Lesson 5: Bitcoin Competitive Strategy Assessment

Transcript

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Okay. Hi, everybody. Welcome to the show here.

I'm going to go ahead and share my screen. Okay. So today we're going to talk about Bitcoin and product growth strategy.

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Let me introduce myself first. My name is Sean Everett. I'm the chair and CEO of the company.

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And this is an investment committee report that we prepared internally to analyze and understand Bitcoin a bit better from a product perspective. So I figured I'd share it with the rest of the world because one of the beautiful things about Bitcoin is the fact that, well, it doesn't require permission from anyone. And a lot of our work is under NDA, can be shared, disclosed, discussed, et cetera, but there is no such thing with Bitcoin.

So I figured why not give it away and align with the values of the ecosystem. So here's what we're going to chat about today. I got about 28 slides or so.

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And now let's jump right in. Okay. So just a little bit about us in the background here.

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So primarily we focus quite a bit on emerging tech and consumer brands. Ideally that win markets. I've got a lot of experience.

I've been investing in building emerging technologies for 31 years, got started really young at 13 years old, grew up in a place called Sioux City, Iowa, where Gateway 2000 Computers was founded. So I had a computer from a very young age and has been messing around with the internet and products thereof since pretty much its inception. So obviously Bitcoin is unique.

It's special. It's interesting. And that's why we're here today.

So obviously you've probably heard about it, but we've taken a different lens based on all the companies, products, enterprises, inventions, technologies, et cetera, that we've seen over the years. And so our definition might be slightly different than the one that you've heard in the past, but as we go deeper, obviously you get a deeper understanding of this asset class. One of the things that we've identified here is that Bitcoin really is more like a digital battery and that battery is expanding over time.

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And so as we convert electricity into storing into that battery, it actually gets harder and better and more valuable over time as it's used more, which is different than a traditional battery that we talk about, which degrades over time and loses its capability. So super interesting there. This is an overall summary as you look at it from an investment perspective.

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And what's interesting about this is maybe the upside has kind of always been there and understood, but in the last year or two, it's been around 16 years now, in the last year or two, what we've actually seen is the scalability capabilities of this have increased. The defensibility has increased and the risk level has gone down, which basically means this margin of safety is expanding. And that's the thing you really want to look for in an investment, right, is really high margin of safety.

So through the rest of this report, we'll walk through why we feel this way, but these are one dimension and one analysis type that we can look at from a capital allocation decision. So let's take a look at some of the assessment capabilities. So as I mentioned, emerging tech is really where we spend quite a bit of our time, almost all of our time in our adult life.

And today where we sit, emerging tech at one point used to be browsers, and then it was like social media, and then it was video and stories format. And now it's AI, self-driving, spatial computing, Bitcoin, digital currencies, et cetera. So that's what we mean by emerging tech.

And so you can break this down into some of the traditional terms over here. And then we also break it down in terms of like a tech stack term on what's the interface, where's the sensors, eyes, ears, nose, taste, smell sort of thing. The logic layer, which is really this artificial intelligence.

We've seen LLMs come up recently, biologic intelligence I think is where the end game is going to play out, these two working together, kind of all these things working together actually. Then the storage mechanism, this is what we're going to be talking about today in here. And then obviously none of this stuff works without computation.

So these are the different chip types you may have heard of, CPU, GPU. There's also like neural processing units and ASICs, which help with the miners systems on a chip, which is like the iPhone, things like that. So this is the concept that kind of plays its way around strategy circles.

You don't hear it much in your everyday life. I haven't seen it much in the Bitcoin universe, but as I've thought about this, it's become more clear. And the idea that these outer layers of like these concentric circles move much faster.

So think about like fashion and social media, right? Very easy to create all sorts of weird movements and changes and tests. And it's one reason why you see all these crazy fashion things that nobody wears. It's because while it's been crazy and fast moving up here, the only ones that get like built down into lower layers are the ones that actually make sense.

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You remember the movie Devil Wears Prada, like Cerulean Blue made its way down here. It was a famous scene by the character who played Anna Wintour. So anyways, what we think is obviously spatial computing, the interface layer, there's a lot of movement around up here.

This one has completely taken off in the last year or so with reasoning and computer use. Digital currency, what we're actually seeing is like Bitcoin started, Ethereum developed to create programmability. Then all these altcoins, they're doing a similar sort of thing.

