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BTC240: Economic Calculation w/ Bitcoin with Joe Burnett and Chris Nicholson (Bitcoin Podcast)
01:03:17
Preston, Chris, and Joe discuss the future of Bitcoin Treasury companies and the implications of valuing equities in Bitcoin rather than fiat.
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- [00:01]
Preston Pysh
You're listening to tip.
- [00:03]
Chris Nicholson
Hey, everyone. Welcome to this Wednesday's release of the Bitcoin Fundamentals podcast. On this week's show, I'm joined by Joe Burnett and Chris Nicholson from Unchained to talk about how we should be thinking about equity valuations in a world moving to a bitcoin standard. We dig into discount rates, IRRs, volatility, and whether bitcoin should serve as a new benchmark for opportunity costs when modeling investments. It's a fresh look at asset valuations through a sound money lens. And as a hardcore Warren Buffett value investor, at my heart, this conversation was near and dear to me and I loved this chat. This was really fun. So with that, Here are the two knowledgeable Mr. Joe Burnett and Mr. Chris Nicholson. I hope you guys enjoyed it as much as I did.
- [00:53]
Preston Pysh
Celebrating 10 years. You are listening to Bitcoin Fundamentals by the investors PODC Network now for your host, Preston Pysh.
- [01:11]
Chris Nicholson
Hey, everyone. Welcome to the show, man. I'm excited about this conversation. Your report made me as somebody who has just loved trying to figure out the value of a company, right? Like, that's how this whole show started, was trying to figure out the value of equities. And as a hardcore bitcoiner, you know, it's a little hard to even go down that path these days, or at least it has been for quite a while. And then you guys pump out this report and it is just like, just pump it straight into my veins because this is what I'm all about. And the report is, how in the world do you value everything on the planet, particularly equities, moving forward in a bitcoin world? And I cannot wait to get into this. So welcome to the show, Chris. Welcome to the show, Joe. Great to have you guys here.
- [01:57]
Joe Burnett
Awesome. Thanks for having us, Preston.
- [01:59]
Chris Nicholson
Thank you.
- [01:59]
All right, so we've got to start with the basics because I think a lot of bitcoiners that listen to the show, they don't know. They don't care to know anything about security analysis, how it's done. But walk us through, like, the basic, really basic methodology, like if you were going to go give an MBA class, maybe not use their logic, but like your own valuation metrics to kind of like make this understandable. Do you go through a discount cash flow model, like, what's actually happening there to determine the value of an equity in a traditional way?
- [02:31]
Joe, do you want to get started on this one? You know, last time we talked about this, you had to be the moderator and give the floor to me to explain it. So do you want to take a crack at.
- [02:39]
Joe Burnett
Yeah, and I can kind of give some background on the report as well as to, like, why we wanted to write it. Like.
- [02:45]
Chris Nicholson
Yeah, let's start there. Start there with the, the why of the report. Yeah.
- [02:48]
Joe Burnett
I think a common argument against Bitcoin is it has no cash flows. And I'll tie this into, like how DCF works as well. And people are like, okay, well why would I buy bitcoin if it has no cash flows? Like, that doesn't make any sense. Like a traditional finance brain cannot even comprehend that. And I think that that's potentially the wrong way to look at Bitcoin. I think everyone that's, you know, has that common criticism about bitcoin. They don't actually question what cash fundamentally is. They just assume that it's the dollar and that's the best optimal, long form, you know, long duration form of cash. And I think that that's potentially wrong. Right. With the discovery of Bitcoin, we now have this new form of money that's perfectly scarce, portable over the Internet, and it has all of these unique monetary properties. And so when you actually go back and you value, you know, a company or you just look at, simply look at the stock price of a company or the price of a house over time, in dollar terms, it may be going up, but in bitcoin terms, the stock price or the house, your apartment price or your house price actually may be going down. And so it's a very different way of thinking about it. And so when it comes to valuing a house that could be providing cash flows in the future, or stock that is providing dividends or cash flows in the future, what you would do is you would do a DCF analysis, a discounted cash flow analysis, where you project out the future cash flows and then use a discount rate to discount those cash flows back to the present. And then you come up with a valuation for the company that you're trying to invest in. And so what's happened, you know, over the last few decades is the money has kind of been broken and the future cash flows look like they keep increasing, increasing, increasing. And also the discount rate that you're using might be manipulated or it might be less than what it should be. And therefore people intuitively know that, oh, I can't hold cash like, I need to invest in Apple, I need to invest in Mag7, I need to invest in real estate. And so there's this perpetual chase for yield because the dollar is a potentially A broken form of money. And if we had a superior form of money, then the discount rate that you would use to bring those future cash flows back to the present and come to evaluation for Apple or your house or whatnot, that would make the valuation or the optimal price of those assets significantly less. Which basically just means that Bitcoin is a much more attractive investment or form of long term savings. So that's kind of like the general thesis behind the report is the money is broken, everyone's rushing to chase for yield. Well, let's say we discovered a new form of money that is actually going to appreciate in value and has appreciated in value. Well, that kind of changes the game on how you would actually go about valuing everything in the entire economy.
- [05:42]
Chris Nicholson
Chris, anything to add?
- [05:43]
Yeah, I think what I can pick up from there is some of the implementation details of how we did this. So as Joe said, the gold standard for valuation in tradfi, as they say, is the discounted cash flow analysis. So what is the present value of a company? It's the present value of all the future cash that it's going to bring in. But that's in dollar world. And what we were trying to do is figure out what that fundamental valuation approach looks like when Bitcoin is your money instead of the dollar. So like Joe said, it all comes down to the idea of a discount rate. And we looked at what a discount rate actually means. This is like almost a philosophical question. Yes, it is this thing that we call a discount rate and we plug into the models.
