how to value cryptocurrency: A Deep Dive Into Crypto Valuation

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how to value cryptocurrency

Roughly speaking, the money supply (M1) in the U.S. was worth more than $20 trillion as of the end of 2021. Similarly, people buy gold not because they want to spend with it, but because they know it has permanent storage value for its utility. So, let’s assume Bitcoin has shifted to that status, and that it never takes off as an actual form of payment but instead just serves as a store of value for some people. Since Satoshi released the blockchain technology to all, Bitcoin has no unique claim to the underlying technology. Instead, it merely relies on network effects as the first mover in the cryptocurrency space, and money tends to be a “winner take all” game. Chart 9 shows a plot of the quarterly returns for Bitcoin since 2014 shows “bull” and “bear” periods in its short lifetime, a potential to outweigh other financial assets’ returns and attract investors for longer investment periods.

There are still challenges in understanding crypto assets’ performance and their relationship with traditional financial assets. The feedback from all market participants, however, is that the crypto world is volatile. Aside from stablecoins that are linked to fiat currency, there are 3 cryptocurrencies that have over a $10 billion market capitalization.

how to value cryptocurrency

As mining costs increase, it necessitates an increased value of the cryptocurrency. Miners won’t mine if the value of the currency they’re mining isn’t high enough to offset their costs. And, since miners are essential to making the blockchain function, as long as there’s demand for using the blockchain, the price will have to go up.

Absolute Valuation Model – Equation of Exchange Monetary Model

However, we can use the laws of supply and demand to better understand how the price of cryptocurrency will change in the future. Like any market, the value of cryptocurrencies fluctuates based on the market’s perception of its value at any given time. These fluctuations may be rooted in some of the supply and demand factors mentioned above or can happen as a result of hidden market factors. Just as the desirability of its products impacts a company’s share price, the crypto monetary system impacts the cost of crypto trading. The value of a cryptocurrency is primarily affected by its supply, the market’s demand for it, availability, and competing cryptocurrencies. If Bitcoin drops in market share to just 10% of cryptocurrency usage, and cryptocurrencies only account for 1% of GDP in ten years, and M is 20 million and V is 10, then each bitcoin will be worth about $450.

That should produce better price discovery and reduce the volatility of cryptocurrency pricing. There are thousands of different cryptocurrencies in existence, with new projects and tokens launching every day. The barrier to entry is relatively low for new competitors, but creating a viable cryptocurrency also relies on building a network of users of that cryptocurrency. But some smaller tokens may only be available on select exchanges, thus limiting access for some investors. Some wallet providers will aggregate quotes for swapping any set of cryptocurrencies across several exchanges, but they’ll take a fee for doing so, increasing the cost of investing. Furthermore, if a cryptocurrency is thinly traded on a small exchange, the spread the exchange takes may be too big for some investors.

how to value cryptocurrency

Some investors use technical analysis to make short-term price predictions on a cryptocurrency. Technical analysis involves studying charts and market data to identify price trends. When a cryptocurrency has low liquidity, you may not be able to sell all or a portion of your tokens without moving the market price of the coin lower, as there may not be enough demand to absorb/buy the tokens. Each of those sideways levels is a plateau that is far above the previous one. The recent level has been fluctuating around the $5,000-$15,000 region, and now it’s moving into the next level, according to that method of analysis.

Method Pure Store of Value: Percent of Net Worth

Having a capped currency means Bitcoin can be used as a store-of-value investment tool. Investing in a store of value currency can be compared to investing in gold. Although there is some transactional value in gold, it is mostly used as a store of value. The original cryptocurrency, Bitcoin, is a capped cryptocurrency. This means after 21 million Bitcoins are mined, no more will be mined.

The reason for this is that this model seeks to establish the value that is provisioned to users within a cryptocurrency network, relating this value to the supply and velocity of coins to derive what an individual coin is worth. Although, the traditional valuation models that are used to determine the values of bonds, stocks, fiat currencies or commodities do not translate very well to cryptocurrencies. This is because they do not have any dividend payments, recurring cashflows or a specific terminal value which can be estimated.

