Cermak - Valuation of Scarce Digital Assets

FACULTY OF ECONOMICS AND ADMINISTRATION
Master’s Thesis
Brno 2022 Marek Čermák

FACULTY OF ECONOMICS AND ADMINISTRATION
Valuation of Scarce Digital Assets
Master’s Thesis
MAREK ČERMÁK
Advisor: Mgr. Zuzana Gric, Ph.D.
Department of Finance
Brno, Spring 2022

MUNI
MASARYKOVA UNIVERZITA
Ekonomicko-správní fakulta
Lipová 41a, 602 00 Brno
IČ: 00216224
ECON DIČ: CZ00216224
Zadání
diplomové práce
Akademický rok: 2021/2022
Student: Marek Čermák

Program: Finance
Název práce: Ocenění vzácných digitálních aktiv
Název práce anglicky: Valuation of Scarce Digital Assets
Cíl práce, postup a použité metody: Cílem práce je prozkoumat, které faktory přispívají k hodnotě digitálního
aktiva, a empiricky analyzovat, zda je možné odůvodnit aktuální ocenění na
základě faktorů, jako jsou přijetí sítě uživatelskými skupinami a tokenomika
aktiva.
Postup práce:
1. úvod do tradičních modelů oceňování
2. úvod do digitálních aktiv
3. porovnání tradičních a digitálních aktiv
4. analýza faktorů ovlivňujících oceňování digitálních aktiv
5. hodnocení a popis výsledků
6. formulace závěrů a dalších doporučení
Metody: analýza, komparace, deskripce.

Rozsah grafických prací: Podle pokynů vedoucího práce
Rozsah práce bez příloh: 60 – 80 stran
Literatura: Behavioral finance and wealth managementhow to build investment strate-
gies that account for investor biases. Edited by Michael M. Pompian. 2nd
ed. Hoboken, N.J.: Wiley, 2012. xxiii, 324. ISBN 9781118182277.
BURNISKE, Chris a Jack TATAR. Cryptoassets: The Innovative Investor’s
Guide to Bitcoin and Beyond. McGraw-Hill, 2017. 368 s. ISBN 1-260-02667-
1.
PINTO, Jerald E., Elaine HENRY, Thomas R. ROBINSON a John
D. STOWE. Equity asset valuation workbook. Edited by Raymond D.
Rath. Second edition. Hoboken, New Jersey: Wiley, 2010. vi, 117.
ISBN 9780470395219.
ARIELY, Dan. Predictably irrational : the hidden forces that shape our de-
cisions. 1st. rev. and expanded ed. New York: Harper Collins Publishers,
2009. xix, 368. ISBN 9780061854545.
AMMOUS, Saifedean. The Bitcoin Standard: The Decentralized Alternative
to Central Banking. Wiley-Blackwell, 2018. 304 s. ISBN 978-1-119-47386-2.
Vedoucí práce: Mgr. Zuzana Gric, Ph.D.
Pracoviště vedoucího práce: Katedra financí
Bibliographic record
Author: Marek Čermák

Faculty of Economics and Administration
Masaryk University
Department of Finance
Title of Thesis: Valuation of Scarce Digital Assets
Degree Programme: Finance
Field of Study: Finance
Supervisor: Mgr. Zuzana Gric, Ph.D.
Academic Year: 2021/2022
Number of Pages: 9 + 102
Keywords: valuation, network value, Metcalfe’s law, digital assets, scarcity, cryp-
tocurrency, tokens, bitcoin, ethereum, framework, model
Annotation
The thesis defines a conceptual digital asset valuation framework and applies it to the
valuation of bitcoin. The valuation presents the bitcoin investment thesis, performance
forecasts and risk considerations. It follows with the proposition of multiple valuation mod-
els that are based on properties of the bitcoin network such as store-of-value, transaction
volumes and network growth. The network value model based on Metcalfe’s network value
proposition has been selected to estimate bitcoin value based on the forecasted growth of
monthly active addresses. Conversion of the forecasts into the final valuation and assess-
ment of potential risk factors has been made considering bitcoin value estimation for the
year 2025. Regulatory risk has also been accounted for in the form of a required rate of
return multiplier and subjectively estimated probability distribution of various scenarios.
Declaration
Hereby I declare that this paper is my original authorial work, which I have worked out
on my own. All sources, references, and literature used or excerpted during elaboration of
this work are properly cited and listed in complete reference to the due source.
Brno, 12. May 2022

Author’s signature
Acknowledgements
I would like to express my gratitude to my advisor, Mgr. Zuzana Gric, Ph.D., who guided
me throughout this project. I wish to show my appreciation to friends and family and
thank them for their valuable time. I would like to extend my special thanks to those who
provided constructive criticism and ideas for improvement.
Contents
Introduction 16
I Digital assets 18
1 Definition 19
1.1 Cryptocurrencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
1.2 Tokens . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
2 Blockchain 23
2.1 Decentralisation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
2.2 Immutability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
2.3 Security . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
2.4 Consensus mechanisms and mining . . . . . . . . . . . . . . . . . . . . . . . 25
3 Scarcity 29
II Valuation Framework 31
4 Valuation process 32
5 Understanding value proposition 34

5.1 Tokenomics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
5.1.1 Supply and distribution . . . . . . . . . . . . . . . . . . . . . . . . . . 34
5.1.2 Utility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
5.2 Risk factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
6 Forecasting performance 39
7 On-chain analysis 40
7.1 On-chain metrics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41
7.1.1 Layer 1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
7.1.2 Layer 2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
7.1.3 Layer 3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
7.2 Providers of on-chain data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
7.2.1 Glassnode . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
7.2.2 CoinMarketCap . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
7.2.3 CryptoQuant . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
7.2.4 Dappradar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
7.2.5 The Block . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45
7.2.6 CoinMetrics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
8 Selecting valuation model 47

8.1 Perception of value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
8.2 Absolute valuation models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
8.3 Relative valuation models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
9 Converting forecasts to valuation 51

9.1 Sensitivity analysis and situational adjustments . . . . . . . . . . . . . . . . . 51
9.2 Valuation factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
9.2.1 Macroeconomic factors . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
9.2.2 Microeconomic factors . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
9.2.3 Behavioral factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
9.3 Applying conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53
III Bitcoin valuation 54
10 Investment thesis 55
11 Bitcoin valuation models 60

11.1 Stock-to-Flow (S2F) model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
11.2 Terminal value model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
11.3 Value transfer model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
11.4 Network value model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
12 Selecting valuation model 73
13 Converting forecasts to valuation 76

13.1 Accounting for risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76
13.1.1 Correlation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77
13.1.2 Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79
13.1.3 Going-concern risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
13.2 Considering other valuation factors . . . . . . . . . . . . . . . . . . . . . . . . 80
13.3 Investment recommendation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81
Conclusion 83
Bibliography 85
A Bitcoin investment context 92
B US500 Annual returns 101
C Bitcoin volatility throughout history 102

List of Tables
1 Categories of on-chain indicators: Layer 1 . . . . . . . . . . . . . . . . . . . . . 42

4 Bitcoin valuation models . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
5 Comparison of stock-to-flow ratios . . . . . . . . . . . . . . . . . . . . . . . . . 62
6 S2F model regression characteristics . . . . . . . . . . . . . . . . . . . . . . . . 63
7 Network value model regression characteristics . . . . . . . . . . . . . . . . . . 69
8 Network value model parameters . . . . . . . . . . . . . . . . . . . . . . . . . . 69
9 Bitcoin valuation models summary . . . . . . . . . . . . . . . . . . . . . . . . . 73
10 Bitcoin network value model sensitivity analysis . . . . . . . . . . . . . . . . . 75
11 Bitcoin regulatory risk assessment . . . . . . . . . . . . . . . . . . . . . . . . . . 80
List of Figures
1 Weekly Google search trend for the term “digital asset” . . . . . . . . . . . . . 19

2 Google Search trends for selected terms . . . . . . . . . . . . . . . . . . . . . . 23
3 Ethereum Blockchain Size . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
4 Geographical distribution of bitcoin nodes . . . . . . . . . . . . . . . . . . . . . 27
5 Annual bitcoin inflation rate (new units as % of current supply) . . . . . . . . 30
6 Initial token distribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
7 BTC: All Exchanges Estimated Leverage Ratio . . . . . . . . . . . . . . . . . . . 38
8 Three-layered analysis of on-chain data . . . . . . . . . . . . . . . . . . . . . . . 41
9 Digital asset investments by country . . . . . . . . . . . . . . . . . . . . . . . . 57
10 Bitcoin Dominance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
11 Digital assets ownership forecast . . . . . . . . . . . . . . . . . . . . . . . . . . 58
12 Bitcoin network address growth forecast . . . . . . . . . . . . . . . . . . . . . . 59
13 Bitcoin S2F model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
14 Bitcoin supply and production . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63
15 Bitcoin terminal value model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65
16 Network value to transaction value . . . . . . . . . . . . . . . . . . . . . . . . . 66
17 Adjusted annualised NVT ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
18 Bitcoin simple network value model . . . . . . . . . . . . . . . . . . . . . . . . . 69
19 Bitcoin simple split-epoch network value model . . . . . . . . . . . . . . . . . . 70
20 Bitcoin complex network value model . . . . . . . . . . . . . . . . . . . . . . . . 71
21 Network value model deviation’s from bitcoin’s price at close . . . . . . . . . . 71
22 Bitcoin valuation using network value model . . . . . . . . . . . . . . . . . . . 72
23 Correlation of bitcoin price and total transaction value . . . . . . . . . . . . . . 74
24 Bitcoin volatility index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77
25 Bitcoin 90-day correlation with NASDAQ and S&P500 . . . . . . . . . . . . . . 78
26 Bitcoin 5-year correlation with NASDAQ and S&P500 . . . . . . . . . . . . . . 78
27 Risk assessment given regulation perception and likelihood . . . . . . . . . . . 79
28 Hierarchy of money: The Gold Standard . . . . . . . . . . . . . . . . . . . . . . 94
29 Hierarchy of money: Federal Reserve System . . . . . . . . . . . . . . . . . . . 96
30 Hierarchy of money: Transition from the gold standard . . . . . . . . . . . . . 98
31 Buying power of $100 since 1990 to 2021 . . . . . . . . . . . . . . . . . . . . . . 99
32 US500 annual returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101
33 Bitcoin volatility throughout history . . . . . . . . . . . . . . . . . . . . . . . . 102
Abbreviations
DeFi Decentralised Finance Glossary: DeFi, 20, 21, 40
KYC Know Your Customer Glossary: KYC, 20
NFTs Non-Fungible Tokens Glossary: NFT, 37
S2F stock-to-flow Glossary: stock-to-flow
SEC Security and Exchange Commission 20, 22
10
Glossary
bitcoin is a digital currency created for use in peer-to-peer online transactions; written with
a lowercase b.
(source: Merriam-Webster Dictionary (2021a)) 11, 17, 26, 29, 32, 34, 37, 56, 76, 77
Bitcoin is a software based on the blockchain technology that facilitates the transfer and
custody of bitcoin currency; written with an uppercase B.
(extended definition based on Burniske et al. (2018)) 23, 24, 26, 41, 55, 56
blockchain is a digital database containing information (such as records of financial trans-

actions) that can be simultaneously used and shared within a large decentralized,
publicly accessible network.
(source: Merriam-Webster Dictionary (2021b)) 11, 12, 23, 40, 55
cryptocurrency is the native asset of a blockchain network that can be traded, utilized as
a medium of exchange, and used as a store of value. A cryptocurrency is issued
directly by the blockchain protocol on which it runs, which is why it is often referred
to as a blockchain’s native currency.
(source: Cryptopedia (2021a)) 20, 21, 76
cryptography is the enciphering and deciphering of messages in secret code or cipher

also: the computerised encoding and decoding of information
(source: Merriam-Webster Dictionary (2021c)) 21, 24, 25
DeFi decentralized finance (DeFi); is a major growth sector in blockchain that offers peer-
to-peer financial services and technologies built on Ethereum. DeFi exchanges,
loans, investments, and tokens are significantly more transparent, permissionless,
trustless, and interoperable than traditional financial services, and trend towards
decentralized governance organizational methods that foster equitable stakeholder
ownership. Platform composability in DeFi has resulted in unlocking value through
interoperability with innovations like yield farming and liquidity tokens.
(source: Cryptopedia (2021c)) 10, 20
digital wallet is a place where you can securely keep your crypto. There are many different
types of crypto [digital] wallets, but the most popular ones are hosted wallets, non-
custodial wallets, and hardware wallets.
(extended definition based on Coinbase (2021)) 24, 55
EBITDA earnings before interest, taxes, depreciation, and amortization, it is a pre-interest

flow; therefore, it is a flow to both debt and equity. EBITDA ignores changes in
working capital and noncash revenue.
(source: Pinto et al. (2015b, p. 142)) 50
ethereum is the digital currency used to settle transactions on the Ethereum blockchain.
12, 17, 32
11
Glossary
Ethereum is the second largest blockchain network that facilitates the transfer and custody
of ethereum currency; it is programmable by smart contracts. 21
full-node is a program that fully validates transactions and blocks; almost all full nodes
also support the network by accepting transactions and blocks from other full nodes,
validating those transactions and blocks, and then relaying them to further full
nodes.
(source: bitpanda (2021b)) 12
hard fork (or hardfork), as it relates to blockchain technology, is a radical change to a

network’s protocol that makes previously invalid blocks and transactions valid, or
vice-versa. A hard fork requires all nodes or users to upgrade to the latest version of
the protocol software.
(source: Frankenfield (2021a) and Cryptopedia (2022a)) 20, 55
KYC Know Your Customer (KYC); is the compliance process instituted by regulators for
businesses to verify the identity and level of risk of their customers. This process
normally requires users to provide official identity verification using a passport,
driver’s license, or similar documents. KYC regulation requires financial firms to
collect personal data on their customers and ensure the legitimacy of the person or
client to whom they may provide services.
(source: Cryptopedia (2021e)) 10, 20
light-node is a program whose only task is to verify transactions in the blockchain using
simplified payment verification.
(source: bitpanda (2021c)) 12
mining is the way the peer-to-peer network verifies transactions and reaches common
consensus without requiring a central authority.
(source: bitpanda (2021d)) 24
NFT is a non-fungible token (NFT); a specialized type of cryptographic token that rep-
resents a unique digital asset that cannot be exchanged for another type of digital
asset. This characteristic is in contrast to cryptocurrencies and blockchain utility
tokens (like Bitcoin and Ethereum) that are fungible in nature. NFT’s are created
via smart contract technology and are classified within the ERC-721 token standard.
(source: Cryptopedia (2021f)) 10, 36, 37, 45, 48
node is a computer connected to other computers which follows rules and shares informa-
tion; see also full-node and light-node.
(source: bitpanda (2021e)) 23, 24, 25, 26, 44
P/B price-to-book (P/B) ratio; is the ratio of firm’s market capitalization to its book value.
It’s calculated by dividing the company’s stock price per share by its book value per
share (BVPS). An asset’s book value is equal to its carrying value on the balance sheet,
and companies calculate it netting the asset against its accumulated depreciation.
(source: Pinto et al. (2015a, pp. 399–410)) 50
12
Glossary
P/E price-to-earnings (P/E) ratio; is the ratio for valuing a company that measures its price
relative to its earnings per share (EPS). The price-to-earnings ratio is also sometimes
known as the “price multiple” or the “earnings multiple”. Two variations exist: the
trailing P/E and the forward P/E.
P/S price-to-sales (P/S); ratio is a valuation ratio that compares a company’s stock price
to its revenues. It is an indicator of the value that financial markets have placed on
each dollar of a company’s sales or revenues.
peer-to-peer relating to, using, or being a network by which computers operated by indi-
viduals can share information and resources directly without relying on a dedicated
central server.
(source: Merriam-Webster Dictionary (2021e)) 23, 55, 60
proof-of-stake is a cryptocurrency consensus mechanism that reduces the amount of com-

putational work needed to verify blocks and transactions that keep the blockchain,
and thus a cryptocurrency, secure. Proof-of-stake changes the way blocks are verified
using the machines of coin owners. The owners offer their coins as collateral for the
chance to validate blocks. Coin owners with staked coins become “validators”.
(source: Frankenfield (2021b) and Cryptopedia (2022b)) 26
proof-of-work is a cryptocurrency consensus mechanism that requires a not-insignificant but

feasible amount of effort in order to deter frivolous or malicious uses of computing
power, such as sending spam emails or launching denial of service attacks.
(source: Frankenfield (2021c) and Cryptopedia (2022c)) 26, 28, 41, 43
rug pull is a malicious maneuver in the cryptocurrency industry where crypto developers
abandon a project and run away with investors’ funds. Rug pulls usually happen in
the decentralized finance (DeFi) ecosystem, especially on decentralized exchanges
(DEXs), where malicious individuals create a token and list it on a DEX, then pair it
with a leading cryptocurrency like Ethereum.
(source: CoinMarketCap (2021) and Cryptopedia (2022d)) 35
smart contract programs stored on a blockchain that run when predetermined conditions
are met; used to automate the execution of a set of actions with a deterministic
outcome.
(extended definition based on IBM (2021)) 12
stock-to-flow is a model that quantifies the commodity’s (bitcoin) scarcity and then divides
it by yearly issuance (the flow). 10
token is a unit of value that blockchain-based organizations or projects develop on top of

existing blockchain networks. While tokens often share deep compatibility with the
cryptocurrencies of that network, they are a wholly different digital asset class.
(source: Cryptopedia (2021b)) 21, 22, 76
13
Glossary
trustless in the context of digital assets and decentralised transaction systems, trustless
can be understood as “not relying on trust”, meaning the system is transparent and
constraint with rules that prevent fraudulent behaviour, effectively eliminating the
need for trust among participants of the system.
(source: Cryptopedia (2021b)) 21, 22, 55
volatility is a tendency to change quickly and unpredictably; it is a statistical measure of

