How to Value Bitcoin and Other Cryptocurrencies
Originally published: November 2017 (since updated with editor’s notes)
Cryptocurrencies are one of the most popular asset classes to invest in today. the price of bitcoin in particular has skyrocketed from pennies to thousands of dollars per unit in a decade.
Reading: How to value bitcoin
but is it all a bubble, like the dotcom era or tulip mania? Or is it just the start of something bigger, or even revolutionary?
Price is what an investor pays, but value is what an investor gets. It’s easy to look up the current price of bitcoin, but it’s more difficult to determine what a realistic value is.
I don’t have the answers to those questions, but this article will provide a framework to help you think about valuing cryptocurrencies for yourself, including explaining many of the risks involved.
start here from the beginning or skip to the section you want:
- Cryptocurrency 101: An Overview of the Blockchain
- Bitcoin vs. Fiat Currencies vs. Precious Metals
- The Difficulty of Valuing Cryptocurrencies
- how to value bitcoin and ; another cryptocurrency
I originally wrote this article in the fall of 2017 when bitcoin was in the $6,000-$7,000 range, and I had a neutral outlook, leaning a bit bearish (no personal position). I updated the article every few months with new issues to keep it fresh without changing the main content.
For the next 2.5 years after publication, bitcoin rose to $20,000 and crashed below $4,000, rose to $12,000 and briefly crashed again to below $4,000, and in April 2020 rose back to $6,000 -$7000. therefore, it had 2.5 years of choppy and sideways performance after the original publication.
On my premium research service in April 2020, as it came out of that sharp drop, I became bullish and recommended it on April 12, and initiated a long bitcoin position on April 20 at just under $7,000. then I wrote a public article about bitcoin during 2020, explaining why I’m optimistic:
- 3 reasons to invest in bitcoin (July 2020)
From there, I wrote a series of articles on the subject, which you can read in my library of digital assets.
I am no longer updating this article, but keeping it for legacy purposes as it still shows my evolution in thinking about digital money assets. there are some editor’s notes in the text.
cryptocurrency 101: an overview of blockchain
bitcoin, the first cryptocurrency, was invented by an anonymous person or group named satoshi nakamoto and released publicly online in 2009 as open source software and a white paper explaining the concept.
satoshi claimed to be a Japanese man in his thirties, but his identity has never been verified because all of his communications were over the internet. He wrote with British English influences and had sleep/wake cycles according to his online activity that would presumably place him in North America, leading many to believe that he is not actually Japanese. or maybe he is multi-ethnic.
may not even be a man. could possibly be a woman or a group of people. but most likely it is a man using a pseudonym. and wherever he is, he has about a million bitcoins, now worth billions of dollars, that he has never spent. and he has darkened; having invented the concept, he no longer drives it and his whereabouts and identity are unknown.
It’s like a good suspense novel.
Anyway, bitcoin was invented for the purpose of being a decentralized currency and payment method. it does not depend on any central authority such as a government or bank or the satoshi itself, and instead is fully distributed across numerous clients running open source bitcoin software.
At the core of most cryptocurrencies is blockchain technology, which now has applications outside of cryptocurrencies.
as described in harvard business review:
Contracts, transactions, and records thereof are among the defining structures of our economic, legal, and political systems. they protect assets and set organizational boundaries. establish and verify identities and narrate events. govern the interactions between nations, organizations, communities, and individuals. guide business and social action.
The technology at the heart of bitcoin and other virtual currencies, blockchain is an open, distributed ledger that can efficiently record transactions between two parties in a verifiable and permanent manner.
With blockchain, we can envision a world where contracts are embedded in digital code and stored in transparent, shared databases, where they are protected from deletion, tampering, and review. in this world every agreement, every process, every task and every payment would have a record and digital signature that could be identified, validated, stored and shared. Intermediaries such as lawyers, brokers, and bankers may no longer be necessary. individuals, organizations, machines, and algorithms would freely transact and interact with each other with little friction. this is the immense potential of blockchain.
In other words, blockchain is a fundamental new technology that uses decentralized encryption to record events publicly. The technology was conceptualized in the 1990s, but was not implemented until Satoshi applied the idea to his Bitcoin software and solved the double-spending problem, creating a scarce digital currency that relies not on governments or banks, but on encryption. .
