Bitcoin Is Overvalued, Researchers Say

Bitcoin is overvalued, according to a recent study by Swiss researchers. 

There have been several attempts to put a monetary figure to the cryptocurrency’s valuation over the years. But frameworks used to assess it value focus more on hypothetical future scenarios the than current state of affairs. Per economic theory, markets determine an asset’s value. But wild swings in bitcoin’s price have yielded a wide and divergent range of values.  

However, bitcoin’s phenomenal rise has attracted attention from academic researchers and economists, who have identified relationships and patterns in its price movement and value. Google’s chief economist Hal Varian set the ball rolling in 2014 by suggesting that paper money derived its value not from government backing but from its network effects. This past January, researchers released a paper connecting bitcoin to Metcalfe’s law. Originally devised for telecommunication networks, Metcalfe’s law states that a network’s value is proportional the number of its users squared. The paper hypothesized that transaction volume at a specific price level provides valuable information. 

recent study by researchers at ETH Zurich has further advanced that line of thinking and applied Metcalfe’s law to bitcoin’s current valuations. The results may be none too pleasing to its enthusiasts. “…(There is) current substantial but not unprecedented overvaluation in bitcoin’s price,” the paper’s authors have written. 

The term 'network effects' refers to the number of users of the cryptocurrency. But the paper’s authors tweaked this information. This is because all nodes in bitcoin's blockchain are not simultaneously connected to each other. The authors assume that bitcoin is a “sparsely connected network” in which every user is connected to only 10,000 other users instead of 1 million. According to them, this is a more realistic depiction of the current state of bitcoin’s network. 

Plugging this figure into the general formula for Metcalfe’s law and adjusting for expected network growth rates (which decrease with time) until 2026, the researchers arrived at 0.79 million users that are currently in bitcoin’s network. They expect the number to grow to 2.60 million by 2023. Based on those figures, bitcoin should currently have a valuation between $22 million to $44 million. Bitcoin's market cap is currently $119 billion, suggesting that bitcoin's value is more than double the value predicted by the researchers. “Some separate fundamental development would need to exist to justify such high valuation, which we are unaware of,” the paper’s authors write. 

So, what does the currently overvalued bitcoin market mean? The authors suggest that the current market looks similar to that of early 2014. Back then, the cryptocurrency’s price flirted with the $1,000 mark. But a wave of negative news related to the crash of Mt. Gox, a Japan-based cryptocurrency exchange, triggered a slump in bitcoin’s price, which remained stagnant for the next two years before beginning an ascent.

Investing in cryptocurrencies and other Initial Coin Offerings ("ICOs") is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns 0.01 bitcoin. 

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