- [06:26]
Yeah.
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What does it actually mean?
- [06:28]
Yeah.
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And why when we take an earning that a dollar that Apple earns in the future, why do we discount it to get a present value for it? Why is it worth less today? And fundamentally that comes down to something called the cost of capital, which amounts to opportunity cost. The reason why Apple earning a dollar 10 years from now is worth say 5 to 9% less each year you go back to today is because you have an opportunity cost. When you choose whether to invest your money or Apple or not, the investor can choose to put their money in something else, say a risk free bond that would grow maybe 4 or 5% per year. So at baseline, that's where the opportunity cost of investing in Apple starts. And beyond that, instead of investing in Apple, you could invest in the S&P 500. So there you have just not the opportunity cost from a risk free bond, but you also have the added opportunity cost of just putting it in the general market. And so that adds on what people call an equity risk premium to the risk free rate. But fundamentally this whole thing we call the cost of capital or the discount rate is just what you could have done with your money instead. Yeah, we took that idea into where bitcoins are money. And the basic idea is instead of starting with dollars, if we start with bitcoin as our money, every investment in something else means that we're taking our money out of bitcoin and putting it in that thing. So our opportunity cost is Bitcoin's return. That's what we're missing out on and that's where the discount rate starts.
- [08:05]
Then I know for me personally where it was just like, you know, fireworks went off of my head because I'm doing these discount cash flow models for pretty much every equity out there, especially the ones that had like this really high enterprise value to what they were being traded for on the market. We had filters that we still have on our website to this day to help people find these like really deep value companies. And I remember, you know, we were talking about how bitcoin, this is way back in the day, we were talking about how bitcoin could potentially be this new unit of account. So I'm just sitting there one day and I'm, you know, when you're doing these types of models, you're looking at the last 10 years of performance. A lot of the times, especially if it's a large cap company, you're looking at the last 10 years of performance and you're saying, look at that top line revenue, it's growing at whatever rate and you like plot it out and you can visually see it growing, right? You can look at the bottom line and you can see the bottom line growing. If it's a decent company, it's very stable, it's going up and to the right. And then you're taking those cash flows and you're trying to determine what you think the value is. And I remember sitting there and bitcoin's just eating away at me and I'm saying, what if I went back and redenominated all of these cash flows, these 10 year trend that I'm looking at and I go back and I start redenominating the top line and the bottom line using Bitcoin for call it Apple or Google. So I started doing this for some of the like the large cap companies. And when I did it, I'm just looking at the chart, I'm looking at the graph and I remember this like it was yesterday. I'm looking at it and I'M saying, oh, dear God, like, what am I looking at? This is insane, right? Because anybody that does this drill and you're going back and you're looking at those discrete moment in time of Apple's revenue was this many billions, right? And I redenominated in bitcoin. And then I go back a year and I do it over again, and I do it over again. What I see is a chart where the revenue is just going straight down. And we're talking about a company that's growing like a weed, but their revenue was going straight down. Their bottom line, net income going straight down. And I'm saying, oh my God, like, what am I looking at? Like, what is this? And what happens if this trend continues? Like, all of your models are literally destroyed. Like, all of them. And to the point that what you guys are saying with a discount cash flow, you model out the free cash flow. So you're looking at, like, what's that trend look like? Where is it going to go? And call it the next 10 years. What do those profits and free cash flows look like? And then I come up with, and for me personally, the discount rate. I always found when I was first learning this stuff, super confusing. And I'm sure when people hear us talking about the discount rate, the discount, they're like, what in the hell are they talking about? But this is, this is where in engineering it was always, what are my givens? What are my unknowns? And let me solve for the unknown. And so I'm looking at these equations, these economic calculation equations for discount cash flows. And I'm saying, and I'm sorry I'm talking so much, but I guess I'm telling a little bit of my journey here as well with some of this. I remember looking at these calculations and as an engineer, I'm saying, hold on, this is a given. Like, why am I solving for the market price when I'm literally looking at a screen that's telling me the market price? Like, this is a given, this isn't an unknown, right? Why am I figuring out and treating this as if it's an unknown? I can look at Apple stock and I can see it's trading for $100. Like, why am I acting like I don't know that? And so for me, the irr, the internal rate of return calculation, which is shifting it to, I know the market price, making an estimate on what the free cash flows are. What is the discount rate? What is the irr, what's the percent that I'm calculating for was the Aha moment for me in performing economic calculation that that is telling me and to your point that you just made, Chris, is I'm looking at the entire investment horizon as what's my opportunity cost? Right. And that IRR tells me that this is priced today on the open market. If I'm dealing with a publicly traded company and I know the market price and I'm making an estimate on the free cash flows, I'm looking at it and I'm saying oh, it just came back at 15%. So if I can go get a US treasury that's one month in duration and it's 5% and Apple stock is priced at 15%, is the 10% difference worth the risk of owning an operational business is the question and the framing of the opportunity cost. I would always ask my solve and I would get so frustrated with the business school books and everything is like there's your equity premium, it's this premium and they're breaking it down into all these buckets. When at the end of the day for me it was just what's the IRR? It's 15% at the current market price and the treasury is 5. So is the 10% worth? It was the question. And so obviously we're talking about how to do this in traditional methods and traditional thinking if assuming the dollar is stable and not getting debased and like all this other stuff, that only complicates this convers even more, right? If we start talking what that means. But in general, I think these ideas are really, really important for people to think about first. Before we go where you guys went with this paper, which is phenomenal and really exciting and I can't wait to get into it. So I'm going to shut up. Sorry I talk so much. Chris, do you have anything. Joe, do you have anything you guys want to add to what I just said or any additional points on like the traditional valuation methods and DCFS and whatnot?
