Grayscale Report | Bitcoin’s Purpose: Determining the Size of the Addressable Market

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 New innovations are constantly being made 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 could mean there's plenty of room for Bitcoin's 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. The 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 the longer existence of gold, Bitcoin still has certain characteristics that are attractive to its holders, especially its portability; as long as the holder has access to the Internet and private keys, Bitcoin can be used in the world Use anywhere. 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 billion3 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 (Exhibit 1 ). 4 Even though 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.

Bitcoin as a medium of exchange

Bitcoin's intended use is as a peer-to-peer electronic cash system, but Bitcoin's development as this digital medium of exchange has been slow. 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 transaction costs were relatively low, and the token 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 volatile (Chart 2). These fees are a function of transaction complexity (the number of bytes they occupy in a block), not their dollar value. Therefore, Bitcoin transactions are more cost-effective for large payments.

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 /Situation where the network advantages of the currency system have been overcome.

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 (Exhibit 3). Notably, the Lightning Network is capable of more than just direct Bitcoin transactions; in the future, it could also support stablecoins7 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.

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 a transaction currency) totals about $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 underlying valuation of the token.

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.

Many of these economies have become 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.

Bitcoin as a settlement layer

While Bitcoin was originally envisioned for financial applications, the network's potential uses may extend beyond these uses in the long term. Over the past year, smart contracts and NFTs on the Bitcoin network have received attention, 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 Ordinals allows users to record the smallest unit of Bitcoin (satoshi) as a non-fungible token (NFT). This use case also opens the Bitcoin network to the digital art and collectibles market. Early excitement about the feature drove a total of 1,390 BTC in fees charged to miners in May 2023, accounting for 30% of the total 4,540 BTC in fees collected across the network that month. While Ordinal transaction volume has since slowed, new inscriptions continue to grow at a consistent rate, with a total of 12 inscriptions reaching $26mm this year, suggesting that digital artwork on Bitcoin is likely here to stay.

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 TVL. Last year, the platform also received significant interest and attention from developers, with over 90 Dapps14 and 43 full-time developers15, 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 over the long term, we believe it will also benefit from investment in new areas (e.g., the $67 billion art market16, the $372 billion collectibles market17 and the $227 billion video games Market 18).

Progress of Use Cases

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 experience with ordinal numbers shows, it is 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.