Bitcoin explained to your mother (and Warren Buffett) – Part I
Are 'all of the bitcoin in the world' worth more than $25?
Omaha proclames Bitcoin legal tender
Just kidding. Would have been fun though.
Warren Buffett wouldn't buy 'all of the bitcoin in the world' for $25. Well, me neither, but at the same time, I’m buying some at the current price. Strange, right?
His $25 target is $25 higher than mine. Because for me, it seems very easy to understand how ‘all the bitcoin in the world’ in the hands of any one person, are actually worth 0. Not $25, not 25 Venezuelan bolívars or 25 Zimbabwean dollars. Absolute 0.
It’s hilarious how Buffett’s latest take is not average at all, no, it achieved the rarest combo: 50% brilliant / 50% dumb as a doorknob. I understand he said so to highlight his belief Bitcoin is worthless. I respect Buffett as business man and an investor a lot. But these words only highlight his own misunderstanding of the subject. Let me show you why buying 'all of the bitcoin in the world' is very irrelevant.
‘It’s all just speculation’
I think I understand where it is coming from, and agree the speculative layer on top of Bitcoin’s current valuation can be quite irritating to an entrenched value investor. While the demand for any asset bears some speculative component, Bitcoin is probably in its own category.
However, sophisticated investors have been able to short Bitcoin with size for a while now, and the market for derivatives boomed. The upward speculative component of demand is probably very much dampened by an equally speculative downward pressure. Efficient price discovery is not off the table at all.
Furthermore, the fact that it’s not a company, not a government issued currency, not a commodity, not something tightly fitting a pre-existing asset class surely makes its valuation confusing to value investors…
Some people actually DCF’d Bitcoin and Goldmans Sachs has a model supporting Bitcoin worth $100’000 each in the future, so there are actually quite a few non-speculative ways to value Bitcoin outside Nebraska.
If demand for Bitcoin had been 100% driven by greed, speculation and (why not throw it in the hat too) crime, we don’t believe it would have been enough to jumpstart and grow a $400B market cap. On crime, let’s just put that subject to rest for now: it’s still a lot more convenient and widespread to buy drugs with greenbacks than Bitcoin.
You got it, we don’t believe Bitcoin is worthless, far from it, but would not buy the 18,925,000 bitcoins currently in circulation for $25 either. At least not as investors, maybe collectors, but I digress.
Internet money and a peer-to-peer payment network
The abstract from the original Bitcoin white paper starts with a very simple idea:
A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.
Kudos to those who read the whole paper. For those who did not, note that it’s only 8 low-jargon pages including drawings. You might very well learn something if you make the leap.
Before anything else, Bitcoin is a payment network, with its own qualities and shortcomings. A payment network like any other, with different participants operating software and hardware infrastructures. Each class of participant captures some value in one form or another. In a typical payment network, some participants receive monetary incentive to provide the infrastructure and liquidity, while the others receive convenience, insurance and credit they need to commerce and consume.
Did you pay today?
What other payment system did you use today? Coins and bills? Mastercard? Visa? SWIFT? SEPA? They all have their USPs, markets, and incentives for infrastructure providers delivering value to their end users.
Let’s have a closer look at Visa: infrastructure and liquidity is mainly provided by Visa Inc., along with payment processors and banks. Their incentive to do so is monetary as they all collect fees, commissions and interest charged mainly to merchants and card holders. Those end users benefit in return from facilitated commerce, easy access to (very expensive) credit and other value added services (insurance etc…).
Credit cards dominate the market for retail payments in many places and pretty much replaced paper checks and cash in a lot of settings. Visa processes more than 230B transactions a year for a volume of $13T. The average transaction worldwide seems to be $56 a pop.
The revenue of Visa Inc. directly depends on network metrics:
the number of transactions (fixed fee charged to merchants on each transaction)
the volume of transactions (variable % fee charged to merchants on transactions)
the number of participants (fixed recurring fees on card holders and merchants)
On top of that, they skim interest and other services, licenses etc… Those numbers grow with transactions and participants in a virtuous bandwagon effect: more card holders command more equipped merchants competing for business and vice-versa.
At the time of writing, Visa Inc. (NYSE:V) has an EV of $431.67B with revenue of $27B (TTM). Oh and surprise: Buffet’s Berkshire Hathaway owns a solid 0.5% chunk in the company, worth $1.8B at the time of writing. Smells like someone is only playing dumb here…
I agree 140%, Mr Chairman: a one-man network is worthless.