- [13:32]
Joe Burnett
No, I think you made some pretty great points there, Preston. I do have a question for you though because I think I've heard Trace Mayor say that he's done this in the past. Like he has denominated his portfolio and his assets not only in bitcoin terms, but in gold terms. I'm wondering if have you ever, like before you discovered bitcoin, did you ever think about doing that with gold or, or another asset? Or was it all just based on.
- [13:54]
Chris Nicholson
I wasn't, I wasn't mature enough in my thinking before 2015 to do that. If I was, I think that would have been a lot smarter way to kind of value it now that you have Bitcoin. Yeah, I went from traditional fiat type DCF thinking straight to bitcoin denominated thinking many years ago. But I think prior to Bitcoin really being a thing, I think that would have absolutely been the smartest way to always think about doing this is turning it into what is the value of gold relative to the equity's performance.
- [14:27]
I was wondering something, Preston, when you went into that, because I didn't learn about DCFS in school.
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Yeah.
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I just learned about it because I was investing my own personal money and at some point that led me to have to read DCFS and figure out the basic principles. When they teach it in school, do they just kind of give you the discount rate as a given or do they explain, did they just say, plug this in, here's what the number is, or do they really explain what it means and where it comes from?
- [14:52]
Well, I mean in the traditional business, business school sense, they're telling you to go look at the volatility in the markets. This is how asinine all this is and hilarious this is. They're going to tell you, pull out this chart of the beta, look at how much volatility there was in a S P500 index over this defined range. We're telling you to look. So it might be a 10 year snapshot of this is what the S P 500's volatility was. Right. And then over that same period of time, what was the discrete equity that you're trying to figure out the value of what was its volatility. You come up with this beta figure, you plug it into this other equation and you're determining what your discount rate and all this other garbage is to come to what you think the valuation on the business is. And so like my issue with this approach has always just been number one, how are you selecting the 10 year volatility period for both of those for the index and for the individual stock? And how do you know that that's actually representative of what's going to happen in the future volatility wise? Because you can have a 2008 scenario where the volatility was super intense and you can have other periods where it wasn't. And so then like what is characteristic of like what's on the horizon holding period wise? Right. And like all of this for me was just, I guess for me when I come to the IRR way of kind of looking and we can talk about why irr Has a limitation which is if you're, if you do have negative free cash flows into the future, you get like two answers for your irr, which is something that you have to always have positive free cash flows when you're doing an IRR calculation. And this is probably going way too deep on some of these topic, but my issue with using volatility and this way of doing a cap and model is what we're talking about here in business schools is you're never talking about the fundamentals of the business when you're talking about risk, which to me is the most asinine thing on planet Earth. Like if you're going to go buy a coffee shop in Main street and you're wondering like how much risk there is in what you're paying to buy it, what are we talking about? We're talking about, well, what if Starbucks opens up a shop three doors down? What if the employee accidentally lights the place on fire and my investment goes to zero? What if, you know, there's mold in the beans? And we're talking about like all these risks that are associated with the operational business when we're determining what is an appropriate price to pay and what, how much of a discount to apply to it versus everything else on planet Earth that I can invest in at a similar return or better. Right? That is the key. That is the key framing when you're buying anything. If a person never went to business school, right, that's how they're thinking about buying assets if they have the monetary means to go do it. These are the things they're asking themselves. They're not saying, well, how much volatility was the spot price of the coffee shop relative to all the other businesses in the town for these past five years? How crazy does that sound?
- [17:55]
Like that is really interesting, right?
- [17:58]
It's insane. It's totally nuts.
- [18:00]
Joe Burnett
Let's take a quick break and hear from today's sponsors.
- [18:03]
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- [20:42]
Preston Pysh
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- [22:00]
Joe Burnett
All right, back to the show.
- [22:02]
Chris Nicholson
One thing you said in there actually, like, gave me a mini light bulb moment because as Joe and I were talking about when you tried to do a bitcoin based dcs, one of the fundamental building blocks we decided was you have to plug in the expected return of bitcoin as the baseline, the starting point for opportunity cost, because you're moving from bitcoin into, say, shares of Apple. Now the question we always run into is like, hey, what are you guys saying we should plug in for the expected return of bitcoin? Isn't that bs? But Preston, what you were just pointing out is that the traditional DCF model takes the historical volatility of the market, the historical volatility of the asset and the beta relative to the market, and it just takes those as givens and assumes that they're going to continue into the future. So it's really the same kind of methodology on both sides.
