The Intrinsic Value Of Bitcoin, Calculated Using Sovereign Credit Default Swaps

I reference my thesis on the intrinsic value of bitcoin in this piece, originally published in Bitcoin Magazine in April 2021. It represents my view on the value of BTC as the anti fiat, fiat is the Ponzi, and how everyone needs insurance against the Ponzi collapsing. As Voltaire famously said, “Paper money eventually returns to its intrinsic value — zero.”

As Charlie Munger famously said, bitcoin “is rat poison squared.” Well, Charlie, have your pill, because fiat is the rat.

The basis of my paper is that BTC is insurance on the decaying credit quality of fiat-issuing sovereign nations. As such, it is credit protection on a basket of fiats. When you own insurance, you own volatility. Similarly, when you are long credit, you are short volatility. Most assets/investment mandates are short volatility. Accordingly, the investing world is short volatility, and it desperately needs to offset that risk with insurance (or being long volatility).

In my paper, I calculated the intrinsic value of BTC at the then current credit default swap (CDS) rates and total liabilities of the G-20 nations. This dynamic calculation will increase in value as the price of the insurance increases. An increase in the price of insurance is reflected in a widening of CDS spreads. Well, spreads have widened for a number of reasons. For example, China CDS has widened due to the contagion from the Evergrande fallout. Canada CDS has widened because we have irresponsible politicians who have just been re-elected, yet they “don’t care about monetary policy.” And U.S. CDS has widened because, well… there are four or five reasons, but the most concerning is that the political elite are playing word games with the potential of defaulting.

Wake up people, this is not a drill. Contagion risks are increasing due to potential global stagflation (see the excellent article by Dylan LeClair and Sam Rule, published in Deep Dive issue #072). The intrinsic value of BTC has increased from the beginning of this year when I originally calculated the value to be over $150,000 per coin.

I am going to take a different tack this time. I will run through the calculation of the value of BTC on just the U.S. financial situation. You will see that the market cap of BTC should be far in excess of $1 trillion. What that says is that you are effectively getting default insurance on the U.S. at a discount to intrinsic value, and you are getting protection on all the other fiats for free.

Is it any wonder why I believe BTC to be the best asymmetric investment opportunity I have seen in my 32 years of trading risk? Giddy up.

The Methodology

Five-year CDS for the U.S. just traded at 17 basis points (bps). For the common person, this esoteric measure means that it costs $17,000 to insure $10 million of U.S. Treasury debt (UST) against default. Remember that in 2006, it cost $9,000 to insure $10 million of Lehman Brothers (LEH) debt against default.

That insurance contract became very valuable since when LEH finally did default, the contract was worth over $6 million. The sellers of LEH protection were picking up nickels in front of a steamroller. Are the current sellers of U.S. CDS doing the same?

I don’t believe there will be a short-term default by the U.S. The costs would be astronomical. However, the kids are playing games. Yellen is dangerous in her lack of understanding of true risk markets. Powell is a well-intentioned lawyer who has never sat in a risk chair. These are our leaders, and their pristine backgrounds don’t cut it within the trading pits.

Remember, you don’t have to experience a default in order to make money on the change in spreads in a CDS contract. The mark-to-market function will account for the wider spreads, and you could close out the contract in advance of the five-year maturity and make a profit.

Adjusting The CDS Contract For A 20-Year Term

If five-year CDS is at 17 bps, what would 20-year CDS trade at if it was a freely-traded contract? (Note: In my paper I used a 15-year CDS term, but have since reconsidered the necessity to have longer-term insurance. The value of small incremental annual tenor changes would bring in longer-term buyers. Moreover, if the U.S. was smart it would drastically increase its average term of debt issuance. If the ducks are quacking, you should feed the ducks, and it sure seems like there are a lot of foolish bond investors who are picking up nickels in front of the steamroller).

In order to get that number, you need to do a tenor calculation. This is a somewhat “finger-in-the-air” exercise, but here it goes. Five-year CDS costs 17 bps or 3.5 bps per year. If we effectively do a linear regression on extending CDS to the 20-year term, the cost would be 70 bps per year. My gut tells me it would be wider due to all of the variables that the U.S. and the world will face over the next 20 years. In fact, I am pretty sure I would get lifted on an offer of 20-year CDS on the U.S. at 100 bps per annum (if anyone would take Foss as counterparty risk, which is unlikely). Thus, for the sake of argument, let’s say that 20-year U.S. CDS is between 70 bps and 100 bps per annum.

The Current Funded and Unfunded Obligations Of The U.S.

According to the excellent website, USDebtClock.org, total funded plus unfunded liabilities of the U.S. equal $29 trillion plus $158 trillion. This monumental total of close to $190 trillion needs to be multiplied by the 20-year CDS premium to calculate an intrinsic value of insurance on the U.S.

$190 trillion x 70 bps = $1.33 trillion

$190 trillion x 100 bps = $1.9 trillion

Now what?

The Current Market Cap Of Bitcoin

Using my favorite BTC dashboard, bitbo.io (created by two really solid Canadians: Chris Gimmer and Marc Chouinard), the trading market cap of BTC as of this writing just inched past $1 trillion (at a price of $54,7000 per coin).

How To Interpret The Results

If you compare the current market cap of BTC to the value of insurance on total U.S. liabilities ($1.33 trillion to $1.9 trillion), BTC is clearly cheap for providing protection on the U.S. alone. And you get protection on all other failing fiats for free.

Good golly, Miss Molly. Markets can be irrational, and in my opinion, BTC is far too cheap. Yes, current prices are a rounding error compared to my long-term target price, but this methodology gives me comfort that we are still sooooo early.

How are your hedges doing, Charlie? And hedges are not just for gardeners. Buckle up. Volatility is gurgling. Buy your insurance when it is cheap.

BTC is insurance on crumbling fiat credit quality with no counterparty risk. The U.S. will likely be the last fiat to fail, but ultimately, all fiats fail. Hat tip, Voltaire.

This is a guest post by Greg Foss. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.

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