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Bitcoin's Value Is All in the Eye of the 'Bithodler'

02/20/2021 | 08:14am EST

By Paul Vigna

The total market value of bitcoin crossed $1 trillion on Friday as the price surged above $55,000.

Passionate backers are fond of saying the digital currency is on a trajectory "to the moon." For the less faithful, determining bitcoin's value is much more complicated.

Bitcoin has skyrocketed since the beginning of 2020 when it was trading around $7,000. A steady stream of institutional demand has been credited with driving much of that rally. Billionaire hedge-fund managers disclosed purchases: Paul Tudor Jones called it a " great speculation." A handful of companies, most notably Tesla Inc., recently started buying it for their corporate reserves.

Yet determining a fair value for bitcoin is much harder than valuing stocks, investors say, both because bitcoin isn't a traditional asset and because much about it is misunderstood.

"It's a difficult asset class to value," said J.P. Morgan analyst Nikolaos Panigirtzoglou, who estimates the value of one bitcoin could be as little as $11,000 or as much as $146,000.

The low end of that range is what it currently costs in computing power to create a bitcoin, he said, while the high end marks bitcoin's estimated value if its market capitalization were to match that of gold. Almost any price in between could be justified because of the intense interest from retail buyers, he added.

Bitcoin's backers are a passionate bunch, less concerned with fundamental analysis than a fervent belief that bitcoin is the future. That ethos is summed up in a single word: hodl, a misspelling of "hold" from an impassioned 2013 post on a bitcoin forum by a trader during one of bitcoin's periodic crashes. It means always keep buying, no matter what, and never sell. To these people, bitcoin's value is limitless.

To others, determining bitcoin's value is tricky. Bitcoin has properties that make it appear more like a commodity -- indeed, the Internal Revenue Service classifies it as such -- and properties that make it appear more like a currency, as Japan's Financial Services Agency classifies it.

Yet it really isn't either. Bitcoin is a software program designed to facilitate online exchange, to mimic physical cash, without the need for a bank or other middleman to guarantee the exchange.

One of the most popular arguments for bitcoin? It's a modern version of gold and a store of value. That belief rests mainly upon one specific feature of bitcoin's programming, a limit of 21 million placed on the number of bitcoins that could be created. That, its backers argue, makes bitcoin a scarce commodity and a deflationary rather than inflationary asset, at least compared with government-backed currencies.

Bitcoin, however, does have its own rate of inflation, albeit an entirely predictable one that is designed to decrease in the long run. Currently, 6.25 bitcoins are created roughly every 10 minutes, and nearly 19 million of the intended 21 million bitcoins are already in circulation. That results in a current inflation rate of roughly 2.2%, according to Bitcoin.com.

For comparison's sake, that is higher than both the Federal Reserve's stated goal of 2% and the most recent Consumer Price Index rate of 1.4%.

Bitcoin's inflation rate will drop to zero some time around the year 2140 when the last of the 21 million bitcoins are minted.

The effective inflation rate is likely higher. Nearly 80% of bitcoin's supply is illiquid, analytic firm Glassnode estimates, held by long-term investors who won't sell. Only about 4.2 million bitcoins are in circulation. That small supply is currently far outstripped by demand.

Another way of analyzing these dynamics, and one popular among bitcoiners, is the stock-to-flow model, a framework used to value commodities like gold and silver, made popular on social media by an anonymous trader dubbed Plan B.

Stock to flow measures the ratio of existing stockpiles to production. It is essentially another way of stating bitcoin's inflation rate. By this model, bitcoin should trade more like gold and silver, Plan B argued. To the trader's credit, back in 2019 Plan B predicted that the model implied bitcoin should have a $1 trillion market value and trade at $55,000 some time after May 2020. That prediction was fulfilled Friday.

But if bitcoin is supposed to be a gold alternative, its price is already in line with gold, J.P. Morgan's Mr. Panigirtzoglou argues. Bitcoin's market value is around $1 trillion, and the market value of privately held gold is around $2.7 trillion, he estimates. But in a portfolio that also takes into account volatility, like one managed by a professional money manager or corporate treasurer, bitcoin's much higher volatility means that the two would essentially be evenly weighted, he said.

Because portfolio managers and corporate treasurers need to take that volatility into account, he said he doesn't expect much more institutional money to be invested in bitcoin unless its price tumbles.

"For institutional investors, it is unrealistic here to expect them to ignore the volatility of bitcoin," he said.

To that point, a Gartner survey last week found only 5% of finance executives plan to hold bitcoin as a corporate asset in 2021. Moreover, 84% said they never intend to buy bitcoin.

Meanwhile, the highly publicized flurry of institutional interest in bitcoin may be smaller than it appears. Since September, only about $11 billion of professional money has entered the bitcoin market, Mr. Panigirtzoglou estimates. That isn't enough to drive a $800 billion change in total value and instead suggests that the attention given to institutional investors has drawn in more retail interest, he said.

Therefore, what is driving bitcoin's price isn't some fundamental value proposition, but instead simple retail-driven momentum trading, Mr. Panigirtzoglou said.

There is a simpler way of defining bitcoin's fundamental value, according to Steve Hanke, a professor of applied economics at Johns Hopkins University. Most forms of "money," everything from commercial bank deposits to Treasury bills, pay some amount of interest, no matter how small. Bitcoin doesn't. And while government-issued money doesn't pay interest, it is a universally recognized means of payment, unlike bitcoin.

"Bitcoin's fundamental value is zero," Mr. Hanke said. "It's almost all speculative."

Write to Paul Vigna at paul.vigna@wsj.com

(END) Dow Jones Newswires

02-20-21 0814ET

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