Valuing Bitcoin
One of the topics keeping cryptocurrency traders up at night is determining the value of Bitcoin. Why is valuing Bitcoin, or every other “altcoin” for that matter, such a hard thing to do? Simply put, there is no easy way to do it. Many of the various models used in valuing Bitcoin are classical models designed for either fiat currencies or precious metals like US dollar or gold respectively. The problem: Bitcoin is neither of these. It is entirely unique. Several methods have been used to determine a bitcoin’s value and we will try to go through the best of these before finding an average between them. Other altcoins make valuation even more difficult: they all have a different way of mining, their inflation structure is variable, and they may be backed by anything other than air. So, for ease of understanding we will only discuss six bitcoin valuation models and then Bitcoins as a whole.
Mining
The first way we can value Bitcoin is through evaluating the price of mining coins prior to adding a modest profit. This is in fact a reliable method of valuing Bitcoin because it follows the classical supply and demand curves. Bitcoin’s value can mimic typical “gold rush” behavior. In the initial years first movers were able to mine bitcoin with computer CPUs and earn a modest profit. As the coin gained in popularity and with the halving events, the price to mine a single bitcoin increased but so did the price of the coin (though by not as much). Now those who wish to mine bitcoin must use several or thousand GPUs, or better still ASICs, processing up to 100 terahashes per second (TH/s). Hashes measure mining processors, where a TH is one trillion hashes per second. The newest ASICs cost $3,900 each. The result is that economies of scale, like with the gold mining industry, becomes the only way to mine. Most miners now join pools to share the wealth—the largest being “F2Pool”, which with 23.02 EH/s (1 EH/s is one quintillion hashes per second) controls 24.15 % of the total Bitcoin network computational power.
Distribution of the Bitcoin network’s hashrate (Source: Blockchain.com)
Purchasing the newest ASICs to match the hash rate of this pool would cost 87 billion US dollars (23.02 EH/s divided by 100 TH/s multiplied by $3900/ASCI). The second and third expenses are an internet connection and electricity for running all of these processors (not to mention the real estate and cooling needed). Some countries are better than others at doing this. In 2019, 65 percent of the global bitcoin hash rate originated from China. Also in 2019, total bitcoin revenue was $5.4 billion. If there was a cost of $87 billion to generate 24.15% of that revenue, or $1.304 billion per year not accounting for electricity, internet, or a 1.5% interest rate opportunity cost. This means one of two things: either mining is not very profitable, or miners expect the bitcoins they are receiving from mining to be undervalued and, in the future, will rise in value significantly. For a smart investor, it may be worthwhile to invest in a company that makes ASICs—the picks and shovels of the Bitcoin mining industry.
TradeBlock’s February 2020 post-halving mining cost estimate of $12,525 assumed the network’s processing power would stay at its most recent pre-halving level of May 11, 2020. Their analysis also assumed an electricity price of 6 US cents per kilowatt-hour, which is higher than the roughly 2 cents some big crypto-mining firms say they can obtain through wholesale purchasing agreements. There has been an unprecedented hash rate decrease since the last halving and thus the price to mine has fallen by approximately 20%. If we assume the decrease is equal to the profit needed to break even, $12,525 is a value we can use to equate to Bitcoin for now.
Fundamental Valuation
Many people in finance say Bitcoin is only a store of value (SOV), like gold. They also say gold does not have any intrinsic value; its $7 trillion market cap is primarily a result of its use as an SOV. But when you look at Bitcoin from a fundamental valuation perspective, this is not an accurate comparison, nor is gold only an SOV. Half of the world’s gold supply is used for practical purposes such as jewelry, and only 38% are investments or reserves sitting in a vault. Gold’s market capitalization (market cap) is determined by the supply and demand of gold as it is used for those economic purposes. If gold did not have an economic use, demand would fall, and a resulting fall in price would occur. In order to compare it to gold, Bitcoin needs an economic use; Bitcoin would have to be a transactional currency. Then we could evaluate it with the fundamental formula: MV=PQ.
As a quick macroeconomics lesson or refresher:
With the USD, the congress and the Fed expands and contracts the money supply. “PQ” is the total value of all transactions in the economy. Yearly GDP would be an approximation for “PQ” for one year. “V” stands for velocity, and has averaged seven historically. A “V” of seven simply means that each dollar is exchanged an average of seven times per year (but this is slowing). With a greater money supply, “PQ” tends to increase as well. It can be thought of as: more money = more spending. During periods of growth, the government keeps a careful eye on the growth rate, because too much money can also lead to inflation. Inflation often results in holders of assets like real estate and stocks increasing their wealth, while those holding cash lose the purchasing power of their money.
