Bitcoin remains the leading decentralized cryptocurrency, which has increased interest over the past decade in potential applications using its underlying blockchain technology. However, in a very dynamic (and often volatile) market, Bitcoin has also found its fair share of competitors – including other digital tokens such as EOS, Cardano, Ripple, and Ethereum (among many others) – all of whom have seen both bulls. And the bear runs.
Today, the market values of many blockchain-based tokens range from several million to billions of dollars, with the entire cryptocurrency ecosystem worth over a trillion dollars. Cryptocurrencies have evolved into a major economic force.
So how does one determine what the market sees as the fair value of a digital currency, or how does one arrive at a Bitcoin valuation? How do you even think about the intrinsic value of something that exists only within computer networks, yet has risen in price faster than the stocks of even the hottest technology stocks? These questions have baffled investors and analysts for years when it comes to Bitcoin, with competing views on the matter.
- Bitcoin and other cryptocurrencies have seen their market capitalization rise incredibly over the past decade.
- However, how to arrive at a fair or intrinsic value for a virtual token has confused economists and investors.
- Today, there are a few competing approaches to valuing Bitcoin and its peers, including those based on the scarcity of its network effects, to the marginal cost of production.
Bitcoin fair value calculator
When it comes to digital currencies, there are several ways to approach valuation. Most of these approaches differ in how one views the nature of digital “currency”.
based on expected value
For example, if one views bitcoins as equivalent to stocks or bonds, pricing models estimate their expected value. Expected value is the discounted value attributed to the return on investment in the future. Since Bitcoin does not pay dividends or interest, the expected value will be due to a strong belief in the underlying technology and its potential to be disruptive or even revolutionary. This could be a similar approach to valuing a startup or a young technology stock that has no current earnings or earnings. Once the expected value has been predicted, one can start making estimates about the current fair value of Bitcoin.
Supply and demand
Alternatively, the value of bitcoin can be manipulated using the principles of supply and demand. Like any other market, the Bitcoin market achieves price discovery through the interactions of many buyers and sellers. If there is high demand that outweighs the number of new bitcoins being mined, this raises the fair price of bitcoin.
Like many assets, there is only a finite supply of Bitcoin (21 million will be produced by 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 mainly related to its scarcity. This brings the value of Bitcoin closer to a collectible, like rare baseball cards or works of art.
There is a different supply and demand angle that looks at stocks versus flows. The inventory-to-flow ratio looks at the currently available inventory circulating in the market relative to the newly inflow inventory that is added to circulation each year. With Bitcoin, about every four years, the number of bitcoins contained in each block mined is reduced by 50%. Thus, each halving event increases the stock-to-flow ratio because less new supply is created relative to the existing stock.
Since Bitcoin’s inception, its price has tracked this increasing stock-to-flow ratio; Each Bitcoin halving was accompanied by a bull market that led to new all-time highs.
If Bitcoin is not seen as an asset, but instead as a network, its value can arise from the size and robustness of the network itself. The term “network effects” refers to the number of users or nodes mining cryptocurrency.
Originally designed to understand the value of communication networks, Metcalfe’s law It states that the value of a network is proportional to the number of its users (or nodes) squared. While there are limitations, this perspective means that as the Bitcoin network grows in size, so must its value.
One final way to look at the intrinsic value of bitcoin is to look at it as a produced good, similar to oil or silver. Most commodity prices are driven by the marginal cost of production, or the cost to producers of creating one additional unit. Economic theory states that in a market where many producers of the same product (in this case bitcoin miners) compete with each other to sell their products to consumers, this process of competition will cause the selling price to drop to its marginal cost.
Thus, even if demand is less than supply, producers will be reluctant to sell below cost of production and incur losses. From this point of view, the price of bitcoin should be driven by similar dynamics.
The main difference between producing Bitcoin and, say, mining ore or producing something like chairs or tables, is that an increase in demand cannot motivate producers to make more Bitcoins – since it is limited to one block that can be found about every ten minutes. Thus, as higher prices in the market motivate new and larger miners to join the network, the number of bitcoins made remains the same. What changes is the difficulty level of mining those bitcoins. This increased difficulty maintains a fixed target of 10 minutes between when new blocks are produced.
As a result, the marginal cost of production increases without increasing supply. Recent research has shown Production cost to predict the bitcoin market well over time.
The value of Bitcoin is always changing, based on the demand for the cryptocurrency as well as public perception of the value of the currency itself. It also changes based on an ever-growing network of miners and users. As miners join the network, the difficulty for miners also increases, which increases the cost of production.
Even if we can determine the fair value, investing in cryptocurrency remains one of the most volatile investments, which means any potential investor should do their due diligence. However, for a chance to make a huge profit (or simply be a part of the fun), knowing how to value a coin’s fair market value will be key.
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