the dispersion of returns for a given security or market index. In most cases, the
higher the volatility, the riskier the security. Volatility is often measured as either the
standard deviation or variance between returns from that same security or market
index and is one of the key variables affecting a marketability discount.
(source: Pinto et al. (2015a), Merriam-Webster Dictionary (2022), and Hayes (2021))
36
14
Introduction
Introduction
Digital (crypto) assets are a complex topic where various branches of knowledge are
intertwined. Technology, economics, politics and finance all come together in synergy
to create a whole new market. The market, in its present state, is changing dynamically.
New tokens and cryptocurrencies entering the market, attempting to disrupt industries
like finance, gaming, supply chains and even attempting to replace the existing financial
system.
The goal of the thesis is to empirically analyse factors that affect the valuation of digital
assets and explore potential valuation methods based on properties that are unique to
particular assets — known as token economics — and examine demand-side approach to
valuation based on network adoption and user growth. Particularly, it focuses on tokens
and cryptocurrencies with limited supply, also called scarce digital assets. This thesis will
not propose a price-prediction model. Instead, it will attempt to propose a conceptual
approach to estimating a fair value of a digital asset at a certain point in time based on the
investment thesis and various assumptions about the future development of the digital
asset market. The thesis defines a conceptual framework for the valuation of scarce digital
assets that builds upon the traditional equity valuation framework proposed by Pinto et al.
(2015a). As such, it might serve as a reference for investors that might need inspiration as
to how to approach a valuation of a digital asset they are interested in.
Michael J. Mauboussin, a former chief investment strategist at Legg Mason Capital
Management has written in his foreword to the book The Little Book of Valuation that
“Valuation is at the core of the economic activity in a free economy.” (Damodaran, 2011,
p. 16) Digital assets, if anything, are attempting to create a free economy. As a consequence,
working knowledge of valuation’s broad concepts as well as its ins and outs is of great utility.
Equity asset valuation has been covered for decades by the most exceptional of investors
like Benjamin Graham in his definitive guide on value investing, a classic book called The
Intelligent Investor (1973), or Warren Buffet whose himself praised the aforementioned
book as “by far the best book on investing ever written”. However, most of the valuation
techniques and traditional valuation models have a) been developed decades ago and
simply do not capture some of the aspects of the modern age1 and b) rely mostly on some
sort of cash flow, whether present or a promise of future earnings.
Digital assets don’t fit into the concept. Concepts such as revenue or cash flow are either
not applicable at all, or require some degree of imagination to extract them from other
monetary properties. Digital assets are, however, conceptually closer to commodities in
the sense that their price is driven fundamentally by supply and demand. In the world of
investing and trading, it’s not very common to hear a question that goes “What do you think
is the intrinsic value of a pound of Arabica coffee beans?”. Instead, commodity markets are
targeted by traders who speculate on the short term movements given the primary factors
that directly impact the underlying. Following the Arabica coffee example, that could be a
near-term global climate outlook2 , distribution costs, storage costs or even health policies
and modern consumption trends. Given these inputs, the result of this kind of valuation is
1. Even one of the greatest investors of all times, Benjamin Graham, has admitted that the techniques he
presents in his book may already be insufficient or outdated.
2. Coffee crops are very sensitive to sudden weather changes and drops in temperature
16
usually either up or down from the current price. Also, technical analysis plays a major role
in determining the short-term direction of the commodity market. Digital assets currently
trade in a very similar fashion.
Perhaps it is also for these reasons that there is a serious lack of existing literature and
academic research regarding the valuation of digital assets. Despite the abundance of price
predictions — especially regarding bitcoin and ethereum prices — that have been issued by
institutional investment giants, their analyses are mostly shallow and arguments are vague.
Moreover, since bitcoin and ethereum are extremely volatile assets, it is entertaining, to
say the least, to watch those price predictions and analysts’ sentiment about future change
directions along with the trend of the underlying asset (see also Section 8.1). That being
said, institutional analysts have gone a long way since 2014 and 20173 and there is an
increased amount of attention to the research of the value proposition of those assets. This
might be a reaction to the demand reported by the major banks, stating that a significant
portion of existing customers demands crypto-related services (Mayor, 2021). For example,
institutions like Goldman Sachs have recently declared crypto a “new asset class” in their
global macro investment report Nathan (2021b). Goldman Sachs also agrees with the
prevailing investment thesis and regards bitcoin as a store of value. The store of value
property of bitcoin will be examined thoroughly in this thesis.
Most of the academic research in the space is focused on the leading assets like Bitcoin
(BTC) and Ethereum (ETH) and the models also target these assets in particular. Even
though the thesis focuses on these assets, the proposed framework is generic and should
apply to any digital asset. The thesis examines existing models such as S2F (Plan B, 2019),
it attempts to come up with a creative valuation approach with the terminal value model
(Section 11.2) or value transfer model (Section 11.3) and it also builds upon existing work
of Peterson (2018) to propose a model based on Metcalfe’s definition of network value that
states that the value of a network grows proportionally to the number of its users (Metcalfe,
2013).
The thesis consists of three parts. Part I begins with the definition of digital assets,
provides elementary knowledge regarding the underlying blockchain technology and
formulates the concept of scarcity. Part II follows by the proposition of a conceptual frame-
work for digital asset valuation based on similar equity asset valuation approaches and the
framework is then applied to bitcoin valuation in the final Part III.
3. In those years there has been a significant increase in interest in digital assets as evidenced by the increase
in google trend search and media coverage (see trends.google.com). 2014 is also the first year that Goldman
Sachs covered bitcoin in their research.
17
PART I
DIGITAL ASSETS
1 Definition
As of the time of writing, governments struggle with the definition and scope of digital
assets and regulation and legislation around digital assets are writing a hot topic. Histori-
cally, digital assets have been called cryptocurrencies. This term is, however, inaccurate as it
covers only a subset of digital assets that fall within the definition of a currency. Recently,
a new subset of digital assets called tokens has emerged. These tokens are units that may
represent a single piece of art, music or real estate. Hence, they may not be fungible, which
is the basic requirement that a currency has to satisfy.
As evidenced by Figure 1, the term “digital asset” has become increasingly popular
and it is being adopted even by legislation.
Source of data: Google Trends

Figure 1: Weekly Google search trend for the term “digital asset”
There have been attempts to compile a comprehensive definition of the term and define
its scope. Surprisingly enough, one of the latest definitions has occurred in the bill H.R.3684
- Infrastructure Investment and Jobs Act (117th Congress, 2021). What’s interesting here are
two things – that the definition has occurred in a Congressional bill, which would have been
unthinkable even two years ago and secondly, that the bill is part of the INVEST in America
Act which is primarily focused on infrastructure and jobs. Section 80603, paragraph b) on
information reporting for brokers and digital assets (117th Congress, 2021, p. 911) of the
bill defines digital assets as such:
“Except as otherwise provided by the Secretary, the term digital asset means any digital
representation of value which is recorded on a cryptographically secured distributed ledger
or any similar technology as specified by the Secretary. ”(SEC. 80603, 2021)
The bill aroused much controversy both among supporters and opponents of digital
assets due to ambiguous wording and unclear definitions regarding reporting of digital
assets — primarily for tax purposes — which could lead to various kinds of issues, especially
for brokers and exchanges. This resulted in hundreds of amendments being proposed to the
bill and various petitions. Nevertheless, various definitions and extensions can be found.
For example, congressman Beyer introduced new legislation to regulate digital assets in
19
1. Definition
July 2021 cited as the “Digital Asset Market Structure and Investor Protection Act”4 . The
act proposes an amendment to the DEFINITION OF SECURITY, Section 3(a)(10) of the
Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(10)) and introduces the term “digital
asset security” which is treated very similarly to an investment contract. As a side note,
declaring digital asset security might have drastic implications on some of these assets
or even on the whole market since securities are regulated by the Security and Exchange
Commission (SEC). For example, Know Your Customer (KYC) is a strict requirement
for any security exchange and KYC is difficult — even impossible in some cases — to
implement in the Decentralised Finance (DeFi) space, i.e. trading coins that were deemed
securities may become illegal on the decentralised exchanges and they’d most likely be
delisted. The proposal defines the term digital asset security as a digital asset that:
1. provides the holder of the digital asset with any of the following rights:
(a) Equity or debt interest in the issuer.
(b) Right to profits, interest, or dividend payments from the issuer.
(c) Voting rights in the major corporate actions (which shall not include new block
creations, hard forks, or protocol changes related to the digital asset) of the
issuer.
(d) Liquidation rights in the event of the issuer’s liquidation.
2. In the case of an issuer with a service, goods, or platform that is not wholly opera-
tional at the time of issuing such digital asset, with respect to any fundraising or
capital formation activity (including initial coin offerings) which is accomplished
through the issuance of such a digital asset, issues such digital asset to a holder in
return for money (including other digital assets) to fund the development of the
proposed service, goods, or platform of the issuer.
Any other digital asset not defined as such is then proposed to be considered and regu-
lated as a commodity. This is a more comprehensive and reasonable proposal that shows
an effort to regulate, not ban, digital assets, which is great news after a lengthy period of
uncertainty and doubt about whether digital assets will be banned or not — the uncertainty
is still present, but it diminishes year by year. However, using acts written in 1934 and
attempting to bend them to fit one of the most profound technological breakthroughs of
this millennia is only putting off the inevitable – completely new legislation will most likely
have to be introduced for digital assets.
With that being said, in the context of this thesis, we’re going to understand the term
“digital asset” as a non-tangible, digital representation of value that is cryptographically
secured and recorded on a blockchain. Digital assets will be further divided into cryptocur-
rencies (also called simply “coins”) and tokens.
1.1 Cryptocurrencies
Gemini’s Cryptopedia glossary (2021) defines a cryptocurrency as follows:
4. Available at https://beyer.house.gov/news/documentsingle.aspx?DocumentID=5307
20
1. Definition
the native asset of a blockchain network that can be traded, utilized as a

medium of exchange and used as a store of value. A cryptocurrency is issued
directly by the blockchain protocol on which it runs, which is why it is often
referred to as a blockchain’s native currency. In many cases, cryptocurrencies
are not only used to pay transaction fees on the network but are also used to
incentivize users to keep the cryptocurrency’s network secure.
Cryptocurrencies typically exhibit the following characteristics (Cryptopedia Staff,

2021):
• they are decentralized, or at least not reliant on a central issuing authority. Instead,
cryptocurrencies rely on code to manage issuance and transactions.
• they are built on a blockchain or other Distributed Ledger Technology (DLT), which
allows participants to enforce the rules of the system in an automated, trustless
fashion (more on that topic in Chapter 2).
• uses cryptography to secure the cryptocurrency’s underlying structure and network

system.
1.2 Tokens
Again, using Gemini’s definition (2021):
Tokens — which can also be referred to as crypto tokens — are units of value
that blockchain-based organizations or projects develop on top of existing
blockchain networks. While they often share deep compatibility with the
cryptocurrencies of that network, they are a wholly different digital asset
class.
As opposed to cryptocurrencies are the native asset of a specific blockchain
protocol, whereas tokens are created by platforms that build on top of those
blockchains. For instance, the Ethereum blockchain’s native token is ether
(ETH). While ether is the cryptocurrency native to the Ethereum blockchain,
many other different tokens also utilize the Ethereum blockchain. These
tokens can serve a multitude of functions on the platforms for which they are
built, including participating in decentralized finance (DeFi) mechanisms,
accessing platform-specific services, and even playing games.
Most of the tokens are built on top of Ethereum, however, there are other popular
so-called first-layer blockchains like Ethereum, for example, Cardano (ADA) or Polkadot
(DOT) among others.
The typical characteristics of crypto tokens are (Cryptopedia Staff, 2021):
• programmable – they run on software protocols, which are composed of smart

contracts that outline the features and functions of the token and the network’s rules
of engagement
21
1. Definition
• permissionless – anyone can participate in the system without the need for special
credentials
• trustless – no one central authority controls the system; instead, it runs on the rules
predefined by the network protocol
• transparent – the rules of the protocol and its transactions are viewable and verifiable
by all
To get a better idea about a token, it can be viewed as a representation of an asset. The
represented asset can be either abstract, like a service or a certain utility5 ; but they can
also represent physical tangible assets such as real estate or paintings. Tokens share many
similarities with investment contracts6 in the sense that they are bought with an expectation
of value. This similarity might be problematic when it comes to regulation in the future
since they might be qualified as securities (also refer to the definition of digital asset security).
. According to the Howey test, which is used to determine whether a transaction qualifies
as an investment contract and therefore would be considered a security and subject to
disclosure and registration requirements under the Securities Act of 1933 (SEC, 2018a) and
the Securities Exchange Act of 1934 (SEC, 2018b), there are multiple criteria to consider. The
Security and Exchange Commission (SEC) has come up with a Framework for “Investment
Contract” Analysis of Digital Assets (SEC, 2019). According to this framework, the “U.S.
Supreme Court’s Howey case and subsequent case law have found that an ’investment
contract’ exists when there is the investment of money in a common enterprise with a
reasonable expectation of profits to be derived from the efforts of others. The so-called
’Howey test’ applies to any contract, scheme, or transaction, regardless of whether it has
any of the characteristics of typical securities.” That means, that the investors in digital
assets should, as part of their due diligence regarding a particular token, also consider
the legal aspect of the asset and whether it may satisfy the security test. The framework
provided by the SEC may be used for such investment contract analysis. In the case that an
asset could be potentially classified as a security, the risk of potential regulation should
also be included in the valuation of the asset.
5. That utility can be for example the right of ownership, return in a form of yield, access to a platform or its
governance, etc...
6. The U.S. Supreme Court’s Howey case and subsequent case law have found that an "investment contract"
exists when there is the investment of money in a common enterprise with a reasonable expectation of profits
to be derived from the efforts of others (SEC, 2019)
22
2 Blockchain
The underlying technology that most if not all digital assets are built on is called a blockchain.
The blockchain is a system of decentralised trust for value transfer. As Burniske et al. (2018)
puts it, it is “relying not on the ethics of humankind, but the cold calculation of computers
and laying the foundation potentially to obviate the need for much of Wall Street”. This
chapter is going to explain in sufficient detail what the technology entails and lays down
the foundations for the value proposition of a blockchain network.
The foundations for blockchain technology were laid on October 31, 20087 when the
Bitcoin white paper was released by a pseudo-anonymous8 author called Satoshi Nakamoto
(Burniske et al., 2018). The real identity of this person — or a group of people — has
remained unknown to the day of this writing.
The word blockchain hasn’t been mentioned even once in the original white paper, though
phrases such as “blocks are chained” or “chain of blocks” are rather common, which might
be the origin of what will later be called the blockchain. The term started to be widely used
around the year 2015 when the technology piqued the interest of the prominent financial
magazines, including Bloomberg Markets, Masters or the Economist and they used the
term quite frequently (Burniske et al., 2018). This has led to a subsequent spike in Google
searches for blockchain and related terms (see Figure 2).
Source of Data: Google Trends

Figure 2: Google Search trends for selected terms
Initially called “digital ledger”, blockchain is a decentralised, immutable database that

uses cryptography to verify peer-to-peer transactions, i.e. changes in user balances. The
database is then able to store all the transaction data and being a decentralised network of
nodes, the network is also most often publicly accessible. Blockchain, surprisingly enough,
is a synergy of technologies that alone are not that innovative. One of the cornerstones of
7. The paper was revised in 2009.

8. There have been several phoney Satoshis since the original paper was released. However, all of these
self-proclaimed creators of Bitcoin were debunked. Various investigations have been made, claims of Satoshi’s
origin span over five continents, yet the mystery remains unsolved.
23
2. Blockchain
blockchain technology is cryptography, which — admittedly, in a much simpler form — has

been in use way before our Common Era9 .
Today, various kinds of blockchains exist. however, they share many similarities with the
original Bitcoin blockchain proposed back in 2008-9. Three key characteristics are common
to the majority of blockchains – decentralisation, immutability and security through applied
cryptography. This blockchain trinity will be discussed in the following sections of this
chapter.
2.1 Decentralisation
For blockchain, decentralisation plays a vital role. It is the decentralised nature that deter-
mines a lot of blockchain properties. Being a distributed database, there is no rigid control
of who can access the information stored within the database. Therefore, anyone at any
time can access Bitcoin’s blockchain and see the records of transactions – debits and credits –
between digital wallets in real-time. It creates a transparent system of global trust Burniske
et al., 2018.
Because of the distributed nature, the barrier of entry for blockchain participants is
relatively low. Since there is no central authority which would permit or forbid participation
in a blockchain network, it comes down to having a machine which could act as a node on
the network and an internet connection.
In general, the decentralisation of the blockchain has its drawback. One of them might
be the size of the database and the processing power required to validate transactions.
When a blockchain grows, so do the requirements for each node, particularly regarding
storage and processing (CPU) power. Bitcoin blockchain, for example, is relatively compact
considering how many participants there are. Even though it is subjected to continuous
increase, Bitcoin has a block size of 1 megabyte10 and a block is mined approximately every
10 minutes according to the original design proposed by Nakamoto (2009). So far, that
is since its genesis in 2008, the size of Bitcoin’s blockchain is approximately 15 Gigabytes.
That is the equivalent of just about one movie in high resolution (Full HD) (Catoy, 2020).
Hence, the size of Bitcoin’s blockchain is negligible. However, there are other blockchains
besides Bitcoin that store much more data and process it at high speed, like Ethereum,
which has grown almost sixfold in two and a half years from 168 gigabytes to nearly 1TB
as of the time of this writing (see Figure 3). These blockchains might have much higher
storage requirements and grow at a higher rate. Therefore, in contrast, they might present a
higher barrier of entry for the participants and as a result, are prone to be more centralised.
9. Reportedly, Julius Caesar used a so-called Caesar Code to communicate. The Caesar Code was a substi-
tution cypher which encoded words based on alphabetical shift.
10. For whom a 1 megabyte is difficult to imagine, think of it as around half a second of a movie, considering
the most common Full HD resolution (Catoy, 2020).
24
2. Blockchain
Source: YCharts
Figure 3: Ethereum Blockchain Size [in Gigabytes]
2.2 Immutability
“Immutability is a rare feature in a digital world where things can easily be

erased, and it will likely become an increasingly valuable attribute.”
— Chris Sowell (1993)
Another, this time a bit more controversial, property of the blockchain is immutability.
Being immutable means that once a transaction is confirmed and accepted by the blockchain,
it’s permanent. It cannot be reversed or erased. Being immutable has its pros and cons. An
eloquent argument often mentioned by the opponents of this feature is that once an error
occurs, like a typo in the recipients’ address, which might eventually result in a debit to
the wrong person, the only way to get your money back is to rely on the recipient’s good
will and politely asking him to send it back.
2.3 Security
Being immutable builds upon the last property in this trinity – security. This is where the
concepts get a bit more technical. It is the concept of the combination of globally distributed
nodes that can cryptographically verify transactions and store them in an immutable
database in an append-only fashion11 that contributes to the security of the blockchain.
What ties together the aforementioned concepts, such as decentralisation, cryptography
and immutability, is the process of verification. Without getting too deep into the details, it
is the nodes who verifies the transactions. To do that, they have to reach a consensus about
the validity of those transactions, how the transactions will be grouped into blocks and
how those blocks will be chained together — and appended to the blockchain.
2.4 Consensus mechanisms and mining
Consensus mechanisms are the most fascinating aspect of blockchain. Initially, they might
seem like purely practical algorithms to verify transactions, i.e. binary decision whether the
transaction is valid or not. Consensus mechanisms, however, also entail economic concepts
11. Meaning that the information can only be added and never be deleted.
25
2. Blockchain
such as game theory, reward mechanisms and supply-demand rule-based models. There
are many types of consensus mechanisms, but the two most important ones are proof-of-
work (PoW) and proof-of-stake (PoS). PoW is the original consensus mechanism that was
proposed by Nakamoto (2009) and that is still most widely used — even though the latest
trend suggests a shift to Proof-of-Stake due to environmental concerns and performance
reasons.
We’re going to demonstrate the mechanism on the PoW alogirthm since this thesis
primarily focuses on Bitcoin and Bitcoin’s economical incentive is based mostly on this
consensus mechanism and it’s highly unlikely that it shifts towards a different one any
time soon. Ethereum, on the other hand, might benefit more from the proof-of-stake and
it is already scheduled to shift to the new consensus mechanism with the new upgrade –
Ethereum 2.0 – at some point in 2022.
Proof-of-Work
Bitcoin’s blockchain will be used for the explanation of proof-of-work, but it will roughly
apply to many other blockchains that utilise this consensus mechanism. In the proof-of-
work consensus mechanism, the nodes — think of them as computers owned by individuals
or institutions — are called miners. The name probably relates to the often pointed out
similarities between bitcoin and gold and the way bitcoins are produced. The miners
compete for rewards by verifying transactions. A transaction is considered verified once it
is part of a block that gets added to the blockchain. Miners compete for the privilege to be
able to add a particular block to the blockchain. If they earn that privilege, they are rewarded
with bitcoins. Those bitcoins are the bitcoins that are mined (or minted), in other words,
released to the circulation from the initial pool of 21 million bitcoins. Miners, therefore,
also act as producers of new bitcoins and they are incentivised to verify transactions by
rewards in the form of newly created bitcoins. This economic incentive propels the Bitcoin
network.
That being said, how do the miners compete against each other and how do they earn
the privilege to add a block to the blockchain? This is where the proof-of-work comes
into play. The rules of the competition are simple: “Solve a puzzle and solve it faster than
anyone else.” The puzzle here is a cryptographic puzzle that requires a significant amount
of computational power. To solve the puzzle, a miner has to scan for a value called nonce
that when ran through what’s called a hash function12 , the output begins with several zero
bits. The average work required is exponential in the number of zero bits required and
can be verified by executing a single hash (Nakamoto, 2009). The difficulty of finding the
right value is periodically adjusted based on the computational power of the nodes in the
network such that the puzzle is solved roughly every 10 minutes. In other words, the more
nodes there are and the quicker they could produce bitcoins, the harder the production
gets. As the network is growing, the computational power — measured in terahashes per
second — is exponentially increasing. Moreover, in the case of Bitcoin, in particular, the
number of bitcoins rewarded to the miners is halved roughly every 4 years. This results in
economic cycles of periodical adjustments to supply reduction.
12. The hash function is a function that, besides the nonce takes various other inputs, such as time, the hash
of the previous block or a summary of the proposed transactions. It is based on the SHA-256 cryptographic
hash function.
26
2. Blockchain
A careful and perhaps more technical reader and thinker might at this point ask a
question about whether a single malicious miner could attack the network by providing a
false block. To quote from the Bitcoin whitepaper: “Proof-of-work is essentially one-CPU-
one-vote. The majority decision is represented by the longest chain, which has the greatest
proof-of-work effort invested in it. If a majority of CPU power is controlled by honest nodes,
the honest chain will grow the fastest and outpace any competing chains. To modify a past
block, an attacker would have to redo the proof-of-work of the block and all blocks after it
and then catch up with and surpass the work of the honest nodes” (Nakamoto, 2009, p. 3).
It can be proved that the probability of an attacker (who is assumed to be slower) catching
up to the honest nodes diminishes exponentially as subsequent blocks are added. A special
case would be what’s called a 51% attack, which could happen if a node or a group of
malicious nodes owned the majority of the network. This used to be one of the concerns in
the early days when the Bitcoin’s network wasn’t as big as it is right now, however, with
the exponential growth that the network experienced, the probability of this happening is
already almost non-existent. Nevertheless, besides Bitcoin’s blockchain, this possibility still
exists for smaller blockchains and the investors should be aware of the possibility when
investing in a less decentralised network with uneven distribution of hash power among
its nodes (see Figure 4).
Source: bitnodes.io
Figure 4: Geographical distribution of bitcoin nodes
27
2. Blockchain
It is the proof-of-work mechanism that contributes to the security of the blockchain and
that creates the economic incentive that perpetuates the network. There are many other
nuances to the proof-of-work and it gets even more complicated for the proof-of-stake and
other consensus mechanisms, but this should give the necessary foundation to understand
the basic principles.
28
3 Scarcity
“The first lesson of economics is scarcity: there is never enough of anything

