Babbitt's first release丨Fidelity Bitcoin Investment Report: Bitcoin is an ideal store of value

Fidelity Digital Assets, a subsidiary of asset management giant Fidelity, today released the first report in its Bitcoin investment thesis series, "Bitcoin is an ideal value storage system." This article is the Chinese translation of the report, translated by Babbitt.

At Fidelity Digital Assets, we have conversations with investors who are at different stages of their digital asset journeys – those who are actively researching investment thesis, those who are seeking validation of the theory, or those who have yet to embark on digital asset investment research. To help the spectrum of investors at different stages, we are developing a series of reports to examine the perspectives driving investor interest and investment in Bitcoin today and the potential for future developments and traction. In the process, we hope to help investors build a comprehensive evidence-based investment thesis and understanding, especially as Bitcoin becomes increasingly integrated with traditional markets and portfolios.

Bitcoin is many things to many people - why people choose to own Bitcoin depends on their own circumstances and views on Bitcoin today and in the future. These views have been the subject of much misunderstanding, confusion, and debate. Historically, such debates have revolved around whether Bitcoin is a store of value, a medium of exchange, an alternative asset, all or none of the above. In addition, it is uncertain whether Bitcoin's underlying blockchain technology is best suited to facilitate wholesale clearing, settlement, consumer payments, or the anchoring and timestamping of arbitrary data.

The fact is that Bitcoin can serve many functions simultaneously, either at the base layer or through incremental layers, as the ecosystem matures. One of the beauties of Bitcoin is that its success is not premised on serving a single purpose.

In this article, we will focus on Bitcoin as an ideal store of value. We will explore the intrinsic characteristics that make Bitcoin suitable for this role in the future, as well as consider whether Bitcoin is being used in this way today, and discuss factors that may drive greater demand for this utility.

In conducting research for this report, we interviewed some of the industry’s top investors and thinkers and incorporated their investment perspectives. Special thanks to Brian Kelly, Brian Estes, John Vincent, Benson Durham, Roberto Perli, Dan Morehead, John Pfeffer, and Nic Carter for sharing their thoughts on this topic.

Key Takeaways

• Many investors believe that Bitcoin is an ideal store of value because it possesses store of value properties, but this property has not yet been widely accepted.

• At least in its early days, Bitcoin’s volatility was its promise, its catalyst for attention, growth, and innovation.

• Scarcity is a key characteristic of a good store of value because it is essential to prevent the depreciation of real value in the long run. One of Bitcoin’s most novel innovations is its unforgeable digital scarcity.

• Bitcoin’s scarcity was coded into the protocol at creation. The independence of monetary policy is supported by a decentralized network of computers that run the network and implement proof of work.

• Current record-low bank interest rates, unprecedented levels of global monetary and fiscal stimulus, and the unknown consequences of deglobalization are all contributing to the growth of Bitcoin awareness and adoption.

• Long-term drivers for Bitcoin include “slow and steady” inflation and a massive transfer of wealth to the millennial population who have a favorable attitude toward digital assets.

Bitcoin: An ideal store of value

Bitcoin is an ideal store of value that can create value as it matures. To use an analogy, investing in Bitcoin today is similar to investing in Facebook when it had 50 million users and had the potential to grow to over 2 billion users today. This is driven by the idea that Bitcoin offers asymmetric upside. If Bitcoin is widely adopted as a store of value by retail and institutional investors, the upside could be large relative to the initial upfront investment. Today, Bitcoin is relatively nascent and has a narrow fundamental demand compared to global stores of wealth such as gold. Stakeholders’ perception of its value and potential is also evolving. However, the rationale for investors to build exposure to Bitcoin now is that Bitcoin will be a much larger market if it is widely adopted as a store of value in the future.

Today, one of the main arguments against Bitcoin as a store of value is its volatility. Bitcoin holders object to the idea that the trajectory of a new asset from negligible awareness and adoption to a global store of value is unlikely to be linear. A different view is that many participants initially learn about Bitcoin due to its volatility. As new participants conduct further research, perceptions tend to shift to focus less on short-term performance and more on the long-term value proposition.