With bitcoin, each user has a private key, which is a giant integer that acts as a digital signature and is kept secret, known only to that user. users then have public addresses (more numbers), to which people can send money in order to make a transaction.
It doesn’t actually “store” bitcoins anywhere. it’s just a public ledger that attributes a certain number of bitcoins to addresses you control with your private key. what you store is just your private key.
Bitcoins can be “mined” by verifying third party transactions. people can contribute computing power to verify bitcoin transactions, and in return, the algorithm allows them to create a certain number of bitcoins for themselves. the total amount of bitcoins will reach a maximum of 21 million, at which point they can no longer be mined.
Because bitcoin technology is open source and not proprietary, other cryptocurrencies can and have been created, and many of them, like litecoin, even have specific advantages over bitcoin itself, such as faster processing times .
Another great application of blockchain is for software. Ethereum, now the second largest cryptocurrency, was developed to be broader than bitcoin in terms of using blockchain technology to transfer various types of value. it is like a decentralized application platform with a built-in currency in ether units. Typical app platforms have a central authority like Google or Apple, and developers can apply to put apps on those networks to sell to consumers. ethereum can do that without intermediaries.
bitcoin vs. fiat currencies vs. precious metals
You may be wondering what the possible advantages of cryptocurrencies are. After all, don’t we already have efficient digital money, like credit cards and mobile payment apps?
Historically, there are two types of money. precious metals and fiat currencies. cryptocurrencies are a third new type.
For thousands of years on several continents, humans have exchanged valuable commodities as forms of value, to facilitate barter. Any material that is rare and attractive and can be broken down into small amounts works quite well, but gold and silver are the almost universal choices.
gold in particular is rare and beautiful, extremely resistant to reaction (i.e. lasts forever), and easily malleable into coins and bars, which made it pretty much perfect as a form of money, at least until the modern era . It’s no longer practical or possible to go around paying gold and silver for the things you want to buy, unless government currencies return to using a direct gold standard. it also has quite a bit of industrial use due to its chemical properties, but its price level maintains most of its use for money and jewelry.
The main advantage that gold still has is that no government has price control over it. it has inherent value and scarcity of its own, and is recognized everywhere. Investors see it as catastrophe insurance, because it will always have at least some kind of value, and it offers protection against inflation, fraud, and economic collapse.
dollars, pounds, yen and all other currencies are “fiat currencies”, meaning they have no intrinsic value other than that a government has decreed that they are legal tender and require them for the payment of taxes. they can print as much as they want.
fiat is Latin for “let it be done”. US dollars have value because the United States government declares them to have value and makes them the only legal tender to pay for US dollars. taxes with, and people have enough faith in the stability of that statement to accept it and use it as a medium of exchange and store of value, even though over time, the dollar has lost most of its purchasing power due to inflation. money supply.
Fiat currencies are convenient, but they are not without risk. when a government fails, its fiat currency is usually hyperinflated out of value. most fiat currencies ever created have eventually become worthless; the ones that exist now are quite recent and have lost most of their purchasing power over time.
Bitcoin was invented to be like a new and modern form of gold and silver. like some kind of science fiction libertarian money.
it is scarce, durable, portable, divisible, verifiable, storable, relatively fungible, salable and recognized across borders, and therefore has the properties of money.
It is digital and can be used for both in-person and online transactions, assuming both buyer and seller have the technology and are willing to use it.
is decentralized, meaning its existence and value are not tied to any agency, government, corporation, or bank. no third party can prevent you from transacting with someone, although they may make it more difficult or illegal.
can be divided into small fractions. you can send someone 0.08235179 bitcoins, for example.
It’s safe, as long as you protect your private key. bitcoin uses a standardized encryption level for which even the best supercomputers would take much longer than the current age of the universe to break. the core algorithm is quantum hard, which means that even the theoretical quantum computers of the future will not be able to break the blockchain and alter it. however, one day quantum computers will be able to find specific private keys, but there are possible solutions to defend against that, and the bitcoin protocol can be updated by consensus if necessary.
cannot be easily tracked or regulated. Although all transactions are on the public ledger, there are steps to distance the user from the transaction, making it difficult to track bitcoin transactions. however, increasingly sophisticated methods, combined with know-your-customer policies at major fiat-to-cryptocurrency entry points such as exchanges, have made tracking much easier over time.
You don’t need to trust organizations with your private data. To buy with a credit card, you have to provide your credit card information, and sometimes those databases get hacked. but to buy with bitcoins, you never have to give anyone your private key.
