On Business Insider’s cryptocurrency show, “The Bit,” Tom Lee, the cofounder of FundStrat Global Advisors, explained the reasoning behind his bullish stance on bitcoin, along with how he goes about valuing the cryptocurrency.
He says his short-term model, built on Metcalfe’s law, can efficiently explain the majority of bitcoin’s price action over the last few years.
Simply put, Metcalfe’s law says the value of a network is proportional to the square of the number of users on the network.
For instance, a cellphone is utterly useless if you’re the only person who owns one, but its value increases exponentially as other people get cellphones.
This is also the case for social networks — Facebook is only valuable because of the amount of people who use it.
“If you double the number of users, you’re more than doubling the utility value,” Lee said.
Lee believes the same is true for bitcoin. FundStrat analyzed the number of active bitcoin addresses to estimate the number of users on the bitcoin network and found that the square of his value explained 63% of bitcoin’s volatility since 2013.
Below is a portion of “The Bit,” where Tom Lee explains his thinking.
Lee: In the short term, we think bitcoin has really followed very closely the idea of acting like a social network — meaning the more engagement there is, the greater the value rises. And in the short term, we think bitcoin will reach $6,000 by mid-2018.
Sara Silverstein: And you’re using Metcalfe’s law. Can you explain that?
Lee: So Metcalfe’s a professor. He actually came up with a theorem based on George Gilder, which is the value of a network is the square of the number of users. And so if you build a very simple model valuing bitcoin as the square function number of users times the average transaction value, 94% of the bitcoin movement over the past four years is explained by that equation.
Additionally, FundStrat took their analysis a step further by adding the bitcoin transaction volume per user. This linear model explained 83% of the variation in bitcoin’s price.
The company also discovered a formula by regressing the price of bitcoin against both unique addresses squared and transaction volume per user. This model provided an explanation for 94% of bitcoins price action since 2013.
The chart below plots the projected price of bitcoin based on this model (light blue) against the actual price (dark blue dotted line). The model is a relatively good fit for bitcoin’s price movement since late 2014.
FundStrat can also utilize this model to project bitcoin’s price within the short-term future. The model requires an estimate of the number of unique addresses on the bitcoin network (squared) and estimate of the number of daily transactions.
Lee claims that the model only provides an effective estimation for the “…short-term range…,” however, given this premium, Lee is a bit more cautious in the short-term.
“Bitcoin’s longer-term technical trend remains positive,” he said, “but the short-term upside seems limited, and the risk of a correction is growing.”
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