I’ve done a lot of reading up on crypto currencies and blockchain the past month—not because I want to invest in it, but because I find it fascinating and potentially life-changing. Just last week I was traveling internationally and I can’t tell you how many times I thought to myself “this would be so much easier if everyone was using a Bitcoin app on their phones.” I have no idea if Bitcoin is the MySpace or the Facebook of the cryptocurrency future, but it’s fun to learn about either way. One thing I haven’t seen much of is people attempting to value Bitcoin.
I’ve read plenty of logical sounding arguments for why Bitcoin will be $20,000 or $50,000 in 10 years, but those people rarely mention the discount rate that needs to be slapped on those estimates. Even if you’re a Bitcoin bull, you have to admit it’s an incredibly risky asset and there’s a chance it’s worth $0 at some point in the future. Given that, a high discount rate is required. When I value profitable, growing public companies that have little debt on their balance sheet I use an 11% discount rate. Thus, I’d say any discount rate on a Bitcoin valuation needs to be significantly higher than that—maybe 30-40%—though I wouldn’t fault anyone for going even higher.
One way to value Bitcoin is to think about what markets it might affect the most and what share it could take in each of those markets. In my opinion, it makes the most sense for Bitcoin to have a noticeable impact on remittance, e-commerce, the black market, and gold. Below are the estimated current global markets of each of those:
- Remittance – $500 billion
- E-commerce – $2 trillion
- Black market – $15.2 trillion
- Gold – $2.4 trillion (investable gold that is)
Your guess is as good as mine as to what market share Bitcoin could eventually take, but assuming it’s successful, below is one guess. Whether it’s conservative or aggressive, I don’t know.
- Remittance – 25% share
- E-commerce – 5% share
- Black market – 15% share
- Gold – 10% share
The final two factors are how long it takes Bitcoin to achieve the above market share and what discount rate is appropriate for how risky of an asset Bitcoin is. Below is a chart that shows what the current market cap of Bitcoin should be if it achieves the above market share in 5 years, 10 years, 15 years, or 20 years and then each of those values is discounted back to today at a rate between 20% and 50%.
So if you thought my market share estimates were reasonable and that they can be achieved 10 years from now (9/13/2027) and a 30% discount rate is justified, then you’d estimate Bitcoin’s market cap should be $199 billion today (vs the actual market cap which is $55 billion).
A simpler way to think about Bitcoin is to look at the global money supply ($81 trillion) and take a guess at what percent of that Bitcoin can eventually take. For reference, Bitcoin’s market cap today is roughly 0.07% of the global money supply, which is pretty meaningful in my opinion. The below three charts show what Bitcoin’s current fair value should be based on it taking anywhere from 0.1% up to 25% of the entire global money supply over the next 5-20 years. The first chart uses a 20% discount rate, the second a 30% discount rate, and the third a 40% discount rate.
Similar to before, if you think 30% is an adequate discount rate, you’d focus on the middle chart. Then, if you think Bitcoin can take 5% of the entire global money supply in ten years (9/13/27), your estimate of fair value for today would be $294 billion (again, vs $55 billion today). In that case, you’d probably be a buyer 🙂 If you think Bitcoin either won’t achieve meaningful share of the world’s money supply and/or you think it’ll take much longer (20+ years), you probably aren’t a buyer at today’s price.
It’s interesting to look at how much of an effect the discount rate has. I can’t imagine someone convincing me Bitcoin deserves a discount rate lower than 20%, but I could probably be convinced that it deserves to be much higher (50%? 60%?). In that case, it becomes almost impossible for today’s price to be justified.
Now I have no idea what discount rate is justified for an asset like Bitcoin and I have no idea what market share it will take in the future, but I think it’s helpful to look at the above charts to at least have an idea of what is baked into today’s price. In my eyes, it looks like the market is currently pricing Bitcoin as if it’s going to take notable (but not massive) market share in the world’s movement of money sometime in the next 10-15 years. It’s interesting to note that it’s very possible for Bitcoin to be wildly undervalued or overvalued at today’s price—I guess that explains that wild price swings.
