Following China’s recent banning of cryptocurrency usage last week, the nexus of sovereign adoption and digital assets has reemerged as an important question in the industry. When it comes to Bitcoin, one of the key risks for investors has always been that of government rejection and if the cryptocurrency will be banned, shutdown or too heavily regulated. This risk has been widely addressed by thought leaders in the crypto industry, and is best put in context by investor analyst Lyn Alden in her 7 misconceptions about bitcoin. Nevertheless, it remains a genuine risk at least in the perception of many serious institutional investors.
As the digital assets ecosystem continues its journey from volatility and speculation to a more mature and established market, institutional investors have served as the catalyst for the current phase in crypto adoption. Institutional investment has therefore diminished this risk of a coordinated attack by governments, but the most credentializing development will be when sovereigns put bitcoin on their own balance sheets.
Before diving into what this will mean for the future of crypto markets, it is worth taking stock of bitcoin’s market value, and its long-term valuation prospects.
To the maximalists, Bitcoin is a truth machine protected by a fortress of misconceptions. As Niall Ferguson defines in his book The Ascent of Money, money is Trust Inscribed. Bitcoin is the most verified inscription of trust ever established, and with a network effect that provides a moat of global protection. As for the misconceptions, such as the perceived risks of ESG, volatility, legitimacy, theft, competition from other cryptocurrencies or CBDCs, these can all be addressed through readily available research online.
Bitcoin’s opportunity is therefore a function of time – the time of an investor’s attention and research to peel away these misperceptions. The faster one invests time to understand it and deeply understand the misconceptions, the earlier can one benefit from its still emerging price trajectory.
In recent months, bitcoin’s market cap has remained relatively stable at the $1 trillion range, priced at $40,000-50,000 per bitcoin. Given that it was priced at $0.08 in 2010, this continues to remain the best performing investment in history.
Consider present-day valuations of gold, real estate and equity markets. Today, the global gold market is valued at approximately $11.6 trillion. The global residential and commercial property market is valued at over $200 trillion, alongside global bonds at over $120 trillion, and the global stock market at around $95 trillion. In comparison, the combined market cap of Bitcoin and all other cryptocurrencies is a mere $2.1 trillion.
Considering the growing sophistication of distributed ledger technology and the boom in institutional adoption of decentralized digital assets, it’s clear that there is still plenty of room for bitcoin to grow – and even absorb – other major asset classes.
This begs the question: why haven’t sovereign investment funds – often considered to be one of the most important influencers in financial markets – commenced investing in crypto?
Sovereign wealth funds (SWFs), large institutions with billions of dollars in assets under management, typically allocate a small portion of their assets in inflation hedging assets such as gold. The market capitalization of bitcoin is a fraction of the capitalization of the entire market for gold, and yet, SWFs largely ignore the fledgling crypto asset class. However, this trend promises to change over the next few years as SWFs take note of the shift towards digital financial infrastructure and decentralized finance applications. With a trillion-dollar market cap, this asset class can no longer be ignored.
The impending move of SWFs into the crypto market will be transformative for the asset class. As sovereign wealth funds enter the market, it will not only lend institutional credibility to the asset class, but will also reduce volatility. Valuations across the entire crypto sphere will rise providing greater confidence and consensus in the nascent asset class.
Apart from the potential entry of SWFs into crypto markets, we will likely witness a growing interest in the digital asset ecosystem from central banks and other traditional financial institutions. With balance sheets totaling somewhere between 40-50 trillion dollars, sovereign investors represent the final layer of legitimacy for bitcoin. When central banks start entering cryptocurrency markets, it will trigger a feedback loop where increasing institutional adoption will strengthen demand, more interest from existing SWFs, and thus more price appreciation. We are already beginning to see central banks announce pilot programs for their own digital currencies. Central bank digital currencies (CBDCs) do not compete with bitcoin, but rather they will force governments to answer the question of what hard assets stand behind these CBDCs, thereby creating greater demand for bitcoin.
The price of bitcoin — and subsequently, its market capitalization — is derived from the finite nature of its circulating supply. Bitcoin’s most recent halving event on May 11, 2020, produced the supply shock necessary to kick-start an exponential uptrend across the entire cryptocurrency market.
Historically, bitcoin’s four-year cycle has pushed the cryptocurrency market through consecutive phases of exponential highs, correction, accumulation, and recovery. It remains to be seen whether bitcoin will see a continuation of this pattern over the next year. Many believe that if there is a correction on the horizon, wider market volatility is likely to be tempered by the recent spike in the adoption and integration of cryptocurrencies among traditional financial institutions and central banks.
Bitcoin’s long-term bullish outlook is supported by several supply-demand models, including PlanB’s popular stock-to-flow (S2F) model. According to the S2F, scarcity-induced supply pressure should see the price of bitcoin rising to $100,000 by Christmas. In a blog post earlier this year, PlanB also unveiled the S2FX, an updated projection model which enables cross-asset forecasting for bitcoin, gold, and silver. From an analysis of the S2FX, PlanB estimates that the market capitalization of bitcoin could exceed $5.5 trillion by 2024. If this projection pans out, the next halving event will see a single bitcoin priced at over $288,000.
As crypto markets prepare for the inevitable flood of institutional investment, sovereigns will likely drive the coming price explosion. By allocating a small percentage of their balance sheet to bitcoin, first movers will be positioned to become the wealthiest countries in the world to the benefit of their citizens. El Salvador’s declaration of bitcoin as legal tender this year is just the beginning.
