April 26th, 2019

Bitcoin: The Challenge of Valuing

a Financial Social Network

Angela Dalton
Managing Partner, Technology Signum Global Advisors
angela@signumglobal.com

Executive Summary
More than 105 news articles declaring the death of Bitcoin have run in the likes of the Wall Street Journal
and the Financial Times since the cryptocurrency began an ~84% retrace from its December 2017 all-
time high. During the last bear market, 35 similar articles surfaced, only to be left on the sidelines as the
cryptocurrency began its 100x run from January 2015 onward. As such, the recent change in sentiment
among even the most bearish of traders warrants a serious look for investors searching for a long-term
entry into Bitcoin.

This note will focus on the following takeaways:

1. Bitcoin is best understood as a financial social network, in which stakeholders are perpetually
underpinning the integrity of their common digital commodity.
2. We believe the bottom of the 2018 “Crypto Winter” likely came on December 15th at ~$3,200.
3. Bitcoin price movements follow a clear cyclical pattern, with price bottoms following a logistic
growth curve and price tops coinciding with regular protocol events.
4. Bitcoin’s low correlation to other assets could make it attractive as a portfolio addition.
5. Valuation – while numbers and price targets are abundant, each has its flaws. The ‘social
network’ aspect of Bitcoin also makes it difficult to value.
6. Transactions Comparisons showing that Bitcoin is larger than Paypal miss the mark because
the use cases are completely different. Paypal (and Visa, other) are for small-sized, transaction
purposes, while Bitcoin is for larger-sized, security seeking, settlement purposes. To make a
bigger picture, social network analogy on size, I would argue that Bitcoin is to Paypal as Twitter
is to Facebook.

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Bitcoin is a Complex System – a Financial Social Network

Although the growth of Bitcoin’s market capitalization appears alien at first, it has followed a pattern
over the past decade.

James Todaro, Blocktown Capital (4/5/2019)

Comparison to Commodities
We can attribute this pattern to two factors: short-term price inelasticity and long-term network effects.
The former is analogous to traditional commodities markets, except the timespans are shorter. Like the
way in which commodities producers rush to build capacity in a rising price environment to the point of
overbuild, Bitcoin miners will chase rising prices until market saturation results in shuttered operations.
However, Bitcoin miner dynamics are different from that of other commodities like gold because the
block reward remains unchanged. The guarantees underlying Bitcoin - its predictable supply, its regular
block times, its immutability - are all constantly being secured by the miners, nodes, and holders
maintaining the network. This also contrasts with gold, where its intrinsic value is ensured by the laws of
the universe; that is to say, the mining company does not have to pay in perpetuity to ensure than an
ingot in Fort Knox does not just suddenly evaporate. Finally, Saifedean Ammous, author of The Bitcoin
Standard, also made the point that Bitcoin will be differentiated from other commodities in that it will
have a stock to flow ratio that is lower than any other commodity and a lower inflation rate than the
Fed target due to the “halvening” effect which we will discuss later in this post.

Comparison to Social Networking

The network effect results from social and cultural aspects that take their cue from religion. Born in the
aftermath of the Global Financial Crisis from the white paper of the pseudonymous Satoshi Nakamoto,
Bitcoin has given rise to a fervent community of believers. Believers consider themselves to be a part of
a monetary revolution and have profited handsomely from their participation. While I’m expecting a
comparison to religion, with its monotheistic character and central text, to seem extreme, consider the
positive feedback loops that allowed Facebook and WeChat to scale. If “likes” and “shares” can
attract billions of users to convene, it should not surprise us to that a network centered around financial
sovereignty could grow similarly.

The following chart demonstrates how Bitcoin price bottoms, when graphed on a logarithmic scale,
accurately follows the growth of a Gompertz Curve. This curve is typically used to model population
growth, or the adoption of technology over time. No matter the reason observers have attributed price

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bottoms to in the past (e.g. protocol bugs, exchange hacks), the curve has held. This is a picture of the
growth of a social network in terms of the price of its underlying asset!

