The price of Bitcoin has fallen sharply, even briefly diving below US$7,000, a new low for the second half of 2019. Yet according to LongHash’s token valuation chart, Bitcoin is still considered “overvalued.” What is the explanation for this?
LongHash’s chart is based on Metcalfe's Law, which states that the value of a network is proportional to the square of the number of users in it. Metcalfe's Law was originally used to evaluate the value of communication networks, but with the growth of social media and large-scale data sets in recent years, it has also been applied to social networks. In the case of Facebook and China's Tencent, scholars have found that the growth of these companies' value and user base is not linear, but coincides with Metcalfe's Law.
Crypto assets rely on the networks that connect users in the digital space. Users interact with each other by exchanging information and participating in transactions. Since these networks are digital, always online, and launched on the blockchain, it is not difficult to obtain network usage data. Therefore, we have established a valuation model for crypto assets like Bitcoin that incorporates the unique addresses of daily active users on the basis of Metcalfe's Law.
The graphs above show the respective valuation of Bitcoin and Ethereum based on Metcalfe's Law. We found that the predicted value of ETH is closer to its actual market value, while there is a comparatively large gap between the predicted value and actual market values of BTC.
One possible reason for this discrepancy is that the block generation interval on the Bitcoin network is about 10 minutes, and the number of transactions per second (TPS) is generally between three and seven. This causes unconfirmed transactions to accumulate and limits the number of addresses that can be active at any given time. Because of this, a Metcalfe model — which is based on user activity — leads to a rather low valuation for Bitcoin.
Additionally, Bitcoin is seen by many as digital gold, filling a role that might be described as a crypto version of the gold standard. Most crypto assets are linked to Bitcoin, and Bitcoin has a large number of trading pairs on crypto exchanges. That status as a "standard" currency for all kinds of crypto trading makes Bitcoin more valuable, but that value is not factored into the Metcalfe model.
The Metcalfe model may work better for the valuation of the crypto assets with higher TPS or scalability than Bitcoin, and for assets that aren’t a “gold standard” in the way that Bitcoin is. That said, while it’s not a perfect way to measure Bitcoin’s true value, the Metcalfe model valuation is still a useful point of reference. Even according to the model's prediction (which likely underrates Bitcoin’s true value), Bitcoin is still far from a bubble risk. Thus, we can stay cautiously optimistic about Bitcoin’s future performance.