Bitcoin’s
BTCUSD
impressive rally has brought it to within shouting distance of its fair value. As recently as November 2022 it traded at a 40% discount.
That’s according to the only bitcoin valuation model of which I am aware, which is based on something called Metcalfe’s Law. Claude Erb, a former commodities portfolio manager at TCW Group who has applied Metcalfe’s Law to bitcoin, calculates its fair value currently is just over $27,000 — versus a current price of around $22,000.
Metcalfe’s Law holds that the value of a network is proportional to the square of the number of users. To apply this law, Erb assumes that every bitcoin that has been mined represents one user in the network. Overall, after reviewing the accompanying chart, it’s clear that Erb’s Metcalfe’s Law-based model has done an admirable job of throwing cold water on bitcoin’s extreme highs and providing encouragement when the cryptocurrency drops to unjustifiable lows.
Bitcoin’s future
Since the number of bitcoins that can ever be mined is limited, along with how quickly they can be mined, Erb’s Metcalfe’s Law model is able to calculate what its fair value will be in the future. In 2140, for example, which is when the last allowable bitcoin is projected to be mined, its fair value would be around $74,000, according to Erb’s calculations.
Given where bitcoin is trading today, that’s equivalent to a return over the next 117 years of 1.0% annualized.
When informed of this, investors typically fall into two extreme camps. Those who believe that bitcoin is worthless argue that any fair value above $0 — much less as much as $74,000 — is ridiculous. In contrast, those who believe bitcoin’s potential is a lot higher than $74,000 are sure that this fair value estimate is way too low.
Erb’s model takes a middle path between these two extremes. That’s one reason why it has worked so well. Like any other asset, bitcoin’s price swings wildly between the extremes of bullish euphoria and bearish despair. Any valuation model that avoids those extremes — not just Erb’s model — is therefore at least a step in the direction of discouraging investors from buying high and selling low.
This is key to understanding Erb’s model. In an email, Erb said he doesn’t believe his Metcalfe’s Law-based model is the final word on bitcoin valuation. Instead, he offers it in the same spirit as those statisticians who like to say that “all models are wrong, but some are useful.” His particular model is “a way to anchor a conversation” about the cryptocurrency’s valuation that is sufficiently “intriguing” to warrant our serious consideration.
“If someone wants to come up with a better fair value estimate for bitcoin than Metcalfe’s Law, fantastic,” he said.
I first wrote about Erb’s valuation model in December 2020. So Erb’s invitation to come up with a better fair value estimate is now over two years old. He’s still waiting. In the meantime, according to his model, there is not a valuation-based argument for believing that bitcoin will either rally strongly from current levels or fall precipitously.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com
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