How to Value Bitcoin – 2 Simple Methods

How much should 1 bitcoin (BTC) be worth? 

With most assets like stocks and real estate that produce cashflow, you can use mathematical formulas to derive an intrinsic value. Bitcoin is more of a commodity/currency which makes it less straight forward and requires a different approach.

As of this post, bitcoin sits around a price of $47,000 USD. For an asset that was created 13 years ago and worth essentially $0 at that time, it is one of the best performing assets of all time. Lot’s of people have made a ton of money from bitcoin!

Of course, reminiscing on the whole “if only I invested $1000 back in 2010, I would be rich today” is pointless. People care about the now, as they don’t have a time traveling machine (hit me up if you do).

With any investment, to make money, risk needs to be taken. With any risks taken, you can win or lose money (there are never guarantees). Therefore, if I’m buying bitcoin as an investment now, I want to think about the potential for the asset value and see if it still is a good risk to reward.

If someone says “bitcoin is going to a million USD”, that doesn’t help us at all. We want to know why and how bitcoin could get to a million USD. If you agree with the premise and theory, that is when you can decide to gain exposure to the asset class or avoid it entirely.

There are usually two main ways that I look at backing into the value of bitcoin (other cryptocurrencies are different based on their complexity). The first thing you need to determine is if you think bitcoin acts more as a currency or a store of value like gold.

The reason that is important is because I tend to value it more like digital gold and therefore use the following two methods below. If you see bitcoin more of a currency, then the below options make less sense to derive a theoretical intrinsic value.

I’m more in the digital gold camp because that is how I personally use it and see others use it. While bitcoin was created as an e-cash, the issue I see with it right now is scalability and the ability to transact in a cheap way (this may change over time). I mean even the government treats it from a tax standpoint as property (but then again I think that is mainly because they want to collect taxes on the upside gains lol).

I think the main thing that draws people to bitcoin right now is that it is scarce by design, easy to transfer, easy to store, it can’t be duplicated or faked, and it can’t be influenced by governments. In a world that is becoming more dependent on software, having a digital store of value makes a ton of sense.

This chart from Investopedia does a good job of highlighting Fiat vs. Gold vs. Bitcoin.

Let’s dive into two ways I like to look at bitcoin’s value.

Store of Value (Gold Comparison)

If we conclude that bitcoin is a better digital version of gold, then we can compare the value of the gold market to see the potential that bitcoin has if adopted in a similar fashion over time.

The estimated value of gold that is mined currently sits around $10 to $11 trillion USD. 

In regards to broad money, all currencies out there are valued around $96 trillion USD. As for national net worth (value of all countries’ assets minus liabilities) we get around $418 Trillion. So gold is around 2.5% of the world’s net worth of value.

The idea that gold and bitcoin is comparable means that we can back into a long term upside target by making some simple assumptions of total % of the world’s assets being held in bitcoin.

As of now, the total value of cryptocurrency as a whole is $2.2 Trillion.

While the total market cap of all cryptocurrencies is around 21% of the market cap of gold, if we focus on just bitcoin which holds a current dominance of only around 40% of all cryptocurrency for a market cap of $885 Billion.

So if your belief is that bitcoin can get on the same level of gold eventually (if adopted as a global standard), then we would assume bitcoin could reach a total market cap of $10 trillion.

The Tokenomics of bitcoin is that the max supply will only ever be 21 million, but current circulating supply is around 19 million. That’s not factoring in that there is probably a ton of bitcoin out there that is lost or locked up in wallets that can not be accessed 🙁

Let’s use the full 21 million in our calculation to be conservative, even though that supply isn’t expected until after 2140 (anyone reading this probably won’t be around unless we can all become cyborgs).

At $10 trillion, that puts bitcoin around $476K per bitcoin. That is potentially a 912% return from today’s prices! Of course how long will it take bitcoin to reach the same level of acceptance as gold? 

I unfortunately don’t have that answer 🙂

Through some simple assumptions, you see how we have backed into a value instead of just looking at previous price action and drawing some lines on a chart. This reference point tells us the market still has room for growth.

Stock to Flow (Scarcity)

The idea behind stock to flow (S2F) is that it shows you the scarcity of an object based on it’s current supply and it’s rate of yearly production.

The formula: Stock/Flow

Easy enough to remember!

If we take gold as an example, it has a S2F ratio of 62. That means that it would take 62 years of current production rates to produce as much gold there is currently in supply. The higher the number means the higher the scarcity. The thought is all things constant, if the scarcity is increasing that the value of that asset should also increase.

Bitcoin has one nice thing over gold. The supply and production rate at all times is known and public. With gold, it’s hard to understand the potential reserves underground, the exact current supply, or get an exact number for annual production (so the S2F of 62 has some assumptions).

The entire supply and production is programmed into the bitcoin protocol, so at any point in the past, present, and future we can calculate S2F. 

Current S2F ratio for bitcoin:

18,920,025 Stock / 657,000 Annually produced Bitcoin = 28.8

That means that gold actually has a higher scarcity rate than bitcoin right now.

The kicker though is that over time we have halving cycles. This means that the rate of bitcoin production is cut in half every 4 years. Because of that, the scarcity and therefore the S2F ratio is programmed to increase over time.

In 2019, a mathematical equation was created to back into a value for bitcoin based on a certain S2F ratio.

ModelPriceUSD​=exp(−1.84)⋅SF3.36

That means that you can theoretically plot what the price of bitcoin would look like for the past, present, and future as well (exactly what was done).

Site to access above chart.

This is the famous stock to flow chart that shows us how the past price action in bitcoin through the halving cycles has been correlated with an increasing S2F ratio. Some people in the online communities take this chart as gospel. 

I definitely will use it to get a reference point as it may be a self fulfilling prophecy and it’s a quick way to gauge the timing of halving cycles.

It has proven so far to be a relatively good prediction model. What’s the downside?

It was created in 2019. We could be seeing a coincidence that the price has so far correlated nicely with the chart (back testing to the creation of bitcoin) and derived mathematical formula. 

I mean if it didn’t correlate so well, we wouldn’t even be talking about this method of valuation to begin with.

So it’s hard to say that it 100% follows the price predictions because realistically 10 years of data is a small sample size. There are other factors outside of scarcity at work to determine what people are paying for bitcoin.

Conclusion

Any method you come up with to calculate an intrinsic value for bitcoin is going to be based on assumptions. The only thing you can really do is manage your risk. Crypto in general offers high potential gains, but with that has higher risk and volatility. 

As they say “got to risk it to get the biscuit”.

Hypothetically, if one day quantum computing is able to brute force wallets and the security of bitcoin which is it’s biggest strength, the value would disappear overnight (of course at that point then nothing online in regards to security is probably safe). At the same time, the protocol can be changed (as crypto is upgradeable) in order to deal with foreseen issues on the horizon.

So if you risk 1% of your worth in crypto and it doesn’t work out, not the end of the world (but you are potentially looking at a 9 bagger which is pretty good from a traditional sense). If 80% of your net worth is in crypto and it tanks because of some unforeseen reasons…then that is what you have to live with.

Have I mentioned the importance of risk management enough yet? 🙂

Leave a comment below on your favorite valuation method or where you think bitcoin will be by the end of 2022!