Whenever I talk to someone not involved in this space, the first thing I hear is that Bitcoin has no intrinsic value.
The following question is what is one Bitcoin even worth.
Valuation Models
Over the last few years, multiple models have popped up to explain what is driving the price. I’m going to go through these models and at the end will explain my overarching hypothesis.
Stock to Flow
The Stock to Flow or S2F model was first presented in the book, The Bitcoin Standard and further elaborated on by a data scientist, 100TrillionUSD. The model claims price is a function of the new supply of Bitcoin which drops every four years during the halving. The most recent model claims an r-squared of 99.7% and a market peak of $288,000 per Bitcoin.
Bitcoin Energy Equivalence
The Bitcoin Energy Equivalence formula posits that the intrinsic value of Bitcoin can be determined by the energy spent to produce it. It maybe be a superior model than S2F because it’s mathematically independent of Bitcoin’s trading price and volume. It’s r-squared is similarly high at 80% and suggests there’s a floor to Bitcoin’s price.
Never Loop Back Price
The Never Loop Back Price or NLB is essentially an extrapolation of current price action more akin to adoption s-curves.
As the author puts it:
“The NLB price is the last time bitcoin was at a particular price level. Once it reached that price, it only proceeded up, it never retraced to that value again”.
Overvalued / Undervalued
There are a number of ratios and figures you can use to determine if the market is undervalued or overvalued in relative terms.
VWAP or Realized Cap
VWAP (volume weighted average price) and realized cap both attempted to value all the coins in circulation at the price they last moved.
Consider it a proxy for what people paid for their tokens.
Extending this, we can divide it by the price & market cap respectively to determine overextended markets. From the graph below, you can see both oscillate around 1 - marking periods of undervaluation and overvaluation.
NVT Ratio
This ratio measures the Network Value to Transaction Value. The underlying assumption is that when the network value exceeds the transaction value by too much - speculation is driving the market.
Intuitively this makes sense as Bitcoin is a medium to exchange value and this fundamental value proposition provides a floor for the market. Green bands represent periods of undervaluation and red bands the opposite.
Mayer Multiple
The Mayer Multiple is named after Trace Mayer and is a ratio of the current price to the 200 day moving average of Bitcoin. Historically, the average multiple has been 1.37 and best long term results have been achieved by accumulating Bitcoin below a Mayer Multiple of 2.4.
Bitcoin Difficulty Ribbon
Difficulty ribbons are a Bitcoin mining driven hypothesis where when network difficulty squeezes out smaller miners who have to turn off their machines leaving only strong miners with margin remaining.
Theoretically, this reduces selling pressure in the market as less Bitcoins are being sold to cover expenses. The best time to buy historically has been when ribbons compress initiating the margin compression.
My Thoughts
All these metrics to me track the same concept - adoption.
The supply side models like Stock to Flow or Bitcoin Energy Equivalence just overlay that with the Bitcoin halving and miners who fundamentally alter the available new supply thereby compressing it against a steadily increasing demand and adoption of the underlying network.
This network effect is enshrined in Metcalfe’s Law which states:
A network’s impact is the square of the number of nodes in the network. For example, if a network has 10 nodes, its inherent value is 100 (10 * 10).
We see this in the stock market with public internet companies like the FAANG stocks. FundStrat did a study and found that 70% of the returns for investors could be explained just by the growth of the internet alone.
Empirically, you know this as well - when one family member had iMessage, you could leave the ecosystem but when everyone had iMessage or Facebook or Instagram, it became really hard to leave but also become significantly more valuable to all.
I would extend this rule to any other crypto network wherein it captures an entrenched audience, transaction volumes pick up and a community of developers and users forms around it.
In the coming weeks, I’ll present some of my picks so subscribe to this newsletter if you haven’t yet. Click the link below to subscribe.
Common Questions
Will Bitcoin ever be used as money?
Not on-chain. Transaction fees will only go up as the community doesn’t want to increase the block size. However, side chains are popping up that consolidate transactions and could make individual transactions cheap enough for daily use.
Is Bitcoin too volatile to be money?
Now, yes. In the future, maybe not. From the chart below, you can see volatility in the price has been going down since inception. Like a motorcycle moving at high speed, Bitcoin becomes more stable the faster and larger it becomes. All monetary assets including Gold and the Dollar experienced this same effect early in their history.
Around the Space
a16z raises $515M for 2nd crypto fund
Andreessen Horowitz recently announced their second crypto fund. Obviously, they are incredibly bullish on the space having significant investments including Coinbase, DyDx, Maker, Orchid and OpenBazaar.
Peer to peer credit pools coming to Ethereum
Union Finance is a new platform that will allow you to lend to friends and family. Talk about disaster. Just kidding. Without a decentralized ID or credit rating system this may be a good way to protect privacy while creating a market for much needed credit.
DeFi usage numbers and forecasted trend
DeFi only really kicked off last year but it has exploded. Forecasts made in the report suggest at our current growth rate of 0.56% per day we’ll onboard one million by 2021 and 10 million by 2022.
Grayscale bought 48% of all ETH mined in 2020
Grayscale investment trust scooped up 756,000 ETH or 48% of all new ETH mined this year. This indicates investors are piling into Ethereum while 77% of supply hasn’t moved in 6 months. 🚀
Trustless fund allows anyone to time lock their money
Want to store crypto for your children? Pop it into the Trustless Fund which allows you to lock it into a contract and release it to a beneficiary on a set date. This could be great for wills or just HODLing.
Create unstoppable requests with ErasureBay
Want to see someone dig sand out of the Venice Beach skate park? The request was made on ErasureBay and someone collected $619 for their efforts. Crowdsourced requests that no one can stop.
Recursive rollups could scale complete privacy on-chain
Aztec’s goal is to create a global network of P2P private programmable payments and are one step closer with recursive roll-ups. Privacy is a fundamental right and will come to the currency space.
If you read this far and are as excited as I am about all the stuff being built please share it with someone who should get their feet wet in this space.
Disclaimer: Statements on this site do not represent the views or policies of anyone other than myself. The information on this site is provided for discussion purposes only, and are not investing recommendations. Under no circumstances does this information represent a recommendation to buy or sell securities.