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Bitcoin valuation and the Gold price (4)

by | Jan 13, 2020 | 0 comments

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Bitcoin is a medium of payment but its core price is based on the  store of value concept that makes it comparable to Gold

Bitcoin  is not yet fully used as a medium of payment (number of Bitcoin users as a mean of payment is estimated at roughly and only 30 million people all over the world) because of somewhat high average transactions fees, especially for low criticality transfers and long validation periods (several minutes). In this article, we’ll be focused on a Bitcoin analysis as a store of value (see the article published 21 November 2019) and as a transaction value.

Bitcoin and Gold are both stores of value – Pricing  Bitcoin compared it to Gold

As a store of value and scarce asset (number of bitcoins issued limited to 21 million units by 2140), the crypto currency would then act as ‘Gold 2.0’ as we have mentioned in the previous article. By continuing to compare Bitcoin and Gold, let assume that the total value of all bitcoins in circulation   (equivalent to the market capitalization for securities) would equal the total value placed in Gold .

Assuming this, the bitcoin’s value would then be the result of the following equation :

= (Value of Gold x market share in %)/number of bitcoins in circulation

Assuming that the total amount of Gold is close to USD 9400 billion  (on the base of a Gold price at \$1550 as at January 3, 2020) and that the total number of bitcoins that have been created  is roughly 18 millions , we get the following figures (see the table below for different market shares) :

In other words, assuming that the current market price  of \$7450 and a market capitalization of USD136 billion , Bitcoin only represents a little bit less 1,5% of the total value of Gold (or 136/9400).

As shown by the above table, and taking the assumption of a Bitcoin that would represent  5% of the total value of Gold (meaning that the Bitcoin and other crypto currencies investments would represent  an average 5% of all investments), the unit value of a bitcoin would be about 26 000\$

Bitcoin pricing if its use becomes transactional

If Bitcoin becomes a transactional mean (largely used to carry out transactions) and combined the functions of storing value and the one of medium of payment, let’s have a look on how to price it by using the well known quantity theory of money equation :

MV=PQ

with

M : the quantity of money in circulation

V : velocity of circulation of money  (the number of times money ‘changes hands’ over a certain period)

P : the price of money

Q : the quantity of money

Through this equation, the Bitcoin value can be estimated by forecasting the demand generated by the underlying resource distributed by the network (product PQ could be equated to the network revenues), divided by the available monetary base (in bitcoins).

Transactional value

The former equation may be summarized by the equality Supply= Demand with supply consisting of available money multiplied by velocity of circulation of the money (MV) and the demand that is equivalent to the wealth produced by the network (PQ). So, the monetary mass should equalize the network value creation   (as for fiat currencies that should equalize the macro total Gross Domestic Product).

About the Bitcoin velocity, it is difficult to estimate a good assumption given its very high volatility . It is therefore obvious that its velocity used to be higher than the velocity of traditional currencies (fiat) because of infatuation and strong speculation. Then, a velocity 7 to  8 times larger than one of Fiat monetary mass seems credible.

Without elaborate too much about the needed calculation for this approach, but  :

1/by combining a Bitcoin velocity level (assumption of 7.5x greater than the  dollar US velocity)

2/ By estimating a share of the total GDP generated by the Bitcoin network,

We do obtain a price of  \$25 000 \$ per Bitcoin unit, knowing that this value is very sensitive to the different parameters

Total value = Store of value  + Transactional value

If Bitcoin becomes more widely used as a store of value and as a transactional tool, the approach is simply to add both valuations. By combining and give more details to the formula, one way to express is to calculate the average velocity for each of the two uses, weighted by the demand associated with each use respectively The Bitcoin’s velocity would then be expressed as follows :

V= (storage value x demand ‘store of value’) + (transactional value x demand ‘ transactional value’)/ (demand ‘store of value’ + demand ‘ transactional value’)

The benchmark ‘store of value’ is expressed by a market share of 5% of the Gold value (hypothesis as mentioned before) equals to \$ 470 billion.

Assumptions for the transactional value are considering a network that represents 4% of the total GDP  (\$3170 billion), given a Bitcoin network GDP (revenues) of \$3550 billion with an average velocity of 3

So,   V= (470+(3×3170))/3550=2.81 that gives Bitcoin market cap of 3550/2.81=\$1263 billion  and, Considering the 18 million bitcoins in circulation , Bitcoin value must be equal to 1 263 000/18= \$70 166   a superior price to the simple sum of the store of value (linked to Gold) added to the transactional value, as calculated before (26000\$+25000\$).

Conclusion

All the calculations tell that Bitcoin price  has a room to rise if we consider its potential to replace (or ‘co replace’) Gold, the traditional asset haven / store of value, and also the potential function of transactional value of the first crypto currency.  Obviously, one can bring criticism to the calculations given assumptions that are used, and can bring criticism because other competing protocols and crypto currencies are not taken into account.

Tough Bitcoin has a legitimacy and is now a benchmark in this new digital asset class, Bitcoin could be tackled with success by some other projects. It has been the case with Ethereum in some extent. Of course, this potential scenario could reduce the intrinsic and fundamental value of Bitcoin.

A passion : Economics, behavioural finance and emerging digital assets

Yves started his career in the asset management in 1986 where he worked at different positions as manager of equity funds and diversified funds. at Crédit Commercial de France and later, at Barclays group in Paris. In 1998, he took the lead of equity funds and diversified funds, then of the whole fund management business at the French team of the Dutch Robeco group  before joining Natixis Asset Management in 2012 as Director of the Equity Investment business unit. Yves left Natixis AM in 2018 to start as an independant player for professional investors and corporates (advisor and fund raiser).

He likes to engages in sports that test his endurance like running and swimming, Yves is also fascinated by social sciences, and more specifically by history and economics. But this is the economics mechanisms behavioural aspect and the markets behavioural analysis that are a constant source of thought and discussion. Since few years, the blockchain issue and emergence of crypto assets is a new field of passion and opportunities for him.

Yves Maillot

Financial markets and asset management

Yves Maillot

Financial markets and asset management

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