Upward volatility also attracts investment, development, and innovation. Industry cycles begin with rising prices of digital assets such as Bitcoin, which attract new attention through news and social media discussions, leading to a large influx of talent into new products, new projects, and new infrastructure, as well as the maturation of the industry compared to the previous cycle.

Bitcoin volatility is likely to remain elevated relative to traditional assets, as volatility is a side effect of Bitcoin's completely inelastic supply and borderless, relatively intervention-free markets. Over time, volatility should continue to decline relative to current levels as adoption expands, fundamental demand grows, activity on institutional platforms expands, and sophisticated investment transactions and investment products emerge.

The potential of Bitcoin as a store of value can be framed by comparing it to other investable assets that investors use to store value, as shown in the table below. In order to gain a respectable position, more investors need to gain some understanding of Bitcoin's inherent characteristics and determine that the benefits of storing at least some value in Bitcoin outweigh the opportunity cost of storing value in a different medium. In the following sections, we discuss the main factors that investors are considering when making a Bitcoin investment.

Source: Messari (July 2020), Yahoo Finance (July 2020), Visual Capitalist (May 2020)

What makes Bitcoin a potential store of value?

Bitcoin’s Digital Scarcity

A strong store of value preserves purchasing power over the long term. Emerging stores of value increase purchasing power until they stabilize. The key characteristics cited when referring to a good store of value are scarcity, portability, durability, and divisibility. Arguably the most important of these properties is scarcity, which is essential to preventing real value from depreciating over the long term. Scarcity means that there are a limited number of assets, more cannot be easily created, and they cannot be counterfeited.

One of Bitcoin’s most novel innovations is its unforgeable digital scarcity. Investors believe this property is fundamental to understanding and appreciating Bitcoin. Prior to Bitcoin, multiple innovators made important contributions to achieving digital scarcity but failed to implement it successfully. Computer data has always been stored and shared only briefly, dating back at least to Larry Tesler’s invention of the copy, cut, and paste functions in the early 1970s. In more modern times, copying and sharing files has become a ubiquitous and integral feature of the Internet.

While efforts have been made to restrict the sharing of certain types of files (for example, digital rights management (DRM) technology was developed to track files and make them difficult to copy), creating digital scarcity that cannot be forged remained elusive until the launch of Bitcoin in 2009. In inventing Bitcoin, Satoshi Nakamoto drew on concepts from previous efforts but also used a clever combination of computing, cryptography, game theory, and incentives to solve previously unsolved problems, such as the double-spending problem, to build a decentralized protocol that enforces a fixed issuance schedule.

Bitcoin’s supply is completely inelastic and not susceptible to supply shocks. Supply does not respond to changes in capacity (i.e. more hashrate) as increased demand causes price increases. Even gold, which has been used as a store of value for thousands of years, is not immune to supply shocks. While gold is limited in its ability to increase production in response to demand growth, it is not completely inelastic.

Rising prices both incentivize existing Bitcoin mining operations to become more efficient and attract new mining operations, but the increase in network hashrate does not affect supply changes. Bitcoin achieves this through network difficulty adjustments. As miners join the network or existing miners upgrade their mining hardware to more efficient versions, Bitcoin's hashrate rises. At the same time, mining difficulty also rises (or falls) to ensure that, on average, one block is produced every ten minutes. This adjustment mathematically regulates the supply of Bitcoin.

Bitcoin is released approximately every ten minutes through block rewards paid to miners. This block reward is halved every 210,000 blocks until there are 21 million bitcoins in circulation. This fixed total supply is hard-coded into the protocol and cannot be changed. The third halving occurred in May 2020, causing the block reward to drop from 12.5 BTC to 6.25 BTC, a 50% drop, and the annual issuance rate to drop from over 3.5% to under 2% - making Bitcoin an interesting special case in the context of unprecedented and unlimited money issuance by central banks around the world during the same period, which we will discuss in more detail below.