to fully satisfy all those who want it. The first lesson of politics is to disregard
the first lesson of economics.”
— Thomas Sowell (1993)
Scarcity is an important fundamental driver in economics as it represents the gap

between limited resources and theoretically limitless wants. This situation requires people
to make decisions about how to allocate resources efficiently, to satisfy basic needs and as
many additional wants as possible. Any resource that has a non-zero cost to consume is
scarce to some degree. The quality of scarcity describes limitation in relation to demand
(Knight, 1934, p. 45).
Burniske et al. (2018, p. 152) wrote: “Based on our evolutionary past, a key driver for
humans to recognise something as valuable is its scarcity.” This applies to digital assets —
and many other assets — of course as well. Scarcity plays an important role in supply and
demand and hence might have a significant impact on both the spot price of the asset and
eventually the value of the asset. One of the main reasons why precious metals are called
as such is because they are rare. Their supply is limited, they might be difficult or even
impossible to produce. Contrast it, for example, to fiat money, i.e. a government-issued
currency that is not backed by a physical commodity. Is fiat money valuable? It might be
challenging to obtain for some, but not difficult to produce. In fact, the supply of the world
reserve currency – the USD – is constantly increasing and it is estimated that in the last
100 years, the USD has lost about 96% of its value due to the inflation, which averaged 3%
annually over the period (Amaros, 2019). Interpolated to infinity, fiat money is practically
worthless. Inflationary assets are somewhat challenging to value, especially if the inflation
rate is variable and difficult to predict. However, an asset being inflationary does not
necessarily mean it is not scarce. A scarce asset can also experience inflation of sorts, we’ll
get to this topic later in the text. What matters, however, is the limited supply of the asset.
For example, the supply of bitcoin is limited to 21 million coins and yet it does exhibit
some sort of algorithmic inflation. It is a bit hard to notice and it is insignificant given its
appreciation rate, but it’s inflationary nonetheless. The important factor that distinguishes
it from fiat money is the supply. The supply of USD is ever-expanding and, moreover, it
isn’t even rules-based expansion. It’s usually in reaction to a certain macroeconomic event
and it’s therefore pretty much impossible to accurately predict how the supply will change.
On the contrary, the amount of mined bitcoins halves roughly about every 4 years (see the
Figure 5). This property is called an artificial scarcity.
Regarding those digital assets that do experience inflation, it is often the case that the
inflation rate is algorithmic and can be accounted for in the valuation even if the asset
itself has an elastic supply. However, the digital asset valuation framework proposed in
this thesis will assume primarily scarce digital assets. That is, cryptocurrencies and tokens
with limited supply, that can arguably be used as a store of value. Most the digital assets
are scarce, but not all of them. Some may even be naturally deflationary with a periodic
token burn, which means that the amount of circulating tokens diminishes over time. These
particular characteristics are usually unique to specific cryptocurrencies and tokens.
29
3. Scarcity
Source: Nathan (2021a)

Figure 5: Annual bitcoin inflation rate
For the purposes of this thesis, whenever we talk about digital asset valuation, we
implicitly expect that the underlying digital asset is scarce, that is, its total supply is capped.
Otherwise, the valuation approaches and models presented in this thesis might be skewed
by changes in the total supply.
30
PART II
VALUATION FRAMEWORK
4 Valuation process
“Valuation is at the core of the economic activity in a free economy. As a

consequence, working knowledge of valuation’s broad concepts as well as its
ins and outs is of great utility.”
— Legg Maison (Damodaran, 2011, p. 16)
Before investing in any asset, most investors will try to determine its value of the asset
to conclude whether a) the asset is investible, i.e. has any value — future or present — at
all; b) the current market valuation poses an investment bargain and there is a potential
of return on the investment and c) presents a better investment opportunity than another
asset. This chapter outlines the valuation theory from the traditional point of view. The
value of any valuation model rests on a few key drivers. These drivers may vary from asset
to asset and understanding of the underlying business means that it is possible to identify
value plays – stock that are investment bargains (Damodaran, 2011, p. 8). This chapter
will present the theoretical background of valuation. It will introduce the core concepts of
valuation, the approaches to estimating a value of a company and identifying the value
drivers of a business. These concepts will be called the traditional valuation models. The
core concepts will be transferred to a valuation of digital assets later in the thesis and
contrasted with valuation of the traditional assets.
It is important to note that all valuations are biased. The bias in the process starts by
choosing what company to value and this choice is not random (Damodaran, 2011, p. 15).
Indeed, by the time investors start to quantify a value of a company, they’ve already heard
about it and they’re probably already interested in the company. That makes investors
biased from the beginning and since most of the models require a significant amount of
assumptions going into them, including numerical factors like revenue growth rate, daily
active users growth, margin expansion, etc. All these are subjective.
In recent years, various complicated valuation models have been developed as a con-
sequence of technological progress and developments in computational power. advises
drawing from the principle of parsimony13 and using a simple rule: “When valuing an
asset, use the simplest model that you can.” (Damodaran, 2011, p. 18). This is also the
principle that this thesis will follow.
The valuation of digital assets is rather different from the valuation of assets like equities.
To gauge the value of equity (i.e. stock), the underlying business, cash flows, debt and other
financial characteristics of the share issuer are considered as the basis for valuation. Tokens
may be considered securities in some cases and therefore, the process might apply to them
as well and there might be an underlying business behind the token issuer. Cryptocurrencies
(like bitcoin, ethereum, etc.), on the contrary, in most cases won’t be considered securities.
Therefore, a modified valuation framework is needed to approach digital asset valuation.
We’ll show that a parallel can be drawn between traditional asset valuation and digital
asset valuation. Pinto et al. (2015a, p. 7) divides the valuation process into 5 steps:
1. understanding the business
13. It is a problem-solving principle commonly used in physics, also referred to as “The Law of Parsimony”,
or “Occam’s razor”.
32
4. Valuation process
2. forecasting company performance
3. selecting the appropriate valuation model
4. converting forecasts to a valuation
5. applying the valuation conclusions
Digital assets differ in many ways from the traditional ones, like stocks and bonds, as
was explained in previous chapters. Many of the steps in Pinto’s valuation process won’t
fit off-the-box. However, digital assets are financial instruments nonetheless and as such, it
should be possible to estimate their value using a similar valuation process.
In this part of the thesis, a generic approach proposed by Pinto et al. (2015a) will be
adjusted for the purposes of digital asset valuation and used as the basis for the valuation
framework. The framework will attempt to stick to the approach and principles of equity
valuation to be compliant with the existing valuation processes. From the top-level per-
spective, the basic steps in the valuation process of digital assets are quite similar to the
ones proposed by Pinto et al. (2015a) with the exception of the first two steps:
1. understanding the business → understanding the value proposition

2. forecasting company performance → forecasting asset’s performance
3. selecting the appropriate valuation model
4. converting forecasts to a valuation
5. applying the valuation conclusions
Individual steps of the valuation framework will be described in greater detail in the
following chapters.
33
5 Understanding value proposition
The first step of the valuation includes evaluating industry prospects, competitive position,
corporate strategies and financial statements, all of which contribute to making a more
forecast (Pinto et al., 2015b). Analogically, when trying to value a digital asset, the first
step would be to understand the value proposition. In the context of digital assets, the
aforementioned factors to evaluate in order to understand the value propositions can be
transformed in the following way:
• evaluate industry prospects – this holds for both a company’s business model and
digital assets (like cryptocurrency or a token); especially crypto tokens might target
various industries, like decentralised finance, transportation, supply chain, gaming,
art, real estate, etc.
• competitive position – as there probably isn’t just one single token or cryptocurrency
of the sort, examining its competitive position in the field is vital. First mover ad-
vantage is a huge value driver in the space as young as digital assets; evaluating
competition means comparing factors such as network size, user growth, degree of
decentralisation, percentage of assets in circulation, etc.
• corporate strategies and financial prospects – even this point holds for digital assets,
there is usually a business or community behind a cryptocurrency or a token and
there is an underlying business model. The strategies and financial prospects may
include coin/token distribution and issuance schedule, inflationary prospects, the
utility for the stakeholders and growth prospects.
These points provide the basis for forecasting the asset’s performance. They will be
explained in greater detail and put into practice in Chapter 11 when applied to bitcoin
valuation.
5.1 Tokenomics
Digital assets have unique qualities that make them different from their peers. Tokenomics
(short for token economics) is what describes the qualities of a digital asset. It is also a
useful tool for assessing tokens’ future performance, usually relative to other tokens. Note
that despite the word “token” being used, it concerns all the digital assets, irrespective of
whether the asset is considered to be a token or a currency.
Tokenomics is a complex topic that varies from asset to asset. Nevertheless, it is a useful
tool for assessing an asset’s worth. In this section, we’ll present a selection of tokenomic
indicators that an investor might consider in the valuation process.
5.1.1 Supply and distribution
Tokenomics relates to various factors. The elementary economical indicator of a digital

asset is its supply. That includes both total supply and circulating supply. Some beginner
investors and traders look at the spot price of an asset and compare assets relative based
34
5. Understanding value proposition
on that. For example, ethereum spot price of $3 000 might be considered “cheap” relative
to bitcoin’s $50 000 price. Following that logic, on a relative basis, it could be estimated
that ethereum might be worth at least 10 times more. However, that would put ethereum
market capitalisation given its total circulating supply to over $3.5T, which would make it
about 3 times more valuable than bitcoin.
Distribution, issuance (emission) and lock-ups are tightly related to the supply. The
distribution of a token, resp. cryptocurrency describes how the total supply of an asset is
split across various entities. The distribution model is usually set ahead of the public sale.
It can vary in complexity, see Figure 6.
(a) Chainlink (LINK) (b) Ethereum (ETH)

Source: messari.io
Figure 6: Initial token distribution
Apart from the initial token distribution, the total supply is most likely not released
during the public offering. Instead, an issuance schedule is defined, that is the rate14 at
which the remaining tokens are released into circulation. Some tokens may also be locked
up until a certain date before being available for sale. This usually applies to founder tokens
to prevent rug pulls and other malicious behaviour.
5.1.2 Utility
An asset’s utility is the value that it brings to the users and/or holders. It varies significantly
from asset to asset and has to be considered and evaluated on an individual basis. Currencies
are native tokens of a blockchain, therefore, the utility is usually the direct usage of the
blockchain. For example, bitcoin’s utility, in this particular sense, is that it enables users to
perform transactions and purchase goods. Tokens are usually security-like assets that give
their holders certain privileges. In a sense, they can be compared to company shares with
(optional) additional utility. For example, certain platforms might require that their users
hold a certain amount of tokens to interact with the platform.
14. The rate can be any discrete or continuous mathematical function. Bitcoin, for example, defines a simple
step function that changes the rate of block rewards roughly every four years during the halving event.
35
A special form of utility might be staking and participation in decentralised autonomous

organisations (DAOs). Staking is a process in which a holder of an asset stakes (in other
words, locks) a certain amount of coins or tokens for a given period. During that period
holders receive interest on the amount of staked tokens, however, they can’t access them
before maturity15 .
Participation and voting rights in a DAO might be another benefit. This is often a trait of
non-fungible tokens NFTs. For example, holding a certain minimal amount might enable
the holder to vote about the future development of the project, proposed requests for
enhancements, policy changes etc. Getting into details of this topic is, however, beyond the
scope of this thesis.
There are of course other potential utilities specific to the asset. Investors should always
research carefully and consider the utility on an individual basis.
5.2 Risk factors
Multiple aspects need to be considered when accounting for risk. A common way to
measure risk is by volatility. Statistically speaking, volatility is just a dispersion of returns
representing price swings in both directions around the mean price. Arguably, it presents
an equal opportunity as the risk. Nevertheless, the volatility of an asset is measured with a
parameter β16 . The beta (β) is a relative measure which evaluates the level of risk an asset
is exposed to relative to the broad market:

above the market
 if β > 1,
risk = equal to the market if β = 1, (5.1)
below the market if β < 1


For example, if an asset’s volatility exceeds that of a market such that β = 2, when the
market fell 5%, the implied move of that particular asset would be 10% to the downside.
The analogy is obvious for the move to the upside. The expected return on the investment
is described by the capital asset pricing model (CAPM). Digital assets are no different
when it comes to estimating capital risk and therefore, the model is also applicable.
The formula can be written as:
expected return = risk-free rate + β · market risk premium (5.2)
The β can be estimated as such:
cov( Re , Rm )
β= (5.3)
var ( Rm )
where
15. It is usually possible to unlock the staked assets, however, the interest would be lost. Some tokens may
also charge additional fees for unstaking before maturity.
16. Beta is often called a “risk premium”. That is because the greater the risk of an investment, the higher
the expected return should be. I.e. investors should be paid a premium for accepting the risk involved with
holding a risky asset.
36
Re = the return on an individual stock

(5.4)
Rm = the return on the overall market
Digital assets are notoriously volatile, which makes them riskier than most other assets
(see Appendix C that shows bitcoin volatility). The high volatility is the result of various
factors:
• high liquidity – they trade 24/7 on the spot markets and can be easily17 converted to
cash or other digital assets. Even a relatively new emerging digital asset class – NFTs
– are becoming highly liquid despite being similar to assets like art collectables, or
real estate. NFTs trading volume reached $23 billion in 2021. The top asset from the
CryptoPunks collection — currently the most valuable NFT collection with market
capitalisation of 875 421 ETH (CoinMarketCap, 2022) — has changed hands 3 times
in 2021 according to LarvaLabs while being valued at roughly $23.7M as of the time
of writing.
A contrast to that would be assets like real estate where the liquidity is relatively low.
An average time-to-sale in the real estate market based on the data from January
2018 through September 2020 is 30 to 45 days (Zillow, 2021).
• high leverage – as evidenced by bitcoin’s estimated leverage ratio (see Figure 7),
cryptocurrency markets are highly leveraged — some exchanges allow up to 100x
leverage — which in combination with high volatility may cause a domino effect of
chained liquidations, resulting in highly volatile price swings.
• relatively low market capitalisation – at the time of writing, the estimated total
market capitalisation of all publicly traded cryptocurrencies and tokens is still sitting
below $3 trillion. That’s just slightly bigger than the market cap of Apple, Inc.;
about 1/4 of the market capitalisation of Gold (the precious metal) or roughly
one-third of a professionally managed global real estate market (Hariharan et al.,
2021). Low market capitalisation means that even a relatively small investment can
have significant price impacts.
Volatility isn’t the only measure of risk, another way to gauge the risk of a portfolio is to
measure the correlation of assets in the portfolio. Especially when building a portfolio of
digital assets, it’s important to keep in mind that there exists a high degree of correlation
between individual assets and bitcoin. This reduces the diversification effect of such port-
folio and exposes the portfolio to systemic risk. Going-concern risk can also be applied to
digital assets in which case a probability of the asset surviving — i.e. the project behind the
asset has a self-sufficient and functioning business model and drives the development and
value of the asset — in the market can be assessed. Examples can be found in Section 13.1.
17. The statement applies to the top digital assets like Bitcoin, Ethereum and the likes with – digital assets
with mature networks and high enough market capitalisation. Emerging alternative coins are disregarded.
37
Source: CryptoQuant
Figure 7: BTC: All Exchanges Estimated Leverage Ratio
38
6 Forecasting performance
The second step in the valuation process – forecasting an asset’s performance – can be
viewed from two perspectives: the economic environment (i.e. an industry, national or
global economies) in which the company issuing the digital asset operates and the assets’
own operating characteristics.
Forecasting the performance of an asset is usually done in one of two ways – a top-
down or a bottom-up approach. In forecasting company performance using the top-down
forecasting approach, it is proceeded from the macroeconomic analysis down to segment
and industry forecasts and finally to the forecast of individual company performances and
asset forecasts.
On the other hand, the bottom-up approach aggregates micro-to-larger scale forecasts
under certain assumptions into individual asset’s forecasts. In traditional equity valuation,
the bottom-up approach might for example aggregate quarterly sales per store and net
income per store. Forecasting the number of stores the company could open in the next X
years, the total sales of that company — and in turn, net income of the company — can
be forecasted. Again, finding a parallel to the world of digital assets, the digital networks
consist of operating nodes, i.e. validator nodes. These nodes exhibit certain operating
characteristics, like hash rate per node number of blocks mined, etc. Forecasting the growth
of the number of nodes might provide valuable insights into the growth of the network
itself. Although it is not possible to simply aggregate the data per node to receive an overall
performance like in traditional equities, analysts may still draw conclusions from such
characteristics.
There are various ways of forecasting an asset’s performance. Considering the asset’s
utility is one of them. For example, using a relative valuation approach, as shown in
Section 11.3, it can be assumed that the primary utility of an asset is to transfer value
among network participants. This is the case with the Bitcoin and Ethereum networks.
Characteristics of such digital assets can be compared with respect to the value transfer
utility (like transaction rate, transaction volume, total transaction value, etc.) and compared
it to the equities providing similar services, like Visa or PayPal. In Section 11.3, a relative
valuation model is proposed. The model is based on the value transferred over the network.
Forecasting the performance of an asset is the nuts and bolts of the valuation. It is the
creative part that requires a thorough understanding of the underlying asset’s characteristics
and mechanics. Knowing these, some concepts can be taken from the traditional equities.
The forecasts form the input to the valuation models. Selecting the appropriate valuation
model is the topic of the Chapter 8.
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7 On-chain analysis
As opposed to the traditional markets where quarterly reports and financial statements
are available to investors, traders and other individuals, digital assets have no such thing.
Investors and traders particularly, however, need a way to gauge the current state of a
blockchain or a particular project.
With the blockchain being publicly accessible and fully transparent, anyone can access
the data on the blockchain. This data is called on-chain data and the analysis of such data is
usually referred to as on-chain data analysis. To put it bluntly, it includes all the data stored
on the blockchain:
• addresses on the blockchain
• supply
• DeFi related metrics 17
• derivatives
• distribution
• fees
• mining and miners’ revenue17
• transactions
• smart contract data17
• other complex indicators
For this work, we’ll consider the Bitcoin blockchain, which is not a smart contract
platform. Therefore, the third point – smart contract data – is not applicable. It’ll be shown,
however, that the transaction data and block data contain more than enough information
to support an in-depth fundamental analysis.
Blockchains form their own ecosystems and micro-economies and in that sense, the
on-chain data provide a similar insight into the ecosystem as the company’s financial
reports or government’s reports on the state of the population and economy. The difference
is that the on-chain data is updated in real-time and can be accessed by anyone. On-chain
data offers a new framework in which to analyse emerging monetary assets like bitcoin.
Analysing on-chain data might be extremely valuable for investors.
17. These metrics do not apply to all blockchains, they vary depending on the consensus algorithm of the
underlying blockchain.
40
7. On-chain analysis
7.1 On-chain metrics
The thesis will use a modified 3-layer data model (see Figure 8) proposed by Elmandjra
et al. (2021). The study explicitly focuses on the Bitcoin network, which is convenient for
this thesis as well. The pyramid proceeds from the most fundamental indicators assessing
the health, security and monetary integrity of the network (layer 1) through buyers’ and
sellers’ behaviour and holdings (layer 2) up to relative valuation metrics and other more
complex indicators forming the layer 3 that can be used to predict future performance and
short-term price inefficiencies.
With respect to the purpose of this thesis which is focused primarily on the Bitcoin
blockchain, some metrics presented in this section are specific to a proof-of-work blockchain
(like Bitcoin) and therefore include metrics related to hash rate, mining difficulty and
miners’ economics. Most of the metrics are not specific to Bitcoin and should be consensus-
agnostic18 .
Source: Elmandjra et al. (2021)

