The debate over Bitcoin – and the cryptocurrency craze it has spawned – runs the gamut from advocates who see it as the future of finance to skeptics who compare it to a classic pyramid scheme.
The market capitalization of the crypto universe has increased from roughly $200 billion in 2019 to more than $2.2 trillion at the end of 2021.
Given Bitcoin’s volatility, how can investors determine a reasonable price for it?
Bitcoin’s valuation is a real paradox. On the one hand, it’s an asset that can never produce earnings and, like all assets that can never produce earnings, it has an intrinsic value of zero.
You can’t do a discounted cash flow analysis of Bitcoin just as you can’t do a discounted cash flow analysis of gold or any other form of collectible.
Anything that can’t produce earnings is only worth what other people will pay for it. And so, in a sense, the valuation is completely arbitrary.
However the unique properties of Bitcoin are almost universally interesting to everybody who interacts with money.
No one can create any more of it. There will always be a supply cap of 21 million bitcoins, so no person or government can dilute your position by printing more.
Bitcoin is the only form of money that can’t be censored. It’s available for use by anyone with an internet connection, and no one can stop you from sending or receiving a transaction.
It’s hard to confiscate. Your bitcoin is really just a password. You can carry it around in your head, or write it down, and take it with you across any border in the world.
Unlike the money in your checking account, it can’t be confiscated by the government or creditors.
The price of Bitcoin is set by the financial markets – by people who are buying it solely because they think other people will pay more for it in the future.
People can make a lot of money and they can lose a lot of money, but putting an intellectual framework around Bitcoin’s valuation is near impossible.
First, some might look at their cash holdings and wonder why they are losing purchasing power in a fiat currency. And some percentage of them will come to Bitcoin, because it is the only form of money in human history where you can’t change the monetary policy and you can’t print more.
Second, if you’re looking to avoid currency risk, then the key decision is to get your money out of that currency and moved into gold or Bitcoin.
Third, there are lots of tangible assets that can work well as a hedge against inflation, including equities and oil.
Bitcoin was designed with a decentralized architecture precisely to prevent anyone from being able to control the future of the system and that includes governments.