Traders often say there's truth in price. However, price and value aren't always the same thing and that's particularly true in the world of cryptocurrency where the store of value and intrinsic value debates continually run hot.
Bitcoin, the largest digital currency, resides around $62,000 as of late Nov. 4 and sports a market capitalization $1.17 trillion. That price is, roughly, what buyers are willing to purchase the asset at and what sellers are willing to part with it at, but beyond that, it's not instructive in terms of valuation.
And that's a big part of the rub with bitcoin and other digital assets. Traditional valuation metrics, such as price-to-earnings and price-to-book ratios aren't relevant here and that vexes investors.
Fortunately, hope is not lost. Recent research by ARK Investment Management posits that relative-value metrics similar to Enterprise Value to EBITDA (EV to EBITDA) can be applicable in establishing a foundation for properly valuing bitcoin. Undoubtedly, some of what follows is wonky stuff, but advisors can synthesize it into digestible nuggets for crypto-hungry clients.
Inside the Framework
ARK analyst Yassine Elmandjra highlights four cost basis metrics and three profit and loss metrics that are relevant in adequately valuing bitcoin, The cost basis metrics are Market-value-to-realized-value (MVRV) ratio, Market-value-to-thermo-value (MVTV) ratio, Investor capitalization and Short-to-long-term-realized-value (SLRV) ratio.
The profit/loss metrics are Realized profits-to-value (RPV) ratio, Short-term-holder profit/loss (STH P/L) ratio and the seller exhaustion constant. From the first group, MVRV is a concept some clients can grasp right off the bat.
“The MVRV ratio is market capitalization divided by realized capitalization, which measures the price of bitcoin relative to the average on-chain cost basis of all participants in the market,” says Elandrjra. “When MVRV is below 1, the market is selling at a loss, which historically has marked cyclical bottoms. Conversely, when market capitalization rises dramatically relative to average cost, bitcoin typically is poised for large-scale profit-taking.”
On the other hand, an MVRV reading of 8 can signal trouble while 10 has repeatedly marked tops. Fortunately, the metric reads around 4 today, which implies bitcoin is not overvalued.
The SLRV ratio pioneered by ARK is another potentially useful tool because it latches onto a crypto concept clients have already know about: HODLing or holding on for dear life.
“This metric compares the number of bitcoins moved per day to the number moved six months to one year previously: in other words, short term velocity relative to medium- and long-term velocity,” adds the ARK analyst. “This ratio illustrates how complex calculations can detect price inefficiencies. Historically, a ratio below 0.04 has been associated with bear markets when short-term velocity is low, suggesting apathy, relative to medium- and long-term velocity.”
Bitcoin Profit/Loss Metrics
Some of the bitcoin profit and loss metrics are “inside baseball” type stuff, but one of the three that's relatively easy to convey is the STH P/L ratio.
This ratio is the the short-term supply of bitcoin at a profit divided by the short-term supply at a loss. In plain English when that ratio is around 1, apathy is likely setting in and when it falls below 1, a new bear market could be around the corner.
“After bitcoin’s 53% correction from $63,000 USD to roughly $30,000 this past spring, its STH P/L ratio stabilized around 1, as shown below, suggesting that it was bottoming out. Today, STH P/L stands at 52, a value indicative of a potential local top,” according to Elmandjra.
Bottom line: Bitcoin and other digital assets aren't standard and that means outside-the-box thinking is required for proper valuation. For advisors that want to boil things down in truly simple terms, emphasize to clients that bitcoin's value is a reflection of its economic utility, which implies that as its usage case grows, so will its value. Potentially, anyway.