Figure 8: Three-layered analysis of on-chain data
18. Applicable to any blockchain, irrespective of its consensus algorithm.
41
7.1.1 Layer 1
The most fundamental metrics of any blockchain are classified as layer 1 indicators. They
are used to assess the health of the network. ARK Invest in their study differentiate the
health of the network into three categories (Elmandjra et al., 2021) – monetary integrity,
security and usage. We’ll base our layer 1 indicators on those proposed by ARK.
Table 1: Categories of on-chain indicators: Layer 1
Category Description Indicator
Monetary Integrity Issuance rate and circulating supply. • circulating supply

• issuance rate
Activity Activity and usage of the network. • active addresses

• addresses with non-zero balance
• transaction count
• transaction volume
Security Security of the network. • hash rate

• difficulty
• address supply distribution
Based on: Elmandjra et al. (2021)
7.1.2 Layer 2
Digital asset prices are in majority of cases driven by supply and demand. While the supply
side is governed by the monetary integrity of the network and expands according to the
predetermined issuance schedule, its demand is driven by monetary characteristics, net-
work growth and buyers’ and sellers’ behaviour. The behaviour differs among participants
of the network. Various entities participating in transactions can be identified, such as:
• miners
Despite the supply side being limited by the issuance schedule, miners affect the
supply side as well by either selling or holding their mining rewards. Miner’s profit
is the difference between their operating expenses (OPEX) — like rent, equipment,
inventory or energy cost, etc. — and the spot price at the moment of the realised
sale.
• exchanges
Most market flows pass through exchanges. Exchanges allow price discovery by
providing network participants access to the price discovery, mediating transactions
and offering custody. They are also often direct participants in the network – market
makers, lenders and investors themselves.
42
• investors, holders and users

Many digital assets have evolved, becoming an investment asset that is used by both
individual investors and institutions as a store of value, to hedge their portfolios, to
speculate about their price and growth, to hedge against inflation, etc.
These participants can be therefore differentiated:
– individuals
– institutions
The primary purpose of any digital asset, however, is to be adopted and used.
Meaning that the primary actor in its economics isn’t investors and passive holders,
it’s the users who perform transactions, reward miners (in the case of proof-of-work-
based blockchains) and create activity on the network.
Layer 2 metrics assess holders’ positions, i.e. the behaviour of buyers and sellers, and
explore activity and distribution of the supply. The metrics of the Layer 2 will be divided
into the following categories – supply activity, and supply distribution. Many indicators can
be included, Table 2 shows some of the selected metrics provided by glassnode that may be
analysed to investigate buyers’ and holders’ behaviour and supply activity and distribution.
Supply activity Supply activity measures short-term and long- • spent outputs
term supply activity, spent outputs and/or dor- • supply-adjusted dormancy
mant coins. • supply last active N+ years ago
• exchange net position change
• miner net position change
• long-term holder position change
• HODL waves
Supply distribution Exchange balances, inflows and outflows, short- • gini coefficient19
term vs long-term holder supports and miner • herfindahl index
balances and net position change. • exchange balance
• miner balance
• miner netflow volume
• exchange netflow volume
• short-term holder supply
• liquid supply change
• long-term holder supply
• relative long/short-term holder sup-
port
19. This indicator may be considered a layer 1 indicator as well since it can be used as a measure of the health
of the network.
43
7.1.3 Layer 3
The top layer indicators in this hierarchical metrics model explore buys and sell signals
based on relative-value metrics. They are, to a certain extent, similar to relative-value metrics
— like EV-to-EBITDA or price-to-earnings — in traditional equity analysis. Layer 3 is meant
to explore inefficiencies in the current market pricing and is usually more time-sensitive
than the previous layers.
The metrics structure proposed by Elmandjra et al. (2021) is the following:
Cost-base metrics A function of the costs at which market partici- • market-value-to-realized-value

pants transact (in bitcoin). (MVRV)
• short to long-term realized value
(SLRV)
• (percent) supply in profit (loss)
• investor capitalization
Profit and Loss Metrics Relative-value metrics derived from the way • realized profits-to-value (RPV) ratio
buyers or sellers hold or take profits and losses. • realized P/L ratio
• relative unrealized profit (loss)
• net unrealized profit/loss (NUPL)
• seller exhaustion constant
Based on: Elmandjra et al. (2021)
7.2 Providers of on-chain data
Even though the most popular and the most widely used blockchains have open and
transparent ledgers and anyone can access them, accessing the data itself is not a trivial
task. As for the Bitcoin blockchain, a node has to be installed to extract the data from
the blockchain, which requires a certain level of technical expertise. There are, however,
multiple existing providers of on-chain data, metrics and various analytic tools.
7.2.1 Glassnode
The metrics and indicators shown in Section 7.1 have been taken from glassnode. Glassnode
is as of the time of writing the most widely used on-chain data and intelligence platform
that provides a library of on-chain metrics ranging from layer 1 indicators to advanced
layer 3 derivatives20 . These metrics are divided into tiers. The higher the tier, the more
metrics are available. Also, the time frame of the data may be limited, lower tiers may not
have access to the complete historical data, either they get only the most recent data or, on
20. Derivatives, in this context, means indicators derived as a function of another metric (even a collection of
other metrics).
44
the contrary, the most recent data is not available to them. Glassnode offers both a Studio
— an interactive dashboard with an integrated chart for each metric — as well as an for
direct access to the data in machine-readable format.
Glassnode has been chosen as the data provider for the purposes of this thesis, since
the free tier – Tier 1, available to registered users, offers a reasonable set of metrics to cover
the basic preliminary analysis as well as the data API. Furthermore, individual metrics are
described in great detail and users can learn about the most commonly used ones for free
in Glassnode’s academy.
7.2.2 CoinMarketCap
CoinMarketCap is the website to go for a quick peek into a digital asset. It provides the
core metrics like real-time price feeds, market capitalisation and trading volume. It also
tracks the total market capitalisation of all digital assets and monitors volume on particular
exchanges.
It is particularly useful with regards to NFTs as it keeps track of NFT collections and
their core metrics, like volume, floor price, sales and even owners.
7.2.3 CryptoQuant
CryptoQuant is an alternative to glassnode (see Section 7.2.1), it provides similar met-

rics, and offers well-arranged and easy-to-understand dashboards. CryptoQuant, just like
glassnode, allows users to create custom dashboards directly on the platform and offers
custom alerts and notifications.
What’s significantly different from glassnode is that in the free tier, CryptoQuant
provides only a subset of the on-chain data that glassnode does.
7.2.4 Dappradar
Dappradar differs from the previous on-chain data providers in that it focuses on decen-
tralised applications or so-called dapps. It’s a hub for accessing the ranking of the most popular
decentralised applications. The applications are ranked by users, volume, balance, activity
and even categorised into categories. It’s a useful tool to gauge the state of development
and usage of a particular blockchain.
7.2.5 The Block
https://www.theblockcrypto.com is a free on-chain data provider that provides useful

categorised metrics that other providers don’t, like NFTs transaction data, lending, value
locked in particular chains and even data regarding exploits. Unfortunately, The Block
doesn’t offer an API for programmatic use and data processing.
20. The data is provided by the API in JSON or CSV format.
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7.2.6 CoinMetrics
CoinMetrics is one of the first on-chain data providers. It is perhaps for this reason that it
became rather a legacy on-chain data provider and the aforementioned ones are preferable
nowadays. CoinMetrics doesn’t offer the full scale of on-chain data that glassnode or
CryptoQuant do and the visual presentation of dashboards is also quite outdated. Moreover,
even the free tier requires an API key that is available only to registered users and provides
limited historical data.
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8 Selecting valuation model
Having a thorough understanding of the underlying asset and its value proposition and
having forecast its future performance, it should be proceeded by selecting the appropriate
valuation model. The model should be consistent with the characteristics of the asset being
valued. This means that, for example, a discounted dividend approach is most suitable
for dividend-paying stocks in which the company has a discernible dividend policy that
has an understandable relationship to the company’s profitability (Pinto et al., 2015b, p.
34). As noted by Pinto et al. (2015b), the model should also be appropriate given the
availability and quality of the data and be consistent with the analyst’s valuation purpose
and perspective.
There are two broad categories of valuation models – absolute and relative valuation
models. It might be difficult to estimate an intrinsic value for digital assets, just like it is
difficult to estimate an intrinsic value for commodities, collectables, art, ownership rights
etc. For that reason, in most cases, a relative valuation of some sort will likely be preferred.
With every digital asset being highly specific, having different tokenomics and distinct
utility, it is unlikely that a universal model that can be applied to all digital assets may exist.
Instead, this framework proposes various approaches that can be used to come up with a
model-specific to a particular digital asset. Specific models proposed for bitcoin valuation
will be shown in Part III.
8.1 Perception of value
Multiple inputs go into the valuation process and financial forecasting. In general, analysts
consider both quantitative and qualitative factors. For example, an analyst might modify
his or her forecasts and valuation judgements based on qualitative factors, such as the
analyst’s opinion about the business acumen and integrity of management, and/or the
transparency and quality of a company’s accounting practices. Such qualitative factors are
necessarily subjective (Pinto et al., 2015a, p. 18).
The subjective perception of value is what makes valuation so difficult. At the end of
the day, models are just that, models, they are deterministic, i.e. two identical inputs do not
produce different results. It is the analysts and investors though, who come up with those
inputs and that makes them highly subjective. As far as digital assets are concerned, the
subjectivity factor is immediately apparent. All it takes is to take a look at the dispersion of
price targets for the year 2022 (Vold, 2021; Browne, 2021):
• $10 000 – Carol Alexander, professor of finance at Sussex University
• $140 000 – Kjetil Hove Pettersen, CEO of Norwegian Bitcoin miner Kryptovault
• $250 000 – Bernardo Schucman, Senior Vice President of Bitcoin miner CleanSpark
• $500 000 – Julian Liniger, CEO of Switzerland-based bitcoin broker Relai
The price predictions above are projections one year out, but the situation gets even
more dire when projecting further into the future. Nassim Taleb, the author of The Black
47
8. Selecting valuation model
Swan, for example, is of a completely different opinion when it comes to the value of bitcoin.
In his recent publication21 , he argues, contrarian to the consensus, that bitcoin is worth
exactly 0, citing its fragility, volatility and transaction fees.
That being said, it might be the case that due to the subjective nature of the valuation of
digital assets, what should be considered a priori is whether the asset does have any value
for the investor. There isn’t, unfortunately, a universal approach to determine whether a
particular digital asset has any value or not. Investors have to consider that on an individual
basis (see Section 8.1).
A great example may be NFTs. NFTs are non-fungible tokens, digital assets that repre-
sent ownership. These are typically collectables, digital art or a digital representation of a
physical holding. These are subjective by nature and it is usually the unique characteristic
and limited supply (i.e. scarcity) that creates value for collectors. There are also NFTs
that come with particular ownership benefits, like virtual land or music ownership rights.
Considering these scarce assets, however, is beyond the scope of this thesis. Besides NFTs
that are opinionated by their nature, there are of course hundreds, perhaps thousands
of cryptocurrencies and tokens that did not make it through the bear market of 2018 and
simply ceased to exist even despite some of them having reached the top 100 by market
capitalisation at the time. The value of digital assets is perceived very subjectively and
investors should form a thesis and carefully weigh potential risks.
8.2 Absolute valuation models
The intrinsic value of an asset is its value given a hypothetically complete understanding
of the asset’s investment characteristics (Pinto et al., 2015b). The value is determined by
the cash that an asset is expected to generate over its life — that is, ideally infinitely — and
the level of uncertainty about those cash flows, systematic and unsystematic risks, credit
risks and various other risk factors (Damodaran, 2011).
The intrinsic valuation builds upon an understanding of the underlying asset’s invest-
ment characteristics. The more complete the understanding, the closer the valuation should
be to reality. As such, fundamentals and, in the case of businesses, business characteristics
play a more important role than the current market sentiment, technical indicators or
short-term projected market volatility.
Four basic inputs are needed for a value estimate (Damodaran, 2011):
• cash flows from existing assets (net of reinvestment needs and taxes)
• expected growth in these cash flows for a forecast period
• the cost of financing the assets
• an estimate of what the firm will be worth at the end of the forecast period
In the traditional markets, investors can then receive cash flow from the company
(project) in a form of a) dividends or b) stock buybacks. Both of them are a mechanism
for returning cash to shareholders. Many companies these days prefer share buybacks to
21. Available at https://www.fooledbyrandomness.com/BTC-QF.pdf.
48
dividends since it allows them to control at what price the buyback is done and is usually
perceived as a positive surprise by the investors. Note that this also poses an issue. The
buybacks are irregular, i.e. they can spike in some years and may be completely flat in
others, which makes it difficult to predict. Hence, the buybacks are usually averaged across
multiple years to obtain annualised numbers. Some companies also do both, issue dividends
and do share buybacks. To account for both of these cases, a simple definition of augmented
dividends has been introduced, which is a sum of dividends and stock buybacks. The
augmented dividends could be a one way to base the intrinsic valuation on. However, in
practice, it’s rarely used. The reason is that with the augmented dividends, it is assumed
that the investors are paid the excess of what’s left after meeting operating requirements
and reinvestment needs. This isn’t usually the case, companies tend to keep some cash on
the sidelines, invest in other businesses or pay their employees stock compensations, etc...
A much more useful measure is the concept of cash flow. In general, a cash flow summa-
rizes the change (i.e. an increase or decrease) in the amount of cash and cash equivalents
(i.e. money) of a particular subject. When talking about companies, it is the total amount
of money being transferred into and out of a business. There are multiple variations of
cash flows, like free cash flow to equity (FCFE) and it’s the variation which Warren Buffet
calls “owners’ earnings” as it ignores the net cash flow from debt (Damodaran, 2011).
There are also other measures like free cash flow to the firm (FCFF) which is calculated
before interest and principal debt payments. The reader is encouraged to look up these
calculations. The purpose of this quick introduction to these concepts was to show what
the traditional valuation metrics are so that they could be later in this thesis compared to
the characteristics of digital assets.
Digital assets may exhibit some characteristics similar to those of traditional assets,
like stock buybacks, dividends or even debt issuance, principal pay-offs or depreciation
and even cash flow (as shown in Section 11.2). Admittedly, however, it requires a certain
amount of creativity and a thorough understanding of the underlying asset.
Stock buybacks, for example, is a mechanism which is leveraged by companies to
increase the value of the shares for their shareholders by taking a certain amount of
outstanding shares out of circulation. Since there are fewer shares available for investors,
the shares become more valuable, therefore appreciating at price per share. Similarly, some
digital assets implement a burn mechanism that under certain conditions burns a certain
amount of circulating supply — literally wiping them from existence — and therefore
directly reducing both the total and circulating supply. Lower supply means a price increase,
other things being equal.
In Part III of the thesis, some of these parallels will be introduced when valuing bitcoin
using the terminal value model (see section 11.2).
8.3 Relative valuation models
Intrinsic valuation is difficult as it incorporates a lot of assumptions, has a lot of variable

inputs and a complete understanding of the asset’s investment characteristics is nearly
impossible. In practice, a more commonly used approach to valuation is relative valuation.
In relative valuation, assets are valued by comparing how the market prices their industry
peers or similar assets. As applied to equity valuation, relative valuation is also known as
49
the method of comparables. The stocks are often compared by their financial ratios, these
might be well-known P/E, P/S and P/B ratios or other indicators like EBITDA, assets to
liabilities, etc.
Relative valuation is a method based on a comparison of similar assets. The idea is to
find bargains by comparing how the market prices different, but similar (i.e. sector) assets,
perform with respect to their financial indicators. For example, a house buyer would look
at house prices of similar real estate properties in the neighbourhood. Damodaran (2011)
mentions the three essential steps in relative valuation are:
1. find comparable assets that are priced by the market.
2. scale the market prices to a common variable to generate standardised prices that
are comparable across assets
3. adjust for differences across assets when comparing their standardised values
It is important to note that relative valuation is subject to market sentiment and is more
likely to reflect the current market mood. In other words, if the market price of a particular
asset moves upwards, a similar asset might likely move as well even if there are no changes
to the fundamentals of the other asset.
The key financial multiple of traditional equities is the P/E ratio, which is obtained by
dividing the market value of equity by the net income. It estimates how much investors are
paying per dollar of earnings and it can also be reversed to determine earnings yield – the
rate of return and compared to treasury yield. The other commonly used multiple is the
EV/EBITDA indicator which is used to get a sense of the market value of operating assets,
relative to operating cash flow (Damodaran, 2011) and various other financial multiples,
like P/E or P/B.
Digital assets may as well be compared on a relative basis, given that a set of similar
digital assets is selected — that is, however, quite difficult, since individual assets might
be quite different despite being in the same sector. Since the digital assets are transaction
peer-to-peer networks, it’s also possible to leverage those properties and compare them as
networks, i.e. by comparing user growth, transaction rate and volume growth, transaction
speed, etc. One of the multiples used in the digital asset space similar to the P/E ratio of
traditional equities is the network value to transaction value (NVT) ratio. The ratio will be
explained in Part III of this thesis in Section 11.3.
50
9 Converting forecasts to valuation
The final steps of the valuation process stay the same for both traditional and digital assets.
Given the raw numbers that are presented by the model, an analyst has to evaluate them
and convert them to recommendations about a potential strategic investment. Estimating
value based on the models involves a certain degree of subjectivity and judgement.
9.1 Sensitivity analysis and situational adjustments
Pinto et al. (2015b) points out two important aspects of converting forecasts to valuation –
sensitivity analysis and situational adjustments. Sensitivity analysis determines the overall
uncertainty of the model based on the sources of uncertainty, i.e. inputs to the model. It
is an analysis to determine how changes to these inputs affect the outcome of the model.
Sensitivity analysis depends on the context. For example, considering an asset that has a
dynamic issuance policy and provides a staking mechanism, given uncertainty about the
asset’s competitive response – will the interest rate stay the same, will the supply change
dramatically, are there going to be any changes in the holder privileges — the analyst could
create a baseline forecast and then analyse how different competitive responses would
affect the estimated valuation.
Situational adjustments include control premiums. These are premiums for a controlling
interest in a company. For example, some companies issue various types of shares, some
of which do not permit the shareholder to have a vote in the company’s decisions. The
situation is the same with digital assets. Some digital assets might also enable their holders
to vote and make decisions regarding future business development, this is typical for
decentralised autonomous organisations (DAOs). Particular tokens and NFT may yield
an additional interest to their holders. These and other adjustments should be taken into
consideration when converting forecasts to valuation.
Moreover, some assets may only be traded privately and are not available to retail
investors and the general public. This often comes with lower liquidity. Situational adjust-
ments may also be discounts for the lack of marketability — or lack of a public market in
general — for the asset and illiquidity discounts reflecting market illiquidity.
9.2 Valuation factors
The valuation models are typically forward-looking and long-term oriented. They don’t
typically take into consideration short-term events, like macroeconomic conditions, geopo-
litical events, supply chain issues, inflation or even an ongoing trial with a CEO of a
company, for example. These are valuation factors that might be considered when finalis-
ing investment recommendations. In this section, these factors are presented, categorised
into three categories – micro and macroeconomic factors and behavioural factors. Although
they might be irrelevant in the long-term, considering these valuation factors before mak-
ing an investment decision might provide a better entry point to the initial position and
significantly improve the alpha of the investment. Getting into details is beyond the scope
of this thesis. Individual factors will be just mentioned and briefly described.
51
9. Converting forecasts to valuation
9.2.1 Macroeconomic factors
Macroeconomic factors as fiscal, natural, or geopolitical events may broadly affect a re-
gional or national economy. Macroeconomic environment poses a nondiversifiable risk
for investors. Previous research suggests significant effects of inflation and the money
supply on equity returns (Flannery et al., 2015). Strong risk factor candidates identified by
the study of macro series announcmenets of 1980-1996 period are CPI and PPI inflation
measures, balance of trade, employment, housing permits and monetary aggregate (M1)
(Flannery et al., 2015).
An example of a macro event from recent history that had a significant impact on
the whole economy is the fiscal and monetary policy changes during the pandemic of
COVID-19. FED’s quantitative easing policy resulted in the peak of year-over-year (YoY)
growth in the money supply of 39.1% as of February 2021 (Mises Institute, 2022). Money
supply tends to grow in the periods of high economic activity (and output) and results
in an economic boom as commercial banks tend to provide more loans and consumers
sentiment is high. Combined with a generous fiscal policy, PPP22 and COVID-19 relief plans,
the unspent (excess) money found its way into both traditional and digital asset markets.
Macroeconomic factors tend to present a systematic risk. This risk is inherent to the
market as a whole that can’t be diversified by investing in individual assets and is largely
unpredictable. It is for this reason that investors should diversify across different markets
and shouldn’t be fully invested in one particular market or industry. Diversification within
the space of digital assets is, however, quite difficult. The risk of correlation with other
assets or markets shouldn’t be overlooked.
9.2.2 Microeconomic factors
Factors linked directly to company/project development are microeconomic factors. These

