
  • The rise of smartphones and secure web browsers give individuals the power to navigate the web anonymously.
  • The creation of bitcoin gave the citizens of any country a vehicle to store wealth in the same way they use high denomination currency notes.

You’re up to date now… We’ll conclude with the second tranche of 5 objects that explain the rise of bitcoin.

Item #6: A QR Code

Chances are good you’ve seen these: they look like a square filled with random black squares and rectangles. Every one created is slightly different, and your cell phone camera can read them and translate the code into a unique identifier.

The relevance to bitcoin is that QR codes allow your smartphone and a “Wallet” app to send or receive funds. Just flash a QR code to another phone, punch in how much you want to send, and the system handles the transaction. No bank, no credit card processor, no intermediary required.

Item #7: The Country of Nigeria

If you check Google Trends for which country registers the most searches for “bitcoin” over the last 5 years, you’ll find Nigeria at the top of the leader board. Not China, or South Korea, or even the US makes the top 5. South Africa and Ghana are #2 and #3.

Why? Not every country has a reliable currency. And in the absence of that, citizens look for other stores of value. This is probably the most important point that westerners miss about bitcoin. It’s a big world out there, and not everyone has the privilege of receiving dollars or euros for their work.

Item #8: The Scales of Valuation

At this point, we have all we need to create a valuation construct for bitcoin. We know the total addressable market for dollar/euro high denomination notes is $1.9 trillion. We know demand for such stores of value is growing. We know bitcoin is popular in areas that want something akin to the same.

So we can do a venture capital style analysis here – take the TAM (total addressable market) and run a sliding scale of how much bitcoin might be worth as it grows in usage.

Here is such an analysis, based on bitcoin as a percentage of dollar/euro high denomination notes in circulation (based on 17 mm bitcoin outstanding):

  • If bitcoin can be 5% of $100 bills/high denomination euros, price = $5,588
  • At 10%, bitcoin’s price = $11,176
  • At 20%, bitcoin’s price = $22,352

There two problems with the simple math. First, there are other crypto currencies in circulation. Bitcoin was the first, but there are 1,300 others vying (to some degree) for their slice of this pie. Second, there are likely as many fake $100 bills in the world as real ones. The TAM may therefore be much larger. These two factors are, in our simple estimation, a wash.

One last, but important, point: bitcoin doesn’t need to replace $100 bills or 100 euro notes. It just has to be seen as another way to store value.

But what about all the volatility recently, you might ask… For the majority of bitcoin owners, it just doesn’t matter. Every bitcoin purchased before mid November 2017 is still in the money. And every bitcoin bought before October 2017 is worth at least 100% more than its purchase price.

Item #9: A CryptoKitty

The second largest crypto currency by value is Ethereum, and it spawned an odd craze at the end of last year. An app called “CryptoKitties” allowed users to create their own cartoon cat and then trade them for ether (the name of the Ethereum currency). It was a wildly successful application, but it had the effect of slowing down the whole system and making transactions more expensive as users vied for bandwidth to make and trade cartoon cats.

This is a cautionary tale about crypto currencies generally – they don’t yet have the scale to allow for even simple applications like this one.

Item #10: A Quantum Computer

One question I often hear: “What will kill bitcoin?” Pundits like to say “Regulation” or wave their hands and say “It’s a bubble! It won’t end well!” (Personal life hack: when I hear someone say, “It won’t end well” I know they have usually done precisely zero real work on the topic under discussion but still want to give their opinion.)

The real answer as to what will kill bitcoin and every other current crypto currency is the quantum computer. They are still in a development phase, but if and when they go online they will have the power to decode the “Crypto” in every system. That’s because their processing power (in theory, anyway) far exceeds anything in computing today.

The conclusion of our “10 Objects” talk:

  • Bitcoin is an online analog to high denomination physical currency
  • As such, we can establish some broad valuation parameters based on market size
  • Crypto currencies need a lot of work before they can be useful for other applications
  • All cryptos are anchored in technology, which brings both promise and challenge
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