For these reasons, bitcoin and other cryptocurrencies share some characteristics with precious metals. they serve as an asset class that may not be partially correlated to other asset types, and are popular with people who don’t have much confidence in governments or the stability of the global economy and, of course, other people who just want speculate financially.
Unfortunately, this also makes cryptocurrencies perfectly suited to criminal activity. they are widely used for transactions related to drugs, money laundering and the dark web. (Editor’s note: This is no longer true as the asset class has matured.)
the difficulty of valuing cryptocurrencies
Most cryptocurrency buyers and sellers are speculating, meaning they are just looking at price charts and guessing what may go up or down with technical analysis.
Fundamental investing, on the other hand, uses a bottom-up approach to finding the inherent value of something. This is possible with anything that produces cash flows, such as companies or bonds, by using discounted cash flow analysis or similar valuation methods.
But when something doesn’t produce cash flows, like raw materials, it gets more complicated.
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In my article on precious metals, I described how there are numerous ways to determine an approximate value for gold and silver, even though they don’t produce cash.
You can, for example, consider how much money it takes to extract those metals from the ground per ounce, which has significant effects on the balance between supply and demand for them.
You can also compare the long-term (several decades) inflation-adjusted price of gold and silver to see how their purchasing power has changed over time.
Finally, you can compare them to other commodities, such as the gold-to-oil ratio.
There is no answer to knowing exactly how much a precious metal or other material is worth, but what those methods can give you is a reasonable range of where the price should be and helps you identify the specific assumptions you need to make for certain estimates. of valuation are correct.
And what makes all of these valuation methods remotely possible is that gold and silver have inherent scarcity; there is only so much that can be extracted economically. in fact, the entire volume of all the gold ever mined can fit into a cube less than 25 meters on a side.
Likewise, any individual cryptocurrency is scarce. for example:
- the bitcoin algorithm limits it to 21 million bitcoins in total.
- the bitcoin cash algorithm limits it to 21 million bitcoins in total
- the algorithm of litecoin limits it to 84 million litecoins in total.
- ripple’s algorithm limits it to 100 million ripples total.
- ethereum’s algorithm is flexible, which is a common criticism.
The problem is that while units of any individual cryptocurrency are in short supply, unlike precious metals, there is no shortage when it comes to the total number of all cryptocurrencies that can exist. Any programmer can create their own cryptocurrency, but the hard part is that it’s worthless until enough people recognize it, adopt it, and start trading it.
here is a list of all current cryptocurrencies. there are thousands of them!
In addition to stablecoins that are pegged to fiat currency, there are 3 cryptocurrencies that have a market capitalization of over $10 billion. bitcoin, ethereum and ripple are the three that are very much in the lead in terms of adoption. bitcoin in particular has two-thirds of the market share of the total cryptocurrency market capitalization, with all the other thousands of cryptos together equaling the other third.
When I originally wrote this article in 2017, bitcoin was worth approximately $6,500. it then went on to rise above $19,000 only to drop back below $4,000, and has since risen back to above $10,000 and then well below $10,000 again. (editor’s note: I no longer update these numbers here).
Cryptocurrencies will only be worth much money in the long run if they take off as a spending method or store of value and a handful of cryptocurrencies continue to account for the majority of market share, rather than all cryptocurrencies becoming too diluted. so far that is happening; bitcoin maintains its market share among the growing number of coins.
One of the ongoing debates has been what the ideal block size should be. small block sizes greatly slow down the network and make the coin unscalable, while large block sizes require larger data centers to process, meaning the coin network can become highly centralized, which is exactly what users don’t want to happen. Some solutions process transactions outside of the blockchain and then reconcile them to the blockchain, such as bundling multiple transactions into one large transaction. however, with the increasing use of bitcoin as a store of value rather than a medium of exchange, transaction time has become less important.
All that discussion about block sizes and off-chain scaling solutions, plus all the other features of certain coins, makes it hard to predict which coins will end up with a dominant market share. Which ones will best solve all the major problems and achieve the widest adoption?
These coins are volatile, their market share is fickle, and updates can lead to split coins, which has happened with both ethereum and bitcoin. however, historically, when this happens to these major networks, the original network holds the vast majority of market share.
how to determine the value of bitcoin and other cryptocurrencies
Now that we have established what cryptocurrencies are and why they are difficult to value, we can finally get into some methods to address how to determine their value.
remember, price is what you pay, value is what you get. a stock can be priced higher or lower than it is actually worth, and a cryptocurrency can too. what is a realistic bitcoin value?