factors include important incoming changes to the company or a project. In traditional
equity valuation, these might be for example expected stock splits, changes in the board
members, product price hikes or potential acquisitions. Microeconomic factors typically
influence the price in the short-term due to the presence of traders and speculators and, as
opposed to macroeconomic events, some of them might even have long-lasting impacts —
like decisions in changes in company policy, for example. These are, however, often difficult
to quantify numerically.
A microeconomic factor that is also highly relevant for digital assets is competition.
Digital assets are competitive space, most of the projects are quite young and the sooner
they attract attention, the better. There’s also definitely a first-mover advantage, as can be
seen in the case of Ethereum or Bitcoin. Digital assets are networks and as such, the growth
of the network compounds. It can also be shown that the bigger the network, the more
valuable it is (Farris et al., 2009). Analysts should assign probabilities to these events and
discount them in their final valuation if such events are expected to occur.
22. Paycheck Protection Program established by the U.S. government to combat high unemployment during
the COVID-19 pandemic in 2020, ended March 31, 2021. More information available at: https://www.sba.
gov/funding-programs/loans/covid-19-relief-options/paycheck-protection-program.
52
9.2.3 Behavioral factors
The intrinsic value of an asset is the value given a hypothetically complete understanding
of the assets investment characteristics (Pinto et al., 2015b, p. 4). Even if it was possible to
achieve a complete understanding of a digital asset’s investment characteristics, the price
might not reflect that intrinsic value at all, especially in the short term.
Psychology, behaviour and sentiment all have a huge impact on the markets. As such,
these factors form a separate section of behavioural indicators that can affect (especially
short to mid-term) price action. Meir Statman said that “People in standard finance are
rational. People in behavioral finance are normal.” (Pompian, 2012, p. 30). Unfortunately,
it is not the rational who make the prices. Normal people have emotions and biases and
their investment decisions are not solemnly based on the raw numbers in the spreadsheet
and business fundamentals. Most of the insights on the matter presented in this thesis
will be drawn from the book by Pompian (2012) – Behavioral finance and wealth management.
The irrational investor’s behaviour, however, is not completely unpredictable. Relative
comparisons, supply and demand and social aspects, all play their part.
Humans are irrational, but their behaviour is neither random nor senseless – it’s system-
atic and predictable (Ariely, 2009). As opposed to the standard economic, which assumes
efficient and rational human behaviour, behavioural economics, on the other hand, proposes
that people are susceptible to irrelevant influences called context effects, irrelevant emotions,
shortsightedness and other forms of irrationality. Such factors that influences investors
decisions — nowadays more than ever, given the velocity of information sharing, is at its
peak — are market sentiment and social opinion. Since 2015, various studies researched
relationship between bitcoin and social sentiment and they indicated sentimental effect of
tweets on bitcoin price (Sattarov et al., 2020; Shen et al., 2019; Stenqvist et al., 2017). There
has even been conclusive research regarding the influence of particular Twitter accounts
and their effect on bitcoin returns and volume (Öztürk et al., 2021).
9.3 Applying conclusions
Once the model has been selected and the output of the model considered with regards
to the sensitivity analysis, situational adjustments and other valuation factors, an analyst
should be able to draw and apply conclusions based on the results.
In general, applying conclusions depends on the purpose of the valuation. An analyst
may use the valuation to make an investment recommendation about a particular stock,
provide an opinion about the price of a transaction, or evaluate the economic merits of
a potential strategic investment (Pinto et al., 2015a, p. 8). Similarly, the consumer of the
valuation matters as well and analysts have to adjust their roles and responsibilities, as
well as their recommendations.
Conclusions of the valuation have to be communicated properly. As Pinto et al. (2015a, p.
29) pointed out: “[...] although a well-written report cannot compensate for a poor analysis,
a poorly written report can detract from the credibility of excellent analysis. Writing an
effective research report is a challenging task.” The topic of efficient research reports is
beyond the scope of this thesis.
53
PART III
BITCOIN VALUATION
10 Investment thesis
Since digital assets have about as many supporters as opponents and some of the latter
consider them even worthless (Taleb, 2021), part of the valuation process will be dedicated
to the history of Bitcoin and its current value proposition in the historical context. Bitcoin
is quite a complex topic which spans across multiple economical levels and runs deep
into the history of financial systems. Therefore, it is recommended, but not required, to
also review the investment context enclosed in the Appendix A which is a refresher about
the history of the current financial system, introduces the concept of a monetary pyramid
proposed by Bhatia (2021), examines properties of money and mentions the issues of the
current financial system — some of which Bitcoin should be a solution to.
Perhaps coincidentally, perhaps not, in October 2008 amidst the financial crisis, the
Bitcoin white paper was published by Nakamoto (2009), proposing a system of decen-
tralised trust for value transfer, a transparent, peer-to-peer trustless23 transaction system
with bitcoin as a digital currency with limited supply at its core (see Chapter 2). The white
paper was proposing an alternative financial system, deflationary by its nature with limited
supply and strict rules for participants of the system. Since then, the world of digital assets
has changed dramatically.
Nakamoto wrote in the original Bitcoin paper: “We have proposed a system for electronic
transactions without relying on trust.” (Nakamoto, 2009). When Nakamoto proposed his
system for electronic peer-to-peer transactions, i.e. Bitcoin, it was just that – a system for
transactions. As such, bitcoin back then used to have a single purpose – to be a medium of
exchange. The monetary unit of that medium of exchange – bitcoin – was in circulation on
bitcoin’s blockchain. However, the narrative for bitcoin has shifted over the years. As more
and more people started to participate in the blockchain, created their digital wallets and
actually used bitcoin on a daily basis, it turned out that bitcoin, as it was designed, could
not work as a medium of exchange. The current Bitcoin blockchain is able to process about
7 transactions per second on the first layer and it processes them in 1MB blocks. Bitcoin’s
transaction speed is relatively low, especially for a medium of exchange. For comparison,
Visa is able to process about 24 000 transactions per second (Larsen et al., 2018). The block
size (1MB) is believed to be one of the main limitations24 for Bitcoin to achieve a higher
transaction rate. The community is against increasing the block size, which seems to be
the rational decision at this point of development. In 2017, a lengthy debate was held
about Bitcoin’s block size. One side wanted to double it to 2MB, the other wanted to leave
the blockchain as was. Again, getting a bit deeper into the technicalities, expanding the
block size would have meant that the blockchain would have had to undergo a so-called
hard fork. A hard fork creates a new and incompatible version of the blockchain. It is
a drastic measure which requires all participants of the network to migrate to the new
blockchain. Since (luckily — author’s opinion), the majority did not come together, the
idea of expanding the block size was rejected and the original Bitcoin chain has stayed
23. Interestingly enough, some dictionaries, like Merriam-Webster define the word trustless as “not deserving
trust”, which might be misleading. In this context, the word in fact means “not relying on trust”. See the
glossary entry for a detailed explanation.
24. This is not really a limitation per se, nor is it a flaw in the design. The blockchain was designed this way
to be storage-efficient.
55
10. Investment thesis
the way it was originally designed. However, the fork indeed happened, but instead of
migration, a new blockchain was created called Bitcoin cash25 with the increased block
size. With that argument over the block size, bitcoin’s narrative has slowly started to shift
from the medium of exchange to the store of value. Given these properties of the Bitcoin
blockchain, the investment thesis will therefore not involve consideration of bitcoin being
adopted as the medium of exchange. There are scaling solutions like Lightning network
that form the basis of bitcoin becoming a medium of exchange, but as of the time of writing,
it’s an early-stage of development and adoption. Moreover, the medium of change property
is tied closely to the network value which is captured by one of the models that will be
presented in this thesis.
Similarly to gold and other precious metals, bitcoin is scarce. The supply is limited to
21 million units. Moreover, bitcoin’s mining rate constantly adjusts to the demand and
about every 4 years when the halving happens, the amount of new bitcoins mined halves,
effectively lowering the supply even further. This mathematically verifiable property has
led many to believe that bitcoin is a hard money or a hard asset – a true store of value that
can be used as an inflation hedge and can’t be debased by the government. In this sense,
we can think about bitcoin as if it was an asset quite similar to gold or real estate with
some additional highly valuable properties that bitcoin possesses, like being highly liquid,
fungible and easily, quickly and cheaply transferable. Therefore, from being a currency and a
system of payments, bitcoin’s narrative has shifted towards being the digital hard money, a
store of value for the next generation. Bitcoin being scarce is a fundamental value driver.
As of year-end 2021, there are over 8 000 coins and tokens listed on CoinMarketCap and
it is estimated that over 12 000 exist in total. The total market capitalisation as of December
2021 sits around $2.25 trillion with the top being nearly $3 trillion out of which $1 trillion
(40%) is bitcoin’s capitalisation. Arguably, bitcoin has given birth to a whole new industry
that’ already capitalised at about one-third of a professionally managed global real estate
market26 .
Global engagement in digital assets investments averages about 14% (see Figure 9)
according to the Statista Global Consumer Survey (Statista, 2022) and trends higher. The
developed countries, however, still lack behind. There’s a potential alpha once the trend
starts to pick up in those countries. The inhibiting factor seems to be the lack of regulation,
which is, nevertheless, also a potential risk factor. Bitcoin’s market capitalisation to the total
digital asset’s market cap, usually referred to as bitcoin dominance, is shown on Figure 10.
Bitcoin accounted on average for 43.70% of total market capitalisation. The dominance is
on a steady downtrend. This is due to the fact that there is an increasing amount of new
projects (i.e. cryptocurrencies and tokens) entering the market and the capital is flowing
from one to another. Even though the total market capitalization has increased by a factor
of 10 since the beginning of 2020, bitcoin’s relatively high market capitalisation makes it
difficult to follow this parabolic rise. The decrease in bitcoin’s dominance is in fact a good
signal of a healthy market.
It can be assumed that bitcoin’s price will stabilize at some point and the dominance
converges to a certain percentage, capturing the true value of bitcoin given its utility. Should
25. See for yourself where the value of the chain is today compared to the value of the original Bitcoin
blockchain
26. According to the MSCI.
56
the utility be just based on the store of value property, the market capitalization should
also reflect that. For example, the value of such asset should be comparable to gold’s total
market capitalization. Assuming bitcoin becomes a medium of change once the Lighting
network’s adoption picks up, exponential growth of the network is rather likely. In either
case, given the global engagement in digital assets, the adoption has just started and there’s
much more room to grow.
Source of data: Statista

Figure 9: Digital asset investments by country
Source of data: TradingView

Figure 10: Bitcoin Dominance
Given the data, digital asset adoption and transitively also bitcoin user growth can be
forecasted. In a survey from the financial website Finder, they found that 66.7% of cryptocur-
rency investors own Bitcoin (Laycock et al., 2021). This is more than the bitcoin dominance
shown on the chart, which is roughly 43% of total cryptocurrency market capitalisation.
As a conservative estimate, it will be assumed that bitcoin dominance stabilizes around
15%. This number is estimated from the ratio of gold capitalization of roughly $13T versus
57
total stock market capitalization which was $93T as of year-end 2020 according to the data
from The World Bank.
Laycock et al. (2021) also mentioned that roughly 59.1 million Americans own digital
assets. This is a rise from about 7.95% of Americans owning cryptocurrency in 2018, the
percentage rose to 14.4% in 2019 and 23.16% in mid-year 2021. Given the trend, it is possible
to project digital asset adoption as shown on Figure 11.
Figure 11: Digital assets ownership forecast
Bitcoin network growth in terms of the amount of active addresses can be forecasted
based on the adoption of digital assets in general. The following figure shows forecasted
bitcoin network addresses using a linear model (12a) and a more conservative power-law
model (12b). There is a drastic difference in the projection. Even the conservative case,
however, estimates bitcoin active addresses to double by 2030 which poses an interesting
investment opportunity that will be explored further in the thesis.
58
(a) Linear model
(b) Power-law (conservative) model
Figure 12: Bitcoin network address growth forecast
59
11 Bitcoin valuation models
We’ve identified as Bitcoin’s primary value proposition its store-of-value property and
its ability of peer-to-peer trustless electronic value transfer. It hasn’t yet been decided
with certainty whether the network can act as the primary medium of exchange given
certain limiting factors that were discussed in this text. It is a network nevertheless and
it does already act as a medium of exchange. That being said, the thesis considered four
primary models of forecasting bitcoin’s performance as shown in Table 4. Each of the
models explores some part of the investment thesis proposed in 10 and is based on various
assumptions that have to be made. The purpose of this chapter is to present the selected
models and their inputs so that they could be considered for bitcoin valuation. Drawbacks
and shortcomings of these models will be presented in the following chapter.
Table 4: Bitcoin valuation models
Model Property Description
stock-to-flow (S2F)
scarcity Scarcity-based model that values bitcoin based on the ratio of existing
(Plan B, 2019)
reserves (stock) and annual production (flow).
terminal value model store of value Cash flow based model built on the assumption that bitcoin becomes
the preferred store of value and takes over gold’s market capitalisa-
tion at some point.
value transfer model medium of exchange A relative valuation model that uses network value to transaction
value (NVT) ratio in comparison to industry peers.
network value model

network value A model that uses Metcalfe’s proposition of network value relative
(based on Peterson, 2018)
to its size.
11.1 Stock-to-Flow (S2F) model
Stock to flow is a model presented by a pseudo-anonymous27 figure Plan B in 2019 (Plan B,

2019) to value Bitcoin. The model compares bitcoin to commodities and precious metals.
This is an acceptable comparison. As was discussed in the previous text, digital assets are
conceptually closer to commodities than equities and the regulation seems to be tilted
towards commodity-like approach as well 117th Congress (2021, p. 911).
The model is based on the idea of a relative scarcity of resources. Commodities like
gold, silver, platinum, etc. are relatively scarce — meaning that the resource is naturally
limited by supply — which is one of the reasons why they preserve value over long time
frames (given that there is a demand for these resources). Due to their relative scarcity, it is
difficult to increase their supply, which makes them even more desirable. The stock-to-flow
(SF) ratio is not exclusive to Bitcoin. Stock to flow ratio is a quantifier that estimates the
27. Plan B is a regular host on podcasts and he’s an active contributor on various social media platforms.
He’s known to be former institutional investor. Yet, his real identity is unknown, hence why he’s a pseudo-
anonymous person.
60
11. Bitcoin valuation models
ration between output (flow) — the amount of an asset (commodity) entering circulation28
— and the existing amount of reserves in circulation (stockpile or simply stock). The ratio
can be calculated for any commodity. Changing the supply of any existing commodity will
affect the existing stockpiles and impact the price. The commodity with the highest SF
ratio is gold. Gold is the commodity with the lowest price elasticity of supply due to its
limited production. For any consumable commodity, this doubling of output will dwarf
any existing stockpiles, bringing the price crashing down and hurting the holders. For gold,
a price spike that causes a doubling of annual production will be insignificant, increasing
stockpiles by 3% rather than 1.5% Ammous (2018, p. 49).
The hypothesis behind the S2F model is that scarcity (measured by the SF ratio) drives
value. Plan B calculated bitcoin’s monthly SF values from December 2009 to February 2019
and discovered that there is a statistically significant (Plan B states R2 ≈ 0.95, the model
fitted by the author shows R2 of 0.725, see see Table 6) linear relationship between ln(SF )
and ln(market value) and that gold and silver fit the regression model as well (Plan B,
2019).
The S2F model proposed by Plan B (2019) is a power law function fitted on Oct 2009 to
Feb 2019 monthly data and is defined as P = 0.4 · SF3 (where P is the predicted price). A
later model on 2009–2019 yearly data has higher forecasts and is defined by equation 11.1.
The original model is shown on Figure 13.
P = 0.18 · SF3.3 (11.1)
Source: Plan B (2020)

Figure 13: Bitcoin S2F model
28. Usually measured annually or monthly.
61
The SF ratio is calculated as such:

1
SF = stock/flow = (11.2)
supply growth rate
Where stock is the size (quantity) of existing reserves and flow is the annual production
rate. The inverse of the ratio is called the supply growth rate and is often used in this context
as well.
Stock to flow ratios calculated for gold, silver and bitcoin as of year-end 2021 are shown
in Table 5. Considering strictly SF ratios, the linear trend can be projected into the future
and since bitcoin’s SF ratio continuously increases, bitcoin should eventually reach the ratio
of gold. On relative valuation basis, given that properties of these two assets are arguably
similar, bitcoin should eventually reach valuation of roughly $13T. The S2F model proposed
by Plan B predicts that bitcoin reaches this valuation (i.e. roughly $255 000) in the first half
of 2024 and estimates bitcoin’s value to be close to $350 000 as of year-end 2024.
Table 5: Comparison of stock-to-flow ratios
Stock Flow SF Price Market Value
gold 205 238 tn 3 000 tn 68 $1 827.50 per ounce $13.23 T
silver 530 000 tn 25 000 tn 23 $21 per ounce $0.386 T
bitcoin 18.915 · 106 BTC 328 356.25 BTC 58 $49 700 per BTC $0.94 T
Data from: Goldhub, Statista, Yahoo Finance and Glassnode
Figure 14 shows the on-chain data that went into the calculation of bitcoin’s SF ratio.
The total circulating supply of 18.915 million bitcoins dates to year-end 2021. The number
of bitcoins produced that totalled circa 328 356.25 BTC is the annualised bitcoin production
for the year 2021 that is calculated as shown in 11.3 from the block reward of 6.25 BTC per
block and the number of blocks mined per day. The mean number of blocks mined per
day roughly equals 146 blocks. Given bitcoin’s volatility, the resulting market value was
calculated from 30 days MA as of 31 December 2021. The on-chain data was provided by
Glassnode.
T D
FTBTC = ∑ ∑ Rt · Bd (11.3)
t d
where
T is the given period

t is an interval within T with a constant block reward Rt
and D is the number of days d within the interval t
andBd is the number of blocks mined per day
62
Figure 14: Bitcoin supply and production
Table 6 shows regression characteristics of OLS (Ordinary Least Squares) regression of

the model defined by 11.1 and evaluated on annualised data from 2012 to 2021 (N = 10).
Table 6: S2F model regression characteristics
Intercept Slope R2 Adjusted R2
-4.6187 1.712 0.725 0.691
11.2 Terminal value model
The terminal value model uses bitcoin’s main property – store of value – as the fundamental
driver of price. The model builds on an assumption that bitcoin takes a portion of gold’s
market cap (current store of value) and attracts new capital and excess wealth from the
young generations.
Currently, gold’s estimated market capitalisation sits roughly at $13.23T (see Section
11.1). It is estimated by the World Gold Council that the total annual demand (as a per-
centage of the total supply) for gold as an investment29 asset accounted for around 38%.
A simple model with a terminal value that assumes that bitcoin replaces gold as a store
of value implies a terminal value of roughly $5.03T, which would put bitcoin’s spot price at
$254 349 (assuming all of the bitcoins were released into circulation). For the purposes of
the model, arbitrary terminal years — the year when bitcoin’s price reaches the terminal
value — were selected (see Figure 15). A simple DCF-like model was used where the
cash flow is understood as the number of newly issued bitcoin’s over the selected period
(see Equation 11.3). Halving dates were projected into the future arbitrarily (the halving
occurs roughly every 4 years, but the specific date is unknown). The flow over the specific
29. This includes private and public sectors, central banks and other institutions.
63
period is calculated by the equation 11.4 where we use an average number of blocks per
day instead of the exact number that we can only get afterwards from the on-chain metrics:
T D
FTBTC = ∑ ∑ Rt · Bd (11.4)
t d
where
Bd is the average number of blocks mined per day
For the terminal date January 1st , 2025, there are approximately 365 ∗ 3 = 1095 days
since year-end 2021 and during that period, a halving occurs in March 2024. The estimated
number of bitcoins being issued over that period can be calculated according to 11.5. The
calculation is explicitly simplified by the constant number of blocks per day Bd , which was
estimated from historical on-chain data (see Section 11.1).
T D
BTC
F2025 = ∑ ∑ Rt · Bd =
t d
(11.5)
D =791 D =305
= ∑ 6.25 · 146 + ∑ 3.125 · 146 = 860 943.75 BTC
d =1 d =1
The amount of bitcoins entering the circulation in the first valuation period lasting until
year-end 2024 is estimated to be roughly 860 943.75 BTC, which would be valued at approx-
imately $218.98B, assuming the terminal price of $254 34930 per BTC. That is proposed to
be an equivalent to the unlevered cash flow of a DCF model. The DCF calculation assumes
the perpetual growth rate to be equal to the expected interest rate, which, is set to the
long-term inflation target of 2%, that is g = 2%. The cost of capital was calculated using
the capital asset pricing model (CAPM) as described in 5.2. The complete calculation is
shown in 11.6 where the market return was estimated from S&P500 mean annual return
since 1985 (see the Appendix B) that averaged positive 9.86% and bitcoin’s β was estimated
according to 5.3 by comparing bitcoin to S&P500’s daily returns over the last 5 years31 .
Re = R f + β BTC · ( Rm − R f )
0.000126
= 2.77 + · (9.86 − 2.77) (11.6)
0.000156
≈ 8.5%
The calculation of the net present value (NPV) of bitcoin flows is shown in 11.7.
31. Computed from a projected circulating supply as of year-end 2024.

