Bitcoin is free peoples’ money. Bitcoin provides financial sovereignty. Bitcoin is also very volatile, yet has been the best performing asset globally over the past 10-years if you held on for the long term that is. So how does someone figure out how to value Bitcoin?
Since Bitcoin is an asset like no other, the world is still developing a method on how to value Bitcoin, but no one has come up with a tried and tested method, partly because Bitcoin hasn’t been around long enough. Bitcoin does not produce cash flow, nor does it have income statements, balance sheets of assets and liabilities or corporate reports. So it cannot be valued like traditional stocks or bonds. It also only exists online and has no physical form, so it cannot be valued the same way that precious metals are valued.
In this post, I take a brief look at possible ways on how to value Bitcoin.
How To Value Bitcoin
I have broken down the valuation process into two broad categories. The first is more quantifiable and mentally tangible. The second category is more qualitative/soft aspects.
Keep in mind that Bitcoin and especially other cryptocurrencies are very young and volatile and that they are all highly speculative investments for the time being.
Quantitative Markers For How To Value Bitcoin
- Stock to Flow Ratio
- Bitcoin Difficulty Riboon – Hashrate & Cost of Mining
- Adoption Rate
- Movement of Bitcoin (HODL rate)
- True Trading Volume
- Mayer Multiple
- Bitcoin Technical Analysis
- Quantitative Sentiment: Fear & Greed Index
Stock to Flow Ratio
The stock to flow ratio refers to the current existing supply of Bitcoin relative to the annual new supply of Bitcoin produced via mining. The number is expressed as (Current Supply)/(annual new production). This is a fraction that tells us how many years it would take at the current mining rate to replace the entire existing supply.
If there is a low stock to flow ratio it means that there is a large rate of new production compared to the existing amount. This is less valuable because it means the asset is less rare since it can be replaced in a short time frame.
If there is a high stock to flow ratio it means that it takes a slower rate of new production compared to the existing amount. This is more valuable because it means that the asset is rarer since it takes longer to replace the current amount.
Stock to flow can also be expressed as a percent for growth rate: (new supply)/(current supply).
Bitcoin’s approximate current stock to flow ratio is 27. This means it would take 27 years of mining Bitcoin at a rate of 12.5/10min to replace the current supply of ~17,839,825. Gold’s stock to flow ratio is 62, and the gold market cap is ~$8 Trillion USD. Bitcoin’s stock to flow ratio after the 2020 halvening will be approximately 56, and in 2025 Bitcoin’s stock to flow will be ~ 121.
So, as the stock to flow ratio increases, the value of the asset increases because it is a marker of scarcity.
Bitcoin Difficulty Ribbon – Hashrate & Cost of Mining
The Bitcoin Difficult Ribbon is a correlative pattern between the price of Bitcoin and the mining difficulty. When the Ribbon compresses or flips negative, then it is generally regarded as a buying opportunity (not financial advice, you must assess your own financial situation to determine whether or not to purchase a speculative asset).
“The Ribbon” is a series of lines on the graph that represent various moving averages of the Bitcoin mining difficulty. It is plotted alongside the $BTC price in the graph below.
As you know, Bitcoin is mined with a proof of work protocol. The cost of mining refers primarily to the cost of electricity required to mine a block for a miner. However, there are obviously other costs, such as the costs of the mining hardware and associated equipment, staff, rent/mortgage of the mining facility, etc.
The difficulty of mining a block is referred to as the hashrate. The higher the hashrate, the more computation needed for the block, meaning the more energy required to mine the block.
The Bitcoin protocol adjusts the mining difficulty so that a new block is produced approximately every 10 minutes. So if there are more miners/computational power on the network, the difficulty increases proportionately so blocks are not mined faster, thereby increasing the cost of mining.
Inefficient miners have higher costs and must sell more Bitcoin to remain profitable/break-even. As either the difficulty increases and/or the $BTC price drops these inefficient miners increase selling pressure (further dropping the price), or shut down their mining operations.
Once inefficient miners capitulate you witness a compression of the difficulty ribbon, since difficulty drops (fewer miners on the network). This typically occurs at the end of bear cycles since the price has dropped near the bottom and inefficient miners can no longer sustain themselves and go offline. This is when you see the ribbons compress.
Then the selling pressure decreases and the prices start to rise. Again, the observed best time to buy Bitcoin is during these difficulty ribbon compressions or negative flips. Again, not financial advice.
Adoption rate is a tough aspect to evaluate, and it refers to the growing user base as well as actual uses and integration of Bitcoin into the world.
Some things that we can look at for adoption rate include:
- The number of wallets/addresses
- Daily transactions
- The number of developers working on Bitcoin directly or for applications on top of Bitcoin.
