Re: Crypto/BTC-GS Insight Highlights.

GS just published a 50-page thought piece entitled “Digital Assets: Beauty Is Not in the Eye of the Beholder.” My highlights follow.

Re: Crypto/BTC-GS Insight Highlights. GS just published a 50-page thought piece entitled “Digital Assets: Beauty Is Not in the Eye of the Beholder.” My highlights follow. (THREAD)

It’s a comprehensive piece on the entire crypto ecosystem, but what I found most interesting was the valuation discussion.

First, let me state that I have no dog in this hunt yet (either long or short), but I’ve been thinking about/studying the space for a number of years. Given the massive monetary/stimulus giving rise to inflation fears, I’ve naturally investigated crypto.

What’s always given me pause is 1) the question of valuation and where value ought to accrue in the ecosystem, and 2) the religious zeal that proselytizers wield when challenged, which is really more of an anecdotal contra-indicator in my experience.

Another worrying parallel I observe is the similar dynamic of artificially inelastic supply meeting a seductive demand story, replete with references to “Metcalfe’s Law” and “network effects.” I’m reminded of the George Gilder fiber optic/B2B darlings of 2000.

Going back to the question of where value should accrue, if you look at the incredible innovation that emerged out of the Internet Bubble, the lasting value was NOT in those darlings but ultimately in companies that harnessed the tech and found ways to aggregate CASH FLOWS.

In today’s new world of crypto/DeFi innovation, most of the value creation has been in the TOKENS – I keep wondering whether this is like the fiber/B2B bubble, and that the ultimate value creation will be in COMPANIES that learn to disrupt industries using blockchain tech.

GS frames it perfectly: “It is imperative not to conflate the value of cryptocurrencies w/the value of blockchain/DLT, and not to conflate the value of the first 2 with the value of ventures that aim to commercialize this technology.” Bingo.

“While the digital asset ecosystem may well revolutionize the future of everything, that does not imply that cryptocurrencies are an investable asset class.” I’m 70/30 in agreement with this statement.

GS considers 5 key criteria to justify investment allocation to an asset class: 1) steady cash flow, 2) generate earnings, 3) diversification benefits, 4) dampen volatility, 5) inflation/deflation hedge/store of value. GS believes that crypto do not meet any of these 5 criteria.

STEADY CASH FLOW: This is my main objection as well. The various forms of yield farming are not contractual obligations and are more akin to selling vol/insurance in a rather recursive and incestuous way imho.

GENERATING EARNINGS: Similar to above. “Unlike equities, cryptocurrencies...do not generate earnings tied to economic growth...there is no economic rationale that underpins an upward trajectory of prices.” In other words, it is a pure “Greater Fool” trade.

DIVERSIFICATION: While GS acknowledges low BTC/S&P correlation, it claims there is “no diversification benefit” to the near-zero Sharpe ratio of BTC. To be fair, I’m not sure I agree on this one.

DAMPEN VOLATILITY: Ummm...not much more to say here, even if you only use post-2014 vol of 68%.

INFLATION/DEFLATION HEDGE: GS: “no evidence that cryptocurrencies are a reliable inflation or deflation hedge that will store value...Equities are the most consistent and reliable inflation hedge.” Jeremy Siegel FTW!

GS then considers the VALUATION question: “After examining 6 different approaches, we believe that it is virtually impossible to build a defensible framework for value cryptocurrencies.” The 6 approaches follow:

1. CASH FLOW ANALYSIS: Asked and answered -> N/A

2. GOLD COMPARISON: “...since we do not believe that cryptocurrencies are digital gold and...they have no correlation to gold and lack many of the qualities of gold, there is no analytical grounding for tying their value to gold.”

GS had a very interesting chart comparing magnitude of drawdowns of equities/gold/BTC:

3. MONEY SUPPLY: GS argues that since crypto does not serve as a medium of exchange or unit of measurement given “current volatility and slow processing, applying economic equations in relation to money supply to value these assets is meaningless.”

4. PAYMENT SYSTEMS: “Visa processes an estimated 140B transactions/yr, while BTC process about 100 mm...Using the same pricing used by the market to price other credit card payment systems, the price of BTC is estimated to be about $22.”

5. MONEY-TRANSFER SERVICES: “If we use the valuations of major money- transfer services...and apply it to BTC for the $28.8B of annual transfers, the price of BTC is estimated to be about $151.”

6. COMMODITY COST OF PRODUCTION: “One can value BTC based on the cost of mining + a reasonable ROE for the miners...One such model estimated the price of BTC to be $10k...”

“The problem w/such analysis is that BTC is not a commodity in that it is not a raw material used as in input for other goods.”

Good quote from @AswathDamodaran: “You cannot value BTC or invest in it. You can only price it and trade it.”

The last 3 charts are incredible imho and really puts into perspective the size of the “charge” of what I think ultimately is an “inflation capacitor.” The first chart shows the size of EQUITY bubbles:

Next, we zoom out and overlay BTC on this chart along with tulips:

Finally, we zoom out again and overlay ETH’s recent meteoric rise:

Herein ends my summary. For now, I am much more interested in looking at COMPANIES that can utilize blockchain/DLT to disrupt industries rather than the cryptocurrencies themselves, but that’s what makes a market. Let the arrows fly.