- [22:54]
Yeah. And specifically we're talking about the CAPM model when we're talking about these volatility in the beta and all that kind of stuff, which is you go get a business degree, this is what they're going to jam down your throat. Like, this is how you conduct, you know, economic calculation, traditional senses. And I'm sorry, but like, if you're buying a real business with real operations and real assets, like, I'm sorry, I think it's absolutely ludicrous, brain dead, idiotic, like, doesn't make any sense. And so far it's served me really well to never use any of these models, like, really well. But okay, so let's talk about how in the world do we do this? And to be honest with you, I've really struggled with what you guys put together in this amazing report. It's called repricing the economy in Bitcoin. And the issue that I had was the return in bitcoin from what I can see from a network effect, from just users showing up and using it, the fact that it's, you know, you can't debase it. All these things that we always talk about on the show. I don't know what the number is, but I know the number is more than like 10% annualized. Right. And so I'm looking at that and I'm saying the rest of the market is priced at, call it 4% just to, you know, use a general number. And that's pretty close. I would say for public equities, they're probably priced around like 4%, maybe 5%. If it's really good, it might be as high as 10%. And I'm looking at bitcoin, I'm saying it's way beyond 10%. So how in the world can I, you know, even if there's a lot of volatility, I'll lean into that volatility and take advantage of it by buying the dips. And so I'll even have better performance than that because of the volatility. Right. The volatility is your friend. But I didn't really know how to do what you guys did with, you know, applying a stability piece to this, talk this, explain to people how you arrived at this. I love it. And yeah, let's get into it.
- [24:46]
Yeah, so I can take up that part, what I call the equity stability premium. So I explained the first part of what the opportunity cost of an investment is. When you're starting out holding bitcoin instead of dollars, at very least, you begin by giving up bitcoin's return. So that's the first part of the opportunity cost, the discount rate. But at a certain point I said we have to be realistic about volatility here. There is a key difference between dollar money and bitcoin money, which is that when you're starting out with dollars and you're moving into equities, those are riskier than your money. When you start out in bitcoin and you're moving into equities, on average, those are less risky than your money is. So what we had to do basically to avoid stacking the deck in favor of bitcoin was flip the usual logic about how you treat equities relative to money. In the normal dollar based dcf, what you do essentially is say, I am going to punish equities for being riskier than my money. And what we do is say, now what we have to do is reward equities for being more stable than our money. So in technical terms, that means that you take your starting opportunity cost, in this case the return of bitcoin, expected return of bitcoin, and instead of adding an equity risk premium. To get a discount rate, we're subtracting what I call an equity stability premium. So that means that we are ultimately punishing Bitcoin for its volatility relative to equities. If you start out with Bitcoin, say you plug in an expected return of 30%. Well, you would subtract some kind of stability premium for equities and that would give you a lower discount rate. And applying a lower discount rate to say Apple would make it look more appealing as an investment to move your Bitcoin into. Does that framework make sense?
- [26:46]
It makes sense. I understand why everybody's going to love the framing and I think it's fair framing. I just look at it differently in that the volatility is actually an asset for me if I'm trying to acquire a long term position. And I'm literally typing this into AI while you were going there because I'm trying to come up with the proof in the numbers and I'll keep working on that while you guys are going. But imagine if I don't know what the price of Bitcoin was four years ago. Let's just say 20,000. If we go back and let's say somebody wanted the dollar cost average, a position of Bitcoin on a daily basis and they had $100,000 over that four year period and we just distributed that 100,000 equally. Okay. And they did a dollar cost average buy from 20,000 to 100,000. But Bitcoin's performance was perfectly flat and it moved there like perfectly straight. Okay, now let's just take what Bitcoin actually did, which was all over the place for the last four years and let's dollar cost average the same nominal amount every day and let's see who has the higher value. I don't know what it is. I'm trying to get AI to figure this out. But what I suspect might be the answer is that you actually get better performance with the volatility being more all over the place than a straight line path. I'm going to see, I might be wrong here.
- [28:07]
Joe Burnett
I'd be curious to know.
- [28:08]
Chris Nicholson
But yeah, go ahead.
- [28:10]
Joe Burnett
I was just going to add like the way we set up this report was we wanted the reader to choose their own adventure. So and I, Chris and I kind of debated this a lot on what the actual discount rate should be. So this is a, this is, we, we talked about it for weeks. I lean more towards you where I would say there should actually probably be no or the way I would value companies today is there would be no equity stability premium, perhaps you would still add an equity risk premium, because I think over the long duration, Bitcoin is a fundamentally better asset than an individual company because an individual company has potentially a lot more risk than Bitcoin, which is the least uncertain asset. And so that's why we had those different, various models where I would probably pick the bull case model where there is no equity stability premium. And that means when you go about valuing these different companies, then the valuation that is trading for today look ridiculously high. And therefore you should likely sell that company or sell those shares and buy Bitcoin. So that's kind of how I thought about it.
- [29:17]
Chris Nicholson
So here's where I think it is in the eye of the beholder. Right. For me, I'm looking at it from, I can handle the volatility. In fact, I welcome the volatility. And I don't care if my portfolio fluctuates by 20% on a day. It doesn't bother me. Right. You have other people that would literally be losing their mind if their portfolio fluctuated by more than 4% on a day. Yeah. And so it really comes to this definition of risk. Since most people, and I would say most people cannot handle that kind of volatility, like greater than 4% on a daily basis, they would freak out. They would sell it at the worst time, they would question their core thesis, like all of these types of things that we always talk about. And so for that person, I would say volatility is risk. For me and anybody else who, you know, doesn't mind the insanity, we define the risk very differently. And a lot of this comes down to deeply understanding or at least thinking that we deeply understand the core investment that we have. So when I look at your report and I see that there's a discount applied for the volatility, I think this report applies to, you know, most market participants. And when I say most, I would say probably more than 90% of people out there are going to agree with the way that you guys have this frame that there should be a discount associated with some type of stability that you would get by owning equities versus bitcoin is what I suspect.