Purchasing stock grants gives you ownership in a company, whereas purchasing a token grants you ownership of that cryptocurrency. In the U.S. tax system, cryptocurrency transactions are viewed in the same way as stock trading transactions. This reflects how most users are making money from the crypto world. As the years go by, cryptocurrency adoption and payment rates are not really increasing by much. Not many businesses accept them and most people don’t seem to care about paying with them. Bitcoin’s usage in particular has shifted more towards being a store of value and a network that allows users to transmit value, rather than as a day-to-day medium of exchange.

A natural question to ask is whether stablecoins and traditional fiat pegged currencies exhibit similarities in terms of volatility. To do that, we studied the last few years of exchange rates for Hong Kong dollar (HKD) to USD and compared it with the performance of stablecoins. We chose the HKD because its pegging system has been set up for decades and is implemented in a predictable and disciplined way. Pegged fiat currencies typically require large amounts of capital reserves and rely on government and central bank support for maintaining the peg. This process is quite different for the stablecoins ecosystem, where some coins rely on cash and traditional assets as collateral and others use crypto collateral and algorithms. Of note, understanding volatility risk is paramount to appropriately assessing capital and margin requirements when crypto assets are included in portfolios and in trading and lending protocols.

Bitcoin does not store value as gold does, but this is an evolving ecosystem, and the future may prove differently. Cryptocurrency is not the same as the U.S. dollar or the Euro because there is no central authority — such as a government body — to manage its value. Without a centralized organizing body, there are no concrete reasons for cryptocurrency to change in value. Puzzled, the interviewer asked whether the Fed had manufactured billions of dollars.

However, governance tokens require stakeholders to give consensus for any changes. The first block of 50 bitcoin — known as the Genesis Block — had no real value for the first few months. Throughout much of its history, speculative interest has been the primary driver of Bitcoin’s value. Bitcoin has exhibited the characteristics of a bubble with drastic price run-ups and a craze of media attention. This is likely to decline as Bitcoin continues to see greater mainstream adoption, but the future is uncertain. This guide breaks down everything you need to know about cryptocurrency taxes, from the high level tax implications to the actual crypto tax forms you need to fill out.

Investing in virtual currency has produced jaw-dropping returns for some, but the field still presents risks. Cryptocurrencies have also consistently maintained a higher volatility than the tech index, as shown in chart 14 below where we plot the rolling volatility. The aforementioned stablecoins have relatively successfully maintained a value close to their peg over their limited history.

How is cryptocurrency valued?

Bitcoin was invented to be like a new, modern form of gold and silver. From there, I wrote a series of articles on the subject, which you can read in my digital assets library. I don’t have the answers to those questions, but this article will provide a framework to help you think about how to value cryptocurrencies for yourself, including explaining a lot of the risks involved. Price is what an investor pays, but value is what an investor gets. It’s easy to look up the current price of Bitcoin, but it’s harder to determine what a realistic value is.

For these reasons, Bitcoin and other cryptocurrencies share some characteristics with precious metals. Demand can increase as a project gains awareness or as utility increases. Broader adoption of a cryptocurrency as an investment also increases demand while effectively limiting the circulating supply. The value of cryptocurrency is determined by supply and demand, just like anything else that people want.

The speculative nature of cryptocurrencies and their high volatility led to the creation of stablecoins, which act as a bridge between the crypto ecosystem and the traditional financial world. Stablecoins are designed to hold a stable value by pegging to a reference asset such as fiat currency (for example, USD). They create a more stable cryptocurrency and are typically backed by fiat assets, crypto assets, or an algorithm.

