Valuing Bitcoin: Ticket to the Moon vs Rat Poison
How do you value a Bitcoin? Can you measure what it's actually worth? Super important questions, particularly with the price recently breaking above $10,000 and the bulls coming out reiterating seemingly crazy price targets, often upwards of $100,000. How do they reach these targets? To understand the answer to these questions, let’s start with the worst case and best case scenarios. The ultra-bear and ultra-bull arguments. The reality will likely fall somewhere in between and we will look at that too.
The Extreme Arguments...
The ultra-bear case is simple, Bitcoin will go to zero. It’s a ponzi scheme. It’s not backed by anything. It’s a fad. It’s tulip mania #2, It's rat poison squared. Whatever the ultra-bear argument is, it puts the price at zero.
Let’s take the other extreme, “hyperbitcoinization". All seven syllables of it. What if Bitcoin became the defacto currency of the world. What if it replaced transactions globally and was used in every country. What if other currencies ceased to exist and we all live in Bitcoin utopia.
Sounds like someone was smoking something when they came up with this theory but let’s do the math(s) anyway. Global money supply is difficult to measure with accuracy but a quick Google search shows it's estimated by the CIA to be around $80 trillion. There will be a max of 21 million Bitcoins in circulation. If they replace global money supply then $80tn divided by 21m would put each bitcoin at $3.8m.
That’s the most bullish theory out there. Highly unlikely but possible, maybe in a parallel universe somewhere. Given those two scenarios, we can safely value one Bitcoin somewhere between $0 and $3.8m. That’s really not very helpful.
If BTC were a stock then we could do a “DCF" valuation, predicting the future cash flows and discounting them back to the present day. That was part of my old job, a standard day-to-day valuation method for companies. But Bitcoin doesn’t have cash flows, there’s nothing to discount. Bear with me here, it will start to make more sense.
Relative valuation is the other option. The question is relative to what? Let’s start with gold, given "digital gold" is a term often used for Bitcoin. How much is all the gold on the planet worth? The answer is around $3 trillion. So if we value bitcoin relatively to gold, $3tn divided by 21m, puts each Bitcoin at $143,000. This is inline with some of the higher numbers you’ll see from market commentators in the press. Note thats it's all time high was $20,000 in December of 2017.
Let’s look at the same calculation against other assets. Relative valuations at the time of writing lead to the following...
Silver: $52bn = $2,500 per BTC
Amazon: $940bn = $45,000 per BTC
Facebook: $545bn = $26,000 per BTC
Visa: $378bn = $18,000 per BTC
PayPal: $136bn = $6,500 per BTC
USD M0 Money Supply, i.e. $ bank notes: $1.2tn = $57,000 per BTC
1% of Global Money Supply: $800bn = $38,000 per BTC
So what’s the conclusion?
These are all very arbitrary calculations, there’s no clear way to value this asset with any accuracy. However, having some kind of framework (akin to the above) to guide you is important. Hopefully this has shed some light on how market commentators might come up with otherwise seemingly random price targets. If you think Bitcoin is “rat poison squared”, a quote from Warren Buffet, you wouldn’t touch it with a long pole at $10,000. If you think it could be a market similar in size to 1%+ of global money supply, then it looks very attractive. If you believe in “hyperbitcoinization” and it takes 100% of global money supply (disclaimer; I don’t) then it's a ticket to the moon.
One side note, the numbers above assume that all 21 million bitcoins will eventually be in circulation. That’s not actually true, estimates are that around 3 million have been lost and are assumed to be out of circulation. In the next blog, I'll talk about the Blockchain and what it actually is, outside of just "the network on which cryptocurrencies are built". It will also shed some light on how people can actually lose these assets. Remember to subscribe so you don’t miss it.