How To Value Bitcoin More Accurately Than JPMorgan

Reda Farran

4 months ago4:55 mins

How To Value Bitcoin More Accurately Than JPMorgan

In a research report sent out last week, JPMorgan said that the current fair value of bitcoin is $38,000. That’s a long way short of the $44,000 it’s at today, but let’s not get too in the weeds about the figure itself. Because while the framework the investment bank used is a good starting point, it’s also inherently flawed – and you might be able to do better.

How did JPMorgan arrive at $38,000 exactly?

First, the investment bank calculated a long-term theoretical price target for bitcoin by assuming that its total market value is equal to that of all gold held privately for investment purposes. That assumption is based on the growing argument that bitcoin is “digital gold” – i.e. a store of value in the digital age. After all, it shares many similar characteristics with the shiny metal: it’s in limited supply, it’s durable, it’s fungible, it can be divided into smaller “nuggets” (Satoshis), and so on.

According to the World Gold Council, there are 205,238 tonnes of mined gold with a total market value of over $10 trillion. But it wouldn’t exactly be fair to equate bitcoin’s total market value to this figure: almost half of the 205,238 tonnes of gold out there is used as jewelry, and another 17% is held by central banks as reserves. Bitcoin, you might be disappointed to hear, can’t be used as jewelry, and it’s unlikely we’ll see major central banks holding onto cryptocurrencies as part of their reserves any time soon (but never say never).

That’s why the figure JPMorgan is focused on is the amount of gold held privately for investment purposes – that is, gold held by individuals and investors (both retail and institutional) as a store of value. The figure includes all the bars held by gold ETFs, since they’re ultimately owned by private individuals and investors.

So how much gold is held privately?

According to the World Gold Council, there are 45,456 tonnes of gold held privately for investment purposes. This is what they call “bars and coins (including gold-backed ETFs)” on this data page (note that it was previously called “private investment”).

One tonne is equal to 35,274 ounces, which – at today’s gold price of around $1,800 an ounce – brings the total value of gold held privately to $2.9 trillion. And if we divide this by the total number of bitcoins in circulation (18,958,650 as of the time of writing), we get a theoretical price target of around $150,000 per coin.

Now here’s where things get a little interesting. The assumption JPMorgan is making is that investors won’t allocate an equal amount of bitcoin in their portfolios for store-of-value purposes as they would gold because, let’s face it, bitcoin is a lot more volatile – and therefore a lot riskier – than the metal. In fact, bitcoin’s price movements are around five times more volatile than those of gold.

Ratio of 3-month and 6-month realized volatilities for bitcoin vs. the corresponding volatilities for gold. Source: JPMorgan
Ratio of 3-month and 6-month realized volatilities for bitcoin vs. the corresponding volatilities for gold. Source: JPMorgan

If, hypothetically, bitcoin’s volatility was equal to gold’s, then JPMorgan’s framework would assume that the crypto’s fair value is the $150,000 per coin we calculated earlier. But in reality, bitcoin is more volatile, so the framework linearly adjusts the $150,000 by the expected bitcoin-to-gold volatility ratio in the future. JPMorgan assumes this ratio will decline from 5x today to 4x in the future, and will stay roughly steady there. That would value bitcoin at $150,000/4 = $37,500, which is how they arrived at their (rounded-up) figure of $38,000.

Your expectations, of course, may differ, which provides you with an interesting opportunity to play around with these assumptions. If, for example, you think the bitcoin-to-gold volatility ratio will stabilize at 2x in the future, JPMorgan’s framework would put bitcoin’s fair value at $75,000.

What is JPMorgan missing?

While the investment bank’s framework is definitely a good starting point, I think there are two key things it hasn’t considered.

1. Bitcoin has more utility than gold

There’s not much you can do with gold, but there’s a load of stuff you can do with bitcoin. First, you can use it as a form of payment, with a recent survey by Visa showing a quarter of small businesses plan to accept crypto payments this year. Second, you can easily and cheaply send bitcoin to another person on the other side of the globe without a middleman and any risk of censorship, making it an efficient method of money transfer.

Third, you can deposit your bitcoin at centralized or decentralized lending platforms to earn interest. For example, Celsius offers 6.2% on up to 0.25 bitcoin and 3.05% beyond that. Gold not only generates zero yield, it incurs storage costs in the form of custody and insurance fees if you hold it physically. And finally, you can use your bitcoin as collateral at these lending platforms to borrow other cryptocurrencies – including stablecoins, whose values are pegged to fiat currencies like the dollar. One fintech firm even allows you to use your bitcoin as collateral to take out a mortgage.

These are just some examples of bitcoin’s use cases, with more being created every month. The point is that bitcoin is more useful than gold, and that utility is worth something. Worth a lot, actually: PayPal – whose value, like bitcoin, is tied up with electronic payments – is valued at $133 billion, while Western Union – whose value, like bitcoin, is tied up with money transfer – is valued at $8 billion. JPMorgan’s framework completely ignores this additional value.

2. Bitcoin’s supply is more capped

There is a similarity in supply between the assets. 6.25 new bitcoins are mined every ten minutes (this is set to halve in early 2024), which is the equivalent of 328,500 new coins every year. That represents a 1.7% annual expansion of bitcoin’s supply base – a similar rate at which gold’s supply is increasing (roughly 3,500 tonnes being mined every year, on a base of 205,238 tonnes currently in existence).

But the similarity ends there. There are an estimated 53,000 tonnes of proven gold reserves in the ground. That means gold’s supply is set to eventually increase by 25% – or more, if we discover additional gold reserves (which is highly likely). Meanwhile, there’s a hard limit of 21 million bitcoins, which means bitcoin’s supply is set to increase by roughly 10% from here, but no more. Some people even argue that bitcoin’s true supply will decrease once we hit that 21 million, as users forget their wallet keys, accidentally send bitcoin to the wrong address, and so on.

In other words, JPMorgan’s $38,000 figure isn’t really a “fair” value at all. Even if you apply your own assumed volatility ratio to reach your own conclusion, the fact remains that the true value is always going to be higher, because you’re using a flawed framework. Something to bear in mind if you’re trying to reach your own fair value.

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