Returning to Bitcoin we will assume:
- Bitcoin also has a velocity of seven
- 10 million of its future 21-million-coin supply is used for economic transactions
- The total value of these economic transactions (“PQ”) is $700 billion (about 10% of the market cap of gold)
Therefore V = 7, PQ = 700B and we are solving for M.
Using this result Bitcoin has an estimated market cap of $10,000 per coin multiplied by 21 million coins = $210 billion.
These assumptions plugged in result in a price not too far off from 5-28-2020’s Bitcoin market cap.
- Market Cap $173,726,467,647
- 5-28-2020 Price of $9,451.46
- Circulating Supply 18,381,800 BTC
This shows that the more transactions (velocity) we have with a single bitcoin, and the lower our freely traded supply, the greater the value of each coin. When we see that nearly half of all bitcoins have not moved in two years this pushes upward pressure on the price but we can stay conservative at $10,000.
The Puell Multiple
Another method we can use to determine if Bitcoin is under- or overvalued is called the Puell Multiple.
The current Puell Multiple is found by dividing the daily issuance value of bitcoins (in US dollar terms) by its 365-day moving average.
Daily issuance is the total of all new coins added to the bitcoin ecosystem by all miners worldwide. These miners are receiving coins as rewards for validating blocks on the blockchain. Miners will usually cover their mining costs by selling their coins into the market, or in the case of pools, members will be paid in proportion to the amount of hash power they are providing to their pool. The Puell Multiple is influenced by changes in price. For example, if prices drop, the dollar value of the daily issuance declines as well, pushing the Puell Multiple lower. This year (2020) has seen a great deal of movement in bitcoin’s price, with COVID-19 as well as its May 11th halving. Prices fell from $10,200 in mid-February to a 12-month low below $4,000 in mid-March, and in late May 2020 (May 22, 2020) it stands at $9,240/BTC.
This year the Puell Multiple slipped to 0.41 on March 16th, the lowest level since January 17, 2019, before climbing back to 1.15 and again falling to 0.38 on May 17th and is at 0.46 on May 22nd, according to lookintobitcoin.com.
The Puell Multiple is hovering in its “green zone”, or the range from 0.3 to 0.5. This green zone has marked a bear market bottom in the past. If we look at historic data, these dips into the green zone, in 2011, 2015 and 2018, have all indicated respective ends of downward momentum and inflection points for a new bull run.
Looking back at 2017-2018
Bitcoin’s bear market started from the record high seen in December 2017 of $20,000, which correlates with the last time that the Puell Multiple was in its “red zone” between 4 and 10. It then fell and continued to fall until it ended near $3,200 in mid-December 2018, when the Puell Multiple hit a low of 0.30.
2020
Reduced supply from miners can also weigh on the Puell Multiple. That seems to be the reason behind the ratio’s recent May decline. The second below-0.5 reading on the Puell Multiple for this year is the result of the May halving. The Puell Multiple dropped from 1.13 to 0.41 immediately following halving and appears to have bottomed out at 0.37 on May 17th. This event meant that daily miner supply has declined significantly resulting in miner capitulation. Small and older inefficient miners are choosing to scale back their operations due to reduced profitability.
This latest under-0.50 reading suggests the worst is behind us. Mike Alfred, CEO of Digital Assets Data agrees that “dips below $5,000 will be short-lived, courtesy of strong demand from long-term holders”. These holders include investors who bought bitcoins before the massive rally in the fourth quarter of 2017 and during the last five weeks of 2018.
Though the Puell Multiple does not provide a direct way to value bitcoin’s price, some have tried to run various nonlinear logistic regressions, one version of which was a variation of Renato Shirakashi’s nonlinear regression curve. His regression predicted at the halving a price of $11,667. So, the current price is still regarded as undervalued.
National Currency Comparison (second medium of exchange)
A simple way to view the value of Bitcoin is to consider it a medium of exchange, like we did with the fundamental valuation. That way we can compare it to other national currencies without having to assume its velocity. This lets us compare Bitcoin adoption against known fiat currencies.
The US dollar was originally tied to gold until it is uncoupling in 1971. This move allowed the U.S. government to print more money when it deems, necessary to “artificially” stimulate the U.S. economy and boost real productivity. The goal of this move was that if there is a good government at the helm of monetary policy, who knows how to properly manage the supply of money, they could in turn manage real productivity in a way that was not possible before. Of course, this was the goal and on the flip side, if the government does not manage this policy well, a fiat currency can lose its value very quickly.
The rise in US debt levels is a strong indication that current monetary policy is being mismanaged. Ray Dalio, billionaire hedge fund manager of Bridgewater, predicts a non-zero chance of the USD losing its reserve currency status given the current state of affairs. And recently he also forecasted a US decline as China is rising.