They're testing all of these various feature sets and only the best ones get built down into Bitcoin without disrupting its core protocol. And then obviously at the most fundamental is energy can neither be created nor destroyed. So what's interesting is like as the pace of change is slower, it's more like a production-grade environment rather than just like prototyping.

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Okay. So if you've been deep in the Bitcoin space, some of this stuff will be obvious to you, but we've taken sort of a high-level approach just to give you a bit of an overview here. We've looked at sort of four primary use cases here.

One that gets talked about a lot is the monetary premium. Some folks say this is all the way up to like $900 trillion, which is the store of all assets, whether for utility or monetary purposes, like as an investment. So like your house, you live in it, but some portion of that value is actually investment income.

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So basically, if we take a sort of the middle of the road approach, what we're seeing is you add these different ones up, you get to about $200 trillion market cap to $2.5 trillion right now for just Bitcoin. You've got a large upside potential, right? So there's plenty of room to run in this space. Some of the things that are interesting, you've heard about like NFTs on Ethereum.

Well, Bitcoin has similar stuff like runes and ordinals. So you're getting this interesting aspect of the code base, which has some open space that you can store messages in it. And then the thing that I think is really interesting, which we'll get into in a minute, a lot of people treat Bitcoin as a financial product, which is true.

It has huge use cases there. But I think it's also an operational fuel product. So one of the big things, one of the big growth drivers for a lot of emerging technologies is you've got to get out of the innovation department.

And in this case, it's like finance, which is F&A department, DNA department. And you've got to get into the operational department. So out of R&D, into like core operations of your customer base.

This is where I think core operational fuel, because it stores energy, could be super interesting as we move into the new economy. I'll get into that. We'll go deeper into some of this stuff here in a little bit.

But fixed supply is pretty unique across pretty much any asset class. And there is some element of price floors just based on lost keys, Bitcoin maximalists, people who just hold forever. And this one, I think, is a key component.

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It's digital, so you can put it into extreme decimal places. And then I'll get into some of these kind of feature sets. Some are more philosophical.

Some are technical. Others are economic. So a lot of interesting stuff there.

Now, this one, people talk about, well, what's the basis of value? What is it backed by? It does pay transaction fees, which I'll talk about in a minute. But really what this is backed by is electricity. So you're storing energy and you're storing money in these different component capabilities.

So traditionally, energy storage in these different formats have degradation rates that are very short term. Your fundamental raw material like oil and gas can last longer. But some of these, they evaporate in seconds, like alcohol exposed to the air.

So it's not a very long lived storage mechanism. That's the problem with some of these batteries over time. Your iPhone drains down and you got to replace your iPhone because it doesn't hold a charge as long.

So then you get into things like money storage. These are some of the traditional ones, gold, commodities, real estate, art, collectible cars, watches, et cetera. And then digital ones.

So cash is digital now. So our equities and bonds, you trade them on a digital exchange. They go over the internet.

Digital currencies are just an evolution of that. And what you find is that when you actually look at these things, Bitcoin is actually a different sort of thing because of its proof of work capability. It is a digital and a physical and a money and energy storage mechanism, which means its degradation timeline is essentially zero degradation.

It can last potentially infinite. The biggest thing are like if you store your private keys on a piece of paper, obviously that aspect can deteriorate faster. And then the chips are processing transactions.

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These things are updated at different paces, pace layers. So competitive analysis against some of these other asset classes, this is from like if you were going to store money, the big one here, and I'll share this slide deck afterwards, you can detail. I'm going to store it in Google slides and open up comments.

So obviously anything to throw out here, we may have some bits and bobs that you may take issue with, or I think it should go this way or this way. So we can open comments, have discussion, make edits. It's a living document.

So one of the big things here is that you see that Bitcoin is completely unique and that it has like all of these sort of use cases that we care about. And sure, you could say, oh, you're just like picking these. So Bitcoin wins.

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And so, yeah, a little bit, but at the same time, it's like it enables new capabilities and those capabilities have value. And so the legacy ones don't as much, right? Like look at cash, real estate, look at gold. These are classic.

This is like centuries, right? Big tech is more modern and growing fast. You can almost see like the growth rate, the more of these yeses, the faster it grows. So it's an interesting correlation.

