As Bitcoin’s Price Whipsaws, What’s Its Value?

Bitcoin’s has had a notable run in recent months. During the lows of pandemic in the March it traded below $5,000. Then in the fall and into 2021 it surged. It hit $20,000 in December, around the peak of the last run in 2017, and then hit $30,000 and following that, $40,000 just this month. However, more recently it’s fallen back slightly from the of recent highs over $40,000.

Valuing Bitcoin

This incredible volatility also means that Bitcoin is challenging to value. Here are a few ways to think about that.

Reflexivity

Part of the challenge with Bitcoin is termed reflexivity. It’s a currency, if everyone wants a currency, then it has value. If no one wants it, then it’s worthless. That’s part of the story as to why the U.S. dollar has generally been a better investment over time than the Zimbabwean dollar. Neither currency has anything backing it, but the popularity of the U.S. dollar reinforces its value. The Zimbabwean dollar not so much.

This creates a challenge for Bitcoin and can lead to the spirals of fear and greed. If it’s price is rising then that’s good for its popularity, if it’s falling in price and therefore popularity, then that’s bad. As you can see, the valuation gets pretty circular.

Of course, stocks have emotions associated with their trading swings as well. Yet, stocks have fundamental value stemming from assets and cash flows. Bitcoin doesn’t offer that.

The Lindy Effect

The Lindy effect can be helpful too. Basically, the longer Bitcoin lasts, having not been hacked and remaining useful, so our confidence in the currency may increase. Again, like reflexivity, it shows us just why volatility is high with Bitcoin, if it’s surging that’s a reason for optimism, if it’s falling that’s a reason for pessimism. Also, with supply of Bitcoin governed by rules, the laws of supply and demand don’t supply as they would for many other investments. No one can create more Bitcoin simply because the price is high, on the other hand, supply can’t be withdrawn to prop up the price if it’s low.

For example, SPACs are seeing a great run at the moment. What are investment bankers doing? Well, perhaps unsurprisingly, there’s working on churning out perhaps hundreds more SPACs. That may not bode well for that particular investment vehicle at some point in the future.

That same dynamic can’t happen with Bitcoin. With the 2017 rally we saw a number of other crypto-currencies launch in ICOs, but that’s a slightly different dynamic and we haven’t seen that trend to the same extent in 2020-21, largely as most ICOs failed.

The Gold Comparison

One comparison that is useful with Bitcoin is gold. Neither gold nor Bitcoin are productive assets. Both are scarce. They are both potential mediums of exchange and stores of value. In fact, you can argue Bitcoin may be a superior medium of exchange than gold. Investors hold gold almost as insurance, if inflation ramps up of chaos breaks out, gold can be a good asset to own. The same argument, and others, can be made for Bitcoin.

Of course, the criticisms of gold apply to Bitcoin too. Gold doesn’t intrinsically do, or earn, anything. Own a farm, and it will produce over time, whether that’s milk, crops or cattle. Farming has produced wealth for centuries, so there’s value in a farm. Even if the market doesn’t agree with you on what your farm is worth, you can still sit back and collect the income from a farm, or even a company, or a bond. Basically any assets paying you money in some form is reasonably easy to value and compare with other assets.

That’s not true for gold and Bitcoin. The only value is what someone else is willing to pay. It’s necessarily a more speculative investment.

Relative Valuation

So where is Bitcoin compared to gold? Today all Bitcoin is worth around half a trillion dollars. That’s very roughly the market value of a company like Samsung or Facebook. It’s about half the total value of silver and about 5% of the estimated total value of gold in the world.

So if you view Bitcoin as a viable replacement to gold, then the crypto-currency does have a very long way to run, though remember too, gold has been around for many centuries, Bitcoin’s lasted about a decade.

However, if there’s one thing we know about Bitcoin, because it’s so challenging to value, a lot of price volatility should be expected. That obviously cuts both ways as we’ve seen this week.