Short term Bitcoin valuation from the network effect
Bitcoin valuation and growth relies entirely on its user base. The higher the user base, the more likely people are to use Bitcoin. The more people are using the Bitcoin then the higher the user base. This growth cycle has many similarities to social network companies. The growth of Facebook and Twitter relies on the number of users and their interactions. As the social network provides more reasons for its users to interact then the user base grows. Consequently more users provide a greater reason for users to interact. It’s a fly wheel that perpetually grows. As such, with greater engagement then the value of the company rises.
Bitcoin social network
Just as in the case of social networks Bitcoin’s appeal rises the more people that people are using it. With a single user then the addition of one extra user adds an exponential amount of utility to both users. The user experience is now greater than the sum of two single users. This is because they both benefit from shared experience and interactions. The exponential value of each additional user explains the rapid growth in Bitcoin valuation as it’s user base grows.
By way of an example, take the first person to ever have email. There isn’t much value until someone else is able to receive emails. Both users gain even more value from the presence of the other user.
This exponential growth theory was pioneered in Metcalfe’s law. Metcalfe’s law states that the value of a network is proportional to the square of the number of connected users of the system. As such, if a network comprises of two users, x and y then the value of the network is x multiplied by y, or xy. The key observation here is that xy> x + y, that is that the value is greater than the sum of its parts.
Applying Metcalfe’s law to Bitcoin produces some interesting results. Take the squared value of the number of Bitcoin users, multiplied by the average transaction value. The resultant values correlate with the Bitcoin price movement from December 2013 until September 2017 with a 94% accuracy.
Long term Bitcoin valuation as a replacement for gold
The current Bitcoin valuation theory assumes that it will replace some of the uses for gold as a store of value. Traditionally, gold has been seen as a store of value as it’s something that can be transferred into fiat currency, has a physical presence and is reasonably easy to secure using a safe. In a world where experiences are becoming increasingly digital then it makes sense that people would wish to secure their value in the digital space. Bitcoin fulfils that need.
Encryption and privacy
Impressively, Bitcoin has never been hacked making it reasonably secure. Whilst there have been various user-related hacks such as in the case of Mt Gox, there hasn’t been any successful large scale Bitcoin hacks due to code error. The end-to-end encryption as the foundation of the Bitcoin blockchain makes it an attractive means of storing value. It doesn’t need to have a physical presence, nor does it need physical barriers in the form of a vault or safe that may incur regular expenses. The encryption and lack of physical presence makes it very hard for the common criminal to attempt a theft. In many ways, storing wealth as Bitcoin is preferable to storing it in the form of gold.
As of the end of 2017, the gold market is worth $9 trillion. Were Bitcoin to replace just 10% of the gold market it’s value of the Bitcoin market would be worth $900 billion. With roughly 17 million Bitcoins in existence the price of Bitcoin could be $50,000 per coin.
Valuation of $100,000 and beyond
It is possible that Bitcoin could be worth even more than $50,000. Part of the supply of Bitcoin are unavailable. This may be due to lost private keys, damaged computers or accidental computer disposal. As such, 4 million Bitcoin are missing. As such, a valuation of $50,000 doesn’t take this into consideration. Consequently, the loss of so many coins thereby decreases the supply and increasing the price of Bitcoin further.
Additionally, Bitcoin has other uses besides being a replacement for gold. For example, it is often the master currency in order to buy Altcoins and used for cross border currency transfers. Given its wide range of uses and the fact that it could capture more than 10% of the gold market, Bitcoin valuation could price it at over $100,000 per coin.