- The number of Lightning Network nodes
- The number of companies developing tech in the blockchain/Bitcoin or cryptocurrency arena.
Movement of Bitcoin (HODL Rate/Wave)
A peculiar thing about Bitcoin is that it is the first asset class in human history to have an immutable ledger that has a time-stamped record of each Bitcoin from when it was last moved (from one wallet to another).
This means that statisticians can analyze the Bitcoin blockchain and create trends/graphs that illustrate how long Bitcoins are HODLed (aka not moved). To HODL your Bitcoin means that you think it is valuable. When there are greater movements of Bitcoin it is interpreted as many people selling and indicates that perhaps the masses are taking profits, or that Bitcoin might be overpriced.
As you know, to HODL means to hold your bitcoin (or another cryptocurrency) for a long time. Unchained Capital developed the HODL Wave (or HODL rate) that illustrates how long Bitcoins have been held in the same wallet, in macro terms.
The graph below breaks down time frames into <1 day, 1d-1w, 1w-1m, 1-3m, 3-6m, 6-12m, 12-18m, 18-24m, 2-3y, 3-5y, >5y. It is speculated that the >5 years since moved Bitcoin is likely the 1 million BTC in Satoshi’s wallet as well as some of the 3-4 million lost Bitcoin.
The HODL wave used alone is not a good indicator of the value of a Bitcoin nor as an indicator to buy or sell. But it is a piece of the puzzle that gives a little more objective data.
True Trading Volume
True trading volume, which does not include wash trading, as was unveiled with the fake bitcoin trading. This is different than the number of transactions per day since on exchange trades are not necessarily settled on the blockchain (unless it is a DEX).
The greater the trading volume indicates a greater interest in Bitcoin. The forex trading volume of fiat currencies worldwide is in the trillions of dollars, and Bitcoin’s in mid-2019 is in the low billions ($2-$3 billion/day).
The Mayer Multiple was developed by Trace Mayer and is an equation that relates Bitcoin’s current price to it’s 200-day moving average. It indicates whether Bitcoin appears to be overbought or oversold based on longer time frames (200 days).
The lower the Mayer Multiple the higher the probability that the price of BTC will increase, indicating that Bitcoin might be oversold. This is not a rule written in stone, no one can predict what the markets will do, especially in the short term.
The average Mayer Multiple for the history of Bitcoin is 1.47.
Mayer Multiple = ($BTC today) / ($BTC 200-day moving average)
Today the Mayer Multiple is ($9,470 / $6,313) = 1.5
** Keep in mind this changes daily, check for daily Mayer Multiple updates here. **
Bitcoin Technical Analysis
There are a lot of people out there in the investing world who like to use Technical Analysis, and I’m sure that there is some truth and utility to it. However, I myself have not taken the time to learn technical analysis nor do I spend much time looking at it. Therefore, it would be irresponsible of me to really discuss it here. I should note that the Mayer Multiple (described above) is a form of technical analysis, however, I understand that analysis.
I believe that short-term technical analysis is vulnerable to much more error owing to the unpredictability of most markets and especially of Bitcoin, especially with bitcoin whale manipulation.
I think that longer-term technical analysis can have a lot more credibility and accuracy. Consider for example the logarithmic nature of Bitcoin’s price over its lifetime, with respect to hashrate/mining difficulty and stock-to-flow data, time to next halvening event (closely related to Stock to Flow)… those charts have been quite accurate.
The Twitter User PlanB (@100tillionUSD) posts some excellent charts on long term technical analysis of Bitcoin relating the above mentioned characteristics (halvening time, stock to flow, miner difficulty, etc).
Quantitative Sentiment: Fear and Greed Index
“Sentiment” is not typically considered a quantitative indicator. In this regard what I am really referring to is the statistical indicators of sentiment trends. There are a handful of indicators that can help assign value to sentiment, these include things such as Google Trends, Twitter Discussion, changes in daily volume or volatility, and more. Thankfully there is a tool out there that was developed specifically to make sense of these otherwise unobjective factors.
The Fear and Greed Index is a meter that was developed by the website creators of alternative.me. It takes into account a number of various otherwise unquantifiable data and presents it in a simple single number representation.
It uses algorithms to gather data from:
- Volatility (25%) – a sudden increase in volatility may indicate more fear. Compared with the last 30 & 90 days.
- Market Momentum/Volume (25%) – high buying volumes is usually a bullish sign. Compared with previous over the last 30 and 90 day averages.
- Social Media (15%) – analyses keywords from Twitter to discern bullish and bearish attitudes. They are working on a reddit algorithm as well.
- Surveys (15%) – directly asking visitors their feelings on the crypto markets, updated weekly. Roughly 2000 – 3000 participants in these surveys.
