How can Bitcoin be valued?
In order to value Bitcoin, we need to understand its value proposition. Is it a store of value? Is it a currency? Or is it just a Ponzi scheme?
Nic Carter’s medium post lays out how these narratives have shifted over the years. Some version of “Digital Gold” is the most commonly accepted value proposition today –
On the flip-side, detractors like Nassim Taleb have referred to it as an open Ponzi scheme –
Michael Saylor explicitly argues that it is not a currency, but a bank in cyberspace, this is close to the “Digital Gold” narrative –
If Bitcoin is digital gold, can it be valued like Gold? The more dollars that are exchanged for Gold, the more valuable Gold becomes. And then the value of all Gold (excluding industrial and ornamental use-cases) is approximately equal to the total value exchanged for it.
If Bitcoin is an e-bank in cyberspace, you can think of it as a shared savings account between all owners, the balance of which is equal to the total amount deposited, and the units of Bitcoin owned by each individual are equivalent to bank shares held.
If Bitcoin is a Ponzi scheme, the same logic applies, the fair value of a Ponzi at any point in time is the same as the total amount investors have put into it.
All of these are just different descriptions of “Store of Value”, implying that Bitcoin is at least as valuable as the total value stored inside of it.
This leads us to the first component of fair value, which is the total amount deposited. This is also approximately equal to Realized Capitalization.
However, “Store-of-Value” is not all that Bitcoin is. With the advent of the lightning network and El Salvador adopting it as a legal tender, Bitcoin has already cemented its status as a currency. In addition, because of its sovereign properties, it is also a call-option on becoming THE reserve currency of the world.
For each day that Bitcoin resists attacks and doesn’t die, it further proves its value proposition, and the call-option trends towards becoming ITM (In-The-Money).
This call-option premium is modeled with a regression with ‘days without dying’ as a predictor. This is the second component of the fair-valuation model.
The addition of these two pieces, the realized cap, and the call-option premium, leads us to a fair value of Bitcoin, denoted by the blue line. Historically, cycle-tops have been approximately 3 MADs (Mean Absolute Deviations) away from fair value, represented by the red line, and cycle bottoms have been 1.5 MADs away, denoted by the green line.
The green and red lines can be used as buy and sell signals. These signals are sparse as there have only ever been four buy/sell signals each in the history of Bitcoin, but they’ve correctly identified ALL cycle tops and bottoms.
I hope you found this framework valuable. Constructive criticism is welcome, feel free to reach out via Twitter @AzazelAyers!
“Truth is the most valuable thing we have. Let us economize it.”
– Mark Twain on Bitcoin
Disclaimer: None of the information shared on this website should be interpreted as financial advice. Trading cryptocurrencies is risky and should only be undertaken based on your own risk tolerance.
Feel free to reach out to me via Twitter @AzazelAyers