Timothy Peterson, “Bitcoin Spreads Like a Virus” (3/20/2019)

For background, we should first discuss three distinct types of stakeholders who contribute to the
dynamic growth of Bitcoin and its market capitalization: miners, node runners, and holders. The biggest
mistake an investor can make in valuing Bitcoin is to disregard these stakeholders; by examining the
incentives that govern their network participation, we can deduce several forces that drive Bitcoin price
movements.

Miners and Node Runners: Checks and Balances

Two of the three stakeholder groups actively participate in the continued propagation of Bitcoin blocks.
Miners confirm these transaction bundles every ten minutes, while node runners operate the full nodes
that store the history of the Bitcoin blockchain. The adversarial design of Bitcoin provides both groups
with an incentive to check the power of the other, allowing for the network to run without the need for
trust between them.

Since 2013, Bitcoin mining has required industrial scale computing and energy resources. Their decision
to either expand or reign in their operations is driven by two primary factors: mining difficulty and the
block reward. Since the genesis block mined on January 3rd, 2009, the computing power required to
process an incremental block has increased by a factor of 1012, while the reward for doing so has
dropped from 50 bitcoins to 12.5. This is a result of predictable events – hashrate increases and block
reward “halvenings” – that leave market demand and supply for Bitcoin relatively inelastic in the short
term. Accordingly, a lag exists between network hashrate and Bitcoin price, punishing miners who
overextend themselves in bull markets. Cycles in price are akin to that of traditional commodities
markets, except that the time between booms and busts can be measured in months and years, not
decades.

Also, as global markets economist and crypto trader Alex Kruger points out, the breakeven cycles are
very different between commodities and Bitcoin. For commodities, breakevens serve as soft floor, but
prices do fall below breakeven and corrections take time, leading to boom & bust. For Bitcoin,
breakevens can only serve as artificial floor, as large miners can defer selling or put a floor on price
via trading.

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Alex’s comparison:

• Commodities => Price drops below BE => miners shut off => less supply => less inventory =>
price bounces (with prolonged lag)
• BTC => Price drops below BE => miners shut off => less hashing power => lower difficulty
=> same supply

Analyst Hass McCook points out a similar trend:

Hass McCook, “Bitcoin Mining Competitive Economics 101” (1/15/2019)

Node runners complement miners by hosting their own copy of the Bitcoin blockchain, despite not playing
a role in transaction validation. They embody the community refrain of “Don’t Trust. Verify.” by not relying
on a third-party exchange or block explorers to confirm their balances or transactions across the wider
network. These “full nodes” can exercise their influence over the network in what is called a user-activated
soft fork (UASF). An instance of this occurred during the conflict over the SegWit network upgrade in
2017, where miner stonewalling was overcome by a majority of full nodes signaling their agreement with
the SegWit proposal.

Investors can take solace in this robust relationship between miners and node runners as it adds certainty
to the integrity of the network. While they may have fears surrounding the concentration of mining
hashrate between a handful of entities or within an unfriendly jurisdiction, miners will only ever be able
to profit if they cooperate with most full nodes. In a sense, the few who have even a remote ability to
sabotage the network are the ones who stand to lose the most from doing so.

Holders: The Importance of Culture

Bitcoin holders are users who have a wallet address without running their own mining rig or full node. The
spectrum of holders ranges from those who entirely trust a third party like Coinbase or Square to custody
their private keys, to those who self-custody via solutions like Ledger’s or Trezor’s. While holders play no
role in the stewardship of Bitcoin, they act as the psychological bedrock for both price and user adoption.
Like any social network, Bitcoin depended on early adopter to bootstrap its adoption in the beginning,
and they have since left an indelible mark on its identity.

