Bitcoin has been an enigma for most since its conception. Was this a financial bubble designed to burst to zero or the potential currency? Perhaps there might be a reason to accept it as a commodity? Why does one justify their demand and, above all, their market action? Technical analysts across sites, such as TradingView, Twitter or Telegram, are separated by demand directions per bitcoin. After writing this post, Bitcoin is trading on major exchanges for an average of $9,094 per coin. We call for a dip of $5k, and Bulls seem to think that we will see a price of more than $13k per Bitcoin in May.
Existing Valuation Models and their Limitations
The Stock to Flow Model
Among those models based on fundamental Bitcoin properties, the PlanB Stock to Flow model has gained popularity among Bitcoin enthusiasts, based on its principle of the scarcity of future pollution. Further studies on this area, in particular the evidence of Nick’s co-integration of price flow, have further legitimized the model. Since its independent variables ‘ future values are fixed in stone (or rather in code), the future price range of the product can be reliably predicted.
Whilst I am personally fascinated by this model, it is not the ideal method for a swing trader looking at a quarter of time or less. In an intense bull market period, the real price of Bitcoin can be seen trading more than 4 times the model predicts, while blindly following the forecast you will see your underwater accounts by up to half the projected price during the nadir of a bear cycle. Its residual range is too broad.
This model even fails to value certain cryptocurrencies of Proof of Work (PoW), e.g. Among others, Litecoin, Bitcoin Cash, ZCash, Monero. It is not to assume, however, that the prices of these cryptos are zero, if anything that has kept their market share for the last 24 months, then there must be a better account of their evaluations.
Finally, the model assumes that the bitcoin mining cycle will continue until 2142 when the value of a bitcoin is infinite. In case of a mining cessation before 2142, however, bitcoin flow would drop to zero. If this occurs tomorrow, or five years later, will the price of a Bitcoin’s value in the short term go on to endless? No. No. In any case, its price is expected to decrease considerably in response to such a black swan event.
Bitcoin Energy-Value Equivalence
This Charles Edwards model attempts to value a bitcoin-based on its energy costs. It’s a much more realistic approach to Bitcoin value than it was to flow— a premature end to Bitcoin’s mining will tank its price instead of running into infinity. The value of BCH-BTC pairs in satoshis may also be reached by valuing other PoW cryptos and their bitcoin pairs (e.g., by valuing Bitcoin Cash (BCH) in US dollars.
However, the energy value equivalence model is too smooth to be prone to price fluctuations, as is the case with the Stock to Flow model. During serious bear market conditions, Bitcoin price traded 60% below the 2011 and 2015 model price and fell to 45% at the end of 2018. The inability to be a standardized bottom predictor leaves room for further analysis based on production costs.
DataDater’s Bitcoin Cost of Production (CoP) Model
One of its drawbacks is the lack of awareness of adding capital expenditure (CapEx) to the expense of mining Bitcoin as part of the process. CapEx for bitcoin mining will subtract from the cost of buying mining equipment, construction of agricultural infrastructure, regulatory/legal costs, etc. The Operating Expenditure (OpEx) should also include payroll and pooling expenses as well as electricity prices, which the model lacks.
The CoP model thus aims to measure the CapEx and OpEx in bitcoin mining. The following is explained:
The model was developed after May 2011 as miners were introduced to Field-programmable Gate Array (FPGA). The model also assumes that the mining pool wants to use the most productive rig (for obvious strategic reasons), which is why Antminer plants are referred to for most of the sections of this evaluation process.
Data on the current Antminer plant costs and ratings have been collected from the Antminer Website, while data from their former counterparts from e-commerce sites such as Amazon or Alibaba are available.
The average lifetime of the rig is around 2–3 years, so purchasing costs for depreciation are balanced with the method of decreasing balance depreciation. In most cases, more modern rigs are added before the previous model has a lifetime and, thus, the effective cost of the previous plant depends on the number of bitcoins that it has produced before it is substituted. This is called the process of depreciation of units of value. For example, the S3 was used for approximately 153 days (July 2014 to December 2014) and mined 0.97 bitcoins on average during that time. The real selling price, therefore, was $299/0.97= $308.24. It should be noted that the model assumes that all mining networks have moved from one rig to the next launched rig for all rig launches.
Coinmetrics gathers network hash rate data and daily coin questions to measure electricity costs for mining bitcoins. This calculates the number of hashes needed for my 1 bitcoin as hash rate / regular suppression. This value is then divided by the mining righashrate to get 1 Bitcoin per hour. This time value is multiplied by the rig’s power value to achieve the number of units needed for 1 bitcoin in kWh. In conclusion, this unit count is compounded by the cost of energy usage in US dollars to obtain the electricity cost of mine 1 bitcoin.
