Stop and Consider This Before Investing

It seems like everywhere we look there is a sensational media account of bitcoin’s stratospheric price and amazing quadruple digit appreciation. About as often a new ever-higher forecast for 2018 appears.

Massive volatility permits fear and greed exists side by side. That usually means we all need to take a deep breath and try to put emotions aside.

Fundamental help is rare these days. Headlines dominate our actions. Here are a couple of examples. The CME and CBOE’s offering of a bitcoin futures contract will help smooth price volitility. Bloomberg News reports that Goldman Sacs is close to opening it trading desk to Bitcoin.

What Are Headlines Really Worth

These are two announcements are good for investors driving Bitcoin prices ever higher. But they don’t answer the most important question: What are digital currencies worth?

It is an educated guess, so here are some of the best educated guesses so far.

First we need a valuation method and one of the most interesting that I have come across is from crypto disciple Thomas Lee. He currently forecasts a $25,000 Bitcoin price before 2022. Here is how he gets there.

Metcalfe’s Law Makes Sense

Using something called Metcalfe’s Law he compares the value of a cryptocurrency to the value of companies like Facebook and Google.

Here is how the formula works. Take to total number of users, multiple that number by itself. Then, take that result and multiply it by the average transaction for each user.

If this all sounds way too geeky, you’re not alone. It helps if you remember the self generating explosion that took place in social networking and apply that to cryptocurrencies; applying Metcalfe’s Law makes sense.

Lee claims this method explains virtually all of the historic price movements of Facebook, Google and Bitcoin. We haven’t double-checked his work, so we are taking this explanation at face value.

Metcalfe’s On Steroids

Ok, so if we apply Metcalfe’s Law to Bitcoin and other cryptocurrencies, is it just as appropriate to compare their potential to Facebook and Google? That is an easy question to answer, of course it is.

The market for Facebook and Google services is virtually every person on planet earth. The same holds for Bitcoin. So please allow me burn some battery life on my iPhone calculator. Numbers can be really boring so keep some coffee nearby.

Comparing Facebook and Google

The combined value of Facebook and Google is just a tad over $1.25 trillion dollars. Meanwhile bitcoin is bouncing somewhere around the $300 billion level. That is a big upside for bitcoin, if it reaches some sort of level comparable to two of the biggest tech giants of the past 25 years. Here is where things get really interesting.

BusinessInsiders.com recently posted an article with some jaw dropping stats on the global supply of money. This is the addressable market for cryptocurrencies. Under their Broad Based Definition, there is a staggering $90.4 trillion of money floating around the world.

For bitcoin’s theoretical value to match the Facebook, Google combo, bitcoin would need to capture a mere 1.3% of the global loot. Achieving that level of acceptance means bitcoin’s value could reach three times present levels. Is that realistic; from our illustration it looks very achievable. If all these developments took fives years, that offers a better return than most.

Applying Metcalfe to Ether

 If you accept Metcalfe’s law as a starting point for valuing bitcoin then consider applying it to Ethereum. The mantra of successful investing is applying the discipline of comparative selection. Here is the case for Ether, the crypto that fuels the Ethereum blockchain.

The Ethereum platform is not so much a currency as it is a decentralized blockchain the holds the promise of making corporate big data safer to store. Companies that have tested applications of the Smart Contracts that is part of Ethereum have found savings in the billions. Security and savings are two words that are powerful selling tools to corporate CEO every day of the week.

There are limitless business applications to Ethereum. The open source nature of the platform help explain why nearly $4 billion will be raised in startup capital by the end of 2017 and why over 300 major corporations have joined the Enterprise Ethereum Alliance since it founding in February.

Ethereum’s potential should be viewed in terms of the $110 trillion+ World Gross Product. This is not an absurd figure considering that every part of the world is becoming digitized and decentralized blockchain technology has a role anywhere where data is stored and manipulated.

Bitcoin versus Ethereum

 It is virtually impossible to come up with a good reason that either of the two largest cryptocurrencies has greater potential over the other. The prospects for both are pretty amazing. But if that is the case then consider this.

At it’s recent $20,000 all time high bitcoin was valued around $300 billion. Ethereum on the other hand at its $687 high was worth only about $70 billion. Investment analysis is the discipline of comparative selection. This makes Ethereum the clear choice when looking at comparative values.

Over long periods, this spread in values could and should narrow. In the short term, as we witness in Decembers severe price correction, both crypto’s lost equally: about a third of their value: something to keep in mind.

The purpose of all this exercise is to draw attention to a way of looking at value. It is not the only method, but it is something that puts emotion in its place. These are our opinions only so do not consider this in the same context as advice from your regular investment advisor.

Featured image courtesy of Shutterstock.  

Author:
James Waggoner is a veteran Wall Street analyst and hedge fund manager who has spent the past few years researching the fintech possibilities of cryptocurrencies. He has a special passion for writing about the future of crypto.