Nowhere is this more apparent than in the concept of the holder of last resort, referred to as a “HODLer.”
Just as lenders of last resort serve to stave off bank runs in fiat monetary systems, these ideologically-
driven users refuse to panic sell even in the face of volatile bust cycles. The following chart demonstrates
this phenomenon by plotting unspent transactions (i.e. all bitcoins held by wallet addresses) against Bitcoin
price and the time since they last moved. The cooler bands reveal that market bottoms correlate with
peaks in bitcoin holding, despite the outstanding supply increasingly over time. The unwillingness of long-

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term holders to sell their bitcoins contributes to the price floors between waves of Bitcoin adoption during
bull cycles.

Nelson Morrow, Unchained Capital (4/17/2018)

Faith in Math, Financial Sovereignty, and Distributed Systems

Bitcoin is undeniably a technical achievement, but what set the course for its early community was the
publication of its white paper to a niche cryptography newsletter during the Global Financial Crisis.
Satoshi Nakamoto built a decentralized time-stamping mechanism; it was the cypherpunks and
libertarians who first came across it that understood it to be an alternative to existing monetary institutions.
These early adopters - with their distrust of government, passion for open source software, and desire
for community - formed a dedicated user group that was able to weather the uncertainty of black swan
events.

Meltem Demirors of CoinShares, who also happens to be a culture carrier in crypto, wrote a really
interesting Medium post called, “Im not an International Drug Dealer. So Why Do I Need Privacy?”
along with a podcast entitled Surveillance Capitalism (see book by Shoshana Zuboff), which quoted the
Cypherpunk Manifesto and described the beginnings of the crypto ethos.

It started as “cypherpunks write code,” but has evolved to mean something far greater than just writing and
deploying software. Cypherpunks take action as individuals. They take personal responsibility for empowering
themselves against threats to privacy, in whatever way they are capable.

We, as users of cryptocurrencies and other forms of applied cryptography in communications and computing,
are doing something decidedly cypherpunk. We are participating in proving that these early prototypes have
merit, and we are directly participating in their evolution to be usable at scale and en masse. These are
important and essential experiments in the future of privacy preserving technology that can reach not just the
privileged few. In the future, as it was in the past, privacy may define the line between life and death for
individuals, their families, and their social groups.

We believe that the current zeitgeist is providing tailwinds to this asset class unlike for more traditional
asset classes. The technology is distributed and backed with math. The network progresses as we grow

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our collective understanding and create better networks. This is attained through a culture of information
sharing - almost as soon as a concept is learned, it is shared on “Crypto Twitter” and elsewhere.
Simultaneous, collective progress follows. While the early world of crypto has its share of bad actors and
a taint of drug dealing and money laundering, in fact, there is something else happening under this cover
- a tech culture of freedom and sharing that was non-existent in the information guarding, profit
maximizing Silicon Valley culture of the past. Instead, this is a culture of distribution - “we are all in this
together”. This has likely occurred for several reasons.

1. Secular Community
Over a third of Bitcoin’s core demographic, the college educated millennial, is atheist. We believe
that humans crave community, and as seventh generation rabbi Irwin Kula commented, “other
things (brands?) will fill this existential space.” To me, it seems that Bitcoin may be one example.
The sense of community is palatable. In the same way that the technology is decentralized,
individuals in the community learn and almost simultaneously share information as a way to get
the entire community up to speed so that it can evolve thinking in concert. This community believes
that the future of finance is being built over Twitter and Reddit, not Wall Street.

2. Mistrust of Financial Institutions

This same demographic was composed of children and adolescents when the Global Financial
Crisis came in 2008. An unprecedented mistrust in banks has continued to grow, with a backbeat
of disillusionment as their college debt drowns their current and perceived expected income. Add
to this suspicion and resentment that quantitative easing drove up asset prices and bailed out
baby boomers at the expense of millennials. This mistrust of the traditional financial system has
led people to seek modern alternatives.