There is no way to determine a precise inherent bitcoin value, but there are some detailed calculations that can give us a reasonable magnitude estimate for the value of bitcoins or other cryptocurrencies based on certain assumptions.
The trick, of course, is to make reasonable assumptions. 😉
method 1) quantity theory of money
(editor’s note: I no longer consider this to be particularly applicable to bitcoin because its use has shifted primarily to being a store of value rather than a medium of exchange, but back in 2017, it was one of my frameworks to look at when it was less clear that it would change in that direction. This approach values it primarily as a medium of exchange, which still makes it worth getting acquainted with).
The centuries-old equation for valuing money that anyone who has taken a macroeconomics class has learned is:
mv = dot
- m is the money supply
- v is the velocity of money in a given period of time
- p is the price level
- t is the volume of transactions in a given period of time
if you double an economy’s money supply, and v and t remain constant, then the price p of everything should theoretically double, and thus the value of each individual currency unit has been halved.
Most mainstream economists accept that the equation is valid in the long run, except that there is a lag between changes in supply or the velocity of money and the resulting price changes, meaning that there is no is necessarily true in the short run. . but the long term is what this article focuses on.
If you know three of the variables, you can solve for the last one. in other words, we can rearrange it into:
p = (m*v)/t
from that point, p will give us the inverse ratio of bitcoin to whatever currency we use for our variable t. in other words:
bitcoin value = 1/p = t/(m*v)
the total number of bitcoins in existence (m) is just under 19 million, and will peak at under 21 million in the next few years according to their algorithm. that’s the easy part.
Now we need to arrive at estimates for v and t, which is the hard part.
Let’s start with a speed example. Suppose you have a village of only two people, a farmer and a carpenter. the only money in town is that the carpenter has $50. If, over the course of the year, the carpenter buys $30 worth of carrots and $20 worth of tomatoes from the farmer, and then the farmer pays the same $50 to the carpenter to build a fence around his property to keep pests out, then a total of $100 in transaction volume (economic activity) has occurred. the money supply is $50 and the velocity of money is 2.
The velocity of the US m1 (highly liquid) money supply (shown here) peaked at over 10 in 2007 and is now around 4.
The velocity of the US (moderately liquid) m2 money supply (shown here) peaked at 2.2 in 1997 and is currently less than 1.5.
The speed of bitcoin is currently much higher on average, but the problem is that a large part of this speed is just trading volume, not spending volume. for a medium of exchange, the vast majority of volume comes from consumer spending, and only a small percentage of that volume is related to forex trading.
bitcoin, however, has a significant percentage that is only moved by speculators, rather than people going to their coffee shop and buying a cup of coffee with a few fractions of bitcoin. there is no way of knowing what percentage moves to spend compared to what percentage moves to trade/speculate.
but anyway, we have the actual speed, even if the number itself is questionable, and we have the typical speed range of a major fiat currency. When I value bitcoin, I’ll use a range for the velocity value to imagine a few different scenarios.
The final (and most difficult) part is t. this is the variable that represents the real value of goods traded in bitcoins per year.
Let’s start with criminal activity, since that was one of the original applications of bitcoin. (Editor’s note: This example became less and less relevant over time because as it became easier to trace, the use case for bitcoin for illegal activity diminished.)
pwc estimates global money laundering to be $1 to $2 trillion per year.
according to cnbc, the united nations estimates that the global drug trade is worth $400-$500 billion per year, and that organized crime in general is between $800-$900 billion, with much of that figure coming from of his drug trade.
More broadly, this research paper estimates that the global black market is equal to approximately 20% of world GDP, or about $15 trillion annually.
If we imagine right now that 10% of the global black market economic activity occurs in bitcoin and no one else uses bitcoin, that would mean $1.5 trillion worth of goods/services being exchanged per year, which would be huge.
going back to the equation bitcoin = t/(m*v) , if m is 17 million bitcoins in existence, and we use v as 10, and t is $1.5 trillion, then each bitcoin it should be worth around $8,800. let’s call it an unrealistic high-level estimate.
- if t is $500 billion and v is 10, then each bitcoin is worth less than $3,000.
