As a traditional investor I’m intrigued by what has happened with Bitcoin in recent days. Because the bitcoin community, developers, miners, exchanges, and so on, couldn’t agree on how to scale bitcoin, enabling it to process more transactions, a hard fork has occurred. While this is already difficult to comprehend – the fork means we now have two digital ‘currencies’, Bitcoin (BTC) and Bitcoin Cash (BCH), instead of just Bitcoin – I’m also intrigued by the fact that, at least for now, this fork made a lot of people richer.
Now, before I try to figure out for why that is, I strongly recommend you get some idea of what the Bitcoin fork implies, especially if you are a traditional investor. Bitcoin investing is in no way comparable to investing in plain vanilla stocks and bonds, and there’s an awful lot of tech stuff you have to grasp, something I find extremely difficult at times.
‘Ok’, back to the fork then. Did you know that if you held your private Bitcoin keys prior to the hard fork you now also own Bitcoin Cash? That’s right, for every unit of Bitcoin you owned pre-fork, you now also hold one unit of Bitcoin Cash. This is basically the whole idea of a hard fork. The interesting thing is, though, that your total ‘Bitcoin’ wealth is up.
How can that be? Perhaps the best way to illustrate is to use a traditional investment example. Suppose you own stock in a company that is worth USD 100, called SEASONS. This company manufactures both umbrellas and ice cream. This is a pretty cool combination because it offers you diversification effects. SEASONS sells mostly ice cream in summer, and then switches to umbrellas in winter. Since ice cream are sold all year round, this part of the company makes up 70% of the total value, while umbrellas make up 30% of total value.
Now suppose SEASONS decides to spin off the umbrella part of the company, named RAIN. What would be the total value of the two companies after the split? Well, it goes without saying that producing ice cream and umbrellas has little to do with each other. Therefore, the most likely outcome would be that, after the split, SEASONS is worth about USD 70 and RAIN about USD 30. There could be some deviation, for example there could be some kind of premium since the two separate companies can now focus on just one product, but at the same time the separate companies lose their diversification benefit, making them more exposed to a single season. So the 70-30 split sounds reasonable, right?
Before I try to link Bitcoin’s fork, let’s look at another example with a different outcome. This time you own stock in a company worth USD 100, called CARS, which manufactures two kinds of cars, sedans (70% of company value) and SUVs (30% of company value). Both of them are manufactured on the same assembly line. Now, imagine that the company has to scale up production to meet future demand. However, the most efficient way to scale up the production of sedans is to extend the existing assembly line, whereas the most efficient way to increase the production of SUVs is to build another assembly line.
In this case spinning off the production of SUVs into a separate company, SUV, creates growth opportunities for both ‘new’ companies, which would not have emerged in the old situation. As a result, the value of both companies goes up, resulting in a total company value significantly higher than USD 100.
So, how does the Bitcoin fork relate to these examples? Judging by the current market cap, not much to the first one. At the time of writing the total market cap of Bitcoin and Bitcoin Cash is USD 52.4 billion. Before the fork, the total market cap of Bitcoin was USD 44 billion. Hence, the fork in Bitcoin created almost 20% in value, instantly. Interestingly, all of that additional value is represented by Bitcoin Cash, as the market cap of Bitcoin is almost unchanged compared to the market cap just before the fork. What separates Bitcoin from Bitcoin Cash is its scaling solution. Based on developments in market cap, it seems that one scaling solution has unlocked value for a part of the Bitcoin community, while the other solution did not. Or, perhaps more likely, the Bitcoin scaling solution was already priced in. In any case the result is different from the two examples above.
Still, the skewed increase in total market cap does raise questions. First, for many users or investors scaling was a necessity, but the way it was realized seemed less important. I’m no expert, but reaching any kind of consensus was probably key. Second, since no complete consensus was reached we now have two different Bitcoin ‘currencies’, with two different scaling solutions, and blockchains. Surely a bit confusing, something that puts downward pressure on the value of the underlying asset most of the time. Third, when reading some of the statements of Bitcoin wallets and exchanges, I get the impression Bitcoin Cash does not immediately offer new growth opportunities. Many of these wallets and exchanges will not support Bitcoin Cash. Even though it got its own ‘assembly line’, its nothing like the SUV company mentioned above. Fourth, partly because of the lack of support, getting your hands on your freshly mined Bitcoin Cash is far from straightforward at this point in time.
Hence, the Bitcoin fork once again shows that Bitcoin investing is very different from traditional investing. But, at least you got a bit of extra bitcoin.