Source: Alex Thorne (Avon Ventures), May 2020

The stock-to-flow model is a measure commonly used to quantify the scarcity or hardness of a commodity. Stock is the existing supply of a commodity minus the portion of that supply that has been consumed or destroyed. Flow is the annual incremental production of new equipment. In general, the stock-to-flow ratio measures how many years of production it would take to reach the current inventory level.

Historically, commodities that are difficult to double due to low production relative to existing supply have been superior stores of value. These commodities are primarily used for investment purposes and occasionally for industrial use. On the other hand, consumer goods that are susceptible to large increases in supply are less effective in storing value.

In Bitcoin Standard, Saifedean Ammous adapted stock-to-flow to compare Bitcoin to commodities for investment and consumption, and since then, the use of the metric has expanded, and even ratio-based models have emerged. Gold is the most resilient store of value historically, with the highest stock-to-flow ratio, followed by Bitcoin (today) and silver. After the most recent block halving (May 2020), the gap between the gold and Bitcoin ratios has narrowed. After the next halving (2024), Bitcoin's stock-to-flow will exceed gold's.

Source: PlanB (March 2019), Coin Metrics (April 2020)

Note: A 2015 report from Goldman Sachs estimated that the last bit of gold in known reserves will be mined by 2035, and the last bit of platinum will be mined by 2055. The last Bitcoin will be mined around 2140.

Analyst PlanB has also developed a Bitcoin valuation model based on stock-to-flow. Supporters of this valuation model believe that there is a statistically significant relationship between Bitcoin's market value and scarcity as measured by this model. Critics of the model argue that it fails to capture demand, which is a more important driver of market value. While the importance of this model is beyond the scope of this article, we explore why demand for scarce digital assets rises.

Decentralized Checks and Balances

Bitcoin's monetary policy was established at the time of its creation. Its credibility is enhanced in part by decentralization and proof-of-work mining. Bitcoin has a decentralized, leaderless network of full nodes (computers running the Bitcoin software), each of which stores a ledger of transactions and independently performs transaction verification to check that transactions follow the rules. Because of this redundancy, there is no central point of failure. Full nodes that verify transactions are different from miners who expend energy to process transactions and mint Bitcoins. Unlike mining, transaction verification does not require extensive hardware or power resources. Therefore, any computer can join the distributed network to store and verify Bitcoin transactions. Today, tens of thousands of nodes perform this function.

The two main types of transactions include coinbase transactions, which programmatically issue new bitcoins according to a supply schedule, and peer-to-peer payment or settlement transactions between users of the network.

The decentralized network of computers will reject transactions that do not follow the consensus rules (such as transactions that attempt to create new coins or attempt to spend Bitcoin repeatedly (double spend)).

In addition to preventing transactions that do not follow consensus rules, the level of decentralization that exists in the Bitcoin network protects core properties by making virtual assets, such as the 21 million fixed supply, virtually impossible to change. No central authority has sole discretion over Bitcoin’s monetary policy. Rather, such a change would require significant social coordination among stakeholders, such as users, miners, and those who run full nodes. Most stakeholders believe that Bitcoin has value due to its digital scarcity, so support for such a change would be negligible.

Proof of Work (PoW)

Proof of Work is an important design element that reinforces Bitcoin’s fixed supply by making transactions irreversible. Proof of Work provides evidence that a significant amount of computational work has been performed, although it is easy and fast to verify that the work was performed relative to the time and effort spent performing the work. To create blocks of transactions, miners perform hash operations over and over again to find solutions to computationally intensive cryptographic problems in a guess-and-check process known as proof of work. The process is computationally intensive because it requires the use of specialized hardware (which has a high fixed upfront cost) and electricity (an ongoing cost to run). These real sunk costs, along with the block reward that miners receive for processing transactions, incentivize miners to process transactions and to do so honestly.

