Tag Archives: irrational exuberance

Case for Bitcoin Price Reaching “Irrational” Level

BitcoinBracket – On December 5th and 6th. Bitcoin broke through the $12K, $13K, and $14K milestones. Yea, let that sink in. Bitcoin is up 25% in 48 hours. Below is a quick case for a current irrational valuation and a framework for estimating a valuation of the nascent currency.

Bitcoin has increased 25% in the last 48 hours and 6x in the last 20 weeks
Bitcoin has increased 25% in the last 48 hours and 6x in the last 20 weeks

For this analysis start with an assumption that bitcoin is a zero-sum game. Yep, I just lost a couple Bitcoin enthusiasts who believe the world is going to be transformed, but that’s OK. If I haven’t lost you yet, read on. It is a zero-sum game because it is impossible to take more cash out of the market than has been put into the market. The only exception is miners – but even miners invest substantial capital to produce bitcoin in the form of electricity, hardware, software and time.

Assuming it is a zero-sum game means the value of a Bitcoin should be the total amount of money put into the market, divided by the number of bitcoins in existence (about 16.75M at the moment according to coinmarketcap.com‘s Cryptocurrency Market Capitalization).

With this assumption we can say that the value of a bitcoin rises by the amount of new money entering the market divided by the number of bitcoins in existence. If a rich person invests $16.75 million dollars into bitcoin, the value of every bitcoin goes up by $1.

Looking at the market dynamics over the last couple days the volume on Bitfinex and Bitstamp has been roughly 400,000 bitcoins. There are more coins trading at Coinbase, but the volume isn’t disclosed (do you have an accurate volume to share? leave a comment). Let’s assume Coinbase is 50% of the market. Then let’s be generous and say that 1 million coins changed hands in the last 48 hours.

Further. Let’s assume that every one of those coins that was sold was the entrance of new money. Obviously this is impossible because for every buy, there is a sell. Also most of the coins changing hands are likely traders. But let’s be generous.

The average price over the last 48 hours was, again generously, $13,250. That means at most $13B entered the bitcoin market in the last 48 hours. This raises the value of a Bitcoin $13B/16.75M = $776. Yet, in that same time the trading price of a bitcoin increased over $2500.

That sounds like a lot of over-valuation. But markets occasionally get ahead of themselves. The last 48 hours may simply indicate that the value of a bitcoin was artificially low two days ago.

When you do the same analysis over the last 20 week, though, the total volume is closer to 600K btc/week. The average trading price has been around $6500. Again assuming all the money trading was new money, this means $78B has entered the market. That’s about $4600 per coin. Yet in that time, bitcoin value has gone from $2500 to $14,000. An increase of $11,500 – or $7000 more than the value of a bitcoin has gone up. Bitcoin could easily drop $7000 and is at an irrational level.

Again – those numbers are generous. If half of the money is new money then the value of bitcoin has only increased $2300 in the last 20 weeks.

Together, this put bitcoin in nosebleed territory and it is ripe for a pullback.