Bitcoin pricing model recap
In the past I've reviewed several Bitcoin (BTC-USD)(COIN)(OTCQX:GBTC) pricing models. If you haven't read them yet, you can get caught up by following the links below.
- Article 1, in which I review The Fundstrat model and MoonMath
- Article 2, in which I review Willy Woo's NVT and The Mayer Multiple
In case you missed my models, you can get caught up here (Unique Addresses And Bitcoin Market Cap - A Powerful Correlation), here (3 Models To Explain Bitcoin's Market Cap), and here (Bitcoin Value Indicator - July 2018).
Today we're doing a deep dive into a single model from Cryptolab capital, I hope you enjoy.
Cryptolab Capital and the NVM
Cryptolab Capital has been publishing some high quality research into Bitcoin's network value. The article entitled "Rethinking Metcalfe’s Law applications to cryptoasset valuation," by Dmitry Kalichkin is no exception.
First, I want to mention a terminology difference you might not be aware of. Daily active addresses (DAA) is another name for Unique addresses in use. Depending on where you get your data, there's some slight variance, but they essentially mean the same thing. It's the number of addresses that have a non-zero UTXO (meaning the number of addresses with some bitcoin).
Second, I want to give credit where credit is due. This model is very well formed and makes use of best practices in statistics. This is the kind of model that statistics professors drool over. Also, there's a lot of really great links to the theory behind Metcalfe's Law and the history of how it came about.
NVM Key Points
- The NVM stands for Network Value to Metcalfe, which means it's a ratio that is derived from taking the value of the Bitcoin network (assuming market cap here) and dividing it by a the value assumed by applying Metcalfe's Law.
- There are three main schools of thought on how to use Metcalfe's Law, and each has strengths and weaknesses.
Image Source: Cryptolab Capital
- Cryptolab Capital evaluated each of them, and ended up using Odlyzko's Law and Metcalfe's Law to create upper and lower bounds for expected valuation.
Image Source: Cryptolab Capital
This leads to the chart below, which brings all these ideas together.
Image Source: Cryptolab Capital
The blue line is slightly discolored because of the two shades of green, but essentially what you're seeing there is a channel of expected network value (or a log based derivation of it), and the line in the middle is represents the current position of the Bitcoin market cap. Translation, the Bitcoin market cap using this model is much closer to the upper bound than the lower bound. In fact, the author even says:
High NVM suggests that Bitcoin is overvalued at the moment, compared to the Metcalfe NV estimation derived from DAA data. According to our model, Metcalfe network valuation is around $33bn, while the actual NV as of May 6th is $162bn. If we take this result at face value, this means that BTC is ~5x overvalued, compared to a Metcalfe price of about $2,000. Cryptolab Capital
After normalizing their upper and lower bounds, they presented this chart.
Image Source: Cryptolab Capital
When the orange line is in the green zone, it means that the network value is lower than expected based on the DAA. In other words, this might be a good time to buy. The opposite can be said about when the orange line is in the red zone, and you will note that using this method the Bitcoin network would appear to still be overvalued nearly on the same scale as the end of 2014.
My thoughts
I can't help but comment on the similarities between this model and my own work on the correlation between unique addresses and Bitcoin price. See the table below.
Author Dmitry Kalichkin Hans Hauge Data Range 2012 - 2018 2010 - 2018 Data Point Type 30 DMA Monthly Average Standardization Upper - Lower / 2 Z-Score Fair Value BTC Mkt Cap (May 2018) $33B $22B
We can see the visual similarity too.
Image Source: Cryptolab Capital Data Source: Blockchain.com
I feel that these similarities reinforce the relationship between unique addresses and Bitcoin's market cap using Metcalfe's law, since we both used different paths to arrive at a similar conclusion.
Comments on time ranges near outer boundaries
The author of the NVM model notes that:
in December 2017 DAA was unusually high
And
in May 2018 the Daily Active Addresses figure is unusually low
I would like to suggest that this is due to the impact of fees, batching, and address consolidation.
To illustrate this point, just look at average fees on the same chart as the number of unique addresses in use (DAA).
Image Source: Bitinfocharts.com
That's why I said:
At times, the number of unique addresses tends to increase, and at other times it tends to decrease. This is affected by the following factors.
Things that increase unique addresses.
- When fees are high, people leave their UTXOs in multiple addresses, because it costs too much to consolidate them.
- When the network is popular, more unique addresses are in use.
- As the Bitcoin network grows, in general there will be more unique addresses over time.
Things that decrease unique addresses.
- When fees are low, people (or their wallets) will consolidate their funds into a single address.
- Batching reduces the number of unique addresses in use. More batching will decrease unique addresses and less batching will do the opposite.
- When the market tanks, less unique addresses are in use because people just aren't transacting as much (not as fun to speculate).- Hans Hauge on Seeking Alpha
Closing Thoughts
Using Metcalfe's Law we can create a number of really cool models of Bitcoin's current value. The NVM model comes as close as I've seen to working out the kinks in this method and providing clear visuals that could help people know when Bitcoin might be in a bubble, or when it might be drastically undervalued. However, we must be careful using Metcalfe's Law alone, in any derivation. Unique addresses (DAA) might not always be as predictive as it's been in the past. When a significant portion of traffic moves into the lightning network, this metric will need to be updated. Also, we have to be aware of unusual behavior due to the impact of fee volatility, batching and wallet dust.
Have I mentioned that I'm launching a marketplace?
Starting on September 1st, I'm launching Crypto Blue Chips, a new marketplace focused on cryptocurrency investing. We'll be discussing which cryptocurrencies I'm investing in and when. Get the inside track; join us.
Hans Hauge
Principal Quant at Ikigai.
Analyst’s Disclosure: I am/we are long BTC-USD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
