Down the Bitcoin Rabbit Hole
Chapter 3: The Demand Side
For the past two weeks, I have outlined why I am buying bitcoin for the long-term. But I have mainly been looking at it from the supply side of the equation, laying out how there is finite amount of bitcoin that can ever be created and how the mining process works in a way to make sure that supply increases at a decreasing rate.
Today I want to look at the world from the demand side of the coin. To the best of my knowledge, the main sources of demand have been from the early adopters. People who read the original white paper and, for them, it just clicked. They saw that bitcoin had the potential to be a big deal. I am not one of those people and freely admit that I dismissed the idea of bitcoin when I first heard about it…shame on me, I guess.
Some of these early adopters who have accumulated large amounts of bitcoin are known as “whales.” People who track the market closely play attention to the what the whales are doing…I guess they are whale watching. What’s interesting is that these whales appear to be sticky, meaning they are buy and hold for a long time. In fact, in April 2020, Coin Telegraph wrote about how one of these whales, who holds 68,000 bitcoins, has not move the funds in more than five years. Their data also look at the the activity of some of the other big players and notes that on average, they have held for 4.7 years. So it would appear that the big, early buyers, are not moving all that much.
Other sources of demand, until recently, have come from smaller investors like myself. We are believers in the story, the technology, the prospects for bitcoin in the future. Some of these investors are probably like me, buying a set amount each month but realistically don’t move the needle when it comes to the bigger demand picture. I am not going to sit here and pretend that I am “moving markets” when I transact.
There are also the people who trade actively given the volatility in the market. But they are just as likely to be sellers as buyers. Now, it seems that there is a shift taking place. It is early days, but it could be meaningful. That shift is at the corporate level. Corporations with cash on their balance sheets have to decide what to do with that cash. They have plenty of choices, of course. They can invest in the business, make acquisitions, pay a dividend, buy back their own stock or some combination of these. But let’s assume that after exploring all of these options, they still decide to leave a portion of that cash on the balance sheet. They still face a problem. Inflation! Over time, the purchasing power of that cash declines. Take a look at this chart from the team at Messari:
Now, people who have been following my work for the past five - six months know that I am in the camp that the table is set for an acceleration of inflation. I believe that both fiscal and monetary stimulus, enacted to deal with the fallout from the COVID crisis are going to lead to a period of generally rising prices that is faster than what we have seen in the recent past. Add in prospects for a better economic environment and the acceleration could be even greater. This is actually one of the main reasons that I came back to bitcoin in April.
The note from Messari has a lot of interesting information as it relates to cash on corporate balance sheets. Here is what jumped out at me:
Corporate Managers are charged with the unique challenges of ensuring their company’s liquidity, optimizing their company’s capital structure, managing financial risk and diversifying funding sources. This year, given the uncertainty, companies have hoarded cash defensively. S&P 500 companies (excluding Financials) have increased their cash holdings by $250 billion in Q1’20 to a record $1.8 trillion. The amount of idle cash on the S&P 500 balance sheet alone is 7x BTC’s market capitalization.
Companies have been unapologetic in stockpiling cash during this period of uncertainty. However, an unintended consequence of this is that they’ve inadvertently destroyed shareholder value. Cash has underperformed the S&P 500 market itself by 5% YTD while the purchasing power of the USD has eroded by 1%.
And now companies are beginning to take action to protect their purchasing power. A company called Microstrategy (MSTR) announced that they converted cash on their balance sheet to bitcoin, first in August and once again in September. Regarding their decision, MSTR cited that a confluence of macro factors posed a risk to their corporate treasury program. Ultimately the company turned to bitcoin as a primary treasury reserve asset due to its dependability as a store of value and attractiveness as an investment asset with more long-term appreciation potential than cash. If you do a quick Google search of Microstrategy’s CEO, Michael Saylor, you can see a first hand account of his transformation into a bitcoin bull.
After Microstrategy, Square (SQ) announced they were converting a portion of their cash to bitcoin. They even wrote their own whitepaper outlining what they were doing and why. It is also interesting to note that Square’s Cash App business allows its users to buy, sell and store bitcoin. PayPal (PYPL) recently announced that it’s users can do the same thing. Jack Dorsey, the CEO of both Square and Twitter (TWTR) is a well known bitcoin bull. Here is a shot of his twitter profile, enough said.
So, perhaps this paves the way for more companies to convert a portion of the cash on their balance sheets to bitcoin. It is easy to understand that being the first to act carries some risks but now the case can be made that Microstrategy and Square have given other CFOs and corporate treasury departments some aircover.
In my mind, the next big catalyst for bitcoin, in addition to more companies converting their cash, would be broader institutional adoption of bitcoin. This has been a slow grind, and Coin Telegraph tells us why. But there are reasons to believe that this could change. According to Messari again:
Sovereign wealth and pension funds – deemed some of the most conservative investors – are facing the same geopolitical and macro risks and are beginning to invest in this historically-dismissed asset class.
On the hedge fund circuit, in May, Paul Tudor Jones announced that he was investing in bitcoin. Earlier this week, another hedge fund legend, Stan Druckenmiller also announced that he owned bitcoin. Now yesterday we wrote about Bill Ackman and how sometimes these investors get it wrong. Could that be the case here? Of course it can. But we can’t deny the fact that there is scope for bitcoin demand to continue to increase. When this incremental demand (some it from investors with large amounts of firepower) meets the built-in limited supply dynamics of bitcoin, the stage could be set for a run higher in prices. Maybe not today, tomorrow or next week. But from a technical perspective, it looks like higher is the path of least resistance for now. Here is the updated chart, not much standing between current levels and those all-time highs.
I have a spent a few weeks looking at the positives of bitcoin, as I see them. I can certainly be wrong. Of course there are risks and we should explore those next time.
Until Monday, have a great weekend!
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