“Bitcoin” is all the rage right now. Being a value investor by trade, I’ve long had a hard time wrapping my head around the concept. A digital currency and not controlled by a central bank? Really?
Seeing the soaring prices made me even more skeptical since the financial market is the only place where people rush in to buy when it’s expensive and sell when it’s cheap. Meanwhile, anyone running a normal household budget would rightfully tell you to do the complete opposite!
As contradictory as it may sound, just because something soars in price more than 4,100,000% (!) in less than seven years, doesn’t mean that it’s overvalued by definition. So let’s stop talking about Bitcoin’s price and instead ask the more profound question: “What is the fundamental value of one Bitcoin?”
Valuing Bitcoin as a company
The process of evaluating any asset is somewhat simple.
You discount the remaining value of future cash flow of the expected lifetime back to today. This is very simple for a bond with a fixed coupon. While it’s more difficult for stocks since you’ll be owning the stock in perpetuity and the cash flows are not fixed, the method is very standardized and easy to implement.
But what is the valuation of a currency?
It seems obvious to say that $1 is…well, $1. However, a more appropriate way could be to say that $1 is €0.89 or perhaps even 0.6 gallons of gas. Regardless of how you want to measure it, the first step is to quantify it based on the unit of measurement you want to use. In this situation, we’ll simply measure the value of Bitcoin in USD.
So since Bitcoin doesn’t have any cash flow to discount, how do we come up with a valuation for it?
One approach is to compare this to the utility of the currency. This is what we do with oil since a barrel of crude oil can be refined and used for a variety of purposes.
In other words, if you believe that the utility of Bitcoin is to ease the transactions costs for money transfer to practically 0, then we need to take a look at the processing fees worldwide.
In the bestselling book, “The Age of Cryptocurrencies,” authors Paul Vigna and Michael J. Casey came up with an estimate 2017 of 300B dollars.
Based on the valuations and margins of companies like VISA and Mastercard, a company that could solve the problem for processing fees with modest fixed costs would be valued within the $1.5-2.0T range.
With just a little over 16 million Bitcoins in circulation, the true value of each would, therefore, be around $100,000.
Valuing Bitcoin as a tool for storing value.
Bitcoin is often referred to as “digital gold” – and for good reason. This is because of the deflationary nature of the currency.
Unlike our current monetary system, where money can be printed out of thin air, gold and Bitcoin have a more predictable supply that has the history of being a safe haven against inflation and unstable governments. I’ve recently written a Yahoo Finance article about Bitcoin and Inflation Tax that explains this in detail.
Currently, the valuation of all gold ever mined is $7.5 Trillion. Equating that to the aggregate value of all Bitcoins would make the price of just one closer to $500,000. Surprised? I surely was when I crunched the numbers.
Some experts, including Hedge Fund Manager Mark Hart, even argues that as a medium to store value, Bitcoin could also be compared to various levels of the US money supply. Depending on whether you define the money supply as checking accounts, money market securities, or even US treasuries, even a $500,000 valuation would be inadequate.
Clearly, this would require Bitcoin to completely replace the monetary system, which even the biggest enthusiasts of the new digital currency deem highly unlikely. Nonetheless, the message is clear: “As a tool to store value, the current price of Bitcoin of $2,500 would be highly undervalued.”
So what do I think is the correct valuation of Bitcoin?
For me, the utility of the currency is a mean to store value and an instrument to mitigate transactions fees. Whether or not the price of Bitcoin will soar to $10,000, $100,000 or even $500,000, I think it’s evident that we will eventually enter a more efficient currency system that reflects the time we live in.
Monetary systems have always changed throughout history. This was most recently seen in 1971 when Nixon took us off the gold standard.
However, what is not clear at all is when a new monetary system will materialize and in what form and shape. It would likely be more digital than the present system. Whether or not it will be built around Bitcoin remains very unclear.
Therefore, I also find good arguments on why the fundamental value of Bitcoin might go lower than the current price, and why it might eventually drop to $0 as time goes by.
Why the value of Bitcoin might be $0
I’ve recently had the pleasure of speaking to Christopher Whaler about his newest book, “Ford Men.” He has been studying Ford Motor Company for years, and one of the things that really stood out in our discussion was when he told me that while it seems obvious today that Ford would be successful, it wasn’t all clear in the first few decades of the 20th Century.
More than a century later, the dust has settled, and companies like Ford, GM, and Chrysler appear to have come out on top in the car industry. But the road to their success has been filled with dealing with major problems for the American car industry.
Despite the success of the car, hundreds of car manufacturers have gone bankrupt. In fact, even the Big 3 that have weathered the storm have taken multiple hits with Chrysler’s painful merger with Fiat as the best example. In other words, the concept of cars has been way more successful than the individual car manufacturers.
You probably see now where I’m going with this train of thought.
As much as I love the idea of cryptocurrencies, why would Bitcoin be assumed as the choice for everyone eventually? its projected popularity does not seem like a logical reason to back up this assumption. There remains the possibility that perhaps the cryptocurrency that we’ll all be using in 30 years’ time haven’t even been invented yet.
Some people might even argue that Bitcoin is only a short-term phenomenon and merely a spin-off of the blockchain technology that might rightly take its place as one of the main protocols online. It’s the technology that society actually values. This means that the coin itself would turn out to be almost worthless in the end.
What do you think? What is the value of Bitcoin? Share your comments with us below.
Check out this article and other similar posts on my Finance Blog.