3. Explosion in Open Source Software

Finally, the explosion of open source software appears to have led exactly to this point from a
cultural perspective. Fabric Ventures did an excellent job in laying out the democratization waves
of technology, which has most recently culminated in big internet companies like Facebook and
Google growing out of two concurrent developments 1) an explosion of personal data. Like frogs
in a pot of boiling water, we didn’t even recognize it happening or think to control it. 2) the
arrival of opensource software as a quiet, yet ubiquitous, driver of growth. It was quiet because
it wasn’t in the companies interest to advertise the fact that they were using free, opensource
software (and our free data!) to create business models that have netted them billions of dollars.

Allen Farrington has a fascinating description of blockchains like Bitcoin in a recent post here as
‘a new kind of computer’ which, for the first time, makes data scarce. “It is the first and only known
way to electronically transfer data without an intermediary in such a way that the sender loses access
to it after it is sent. It is the only known way to make data scarce.” He continues by describing a
traditional software company as having a proprietary computer that brings in revenues as a
charge for access to their proprietary computer. These revenues are offset by expenses
generated from the proprietary computer.

Traditional equity investors will speculate on the value of this proprietary computer. But when
dealing with blockchains, in large part due to open source, rather than the customer paying for
the right to access a computer at a price determined by the company that owns it, the customer
simply buys the computations with a native currency, the token, and then mediates transfers of
scarce data on a new kind of computer. This shift suggests that our frame of reference for valuation
may not suffice for the new economic models enabled by blockchains.

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What does all of this mean for Bitcoin, and more generally for blockchain technology? These newer,
distributed technologies are emerging as distributed databases, blockchains and cloud services, still based
on open source software, but with distributed value chains. In thinking about the history of technology and
the “winner take all” models that have succeeded in the past, it is worth asking how new platforms could
be different. We believe the value in the networks will be distributed, not centralized, and we will see
more, smaller players along the food chain, even individuals, sharing in future platforms’ value. In other
words, future internet giants may not be giants.

While traditional brands and banks may struggle to navigate the next intergenerational transfer of
wealth, Bitcoin is millennial-native. It offers a sense of community in a time where atheism is the fastest-
growing spiritual response; it offers a deflationary asset in a time of ever-expanding debt; it offers a
democratic technology in a time of proprietary monopolies. Insofar as holders perceive themselves to be
profiting off their participation in a revolution, the psychological impact of Bitcoin has created a flywheel
for user acquisition.
Understanding the Size of Bitcoin
Using market capitalization, which currently stands at $88.8 billion, as a sizing metric for Bitcoin has its
limitations due to the nature of the Bitcoin supply - an estimated four million bitcoins are associated with
lost addresses and should not be considered a part of circulating supply. Nic Carter of Castle Island
has come up with a new metric, realized cap, which only accounts for wallets considered to be active.
The reason that this metric is important is the HODLer concept described above – while Bitcoin is used
for speculation, the base of buyers intend to hold despite volatility.

In the following graph, we see that transaction volume, a proxy for total realized demand, increased a
factor of around 50 to the peak in December 2017…

…but the number of participants providing this demand increased by only just over 2x in the same
period.

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Below is Nic’s graph of realized cap over the same period as the previous graph. While the market cap
of Bitcoin came down by 75%, there is no crash in realized cap.

Transactions Comparisons in the Press of Bitcoin to Paypal are Apples to Popcorn

The use cases are completely different. While Paypal (and Visa, other) are for small-sized, transaction
purposes, Bitcoin transactions are batched and they are for larger-sized, security seeking, settlement
purposes. Therefore, media reports of Bitcoin surpassing PayPal in transaction value are only a piece of
the puzzle. In a bigger picture way, I would argue that Bitcoin is to Paypal in terms of size as Twitter is
to Facebook.

At roughly 7 transactions per second, Bitcoin transactions have been estimated at 200k - 400k
transactions per day. As Nic Carter explains in his Medium post, “together, transaction rate and average
transaction size give you the economic throughput of the system; a measure of its financial bandwidth per
unit of time.” In terms of settlement, Bitcoin is more like cash because it is a virtual bearer instrument.