Furthermore, proof of work makes it extremely difficult and expensive for malicious actors to rewrite or reverse transactions, effectively making transactions immutable. As the number of confirmations increases, in other words, as the number of subsequent transactions increases, the immutability of a block of transactions increases. A block buried under a hundred subsequent blocks is more immutable than a block buried under ten blocks because to reverse it would require reversing a hundred blocks of transactions, while the latter would only require ten. Miners group transactions together to create blocks. Transactions are analogous to entries in a database, while blocks are analogous to pages of entries in a database. Each block links to the previous block so that blocks are linked together to form a chain. Therefore, it is impossible to rewrite a block buried under a hundred subsequent blocks without rewriting every block.

Bitcoin’s monetary policy was established at the outset. Because the network is decentralized, stakeholders have confidence in the policy. No single centralized authority can change core properties and impose those changes on stakeholders. Transactions are immutable, so it is computationally and economically impractical to try to undo transactions and rewrite the ledger.

Demand driven

Investors believe the next wave of awareness and adoption could be driven by external factors such as unprecedented levels of central bank and government intervention, record low interest rates, increased fiat money supply, globalization and potentially inflationary factors, all of which have been accelerated by the pandemic and economic shutdown.

Long-term dynamics that could drive adoption include the use of Bitcoin to preserve wealth amid “slow and steady” inflation and the upcoming generational wealth transfer toward millennials, who see Bitcoin as more advantageous than other demographics.

Short- and medium-term catalysts

Monetary and fiscal stimulus

To offset the demand destruction caused by the global shutdown in response to the coronavirus pandemic, central banks and governments have responded with unprecedented monetary and fiscal stimulus to counter the impact of the economic downturn, stimulate economies and calm markets. In eight months, as many as 285 stimulus measures have been announced, including zero or near-zero interest rates, increasing money supply through unprecedented quantitative easing and a range of lending instruments.

Even before the world entered the current health and economic crisis, investors had predicted that central banks and governments would use more direct forms of liquidity growth to stimulate inflation, which had remained stubbornly low for a variety of reasons.

Central banks and governments have implemented expansionary policies to counter deflationary pressures caused by global lockdowns. Time will tell whether and how quickly the gradual reopening of the global economy will stimulate consumer spending, how central banks and governments will respond, and the impact on consumer price inflation.

If inflation or expected inflation falls, the effect on demand for fixed supply assets is less pronounced. However, an increase in the money supply may translate into higher prices for risky or scarce assets.

If the combination of policy decisions succeeds in offsetting deflationary pressures and creating inflation, or if inflation remains subdued but nominal yields remain low or trend lower, investors may turn to “assets that maintain their real value — assets that cannot be printed” — to rebalance diversified portfolios. Traditionally, in such situations, investors turn to fixed supply assets such as real estate, dividend-producing stocks, and precious metals. This time, investors may turn to a new type of fixed supply asset that protects against potential inflation or low interest rates, but at the same time has huge growth potential — Bitcoin.

Deglobalization

Globalization is one of the structural forces that has historically kept prices of goods and services low in the face of inflationary pressures. While globalization had been slowing in the aftermath of the financial crisis (based on trade flows, globalization peaked in 2008), the restrictions and lockdowns caused by the pandemic have exposed the risks of reliance on global supply chains and provided an impetus for at least some deglobalization. Thierry Breton, the EU’s internal market commissioner, has said that “the problem that this crisis has brought is that we may have gone too far in terms of globalization.” The World Trade Organization predicts that world trade will fall by between 13% and 32% in 2020 as a result of the pandemic. Deliberate actions by governments and policymakers to restrict trade and reduce reliance on global supply chains could further accelerate deglobalization, thereby putting upward pressure on the costs and prices of goods and services, alleviating some of the downward pressure on inflation from globalization.

