Bitcoin over the next 100 years will produce an annualized return of 1.1%.
That’s the prediction of a fair value model that’s based on something called Metcalfe’s Law. According to it, the value of a network is proportional to the square of the number of users.
Claude Erb, a former commodities portfolio manager at TCW Group, applies Metcalfe’s Law to bitcoin
BTCUSD,
by assuming that each mined coin represents one user in the network. Since the number of bitcoins that can ever be mined is known, along with when that total number will eventually be reached, Erb’s Metcalfe’s Law model is able to calculate the cryptocurrency’s long-term expected return. That’s the source of the projected 1.1% annualized return.
It’s easy to poke holes in the model, as Erb himself is the first to point out. Some ”users” in the bitcoin network own less than one coin, while others own more than one. And many bitcoins have been lost. So the number of bitcoins that have been mined doesn’t exactly equal the number of users.
In an email, Erb said he offers his Metcalfe’s Law-based model in the same spirit as those who observe that “all models are wrong, but some are useful.” He added that his model is “a way to anchor a conversation” about the cryptocurrency’s valuation that is sufficiently “intriguing” to warrant our serious consideration.
The model has done an admirable job, as you can see from the chart above. It has issued warning signals when bitcoin reached unsustainably high levels and provided encouragement when its price fell too low. I first devoted a column to the model in late 2020, just as bitcoin was about to triple from around $20,000 to over $60,000. The model held that such a price rise was unjustified, and bitcoin subsequently fell back below $20,000. At that point I reported that, per the model, bitcoin had become undervalued — and it subsequently rallied more than 50%.
I last wrote about Erb’s model in early June, reporting that bitcoin’s fair value was about 10% above its then-current price. It’s gained 4.2% since then. The model currently calculates that bitcoin’s fair value is about $31,400, or around 14% above where it currently is trading.
Even if the model continues to do as good a job forecasting bitcoin’s price, you should still expect the cryptocurrency to oscillate between extremes well-above and below fair value. That is something all assets do, and bitcoin is no exception.
Consider the stock market on the assumption that its fair value is based on its long-term average price/earnings ratio. Over the past 150 years, the S&P 500
SPX
has traded for as much as seven times its fair value and as little as one third. That’s similar to bitcoin’s range in recent years.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at [email protected]
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