Bitcoin valuation methods


Dec 31

Many economists and market modelers have argued over whether or not Bitcoin can be valued. Having considered many of the models, I think there are a few strong candidates out there regarding valuation.  The candidates are, as follows:

The “Call Option” Model
The call option model makes few assumptions on the future price or price trajectory. It basically assumes that the price is random or at least chaotic between a high and a low. Because you can lose at most 100% of your money and make multiple of your risk then the price or (value) is similar to a call option. An important attribute of this model is that the more volatile that Bitcoin becomes then the greater the potential return. One way it differs from an actual call option is that the product doesn’t expire. This model is useful because it requires basically no statistical or other sorts of assumptions. However, one can attempt to bound the high and low using statistical methods to fine tune the value.

The “Network Effect” Model or Metcalfe’s Law
FundStrat co-founder Tim Lee has stated that 94% of Bitcoin’s movement over the past several years can be explained by this one variable. This is a very interesting thesis and seems well reasoned. A problem is that it is often possible to find the factors that drove price in the past and yet to disappointingly discover those factors break down in the future.

The Gold Model and the Replacement Theory Model
The famed Winklevoss twins have often cited that the proper model for Bitcoin is actually gold. In this model, some percentage of the world’s funds stored in gold will flow out into Bitcoin. In general, this is what I think of as a “replacement model” where a limited supply of fiat currencies compete for various investments. The WorldBitcoin Price Modeler is an excellent calculator that allows one to experiment about the various industries that Bitcoin might disrupt.

The Marginal Production Cost Model
A facet that cannot be forgotten is that Bitcoin is mined which cost real dollars. Marginal production cost models are useful because they provide a theoretical floor that Bitcoin would be unlikely to fall below. They might also suggest unfair high prices where miners might be encouraged to bring online extra supply. A problem with these marginal production models is that the network is adaptive to the load and miners face a high risk in the pursuit of their mining profits which are important and complex factors that should not be lost but may be difficult to compute.

The Revenue or Dividend Model
Many economists feels that Bitcoin can’t be valued or that it’s true value is zero because it doesn’t have any sort of revenue stream or dividend. I speculated in a recent post that this could be resolved conceptually by redistributing a portion of the transaction fees to the holders.

Price Based Models
Price based models are typically going to be regression or trend based. They make no assumptions on the causes but instead attempt to extrapolate the future from the historical price data. While these models might explain the price, they are unlikely to explain the reason, which most would agree is important for valuation versus pricing.

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