Yes, there is still news on Facebook Libra. No, I won’t be discussing it this week.
One interesting thing that came from the Congressional hearings is that Bitcoin is more respected and trusted for its lack of corporate centralized figure than Facebook and its Libra project is or will be.
This is good news for Bitcoin. And given that, I thought this week would be interesting to see 2 different models for valuing Bitcoin.
Method #1: Compounded Annual Growth Rates
Pantera Capital, a VC and long-time investor in the crypto-economy, gives us some analysis in their Quarterly newsletter in July. Check out the 3rd section entitled ‘Bitcoin Price Reverting to Long Term Regression.’
You can see from the tweet that they make price projections based on their analysis that include $42,000 per BTC in 2019, which would be a 4x jump from the current price and more than 10x from the low when they made this prediction in March 2019.
How Did They Get These Numbers?
First, Pantera explains that on a regular chart, returns for disruptive technology look like a hockey stick. In other words, no activity for a while and then huge growth, like this.
Then they say if you look at a chart of Apple’s stock price, it’s vertical. And that doesn’t help us when trying to analyze performance and valuations since nothing is vertical forever.
Enter Logarithmic graphs. They are often used to show percentage change especially in high growth environments like we’ve had in Bitcoin.
Pantera charted Bitcoin’s price and then drew a regression analysis or ‘line of best fit’ and that line corresponds to a Compound Annual Growth Rate (CAGR) of 235%. Investopedia defines CAGR as the rate of return necessary to get from the starting balance of near 0 for Bitcoin to it’s current price levels assuming profits and dividends are reinvested. It smooths out all returns over time into a number that tells us this is the growth annually if Bitcoin grew the same amount every year.
235% is a pretty sweet return huh? But that’s not a real rate of return as investment periods differ. After all, if you bought at the Dec 2017 high and only then, you’ve lost value on your Bitcoin.
This line of best fit on the chart above represents 235% CAGR and how returns seem to ‘revert to the mean’ or make their way back towards the line of best fit. With current prices below that trend line, then this MAY be predictive of future growth and this is where the price projections come from.
Regression analysis is a powerful statistical tool and we will see if this line of best fit holds up over time.
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Method #2: Scarcity as Measured by Stock to Flow
Many people make the argument that Bitcoin is valuable because it is scarce. This is a common argument made for Gold. But even with the 21 million coin fixed supply, Is Bitcoin really scarce?
The mysterious Bitcoin quant analyst and investor Plan B takes a deeper look at scarcity by looking at stock and flow in this Medium article. Stock is the current supply available and flow is the annual addition to supply. So for gold the flow is the amount mined and produced each year and for Bitcoin that number is how many Bitcoins are produced each year from all the ~10 minute block rewards. This article came to my attention this week from this tweet.
To review, here are the current numbers:
Block reward: 12.5 Bitcoins
Time: Every 10 minutes
Bitcoins created annually until the next block halving in May 2020: 657,000
So that’s where we are now.
Stock to Flow Compared to Gold & Silver
The first argument Plan B makes is that only Gold and Silver among precious metals are scarce enough to be considered money. For example, palladium is valuable but can’t have monetary properties because it’s stock to flow is 1.1. That means that average annual production of palladium is equal to 88% of the current supply of the metal.
It’s just not scarce enough. Gold and silver have stock to flow ratios (Stock/Flow) of 62 & 22, respectively. This means they are scarce. In the case of gold, it would take 62 years of production to replace (or double) all the current stock. This is VERY scarce.
Bitcoin scores well on this front with a stock to flow ratio of 25. The calculation is 17.5 million coins over a 700,000 annual supply (the number is just a hair higher than our 657,000 as some blocks are found faster than 10 minutes). The 17.5 million makes an assumption of 1 million lost coins.
The Halving Effect on Stock to Flow
After detailing where Plan B got his data from, he goes into financial quant mode and crunches some numbers. Again, enter the logarithmic chart, this one courtesy of Plan B’s Medium post.
R squared is equal to the variance or how much of the chart can be explained by the relationship between the two inputs of market value and stock to flow based scarcity. You see on the graph that this number is 94%, meaning that stock to flow and market value are definitely related, or more accurately that the chances of them NOT being related are close to Zero. Interestingly, this seems to apply to gold and silver as well both sit very close to the regression line or line of best fit.
After the May 2020 halving, the supply will be cut in half and the stock to flow will increase from 25 to 50 and the predictive market value for Bitcoin after the halving is $1 trillion or a little more than 5x where we are today or a price of $55,000 per Bitcoin.
This chart shows a vertical line between 0-12 months after the halving in both 2012 and 2016 with the projection for 2020 with Stock to Flow in black and actual price in color dots.
Plan B’s discusses Power Laws and how they in combination with a 94% R squared make it highly likely that Stock to Flow based scarcity is why Bitcoin has the value it does.
Here is a podcast episode where Plan B talks about this strategy and valuation method in more detail.
Conclusion
To conclude we have the following price predictions based on 2 different models:
2019: $42,000
2020: $55,000 Or $122,000
2021: $356,000
Both are obviously bullish on Bitcoin for the short term and long term. What do you think about these methods?