Prophets

To Value Bitcoin Now, Think Back to Internet Startups

If you accept that the currency will be the main pipe that finances cryptoenterprises, then current prices seem reasonable.

You can gamble with it.

Photographer: Ethan Miller/Getty Images

Bitcoin's meteoric rise is forcing analysts to look for a method to estimate a fundamental value for cryptocurrencies. So far, there is no agreement on a global standard, but bitcoins are unlikely to lose their leading role anytime soon. However there is plenty of room for downside if crypto-technologies do not deliver anticipated economic value, or if that value is not captured through bitcoin appreciation.

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I'm inclined to anchor bitcoin value to the enormous body of code written by cryptodevelopers. Not just bitcoin code, but code for other cryptocurrencies, tokens and assets; plus apps to run on top. Think of this as 1,000 Silicon Valley startups. Many will fail. But some could succeed and perhaps a few will succeed spectacularly. Moreover, new ideas are being introduced every day.

I've done bitcoin valuation since 2012. 1  (Full disclosure: I own bitcoins and other cryptocurrencies.) Initially, I focused on money transfer and value store. Since then, superior cryptocurrencies have emerged for both purposes, and existing financial companies are developing blockchain and crypto competition. Even if bitcoin technology goes mainstream, value capture will likely be achieved by existing financial technology companies, or by second-generation cryptocurrencies, or value may be distributed free.

Bitcoin's value is as a currency for financing other crypto-innovations. Over the last five years much of the creative energy of the world's best developers has gone to writing code in cryptospace. The funding has come mainly through bitcoins, and when, or if, profits are returned to investors, it will likely be in bitcoins. It's implausible that this currency will be replaced in this role given the enormous infrastructure that has been built around it on top of it and the need for a global norm. 2  But traditional venture capitalists are chasing the same profits, and many cryptodevelopers don’t think they need a shared connection to the existing financial system.

An analogy is internet company stock options from 1990-1995. The enterprises were unformed, generally without assets or revenues or clear ideas about how to get revenue. Stock options were not well-defined legal claims; they reflected trust in a group and an idea. There were thousands of these currencies. Traditional companies hired developers for cash, they lost to scrappy startups getting funding and paying developers in options. A new breed of venture capitalists sprang up to pay cash for shares in the upsides of these companies, bypassing Wall Street. Stock and stock options were used to buy and sell services with other internet startups, or to buy and sell the companies themselves.

Then on Aug. 9, 1995, came the Big Bang -- the Netscape IPO. For the first time, the stock option economy met traditional finance. That's when internet companies could be valued in dollars. Traditional investors did not swoop in to buy stock options from thousands of garage startups, they bid frantically for shares in the few public companies. That capital found its way indirectly to smaller firms. The price of Netscape stock was not anchored to revenue from Netscape's core technology, but to investors' desire for exposure to internet startups in general. 3

If bitcoin is the funding currency for the next generation of internet protocols, I can ballpark its value. The internet represents 6 percent of the global economy, and crypto has the potential to significantly expand the value of internet activity, and to add new valuable activities. Maybe 2 percent of the economy is a fair guess for crypto activities financed via bitcoin. Investors might expect half the net revenue of enterprises. Transaction capital stock typically runs 50 percent to 100 percent of one year's economic activity. So if I take 2 percent of the $75 trillion global GDP, divide by two for the fraction going to investors, multiply by 70 percent to get the necessary bitcoin value to support that activity, and divide by 21 million bitcoins, 4  I get $20,000 per coin.

You can tinker to get values from $2,000 to $200,000. Outside that range means questioning my assumptions. I think it's implausible that bitcoins could serve as the gateway to a significant economic sector conducted in crypto terms at under $2,000, or that people will pay more than $200,000 for that service.

Bitcoin skeptics are free to hang on to zero as a value, and true believers can predict dollars will be replaced so bitcoins have infinite value in dollar terms. But if you accept that bitcoins will be the main pipe that finances cryptoenterprises, and that those enterprises will be solidly successful but not world-changing, then current bitcoin prices seem consistent with reasonable guesses about the future. With the rapidly increasing institutional interest in bitcoin, we're about to have our Big Bang and find out.

  1. For example: http://www.minyanville.com/business-news/markets/articles/can-a-value-investor-buy-a/12/11/2013/id/52973

  2. While a few cryptocurrencies, such as Ethereum, may be able to access traditional financial markets directly, the majority will depend on bitcoin intermediation. Some crypto ideas are meant to function solely in terms of their own tokens, but I think most exploitable economic value is in ideas that require a connection to traditional cash.

  3. Five years of extraordinary volatility followed, boom and crash, before we settled down to a reasonably stable system for financing technology innovations. Today the stocks of a few big technology companies are the primary way investment capital flows between developers with new ideas and investors unwilling or unable to analyze individual start-ups or to participate in private financings. I think bitcoin may be the new FANG.

  4. The number that will eventually be created.

To contact the author of this story:
Aaron Brown at aaron.brown@privateeram.com

To contact the editor responsible for this story:
Max Berley at mberley@bloomberg.net

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