And it is not even a network by the way.
What Buffett got wrong here is quite simple: he may have thought buying all the bitcoin in the world equates to buying all the circulating supply of a state issued currency, and deems that bitcoin is worthless as a currency.
This is just ignoring the fact that it is also a payment network, with an innovative incentive structure designed to compete with other payment networks for market share on both value proposition and cost. How does it compete and for how big a market we will cover in a later instalment.
Spoiler: that incentive structure is enabling some of Bitcoin’s USPs previously technically impossible to achieve at a sustainable cost.
Let’s try Buffett’s limp reasoning and amputate Visa from one of it’s token of participation then. There were 3.8B Visa cards worldwide as of December 31, 2021.
Now, imagine we acquire every single one of those. That’s around 19’000 tones of plastic with some silicon and copper from the chip, more or less 25’000 cubic meters of tainted scrap PVC.
How much would Warren be willing to pay to take delivery of a tanker full of tainted scrap PVC from every single Visa card in the world? Truth is, he would probably pay a small fortune to actually avoid taking such delivery (remember when oil futures went negative? I remember).
25’000 cubic meters of tainted PVC is not only worthless, it also carries a big cost to store, displace and dispose of/recycle, while sustaining a very low intrinsic market value. In Buffett’s own word: ‘it doesn’t produce anything’. Not unlike what you’d get ‘buying all of the bitcoin in the world’.
And then, how much would VISA Inc. be worth when no one longer has one or two of those cards in their wallet, and transaction number, volume and revenue subsequently goes to 0 as a consequence? Well, not much right?
A currency running (on) it’s own dedicated network
You may have just discovered Bitcoin is really not only a currency, nor a digital asset, but it’s an entire payment network as well! You can’t amputate the coins from the network. Bitcoin does not exist outside of its own network, and you can’t get bitcoin out of its network. This is just factual, not an argument, unlike the question wether it is a currency, a ‘store of value’ or what so ever.
And not unlike any other networks, if you concentrate nodes a little too much, then the network quickly becomes worthless (that’s less than $25). On the other hand, adoption (number of overall participants from infrastructure providers to end users) and usage (number and volume of transactions) are the main drivers of overall value creation. Not unlike the Visa network.
In order for ‘all the bitcoin in the world’ to be worth more than $25, we now understand that they need to be distributed among a larger number of participants (more than one Nebraskan), willing to transact more on the network for their own reason. Wether Bitcoin will increase in value fundamentally depends on the growth of end users and transaction volume. Same thing for Visa.
Finally, a trivial way to assess a business outlook is to look at the meeting point of supply and demand. Is that point favorable or not? Are Bitcoin USPs valuable enough for a large enough population for it to thrive? What does Bitcoin offer that competitors and substitutes can’t, and more importantly, what is the total addressable market for that value proposition, and why could it be growing?
I’ll see you in Part II (maybe III and IV as well, sorry) for answers to those questions. And we may even find some big ‘moat’ in there…
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This is part I of an ongoing series about Bitcoin that we will insert in between other posts. Next up will probably cover physical Uranium.
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The original white paper for Bitcoin: https://bitcoin.org/bitcoin.pdf
Warren Buffett wouldn't buy 'all of the bitcoin in the world': https://www.cnbc.com/2022/05/02/warren-buffett-wouldnt-spend-25-on-all-of-the-bitcoin-in-the-world.html
BRK’s Visa holding from 13F: https://whalewisdom.com/filer/berkshire-hathaway-inc#tabholdings_tab_link
Latest Visa fact sheet: https://usa.visa.com/dam/VCOM/global/about-visa/documents/aboutvisafactsheet.pdf
Visa financials on Yahoo finance: https://finance.yahoo.com/quote/V/key-statistics?p=V
On Valuing Bitcoin: https://www.cnbs.gob.hn/wp-content/uploads/2019/11/Valuing-Bitcoin.pdf
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Victor Martin (twitter | linkedin)
Entrepreneur, business consultant to founders, investors in tech/business-model innovation and alternative investments.
Laurent Nicolas (twitter | youtube)
Entrepreneur & software developer, Youtuber, crypto enthusiast since 2017. Warned investors about the high risk of UST since early 2021.
Funds we control or advise are currently net long Bitcoin. None of the information provided in this newsletter constitutes financial advice. This is intended for entertainment, education and general information only. The general tone might have given that away, but we prefer making it explicit.