31. It might be more accurate to calculate the expected return from NASDAQ instead of S&P500, since
Bitcoin resembles a tech stock more than a broad market, but this hypothesis would require further empirical
evidence.
64
BTC F BTC · (1 + g) $218.98B · (1 + 2%)

NPV2025 = = ≈ $2.69T (11.7)
( Re − g)(1 + Re )3 (8.5% − 2%)(1 + 8.5%)3
To obtain the price per bitcoin, the net present value should be divided by the total
amount of bitcoins in circulation to the discounted date — that is year-end 2021 — which is
about 18.915 million. The resulting price per BTC for to the terminal date as of 2025 based
on the assumption of store of value property and the terminal market capitalisation as of
2025 of $5.03T is approximately $142 321.24. Figure 15 shows net present value results for
the rest of the terminal years as well.
Figure 15: Bitcoin terminal value model
11.3 Value transfer model
Blockchain networks are basically systems for transactions — transfers of a unit of account
— from one address (user) to another. As such, they are comparable with other facilitators
of electronic funds transfers, like Visa or PayPal. Visa processed annually 140.8 billion
transactions as of year-end 202032 with total payments volume (TPV) including payments
and cash volume of $11.3T (Visa, 2020). PayPal processes as of year-end 2020 about 15.42
billion transactions with TPV of $936 million (PayPal, 2020). Figure 16 shows the com-
parison of the two mentioned facilitators of electronic funds transfers with the two major
digital networks – Bitcoin and Ethereum.
From this amount of data (4 data points), it is not possible to estimate any kind of
relationship between network value (market capitalisation) and annualised transaction
value. However, this results in a rather interesting observation. Bitcoin and Ethereum,
despite being an order of magnitude smaller in terms of the network size (measured by
users) than their comparables in the traditional finance space, are significant competitors
with Bitcoin outpacing Visa in the transfer value by about 5x.
32. Year-end 2020 was selected since network size on-chain data was not available for year-end 2021 on the
free tier.
65
Source of data: Glassnode, Visa (2020) and PayPal (2020)

Figure 16: Network value to transaction value
The network value (NV) to transaction value (TV) ratio, shortened as NVT ratio was
first introduced by Willy Woo and Chris Burniske in 2017 as an alternative to the PE ratio
of traditional assets and they used it to detect speculative bubbles (Woo, 2017). However,
they use a short-term model based on the daily BTC value transmitted over the network.
Here, annualised NVT ratios are considered in comparison to the traditional payment
processors to compare their values. The ratios are calculated relative to the biggest network
(Visa, see above) so that the input could be normalised (see Equation 11.8). The Figure 17
shows the resulting adjusted annualised NVT ratio of the selected assets.
normalised NV value w.r.t Visa NVX TVVisa

NVTX = = · (11.8)
normalised TV value w.r.t Visa NVVisa TVX
Based on the resulting NVT ratios, it could be assumed that bitcoin is undervalued
relatively to Visa, given it’s adjusted annualised NVT ratio of 0.23, indicating about 300%
upside. That puts bitcoin estimated total market capitalisation to about $2.143T, adjusting
for changes in the circulating supply, the price per BTC according to this model is estimated
to be approximately $115 295 as of year-end 2020. Since the NVT ratios were calculated as
of year-ending 2020, in order to estimate bitcoin value for the future periods, projected (or
real) transfer values of the numeraire (in this case, Visa) can be used as a baseline. Under
the assumption that the NVT ratio should stay roughly the same — this assumption may
not hold, see the discussion in Section 12 — the network value change should correspond to
the change in transfer value. Visa’s 2021 annual report suggest 15% change to the upside in
the total transfer value (Visa, 2021). Bitcoin’s conservative value estimate should therefore
be $130 282 (adjusted for the growth of circulating supply).
11.4 Network value model
Demand-side approaches often ignore an important value driver – the non-proportional

value added through the addition of a new user (Peterson, 2018). This model attempts to
66
Source of data: Glassnode, Visa (2020) and PayPal (2020)

Figure 17: Adjusted annualised NVT ratio
explain bitcoin’s price as a function of the network effect. The model is based on network
economics, an emerging field within the information society. Its premise is that value is
added through the growth of large-scale networks. The bigger the network (measured
primarily in terms of users), the more valuable it becomes.
The value of the network is described relative to number of users. As more users join the
network, the value added is proportional to the number of users. Various network models
assign value to a network. Peterson (2018) suggests that Metcalfe’s law is the best suited for
bitcoin’s network value model. According to Metcalfe’s law, the value of a network with n
users is the number of possible connections in the network (see 11.9).
n ( n − 1)
M= (11.9)
2
The model estimates bitcoin’s network value using Metcalfe’s law based on the number
of units (bitcoins) added to the network and the number of users (wallets). A decay factor
is based on bitcoin’s inflation rate to compensate for the growth and adjust for the creation
of new bitcoins. Bitcoin creation resembles an S-curve, Peterson (2018) suggests using
Gompertz sigmoid33 of the form described by Equation 11.10 to model bitcoin issuance,
effectively acting as a decay factor in the resulting calculation of the Metcalfe’s bitcoin
network value Vt (Equation 11.11). As opposed to the study of Peterson (2018), this thesis
chose to use active addresses – addresses that have acted as either a sender or receiver at
some point in the given resolution interval – instead of the total of unique bitcoin addresses.
This is for the following reasons:
• addresses that are active more accurately describe the current state of the network
and effectively discount the addresses that are a) no longer in use b) lost and c)
have been created by entities other than direct consumers (users).
33. The Gompertz model and logistic model are one of the most frequently used sigmoid models fitted to
growth data. A Gompertz function is a sigmoid function used to model a time series, where growth is slowest
at the start and end of a time period (Peterson, 2018, p. 17).
67
• bitcoin is a network for electronic transactions and as such, the amount of transactions
is what contributes to the value of the network, active addresses are addresses that
actively use the network and hence directly contribute to the value of the network
B
bt = bt−1 · ln( ) (11.10)
bt − 1
Vt = A ∗ Xt (11.11)
where
A = proportionality constant
n ( n − 1) 1 (11.12)
X t = Mt · bt = ·
2 bt
The proportionality factor A may be used to capture for example diminishing returns
when the network is already large enough. It might be assumed that, given a sufficiently
large network, the value added by newly created connections is lower since the most
valuable connections are formed first34 . To find A, two models of varying complexity
were created. The first model assumes that A is constant and uses Levenberg-Marquardt
algorithm (Gavin, 2019) for non-linear least-squares curve-fitting to fit it to the bitcoin
price Yt :
Yt ( X ) = A ∗ Xt (11.13)
This results in a model that overprices early in the period (about 2011 to 2013) when
both the price per BTC and the activity of the network were relatively low and issuance was
quite high relative to the later cycles, and underweights the period from 2017 to year-end
2021 (see Figure 18). The model is close to linear regression and as such, it has difficulties
adjusting to the changes in issuance (halvings). Fitting the model per-partes in intervals
2011–2017 and 2017–2022 (year-end 2021) results in a slightly better fit as shown on Figures
19a and 19b.
This thesis proposes an alternative model that accounts for the changes in the bit-
coin issuance and compensates for the constant value for the proportionality factor A by
introducing parameter β .
ln(Yt ) = A ∗ Xt + β ∗ ln(bt ) + ut (11.14)

where
A = proportionality constant
β = issuance factor
ln( Mt ) (11.15)
Xt =
bt
ut = balancing constant
34. This is a hypothesis without empirical evidence. The argument is laid out by Briscoe et al. (2006) as well,
also without any mathematical proof Peterson (2018).
68
Figure 18: Bitcoin simple network value model
The model is fitted on lognormalised data as proposed by Peterson (2018) (see Equation
11.14) using the Levenberg-Marquardt curve-fitting algorithm. Monthly active address
resolution seems to provide better fit than weekly and so the resulting model is presented
with monthly resolution (see Figure 20) can fit through the whole period from 2011 to
2021 (year-end) with mean deviation from the price at the close of approximately 0.227%,
Pearson’s r being 0.91 and p − value approaching zero. Regression characteristics of the
network value model with monthly resolution using the OLS (Ordinary Least Squares)
regression are shown in Table 7 and the following Table 8 shows the parameters that were
selected for the model.
Table 7: Network value model regression characteristics
N = 120
Intercept Slope R2 Adjusted R2
0.5829 0.9177 0.918 0.917
Table 8: Network value model parameters
Parameter Value Standard error Sensitivity
A 14.8569 1.5560 ≈ 28%
β 11.7981 1.8812 ≈ 64%
ut 2.9243 9.4248 ≈ 8%
The model seems to deviate the most (and underweight) around halvings. This might
be due to the fact that around those periods, there used to be an exponential increase in
69
(a) 2011 to 2017
(b) 2017 to 2021
Figure 19: Bitcoin simple split-epoch network value model
70
price, increase in trading volumes and elevated volatility. An interesting property of the
model observed purely visually is that the deviation from the real price seems to oscillate
around the mean and converge to the mean as the network growth stabilizes (see Figure
20).
Figure 20: Bitcoin complex network value model
Figure 21: Network value model deviation’s from bitcoin’s price at close
To estimate future bitcoin value using this model, the input data, that is circulating
supply and monthly active users (addresses), have to be forecasted. Circulating supply
can be projected given the following assumptions:
• over the forecasted period, the total amount of bitcoins (21 million) will remain
constant
• mean number of blocks mined is considered a constant
71
• a rounding error in halving intervals (roughly every 4 years) is considered irrelevant

for the model
Forecasting the amount of monthly active users, however, is much more difficult. The
forecast of the monthly active addresses was based on the projection of digital assets
ownership presented in the investment thesis (see Figure 11). A Power-law relationship
was found between the forecast of the ownership and bitcoin monthly active addresses.
Based on this relationship, monthly active addresses were forecasted into 2040, as shown
on Figure 12b. It was estimated that in the base case, the number of active bitcoin addresses
should more than double by 2030 (see the investment thesis presented in Chapter 10).
As was discussed previously, the model is fitted on exponential data. Even though an
exponential decay was introduced to both monthly active addresses and bitcoin network
value prediction, it still results in a rather high price tag of ($100M per BTC) as of 2040.
Even though it would surely be a pleasant surprise, the author doesn’t have confidence in
this prediction. As far as earlier terminal dates are concerned, 2025 and 2030 provide rather
realistic — optimistic, but still within the realm of possibilities — predictions of $330k and
$4.4M per BTC, respectively (see Figure 22). These price targets are not that far from the
results shown by the S2F model and the terminal value model and similar price targets
have also been provided by various analysts, as was mentioned in the thesis.
Figure 22: Bitcoin valuation using network value model
These relatively high price targets are believed to be affected not only be the network
address growth as the primary value driver, but also by the halvings. Multiple halvings
are happening in the forecasted period, each effectively halving the number of bitcoins
mined, increasing the scarcity of the asset. Historically, it was around halvings when the
price moved parabolically and there were prolonged periods of volatility.
72
12 Selecting valuation model
Each of the models presented in Chapter 11 targets different properties of bitcoin and
captures various points mentioned in the investment thesis.
Table 9: Bitcoin valuation models summary
Model Approach Property V2021 V2025
S2F
absolute scarcity $108 200 $352 000
(Plan B, 2019)
terminal value model relative store of value $89 846 (baseline) $254 349 (terminal
year 2025)
value transfer model relative medium of exchange $130 282 -
network value model absolute network value $31 000 $265 000 (baseline)
(Metcalfe)
The S2F model is a relatively simple linear regression model based on a power-law
relationship between stock to flow ratio and market value of bitcoin.
S2F model basis the valuation on the diminishing amount of bitcoin entering the
market. However, it doesn’t take into account the demand-side, i.e. the amount of network
participants. Should stock to flow ratio by itself really imply value, then, assuming zero
production cost, any network and any newly created digital asset with the same issuance
properties as bitcoin, even with 0 participants, will be automatically quite valuable. That
intuitively shouldn’t be the case.
Moreover, the growth has to be disproportional to the issuance of newly minted bitcoins.
Furthermore, the annual flow of bitcoin is approaching 0, which by definition results in the
S2F model predicting bitcoin price converging to infinity. The SF ratio is a useful indicator
of scarcity of the asset but it doesn’t explain the price action itself.
In theory, the terminal value model should work with any kind of terminal value, since
it is based on the flow of bitcoins generated (mined) over the given period. That being
said, the terminal value is the key to the calculation and assuming that bitcoin balances out
gold’s market capitalisation at a certain date is quite presumptuous. Moreover, the model
doesn’t take into consideration what happens with the gold’s market cap over that period –
will it shrink or will it grow as well? The assumption is based practically purely on the fact
that bitcoin’s utility as the store of value will attract more capital.
The model also suffers similar shortcomings as the DCF model regarding the assump-
tions about the perpetual growth rate, market return and the discount rate. See Pinto et al.
(2015a) for more information on the topic. The model might be useful for an estimation of
a potential future value, but it is difficult to discount to the present since it is unclear when
exactly will bitcoin reach the expected terminal value.
When discussing the value transfer model, it was argued that the NVT ratio is an alter-
native to PE ratio of the traditional equities (Woo, 2017). There are, however, significant
73
differences. Let’s first consider the model proposed by Woo (2017), which is a predictor
based on the daily transfer value. Intuitively, the price of an asset might be a behavioural
factor that draws attention to the network and therefore causes the transaction value to
increase. Hypothetically, there might be a correlation between price of the asset and the
total transaction value, which would significantly impact the NVT ratio as the ratio uses
market capitalisation as the network value. However, this correlation seems to be weak
with r ≈ 0.19 (see Figure 23).
With regards to the adjusted annualised NVT ratio, the total transfer value gathered
for Bitcoin and Ethereum and presented on Figure 17 might be skewed. The data can
be inflated by speculation, trading, activity on exchanges and interaction with miners.
Therefore, instead of measuring the pure utility of the network, which is theoretically the
case for both Visa and PayPal, such data is also included in the calculation. An argument
can be made that such transactions also contribute to the value of the network, they just
target different audiences. Nevertheless, for the comparison to be accurate, we should
likely choose to calculate the total transfer value from similar kinds of interactions, i.e.
user-to-user, user-to-business, business-to-business, etc.
Source of data: Glassnode

Figure 23: Correlation of bitcoin price and total transaction value
Another issue with this kind of relative valuation is that the potential growth is not
considered in the comparison. This is evidenced by PayPal’s NVT ratio which is orders of
magnitude higher than Visa’s, meaning that relative to the total value transferred, PayPal
is priced significantly higher perhaps due to the prospect of faster future growth of the
network. The value transfer model considered a single period, which might be a period
when a particular company (this might even be the numeraire) or the whole sector is
mispriced. The accuracy of the value estimation can be increased by evaluating multiple
periods. This might be a topic for further research. It is a useful model to identify potential
periods when bitcoin is undervalued or overvalued, but with regards to the investment
thesis presented in 10, other models are more suitable.
74
In either of the cases proposed in the investment thesis, the underlying value driver is
the adoption of the technology, i.e. growth of the network. It was forecasted that by 2025,
the amount of people owning some form of digital actives reaches 45% of the population
(projected on the American population).
The model that captures this investment thesis quite well is the network value model
presented in Section 11.4 which estimates the value of the network relative to the number
of its users. As more users join the network, the value added is proportional to the number
of users. It’s a demand-side approach with a relatively small amount of assumptions
(compared to other models).
That being said, the model has also its drawbacks. It relies on various assumptions,
particularly, the projected amount of active addresses (users). This information is rather
difficult to forecast and investors have to make some assumptions while doing so. The
main one is that the network will grow and then stabilise at a convergence point where the
network activity (active user addresses) remains roughly constant.
Another difficulty with the model is that it is fitted on exponential data, but we have
to assume that the exponential behaviour of the model will decay at some point and the
model stabilises. This assumption is a risk factor of the model. The model proposed in this
thesis uses exponential decay for both network address growth and bitcoin value forecast,
but it still exhibits exponential behaviour when projected into the distant future, which
results in a rather high price target for 2040 (see Chapter 13).
The model’s parameters exhibit relatively high standard error (see Table 8) and relative
error (more than 20%). However, based purely on visual observation, the confidence
interval of the prediction – the lower and the upper band as shown on Figure 20, seems
to be fairly reasonable. The model also exhibits high sensitivity to its input parameters
β and A. Using Sobol’s sensitivity analysis that describes to which extent model’s input
parameters affect variance of the output, the total (ST) and first-order (S1) indices (defined
from 0 for no affect to 1) indicate that the model is particularly sensitive to parameter
β, which explains about 64% of the model’s variance, on the other hand, the constant ut
doesn’t seem to have high impact on the output of the model (roughly 8.2% of the variance).
Since β is the parameter that factors in the circulating supply, it is intuitively correct that
this parameter influences the model quite a bit. Table 10 shows complete35 results of the
parameter analysis.
Table 10: Bitcoin network value model sensitivity analysis
Parameter ST S1
A 0.274311 0.274360
β 0.644875 0.644840
ut 0.082836 0.082766
35. Second order sensitivity was left out from the resulting table.
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13 Converting forecasts to valuation
The valuation will consider the price target of the network value model as of 2025 since
the author believes this is within the acceptable margin of error and it’s a conservative
target from the author’s point of view. As of January 2025, the price predicted by the
network value model is estimated to be $330k. The confidence interval lies within $263k
and $425k. To be as conservative as possible, the lower-band price target was chosen for
the valuation. This value of the bitcoin network will be discounted into the present using a
similar approach as for the terminal model NPV estimation (see Section 11.2):
BTC · V BTC
S2025
BTC 2025
NPV2025 =
(1 + R e )3
19 762 600 · $263 011 (13.1)
=
(1 + 8.5%)3
≈ $4.069T
where
BTC
S2025 = current circulating supply as of 2025
BTC
V2025 = estimated value per BTC according to the model (13.2)
Re = required rate of return calculated in 11.6
Given the current circulating supply as of year-end 2021, considering the NPV calculated
in 13.1, the fair price per BTC is estimated to be $215 117. If we compare this value to the
result of the terminal value model, which assumed roughly similar market capitalisation
(about $5T) as of 2025, but of course, under different assumptions, the price predicted
by this model is about 50% higher. That is because the terminal value model assumes a
perpetual growth rate from this date (hence the terminal date) whereas this model assumes
further growth (in this case even exponential growth).
13.1 Accounting for risk
There are generic risk factors that need to be considered before investing in an asset. The
risk is usually defined by the volatility of an asset and its correlation with other assets or
markets. Such correlation might reduce the effect of diversification and expose the whole
portfolio to systemic risk.
The Figure 24 shows bitcoin volatility since inception as a measure of the standard
deviation of daily returns averaged over the preceding 30 days. Notice how the bitcoin
volatility index diminishes over time as the price — and the market capitalisation — grows.
Upon issuance and in the early days, cryptocurrencies and tokens with a small-to-mid
network size tend to exhibit high volatility (see also Appendix C). Bitcoin volatility in
particular was as high as 16% in mid-2011 when the price was sitting below $100. Meaning
that the price of bitcoin was moving double digits most days of the month. As the network
76
grew, the volatility subsided to low single digits as of 2021. Nevertheless, this is still high
volatility compared to other assets such as gold’s average of about 1.2%.
Source: buybitcoinworldwide.com
Figure 24: Bitcoin volatility index
13.1.1 Correlation
Another risk factor might be a correlation with other assets or even markets. A well-
diversified investment portfolio should maintain a relatively low level of correlation be-
tween assets. Diversification, however, is extremely difficult when it comes to digital assets.
Digital assets are correlated on multiple levels. They are financial instruments, meaning
that they are also affected by systemic risks and macro indicators of the traditional markets,
like political and geopolitical events, economic outputs and even inflation, just like tradi-
tional assets. The second level of correlation is the correlation to the traditional markets
(i.e. indices like NASDAQ and S&P500). As shown on Figure 25, when it comes to bitcoin,
it can be moderately to highly correlated (r≈0.64) on shorter time frames with the stock
market indices, but the correlation appears to be highly correlated on longer time frames
(r≈0.9), see Figure 26.
Kristoufek (2013) and Ciaian et al. (2016) have concluded that macroeconomic factors
do not affect bitcoin price action in the long run. Testing the hypothesis is out of the scope
of this thesis. However, the results might differ. Since 2013 — which is when the former
study was done, bitcoin’s fundamentals were much different, the adoption both retail
and institutional was orders of magnitude less than nowadays and so was the market
capitalization. It was shown that both short-term and long-term, bitcoin tends to be in
correlation with the traditional market indices which is an indicator that bitcoin has become
large enough to be affected by macroeconomic developments.
77
Source of Data: Yahoo Finance