Additionally, Bitcoin transactions are large - in the thousands of dollars as seen in the Coinmetrics.io chart
below dated 4/26/19. Also, they are bundles of ledger updates, not a single transfer of value from one
individual to another. The bundle could include thousands of transactions or just be an anchor transaction
for multiples of this number.

Paypal, Venmo, and Visa are for smaller value transfers with some reversibility guarantees. As Nic
explains, the strong assurances of global final settlement that Bitcoin provides are simply not required
for low-value transactions. It is for large, inter-jurisdictional transactions, providing mutual trust is lacking
and rapid settlement.

You don’t wear body armor when you walk to work. You don’t put your petty cash in a safe and handcuff it
to yourself when you buy groceries. - Nic Carter

To make a bigger picture, social networking analogy on size, I would argue that Bitcoin is to Paypal as
Twitter is to Facebook. Even though Twitter is much smaller in terms of a user base (130+ million DAUs vs
~1.5 billion), its users are much more dedicated and tweets are higher volume, of higher importance to
its community of interest, and higher velocity.

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Catalysts on the Horizon

The logistic growth of Bitcoin and the nature of its underlying digital commodity suggests that the network
will accrue value as it a) captures new users and b) emits steadily fewer bitcoins. Eventually, the network
will achieve market saturation, at which price it will reach an equilibrium affected only by supply deflation
(i.e. lost bitcoin addresses outpacing block reward emissions). With unique holders estimated at ~20
million entities and 10% of remaining supply to be mined, we find ourselves well before that theoretical
plateau.

Three catalysts have the potential to drive Bitcoin in the aftermath of the 2018-2019 Crypto Winter: the
2020 halvening, inflows due to a continued lack of correlation with other markets, and the emergence of
institutional grade custody and trading solutions.

1. The 2020 Halvening

Halvenings play a key factor in Bitcoin price developments. At its onset, the Bitcoin protocol
awarded miners 50 bitcoins per block reward; fast forward three halvenings, and miners will
only have 6.25 bitcoins to look forward to, at block 630,000 in May of 2020. Markets have
tended to price in the phenomenon in the preceding months, then adjusted to the new supply
equilibrium slowly over the following year. Given that the Bitcoin market has matured, however,
it could very well be the case that veteran investors have already begun to price in the next
halvening a year in advance.

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@100trillionUSD, Medium.com

2. Low Market Correlation

With both the Federal Reserve and European Central Bank walking back their talk of quantitative
tightening, investors will likely continue to be starved for alpha in traditional assets. This hunt for
yield will eventually drive even more risk-averse institutional investors to take on increasingly
more beta. Q1 saw a glimpse of this as more conservative funds, like the Yale endowment and
the Fairfax County policy pension, made investments in vehicles with cryptocurrency exposure.
Not only has Bitcoin volatility steadily decreased over time, Bitcoin has also avoided any long-
term (i.e. 180 day rolling average) correlation with either the S&P 500 or the USD since 2016.

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BTC v. SPX, Alex Krüger (3/23/2019)

BTC v. USD, Alex Krüger (3/23/2019)

Anthony Pompliano of Morgan Creek Digital has also remarked that this lack of correlation
should outweigh investor concerns over volatility, arguing that “If an investor adds Bitcoin to their
portfolio, the overall risk of the portfolio will actually go down, not up. Also, there is a high
probability that if stocks, bonds, currencies, and commodities suffer over the next decade, Bitcoin
will again prove to be the best performing asset (just like it was for the last decade, even during the
longest bull market in history).”