- Trends (10%) – analysing different keyword trends, not just “bitcoin” but also “bitcoin price manipulation” (bearish keyword).
A live Fear and Greed Index is posted below.
While I do NOT give financial advice, the general idea is that the more fearful the index (lower number) can indicate that investors are over-selling Bitcoin, indicating a possible time to buy. Conversely, the higher the number in the Fear & Greed Index may indicate a time that Bitcoin is overbought and might be good to sell, or at least, not to buy.
While these indicators are not standalone reasons to buy or sell Bitcoin or any other cryptocurrency, it gives you a quantitative idea of the public’s interest in these topics.
Qualitative Markers For How To Value Bitcoin
By the very nature of qualitative markers for Bitcoin, they are difficult to accurately rate and determine how much any factor or collection of factors might affect the Bitcoin price.
- Bitcoin Utility
- Industry Development
- Institutional Investment and Endorsement
- Government Regulations and Endorsement
- Cryptographic Trust
This is a hugely broad topic and a point of contention for many people in Bitcoin, other cryptocurrencies and people from the legacy financial institution. Anti-Bitcoiners will attack Bitcoin as having minimal utility with slow block times, high network fees and minimal transactions per day, with little merchant adoption. While others will argue that there is huge adoption for a revolutionary 10-year-old technology.
I will try not to argue one way or the other. Instead, I will layout the reasonable known current use cases/utility of Bitcoin.
Bitcoin is a (volatile) store of value. Yes, we know that there is a lot of volatility, but for anyone who has HODL’d $BTC for anything over 24-months has had handsome returns. I think that as Bitcoin ages and matures, its volatility will slow down and holding it will be a greater store of value and actually increase your dollar value of Bitcoin.
Bitcoin is borderless, permissionless, open, peer-to-peer, censorship-resistant. These are some of the foundational aspects of Bitcoin. Even if its price drops and you are at a loss in dollar value, no one can stop you from transacting in Bitcoin, and no one can take your Bitcoin from you (if you are careful).
You can send the Bitcoin/money ANYWHERE in the world at ANY TIME within ~10 minutes. You can exchange Bitcoin for any product or service. This utility may seem insignificant to the average person in a stable, democratic nation such as the USA, Canada, Australia, Japan and much of NorthWestern Europe. However, this is not the reality for the majority of the world.
In my opinion, these two aspects: (1) a store of value and (2) permissionless, borderless, censorship-resistant (etc) are vastly important and with these two sets of principles/utility alone, once adopted by the world will have Bitcoin at a highly valuable price target.
Bitcoin and Crypto Patents
Gauging the number of Bitcoin and crypto-related patents being filed with the US Patent office (and the patent offices of other large nations) is a difficult task. I have not personally gone to look this information up, but what I’ve heard on trustworthy cryptocurrency podcasts and YouTube channels is that every year there is a growing number of cryptocurrency-related patents being filed by large corporations such as IBM, Microsoft, Oracle and others.
Venture Capital Invested in Blockchain Startups
Briefly, the general trend here is to determine if venture capital funding in the blockchain industry is increasing or decreasing over time. You can evaluate this in numerical terms ($USD venture capital invested), however, it really is a generic marker for the entire cryptocurrency industry and just because venture capital has made large investments in cryptocurrency companies does not directly translate to an increased valuation in Bitcoin. And this post is all about how to value bitcoin.
That being said, here is a graph of Venture capital invested in the cryptocurrency industry from 2012 to 2018. You can see an obvious uptrend from imperceptible in 2012, less than $250 million in 2013 to well over $3 billion in 2018. I expect this trend to continue upwards.
Legacy Tech and Financial Companies Entering The Cryptocurrency Industry
There are many legacy tech and legacy financial institutions entering the cryptocurrency industry. These are large successful companies that have a lot to lose if Bitcoin and cryptocurrency go bust. Their involvement in the industry can be viewed as an indirect endorsement/positive affirmation that Bitcoin and other cryptocurrencies are here to stay and grow.
Some examples of these large companies are: Microsoft, IBM, Oracle, The Intercontinental Exchange (ICE, parent company of the NYSE, opening Bakkt), JP Morgan, SBI Holdings (in Japan), Facebook, Goldman Sachs, Starbucks (partnered with ICE/Bakkt), Square, Visa, Uber, Mastercard, Twitter, Amazon, Google, NVDIA, and more.
Now, all we know is that these companies have made investments into the cryptocurrency industry. Some have simply participated in venture funding and others are directly working in the cryptocurrency space with blockchain-related departments. None of this news is a direct, measurable indicator of how to value Bitcoin (or any other cryptocurrency). But as a broad statement and sentiment in the industry, it appears to be positive with all of these companies getting involved.