During the pandemic, many investors transitioned to gold, and, as a result, the price of gold increased by more than 40% from mid-2019 to mid-2020. Bitcoin over the same period did not exhibit a clear trend of an asset that holds value and protects against market downturns, as shown in chart 19. For the purpose of our study, we focused on the universal coordinated time (UTC) daily price of a selected sample of cryptocurrencies that dominate the markets.

How does supply and demand impact the price of cryptocurrencies?

The total number of bitcoins in existence (M) is a little under 19 million, and it will max out at under 21 million over the next several years based on its algorithm. These currencies are volatile, their market share is fickle, and updates can result in split currencies, which has happened to both Ethereum and Bitcoin. However, historically when this happens to these major networks, the original network maintains the vast majority of the market share. You can also compare the long-term (multi-decade) inflation-adjusted price of gold and silver, to see how they have changed in purchasing power over time. To buy with a credit card, you have to give your credit card info, and occasionally those databases get hacked. But to buy with bitcoins, you never have to give anyone your private key.

  • Demand for cryptocurrencies is partially determined by general market sentiment — the overall attitude of investors towards cryptocurrency.
  • As seen in table 5 below, the historical correlation since 2018 between the daily returns of the crypto assets, SPX and the largest three stocks is less than 0.3.
  • In response, ETH holders voted to create a new fork of the blockchain which rolled back the history of the blockchain before the hack.
  • In the modern age, government-issued currencies often take the form of paper money, which does not have the same intrinsic scarcity as precious metals.
  • The value of an individual cryptocurrency is based on supply and demand.

But anyway, we have actual velocity, even if the number itself is questionable, and we have what the typical velocity range of a major fiat currency is. When I value Bitcoin, I will use a range for the velocity value to imagine a few different scenarios. The velocity of the United States M1 (highly liquid) money supply (shown here) hit a high of over 10 in 2007 and is now around 4. It’s decentralized, meaning its existence and value is not tied to any agency, government, corporation, or bank. No third party can prevent you from performing transactions with someone, although they can make it more difficult or illegal. The main advantage that gold still has is that no government has price control over it.

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For more information, check out our guide to the best charting tools for cryptocurrency traders. Some critics emphasize that past trends are not necessarily a reliable indicator of future performance. Other projects have a ‘vesting schedule’ for cryptocurrency — for example, early investors may not be able to sell their holdings until after a year. For an example of how governance can impact price, we can take a look at the 2016 DAO hack. In response, ETH holders voted to create a new fork of the blockchain which rolled back the history of the blockchain before the hack.

In fact, the total volume of all gold ever mined can be fit into a cube of less than 25 meters on each side. Most buyers and sellers of cryptocurrencies are speculating, meaning they are just looking at price charts and guessing that it may go up or down with technical analysis. Although all transactions are on the public ledger, there are steps to distance the user from the transaction, making Bitcoin transactions difficult to trace. However, increasingly sophisticated methods, combined with “Know Your Customer” policies on major fiat-to-crypto entry points like exchanges, have made it far easier to track over time. The technology at the heart of bitcoin and other virtual currencies, blockchain is an open, distributed ledger that can record transactions between two parties efficiently and in a verifiable and permanent way. And wherever he is, he has about a million bitcoins, worth billions of dollars now, which he has never spent.

In this world every agreement, every process, every task, and every payment would have a digital record and signature that could be identified, validated, stored, and shared. Intermediaries like lawyers, brokers, and bankers might no longer be necessary. Individuals, organizations, machines, and algorithms would freely transact and interact with one another with little friction. Anyway, Bitcoin was invented for the purpose of being a decentralized currency and method of payment. It does not rely on any central authority like a government or bank or Satoshi himself, and is instead completely distributed on numerous clients running open-source Bitcoin software. Some tokens — called governance tokens — give their holders a say in the future of a project, including how a token is mined or used.

Mary Davis
My name is Mary Davis. I am successful broker. I want to share my experience with you through tutorials and webinars. For any questions of interest, please contact us by e-mail: [email protected]. +1 973-709-5130


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