Here’s how to determine the fair market value of a currency that has appreciated faster than the shares of even the hottest technology stocks.
Bitcoin’s Rise
Bitcoin remains the leading decentralized cryptocurrency, which has over the past decade increased interest in potential applications using its core blockchain technology. Yet, in an extremely dynamic (and often volatile) market, Bitcoin has also found its fair share of competitors—including other digital tokens like EOS, Cardano, Ripple, and Ethereum (among many others)—all of which have experienced both bull and bear runs.
Today, the market values of many blockchain-based tokens are in the several million to billions of dollars, with the entire crypto ecosystem worth more than a trillion dollars. Crypto has developed into a major economic force.
So how can one determine what the market sees as a digital coin’s
fair value, or how can one arrive at a Bitcoin valuation? How do you even think of
intrinsic value for something that only exists within computer networks, but yet has appreciated in price faster than the shares of even the hottest technology stocks? These questions have befuddled investors and analysts for years when it comes to Bitcoin, with competing views on the topic.
Key Takeaways
- Bitcoin and other cryptocurrencies have seen their market value rise incredibly over the past decade.
- How to arrive at a fair or intrinsic value for a virtual token has, however, confounded economists and investors.
- Today, there are a handful of competing approaches to valuing Bitcoin and its peers, including those based on scarcity to its network effects, to its marginal cost of production.
Calculating Bitcoin Fair Value
When it comes to digital currencies, there have been several methods to approach valuation. Most of these approaches differ in how one views the nature of a digital “coin.”
Expected-Value Based
For instance, if one views Bitcoins as equivalent to stocks or bonds, pricing models appraise its expected value. Expected value is the discounted value attributed to an investment’s payoff in the future. Since Bitcoin does not pay dividends or interest, the expected value would be due to a strong belief in the underlying technology and its potential to be disruptive or even revolutionary. This would be a similar approach to valuing a start-up company or young tech stock that does not have any current earnings or profits. Once an expected value is forecast, one can start to make estimates about Bitcoin’s current fair value.
Supply- and Demand-Based
The value of a Bitcoin can alternatively be approached using the principles of supply and demand. Like any other market, the market for Bitcoin achieves price discovery through the interactions of a multitude of buyers and sellers. If there is a high demand that outpaces the number of new Bitcoins that are mined, this pushes up the fair price for Bitcoin.
Like many assets, there is only a limited supply of Bitcoin (21 million ever to be produced by the year 2140), but unlike other securities that have a finite supply, the new supply of Bitcoin cannot be increased by decree or vote among shareholders or boards of directors. Thus, the price of Bitcoin is fundamentally linked to its scarcity. This makes the value of Bitcoin more akin to a collectible, such as rare baseball cards or artworks.
A different angle on supply and demand looks to stocks versus flows. A stock-to-flow ratio looks at the currently available stock circulating in the market relative to the newly flowing stock being added to circulation each year. With Bitcoin, around every four years, the number of bitcoins found in each block mined is reduced by 50%. Each halving event thus increases its stock-to-flow ratio since less new supply is created relative to the outstanding stock.
Since Bitcoin’s inception, its price has tracked this growing stock-to-flow ratio; each halving Bitcoin has been accompanied by a bull market leading to new all-time highs.
Continued on Source: How Can Bitcoins Have a Fundamental Value?
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