- [30:45]
Joe Burnett
Yeah, I agree. And I think that's kind of why we probably went that way with the various models. We wanted to make it approachable for traditional finance types that are still not into Bitcoin. And then once they deeply get into Bitcoin, then maybe they might agree with you and me, Preston, where they're like, okay. We don't need to reward equities for being more stable. Maybe actually equities have more risk if you have a long time horizon compared to holding spot Bitcoin, and therefore maybe we'll add back in an equity risk premium again to our model.
- [31:15]
Chris Nicholson
And I mean, this was part of a very healthy push and pull between me and Joe, I think, because we came to it to the project thinking of two very different audiences. Yeah, I think Joe came to it thinking of what the bitcoin community would want to see and what they would assume. And I came to it thinking, man, you know, we're an asset manager. We're talking to all these companies that don't own bitcoin, trying to tell them that they should own bitcoin.
- [31:40]
Yeah.
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And a company that is already starting out very skeptical of bitcoin or a financial advisor, what are they going to think of it if we, you know, pretend that bitcoin's volatility doesn't exist and. Or that pretend that it's an asset, believe that it's a good thing. And so. And so what we came to out of that healthy friction was this. Choose your own adventure style. If you are a traditional finance participant, you're somebody who's never owned any bitcoin, then you very likely will need to embrace some kind of valuation model where you do consider bitcoin's volatility a bad thing. If you're a maximalist, and not only do you plan on holding forever, you plan on buying the dips, that makes a big difference. And so, Preston, I think that you put it well a while ago, and what you made me really understand was that in our model, it's more subjective inherently and the way you value things depends on your particular strategy for the bitcoin you own and will acquire. So that's kind of the insight at the heart of our framework. How much you care about bitcoin's volatility and valuing things in the present depends on what you plan on doing with your Bitcoin and acquiring new bitcoin in the future.
- [32:51]
Yeah. I think Saylor is going to be your example as to how volatility is actually an asset with the way that he is dollar cost averaging a position. He doesn't care about the price. He's just continuing to use all the tools that he has at his disposable to continue to accumulate as much bitcoin as possible. And I think because of the volatility that he's dealing with, he's going to get some crazy performance out of that. But at the same time, I totally agree with you. I once had a person say to me that the root of almost all arguments comes down to the definitions that the two different parties are using. And this is a perfect example of that. Where one person's definition of volatility is different than the other person. The one person's definition of risk is different than the other person's. But if we're going to truly look at performance, which is a numeric you can't argue with with performance, I kind of think that we could show that. And where this would get arguable is you don't know that bitcoin's going to be higher. And let's just use four year numbers. Right? You don't know bitcoin will be higher in four years. That's impossible to know. Right. And so for a person to say that the volatility in and of itself is an asset, it is only if the price has gone higher than it is right now. Right.
- [34:08]
And I'm not actually sure of that it would be exactly the same. But you could make money with your dollar cost averaging strategy.
- [34:15]
Yes. And if the price was what, let's say the price ripped way higher and then it was stayed higher than the price today and then came down to wherever it was in four years from now, and the price on average was above that linear trajectory from here to where it normally went four years from now, your performance would be worse because your average buys would be higher than where it ended up. But I don't think that that's how bitcoin's performance has really kind of, it like surges and then it dwells down in these valleys for long periods of time, then it surges again. Right. And so that the way that the geometry of that looks is why I think that the volatility is your friend. But I think if geometry was different, where it was constantly higher than it had these surges down and you kind of catch them in those valleys, then, you know, I think you could make an argument that the dollar cost averaging would be worse.
- [35:09]
But, and this is exactly the kind of interesting but tricky territory because what bitcoin is ultimately valued on, the way I think of it is an adoption story. Like people ask me, like, what do you think the price should be?
- [35:22]
Yeah.
- [35:22]
And I say I don't look at the price and I don't predict things like, oh, it's going to be worth a million or 10 million. What I do is start with the assumption that it's going to become the dominant form of money.
- [35:34]
Yeah.
- [35:35]
And then I look at where we are in the adoption curve and not just how many people have adopted it, but who is adopting it.
- [35:41]
Yes.
- [35:42]
And I think that who is adopting it is something that is right in the middle of changing. Right now we see this wave of bitcoin treasury companies, and I think that the nature of the holders of bitcoin is going to change the past volatility patterns that we've seen. When there's some sell off and then the algorithms start to panic, try to get the human traders to panic into selling their own. Bitcoin Strategy is not going to be spooked into selling its bitcoin.
- [36:07]
Nope.
- [36:08]
Almost no Bitcoin treasury company is going to be spooked into selling its bitcoin, nor will any nation. And so I think that we may see meaningfully different volatility patterns on the downside.
- [36:20]
Yeah. And I love your framing on how you think about it from a value standpoint of the network itself. Stop looking at the dollar price, like, relative to bitcoin. I think that it is, and I said this earlier on the show, the network effect. When you're looking at how many more participants, who are those participants? How much buying power do those participants wield around? Are they managing a $5 billion bond tranche? Are they a sovereign wealth fund? Are they, you know, fill in the blank, or are they your grandma with $5 of. And not that one is more important than the other, but one will move the market price and the adoption overall very differently, I think. And when I'm looking at that metric, and I'm looking at that in a snapshot from year to year, it's just. It's insane what that performance looks like from a fundamental standpoint. You want to talk about, like, fundamentals of bitcoin? I think what you're discussing, Chris, is the fundamentals. And like, how do you model that? Right. How do you put that into a, you know, a chart?