- if t is $100 billion and v is 10, then each bitcoin is worth less than $600.
- if t is $10 billion and v is 10, then each bitcoin is worth less than $60.
I’m going to argue in my next section that bitcoin’s transaction volume is at the low end of that range. It’s nowhere near $1.5 trillion, and probably not even a tenth of that.
Now, black market activities are not the only use of bitcoin. A variety of companies accept bitcoin such as Microsoft, Overstock, Expedia, Newegg, plus other companies listed here. but it still seems more like a novelty at this point.
In addition to estimating the current value of bitcoins, we can estimate the future value of bitcoins.
suppose crypto really takes off and in ten years 10% of world gdp is traded in crypto, and half of that is bitcoin. With GDP growth of around 2% per year, global GDP in ten years will be approximately $90 trillion, which means $9 trillion in cryptocurrency transactions, including $4.5 trillion in bitcoin transactions per year.
if t is $4.5 trillion, m has 20 million bitcoins in existence by then, and v is 10, then due to the equation bitcoin = t/(m*v), each bitcoin should be worth $22,500 by then.
and here is a bearish scenario. If bitcoin’s market share drops to just 10% of cryptocurrency usage, and cryptocurrencies only account for 1% of gdp in ten years, and m is 20 million and v is 10, then each bitcoin will be worth about $450.
and I mean, it could drop to zero if its usage completely collapses for one reason or another, whether it’s because cryptocurrencies never gain ground or bitcoin loses market share to other cryptocurrencies.
here is a table i put together showing the value of each bitcoin in the future with a matrix of different speeds and global annual transaction volume figures in usd. velocity is on the horizontal axis and transaction volume is on the vertical axis, with money supply constant at around 20 million in the near future:
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As you can see, there is a wide range of what bitcoins should be worth in the next decade, depending on what economic activity they are eventually used for and what the speed of the coins is.
If you keep a speed of 5 or 10 and look at those columns, you can zero in on the level of economic activity you expect bitcoin to be used for in the next decade, which will give you a rough idea of what it might be worth in that moment.
method 2) national currency comparisons
(editor’s note: this is a second medium of exchange calculation worth knowing about, but no longer a key way to think about cryptocurrency valuation in my opinion).
Now, let’s make it a bit simpler by not worrying about currency velocity. let’s compare cryptocurrency adoption versus fiat currencies as a rough order of magnitude sanity check.
trading economics has a list of the size of the m2 money supply of each country, converted to usd. The United States has more than 18 billion dollars.
Right now, bitcoin is worth between $250 and $400 billion. That puts it in the ballpark of countries ranging from Israel to Malaysia in terms of ample money supply.
This graph gives an idea of the active user base of bitcoin, as the ledger is public. there are around 10 million accounts (addresses) with more than $100 usd in bitcoins and less than 1.5 million with more than $10,000 usd in bitcoins. and users can have multiple accounts, so the total number of active users with significant amounts of money is probably in the low millions. for reference, the bitcoin subreddit has about 1.8 million subscribers.
and then we return to the question of how much economic activity (the equivalent of gdp) actually occurs in bitcoin from this million or so active users. How much of the $400+ billion annual global drug trafficking market uses bitcoin? or how much of the $15 trillion global black market? how much legal economic activity is happening in bitcoins? it’s hard to say.
Considering that there are fewer active bitcoin users than Israeli citizens, the average Israeli citizen is doing pretty well, and most bitcoin users probably only do a small portion of their economic activity in bitcoin, if any. Somehow, there is not as much economic activity in bitcoin as israel’s gdp.
but it could be a tenth, which means the value of all bitcoins together could be a tenth of israel’s money supply. that implies that bitcoin is very overvalued at the moment.
If 500,000 people average $10,000 in bitcoin economic activity per year (no trading, just actual spending), that would be only $5 billion in actual bitcoin economic activity. that’s a tiny fraction of israel’s nearly $400 billion economy, and the total value of bitcoin would be a tiny fraction of israel’s money supply (hence only worth a few billion dollars), which Which means every bitcoin should be worth like a hundred dollars and it’s currently way overvalued in tulip country.
However, one argument as to why bitcoin is worth more now than it should be based on its estimated current economic activity is that some people expect its adoption rate to increase rapidly.