With the COVID-19 response of several governments drastically increasing the money supply, there will most likely be global spikes inflation. It is expected to be approximately 5.8% in India, 3% in China, and to nearly quadruple in the US next year from 0.6% to 2.24%.
The CIA World Fact Book provides a list of each country’s M2 money supply in USD, which shows China’s at $25 trillion, the US’s at $14 trillion, and Japan’s at $9 trillion. We can then compare these to the market values of all cryptocurrencies which added together are worth $256 billion, with Bitcoin making up exactly two thirds at $169 billion. Bitcoin’s market value is roughly equal to the money supply of the Czech Republic (190 billion USD) with its 10.7 million citizens and a GDP of 375.9 billion CZK using its own Koruna as currency.
Looking at the below chart of bitcoin wallet values we see that 7.5 million wallets have values over $100 USD.
This chart also shows that fewer than 700 thousand wallets have over $10,000 worth in bitcoins. Some users have multiple wallets, which leads us to believe that bitcoin holders holding a significant amount of money is well under one million. As a comparison, the Bitcoin subreddit currently has about 1.4 million subscribers total.
Bringing us to ask a few questions:
- How much economic activity (in equivalence to GDP) actually occurs in Bitcoin from these 700K or fewer active users?
- How much of the global annual drug trade estimated at $400 billion trades in Bitcoin?
- How much of the $1.8 trillion global black market uses Bitcoin?
- How much “legal” economic activity uses Bitcoin?
We know by how much Bitcoin changes hands, but these questions are hard to answer. Thus, the economic activity vs. investment trade dilemma is also hard to solve.
There are far fewer active Bitcoin users than the nearly 11 million making the Czech Republic’s population. Most likely, Bitcoin users are only doing a small portion of their spending in Bitcoin—nowhere near the country’s 375 billion CZK GDP.
When we see that the daily trade in bitcoin was 40 billion USD, we can assume Bitcoin is a tenth of the size of the Czech Republic’s GDP. This means the economic activity of all bitcoins together could also be a tenth as much of their money supply, or $19 billion, implying that Bitcoin is highly overvalued with its $173 billion market cap and daily trade at $40 billion
If there are 500,000 people doing an average of $10,000 in Bitcoin economic activity per year (spending, not simply trading), we would have only $5 billion in actual Bitcoin economic activity. This is only 1.33% of the Czech economy, far less than our 10%, again making Bitcoin’s total value much less than the Czech money supply at a few billion dollars. Following this logic, a bitcoin should be approximately worth $100 and is now extremely overvalued.
The counterargument is that Bitcoin is deliberately overvalued, when looking at its current economic activity, because investors expect its adoption and usage rates to go up significantly.
For example, suppose within 10 years, Bitcoin reaches the level of the Taiwan dollar’s economic activity, or a 1.18 trillion USD GDP, and a money supply of 1.37 trillion USD M2 for its population of 22.6 million people.
If there is an 8.5 billion world population in 2030, with 2.5% using Bitcoin, 212.5 million people will be Bitcoin users.
If the average user does only 10% of their spending in Bitcoin, that is equivalent to 21.2 million people doing 100% of their spending in Bitcoin. Taking 21.2 million people, roughly the size of the Taiwanese population, and assuming a similar average per-capita economic activity, we have an estimated Bitcoin market cap of $1.37 trillion. In this scenario (comparing against Taiwan’s M2 money supply), where there are 20 million (of the total 21 million people) bitcoins in existence by then, each bitcoin would be worth $68,500. Halving this to $34,250 is still a bullish scenario, but not an impossible one and can justify the multi-thousand-dollar value of a single bitcoin. Using a yearly return of 7%, the discounted present value is $17,410.
While the number of bitcoins in existence will never exceed 21 million, its money supply can exceed 21 million due to fractional-reserve banking.
Stock to Flow (STF)
All commodities have an STF ratio, which measures the amount of the actual commodity produced every year relative to how much of it is currently stored. If STF is below 1, then the total amount stored is less than a year’s worth of production. Usually this is due to the cost of storage, or when the commodity can expire in less than a year if left unused.
Gold and silver have STFs of 60 times and 20 times respectively. There is 60 years’ worth of production in current gold reserves.
From its beginning, Bitcoin’s STF was predestined to fall, and continues to fall with every halving, until the 21 millionth coin is mined. Bitcoin’s current STF is equal to gold’s. There are now 18.3 million bitcoins with 900 new coins mined every day. That production will again drop to 450 a day in four years when the next halving occurs. With the model created by PlanB, we see an estimated STF value over the coming years and a current average value of $9,413 on May 26, 2020. Please note this is an exponential graph.
Chart courtesy of digitalik.net.
