“That’s Our 2 Satoshis” — Pricing Bitcoin Using a CDS Framework

Jeff Dorman, CFA
Oct 17, 2022

Thats Our 2 Satoshis LogoWhat Happened This Week in the Digital Assets Markets?
Week-over-Week Price Changes (as of Sunday, 10/16/22)

Week over Week Price Change
Source: TradingView, CNBC, Bloomberg, Messari
Pricing Bitcoin Using a CDS Framework
The yield on 10-year U.S. government bonds ended the week over 4.0%, delivering an 11th consecutive weekly jump—the longest stretch in 38 years. Yields in the U.K. (Gilts) also jumped week-over-week back to near YTD highs (10-year at 4.35%) but were more volatile and erratic as the length and transparency of the Bank of England buy program remains in flux. Meanwhile, 10-year Japanese government bonds (JGBs) have basically stopped trading as the Bank of Japan price fixes the 10-year at 0.25%.
As the market fixates on sovereign yields, it’s important to remember what government bond yields really represent. While the term “risk-free rate” gets thrown around for government bonds, this often conflates academic theory with reality, as 2022 has shown that these bonds are anything but risk-free. Instead, the yield represents the return an investor needs to earn to warrant taking the risks associated with holding these government obligations. And while default risk is low for bonds issued by nations that can print their own currency, it is not zero. 
A better way to see this is via the credit default swaps (CDS) market, which tends to more accurately price “risk” than bonds themselves, since they are less heavily manipulated by central banks’ direct intervention. While most people would say the U.S. can never default on its bonds, the cost to insure principal loss on U.S. government bonds for 5 years costs 32 basis points per year. With roughly $23 trillion of U.S. government bonds outstanding, if every single bond owned was insured, it would cost $73 billion annually. That’s hardly pricing in a zero percent chance of default.
And, of course, the U.S. is the best house in a bad neighborhood. Sovereign CDS has blown out this year worldwide, indicating the risk of default has risen, or at least, the cost to insure this low probability outcome has increased significantly. Many South American countries are now 100-200 bps wider, while European and Asian nations are 15-50 bps wider.
CDS Market
Source: Bloomberg [SOVR]
Which brings us to bitcoin. No digital assets enthusiasts have been tougher on bitcoin than we have as it has failed to live up to any of its billings this year: it’s not defensive, it’s not an inflation hedge, it doesn’t get used for transactions, and there is no natural buyer to offset the inflation. That said, bitcoin has always been a call option on anarchy if citizens begin to lose faith in their banks and local governments. In fact, in February 2022, when Russia’s Ruble tanked and Canadian banks froze citizens’ accounts, we highlighted that it would not be surprising if demand for bitcoin skyrocketed. This prediction is even more relevant now with European banks imploding, England’s currency and bond market eroding, and Japan’s yield curve control flummoxing investors. 
But how do you value that call option? In the past, we’ve utilized Black-Scholes’ options model to value bitcoin—a technique that favorably prices bitcoin due to the infinite time horizon and high volatility. But that is an imperfect model given the variance and low confidence of the inputs. Perhaps looking at the sovereign CDS market makes more sense. If bitcoin is a call option on the risks of sovereign anarchy, then shouldn’t bitcoin be much higher YTD to reflect the rising levels of sovereign and bank risk, in line with the moves we’ve seen in sovereign and bank CDS? After all, they both represent the same end game. Greg Foss, bitcoin enthusiast and former credit trader, is the mastermind behind pricing bitcoin using the sovereign CDS framework. Foss argues that bitcoin is default insurance on a basket of Sovereigns/Fiats. If you just look at the U.S. by itself, by buying bitcoin, you are buying default insurance on the USA for an 85% discount to fair value as indicated by the cost of bitcoin compared to the cost to insure against all U.S. liabilities. But equally important, buying bitcoin as insurance also covers you against defaults on ALL other government obligations. Not to mention, it’s not just government debt that seems to be on shaky ground. European bank CDS is at 2008-like wides as the market has lost faith in Credit Suisse and a handful of other European banks. 
There is roughly $88 trillion of combined global government debt, plus trillions more if you include off-balance sheet and unfunded long-term liabilities. Add in global bank debt (Credit Suisse alone has $128B of unsecured debt), and the numbers become staggering. 
Suddenly, paying a 1-time fee of just under $20,000 for bitcoin doesn’t seem that expensive. Perhaps we should stop looking at bitcoin as an inflation hedge or store of value and start valuing it as wealth and livelihood protection. It’s certainly counterintuitive that bitcoin and sovereign CDS serve the same purpose, yet one is more expensive due to very real increased risks (CDS) while the other is on sale for 70% off its recent all-time highs.
Bitcoin vs Sovereign CDS
Source: Twitter

Watch Our Founders Video

And That’s Our Two Satoshis!
Thanks for reading everyone!   
Questions or comments, just let us know.
The Arca Portfolio Management Team
Jeff Dorman, CFA - Chief Investment Officer
Katie Talati - Director of Research
Hassan Bassiri, CFA - Portfolio Manager 
Sasha Fleyshman - Portfolio Manager
Nick Hotz, CFA - Vice President, Research
Alex Woodard - Research Analyst
Bodhi Pinker- Research Analyst 
Wes Hansen - Director of Trading & Operations
Kyle Doane - Trader
David Nage - Principal, Venture Investing
Michael Dershewitz - Principal, Venture Investing
Michal Benedykcinski - Research Analyst
Andrew Masotti - Trading Operations
Topher Macpherson - Trading Operations


To learn more or talk to us about investing in digital assets and cryptocurrency
call us now at (424) 289-8068.

Subscribe For the Latest Blockchain News & Analysis



Disclaimer: This commentary is provided as general information only and is in no way intended as investment advice, investment research, legal advice, tax advice, a research report, or a recommendation. Any decision to invest or take any other action with respect to any investments discussed in this commentary may involve risks not discussed, and therefore, such decisions should not be based solely on the information contained in this document. Please consult your own financial/legal/tax professional.

Statements in this communication may include forward-looking information and/or may be based on various assumptions. The forward-looking statements and other views or opinions expressed are those of the author, and are made as of the date of this publication. Actual future results or occurrences may differ significantly from those anticipated and there is no guarantee that any particular outcome will come to pass. The statements made herein are subject to change at any time. Arca disclaims any obligation to update or revise any statements or views expressed herein. Past performance is not a guarantee of future results and there can be no assurance that any future results will be realized. Some or all of the information provided herein may be or be based on statements of opinion. In addition, certain information provided herein may be based on third-party sources, which is believed to be accurate, but has not been independently verified. Arca and/or certain of its affiliates and/or clients may now, or in the future, hold a financial interest in investments that are the same as or substantially similar to the investments discussed in this commentary. No claims are made as to the profitability of such financial interests, now, in the past or in the future and Arca and/or its clients may sell such financial interests at any time. The information provided herein is not intended to be, nor should it be construed as an offer to sell or a solicitation of any offer to buy any securities, or a solicitation to provide investment advisory services.