- [37:23]
Yeah. Instead of a. Instead of future cash flows, we have future adoption.
- [37:27]
Yeah.
- [37:27]
So that's what I'm always looking at.
- [37:29]
Yeah. Okay, so let's talk more of the numerics on the model that you guys proposed. I love it. So you're saying that there should be a disc. Let's. Let's say Bitcoin's performance is 25 annualized. Just put a little utility on this for people that are listening. Let's say that your underlying assumption is going to be that type of performance. Walk us through this. Stability discount that you're saying needs to be applied in order to compare apples to apples from a opportunity cost standpoint.
- [37:59]
Joe Burnett
Chris, you want to take the stability discount?
- [38:01]
Chris Nicholson
Oh, yeah, sure. So, Preston, do you mean like walk through what it is or how to find a particular one?
- [38:08]
Yeah, I would say just give us an example. Like let's say I'm sitting here and I'm saying I want to own Apple or I want to own Google stock or I want to own Bitcoin. How are you kind of going through that math to determine what you think is something that would put it at parity so people can kind of understand how you're arriving at.
- [38:28]
Yeah, so I gave a brief example of it earlier, but let me break it down conceptually more and then talk a little bit about how you might try and fill in an exact value for it. So the concept is just in the US dollar discounted cash flow analysis. Ultimately what you're doing is you're starting with the risk free rate as the opportunity cost for an investment in some something like Apple.
- [38:54]
So how are you. So define that. I, I'm pretty sure I know how you're defining it, but define that for.
- [38:58]
The, the risk free rate so traditionally associated with bonds. You know, I think it's the 10 year bond that they use. And so that's where the opportunity cost of investing in Apple begins. But it's not just. That's not where it ends. You also have to consider that the opportunity cost would be investing in some broad stock index with similar beta to Apple, similar volatility to Apple. So say the S&P 500. So you'd add on that equity risk premium on top of the risk free rate. So risk free rate where our cost begins, then you add on equity risk premium and ultimately the higher that number is, the higher the discount rate is. And a higher discount rate punishes the thing you're valuing more. That is a key part of it all, that everybody has to realize when they're playing in this space, whether they're dealing with dollars or Bitcoin. A higher discount rate applied to the company's future earnings means that you are discounting all of its future earnings more so their value is lower in the present. So where we come with the equity stability premium, instead of adding an equity risk premium in our framework, we're subtracting an equity stability premium. What that means is that if you hate Bitcoin's volatility more or you expect its volatility to be higher, you would give a greater reward to equity and so you would have a higher equity stability premium. So taking bitcoin's expected return, say 30%, and then subtracting a higher equity stability premium leaves you with a smaller number, a smaller discount rate. And then when you apply a smaller discount to all of Apple's future earnings, that means that you're rewarding it more and it gets a higher value in the present. So that's the basic concept to adapt for the fact that when bitcoin is our money instead of the dollar, our money is now significantly more volatile than the equities we're considering investing in. So from there we're confident in that basic framework. And for bitcoin maximalists, what's beautiful about it is they have the freedom to set the equity stability premium to zero if they want and say, you know what? I'm going to hold forever. And because I'm going to hold forever, all I care about is the adoption story. And I know that 10 years from now bitcoin is going to be higher. Maybe I don't know how high, but I just know in my bones that it's going to be higher. And so I have no intention of penalizing it for its volatility. I have no need to reward equities for their stability relative to it. In fact, Joe might say one thing Joe might think he knows is that 10 years from now, equities will be more volatile than bitcoin overall. And so you have the freedom in our framework to even say, I'll actually punish equities relative to bitcoin. In my long term view, I think that they're actually going to be more volatile than bitcoin. So then you would just, in our framework, that would lead to a negative equity stability premium. And you'd be subtracting a negative number, which means that you take bitcoin's expected return, subtract a negative number, so you're adding, and then you get a higher discount rate. So that's where we begin thinking about it. Now when it comes to the particular details, I just know that if my company's quant were watching this, he'll say, okay, that sounds great, but it's all smoke and mirrors until you try and tell me, Chris, what is your particular equity stability premium you would plug in?
- [42:33]
Yeah.
- [42:34]
And so from there, what we have, to be honest, are starting points. What we offer in this paper is the beginning of a framework. But there's still a lot of development to do. And toward the end of the paper, we lay out a couple different approaches to trying to quantify what particular item you might choose for an equity stability premium. So one way I view it is historical. You could conceive of it by saying, okay, historically, given Bitcoin's known volatility relative to equities, what unit of return have investors demanded per unit of volatility to switch from equities into Bitcoin? So, so that's one example of an approach that I'd hope to develop to flesh out a particular number. And then a second potential line of inquiry that I laid out toward the end there is you might separate Bitcoin from the equation entirely and just think for equities themselves. You might look at something like the Sharpe ratio of the entire market. And what you might try to figure out is for equities in, for assets in general, for each additional unit of volatility, how much additional return do investors demand to accept it? And after you have that number, you'd simply transplant that over into Bitcoin and say, okay, it's got this much more volatility, so they demand this much more return. So, Preston, you know, those are not fleshed out answers, but what I have here is two paths to pursue to try and figure out what my particular equity stability premium would amount to.
- [44:07]
Joe Burnett
Let's take a quick break and hear from today's sponsors.
