What’s the Real Value of Bitcoin, the Magic Internet Money?
Valuing cryptocurrencies can be hard. But there is actually a lot of data - like what's going on with miners right now - out there to consider about digital assets like bitcoin.
Last week, I wrote about the bitcoin market, and its low volatility, liquidity and volume environment right now. In the wake of this, I’ve been asked a bit about fundamental valuations of cryptocurrencies. In a market that has been in a long-term downtrend since November 2021, it might be time to start thinking a bit more deeply about what actually gives a cryptocurrency value.
There’s always been this talk that bitcoin is “magic internet money”. Sure, that phrase can certainly be construed as humor. There are definitely people who interpret that term as something literally out of vapor, that bitcoin doesn't have any real value. But there is real value - if you’re looking for it.
Bitcoin’s Shift
The original crypto bellwether, many in Bitcoin’s early days saw it as a form of electronic cash. Originally, the Bitcoin whitepaper laid out a “peer-to-peer electronic cash system” using cryptography mixed with a ledger or a blockchain - a way to keep track of digital transactions and avoid counterfeiting on the internet.
Since the whitepaper, however, Bitcoin’s focus has shifted more towards a “store of value” concept instead of payments. It’s this idea that the internet needs some sort of digital gold via which more valuable services can be created.
For Bitcoin, that value is on the Lightning Network, a payment protocol that has about $87 million worth of BTC on it. Or in the locking up of bitcoin - for example $3.6 billion is “wrapped” and locked on the bitcoin network. This is called wBTC on Ethereum and deployed in DeFi for lending, liquidity and market making.
Other considerations are in play here as well. Many bitcoiners see BTC as a financial and oftentimes even political revolution. It’s the idea itself that gives it value, and thus the value is actualizing itself as more people wake up to the concept. Many have described this to me basically as a self-fulfilling prophecy, and time will tell if that’s true.
Mining Plays a Role
Another crypto network consideration for value is mining. With Bitcoin, the miners who spend money on pricey hardware reap all the rewards of participating in the network. Large players have entered this space, with data centers and a thirst for electricity at the cheapest possible cost.
The miners get all the transaction fees and new BTC entering circulation. And miners affect BTC price as well. For instance, miners are currently selling quite a bit - which can impact its store of value capacity.
So, if the self-fulfilling prophecy is indeed true - more people learn about the philosophy behind Bitcoin, which garners more interest and thus value - it might also work conversely. And mining would be a big part of that. For example, a recent Bloomberg article talks about the current woes of bitcoin miners. Miners have taken huge loans with BTC and/or mining equipment as collateral.
As you might guess, this isn’t going well in current market conditions. Collateral values are dropping, as BTC has trended down and mining equipment depreciates.
This means that lenders are finding these loans worth much less than what’s on the books. If a bitcoin miner can’t pay its loan obligations, it will have to give up its mining gear and/or BTC as collateral. And what is a lender going to do with the collateral in that situation? They are probably going to dump it to liquidate the loan off their books.
So.. What?
Ultimately, this post is an exercise in evaluating the different dynamics of what goes into a cryptocurrency’s value. With bitcoin, some believe hard metrics like mining can’t determine what BTC might be worth in the future because it’s the original and there’s some political and technological ideology behind it that gives it worth.
I’m not disagreeing with that, because we have seen bitcoin markets behave rather unpredictably in the past. But we’re also dealing with some pretty unique market conditions. There is hidden leverage still in the market with Digital Currency Group’s Genesis and other entities in the ecosystem. Essentially the FTX blowup has not pushed bitcoin prices down as much as many thought it would - yet.
But issues with mining may do that. According to Glassnode, miner revenue hit a two-year low just a few days ago - to $11.6 million on November 26. In order to survive, miners will have to continue to sell mined BTC to pay for opex or face bankruptcy. And bankruptcy just means even more selling to erase liabilities.
When you think about it, there’s a bit of an irony that Bitcoin is desired because it is a permissionless and censorship-resistant thing. It’s “magic internet money” thinking.
Because Bitcoin has actually become somewhat corporate-ized. This due to the permissionless mining aspect that attracted and is now beholden to traditional finance in terms of lending to huge mining. And if the costs of bitcoin mining go way over what BTC is worth for an extended period of time, there’s going to be a big problem.