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Mind Of Mav

Are Bitcoin Stocks A Better Deal & Value Than Bitcoin Itself?

There are lots of ways to get exposure to Bitcoin. The most direct way is to buy spot BTC or some derivatives. The least direct way is to buy correlated assets.

The Bitcoin stocks very much fall into the category of correlated assets, and the good news is that those stocks got hammered in this bear market.

That means they are cheap. 

But, just because they’re cheap, doesn’t mean they’re a better value. So, the real question is this: are they a better deal than buying Bitcoin directly?

Let’s try to figure this out. 

Is it worth betting on the Bitcoin stocks?

Before we start let me get something straight: If you want to have exposure to Bitcoin the easiest way to do so is buy spot BTC and ideally self custody it.

Anything else is a derivative or a correlated asset. Which means there is no guarantee they will track Bitcoin’s moves in direction and amplitude. 

“So why would I bother betting on Bitcoin stocks?” is what you are probably wondering right now.

Good question.

Let’s put aside the case where you can only get exposure to Bitcoin through stocks for regulatory reasons.

The idea is that you are making a bet correlated to Bitcoin with a different risk / reward profile. And maybe under some conditions this correlated bet is a more favourable trade than buying Bitcoin outright.

The core assumption around this Bitcoin stocks idea is that we expect them to be strongly correlated to Bitcoin itself. The rest of our analysis is based on that idea. 

So how true is it that the Bitcoin stocks are correlated to Bitcoin itself?

I’m not going to look at an exhaustive list of all the Bitcoin stocks today. Instead let’s focus on some stocks representative of a few subcategories:

* Microstrategy (MSTR) is your typical Bitcoin hodler stock. That is their main business is hodling Bitcoin. Everything else they do is in service of that.

* Coinbase (COIN) is your typical exchange. They aren’t big hodlers of Bitcoins. Their business model is to take a cut from the volume of trades on their platform. Incidentally, the bull markets are better periods for the trading activity which is why Coinbase and Bitcoin are interlinked.

* Marathon is a Bitcoin miner. They hold Bitcoins as part of their treasury. They also sell some on an ongoing basis. Obviously how valuable they are is tightly related to how valuable Bitcoin is. 

How does this sample of stocks correlate to Bitcoin? Take a look. (Note that Coinbase only started being publicly listed last year which is why there is less data).

The three months rolling correlation between Bitcoin and those Bitcoin stocks is consistently above 50%. That is solid. And given the fundamental reasons behind this correlation it is unlikely to go away any time soon. 

Even more, if you checkout the price action of Bitcoin versus those stocks since October 2020 you’ll observe that the large moves are pretty much aligned in terms of timing. 

So we can be reasonably confident that at least for the next bull run we should continue to see the same kind of behaviour. 

Ok, at least it makes sense to analyze the potential upside on those Bitcoin stocks in relation to the potential upside on Bitcoin. 

I estimate a reasonable target value Bitcoin could reach in the next 5 to 10 years is $120k, so that’s what we’ll take for reference here. Assuming you can build a position with BTC around $20k that’s a 6x return.

A 6x wave is a good wave to ride. But are we getting a better deal riding this wave on the back of the Bitcoin stocks? Let’s find out.

We can try to gauge that with historical data. But keep in mind that we are working with a very small sample. Coinbase IPO was only a year ago. Microstrategy turned into a Bitcoin hodlers only a couple of years ago. And owning miners only became fashionable in 2020. 

Since what we want to try to gauge is how big are the Bitcoin stocks moves compared to the Bitcoin spot moves we are basically playing with at most 3 large waves for each stock. 

For each wave here is how each asset compares in terms of returns.

So the comparison comes to:

BTC +507%, MSTR +787%, MARA +3000%, COIN NA for the first wave starting in October 2020.

BTC +132%, MSTR +120%, MARA +350%, COIN +78% for the second wave starting in the summer of 2021.

BTC +38%,  MSTR +150%, MARA +200%, COIN +200% for this bear market rally.

Let me emphasize that how you breakdown the waves is pretty subjective and discussing that ad nauseam puts us dangerously close to doing technical analysis. That’s not my goal.

I tried different breakdowns methods and haven’t found that the range of ratio between the stocks and Bitcoin’s returns changes much. So let’s stick with the simplest version as above. The first observation is that over the past couple of years the Bitcoin stocks don’t necessarily beat Bitcoin returns. That is except for MARA and other miners.

The typical range of returns for those Bitcoin stocks goes from 1x up to 6x the returns of Bitcoin. 