To demonstrate this process, on 13 October 2014 the daily Hashrate network was mined 266,217,37* 60* 60* 24 Tera hashes and 3,875 bitcoins that day. Therefore, for mine 1, a bitcoin was required to (266,217.37* 60* 60* 24)/3875= 5,935,788.59 hashes. The S3, with a hash rate of 0.43 hours (5.935,788.59/0.43)/(60* 60)= 3.84 hours for my Bitcoin. Assuming that the predominant S3’s power level was $339.57W and the average gross energy cost $0.06, the cost should have been $3.84* 339.57* $0.06= $78.12.
Therefore, on October 13, 2014 the net cost of mining 1 bitcoin was CapEx + OpEx= $308.24 + $78.12= $386.36. This is below the current $391.99 price that day.
Keep in mind that miners will likely buy equipment at a discount and pay fewer energy rates, but these savings would be balanced by higher maintenance costs, labor costs, pitch fees, and other overheads. For simplicity’s sake, these expenses were ignored and the rig price and tariffs were taken as they were.
The following diagram displays the price of the CoP model against the real bitcoin price.
Takeaways from the Model
The model shows how the price of a bitcoin rises in terms of its production costs. This is in line with the whitepaper of its author, Satoshi Nakamoto.
The creation of a more productive mining rig results in a reduction in production costs, while costs double in the case of a block rewards halving. The transition from GPUs to FPGAs in the middle of 2011 and ASICs in 2013 have had a big effect on mining costs.
Currently, mining costs 1 bitcoin are around $7,577.51. Provided that the network hasn’t stayed the same and the S19 Pro is released, these costs are estimated to be $13,964.11 at the next block incentive halving at the beginning of May 2020.
Future Projections of CoP and Price Predictions
Mining costs largely depend on the quality and productivity of the mining rig, which accounts for approximately 70% of overall production costs. The operating expense, which consists primarily of the energy costs of the mining equipment, is just 30 percent of the mining costs.
The cost of mining a bitcoin can be calculated by estimating the efficient cost (Hhashrate*Efficiency*Cost) of future ASIC miners and the Network hash rate by regression of previous results. It must be noted that during this time the cost of electricity is expected to remain constant while there is no improvement in the efficiency of a mining rig, unlike at the end of 2013 when FPGA replaced ASICs which caused efficiency and cost dissipation.
The following diagrams show the exponential rise in costs for ASIC miners and the hash rate network, suggesting that bitcoin price is likely to increase in the future.
Extending the CoP Model for other PoW Cryptocurrencies
This was extended to other PoW cryptocurrencies to test the validity of this cost-based model. Unless the model is to be accurate for Bitcoin’s price analysis, then it should also be the same for other PoW alts.
The following is the result of this model’s study of Bitcoin Cash (BCH).
As with Bitcoin, it is a good predictor of the floor price of Bitcoin Cash.
Also, this model is useful to test an alternative cryptocurrency (altcoin) in Bitcoin or satoshi units. The CoP ratio of BCH to BTC typically includes the price in US dollars.
The CoP model is useful in the evaluation of PoW alts. It is also useful in valuing Bitcoin for these alts. Although the prices of alt are far higher than their COP, they are predicted to fall in a local bubble, and therefore not too far away. We saw that at the end of 2017 with BCH.
Comparing the CoP Model with Other Asset Indices
The relationship between Bitcoin price and the stock market, asset, currency, and energy indices is confused. Some analysts argue that Bitcoin is more analogous to precious metals like gold and that Bitcoin’s price will increase in the event of a crash of financial markets or a major fiat currency crash. Their critics question the validity of this narrative danger and assume that the price of Bitcoin will fall if there were a global recession, whereas the third explanation is that Bitcoin is an entirely unrelated commodity to large capital investment instruments and therefore its growth is not influenced by wider market developments.
The CoP valuation model takes us to the potential reach of the Bitcoin cost analysis with global market indices.
What Price did Bitcoin Start?
Since it was first founded in 2009, Bitcoin has a very volatile trading history. In its very short life, the digital cryptocurrency has seen a lot of activity. Initially, Bitcoins sold for almost nothing. The first major rise came in July 2010 when Bitcoins went from around $0.0008 to $0.08 for one single coin. Since then, the currency has seen several big rallies and crashes.
In 2013, Bitcoin started to take off. The digital currency began to transact around $13.50 per bitcoin in the year. The price rallied to over $220 briefly in early April 2013 before slipping down to around $70 by the middle of April. It was the first major recovery and the subsequent currency crash.
In October and November 2013, Bitcoin started to rally. In early October, the currency traded about $100. By the end of October, it traded around $195. The price went from approximately $200 in November to more than $1,120 by the end of the month. The rally was triggered by the launch of new bitcoin exchanges and mining companies in China. This was also the moment when Mt. Gox was traded. Mt. Gox engaged in about 70% of all Bitcoin transactions.