Some second order effects I wanted to talk about interestingly. So anything that's rare that has a fixed supply, 21 million Bitcoin in this case, you know, think about diamonds, right? You can still mine and find more diamonds, but the more diamond you own, essentially the more power you have in the network. Now it's not direct power over the network.

It's sort of indirect power in the fact that because you have more of these rare assets, you can do more things with it, right? So you can, in its most simple form, you can, as you add own more, you can offer higher credit lines because your basis is higher. So super interesting, but it does in some way require that you hold own and custody your own Bitcoin. Like an ETF, you don't actually own that Bitcoin.

You just own like a wrapper around the outside. It's the securitization of this commodity. So this is one of the things you see happening today.

It's like the next major, like demand wave. And so in some cases you hear people are talking about like, we all work for Bitcoin. Some of us just don't know it yet, which is the assumption that over time as all of these monetary premiums move into the core foundational layer, then it is like a global coordination mechanism on which all of our work at the end of the day settles down and improves the value of Bitcoin.

And so as people realize that they start getting closer and try to drive more value into the network. So a simple, simple flywheel, we've been sort of saying this for years, but there's really two pieces to a flywheel as it relates to capital. And it's a cash generation engine, like some, these are operating companies, it'd be like historical equities.

It's like, I do a thing, I create value via a good or service. If I do it well enough and there's enough demand, I can do it at a profit. So the amount I charge minus how much it costs me is the amount of money I earn over time.

And as that increases, you have a different problem, which is what do I do with the excess cash? I can reinvest it into the business. At some point you run out of stuff to reinvest in that continues to drive higher growth rates. And so then you start looking outside to say, where do I put that capital? So the flywheel is a cash generation engine and a capital allocation flywheel.

So if you allocate capital to Bitcoin, and I'll get into this hurdle rate stuff in a minute, what that says is that there's this cycle between, okay, I earn excess cash, I invest it into Bitcoin, I don't sell the Bitcoin, I can create loans for working capital needs, but as it sort of gyrates, right, and the vibration of this engine kind of moves up into the right, then you start focusing things in your business on things that direct benefits to Bitcoin. So operating companies don't just do anything willy-nilly, they'll start to do anything that also helps Bitcoin. And so that flywheel actually generates more value in the ecosystem.

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We can talk about that after if that's a little less clear. So let's get into product management and that's where we've focused a lot of our efforts. So first things first on products, who are the best product managers of all time? One is Steve Jobs.

You've probably heard of this person. He created quite a bit of value, founded this company called Apple. They made the iPod, the iPhone, the Mac, and on and on, AirPods, you name it.

So a lot of people use it, value it. It's one of the most successful consumer products of all time. ChatGPT, notwithstanding.

But it required 40 to 50 years, hundreds of thousands of people all around the world in order to create three and a half, $4 trillion of value. Who's another great product manager? Satoshi Nakamoto wrote a couple page paper, wrote a little bit of code, sent a few emails off, and then never did anything again for 16 years. And the product has been adopted globally, has grown to almost the same value as big tech and is growing faster.

So I would say that's the best individual or entity that's ever existed. It is the most magical product of all time. So that's cool.

So then what is our mandate? How do we assess and define what good looks like as it relates to products, as it relates to investing in products, as it relates to building products? And so over the next few slides, we'll go into each of these four subsets, but it's really about investor build and defensible products, right? That compound faster than the hurdle rate, which we'll get into this, the hurdle rate at a lower risk, right? You don't want risk. You want high upside, high upside, lower risk with less overhead. Like I don't want to spend a ton of time.

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If I have to spend a thousand hours to make $1, that's not great. If I have to spend one hour to make a thousand dollars, that's really great, right? So, all right, let's go slide by slide. Defensibility, hurdle rate, risk, overhead.

So defensibility, these are well dimensions. You may argue that some of these are within another one, or I might've missed one or two. Fine.

Add some comments. But basically this is sort of a broad based view on what are the things that over time actually drive outsized value where you try to compete with them. And it's very, very difficult to compete once you have this.

So I'll call one out like network effects is the classic one that most people in tech understand. It's like, Oh, the whole Facebook meta thing. They've got 3 billion people.

