Most everyone has heard of the blockchain by now, but for those who are unfamilar with it, the blockchain is a technology that uses a distributed “immutable” ledger that can be used to track data and transactions.
The word blockchain is often used synonymously with cyptocurrency, but crypto is just one application of blockchain technology. There are many more applications, such as smart contracts, which are automated tasks that can be set up to execute based upon various conditions. For example, a company could utilize the blockchain to track various parts of a home purchase and then automatically send the money to the seller once verification has been complete.
The blockchain industry was valued at $4.98 billion in 2021 and is forecasted to grow at a blistering 68.4% compounded annual growth rate according to estimates from Markets and Markets, reaching a value of $67.38 billion by 2028. Blockchain projects are also still receiving a record amount of venture capital funding despite the Crypto Winter, as it is envisioned as an essential cornerstone of Web3, a 3D version of the internet.
Even though crypto has been in the headlines for its recent crash, in the third quarter of 2022, venture capital firms still invested $1.5 billion in Web3 projects, showing confidence in the technology's long-term prospects. Thus, in this article, I break down my top two favorite stocks that I believe are poised to benefit from the usage of blockchain technology; let’s dive in.
1. Global X Blockchain ETF (BKCH, Financial)
The first is not a stock, but an exchange-traded fund that owns a basket of blockchain-related stocks. This is one of the easiest ways to get exposure to the industry and diversify, especially if you're not confident in picking individual stocks in this industry.
The ETF was founded in July 2021 and has net assets of $37.58 million, so is still very small relatively speaking. As an ETF, investors are charged a 0.5% expense ratio which basically covers the portfolio management and administration of the fund.
Its top holdings include the Block (SQ, Financial) , which makes up 19.77% of its portfolio, followed by Coinbase (COIN, Financial) at 9.78% and Riot Blockchain (RIOT, Financial) at 8.14%. Other holdings include: Core Scientific (CORZ, Financial) with 7.7% of the fund, Marathon Digital (MARA, Financial) with 5.6% and Hive Blockchain (HIVE, Financial) at 3.93%.
So far the fund has gotten off to a terrible start, with it plummeting by ~68% since inception. However, the time of its opening was rather unfortunate as it came just before the beginning of the so-called "Crypto Winter," so I don't think this should be taken as an indicator for the future.
2. Block
The second stock that I prefer to play the growth of the blockchain is Block (SQ, Financial), formerly known as Square. The company was founded in 2009 by Jack Dorsey, who started Square as a fintech pioneer which revolutionized the way small businesses transact. The Square ecosystem includes point-of-sale (POS) systems and analytics software. The beautiful thing about this technology is it can be used to track business finances and thus use the data to underwrite credit offerings via Square Capital. Given small businesses are an underserved market from a credit standpoint, this means a huge greenfield opportunity is available.
Square’s second ecosystem is its popular Cash App, which enables individuals to send, spend, bank and invest. Cash App had a major boom in popularity in 2020, as stimulus checks were issued and users invested their newfound cash in crypto via the platform. The Cash App ecosystem aims to drive more transactions, which Block takes a cut of.
The company is involved more deeply in the blockchain space via its “TBD” segment. TBD is an open source platform which gives developers the ability to build products based on decentralized blockchain technology. This business has the mission to make the “decentralized finance world available for everyone." Dorsey is known to have spent a lot of time in Africa and says he sees a huge opportunity to “bank the unbanked” in the continent.
The company’s website talks heavily about the need for a “decentralized identity” as our identity and logins are controlled by centralized entities currently. We see the weakness of the current system exploited when email accounts get hacked, such as the Yahoo email hack in 2016 and even a Gmail “hyperscrape attack” in 2022, which enabled hackers to read gmail emails.
In some countries, government control can even restrict certain individuals from accessing credit, and thus, TBD could help mitigate this danger by eliminating borders and making credit available to anyone.
TBD has also developed a protocol called (tbDEX) which enables a direct “on ramping” and “off ramping” between fiat currency and crypto. The idea is to displace the need for centralized intermediaries such as banks. In 2008, we saw how the financial system can destroy the entire economy if managed improperly, as it is deeply embedded into everyone's lives.
TBD is currently not a revenue driver for Block, but it does offer potential for the future if it can entice more developers to build game-changing applications on the platform.
Block reported strong financials in the third quarter of 2022. Revenue was $4.5 billion, which popped by 18% year over year and surpassed analyst consensus estimates by $47 million. This growth was despite a major decline in Bitcoin trading, which plummeted as crypto prices did during the recessionary environment. Bitcoin trading contributed to approximately 40% of revenue in 2021 and thus the impact on growth is significant.
A positive is Bitcoin trading has never really been a major profit driver for Block, as the company effectively enabled this trading at a very low cost to increase usage velocity and remain competitive. This means that Block’s gross profit actually increased by 38% year over year to $1.57 billion, despite the slowdown in Bitcoin trading.
Block also acquired buy now pay later provider Afterpay in the fourth quarter of 2021, which gave a revenue boost.
The company reported adjusted earnings per share of $0.42 in the latest quarter, which surpassed analyst expectations by $0.19. This was despite a substantial increase in operating expenses of 46% year over year to $1.62 billion. This was mainly driven by a a 19% increase in sales and marketing expenses as well as a 48% increase in general and administrative expenses, which increased to $395 million. The general and administrative expenses were mainly driven by an increase in headcount and acquisition-related costs. Therefore, over time, I expect these costs to fall.
To value Block, I have input its third quarter financial data into my discounted cash flow model. I have forecasted 15% revenue growth for next year, which I believe is fairly conservative given the recessionary environment. In years two through five, I have forecasted a faster 16% growth rate. 
I have also capitalized Block’s R&D investments, which has lifted the net income margin. In addition, I have forecasted the company to increase its operating margin to 15% over the next seven years.
The output of the model gives a fair value estimate of $106 per share. Block’s stock is currently trading at $60 per share and thus is 44% undervalued.
Final thoughts
Both the Global X Blockchain ETF and Block are poised to benefit from the growth in the blockchain industry. I personally prefer Block over the ETF as it has a robust fintech business already established. The Global X Blockchain ETF does include some investments which are more speculative, but the tradeoff is that they offer more diversification.