Figure 25: Bitcoin 90-day correlation with NASDAQ and S&P500
Source of Data: Yahoo Finance

Figure 26: Bitcoin 5-year correlation with NASDAQ and S&P500
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13.1.2 Regulation
Currently, the regulation of the digital assets market, if there is any, is questionable and
rather unclear. In the U.S., the regulation is practically non-existent, excluding some bills
that have recently been issued that cover specific areas, like taxes, for example.
Regulatory risk is difficult to quantify and has to be considered on a semi-qualitative
basis. The risk can be categorised based on how accommodating the regulation is along
with the likelihood — from the author’s standpoint — of such scenario. A potential impact
of regulation given its perception by the public and likelihood of the outcome happening
can be estimated using gradual risk-curves as shown on Figure 27. Most of the risk is
presented by an unfavourable regulation (the higher the likelihood, the higher the risk).
On the contrary, the higher the likelihood of a positive regulation, the lower the risk. Neutral
regulation is considered to be somewhat better than the unregulated market, that is why
the risk curves point to higher risk when it comes to the levels in the unregulated area.
Figure 27: Risk assessment given regulation perception and likelihood
Based purely on subjective opinion, the author expects that economic and political
incentives will drive governments to regulate the market in the not-too-distant future,
hence the likelihood of the market not being regulated is fairly low. At the same time, given
the incentives, governments might not strive to deregulate the market. The economical
incentive is to provide an environment for the adoption and innovation, which brings
investment capital into the country. The political incentive is represented by the public
opinion (and votes). It’s in the best interest of political candidates to gather as many voters
as possible. Since the digital asset adoption drastically grows, it’s possible that publicly
supporting the space is a way to gain more supporters.
The Table 11 shows estimated probabilities from the author’s perspective and potential
expected change in the attractiveness of the investment. The required rate of return is then
adjusted by the risk level and its likelihood. A conservative approach was chosen such
that even the neutral regulation causes a slight value adjustment to the downside and
positive regulation is assumed to not affect the valuation. The resulting NPV is estimated
by Equation 13.1.2 to change from $4.069T to roughly $3.33T, resulting in a valuation of
$176 031 per BTC.
79
BTC · V BTC
S2025
BTC 2025
NPV2025 =
(1 + R̃e )3
19 762 600 · $263 011 (13.3)
=
(1 + 16%)3
≈ $3.329T
where R̃e described by the Equation 13.1.2 is the adjusted required rate of return by
risk multiplier D of likelihood p(d).
R̃e = Re · ∑ p(d) · D (13.4)
Table 11: Bitcoin regulatory risk assessment
Regulation Likelihood p(d) D
Unregulated ≈ 0% 2.0
Unfavourable 15% 4.0
Neutral 75% 1.5
Favourable 10% 1.0
13.1.3 Going-concern risk
For the purposes of this thesis, an assumption is made that an investor wants to allocate a
certain portion of their portfolio to the digital assets market. Quantification of the going-
concern risk is considered to be relative to the asset that has the lowest level of such risk, in
other words, bitcoin. Therefore, in the final valuation, this risk is assumed to be equal to 0,
since there is no other digital asset that has survived longer than bitcoin — bitcoin was the
first one, after all — and neither is there any asset with higher market capitalisation.
13.2 Considering other valuation factors
As of the time of writing, the investment environment is highly uncertain and any level
of uncertainty is difficult to account for in the valuation. One of the primary sources of
uncertainty in the markets — this applies to multiple asset markets and asset classes, equity
markets, bond markets, housing markets and also digital assets — is the macroeconomic
environment. Having gone through a global pandemic, huge monetary changes happened
throughout the period that affected the global economy. The effects of the fiscal and
monetary policies implemented over the last two years combined with the lasting impact
80
of the pandemic have begun to surface, resulting in inflation levels not seen since the 80s,
reaching over 8%. Despite the market being at an all-time high just a couple of months back,
it is now promptly coming off these levels as the outlook changes due to expected monetary
tightening and interest rate hikes. NASDAQ has now corrected over 10%, approaching bear
market territory, with tech stocks being punished the most, with the majority being hit by
over 20% decline over the past 6 months. This results in a significantly bearish sentiment
in the market with under 20% of investors being bullish as of April 2022 according to the
regular weekly AAII sentiment survey. As it was shown in the thesis, bitcoin currently
trades in high correlation with tech stocks and it has corrected about 40% from the all time
highs as well. The correlation is likely to continue in the short-term, it is, therefore, desirable
to evaluate the macroeconomic outlook as well as equity markets before investing in bitcoin
or any other digital asset for that matter. An interesting observation that goes against the
store-of-value bitcoin thesis, at least in the short-term, is that despite record-high inflation
numbers, bitcoin is still trading more like a risk asset than a store of value.
13.3 Investment recommendation
The market at the moment poses an interesting opportunity. While the short-term outlook
might be negative, the inflation is predicted to get under control by the end of the year, with
the inflation currently expected to get under 2% in the second half of 2023 according to the
Federal Planning Bureau, which should end the monetary tightening as well as the rate-hike
cycle. This might either be an interesting opportunity to earn alpha on the investment once
the short-term market effects and the bearish sentiment subside or it should be re-evaluated
whether the thesis and consider bitcoin to still be a risk asset trading more like a tech stock,
rather than as an inflation hedge. Investors should, however, consider the possibility of
bitcoin’s price being affected by an unfavourable regulation and account adequately for
the risk. Accounting for the risk with unfavourable regulation being rather unlikely and
neutral regulation being the most likely outcome, the bitcoin conservative fair value is
estimated to be $176k per BTC. Fundamentals also seem to be quite strong and pointing to
the upside with the model predicting about 300% upside in the next 3–5 years. This might
therefore be a suitable entry-point for starting dollar-cost averaging into bitcoin.
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Conclusion
Conclusion
Since the inception of bitcoin in 2010 when there was just a single cryptocurrency, the
state of the space has evolved so much that digital assets have become a new asset class
represented by tokens, both fungible and non-fungible, and cryptocurrencies. The space
is starting to get attention not only from retail investors and traders as was the case just a
couple of years ago but also from institutions and even regulators. It’s no surprise that with
the total market capitalisation rivalling that of the largest companies in the S&P500, the need
for regulation is being articulated even by public figures and government representatives.
Digital assets are attractive because of their unique properties, particularly their de-
centralised nature, immutability and security. What enables these is the use of blockchain
technology. However, a property that is particularly valuable to investors and important in
the context of this thesis is scarcity. Scarce digital assets — bitcoin being one of them — are
limited in their total supply, meaning that there is a hard cap on the number of units there
will ever be in circulation. This particular property forms the basis of various valuation
methods. Some bitcoin valuation models, like the S2F model or terminal value model, are
based purely on the assumption of limited supply and diminishing issuance. These models,
to name a few, exploit the store-of-value utility of bitcoin while other models might target
a different utility.
To pick the right model, an investor first has to come up with an investment thesis. This
requires a thorough understanding of the value proposition of a given asset. For bitcoin,
the investment thesis presented in this thesis explored two angles. The first angle was how
much of a potential market share can bitcoin capture, being the store of value of choice.
The second was based on the idea that there is a value to bitcoin’s network that can be
quantified by Metcalfe’s law as a function of the number of users of the network.
The thesis based the valuation of bitcoin on the idea of network value and proposed
a network value model. The model shares some similarities with the model proposed
by Peterson (2018), in particular, the usage of Metcalfe’s law to quantify the value of the
bitcoin network using the number of addresses (wallets). However, the model proposed in
this thesis uses monthly active addresses as the independent variable instead of the total
amount of wallets as it is arguably a better indicator of value and quantifies the value
by projecting digital assets ownership growth. The ownership growth was forecasted
using Gompertz S-curve. The number of monthly active addresses was then projected by
establishing a power-law relationship with the digital asset ownership growth. The forecast
assumed diminishing growth over time and included this idea in the model in the form of
exponential decay. The projected number of monthly active addresses forms the input to
the network value model along with the projected growth in supply, which is factored into
the model as well. The model was fitted on historical data and forecasted almost 20 years
into the future, then discounted back to find the net present value.
The network value model proved to be quite difficult to fit and required a lot of assump-
tions and forecasts. The model was fitted on exponential data which resulted in relatively
high price targets when projected 20 years into the future. Even with the exponential decay
introduced to the model to account for diminishing returns as bitcoin is not expected to
continue this exponential growth indefinitely, the price targets were quite high, at least
intuitively. Then again, human minds work on a linear basis and we have difficulties con-
83
ceiving exponential trends, so perhaps such prices are possible. Especially since the network
value model also takes into account halving of the supply which so far proved to result in
exponential movements of the price per unit. However, to stay as conservative as possible
and within the realms of possibilities that can be conceptualised, the valuation was made
using the projected value for the year 2025, which seemed to coincide with multiple other
price targets provided by institutional analysts and industry experts. The model estimated
bitcoin value to reach $263 000 at the baseline. Discounting to the present and adjusting
for the circulating supply, the bitcoin was valued at $215 117. Compared to the results of
other models presented in this thesis, the valuation isn’t too different, with the S2F model
estimating bitcoin current value to be around $108 200, the terminal value model’s baseline
is at $89 846 but the most optimistic estimate reaches $163 245. The relative value transfer
model comparing network transfer value with Visa suggests valuation of $130 282.
To conclude the valuation process, the thesis also considered risk factors associated with
the investment. It was concluded that given the assumptions and the investment thesis, a
major risk factor is the regulation of the market. To account for the risk, a semi-quantitative
approach was proposed. The regulation was labelled by its hypothetical perception of
favourability, in other words, how accommodating from the perspective of investors the
regulation is, and each option was assigned a probability of such outcome and potential
market impact. The market impact was expressed by a multiplier to the required rate of
return and included in the valuation. Accounting for this risk, bitcoin’s network was valued
at roughly $4.069T which translates to valuation of $176 031 per BTC.
This thesis provided a valuation template for scarce digital assets, that is, assets that
are capped in total supply. It demonstrated a complete and conceptual approach to digital
asset valuation for investors to be inspired by. The thesis defined a conceptual valuation
framework similar to the one used in equity asset valuation, presented a bitcoin investment
thesis, performance forecasts and risk considerations and followed with the proposition
of bitcoin valuation models, selection of a suitable model, through sensitivity analysis
and evaluation of the selected model up to the conversion of the forecasts into the final
valuation and assessment of potential risk factors.
84
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Appendix
A Bitcoin investment context
At the highest level, two types of structures of financial systems can be distinguished – bank-
based and market-based. Both of them are autonomous36 systems. The pillars of either of these
are institutions and specialised organisations that act as authorities and intermediaries,
deal with the transfer of payments and mediate the flow of capital. In terms of the bank-
based financial system, it is the banks, i.e. central banks, deposit banks and other financial
institutions. In the centre of a market-based financial system is a stock market. The key
difference is to which degree are these systems bank-based on market-based. Vitols et
al. (2001) states two main distinctions between bank-based and market-based financial
systems. The first distinction being that “in bank-based systems, the bulk of financial assets
and liabilities consist of bank deposits and direct loans. In market-based systems, securities
that are tradeable in financial markets are the dominant form of financial asset. Bank-based
systems appear to have an advantage in terms of providing a long-term stable financial
framework for companies. Market-based systems, in contrast, tend to be more volatile but
are better able quickly to channel funds to new companies...” (Vitols et al., 2001). This
has perhaps a not so obvious corollary – bank-based systems focus on long-term stable
financial framework for companies, which takes away a degree of market freedom and
such systems respond rather slowly to macro-economical changes, like sudden changes in
the demand for funds. Marked-based systems, on the contrary, are able to quickly channel
funds to new companies. The second distinction according to Vitols et al. (2001) is the
degree to which the state is involved in the allocation of credit. Financial systems provide
valuable resources which help states achieve their economic and social goals. It doesn’t
take wild imagination to realise that bank-based systems are effectively much “closer” to
the state and therefor the involvement of a state in the system’s affairs is greater.
To the best knowledge of the author, there hasn’t been any conclusive research as to
which of the two financial systems leads to better — for the lack of a better word, since
the criteria might differ significantly — economic growth37 (see Demirguc-Kunt et al.,
2001; Ergungor, 2008). There are, however, some pattern emerging when cross-comparing
countries with different financial systems. Particularly, banks, other financial intermediaries,
and stock markets all grow and become more active and efficient as countries become richer.
As income grows, the financial sector develops. Furthermore, in higher income countries,
stock markets become more active and efficient than banks. Thus, financial systems tend to
be more market based (Ergungor, 2008). This brings up two important points:
1. Financial systems vary in effectiveness and activity given the level of income of
a country, thus, there is a relationship between stability of a financial system and
income of a country (GDP per capita).
36. An autonomous system has the freedom — an in this context even an obligation — to govern itself and
control its own affairs.
37. An exception to the statement is when the influence of a country’s judicial system is taken into the
equation. Ergungor (2008) found that there exists a nonlinear (contingent) relationship between growth
and financial structure. Countries that have an inflexible judicial system grow faster when they have a more
bank-oriented financial system.
92
A. Bitcoin investment context
2. Bank-based structure is at some point of income not efficient enough and has to be
supplemented by the markets. This requires highly efficient, resilient and reliable
(both functionally and financially) market structure.
Monetary structure
Money isn’t only used as a medium of exchange and a store of value. It’s also a counting
system, a way of listing prices, tracking revenues and profits. Money encapsulates the
entirety of economic activity under one accounting denomination. Throughout the thesis,
terms such as “money”, “medium of exchange” and “store of value” will be used quite
often. When talking about money and terms such as the aforementioned, we’ll make use
of the concept of layered money and the monetary pyramid as formulated by Bhatia (2021).
Over the course of history, the financial systems — even though they certainly haven’t
always been called that way — have been constantly evolving and so did the mediums of
exchange. The complete history of financial systems and the concept of the monetary pyramid
and layers of money formulated by Bhatia (2021) is out of scope of this thesis. Instead, we’re
going briefly walk through the most important milestones in the development of the layers
of money.
The first layer of money is considered to be the form of final settlement. The first layer of
money comes without counterparty risk, meaning the risk that comes with a promise — i.e.
to pay the debt later — by a counterpart. As Bhatia (2021) notes, counterparty risk is in
essential concept in the monetary science, especially because all forms of money in today’s
financial system have a degree of it (Bhatia, 2021). Hence, trust is required for the financial
system to operate.
In the late middle ages during a famous Medici banking dynasty38 . Such first layer of
money, a form of the final settlement without any counterparty risk, is the gold coin. Other
layers of money came into existence based on some form of trust and believe in the solvency
of the issuer.
We’re going to think of the layers as a pyramid, the first layer being at the top, repre-
senting money’s natural hierarchy where the monetary instruments are ranked in order of
superiority from top to bottom (Bhatia, 2021). Each layer of the pyramid becomes a side of
somebody’s balance sheet.
Bills of exchange — the promises to pay at a later date, also known as IOUs (“I owe
you”) — have become the second-layer money. These bills are a form of deferred payment.
The settlement is scheduled at a later date, but will be settled in the first layer of money,
i.e. gold or silver coins. These bills, as previously mentioned, carried a default risk39 , but
immensely sped up the velocity and elasticity of money (Bhatia, 2021).
A couple decades later, the creation of the Antwerp Bourse in 1531 gave a birth to the
new money market. Up until that point, the second layer of money — the bills — as we’ve
described it in the previous text, lacked liquidity. It didn’t have any cash-like characteristics.
It was accepted by some merchants, but the only form of money equivalent to cash were still
just precious metal coins. That change with the Antwerp Bourse. The velocity of the bills
38. The risk that the actor will not (voluntarily or involuntarily) pay off the debt.
39. To be precise, here we’re talking about the Renaissance Florence, from the end of the 14th century until
the end of the 15th century. The Medici Bank was during its peak period the most respected European bank.
93
of exchange was a useful feature for the money market traders and hence the bills slowly
became a preferred means of settlement for the traders – they began to develop cash-like
characteristics. At the Bourse, in order to settle any outstanding balances at the and of
a trading day, bankers issued promissory notes (or just notes). The notes were obligatory
promises to pay the bearer. What was different about the notes was that they didn’t have
the name of the creditor on them. They were a direct predecessor of the paper cash that
exists today.
In 1694, the Bank of England (BoE) was created with a sole purpose to purchase
government bonds to finance a war, effectively injecting the BoE as the actor between the
first and second layer of money. This gives the birth to central banking. Pound sterling, the
currency of denomination of England40 became lawfully valued only in gold, forming
the gold standard which reverberated throughout the world. Figure 28a shows how other
countries also adapted to this new hierarchy of money.
Adding BoE deposits and notes and bills of exchange to the hierarchy introduces a
major change to the system. In the previous, early monetary pyramids, bills of exchange
were second-layer instruments. However, after this hierarchical change, bills were promises
to settle in pounds (instead of settling in gold), i.e. the second-layer money instead of the
first layer, effectively creating
textbfthe third-layer money. Proceeding down the monetary pyramid, each successive layer
has an additional counterparty risk of the previous layer. Hence the risk accumulates. And
so does the transaction requirements. When transacting on the third layer, the transaction
might eventually be settled in gold should one of the parties demand it — they have the
right to do so — and therefore it would take an additional transaction to get from the third
layer to the first one. The monetary pyramid transforms into Figure 28b.
(a) Simple monetary pyramid (b) Extended monetary pyramid
Source: Bhatia (2021)

Figure 28: Hierarchy of money: The Gold Standard
40. The pound sterling was initially represented by a silver coin of 92.5% purity. However, after Sir Isac
Newton altered the exchange rate between gold and silver, gold became preferred over silver and it slowly
driven silver from usage.
94
At the beginning of the 20th century, the financial system as we know it today began to
materialise. The world started to shift towards the dollar as its reserve currency and with
the creation of the federal reserve system (known as the Fed), the dollar gained even a
stronger position. The Fed was an American central banking apparatus which formalised
a three-layered monetary system with private sector banks permitted to create third-layer
monetary instruments on their balance sheets. The Fed is the lender of last resort and
resides at the centre of its financial system. Today, the Federal Reserve remains atop the
hierarchy of money as the dollar still holds the status of the world reserve currency.
Initially, even with the Fed already being installed, gold remained the first-layer money
at the top of the monetary pyramid and the form of the final settlement. Each individual
dollar in the circulation was fully backed by gold41 . The word “reserve” in the title of
the Fed was in fact a synonym for the second-layer money, i.e. deposits issued by the
Fed to private sector banks. These were for banks and banks only. For the public, the Fed
issued notes that could be easily used as a medium of exchange (see fig. 29). This is the
dollar cash that exists today (Bhatia, 2021). As stated in Markham (2002b, p.) “The Federal
Reserve legislation adopted the concept of “open market” operations in which the Federal
Reserve banks bought and sold government securities and eligible private debt issues in
order to influence the money supply. Through these techniques, the Federal Reserve Act
provided further elasticity to the currency and established a more effective supply of funds
for deposit credits.”
Initially, the Fed did not own any US Treasuries, nor did they intend to. However, during
the first World War in 1914 to finance government spending, the U.S. treasuries joined gold
on the first layer of money and by the end of 1918, the Fed’s gold coverage ratio fell from
84% to less than 40% (Bhatia, 2021, p.58) and have been decreasing ever since42 . Even at
the time it was obvious that gold would be pushed out of the first layer of money (more
on that in the later sections of this text). The resulting monetary pyramid is shown on the
Figure 29.
Bhatia (2021) in his phenomenal book Layered money called the next shift in the monetary
pyramid “retiring gold”. I don’t think there’s a more apt and witty description for the
changes in the monetary structure that happened since 1930s. The structure of the financial
system has shifted more towards the stock market as evidenced by the roaring speculation
fuelled by banks lending up to 90% of the capital required to purchase shares (Bhatia,
2021). The problem was that there wasn’t enough gold held by the US government to cover
a potential demand as promised in its enactment, should it be necessary. This fact became
apparent in late 1929 during a historic stock market crash. The Federal Reserve System
(Fed) was not able to provide enough second-layer money and thousands of banks failed
in 1930s wiping out public deposits leading into the great depression.
A shocking executive order issued in 1933 by F. D. Roosevelt which order all US citizens
to give up any instruments granting them ownership of gold. Owning gold, the first layer
money that is supposed to have no counterparty risk and should therefore protect the
holders, was effectively illegal from that point — feel free to stop here to appreciate the
41. As declared by The Gold Standard act in 1900, gold was to be the monetary standard of the United States.
The act also prescribed a minimum reserve of gold to be held by the Treasury for the redemption of currency
(Markham, 2002a).
42. It is estimated that as of 2021, gold represents less than 1% of the Fed’s assets.
95

