Since Bitcoin’s inception, its price has tracked this increasing stock-to-flow ratio; Each Bitcoin halving was accompanied by a bull market that led to new all-time highs.
network effects
If Bitcoin is not seen as an asset, but instead as a network, its value can arise from the size and robustness of the network itself. The term “network effects” refers to the number of users or nodes mining cryptocurrency.
Originally designed to understand the value of communication networks, Metcalfe’s law It states that the value of a network is proportional to the number of its users (or nodes) squared. While there are limitations, this perspective means that as the Bitcoin network grows in size, so must its value.
production commissioning
One final way to look at the intrinsic value of bitcoin is to look at it as a produced good, similar to oil or silver. Most commodity prices are driven by the marginal cost of production, or the cost to producers of creating one additional unit. Economic theory states that in a market where many producers of the same product (in this case bitcoin miners) compete with each other to sell their products to consumers, this process of competition will cause the selling price to drop to its marginal cost.
Thus, even if demand is less than supply, producers will be reluctant to sell below cost of production and incur losses. From this point of view, the price of bitcoin should be driven by similar dynamics.
The main difference between producing Bitcoin and, say, mining ore or producing something like chairs or tables, is that an increase in demand cannot motivate producers to make more Bitcoins – since it is limited to one block that can be found about every ten minutes. Thus, as higher prices in the market motivate new and larger miners to join the network, the number of bitcoins made remains the same. What changes is the difficulty level of mining those bitcoins. This increased difficulty maintains a fixed target of 10 minutes between when new blocks are produced.
As a result, the marginal cost of production increases without increasing supply. Recent research has shown Production cost to predict the bitcoin market well over time.
bottom line
The value of Bitcoin is always changing, based on the demand for the cryptocurrency as well as public perception of the value of the currency itself. It also changes based on an ever-growing network of miners and users. As miners join the network, the difficulty for miners also increases, which increases the cost of production.
Even if we can determine the fair value, investing in cryptocurrency remains one of the most volatile investments, which means any potential investor should do their due diligence. However, for a chance to make a huge profit (or simply be a part of the fun), knowing how to value a coin’s fair market value will be key.
Investing in cryptocurrencies and initial coin offerings (“ICOs”) is highly risky and speculative, and this article is not a recommendation by Investopedia or the author to invest in cryptocurrencies or other ICOs. Because each individual’s situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein.