The big difference between COIN, MSTR and MARA is their market cap of course. Until the last bull run, the miners were very small, pretty much penny stocks. So when a lot of money started flooding the space they benefited from massive returns. 

The question is, are there still extra multiples over Bitcoin to be extracted from those stocks?

Currently:

MARA has a market cap of $1.5bn.

MSTR has a market cap of $3.6bn.

COIN has a market cap of $23bn.

Bitcoin has a market cap of $450bn. 

If we are talking in terms of order of magnitude then MARA and MSTR are already in the same category, COIN is 1 order of magnitude larger and Bitcoin itself is two orders of magnitude larger. So the likelihood of getting a big multiplier on Bitcoin returns by betting on those Bitcoin stocks isn’t massive.

That’s about as much as we can extract from the little data we have, so let’s go through it using the same fundamental questions.

What is the potential upside of betting on the Bitcoin stocks? 

The natural range is the one provided by the little data we have. So anywhere between:

1x the upside on Bitcoin, applicable to all stocks but especially the ones with larger market caps (order of $1bn and above).

6x the upside on Bitcoin, more applicable to stocks with small market caps.

Note that if we pin our expected upside for Bitcoin at 6x that means we expect 6x to 36x returns on the Bitcoin stocks. Honestly that nothing to sneeze at.

What’s the timeframe?

Our assumption is that those stocks are going to move in lockstep with Bitcoin. That means our timeframe is 5 years.

But what’s the probability of hitting this upside?

Well at most it should be the same probability as hitting the upside of Bitcoin. But the higher the extra multiple on top of Bitcoin returns the more you should discount from your base Bitcoin bet. Say you think there is 70% chance for Bitcoin to 6x in 5 years then there is also a 70% chance the Bitcoin stocks will 6x. But moving up to a 36x return in 5 years should maybe drop to 30% chance. Those numbers express your own confidence level in the bet, there is no way to “scientifically” extract those from the market. So take whatever you think and apply some discount to it the higher the target upside. You get the idea.

That’s it for thinking about the upside. But what about the downside? Where should you take your losses and with what kind of probability?

If you compare the individual stocks drawdowns to the Bitcoin drawdowns you’ll observe that there isn’t a big difference. So you might be tempted to choose your loss level in a similar way as you did for Bitcoin. 

That’s fine. 

But on the probabilities side you need to be more conservative. 

Think about it this way. Bitcoin is unlikely to fail completely. However it is totally possible for any Bitcoin stock to die along the way:

Microstrategy could be borrowing too much and get hit with margin calls.

Coinbase could see its profit margin evaporate if they have some real competition say from FTX US.

A miner like Marathon could mismanaged their mining infrastructure and fall behind.

All these are additional risks you don’t need to worry about when you bet directly on Bitcoin. So you’ll want to think of the Bitcoin stocks as having a higher likelihood to fail than Bitcoin itself. 

And that’s about all I can think of if we try to stay general about the Bitcoin stocks. However that’s already enough to inform us on what kind of stock we might want to analyze in particular. 

Hear me out.

If you already have Bitcoin in your portfolio then you don’t need a correlated version of that trade with no extra upside but a higher chance of failing… what we really want is to find asymmetric bets. That excludes looking at the Microstrategys and Coinbases of the world; their potential upside when compared to Bitcoin isn’t high enough.

What we want is stocks with small market caps, with a high correlation to Bitcoin coming from their business model and with extra risk confined enough that they won’t dilute too much the multiple potential growth they have over Bitcoin. 

Those are the requirements. Can we find stocks that fit the bill?

My guess is that we need to dig deeper on the side of the miners to find those.


Bitcoin derivatives

Let’s have a quick look at the CME derivatives as not much has changed since last week. 

From the Commitment of Traders report we can see that the asset managers have aped into the Bitcoin rally. They are pretty much back at an all-time high amount of net long positions (expressed in BTC).

That’s definitely not a sign that this bear market rally is getting long in the tooth . . .

I still can’t tell for sure what’s going on with hedge funds shorts.

My latest interpretation is that actually if we think about it in terms of USD value these shorts have been shrinking in proportion of the futures premium disappearing. It is just that when expressed in BTC or amount of open contracts we are missing this trend.

On the options side absolutely nothing has changed. The puts to calls ratio is stuck at 3:2 with no notable positions added since last week.

 
 

We’ll see if we have really hit rock bottom based on the reaction to the July inflation print… but it feels that at this point of the bear market no news is bad news anymore.

With that, our analysis is concluded (for now), but we’ll definitely cover this topic in the future. Cheers.

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