- [44:10]
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- [47:42]
Joe Burnett
All right, back to the show.
- [47:44]
Chris Nicholson
So when I'm thinking through this, it reminds me of the Fat Tony character in the Nassim Taleb books, which I'm not a fan of the Seam to Lab, but I have read the books and he has this character that he calls Fat Tony. And Fat Tony's role is just kind of like, okay, so this is what all the turbo nerds and the smart people with their pocket protectors and their calculators are going to tell me. The answer is, but at the end of the day, Fat Tony is just going to go out there and he's going to do this, and he's going to have better performance than the person who's performing calculus, right? And so when I'm looking at this and I'm thinking through it, I think this is how your everyday person is going to think about Bitcoin and how to construct a portfolio around it, right? We're talking about discounts for volatility and all this other stuff. But I think everybody's got a portfolio they have. They might have 10 picks, you know, and I'm talking more traditional people, not hardcore bitcoin maxis, of course, but your typical investment portfolio for somebody that's managing other people's money and say, all right, I need 10 to 15 uncorrelated positions. Bitcoin has 80% annualized volatility, which is way too much for this particular client. I buy into the thesis that the network effect is going to continue to, to grow. We got blackrock, we got Fidelity, we got all these people now giving it the green check mark that it's investable. So I'm going to put this in this person portfolio, but I'm going to de risk their portfolio by only buying a half a percent. And all of a sudden the volatility isn't a problem. And like, that's the end of the analysis. And I guess a little bit of this is getting to the idea that if you're doing this opportunity cost of I'm only selecting one stock, everything you're talking about in the paper is warranted and needed in order to, I think, think about things in a very thoughtfully constructed way. But in practice, most people are doing it across 10 or 15 or more picks, and therefore they're performing that reduction or that discount just through the sheer sizing of the portfolio. So I'm curious if you guys agree with that. I'm curious if you think that it's important or, you know, do you think that there's some merit to really clearly defining this, as if you're only going to make one particular pick in order to properly define opportunity cost?
- [50:03]
So I'm thinking about that and I'm working through my answer right now. Fat Tony question.
- [50:09]
Fat. Fat Tony is hard to argue philosophy.
- [50:12]
Philosophy before finance. So whenever I encounter a tough question, I ask a question back.
- [50:17]
Yeah, yeah.
- [50:18]
So my question to you is does that same question you're raising about the effect in the portfolio and how the portfolio affects volatility, does that affect about how you think of DCF in dollar terms? Because in dollar terms, do we just do the DCF on a particular individual stock? Yeah, we don't consider the fact that it's going to be one part of a 10 holding portfolio with uncorrelated assets.
- [50:40]
Yeah.
- [50:40]
And so my initial answer is all we're doing is trying to do whatever we did in the $dcf, but move that into bitcoin based ecf. So my answer is we don't consider its place in the diversified portfolio yet. If we really wanted to, we might factor that into how much we care about bitcoin volatility. And we could think, in my particular portfolio, in my particular dollar cost averaging strategy, Bitcoin's volatility is not going to matter. And so such a person could choose to do it on a portfolio level by lowering the equity stability premium. But the way that we were conceiving of it is just, it's the same as in Dollar World. In Dollar World, you're doing a DCF on an individual stock. Here you're doing a DCF on an individual stock. And once you move toward the portfolio level there, you will just plug it all into an efficient frontier, do some Markowitz portfolio analysis, apply some modern portfolio theory, and it's on that level where you will choose the sizing of your bitcoin allocation.
- [51:45]
Yeah, I love this counter. Where I think that it's going to maybe then more apply to me is I'm looking at something that once I start pricing equities in bitcoin terms and it's really close to what I think I'm going to get on the return of just Bitcoin itself. That's where I think this really starts to come into play for folks. And it's a fair response back that you just gave me. It's like, hey, if you're doing that in dollar terms, why would you do it any different in bitcoin terms? I think you might be right that it's going to be warranted. I'm just trying to think through what that would look like. Because the bitcoin return, let's just say we're 15 years into the future. Right? Let's say that the bitcoin return is now, we're expecting it to be 10% annualized or something like that. And we have companies, equities that are trading at a PE of 10 right now. You're at parity with each other. Right. Which one do you own? Well, I would own the equities at that point.
- [52:38]
Why is that? Why wouldn't you flip a coin?
- [52:40]
Well, for me, if I can get something that's going to compound. Right. I think I. Well, you'd have to argue that the operational risks are exceeding that of the bitcoin. So I guess you would own the bitcoin at that point. So. Yeah, yeah. As you start getting to the Equity giving you 12% and the Bitcoin giving you 8%, now it's starting to become more interesting to own the equities. Right.
- [53:03]
Joe Burnett
So, Preston, I guess you would be, and I think I would agree with this, you would say there still is an equity risk premium in a bitcoin world. Like you want equities to return in excess of holding spot bitcoin.
- [53:15]
Chris Nicholson
Yeah.
- [53:16]
Joe Burnett
I think, whereas, Chris, and then part of our paper is still saying, even in that world, if bitcoin is still more volatile than equities, then that way of framing would be willing to say, okay, I'll accept less of a return for holding equities because it's less volatile.
