What is the potential market size of Bitcoin?

• Today, Bitcoin is a scarce digital commodity and a substitute for physical gold. Bitcoin is still relatively small compared to the size of the gold investment market. We expect Bitcoin to continue to take market share from gold as a store of value asset more suited to our digital age.
• But Bitcoin’s possible uses are not limited to its role as a potential gold replacement, as a reduction in transaction costs through the adoption of the Lightning Network or other solutions may help Bitcoin compete with fiat currencies in certain areas of the global economy, And continue to create new innovations in the global economy. Over time, the development of layer 2 protocols for networks such as NFTs and smart contracts may contribute to Bitcoin's potential.
• The overall size of these addressable markets likely means there is plenty of room for Bitcoin valuation to grow over time.

Although Bitcoin is over 14 years old and owned by tens of millions of people (1), the possible uses of the network remain controversial. In a way, this is not surprising: because Bitcoin is so different from what it was before, the core technology and the ecosystem around it will take time to mature. For investors, this means that the addressable market for the asset (the existing economic structure that the technology can disrupt) is always a moving target. While we can quantify some aspects of Bitcoin’s market opportunity, innovation is always expanding the possibilities for the world’s first public blockchain. We see a range of potential use cases: from a digital store of value, to a medium of exchange, to a settlement layer for non-monetary blockchain activities.

Bitcoin as a Store of Value

Today, Bitcoin has been established by some as a scarce “store of value” asset and a digital competitor to gold. This use case was obvious from the start—Bitcoin creator Satoshi Nakamoto likened the token to a rare base metal with special properties: it “can be transmitted through communication channels” (2). Despite gold's longer existence, Bitcoin still has certain characteristics that are attractive to its holders, especially its portability; Bitcoin can be used anywhere in the world as long as the holder has access to the Internet and private keys. local use. Economic conditions since Bitcoin’s inception — financial crises, pandemics, soaring inflation — have accelerated demand for tools that might help protect the real value of assets and supported Bitcoin as a digital alternative to gold. Bitcoin’s market capitalization of approximately $500 billion (3) is relatively small compared to the physical gold market. We estimate that the market value of above-ground gold stocks is about $13 trillion, of which about $3 trillion is private gold investment (ETFs plus holdings of gold bars and coins) and just over $2 trillion is held by central banks (see chart 1) (4). Although Bitcoin has grown significantly over the past decade, the investment market in gold is still about five times the size (or nine times, including gold held by central banks). We anticipate that Bitcoin will likely continue to take market share from gold as a store-of-value asset more suited to our digital age.

Chart 1: Bitcoin is still small compared to investing in the gold market

Bitcoin as a medium of exchange

Bitcoin's intended use is as a peer-to-peer electronic cash system, but Bitcoin has been slow to get started as this digital medium of exchange. This likely reflects a variety of factors, including its historical volatility, the network strengths of existing monetary systems, and Bitcoin’s transaction costs. In the early history of the network, Bitcoin's transaction costs were relatively low, and Bitcoin was often used as an experimental medium of exchange. As network usage increases and blocks begin to fill up, its transaction costs become higher and more unstable (see Figure 2). These fees are a function of transaction complexity—the number of bytes occupied in a block—rather than dollar value. Therefore, Bitcoin transactions are more cost-effective for high-value payments and may in fact be cheaper than traditional payment systems, but not cost-effective for low-value or retail payments.

Chart 2: Bitcoin transaction costs increase when block size limit is reached

Could Bitcoin become more widely used as a medium of exchange? In advanced market economies with stable monetary systems, this scenario seems unlikely to occur even in the long run. Blockchain technology may help improve existing payments infrastructure, but we believe the vast majority of retail transactions are more likely to use stablecoins and, ultimately, central bank digital currencies (CBDCs). While some users may value the fact that Bitcoin transactions avoid centralized intermediaries, the dominance of card-based digital payments today suggests that most users value speed, convenience and stability.

That being said, we can foresee Bitcoin becoming more widely used as a medium of exchange in parts of the global economy that meet certain conditions. For example, in countries with unstable domestic currencies or banking systems, Bitcoin may be the preferred medium of exchange; in these cases, users may also appreciate Bitcoin's censorship-resistant properties, especially where transaction costs are low or existing currencies / A situation where the network advantages of a currency system have been overcome. Bitcoin usage in El Salvador meets some of the following criteria: Chivo wallet (5) covers all retail transaction fees and government fiat overcomes network challenges (6), but importantly, the country does not have an unstable national currency beforehand (it dollarized), it remains to be seen to what extent Bitcoin will remain an enduring medium of exchange.

Organic adoption is likely to increase due to efforts to reduce Bitcoin transaction costs through the Lightning Network, a "layer 2" protocol. The first layer of blockchain is the base-level database or "digital ledger" where transactions are settled. Layer 2 is an additional protocol that exists alongside the Layer 1 chain and benefits from its consensus mechanism and security. Tier 2 typically provides additional application functionality and/or lower cost.

The Lightning Network is a Bitcoin layer 2 scaling solution designed for low-cost and high-volume payments. Rather than settling every transaction on a layer 1 blockchain, users send and receive payments through off-chain channels, which can then be settled periodically to the main network. Lightning Network had low initial adoption, but as development continued, it showed more progress (see Figure 3). It’s worth noting that the Lightning Network is capable of more than just direct Bitcoin transactions; in the future, it could also support stablecoins (7) or fiat payments via Bitcoin (i.e. fiat-to-bitcoin-to-fiat payments). In these cases, Bitcoin will accumulate value as a settlement asset for the network used for digital payments, even if it is not used directly as a digital payment medium.

