Amun AG, on 7 Unique Metrics of Bitcoin Valuation

When Bitcoin price reached its all-time-high (ATH) in Dec 2017, everyone has fantasized to make heavy investments in Bitcoin to become billionaires. The massive drop in Bitcoin price led to a bear market in 2018, and its price is gradually recovering this year. Apart from technical analysis, valuation enthusiasts attempted to use different methodologies to predict the price movement for Bitcoin in making smart investment decisions.

The valuation of Bitcoin is a deep ocean to be explored. In September Amun AG published a detailed analysis of methodologies in Bitcoin valuation. We have exclusively spoken with Lanre Jonathan Ige, Researcher of Amun AG on the limitations of the traditional valuation approach and some unique metrics for Bitcoin valuation.

In traditional equity valuation, discounted cash flow model (DCF) is the most common approach, in which the intrinsic value of the stock today is based on the projection of how much money it will generate in the future. While the present value of expected future cash flows and discount rate are the key parameters for DCF model, such model has limited applicability in Bitcoin valuation, as explained by Ige below.

Q1: Why traditional valuation approaches like the Discounted Cash Flow (DCF) are not applicable for Bitcoin valuation?

A1: A bitcoin is a not share in a company like an AMZN or AAPL stock are and the network generates no cash flow like a normal company. Therefore, it can’t be valued through the discounted cash flow approach which is predicated on the fact that the asset in question can generate cash flow. Instead, Bitcoin can be understood as being more similar to a commodity like gold which also cannot be valued through a DCF approach. This is not a problem however, as we show in the report there are many alternative ways to value Bitcoin.

The cost approach is another popular method in valuing commodities like gold, in which the price of an asset should be equal to the costs incurred to build that asset. While Bitcoin exhibits certain properties similar to physical gold, there are limitations in Bitcoin valuation using the cost approach in regard to mining difficulty.

Q2: For cost approach, how does mining difficulty of Bitcoin limit the effectiveness of Bitcoin valuation?

A2: One major problem with the cost of mining approach is that difficulty itself is a variable that is affected by Bitcoin’s price to some extent. As we mention in the research report, Bitcoin’s difficulty is adjusted in order to ensure that blocks are mined every 10 minutes on average; cases when the hash rate increases due to an increased interest in mining would bring the average time to mine a block lower. Such a case could often be caused by positive changes in miner’s expectations about their own revenue via the block reward which is itself impacted by Bitcoin’s current price. This leads to a kind of circularity which greatly limits any variation of the cost of mining method.

Amun AG’s report listed out seven key metrics in Bitcoin valuation: market sizing method, NVT ratio method, NVRV method, NVHR method, active addresses method, equation of exchange method and cost of mining method.

Q3: Among all the valuation approaches on Bitcoin stated in your analysis, which approach is the most comprehensive model of Bitcoin valuation and why? Besides, which model is applicable for short term Bitcoin valuation, which one is for the long term?

A3: We prefer to stay away from claiming that any single valuation method is the ‘most comprehensive’ since, as I argue in the report, each has its own strengths and weaknesses. That being said, the Network-Value-to-Realized Value (NVRV) Ratio is an extremely useful tool in ascertaining market bottoms and disambiguating between bull-bear cycles.  

Q4: What’s your view on the correlation of stock indices like the S&P 500 and Bitcoin price? Positive, negative or uncorrelated?

A4: Typically, when we talked about correlations of different assets we talk about the correlations (or lack thereof) between assets’ price returns rather than the price level. As we show in our report, Portfolio Optimization with Crypto, Bitcoin’s returns has generally been quite uncorrelated with other assets such as stocks, bonds, and commodities like Gold. Naturally, the extent of this lack of correlation changes over time and following the escalation of the US-China trade war in Q2 2019, the magnitude of correlations actually increased as investors may have sought safety in Bitcoin.

Market Sizing

In the market sizing method, Amun AG stated that global remittance markets and the gold market can be the comparable markets of Bitcoin. The implied bitcoin price is computed in this formula:

Q5: The report mentioned the gold market as the comparable of the Bitcoin market, what is the current level of penetration for Bitcoin and what are the assumptions made?

A5: According to the World Gold Council, the current supply of the Gold market is around 190,040 tonnes and if we take the current gold price to be around $1,491.88 which means that the current size of the gold market is around $10 trillion as of October 30. Bitcoin’s current market capitalization is $164 billion which places Bitcoin’s current penetration at about 1.6%. However, it’s important to note that this thesis over the level of penetration is predicated on the assumption that people will move from investing in Gold to Bitcoin — to date it could be argued that the investors into Bitcoin have not necessarily been previous investors in Gold. We expect this to change going forward as Gold investors begin to realize Bitcoin’s ability to serve as a digital Gold.

Q6: For alternative markets such as peer to peer markets, is the current market size of the Bitcoin lightning network an appropriate comparable? If not, what are the limitations?

A6: Potentially, the lightning network and similar payment channel frameworks could eventually make Bitcoin more apt for peer-to-peer payments in which case comparison to other peer-to-peer markets may make more sense.

We will explore other valuation methods for Bitcoin such as NVT, NVRV, NVHR, cost of mining and possible valuation approached for altcoins, stay tuned!