Next Stop: $100,000 – Five Ways to Value Bitcoin

Bitcoin doesn’t generate cash flow, so it’s difficult to value, but there are some creative workarounds.

Editor's Note

After breaking through $69,000 last week, Bitcoin rose to a record high of $727,160 on Monday (March 11). Bitcoin has risen by about two-thirds since the beginning of the year, and investors continue to pour into spot Bitcoin ETFs as a key force driving price increases. Samir Kerbage, chief investment officer of crypto asset management company Hashdex, believes that spot Bitcoin ETFs have fundamentally changed the supply and demand dynamics of Bitcoin, and after breaking through $70,000, the next target price is $100,000. "

How much is Bitcoin really worth? In a recent article, Barron's listed five valuation methods used by some Bitcoin analysts.

I first wrote about Bitcoin in June 2011, when I called it "the world's best performing currency" in an article on SmartMoney.com. At the time, Bitcoin was up 200,000% in a year and trading at just over $10. If I had sold everything and bet on Bitcoin, I'd be living next door to Jeff Bezos in a yacht, but I continued to invest my paycheck in boring stocks and bonds and live in a suburban house.

I have always been a Bitcoin skeptic, but it has been doing so well lately that it makes me feel ashamed in front of the crypto tycoons. I don't know where the price of Bitcoin will go next, and I am not going to turn bullish just yet, maybe because I am too old-fashioned.

But for those who are attracted to Bitcoin ETFs (including Bitwise, iShares, Fidelity, Invesco and WisdomTree, etc.), or those who don't know when to sell, it might be more helpful to have something more important than the narrative of "Bitcoin is the future of money" to refer to. Bitcoin does not generate cash flow, so it is difficult to value it, but there are some creative workarounds. I contacted several Bitcoin analysts and asked them to describe the models they use. I did this out of curiosity and does not mean that I endorse these valuation methods. Here are five ways to value Bitcoin.

Valuing Bitcoin Based on the Value of Gold

JP Morgan has used this valuation method. JP Morgan considers Bitcoin to be digital gold because the two assets have some common features: limited supply; both are fungible and divisible stores of value; both are not controlled by governments; and both are obviously durable. The value of all gold ever mined is estimated to be close to $15 trillion, but most of it is jewelry or held by central banks. The value of gold held by private investors - including bars, coins and gold ETFs - is estimated to be $3.3 trillion. Bitcoin has a market value of about $1.3 trillion, and if it is as good as gold, perhaps its price should be more than double its current price.

JPMorgan Chase lowered its fair value of Bitcoin because Bitcoin is more volatile than gold. Reda Farran, an analyst at financial information website Finimize, believes that JPMorgan Chase's downward adjustment to Bitcoin's fair value is too large because Bitcoin's volatility has been declining. Farran also pointed out that Bitcoin's supply is growing slower than gold, and in his opinion, Bitcoin has greater financial utility, which are all reasons why Bitcoin's price should be adjusted upward.

The question I want to ask most is: If Bitcoin is really as good as gold, shouldn't there be a substitution effect? ​​Gold prices would fall because of this effect, rather than setting new highs. Farran said the substitution effect is evident in ETF flows, but central banks have been buying gold to offset this effect.

Valuing Bitcoin Based on “Mining” Costs

Analysts sometimes talk about pegging the cost of mining an ounce of gold to the price of gold, which is one possible way to value Bitcoin because Bitcoin "mining" requires huge computing power, which means the marginal cost of production is related to electricity prices, hardware efficiency and the rewards received by "miners". The rewards received by "miners" will be halved every once in a while, and the supply growth will slow down until it eventually stops growing. The next "halving event" will come in April.

Anticipation surrounding the halving, combined with new demand for bitcoin ETFs, is part of the reason bitcoin bulls are so excited. Adam Hayes of the Hebrew University of Jerusalem, who studies using bitcoin production costs as a valuation guide, predicted last year that after the halving, the cost of mining a bitcoin would be around $75,000. Finimize's Farran believes that production costs should be viewed as a price floor, not fair value.

Impress investors with technical charts?

The data regularly released by financial data service agency Ibbotson Associate is an important source of data for many analysts. Financial advisors often use Ibbotson charts to show the long-term performance of stocks, bonds, bills and inflation. If financial advisors pull out a chart depicting the performance of Bitcoin, their customers will say, "I want to buy some Bitcoin."

We would all say that after seeing a chart like this, according to Raphael Zagury, chief investment officer at Swan Bitcoin, which offers buying plans for cryptocurrencies. He believes a 20% allocation is the ideal risk/reward tradeoff, or as he puts it, the “optimum point on the efficient frontier.”

This is less a valuation model than a rationale for higher prices.

Valuing Bitcoin from the perspective of obtaining a “monetary premium”

Global real estate is valued at $320 trillion, a portion of which reflects a "monetary premium," or pure investment value beyond the utility of the land and buildings themselves, which accounts for 30%. Zaghari believes that Bitcoin has the potential to become the world's top monetary asset, swallowing up this premium not only from real estate but also from stocks, bonds, gold, silver, other cryptocurrencies and art. On nakamotopportfolio.com, a website created by Zaghari, users can enter their own assumptions. For example, the default assumptions show that there is a 5% probability that Bitcoin will receive a 30% monetary premium for real estate in the next 20 years and a 90% probability that it will receive a 100% monetary premium for other cryptocurrencies in six years. The fair value of Bitcoin calculated using these default assumptions is more than $620,000.

Imagine what our society would be like if so many financial assets around the world collapsed at the same time. In such a world, food would be what everyone covets, not digital currency.

Valuing Bitcoin through CDS

There are financial instruments that allow investors to receive a return if a bond defaults, called credit default swaps (CDS). CDSs also exist in the U.S. Treasury market (although the U.S. government can always print money when it needs to). The existence of a Treasury CDS market implies some risk of default, no matter how small, and you can use pricing from that market to calculate the probability of default. If your assumption is that Bitcoin will win if U.S. Treasuries get into trouble, you can also use CDS pricing to calculate Bitcoin's fair value. Zaghari calculated the fair value to be between $75,000 and $100,000, "depending on your assumptions," he said.