Suppose, for example, that 10 years from now, bitcoin overtakes the Canadian dollar in terms of economic activity to become one of the world’s top ten currencies. Canada has 38 million inhabitants and a GDP of 1.8 trillion dollars and its m2 money supply is worth more than 1.5 trillion dollars.
If there are 8 billion people in the world in ten years, and 5% of them use bitcoin, that will be 400 million bitcoin users. if the average bitcoin user does only 10% of their economic activity in bitcoin and 90% of their economic activity in typical currencies, then that is the equivalent of 40 million people using bitcoin for 100% of their economic activity , or roughly the size of the Canadian economy assuming similar average per capita economic activity.
if bitcoin’s reasonable market capitalization reaches a value of, say, $1.5 trillion in that scenario (comparable to canada’s m2 money supply), and 20 million bitcoins exist by then, each bitcoin would be worth $75,000. that is a bullish scenario, but not an impossible one. explains why some people are willing to pay several thousand dollars for bitcoin today.
method 3) pure reserve of value: percentage of net worth
(editor’s note: for bitcoin in particular, this type of model is one that I still find more valuable at this point).
Finally, let’s compare the value of bitcoin to the value of gold.
As the years go by, cryptocurrency adoption and payment rates do not increase much. not many companies accept them and most people don’t seem to mind paying with them. the use of bitcoin in particular has become more of a store of value and a network that allows users to transmit value, rather than being an everyday medium of exchange.
Similarly, people buy gold not because they want to spend with it, but because they know it has permanent storage value because of its utility. So let’s assume that bitcoin has changed to that state, and that it never takes off as a real form of payment, but only serves as a store of value for some people. since satoshi released blockchain technology for all, bitcoin does not have a sole claim on the underlying technology. instead, it simply relies on network effects as the prime mover in the cryptocurrency space, and money tends to be a “winner takes all” game.
the world has about 400 trillion dollars in wealth if you translate to us. uu. dollars this consists primarily of stocks, bonds, real estate, business capital and cash.
All the gold in the world is worth about $10 trillion, according to the world gold council’s estimate of how much gold has been mined and what the price per ounce is. in other words, maybe 2-3% of the global net worth consists of gold.
This is one way that analysts speculate on potential gold price movements in a fundamental sense: they ask what if more people want to own gold in their net worth, due to various factors, such as depreciation of the currency. In other words, if people all over the world are freaking out about something and want to put 4-6% of their net worth into gold instead of 2-3%, and the amount of gold is relatively fixed, it means that the price per ounce it would double. .
If the total market capitalization of bitcoin reaches half the global value of gold ($5 trillion, or about 1-2% of the global net worth) and the number of bitcoins at that time is 20 million, so each bitcoin would be worth $250,000
if bitcoin is only worth 10% of the global value of gold (well below 1% of the global net worth), then each bitcoin would be worth around $50,000
If bitcoin only makes up 5% of the global value of gold, then each bitcoin would cost $25,000.
if bitcoin collectively is only worth 1-2% gold, then each is reduced to $5,000 to $10,000.
stock to flow
(editor’s note: I added this section in 2019 or so and didn’t update it).
Each commodity has a stock-to-flow ratio, which is a measure of how much is mined or produced per year compared to how much is stored.
Agricultural commodities, oil, copper, iron, and other industrial commodities generally have stock-to-flow ratios of less than 1x, meaning that the amount of them being stored is equal to less than the value of one year production. most of them rot or rust, or are very large relative to their price and therefore expensive to store. therefore, people produce as much as they need in the near future, with a little storage for months or, at most, one or two years.
Silver, being somewhat more of a monetary metal and therefore stored as coins, bullion and silverware, has a stock-to-flow ratio of more than 20x. this means that people collectively have more than twenty ounces of annual silver production stored around the world.
Gold, being primarily a monetary metal, has a stock-to-flow ratio of 50-60x, meaning there is 50-60 years worth of production stored in vaults and elsewhere around the world.
When bitcoin started in 2009, it had a low stock-to-flow ratio, but as more coins emerged, while the number of new coins produced every 10 minutes decreased due to its three pre-scheduled halving events, its Stock-to-flow ratio has continued to rise and is now roughly equal to that of gold. specifically, there are over 18 million bitcoins already created and about 300,000 new ones created per year, so the stock-flow ratio is 50-60. in four more years, when the next halving occurs, that will increase even more significantly, as the rate of production of new bitcoins continues to decline.
planb has come up with a stock-to-flow model that, as a backtest, does a solid job of categorizing and explaining bitcoin’s price rise from inception by comparing it to its increasing stock-to-flow ratio over time. . the line is the model and the red dots are the price of bitcoin over time. note that the graph is exponential.
chart source: planb
The model predicts a six-figure price in the next few years. Frankly, I have no idea if that will happen, but it is true that bitcoin’s stock-to-flow ratio continues to increase over time, and the supply of new coins entering the market is declining and ultimately limited.