Figure 29: Hierarchy of money: Federal Reserve System
96
irony. What followed after that was a series of acts and global artificial currency devaluing
against gold that led to the (in)famous Bretton Woods agreement which made the dollar
world reserve currency and from the perspective of the monetary pyramid (see fig. 30a)
vertically separated the dollar from the other currencies, which couldn’t be redeemable for
gold.
This financial structure was, however, deemed to fail. The reason behind the failure
was actually quite simple. The US had to artificially inhibit the price of gold (since it was
denominated in the US dollars) and the only way to do that was to sell gold from their
reserves. The other countries obviously accumulated gold and also wanted to convert their
dollars to gold. This led to the point where the US could no longer keep the lid on the price
of gold and several years after the Bretton Woods agreement, the price of gold exceeded its
initial peg of $35. The US was forced to suspend gold convertibility for the dollar in 1971,
effectively removing it from the monetary pyramid, leaving the US treasuries alone atop
the dollar pyramid. The monetary pyramid of the current US dollar system is shown by
the Figure 30b43 .
The Fed shifted to a monetary policy regime focused on managing short-term interest
rates and it’s become the largest holder of Treasuries in the world. As Bhatia (2021) correctly
noted, “it is likely to purchase them ad infinitum because the purchase of Treasuries is how
the Fed creates second layer reserves into the system.”
Ever since, despite the original intent of the Federal Reserve System being just to provide
a second layer of money elastic enough to withstand shocks to the system, the Fed keeps
flooding the market with reserves by purchasing US treasuries in fact most of the time
to propel the economy. The purchases are exacerbated during unexpected shocks to the
system or crashes of the stock market, as could be observed during the COVID-19 stock
crash in 2020. The Fed balance sheet doubled from $4 about trillion to more than $8 trillion
in a single year44 .
43. Explanation of the money market funds (MMF) was skipped. Feel free to find out more in Bhatia (2021,
ch. 6).
44. Source: federalreserve.gov.
97
(a) Bretton Woods (b) U.S. dollar system

Figure 30: Hierarchy of money: Transition from the gold standard
The monetary pyramid has changed quite a bit since the early days when gold coins
were the be-all and end-all of the financial system of that period. It was what is today often
called hard money. The opposite to that would be the money that is used on every-day
basis nowadays – the fiat money, in other words, a government-issued currency that is not
backed by a physical commodity (see sec. 3). Since the dollar took its place atop of the
monetary pyramid, businesses, consumers and in fact whole economies have become so
accustomed to the inflationary environment, that it is now a matter of course. Most people,
however, are not financially savvy and they don’t really understand the implications of
inflationary environment.
According to the FINRA report (Lin T. et al., 2018), despite the U.S. economy expanding,
the “financial capability, stability, and confidence are no longer improving in step with the
economy.” Not only there is a widening gap in financial capability, for 44% of respondents,
discussing their finances is stressful. When it comes to the inflation itself, only 55% of
survey respondents answered the questions correctly and stunning 4 in 5 youths failed the
general financial literacy quiz. Considering that as of 2017, according to Forbes.S. workers
live paycheck to paycheck, these are the ones that are on the frontlines, suffering the worst
consequences of inflationary environment (Friedman, 2019).
Millenials — the generation of people who were born between 1980 and 1995 — is
often told to be the generation hit the most by the current economic environment. Consider
for example Figure 31 how buying power of $100 changed since 1990. The dollar had an
average inflation rate of 2.46% per year between 1990 and today, producing a cumulative
price increase of 112.66%. This means that today’s prices are 2.13 times higher than average
prices since 1990, according to the Bureau of Labor Statistics consumer price index. A dollar
today only buys 47.02% of what it could buy back then (Webster, 2021).
Should money, however, even be inflationary in the first place? Many economists argue
that inflation is the engine of the economy, whereas others that deflation is the key to an
abundant future. Jeff Booth argues in his book The Price of Tomorrow that we’re entering an
98
Source: Inflation Calculator

Figure 31: Buying power of $100 since 1990 to 2021
age of deflation. Particularly due to the deflationary nature of technology and our economic
systems which were not built for a world driven by technology. The other factor is that the
concentration of wealth is extremely high, in fact the highest since 1920s. In the U.S., the
top 5% of the population now holds more than two-thirds of the wealth (Booth, 2020, p.
16). This inequality causes instability in the economy. With the asset prices at or near of
their all time highs as of December 2021, homes priced at double digits of average yearly
income in some countries and historically high inflation exceeding 5% (6.8% in the U.S45 ),
it is a tough environment for the young generation entering the labour market and for the
new investors as well.
The issues of the current financial systems have really surfaced in 2008 during a se-
vere financial collapse followed by a prolonged financial crisis. The crisis was born of
irresponsible lending. The loans, known as subprime loans, were issued to borrowers and
then — instead of the banks ensuring that the borrowers repaid them the loans — they
were securitised into a complex financial instruments known as collateralised mortgage
obligations (usually called shortly CMOs) and sold to investors on the market, as Burniske
puts it: “...effectively passing on the risk like a hot potato through the financial markets,
with purchasers lured by the promise of high returns combined with low risk due to
purported diversification.” (Burniske et al., 2018, p. 38).
Since the risk was passed to investors, the banks were not incentivised to thoroughly
check financial background of loan applicants and issued loans even to Americans who
couldn’t afford to repay their debt. This, in the beginning, caused a real estate bubble as
mortgage applications exploded. Nevertheless, the bubble was caused by an excessive
leverage due to mortgages that were issued even with 0% down payments, effectively
inflating the amount of “money” in circulation. The crises started unfolding with U.S banks
45. CPI measurement as of November 2021, Bureau of Labor Statistics, U.S. Department of Labor.
99
and financial institutions being distressed, unable to pay their creditors, resulting in the
largest bankruptcy of the modern history when Lehman Brothers, at the time the 4th largest
investment bank founded in 1847 with over 26 000 employees, filing for bankruptcy in
September of 2008. Just four moths prior to the bankruptcy filing, as of May 2008, the
company had over $600 billion46 worth of assets under management (Wilchins, 2008). To
combat the crisis, U.S. government established $700 billion Troubled Asset Relief Program
and the U.S. Federal Reserve further expanded their balance sheet resulting in an increase
in total assets from $900 billion as of August 2008 to $2.25 trillion in December 2008 —
effectively doubling their balance sheet in just three months — to provide liquidity to the
financial markets.
Properties of money
Money is a rather difficult concept to grasp. If asked the question “What do you understand
by the word money?”, most people would probably immediately have an association with
the cash in their wallets – the fiat money. In other words, something they can use to obtain
goods and services they need. From the economic perspective, the most basic understanding
of money is as a medium of exchange. As such, it can basically have any form that satisfies
the following properties: divisibility, durability, fungibility, portability, stability.
The money has to be divisible into units small enough to be able to pay for individual
items in the average consumer’s basket of goods. At the same time, it should be portable so
that a) there are no transportation costs and b) has no detrimental effect on consumer’s
shopping experience, i.e. does not discourage the consumer from buying the goods. Money
also needs to be fungible, meaning that its units are equivalent and interchangeable. A
counter-example would be a hypothetical currency with paper notes that are in good shape
and those that are in bad shape. If the currency weren’t fungible because of this property,
a customer with the notes in “bad shape” would have to pay more for the same goods.
This is of course unacceptable. Sticking with the example of the paper notes, the medium
of exchange has to be durable. Non-durable medium of exchange would contradict with
the future-oriented value of money47 . Moreover, considering the current monetary system
of the fiat money, if the fiat money wasn’t durable, i.e. would simply “parish” over time,
the money supply would shrink at a high rate, which would in turn cause high deflation
and probably result in a sudden recession. The money is obtained for future spending. For
example, workers are paid their salaries so that they could spend them over the following
month on live expanses. The last property of money – stability – is the most important
property of them all. Volatility of a medium of exchange causes a chain reaction through
the whole financial system. Consumers, businesses, investors and even governments would
incur transaction costs and would be exposed to a currency risk. Consumer sentiment
would degrade as they wouldn’t be incentivised to buy goods and spend money, financial
outlooks would uncertain as well and nearly impossible to predict.
46. Adjusted for inflation, $600 billion would be worth $774.58 billion as of 2021.
100
101
Year Open High Low Close Volume
1985 -
1986 23,27% 19,61% 20,58% 14,62% 16,28%
1987 -7,58% -0,60% -8,31% 2,03% 20,42%
1988 18,83% 10,70% 22,25% 12,40% -27,55%
1989 26,43% 26,26% 25,57% 27,25% 12,95%
1990 -6,87% -5,68% -5,20% -6,56% -3,01%
1991 16,41% 25,25% 15,34% 26,31% 33,32%
1992 14,99% 5,82% 15,42% 4,46% 17,35%
1993 7,09% 6,47% 7,66% 7,06% 18,77%
1994 -1,81% -1,82% -4,02% -1,54% 9,68%
Figure 32: US500 annual returns

1995 33,47% 34,61% 36,62% 34,11% 21,19%
1996 25,05% 22,29% 18,45% 20,26% 18,08%
Source of data: Yahoo Finance

1997 26,21% 29,47% 29,05% 31,01% 31,57%
1998 21,80% 26,23% 22,92% 26,67% 26,95%
1999 19,36% 18,33% 22,03% 19,53% 29,37%
2000 -5,33% -5,71% -9,61% -10,14% 20,21%
2001 -13,35% -15,51% -11,13% -13,04% 6,43%
2002 -17,83% -18,69% -21,99% -23,37% 3,44%
2003 13,02% 16,59% 21,16% 26,38% 7,10%
2004 10,92% 9,42% 11,43% 8,99% 11,72%
2005 6,45% 4,80% 6,20% 3,00% 34,25%
2006 12,10% 12,23% 11,18% 13,62% 13,94%
2007 5,64% 6,41% 3,59% 3,53% 36,24%
2008 -39,94% -39,69% -43,18% -38,49% 74,15%
2009 23,66% 23,02% 33,13% 23,45% -20,70%
2010 7,98% 11,70% 9,27% 12,78% -9,53%
2011 5,08% 0,54% 1,33% 0,00% -7,71%
2012 13,59% 14,07% 16,28% 13,41% -11,18%
2013 27,55% 27,72% 26,46% 29,60% -2,15%
2014 14,35% 13,20% 11,57% 11,39% 24,30%
B US500 Annual returns
2015 0,83% 0,51% 1,05% -0,73% 3,60%

2016 5,63% 8,23% 9,74% 9,54% -10,04%
2017 20,22% 18,33% 19,11% 19,42% -13,29%
2018 5,50% 3,90% -9,94% -6,24% 28,00%
2019 12,66% 15,99% 30,84% 28,88% -13,73%
2020 15,97% 15,77% 18,34% 16,26% 33,31%
2021 26,25% 27,89% 23,72% 26,89% -28,48%
2022 -3,34% -7,25% -2,21% -7,76% -97,23%
9,84% 9,74% 10,13% 9,86% 8,33%
102
Top of Mind
Source: Goldman Sachs Global Investment Research (Nathan, 2021c)
2017-2021
$65,000 August 2020
August 2017 December 2017 April 2021
November 2017 MicroStrategy Coinbase IPO.
A "hard fork" occurs as BTC futures contracts begin
$60,000 Future Fed chair announces adoption of
Bitcoin Cash (BCH) Jerome Powell trading on the CBOE and CME
exchanges. BTC as primary
splits off of BTC; BCH says BTC is not
$55,000 promises speedier May 2020 Treasury reserve
big enough to asset. February 2021
processing times, as its The reward for BTC miners
pose a threat to NY AG $18.5mn
$50,000 halves for the third time,
Figure 33: Bitcoin volatility throughout history

blocks contain 8x the the US economy. January 2018 July 2019 Tether
data capacity of BTC falling from 12.5BTC to
Chinese officials order mining operations to close; US Congress settlement.
$45,000 blocks. 6.25BTC; investor Paul
hackers steal more than $500mn of XEM—another holds hearings on
Tudor Jones announces October 2020
crypto—from the Japanese exchange, Coincheck. cryptocurrency
$40,000 BTC holdings. PayPal to
regulation. May 2021
September 2017 accept BTC;
October 2018 July 2020 Tesla announces it
The Chinese May 2018 November 2019 Square
$35,000 Fidelity announces US Office of the will no longer accept
government bans US DOJ opens criminal probe People's Bank of China announces
initiative to handle trading Comptroller of the bitcoin; China widens
March 2017 ICOs and into cryptocurrency price launches crackdown on $50mn BTC
$30,000 and custody of crypto Currency (OCC) crypto regs.
The SEC rejects two subsequently manipulation; US and Canadian cryptocurrencies. investment,
assets for institutional allows nationally April 2021
separate BTC ETF closes the regulators announce "Operation acceptance as
investors. chartered banks BTC corrects driven
$25,000 applications. nation's BTC Crypto-Sweep" to police crypto January 2020 payment.
exchanges. July 2019 CME begins to to custody by liquidations, China
investment schemes. September 2019
President Trump tweets that trade options on cryptocurrencies. mining outage, and
$20,000 July 2018 BTC and other
NYSE launches
April 2017 BTC futures regulatory concerns.
SEC rejects BTC futures.
Japan recognizes BTC as cryptocurrencies are "based contracts.
$15,000 legal tender, while bringing
application for on thin air".
BTC ETF. February 2021
the cryptocurrency under Tesla announces $1.5bn
$10,000 AML/KYC rules and BTC position and
February 2020
C Bitcoin volatility throughout history
regulations. acceptance as payment;

$5,000 Treasury Sec. Yellen
warns of illicit financing BNY Mellon announces it
via cryptocurrencies. will custody BTC.
$0
Jan-17 Apr-17 Jul-17 Oct-17 Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 Oct-19 Jan-20 Apr-20 Jul-20 Oct-20 Jan-21 Apr-21
2013-2016
$1,200 After being unveiled December 2013
in 2009, BTC's price Media attention
remains relatively pushes BTC to an all- January 2014 February 2016
flat, peaking at about time high. Zynga and Overstock.com Influential members in August 2016
$30 in 2011. begin accepting BTC. the BTC community Bitfinex, the largest
$1,000 meet in Hong Kong to BTC exchange by
discuss a possible volume, is hacked;
March 2013 change in BTC's
An accidental fork occurs in the BTC cybercriminals
transaction format that capture $72m
blockchain; due to the introduction of would effectively
$800 a flawed software update, the correct September 2015 worth of BTC.
increase the size of BTC
version of the public ledger becomes The US Commodity blocks; the aim is to
unclear for nearly 6 hours. June 2015 Futures Trading speed up transaction
The New York State Commission (CFTC) processing times.
March 2013 January 2015 Department of defines BTC as a
$600 FinCen says that BTC will be Financial Services commodity, which falls
Coinbase launches
treated in the same way as money its own US- unveils the first set of under its regulatory
for the purposes of AML laws. licensed BTC state-level regulations purview.
5
.
exchange (GDAX). targeting July 2016
October 2013 February 2014
$400 cryptocurrencies. The reward for BTC
April 2013 US law Attacks on
miners halves for the
Mt. Gox exchange enforcement exchanges lead to
second time, falling from
goes down for a day. officials shut down a halt on some April 2014 25BTC to 12.5BTC.
the Silk Road. withdrawals; Reports indicate that the
Mt. Gox exchange PBOC plans to shut down
$200 collapses. October 2015
the bank accounts of
Chinese BTC exchanges. The EU decides not to impose a value-added tax (VAT) on crypto
transactions, effectively regulating BTC (and other
cryptocurrencies) in the same way as fiat currencies.
$0
Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16
Note: Market pricing as of May 19, 2021.
Issue 98
Source: CoinDesk, 99bitcoins, Bloomberg, various news sources, Goldman Sachs GIR.

Cermak - Valuation of Scarce Digital Assets

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FACULTY OF ECONOMICS AND ADMINISTRATION

Brno 2022 Marek Čermák

Valuation of Scarce Digital Assets

Advisor: Mgr. Zuzana Gric, Ph.D.

Brno, Spring 2022

ECON DIČ: CZ00216224

Student: Marek Čermák

Metody: analýza, komparace, deskripce.

Author: Marek Čermák

Title of Thesis: Valuation of Scarce Digital Assets

Degree Programme: Finance

Field of Study: Finance

Supervisor: Mgr. Zuzana Gric, Ph.D.

Academic Year: 2021/2022

Number of Pages: 9 + 102

Brno, 12. May 2022

5 Understanding value proposition 34

8 Selecting valuation model 47

9 Converting forecasts to valuation 51

III Bitcoin valuation 54

11 Bitcoin valuation models 60

12 Selecting valuation model 73

13 Converting forecasts to valuation 76

A Bitcoin investment context 92

B US500 Annual returns 101

C Bitcoin volatility throughout history 102

1 Categories of on-chain indicators: Layer 1 . . . . . . . . . . . . . . . . . . . . . 42

1 Weekly Google search trend for the term “digital asset” . . . . . . . . . . . . . 19

DeFi Decentralised Finance Glossary: DeFi, 20, 21, 40

KYC Know Your Customer Glossary: KYC, 20

NFTs Non-Fungible Tokens Glossary: NFT, 37

S2F stock-to-flow Glossary: stock-to-flow

SEC Security and Exchange Commission 20, 22

blockchain is a digital database containing information (such as records of financial trans-

cryptography is the enciphering and deciphering of messages in secret code or cipher

EBITDA earnings before interest, taxes, depreciation, and amortization, it is a pre-interest

hard fork (or hardfork), as it relates to blockchain technology, is a radical change to a

proof-of-stake is a cryptocurrency consensus mechanism that reduces the amount of com-

proof-of-work is a cryptocurrency consensus mechanism that requires a not-insignificant but

token is a unit of value that blockchain-based organizations or projects develop on top of

volatility is a tendency to change quickly and unpredictably; it is a statistical measure of

Source of data: Google Trends

Gemini’s Cryptopedia glossary (2021) defines a cryptocurrency as follows:

the native asset of a blockchain network that can be traded, utilized as a

Cryptocurrencies typically exhibit the following characteristics (Cryptopedia Staff,

• uses cryptography to secure the cryptocurrency’s underlying structure and network

Again, using Gemini’s definition (2021):

• programmable – they run on software protocols, which are composed of smart

Source of Data: Google Trends

Initially called “digital ledger”, blockchain is a decentralised, immutable database that

7. The paper was revised in 2009.

blockchain technology is cryptography, which — admittedly, in a much simpler form — has

“Immutability is a rare feature in a digital world where things can easily be

2.4 Consensus mechanisms and mining

“The first lesson of economics is scarcity: there is never enough of anything

Scarcity is an important fundamental driver in economics as it represents the gap

Source: Nathan (2021a)

“Valuation is at the core of the economic activity in a free economy. As a

2. forecasting company performance

3. selecting the appropriate valuation model

4. converting forecasts to a valuation

5. applying the valuation conclusions

1. understanding the business → understanding the value proposition