introduction
Before we delve into the duty of valuing Bitcoin, we must first acknowledge that this isn’t any strange undertaking. Unlike traditional assets like stocks and bonds, Bitcoin lacks the standard characteristics required by traditional valuation methods. It doesn’t generate money flows, pay dividends or otherwise provide returns and subsequently could also be more harking back to commodities, that are each cyclical in nature and notoriously difficult to value. Nevertheless, there are quite a lot of useful frameworks for viewing this development in money and finance.
1. Compare it with the alternatives
One option to assess the worth of Bitcoin is to find out which asset classes or securities it competes with and compare their potential value.
So to expand on our commodity metaphor: Where does Bitcoin – the so-called digital gold – stand in relation to real gold? Both are fixed-term, counterparty-free assets with rare and desirable monetary properties which are utilized by investors as long-term secure havens for capital preservation. Today, gold has a market capitalization of around $11.5 trillion.
If Bitcoin reached an identical market cap, the value per coin would exceed $500,000.
Bitcoin Rating: Comparing the Alternatives
Sources: Glassnode, World Gold Council, Trading Economics, Savills, Visual Capitalist and Sound Money
Of course, Bitcoin has a technological edge over gold. It is digital, decentralized and free from government influence. So when the market cap reaches $11.5 trillion, why should it stop there? And is gold its only competition? Couldn’t Bitcoin replace other financial securities and stores of value reminiscent of global bonds and even home ownership?
Of course, definitive answers to those questions are difficult to search out, but looking for them can improve our understanding of Bitcoin, Bitcoin valuation, and the crypto phenomenon usually.
2. Be based on production costs
We consistently hear in regards to the electricity and equipment required for Bitcoin mining. These associated costs represent one other option to determine the worth of the cryptocurrency. While estimates of those costs vary widely and are inevitably inaccurate, Researchers on the University of Cambridge have compiled among the most reliable data.
Bitcoin production costs
Source: Capriole Investments. Created with Data Wrapper
Of course, Bitcoin is a store of value and another currency technology. But few users set Bitcoin pricing based on the latter quality. For this reason, Bitcoin’s production costs serve an identical purpose to gold: they set a price floor that will help determine whether the underlying asset is undervalued. Historically, Bitcoin price has tended to bottom around its production costs, reminiscent of within the second half of 2016, the primary half of 2019, March 2020, and the second half of 2022.
Because they assist determine whether Bitcoin is undervalued, production costs are a vital consider valuation. However, because they’ve little ability to quantify the upside price potential related to Bitcoin’s currency premium, also they are a limited input.
3. Look on the US dollar
So how can we evaluate Bitcoin’s monetary premium? As another currency technology, Bitcoin have to be evaluated within the context of the dominant monetary system: the US dollar. Real rates of interest, money supply growth and financial policy, amongst other things, influence the valuation of Bitcoin.
Higher real rates of interest and limited money supply growth are indicators of sound monetary and financial policy. They help gauge whether authorities are protecting the worth of the dollar. Such aspects should counteract Bitcoin prices. If policymakers care in regards to the existing monetary system, investors are less prone to search for another.
When valuing Bitcoin, the prudence of dollar policy is significant
Sources: Glassnode, Google Finance and Sound Money
Of course, monetary policymakers often take wasteful actions that reduce the worth of the dollar. Quantitative easing (QE) and other monetary stimulus during the last 15 years resulted in low and negative real rates of interest and rapid money supply growth. These were ideal conditions for Bitcoin and fueled the crypto boom.
Under tighter macroeconomic conditions, Bitcoin is less invaluable. It is more invaluable in loose conditions.
4. Measure the conviction of Bitcoin holders
Using a more behavioral approach, we may assess the underlying belief of long-term and short-term Bitcoin holders to supply clues about Bitcoin’s value. The proportion of long-term holders tends to extend in bear markets and reduce in bull markets.
Long-term Bitcoin holder percentages suggest under/overvaluation
Sources: Glassnode and Sound Money
This suggests that Bitcoin is overvalued when short-term speculators hold a bigger portion of the availability and undervalued when long-term investors predominate.
Those accustomed to discounted money flows, price-to-earnings ratios, and other traditional metrics may find Bitcoin’s valuation methods unconventional. But whether unconventional or not, they provide a option to move forward. Results may vary, but that is no surprise in terms of latest and potentially transformative technologies.
Bitcoin’s many critics may thoroughly be right. Bitcoin and cryptocurrencies usually could all fail and have essentially zero intrinsic value. But crypto advocates is also on to something in the event that they expect Bitcoin to develop into a world reserve asset.
Few assets have ever provoked such diverse opinions. As the financial industry delves deeper into the query of crypto valuation, we must always do not forget that it has at all times been difficult to value the printing press, the steam engine, the Internet and other revolutionary technologies, especially of their early stages. But these innovations ended up changing the world in ways people couldn’t have initially imagined. Crypto can do the identical. Or perhaps not. We’ll just should see.
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