3 Models To Explain Bitcoin's Market Cap

| About: Bitcoin USD (BTC-USD)

Summary

Unique addresses, total transactions and network hash rate are evaluated side by side.

Why each might give us unique insight into the market right now.

Putting it all together into one simple chart.

Three different ways to look at Bitcoin's market cap

Earlier I submitted an article about the relationship between the number of unique addresses in use and how it relates to Bitcoin's market cap (BTC-USD). Today I want to talk about two other pieces of data that can give us more color into this topic. I have found three very strong correlations between the Bitcoin market cap and the data that we can parse from the network. Each of these were derived from log transformations and regression analysis.

Indicator Name Unique Addresses Network Hash Rate Total Transactions
Strengths Good gauge of actual network activity on a monthly basis. This metric is less subject to speculation because of the real world implications of mining at scale (moving dirt, laying power lines etc). Gives a ratcheting up point of view in which Bitcoin's price is either forced up over time or has to fail completely.
Weaknesses Can be thrown off by batching and volatility in transaction fees due to dust consolidation Indicator can be thrown off by advances in computing and can lag the market because of the gap in time between investment and operations of large mining facilities. If people completely stop using Bitcoin, this figure would break down because it would simply flatten out instead of showing the market cap drop to zero.
Reasoning Metcalfe's Law (the network effect) Miner CAPEX may reflect future expected earnings of industry insiders Longer blockchains are more secure and closer to immutability
Correlation (monthly sample) 0.9708 0.9567 0.9676
P-Value 3.1501E-58 1.4915E-50 3.2910E-56

The chart below illustrates these three signals and their output over time. The yellow line is the actual Bitcoin market cap (taken monthly).

three signals on the same chart Data Source: blockchain.info

Since data is sampled once per month, the last point on this chart represents the outlook on June 1st, using all the available data from May. The values are:

Indicator Name Unique Addresses Hash Power Total Transactions
Predicted Market Cap $21,461,365,184.44 $86,503,013,458.64 $55,540,094,880.65
Actual / Predicted 5.698 1.481 2.306

As you can see, the hash rate of the network would seem to indicate a market cap that's four times higher than we would arrive at using the unique addresses method. Total transactions is in between the other two signals, proposing a modest market cap of only $55 billion.

Where we're at now

As you may have noticed from the chart, by any of the three valuation methods, Bitcoin's market cap is above projected levels (as of June 1st, 2018).

My personal opinion

In the short term, I expect Bitcoin's market cap to come back in line with the historical trends, possibly passing below the predictors as it did in 2014 (but likely not as far because there was no Mt. Gox scale event this time).

In the medium term, I think Bitcoin's market cap will level out and begin a slow recovery.

In the long term, we will have another Bitcoin bubble as slow growth speeds up and the market overheats again, and everything that's happening now will happen again as Bitcoin is declared dead for the 400th time.

Please remember this is not investment advice, it's just a set of tools that might help you evaluate the current valuation of Bitcoin's market cap on a monthly basis.

Future Tech

I believe that in order for Bitcoin to get to higher adoption levels, it needs a lot of work in scaling and user experience. Last year we saw the upper limits of how many transactions that could be processed and the skyrocketing fees that resulted. I believe this is what popped the last bubble, and in order for the next cycle to take place we need scaling technology to be vetted, tested, adopted and made seamless. This will take some time and nobody can say for sure how much.

The two big scaling solutions that are being worked on right now in Bitcoin are Lightning network and segwit. Segwit has been out since August of 2017, but it still is only being used in about 35% of network transactions. This figure needs to get much higher to allow the network to support further scaling.

segwit usage Image Source: P2SH.info

The lightning network will allow Bitcoin to scale to thousands of transactions per second. The network itself is still microscopic, but it's growing at incredible speed.

lightning network channels Image Source: P2SH.info

Another way of thinking about the lightning network, is via the amount of Bitcoin in all channels. By that measure less than one Bitcoin per million is using this second layer technology, but this figure represents growth by a factor of four in the last three months.

Summary

By using the number of unique addresses of the Bitcoin network, the total hash rate, and the running total transaction count; we can create three distinct measurements that each give us insight into the possible upper and lower bounds of the Bitcoin market cap.

At times the market cap will be above what we expect, and at other times is might be below what we expect. However, I believe by understanding the strengths and weaknesses of each kind of data we will have a much better grasp on the overall direction of the market. This type of understanding is not possible without thinking long term and in log scale.

At the beginning of each month, I will post an update to this chart with commentary on the status of the network and key events in the last month. I hope you found this information useful. See you next time.

Disclosure: I am/we are long BTC-USD.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.