With this model, after each halving event every four years (where the number of new bitcoins created every 10 minutes decreases by half), the price of bitcoin eventually skyrockets, reaches a period of euphoria and then it drops back down to a choppy lateral level. each of those lateral levels is a plateau that is well above the previous one. the recent level has been fluctuating around the $5,000-$15,000 region, and is now going to the next level, according to that method of analysis.
(editor’s note: these no longer capture my current thoughts on the asset class).
personally, I prefer precious metals to cryptocurrencies when it comes to alternative investments.
They have thousands of years of reliable history, and every precious metal has inherent scarcity and utility. they are all chemically unique, especially gold, and there is a very small amount of precious metals.
Cryptocurrencies, on the other hand, while each has scarcity, are infinite in terms of the total number of cryptocurrencies that can be created. In other words, there is a finite number of bitcoins, a finite number of litecoins, and a finite growth rate of ether, etc., but anyone can create a new cryptocurrency.
what this means is that even if cryptocurrencies become popular in use, they could be so diluted by the sheer number of cryptocurrencies that any given cryptocurrency only has a small market share and therefore not much value per unit. that makes it difficult to determine a realistic value of bitcoin or the value of other cryptocurrencies.
Right now, bitcoin, ethereum and a few other systems have most of the market share. if cryptocurrencies take off in spending usage around the world, and a small number of cryptocurrencies continue to account for the majority of cryptocurrency market share, then the major cryptocurrencies are likely to remain valuable, especially if you hold all the currencies when hard forks (currency splits).
Blockchain is an extremely useful technology, and cryptocurrencies based on blockchain technology have many reputable applications as a global medium of exchange.
The engineering approach to problem solving is to break a difficult problem into several small parts and then solve them individually, or realize that certain parts are unsolvable and identify what assumptions need to be made. The benefit of this article is that it quantitatively shows what assumptions are necessary to justify various cryptocurrency valuations.
This is what it takes to arrive at a reasonable forward valuation estimate for a given cryptocurrency:
- Understand the numbers and growth rates of how many units can exist in that cryptocurrency. that’s easy.
- estimate how much economic activity or storage of value will occur in the total blockchain cryptocurrencies in 5-10 years. that’s hard.
- estimate how a given cryptocurrency will change or retain market share of total cryptocurrency usage. that’s hard.
Basically, it takes a lot of assumptions to determine anything close to an inherent value for units of any given cryptocurrency. I don’t know to what extent cryptocurrencies will be used to spend in the next 5 or 10 years. and I don’t know which cryptocurrencies will have the dominant market share over time, or if they will all be diluted.
But I recognize the larger cryptocurrencies as a respectable (albeit extremely risky) alternative asset class at the moment, and it may be worth having a very small portion of a portfolio allocated to a basket of them.
Based on the estimated number of current users and current spending activity (inferred from the number of known addresses, volume data, etc.) applying the quantity theory of money, bitcoin appears to be highly overvalued. bitcoin’s market capitalization is in the same ballpark as singapore’s m1 money supply, although it has far fewer active users and probably far less economic activity per user.
but considering where this technology could go in the next decade and the prices that bitcoins could reach if there are certain bullish results, I also don’t consider it a tulipomania for those who really believe that this could become a world currency important. at least I can see a rationale there and the more optimistic numbers support his thesis.
bitcoin values can rise a lot, or they can fall to nothing, and it mostly comes down to how much and how fast bitcoin or any of these cryptocurrencies can achieve widespread spending use, if any of them ever do. does.
At this point, there is already a lot of optimism backed up; bitcoins and other major cryptocurrencies are extremely expensive compared to their estimated current usage. investors are assuming they will achieve widespread adoption and are paying accordingly. that means investors should exercise extreme caution.
(Editor’s note: Check out my digital asset library for the latest ideas. I also have a resources page with recommended books and services.)
See also: VALUE PICK FROM INDIAN STOCK MARKETS