The PlanB model predicts a price over $100,000 by 2022. If there is hyperinflation in the US dollar, then maybe this can happen but several factors would have to come into play first. No matter what, with the planned slowing of Bitcoin production, the STF ratio will increase. We will see if there is a long-term correlation to the price or it will correlate a short time longer than the correlation diverges. In the past, price jumps have happened well after halving events (yellow/green areas in the above graph), or roughly 800 days prior to the next halving.
Store of Value (SOV)
Let’s return to the store of value concept and compare Bitcoin’s to gold. We have stated that much of gold’s value is industrial, for if it were not the case and only a store of value, much of its current value would be lost. However, it still remains an SOV for many investors (≈40% of all gold). We will review this particular use this for the sake of valuing Bitcoin.
Though many US small and medium-sized businesses are starting to accept Bitcoin, 47 percent of the surveyed companies which are accepting cryptocurrency had been in business for five years or less, compared to the 21 percent being in business more than 20 years. The actual transaction count for cryptocurrencies is still minimal. Coinbase Commerce processed $135 million worth of all cryptocurrency payments for thousands of merchants in 2019. A substantial percentage increase over 2018 but nevertheless, a drop in the bucket of the world’s total commerce. Bitcoin’s usage remains primarily a store of value.
Assuming Bitcoin maintains such a position and does not become a payment choice for many, we must consider bitcoin as only an SOV commodity. Bitcoin has no unique underlying technological advantage. Rather, it is a first mover in the cryptocurrency space.
According to Credit Suisse, global total wealth in 2019 was $360 trillion, with 44% in the hands of the world’s 46.8 million millionaires. Most of this wealth is in stocks, bonds, real assets and cash. Roughly $9 trillion of this is in the form of mined gold, or about 2.5% of the planet’s total wealth.
This enables a fundamental analysis of gold. If demand doubled to where people placed 5% of their wealth into it, from the current 2.5%, the price should also double since the supply does not increase much year to year.
If in the next 10 years Bitcoin’s market cap reaches half of gold’s (rounding up to $5T or 1.38% of global net wealth, which we are assuming will only grow slightly) and remains at an estimated 20 million coins in existence, a single coin would have a value of $250,000. This is very unlikely, but if Bitcoin were to have between 5% and 10% of gold’s current value, then each bitcoin would have a value between $25K and $50K. This is well within the realm of reason.
If we demand a 7% return on our money before rewinding back 10 years from 2030’s $25K, the present value is $12,700.
Summary
So what is the end result from all of these different valuation methods, acknowledging there are other factors we need to take into account if we assume none of the methods is particularly better than the other? Let’s employ a simple average instead, where we find the following:
When we account for all 6 of the methods we arrive at an average of $12,285(as of May 28, 2020). The May 28, 2020 price stands at $9,451.01. None of these valuations are unreasonable, and in combination give a sound estimate. If we assume an efficient Bitcoin market utilizing all of the available information, why do we have an undervaluation of 30%?
The first reason: this intrinsic value may be under pressure by investors interested in taking profits. Estimates suggest there are around $40 million worth in roughly $10,000 active sell orders on both the Binance and Bitfinex exchanges.
The second major reason we have not yet taken into consideration is that there are a few major cryptocurrencies, such as Libra and the Chinese digital Yuan (to be called the DCEP), potentially on the horizon. This leaves altcoin investors worried they will not only compete with Bitcoin, but also with the US Dollar going forward. These two cryptocurrencies alone could drastically change Bitcoin’s valuation.
The third reason which must be considered is that governments may never allow Bitcoin, or an “unapproved crypto”, to be traded freely, It is hard for those with power to give away any power, and control over a money supply is power. James A. Garfield once said: “He who controls the money supply of a nation controls the nation”.
All three reasons will greatly hamper Bitcoin’s acceptance and use. We shall see if Bitcoin will remain the main player in the cryptocurrency space. All else being equal, Bitcoin does appear to be currently undervalued; we do know the current price will not remain this low. Investors need to keep a close eye on several factors such as the six methods described above to determine how long this remains the case going forward.
Disclaimer: The author of this text, Jean Chalopin, is a global business leader with a background encompassing banking, biotech and entertainment. Mr. Chalopin is Chairman of Deltec International Group, deltecbankstag.wpengine.com.
The co-author of this text, Robin Trehan, has a bachelor’s degree in economics, a master’s in international business and finance, and an MBA in electronic business. Mr. Trehan is a Senior VP at Deltec International Group, deltecbankstag.wpengine.com.
The views, thoughts, and opinions expressed in this text are solely the views of the authors, and do not necessarily reflect those of Deltec International Group, its subsidiaries, and/or its employees.