You're not going to go, you can rebuild Facebook. That's easy, but you can't rebuild 3 billion people on your network because that's really hard. And I want to message other people on the network.

So that's a good one. We'll go through each of these definitions, but we've essentially done some scoring and some trending and some commentary here. And you can argue on what's the trend, what's the impact, what's the score.

I think directionally we're accurate here, but some of the ones that really stand out for Bitcoin are like scale, network, counter-positioning for sure, which I'll get into in terms of its business model, geographic distribution, its decentralization. But what you find is you look across this whole thing and we've done a ton of these over hundreds of businesses over the years, hundreds of products, not a thousand. We've never really disclosed any of that publicly.

Actually we haven't. But what I will say is that Bitcoin is one of the products that makes it super special that it has the highest defensibility score of pretty much anything I've ever seen, which is wild. And so that then drives this.

So this one is super interesting. So you've seen Michael Saylor, he's a badass, he's awesome, but super smart dude. And so this information here just came from MicroStrategy's chart they published on their website.

This was a couple of days ago. That's based on FactSet, which is a generally recognized finance tool to providing metrics and accounting. But I think the thing about this, whether you say, oh, it's a one year, you got to look at since inception or three years and you're cherry picking, fine.

But directionally, this thing continues to play out regardless of the time period you're looking at. So traditionally you're trying to beat the S&P 500, hedge funds, investment managers, Warren Buffett, things end towards the S&P 500 return. What's crazy though is that big tech, seven companies, seven, eight, nine, 10, depending on how you count, are now creating almost the majority of the value of the S&P 500.

So out of 500 companies, the best seven or eight are driving this return of the S&P 500, which is why you see Amazon, Microsoft, Google, Apple, Meta, NVIDIA, Tesla, they're kind of hovering around that place. What's crazy though is Google, Apple, Amazon, Meta have the same market cap as Bitcoin, the same value, the same number of outstanding shares times the price, but the growth rates are very different. It's because of this S curve.

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How many more humans are on the planet? You got like three and a half, four billion. There's five and a half billion people on the internet. You've reached the top of the S curve.

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There's not much more growth to get. The growth is in the rear view mirror. Same thing for Apple, right? The AI story, fine.

So say you believe this S&P 500 hurdle rate, 8%, 12%, whatever you want to pick over the years, look at the space between AI. That's the only other thing that's driving outsized growth. And that's creating NVIDIA, right? Meta is putting hundreds of billions of dollars, paying people hundreds of millions just to like steal from the other companies.

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And what's that do? It gets you a little bit more upside. But now you zoom out and you look at Bitcoin and you're like, Jesus, like this thing's just crushing everybody. Instead of this tiny little like gap that you're spending all this time, you're competing with the smartest, most well-capitalized, best mathematicians on the planet.

You're going as hard as you can, and you're barely beating this. And Bitcoin is just like hanging out by the beach or like drinking Mai Tai with a little umbrella and it's kicking butt. And then there's this thing called micro strategy, which just like levered up Bitcoin because they saw the product mechanics in this thing.

And they said, we're going to start creating products on top of Bitcoin. And guess what? Like now we're going to like improve this. So what's your hurdle rate? Well, if you're in the past, your hurdle rate is the S&P 500.

If you're in the future, your hurdle rates AI, which is NVIDIA. It's now the biggest company on the planet at $4 billion. And then it's like, well, if we zoom out a little bit more, Bitcoin is actually producing higher and then Bitcoin products build on top of Bitcoin is crazy.

Okay. So now you're saying, yeah, but what's the risk profile, right? Like the first mandate is don't lose money. So what you've actually found is Bitcoin has kind of reached the stage where the risk profile is similar to other asset classes, which is also wild.

So we're looking at these major categories, economic, technological, geopolitical, black swan events, like your blind spots, risk that is risk. And so really the one that we kind of look at, and it's like kind of the one that we've seen play out a little bit is like governmental laws and it dampens it. But, you know, you ban it in one area.

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You can't ban someone from buying a chip, booking up a solar panel, running a Bitcoin node, processing transactions. Like you can't do that across 8 billion people or even machines. So I upped the risk profile to say that it shows a little bit, but, you know, I I'm really thinking that the risk profile here is it's sort of comparable to other asset classes, right? Like climate, war, that affects everything.