Exhibit 3: Development of Lightning Network improves prospects for transaction use cases

If Bitcoin can make headway as a medium of exchange or a network that facilitates digital fiat transactions, the potential market opportunity could be significant. For example, we estimate that global "M1" (economists' traditional definition of transaction currency) totals approximately $60 trillion (8). Therefore, if Bitcoin is able to capture a small portion of this market, we believe it will have a meaningful impact on the token's underlying valuation.

As noted above, we do not expect Bitcoin to become the dominant medium of exchange for retail transactions in developed market economies, as we predict stablecoins are more likely to fill this role. But not all types of “money” are the same, and there will be some parts of the existing stock of money-like assets that should be more easily replaced.

Consider the international use of the U.S. dollar: The U.S. dollar is widely used outside the United States, including in transactions that do not include U.S. residents. These uses may be more easily disrupted by blockchain-based media. In domestic economies, national governments can control the public's use of particular currencies through rules and regulations (for example, requiring taxes to be paid in the national currency, or limiting the amount of foreign currency that can be held in bank deposits). In international markets, by contrast, the de facto medium of exchange and store of value is a matter of choice and determined by public demand. Therefore, the dominance of any one international monetary medium is likely to change over time.

Although the U.S. dollar currency stock is smaller than the domestic currency stock, the international U.S. dollar market is also very large (Chart 4). For example, it is estimated that there are approximately $1 trillion in banknotes in circulation outside the United States (mostly large denominations), and approximately $12 trillion in U.S. dollar deposits in major national banks outside the United States. The latter figure excludes all dollar-denominated deposits in Latin America’s less developed economies, many of which are heavily dollarized (9). The complex geography and multifaceted functions of money in the global economy may mean that there is a market opportunity for Bitcoin and/or other cryptocurrencies as a medium of exchange, even if fiat-backed stablecoins are the primary medium of exchange in the future.

Chart 4: Bitcoin can compete with the US dollar as an international currency

Bitcoin as a settlement layer

While Bitcoin was originally envisioned for financial applications, the network's potential uses may extend beyond financial applications in the long term. Over the past year, smart contracts and NFTs have developed on the Bitcoin network, effectively expanding the reach of the network. In December 2022, Bitcoin developer Casey Rodarmor released the ORD software, paving the way for Ordinals or NFT-like assets on the Bitcoin network. The 2021 Bitcoin protocol upgrade reduces the cost of storing arbitrary data, and as a result, Ordnals allows users to engrave the smallest unit of Bitcoin (a satoshi) into a non-fungible token (NFT). This use case will also open the Bitcoin network to the digital art and collectibles market. In May 2023, the early popularity of this feature helped miners earn 1,390 BTC (10) in handling fees, accounting for 30% of the total network handling fees of 4,540 BTC (11) that month. While Ordinal transaction volume has since slowed down, new inscriptions have continued, with total inscriptions reaching 26mm this year (12), suggesting that digital artwork on Bitcoin is likely here to stay (see Figure 5).

Exhibit 5: NFTs on Bitcoin may continue to exist through Ordinals

The potential of smart contracts on the Bitcoin blockchain will further expand the network’s reach. One of the early leaders in this effort is Stacks, a Bitcoin layer 2 that brings smart contract functionality to the Bitcoin ecosystem and provides decentralized applications including finance, gaming, and social applications ( dApp). With TVL (13) costing just 20mm, Stacks can still be considered a pilot project; larger smart contract platforms – such as Ethereum, its largest scaling solution, and Solana – each maintain over 300 USD TVL. The platform also received significant developer interest and attention last year, with over 90 Dapps (14) and 43 full-time developers (15), ranking 28th among all smart contract platforms, ahead of Lido, Chainlink , The Graph and XRP. Overall, the early progress of Ordinals and Stacks demonstrates Bitcoin’s potential relevance to areas ranging from digital art and collectibles to any asset that can be programmed into smart contracts. These new use cases are in the preliminary stages of bringing new end-users to the network, including artists, developers, speculators, collectors or gamers, but if Bitcoin can translate the growing activity and developer interest into these areas With global appeal in the long term, we believe it will also benefit from investment in new areas (e.g., the $67 billion art market (16), the $372 billion collectibles market (17), and the $227 billion USD Video Game Market(18)).

Progress of use case

From its ubiquitous status as the digital counterpart to gold, to its use as a means of payment and potential future relevance in other areas, Bitcoin's utility and importance has and will continue to evolve. Currently, we expect that Bitcoin will likely continue to grow as a store of value, taking a larger share of the global gold investment market. Going forward, assuming mass adoption of scaling solutions like the Lightning Network, the use of Bitcoin as a means of payment may open up larger markets to the network, while Bitcoin's status as the first and most trusted cryptocurrency may also make it Becoming a strong competitor to other smart contract platforms could unlock opportunities in several new markets.

The addressable market for Bitcoin can only be roughly estimated, and there is naturally a great deal of uncertainty in providing such an estimate, as Bitcoin is only an asset that needs to compete with other cryptocurrencies (or unknown future innovations) to compete. Capture market share of gold and fiat currencies. Furthermore, as Ordinals' experience shows, it's difficult to predict how developers will apply the Bitcoin network in the future. Nonetheless, Grayscale Research is optimistic about multiple avenues for Bitcoin’s continued growth.