For extra on crypto valuation, learn Valuation of Cryptoassets: A Guide for Investment Professionals by Urav Soni and Rhodri Preece, CFA, from CFA Institute Research and Policy Center.
“On behalf of the professional investment community, I am respectfully asking any crypto expert to put together some cogent, coherent concept of how to make buy and sell decisions in a cryptocurrency portfolio.” — Franklin J. Parker, CFA, “Crypto’s Unanswered Query: At What Value?”
Introduction
Earlier than diving into the bitcoin valuation job, we should first acknowledge that that is no strange enterprise. In contrast to conventional property corresponding to shares and bonds, bitcoin lacks the everyday traits required for conventional valuation strategies. It doesn’t generate money flows, pay dividends, or in any other case supply yields, and thus could also be extra paying homage to commodities, that are each cyclical in nature and notoriously tough to worth. However, there are quite a lot of smart frameworks by means of which to view this evolution in cash and finance.
So, in response to the query posed by Franklin J. Parker, CFA, listed here are 4 bitcoin valuation strategies that spotlight other ways of exploring the cryptocurrency’s price and supply insights into this nascent but highly effective expertise.
1. Evaluate It with the Alternate options
One solution to gauge bitcoin’s worth is to find out what asset lessons or securities it competes with and evaluate their potential worth.
So, to increase our commodity metaphor, the place does bitcoin — so-called digital gold — stand relative to precise gold? Each are fixed-supply, counterparty-free property with uncommon and fascinating financial traits and utilized by buyers as long-term protected havens for capital preservation. At present, gold has a market capitalization of roughly $11.5 trillion.
If bitcoin reached an analogous market capitalization, then the worth per coin would exceed $500,000.
Bitcoin Valuation: Alternate options Comparability
Sources: Glassnode, World Gold Council, Buying and selling Economics, Savills, Visible Capitalist, and Sound Cash
In fact, bitcoin has one thing of a technological edge over gold. It’s digital, decentralized, and free from authorities affect. So, if its market capitalization reaches $11.5 trillion, why wouldn’t it cease there? And is gold its solely competitors? Couldn’t bitcoin stand in for different monetary collateral and store-of-value property like world bonds and even residential property?
To make certain, definitive solutions to those questions are elusive, however looking for them can improve our understanding of bitcoin, bitcoin valuation, and the crypto phenomenon extra typically.
2. Base It on Manufacturing Prices
We hear on a regular basis in regards to the electrical energy and gear required to mine bitcoin. These related bills present one other technique of figuring out the cryptocurrency’s worth. Whereas estimates of those prices are extremely variable and inevitably inaccurate, Cambridge University researchers have compiled some of the most reliable data.
Bitcoin Manufacturing Prices
Supply: Capriole Investments. Created with Information Wrapper
In fact, bitcoin is a store-of-value asset and another financial expertise. However few customers are pricing bitcoin primarily based on the latter high quality. That’s why bitcoin manufacturing prices serve a objective much like these of gold: They set a ground on the worth, which may also help decide whether or not the underlying is undervalued. Traditionally, bitcoin’s value has tended to backside out at round its manufacturing value, as within the second half of 2016, the primary half of 2019, March 2020, and the second half of 2022.
By serving to decide whether or not bitcoin is undervalued, manufacturing prices are a important enter to its valuation. However since they will hardly quantify the upside value potential related to bitcoin’s financial premium, they’re additionally a restricted enter.
3. Have a look at the US Greenback
So, how will we worth bitcoin’s financial premium? Instead financial expertise, bitcoin needs to be assessed within the context of the prevailing financial system: the US greenback. Actual rates of interest, cash provide development, and financial coverage, amongst different elements, all affect bitcoin’s valuation.
Elevated actual rates of interest and constrained cash provide development are indicators of sound financial and financial coverage. They assist gauge whether or not the authorities are defending the worth of the greenback. Such elements ought to represent headwinds for bitcoin costs. If policymakers are taking care of the prevailing financial regime, buyers are much less prone to search for another.
For Bitcoin Valuations, Greenback Coverage Prudence Issues
Sources: Glassnode, Google Finance, and Sound Cash
In fact, financial policymakers usually undertake profligate measures that debase the worth of the greenback. The quantitative easing (QE) and different financial stimulus of the final 15 years created low and unfavorable actual rates of interest and fast development within the cash provide. These had been preferrred situations for bitcoin and fueled the crypto growth.
Underneath tighter macro situations, bitcoin is much less invaluable. Underneath unfastened situations, it’s extra invaluable.
4. Measure the Conviction of Bitcoin Holders
Taking a extra behavioral strategy, we will additionally consider the underlying conviction of long-term vs. short-term bitcoin holders for clues to bitcoin’s worth. The share of long-term holders tends to extend throughout bear markets and reduce throughout bull markets.
Lengthy-Time period Bitcoin Holder Percentages Point out Underneath/Overvaluation
Sources: Glassnode and Sound Cash
This means that bitcoin is overvalued when short-term speculators maintain extra of the provision and undervalued when long-term holders predominate.
These accustomed to discounted money flows, price-to-earnings ratios, and different conventional metrics might discover bitcoin valuation strategies unconventional. However unconventional or not, they provide a solution to transfer ahead. The outputs and outcomes might range, however that’s no shock on the subject of rising and doubtlessly transformative applied sciences.
Bitcoin’s many detractors may very effectively be proper. Bitcoin and crypto on the whole may all finish in failure, with an intrinsic worth of successfully zero. However crypto advocates may be on to one thing once they anticipate bitcoin changing into a world reserve asset.
Few property have ever sparked such divergent opinions. Because the monetary business delves deeper into the crypto-valuation query, we should always keep in mind that the printing press, the steam engine, the web, and different revolutionary applied sciences have at all times been tough to worth, notably of their early phases. However these improvements ultimately reworked the world in methods individuals didn’t initially think about. Crypto might do the identical. Or it might not. We’ll simply must see.
For extra on this subject, try Valuation of Cryptoassets: A Guide for Investment Professionals by Urav Soni and Rhodri Preece, CFA, from CFA Institute Research and Policy Center.
Should you favored this submit, don’t overlook to subscribe to the Enterprising Investor.
All posts are the opinion of the creator. As such, they shouldn’t be construed as funding recommendation, nor do the opinions expressed essentially mirror the views of CFA Institute or the creator’s employer.
Picture credit score: ©Getty Pictures / Vertigo3d
Skilled Studying for CFA Institute Members
CFA Institute members are empowered to self-determine and self-report skilled studying (PL) credit earned, together with content material on Enterprising Investor. Members can file credit simply utilizing their online PL tracker.