Electromagnetic pulse, it affects everything. Encryption breaks, affects everything. Volatility, demand, affects everything, right? Fixed supply chain affects everything.

Bankruptcy, theft, right? Like it affects everything. Okay. So let's look at the key risks.

I think one of the key risks about this network effect is, so we spent time thinking about how do you break Bitcoin, right? Like that's that's key. How can you break this thing? And really like the key value is in the network. So how do you break the network? And so we started looking deeper into each one of these areas and then understanding like, what does it actually take to do this breaking? And then how difficult is it? And so one of the biggest things we saw, like you can read this later and we can talk about it, which is interesting.

We may, you know, different people may have different risk profiles, but what's crazy that you realize is that actually the biggest thing to break this network effect would be no volatility, which most people say that is like the biggest downside to Bitcoin is, oh, it's volatile. But what you realize, and I'll get into this, into this anti-fragility thing in a minute, is like that volatility actually is the thing that's driving the network. So you actually want volatility.

You want trading volume. You want liquidity. And so if you have like a one to two week view or a couple month view, sure, this thing might drop 50%.

But the longer you extend your time horizon, three years, five years, 10 years, 20 years retirement, like think about this as a retirement asset, then this thing is like, yeah, everything has volatility. And like, I actually liked the volatility. I'm not worried about it.

The only thing you're really worried about is I need enough working capital to pay my bills, pay my people, like manage any sort of like disruptive threat that comes. And so that's why you can take some excess cash outside of your working capital needs, your emergency fund needs, and start to look at Bitcoin more seriously. The other big thing is people say like, ah, it doesn't have cashflow, right? It's not an equity.

I value equities based on discounted cashflow. So like I earn $10 profit every year, and that $10 goes to 11 next year, goes to 12, goes to 13, notwithstanding inflation impacting like asset values, inflated asset values. But Bitcoin actually does have cashflow, right? The miners process transactions, they earn a transaction fee and a tip from the people pushing the miners.

And Bitcoin in the beginning gives Bitcoin bonuses. They give processing fees and bonuses. The difference is they share 100% of the profits with their customers.

Apple doesn't do that. Google doesn't do that. Facebook damn sure doesn't do that.

Does your company give you 100% profit sharing by helping build their business? No, they don't. But if you're a value investor and you start reading all of these deep value investor books about like these crazy tire businesses that started in the fifties or sixties and grew, what you see is two major features. One, they decentralized decision-making to each of the retail locations.

And two, they enabled profit sharing. So each of the managers and each of the different like retail locations then managed revenue, increased revenue, increased sales, managed their cost basis, and then drove that because that was their income. What's Bitcoin? It's decentralized and profit sharing.

The same thing, just entirely digital, which is crazy. So then you start to look at just one use case, which is like global payment flows, which is nuts. I mean, this is JP Morgan, $250 trillion in global payment flows.

Bitcoin, it doesn't even show up. It doesn't even show up. Here's all crypto.

Here's B2B e-commerce, which is like Amazon. Well, payments like Stripe, Stripe won't get you microtransactions below 50 cents, even though they bought a stable coin company. Global GDP, the value of all finished goods and services sold every year, payment flows, transaction fees, giant.

So then we're into like product mechanics. And so the best products people in the world are inventors and they invent product mechanics, right? So it's like creating an engine. I do this thing, it incentivized the network to do this thing, and that then increases.

So let's give a good one. Instagram, post a photo, get a like, feels good, strokes my ego. I post another photo, get another like, get two likes, feels better.

And so you see the engine. That's a product mechanic. That's like a viral loop.

And then they also gave like sharing stuff. What Bitcoin does is it takes this selfish mechanic and it actually makes it selfless, because if you invest in it, right, you use it, you build on top of it, that benefits you in the short term, but it also benefits the entire network, which you own a piece of, which is wild. So it's basically hacking human behavior into network values.

So I already discussed this volatility equals value thing, right? So the more it's traded, the more security there is with more miners, the more awareness there is from news stories, usage goes up, transaction fees go up, and they sort of, right, like difficulty adjustments, prices go. So it's like this interesting piston in a car that just helps move the motor and the wheels, keep the thing going. Profit sharing, I talked about already, sharing profits with miners increases the value to the network.

It's an incentive, right? So incentive design. If you were an HR...