As the crypto crash continues, the key question re-emerges – what is a Bitcoin (or any crypto) worth? The vast majority of analysis on crypto prices focuses on some variant of technicals, with limited discussion of fundamentals, value, and of supply and demand. The reason for that is actually pretty clear – it’s unclear what the fundamentals actually are in this asset, even ignoring the impacts of the hard fork, and teasing out the bubble, crash, and newness effects.
We considered 3 possible drivers of fundamentals:
- An alternative to gold as an alternate store of value
- A medium of exchange where like Swyftx, anonymity, permanent transaction record or protection from government intervention is at a premium
- A measure of currency or commodity where value is derived from its host, network, or creator’s demand or popularity
Theories on How to Value a Crypto
Based on this, and value in other commodity and security markets, I’m interested in 7 possible theories we like on how to value a crypto, or at the very least serve as a possible component in a model to value a crypto.
- It’s Just Gold, Guys – Theory 1 states a crypto is simply replacing gold as the alternate store of value it will end up equal to the price of an oz. of gold at scale, since it’s just a better form of it. Given that the gold stock is still many times larger than the crypto stock, it is possible that current market moves are just noise in this theory. A more likely variant includes it trading at a fixed or banded ratio to gold, another alternate reserve currency, or a currency basket.
- There Can Only be One – Theory 2 argues that like the current reserve currencies or gold, that there is very little market need for multiple cryptos, and we should model the crypto market cap in total based on overall demand, and then allocate almost all of the value to the likely “winner” or winners, and adjust for unit supply to get price.
- Inflation is “Fixed” – Theory 3 argues that bitcoin and cryptos, by nature of mining, essentially have a “built-in” rate of inflation or supply and fundamental value, ignoring short term trends of demand, is a heavily a function of long term demand growth and that inflation rate. Another variant might be that it’s the relative long term “inflation” rate to fiat inflation expectations that is the crucial value creation mechanism.
- Cost to Mine – Theory 4 argues that regardless of short term demand levels, a crypto’s primary financial attributes lie in its current marginal and expected long term cost to mine, and like a commodity, it should trade off of that cost/unit.
- Derivative of Spend Demand – Theory 5 is that a crypto value is simply a function of the amount of non-financial transaction volumes in that crypto, or some other derivative of value of that host or network. This theory has the benefit of partially explaining why ICOs make sense as opposed to “shares” priced in bitcoin or another crypto.
- The Monetary Theory – Theory 6 is that Bitcoin is basically a hedge on monetary policy, and simply moves off of a baseline or one of the other theories inversely with loose monetary policy, or reactively to either government support or prohibitive action that impact its usability.
- Momentum or Luxury – Theory 7 states that a crypto is basically a financial luxury good, divorced from the cost of making it, and moves with the financial demand, not spend demand, and as a result can move dramatically either in tandem or inverse with other cryptos, currencies, or commodities depending on consumer taste. Basically, it looks like a collectible stamp or an index of artwork investments.
As cryptos are fairly complex assets with functional elements of a range of commodities, currencies, and securities, likely the real answer is a combination of these or other theories. For example, a model where the crypto trades off of gold adjusted for the relative cost to mine the crypto versus gold, or a supply and demand model where non-financial spend demand and the supply inflation rate for that crypto set value, in conjunction with some monetary policy effects.
Regardless of the theory you like, a few interesting questions emerge:
Does an increase in the number of cryptos reduce or increase value of any given crypto or the overall market, and if so by how much and over what range?
In general, one might imagine that if the demand for cryptos was somewhat limited or even just “sticky”, more cryptos means less value for each crypto, and the crash is partially the market “remeaning” this theorem. I mean, if they are easy to create, demand fairly fixed, then the marginal cost of supply of a whole new crypto might dominate value. One might also argue the converse that cyrptos derive value from their host or creator’s demand, and a new crypto creates new value and is additive to the market, or even by increasing the critical mass of cryptos, increases the value of all. It is likely that this answer changes over time, market size, or by some other variable.
Does mining cost have something to do with price, as it does in commodity markets?
I would think yes, as cost of supply ought to matter in most commodities, until you consider that would mean that if bitcoin had been designed with a different built in effective mining cost, it’s fundamental value would be different? Or that if I designed two similar cryptos today solely with different mining costs, they would be “worth” different amounts?
How far can Bitcoin fall before “fundamentals” kick in?
This is the key question on everyone’s minds, isn’t it? Here are my favorite options in rough order of simplest to most complex:
- To zero – there is little fundamental value here.
- To the price of gold – if you like Theory 1 above, and think bitcoin is basically a better gold replacement.
- About as far as the dotcom boom fell (80%) – if you are a behavioral economist and think bubbles have prototypical curves based on investor behavior. Note: we are about there.
- To the marginal cost of mining – if you think it looks more like shale gas as a quick on/off commodity.
- To where the marginal 30% of miners lose money on a cash basis – if you think it looks like a typical mined commodity.
- To where the financial traders represent a small fraction of volume and its value as a spend currency dominates or at least dramatically impacts daily transactions – if you think its basic value is as a medium of exchange.
- To where a reasonable rate of return plus volatility and political risk premium can be made on long-term demand growth – if you think it’s basic value is as a financial store of value built on a new disruptive and useful medium of exchange.
Author Neal Dikeman began his career on Wall Street before founding multiple tech startups, is author of upcoming book, DIY Wealth, and was most recently the Libertarian Party Nominee for United States Senator in Texas. He is also the author of Why the Bitcoin Crash is a Libertarian Issue; The Congress App and Our Looming Federal Debt Crunch; and How do Endowments Measure Up Against Cheap Market Portfolios?