Are there any readers who are invested in Bitcoin and/or are more knowledgeable about it than I am? If so, I’d love to know if anything I said is way off base.
8 thoughts on “How to Value Bitcoin”
Thanks for sharing your thoughts. I also have been reading a lot on this and still can’t make my mind on why bitcoin is so hyped. Anyway I just had following thoughts that I wanted to share and would like to know how you think about it.
1. In your calculation for any market (for example e commerce market of 2000B), actual bitcoin required will be much smaller due to multiplier affect that you get from money velocity. Comparison with money supply seems more fair to me but I thought total money supply was much smaller. Anyway challenge in replacing global money supply with bitcoin is that governments are not going let this power go away easily. And practically global single currency system is not going to work if we look at Euro.
2. More of a fundamental question: currently miners validate the transactions as they get rewarded with new bitcoins. As it gets more and more difficult to get new coins, would it be economical for miners to mine? If not, who will verify the transactions and how will it work? If miners don’t verify it, who else and why? Sorry for my limited knowledge but so far my research has not helped in finding answer to this.
Thanks for the comment.
1. It will be interesting to see if the government steps in and how so–I have no idea how to handicap the odds of that happening. My source for the $81 trillion is here: http://money.visualcapitalist.com/all-of-the-worlds-money-and-markets-in-one-visualization/
2. My research so far has focused on the high level stuff (pros and cons of cryptocurrency, what markets it will affect if it takes off, etc). I understand the basics of how it all works, but not at a deep level. Thus, I’m not the best person to ask for more tech-oriented questions.
interesting stuff, i think finding a way to fundamentally analyze crypto is the next stage of investing. hopefully will lead to shakeout of the worst speculators/uninformed gamblers. here’s a great link to some of the leading minds in fundamental analysis of crypto
Finally got a chance to listen, thanks for posting. Interesting that the one person who mentioned discount rate suggested 25%.
Replying to your direct message. No. Although simply valuing something with no intrinsic monetary value (per lack of cash flows) or useful value (like toilet paper or water) that has a very limited existence with a discount rate of 35% 20 years into the future is bizarre. And then estimating (generous term) how much of each exchange market it might effect compounds the guestimation. It’s guessing – that’s the gist. I’m simply chuckling at the attention bitcoin is getting – and from the likes of “investors” and then the cognitive dissonance that appears once the endowment effect is firmly set in.
I actually hope you are dead on and I’m the one making silly comments – it would turn out much more educational that way (and you’d probably be rich!)
Appreciate the response. Just to be clear, I am not invested in Bitcoin and have zero intention to do so. If anything, this post proves I have no business investing in it 🙂 I just think crypto and the block chain are fascinating technologies to learn about. I agree that my estimates are complete guesses (aren’t all company valuations?) and that Bitcoin is a weird thing to attempt to value, which was the point of this post. But I don’t know a better way to value it other than taking some guesses at what it could achieve if it’s successful and then discounting that back to today.
I don’t expect anything I estimated in this post to come true, but it’s an interesting thought experiment in my opinion. I do think those simple money supply charts can help with how to directionally think about the valuation. If those charts showed that Bitcoin needs to eventually be 10% of global money supply to justify today’s price, I’d say it appears way overvalued. However, it looks like an investment in Bitcoin can potentially work out well if Bitcoin gains low single digit market share (which at least sounds reasonable, who knows).
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This reminded me of Bitcoin Valuations: In the early 1980s AT&T asked McKinsey to estimate how many cell phones would be in use in the world at the turn of the century. They concluded that the total market would be about 900,000 units. This persuaded AT&T to pull out of the market. By 2000, there were 738 million people with cellphone subscriptions. http://andrewchen.co/bad-product-fallacy/
I compare it to a company All crypto is worth about as much as Cisco or the GDP of Cuba – not that much in the overall scheme of things…
As an investment asset – if all or even a few investors decide to hold 0.5% or even 1% of their portfolio in crypto – it will go to the moon and stay there….
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