- [53:34]
Chris Nicholson
Well, and I think the other thing that you. That we're going to have to think about at this point is how are you coming up with that 10% growth in Bitcoin? How I think it's going to be determined is you're going to be looking at desirable commodities. Call it oil, call it corn, call it coffee, whatever. How much more of that can you buy on an annualized basis? Right. Because your buying power is appreciating because there's coins getting lost or whatever. But let's just say that it's becoming somewhat stable. And in my opinion, bitcoin against desirable commodities will become more and more stable with time. Bitcoin against dollars and fiat will become more volatile and crazy with more time. Okay, Those two things are going to separate drastically where commodities are going to stabilize against Bitcoin, desirable commodities are going to stabilize, and fiat is going to just look like a Weimar Republic chart. And so then. And the other thing that I think is important is just like commodities stabilizing against Bitcoin, desirable equity will stabilize against Bitcoin and probably offer better returns than bitcoin at a certain point. And so then this is where a lot of what you guys are doing today, which I think you guys are a decade or, you know, maybe even two decades early to get ahead of this in how we think. And maybe that's a bad assessment. I don't know. But I do know this real money, right, will be that against scarce desirable things. And that will stabilize. It will not become crazier, but in fiat, I think it's going to get wild. I think it's going to be like unimaginable for some folks what the value against one bitcoin will be.
- [55:13]
That's really interesting. And this does dovetail with some things I've been thinking about lately. I've been thinking, you know, bitcoin, as its adoption story continues, you can just see that the volatility already goes lower over time and the returns go lower over time. And those two things really go hand in hand. And if bitcoin wins as money, then I do expect that we will enter a world where the returns just get lower and lower every year. Maybe at Some point they're 10% with pretty low volatility, and maybe at Some point they're 5% returns per year. And at that point, you could still apply this framework that we're talking about. You would just have a much lower number to plug in for bitcoin's expected return.
- [55:56]
Yeah.
- [55:57]
And you would have a much lower number to plug in for equity stability premium. So bitcoin would become less volatile. So you could still use this in that world. And Preston, I think you made a great point when you said that when we enter this world, as we gradually enter this world, equities, at least of good companies will start to become more appealing relative to bitcoin than before.
- [56:22]
Absolutely.
- [56:22]
This is something I'm not sure I see all bitcoiners believing. Some of them seem to sometimes believe that bitcoin's always going to be better than equities. But I think no, now in the success story, the good companies of the world, the mag sevens of the world, whatever they'll be 50 years from now, may very well give you higher returns than bitcoin. We're just going to be gradually transitioning toward that world. And so we need some kind of framework that's able to gradually transition to.
- [56:50]
Yeah, 100% agree. The people. You know, if I was going to try to characterize these folks that say what you just said, because I see it too, they just don't understand security analysis. They understand that the world's broke and that the governments are corrupt and blah, blah, blah, and that bitcoin solves all that. And so they're just kind of like leaning into that and that that's what they know, that's what they understand. But for anybody that understands security analysis and Understands pricing and understands it's just math, is just freaking math. And you're just looking at the return profile and you're looking at the risk that's associated with that return profile and you're just comparing against everything else and that's the end of it. Guys, this was amazing. If people want to read this report, this is on Unchained. Correct? We'll have a link to this in the show notes. If people want to download this report, it is awesome. It's really fun. If you're into this kind of stuff, you'll love reading this. What else do you guys want to point people towards?
- [57:44]
Joe Burnett
Yeah, I would just say you can go to unchained.com strive report S-T R I V E and then report and check that out. And then obviously if you guys want to follow Unchained or me, you can type in Joe Burnett or Unchained on Twitter and YouTube.
- [57:59]
Chris Nicholson
And Chris, you on X. Oh, yeah.
- [58:02]
I have like below 1,000 followers.
- [58:04]
That's okay.
- [58:05]
I'm a non entity right now, but you can find me there. I think it's C. Nicholson, 1988.
- [58:11]
Well, if you're listening to this and you want to have an interaction with Chris or Joe, we'll have links in the show notes to both of their X handles. Please read the report, give them candid feedback. Hopefully some of our, some of our back and forth sparked some interest in people and maybe gave them some ideas on how this could be improved, maybe different takes than what we had. And I'll reach out to these guys and I'm sure they're anxious to kind of hear your comments on the report and anything else you guys got. So, guys, thank you. I really enjoyed this. Sorry I talked so much, but it was really fun.
- [58:45]
Joe Burnett
Yeah. Thank you, Preston. This was great. And I definitely am excited to hear feedback on the report because I agree, like, there's so much room for debate on whether there'd be an equity stability premium or an equity risk premium. It's like, it's fascinating to think about, like how it's going to play out, you know, decades from now, like you talked about.
- [59:02]
Chris Nicholson
Thank you, Preston. This was a great conversation and great in part because you really understand the issues and you come from that traditional finance background. We weren't able to pull any fast ones on you. It's going to take a lot of conversations like this to flesh what it looks like to value things in a bitcoin world. I don't think either Joe or I think that we have an answer here. What we have is the beginnings of an answer. That's why we call it a framework.
- [59:27]
Yeah, I love it. What an exciting thing to kind of be on the precipice of, though. So, like, I'm really excited for you guys that you get to continue to kind of chew on this and work through it moving forward. So bravo, and thank you guys for making time.
- [59:40]
Joe Burnett
Thanks, Preston.
- [59:41]
Chris Nicholson
Thank you.
- [59:42]
Preston Pysh
Thank you for listening to Tip. Make sure to follow Bitcoin fundamentals on your favorite podcast app and never miss out on episodes. To access our show notes, transcripts or courses, go to theinvestorspodcast.com this show is for entertainment purposes only. Before making any decision, consult a professional. This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.