What traditional investors don't get about crypto

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Hey everyone,

Looking forward to another week in crypto.  Hope things are going well. 

Some traditional investors (think stock pickers) say crypto has no fundamental value because there isn’t an underlying business.  This is because traditional investors focus on valuing assets using cash flows from business profits and crypto doesn’t have business profits. The investment valuation method they use is called a discounted cashflow analysis.

Cash flows of a company:

While crypto assets don’t have business operations…they do have cash flows.

Cash flows of most crypto assets (e.g., Bitcoin):

So the question is if there is no business operations, what drives the long term value and how can the long term price be forecast?

I’d argue many crypto asset values are driven one main thing…Metcalf’s law. Metcalf’s law provides a way to value tech networks. A tech network is just a way users can interact with many other people via connected computers (e.g., Instagram, Facebook, internet). Most crypto assets would qualify as tech networks.

So what does Metcalf’s law say about valuing a tech network? 

Metcalf’s law says that the value of a network is proportional to the square of the number of members of the network.

Aka…the more people that use a tech network…the more useful it gets…and the more valuable it gets.

Lets illustrate this using Bitcoin as an example:

• The use case of Bitcoin is primarily as a savings technology that holds its value and appreciates over time, even after inflation

• Lets say there is one person saving in Bitcoin…if this is true Bitcoin shouldn’t be as valuable because when someone is looking to buy or sell it…its going to be hard to find a buyer or seller

• Now lets say theres 5 people saving in Bitcoin…its now a little more valuable because it’s easier to find a buyer or seller

• Now a million people saving in Bitcoin…now its way more valuable because its easier to find a buyer and seller

• And so on…

We can do this with many of the major crypto assets.  Lets try Solana (smart contracts):

• The use case for Solana is smart contracts: Being able to put contracts in code and ensure they are executed correctly because they are on the blockchain which secures it

• If there is one investor / user of Solana its not very useful because they would only be able to create a contract with themself

• If there are 5 investor / users of Solana now its a little more valuable and useful because there are a few people they can create contracts with

• Now if there are a million users…its way more valuable and useful because there are way more people they can create contracts with

• And so on…

Just like shown above, we can use Metcalf’s law to see many crypto assets do have fundamental value…but the long term value will be determined by whether the number of users grows, or shrinks.

Ok great so how can we tell what the cash flow out would be?

To try and estimate a future long term price, we need a long term price model that has a track record of success. In the case of Bitcoin one model that has worked is the Bitcoin Power Law. This model has worked for over 10 years.

Chart source: BitBO

(Hint: If you do some quick mental math on this…the rate of return at the price today to the lowest level (red line) in 2030 is 18% per year!)

Summing it up

What this all translates to is that as long as a crypto asset is a tech network that has a stable or growing number of users, it has fundamental value and associated cash flows. We can use this framework to evaluate each crypto asset as an investment opportunity.

Have a good week,

Justin

P.S. We recently got a puppy.  She’s a bernedoodle named Lucy. Lucy says hi.

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Disclaimer: The Blockchain Breakthrough is not financial advice. Please do your own research.