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3. Institutional Grade Solutions

For all the doom and gloom that characterized the past year and a half in the market, the
institutional infrastructure landscape has matured significantly. It has never been easier for an
enterprise entity to buy, hold, and exchange bitcoins. Below are just a few headlines from the
past four months:

• Gemini passed a SOC 2 security review conducted by Deloitte and Touche, LLP.
• Fidelity Digital Assets has been onboarding enterprise clients
• A16z invested $17 million in crypto custody startup, Anchorage
• BitGo now offers insurance on up to $100 million in cryptocurrencies via Lloyds
• Bakkt will bring physically-delivered daily Bitcoin futures to market

The Long-Term Bull Narrative for Bitcoin

The value proposition for Bitcoin is unique, both among asset classes and within the cryptocurrency
category itself. Bitcoin bootstrapped the first digitally-native medium of exchange and has challenged
our traditional understanding of monetary economics. No other asset class boasts a similar combination
of deflationary economics with social networking; no other cryptocurrency can claim to have its degree
of security and independence. So, what comes next?

We have made the case in this paper that Bitcoin is a financial social network, but that does not
necessarily make it any easier to determine a price target. As Yassine Elmandjra of Ark Investments put
it, “one can hypothesize on use cases and how additive various opportunities will be but a specific price target
in the traditional sense is elusive.” Having said that, he views Bitcoin as a multi-trillion dollar opportunity
in the next 5 years.

Some back of the envelope numbers that go into his thinking:

• 10% of gold’s role as a store of value ~ $1T
• As a medium of exchange catalyzing currency demonetization - Bitcoin could capture 20% of
M2 outside of the top 4 currencies. This is roughly equivalent to ~$2T.
• Serving as an insurance policy against asset seizure, Bitcoin could capture 5% of HNWI wealth,
amounting to another $1T

On the qualitative side, we see a number of narratives coming to a head in the coming years that argue
in favor of a stateless and deflationary “magic internet money.”

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• Suspicion surrounding Big Internet’s role in government surveillance

• Continued interest in online communities amongst millennials and Gen Z-ers
• Fear of hyperinflationary policies under the guise of “Modern Monetary Theory”
• Desire of payments processors to sidestep traditional payments rails
• Decline of international institutions and reserve assets

Across the last decade, Bitcoin has come from a connotation of drugs and money laundering and Dutch
tulip mania analogies. Regardless, it has convinced reputable institutions like Fidelity Investments to offer
custody solutions to individuals. Reports ranging from 30 million - 50 million active Bitcoin users (relative
to PayPal’s 267 million active accounts as of January 2019) imply that it is likely very early. Given the
above trends as well as Bitcoin’s low global penetration, we believe this is only the beginning.

In addition to the many contributors cited in this paper, it has been written in collaboration with
Maximilian Fiege, a digital asset analyst whose previous work has been featured by the Council on
Foreign Relations and The Block.

For client inquiries, please contact:

Jason Press
Global Head of Sales and Client Services, Signum Global Advisors
jason.press@signumllp.com
+1.917.353.5566

Signum Global Advisors

New York
London
Washington DC

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Disclaimer
This material is prepared by SIGNUM GLOBAL
ADVISORS and is not intended to be relied upon
as a forecast, research or investment advice,
and is not a recommendation, offer or
solicitation to buy or sell any securities or to
adopt any investment strategy. The opinions
expressed are as of April 25, 2019, and may
change as subsequent conditions vary. The
information and opinions contained in this
material are derived from proprietary and
nonproprietary sources deemed by SIGNUM to
be reliable, are not necessarily all inclusive and
are not guaranteed as to accuracy. As such, no
warranty of accuracy or reliability is given and
no responsibility arising in any other way for
errors and omissions (including responsibility to
any person by reason of negligence) is
accepted by SIGNUM, its officers, employees or
agents.
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This material may contain ‘forward-looking’
information that is not purely historical in
nature. Such information may include,
among other things, projections and
forecasts. There is no guarantee that any
forecasts made will come to pass. Reliance
upon information in this material is at the
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is intended for information purposes only
and does not constitute investment advice or
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