💰Bitcoin Part 1: How Can We Value It?
This is part one of my two part series on Bitcoin covering the basics of how to value this crypto asset. Next week in part two I will show you how I crunch the figures to reach a rough valuation and future potential price. (Disclaimer: This is not financial advice, please always do your own research).
💵 How can we value it?
Bitcoin is a huge topic. It touches on a number of areas including blockchain technology, macroeconomics, game theory and geopolitics to name a few. The goal of this report is to provide an introduction to Bitcoin as an investment.
Before we can decide whether it is over-valued, under-valued, or over-hyped, we need to understand the criteria for how to value it. In theory this framework can be applied to other crypto assets as well:
Transaction Value
Bitcoin is obviously not a company so it does not have earnings or revenue. Instead analysts look at both the volume and value of transactions on the network as key metrics.
Bitcoin’s main value proposition is its ability to to transfer money (value) without the need of third party such as a bank or credit card company. The basic logic is that the more transactions flow through the Bitcoin network, the more valuable the network is as a whole.
User Adoption
Closely related to transaction volume, analysts also track user growth and usage. This includes the number of new users buying the asset, how many are setting up new wallets, and how often they are transacting.
Hash Rate
Hash rate is a technical term which simply measures the combined processing power of all the mining computers connected to the Bitcoin network. In a proof of work system like Bitcoin this is important to guarantee its security and protect against a 51% attack.
Network Value to Transactions Ratio (NVT)
NVT is often referred to as the price-to-earnings (PE) ratio of crypto.
As Willy Woo, the inventor of the term puts it: “NVT is calculated by dividing the Network Value (market cap) by the daily dollar volume transmitted through the blockchain”.
When the NVT figure is low, it means Bitcoin is potentially under-valued i.e. there are a high level of transactions being processed relative to how investors are pricing the asset.
When NVT is high, the reverse is true: this indicates that the price of Bitcoin is potentially over-heated and it is not keeping pace with the relatively lower number of transactions on the network.
Since the NVT ratio was introduced in 2017, a few more complex alternatives have been added. If you want to go deeper, check out: MVRV and MVRV-Z.
📱 Product → Utility
Again, Bitcoin is obviously not a conventional business with products and services. Instead we must analyse the more abstract concept of utility in order to arrive at a valuation. Bitcoin has two main forms of utility:
Medium of Exchange
The primary purpose of Bitcoin as outlined in the founding white paper was to be a “purely peer-to-peer version of electronic cash”. In other words, Bitcoin would act like a digital form of physical cash by enabling transactions to take place directly between two people without the interference or high commissions of a third party.
In September 2021, El Salvador became the first nation-state to accept Bitcoin as legal tender. A major part of the country’s motivation was to reduce the cost of cross-border remittance payments for its citizens.
Store of Value
Bitcoin is also often referred to as “digital gold”. While new Bitcoin units are being created or “minted” every day, the total supply is capped at a maximum of 21 million coins. This rule is embedded in the core programming logic of Bitcoin and cannot be changed. Some investors see Bitcoin as a way to hedge against inflation and protect wealth in the face of high levels of government money-printing and historically low interest rates.
In a recent episode of the What Bitcoin Did podcast, Lyn Alden an independent analyst described the similarities between the store of value properties of Bitcoin and gold. Physical gold mining constraints mean that over the past century only 2 percent of new gold supply is “created” every year. She explains that even if a central authority wanted to, it is almost impossible to change this rate of gold supply.
Bitcoin is similar because there are hard limits defined in code which prevent any central entity from changing the monetary policy or supply schedule of the currency. Bitcoin is also superior to gold in a number of respects. It is far cheaper and easier to transfer and store for example.
In previous years smaller entities such retail individuals, hedge funds or family offices were the main investors in Bitcoin as a store of value. But since the corona crisis in 2020, this has begun to change.
The most notable example of this shift is MicroStrategy, a major publicly listed software firm which currently has122,478 Bitcoins on its balance sheet. This is worth about $5.3 billion at the time of writing. Tesla is of course another high-profile corporate name which invested in Bitcoin recently but subsequently retreated from the move, ostensibly due to environmental concerns.
👨 👩 Leadership
Little is know about Satoshi Nakamoto, the pseudonymous founder of Bitcoin, or whether Satoshi is in fact one person or a team of people. If Satoshi is indeed one person, it is clear he has little interest in money or the spotlight. Satoshi left his final message on an online Bitcoin forum in December 2010 and has not been heard from since.
Recent research by cryptocurrency experts shows that Satoshi also accumulated a Bitcoin fortune worth roughly $10 billion at today’s prices. The virtual wallets containing these funds have been left dormant since late 2010.
I hope you found this introduction to Bitcoin useful! As mentioned above, in part two next week I will apply this valuation framework to the current market cap and price figures to reach a rough valuation and future potential price.
What did I miss? - These reports are a learning process for me and I’m very open to constructive feedback and suggestions.
What stock or crypto asset should I cover next? You can contact me by email: hellorobostox@gmail.com or feel free to leave your response in the comments below. You can also follow me on Twitter: @daneasterman.
Disclaimer: I am not a financial advisor, none of this report should be taken as financial advice. Instead this should be viewed as starting point to conduct your own research. I have been long Bitcoin since spring 2018.