Valuing Bitcoin

Executive Summary

After investors have learned the basics of bitcoin, they often ask, “how is it possible to own an asset if they are unable to determine what its fair value should be?” Valuation methods vary widely across a variety of assets, from traditional cash flowing businesses to physical commodities. Valuation can be straightforward and simple, or cumbersome and complex depending on the asset class, model, and users’ preference. Regardless of the method, investors should always aim to maintain some type of framework for which they can value assets that are being considered for investment in their portfolio. Only then can they decide whether that asset is expensive or cheap relative to their estimation of its current and potential future value.

In this piece, we unravel how one may use their understanding of bitcoin’s unique characteristics to help inform valuation. As mentioned in our prior research, we believe that bitcoin is best understood as an emergent monetary asset, and therefore the optimal approach for determining long-term fair value could potentially be derived through the analysis of its supply and demand curves. As discussed throughout the paper, the combination of bitcoin’s predetermined supply schedule and its technology-like adoption curve makes the use of Metcalfe’s Law one of the most compelling valuation techniques available. This paper can be largely summarized through the following ideas:

• Having a framework for which to value any investment opportunity is a necessity: Bitcoin represents a non-sovereign monetary asset with no cash flows or industrial use case and therefore derives its value through its relative attractiveness as an alternative store of value. As a result, we believe supply and demand curves largely drive its long-term value.
• Bitcoin’s supply is predetermined, increasing in scarcity and is inelastic to changes in demand: The stock-to-flow model gained popularity as a supply-side only valuation model for bitcoin. Despite its historic popularity, we do not necessarily see use of the model on a standalone basis for forward price expectations. It does however highlight an important supply imbalance created by each subsequent halving event, though these are likely to be less impactful as they have been historically given bitcoin’s issuance is already relatively low.
• Network effects have shown to be important in the age of technological innovation: Successful emerging technologies often exhibit steep S-shaped adoption curves and undergo periods of rapid user growth. Evidence suggests that an increase in the number of users to a given network can, and does, have a direct relationship with the value of that network. Cell phone and internet adoption provide a useful proxy for the estimated future growth in the adoption of bitcoin and are potentially useful in helping to estimate future adoption and price.
• A shift in importance from the supply curve to the future demand curve has likely emerged: Modeling bitcoin via a demand-side method, although sensitive to the implied network adoption rate, delivers a potentially useful framework for the ascension of a new, digital store of value coming into fruition this decade. Indeed, in our view, bitcoin’s adoption curve is likely to be one of the most important drivers of value accrual over the coming years.