Institutional Investment and Endorsement
Larger institutions such as family offices, pension funds and university endowment funds have started to invest small percentages of their portfolio into Bitcoin. These institutions are private (although some pension funds are public) and have vast sums of money at their disposal. They have the ability to significantly increase the market capitalization of Bitcoin.
Since most of these funds are privately managed it is next to impossible to know how much they are/aren’t investing and none of this information really gives us a real idea of how to value bitcoin. However, the more institutions that are investing then it generally indicates a positive trend/outlook for Bitcoin.
Family Offices tend to be (relatively) small compared to Pension Funds and University Endowment Funds, managing funds in the $100s of millions. However, Family Offices tend to be run by smaller staff and have significantly greater flexibility in their investment decisions. There are a growing number of Family offices that have been investing in Bitcoin over the last couple of years.
Regarding Pension Funds, they are significantly larger than Family Offices and typically manage billions of dollars, if not tens to hundreds of billions. Anthony Pompliano, from Morgan Creek Digital, was the first person to educate and introduce pension funds to Bitcoin investing. He convinced two pension funds in Fairfax country, Virginia, USA to invest in a $40 million venture capital fund that invests in Bitcoin. A percentage of $40 million USD is peanuts even to small pension funds. If/when they see great returns, undoubtedly they will invest more as will other larger pension funds. Although, at the time of writing there is not a significant amount of Pension Funds investing in Bitcoin, let alone other cryptocurrencies.
University Endowments have started investing in Bitcoin as of a couple of years ago. The first known University Endowment to invest in Bitcoin was Yale University, the second-largest endowment in higher education – which undoubtedly will lead other University Endowments to at least examine the notion of investing in Bitcoin.
There appears to be a growing trend of institutions’ interest in Bitcoin and cryptocurrency investments. An article from news.bitcoin.com revealed that 47% of Institutional Investors Welcome Crypto Investments. I would imagine that the real number is actually lower than 47%, primarily because the survey likely has a strong selection bias. However, this is still a high number, even if it is lower. I expect this number to continue to grow.
Government Regulations and Endorsement
Bitcoin, as a decentralized value network, poses a large threat to governments in the value proposition against sovereign fiat currency. With that in mind, there are not many governments that have embraced Bitcoin/cryptocurrency. Japan is a rare exception. Most governments worldwide have taken a cautious approach to Bitcoin, especially larger world powers as they have the most control to lose.
There are some smaller governments/countries such as Afghanistan, Tunisia and Uzebekistan that have strongly considered using Bitcoin to issue bonds and/or back their fiat currency to help it hold value. Additionally, Venezuela in their economic strife in recent years has made Bitcoin legal tender (in addition to their national fiat currency).
The USA, Canada and many large European nations are still cautious towards Bitcoin and other cryptocurrencies. They have not done an outright ban (unlike China and perhaps India), however, they have not openly embraced Bitcoin. Their lack of a ban thus far is encouraging for a more positive approach towards Bitcoin.
Gauging a government’s sentiment towards Bitcoin is virtually impossible, but when you watch/read the news, pay attention to the actions that governments are taking towards Bitcoin and other cryptocurrencies.
If Bitcoin is embraced by governments I think it would be a positive thing for its adoption and value. Interestingly, if most governments take an aggressive anti-Bitcoin approach, I also think that this will be a boon for Bitcoin (less than positive adoption obviously), as Bitcoin will still continue to exist and people can still buy Bitcoin as a hedge against a tyrannical government.
Bitcoin, it’s Proof of Work blockchain, and its decentralized nature are what create the technological foundation of digital scarcity and digital trust. This feature of the Bitcoin protocol that is most promising and that everything else is built upon.
As long as the computing power of the Proof of Work continues to rise and the number of nodes and miners continues to rise and become more and more decentralized, Bitcoin’s value proposition will grow.
With this concept, it is very, very difficult to assign a numerical value to Bitcoin. In fact… the open, peer-to-peer, permissionless, censorship-resistant nature of the Bitcoin network is partly what makes it so invaluable…
Markshire Crypto Conclusion on How To Value Bitcoin
All in all, deciding how to value Bitcoin is an exceedingly difficult task and one that no one truly knows the answer to yet.
I think that estimating the quantitative factors is tough, and gauging the qualitative factors is even tougher. As time progresses and we have more history to Bitcoin, more halvening and more institutions investing and the market grows and becomes more liquid I think that knowing how to value bitcoin will become a little more straightforward.
Objectively, the two quantitative markers I would use are:
- The Mayer Multiple
- Bitcoin Difficulty Ribbon
Personally, not financial advice, I think that Bitcoin’s value will certainly increase in roller-coaster fashion over the next 10-25 years.
Review What is Cryptocurrency here.