Current interest in Bitcoin’s store of value properties

The decision by global investment giant Tudor Investment Corporation to allocate investment in Bitcoin in the Tudor BVI Fund is evidence that unprecedented levels of monetary growth are driving institutional interest in Bitcoin's store of value properties. The company's founder and chief investment officer, well-known Wall Street trader Paul Tudor Jones, and global head of research Lorenzo Giorgianni made the case for investing in Bitcoin in their May 2020 investor letter, The Great Monetary Inflation. The Tudor Investments team scored financial assets, legal cash, gold, and Bitcoin based on four characteristics that define a store of value asset - purchasing power, trustworthiness, liquidity, and portability. Bitcoin scored 60% of a financial asset’s score and was 1/1200th of its market cap, it scored 66% of gold and was 1/60th of its market cap, the conclusion being: “It looks like something is wrong here, my guess is the price of Bitcoin.” While many expressed the same reasoning, this was seen as a watershed moment as the arguments and investments came from both a traditional hedge fund manager/legendary macro investor (Paul Tudor Jones) and a former Deputy Director of the IMF’s Strategy, Policy and Review Department (Lorenzo Giorgiani).

Long-term catalysts

Long-term value preservation

Store of value assets are not important in a high inflation environment alone. Over a long enough period of time, even “low and stable” inflation will erode the purchasing power of the most stable fiat currencies. This drives people to invest in financial assets to preserve or grow their wealth over a longer period of time. Proponents of the argument that Bitcoin is a potential store of value believe that as more people realize that Bitcoin is a long-term wealth preservation tool, the fundamental demand for Bitcoin will grow.

Source: Federal Reserve Bank of St. Louis, April 2020

A huge transfer of wealth

A report released by Coldwell Banker in October 2019 shared data that $68 trillion in wealth is being transferred to millennials, which is estimated to be one of the most significant wealth transfers in history. The study also found that there are nearly 620,000 millennial millionaires in the United States, accounting for about 2% of American millionaires. The millennial population (people born between 1981 and 1996) prefers new, digitally native alternatives to traditional products and services, and is more inclined to make new types of investments more easily.

This open attitude is partly due to the 2008 financial crisis. Entering the workforce at such an inopportune time has created a certain level of skepticism toward the traditional banking system. According to the WEF’s 2017 Global Shapers Survey, 45% of the 30,000 millennials surveyed disagreed with the statement that they trust banks to be fair and honest. xiii An October 2018 Edelman survey of affluent millennials (those aged 24-38 with $50,000 to invest, or those with an individual or joint income of $100,000) found that 77% of affluent millennials believed that “the entire financial system is designed to support the wealthy and the rich” and that “it’s only a matter of time before bad behavior in the financial industry sends us into another global financial crisis.”

There is also evidence that millennials are highly willing to hold Bitcoin relative to traditional stores of value such as gold. Nate Geraci, president of ETF Store Investment Advisors, said interestingly that about 90% of millennial clients said they prefer Bitcoin to gold - "It's a slippery slope." According to Edelman's "Millennials and the Future of Money" report released in November 2019, 63% of "crypto users" said that cryptocurrencies are a better investment than gold in a turbulent economy.

in conclusion

Bitcoin’s inherent properties give rise to belief in its potential to be a store of value, with complementary and interdependent components – the decentralized settlement network (Bitcoin) and its digitally scarce native asset (BCT). It is also important to consider the demand for Bitcoin’s unique features – if there is no sustained demand for these properties, then there is no long-term value creation or storage.

External forces accelerating interest and investment in Bitcoin include unprecedented levels and bizarre forms of monetary and fiscal stimulus around the world with unknown consequences. This exacerbates many of the problems Bitcoin was designed to solve and is leading more investors and users to Bitcoin as an “insurance strategy” that provides protection against unknown consequences. At the same time, the large transfer of wealth from the elderly to the younger population as younger people take to Bitcoin is a gradual but significant long-term positive. As they inherit and grow wealth, this is an important catalyst for Bitcoin adoption.

While there is no guarantee that Bitcoin will succeed as a store of value, if sustainable long-term demand for use cases does not materialize, the headwinds described above will drive incremental demand for new assets with unique properties. Moreover, as we will explore in subsequent parts of our Bitcoin investment thesis series, Bitcoin has the advantage of having properties that enable it to perform multiple functions, further solidifying the likelihood that its success will be measured by value growth.

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