Throughout 2024, Bitcoin has experienced a dynamic journey marked by corrections, surges, all-time highs, Federal Reserve interest rate cuts, and the U.S. presidential election. For investors, understanding its value remains critical. This article analyzes three key valuation models, comparing their strengths and limitations to provide comprehensive investment insights from multiple perspectives.

BTC/USDT Trend Over the Past Year（Source: tradingview)

Stock-to-Flow (S2F) Model

The S2F model, proposed by renowned crypto analyst PlanB on Twitter [1], uses Bitcoin’s “scarcity” to predict its price. The core idea is that over time, Bitcoin’s supply will diminish while demand continues to grow, resulting in a rise in Bitcoin’s price.

S2F Model Concepts and Implications

1. S2F Indicator:
   • Stock: The current total reserves or inventory of Bitcoin.
   • Flow: The annual new supply of Bitcoin (i.e., mining output).
   • Calculation: Stock / Flow. This formula quantifies scarcity; a higher ratio implies greater scarcity and higher value as a “store of value.”
2. Bitcoin Compared to “Store of Value” Assets:
   • The S2F model views Bitcoin as analogous to scarce commodities like gold and silver, which maintain value due to the difficulty of rapidly increasing their supply.
   • Bitcoin, as the first cryptocurrency, has a capped total supply of 21 million coins and a halving mechanism (which periodically reduces mining rewards). Currently, fewer than 1.5 million Bitcoins remain unmined, and significant electricity and computational resources are required for mining, ensuring a controlled supply rate.
3. Price Predictions Based on the S2F Model:
   • The S2F model predicts that its theoretical price will significantly rise as Bitcoin’s scarcity increases (e.g., through halving events approximately every 4 years that reduce supply).

Limitations of the S2F Model

• Some critics argue that the S2F model overemphasizes the impact of halving events without adequately accounting for the dynamic role of market demand.
• Certain crypto enthusiasts question its long-term accuracy, noting that real-world market prices are influenced by multiple factors such as investor sentiment and policy changes, which introduce limitations to this model.

Bitcoin Price Predictions Based on the S2F Model（Source: bitcoinmagazinepro)

This chart overlays Bitcoin’s price on the stock-to-flow ratio curve. According to the S2F model, Bitcoin’s future mining activity can be used to predict price trends.

The color of the price line indicates the number of days until the next halving event. Bitcoin halving occurs every 210,000 blocks (approximately every 4 years), reducing miner rewards by 50% until the total supply reaches 21 million coins. Based on the S2F model, halving events increase the stock-to-flow ratio, and the resulting rise in scarcity theoretically drives prices upward.

The deviation curve below represents the difference between the price and the stock-to-flow ratio. The deviation curve shifts from green to red when the price exceeds the ratio.

[1] Plan B：

Plan B is an anonymous Bitcoin analyst on Twitter, whose name originates from Bitcoin often referred to as “Plan B.” This is because many Bitcoin supporters believe that Bitcoin could potentially become a global reserve currency in the future, leading to a shift from the current government and central bank-controlled monetary system (Plan A) to a Bitcoin-based system (Plan B).

Metcalfe’s Law

What is Metcalfe’s Law?

Metcalfe’s Law describes the relationship between a network’s value and its number of users (or network growth). Proposed by George Gilder, it was named after Robert Metcalfe, the co-inventor of Ethernet, in recognition of his contributions to networking.

The law states that the more users a network has, the greater the value of the entire network and each connected device. Specifically, the value of a network is proportional to the square of the number of its nodes, meaning the network’s value increases quadratically with the number of users.

For example, a single fax machine has no utility, but as the number of fax machines increases, the value of each one grows because users can interact with more people. Similarly, when a popular writer posts a social media update, its views (likes, comments) grow exponentially in relation to the network’s and social platform’s user base. This principle applies to social networks and cryptocurrency networks alike.

Metcalfe’s Law in Cryptocurrency

Metcalfe’s Law plays a critical role in the operation of cryptocurrency networks, which can be explained from the following perspectives:

1. Network Effects

• As network adoption increases, the utility and appeal of cryptocurrencies grow, thereby enhancing market attention and value.
• Metcalfe’s Law states that the value of a cryptocurrency network grows exponentially with the number of users. This growth attracts more participants, creating a positive feedback loop.
• The more participants there are, the higher the network’s utility, motivating project teams to focus on building a large and active user base.

1. Decentralization

• Larger and more decentralized networks (e.g., Bitcoin) can more effectively resist attacks, such as 51% attacks.
• As the number of nodes increases, the risk of centralized control or single points of failure decreases, ensuring the network’s structural stability and resilience.

1. Market Valuation

• Metcalfe’s Law serves as a framework for investors and analysts to evaluate cryptocurrency projects.
• Networks with more users typically have higher intrinsic value, influencing market sentiment and guiding investment decisions.

1. Tokens and Utility）

• Metcalfe’s Law explains that the value of tokens depends on their ability to provide goods, services, or other advantages to users.
• User growth can also be seen as an increase in token value; as more users perceive the token as valuable, demand and market value rise, creating a growth cycle.
• However, as the network expands, increased transaction volume and user activity may pressure blockchain capacity. Project teams must consider scaling solutions to address growth, ensuring network performance and user experience remain unaffected.

Limitations of Metcalfe’s Law

Assumptions of the Law

Metcalfe’s Law assumes that all users in a network have the same value, but in reality, the quality of connections between users can vary significantly. For example:

• Active users vs. passive users
• Large transactions vs. small transactions

External Influencing Factors

The cryptocurrency market is affected by numerous external factors that may not be directly related to network effects but significantly impact price and value, including:

• Market Sentiment: Investor psychology and confidence directly influence price fluctuations, especially since cryptocurrencies are often considered highly volatile assets. Additionally, cryptocurrency prices are frequently driven by market hype and speculative behavior (e.g., meme coins).
• Regulatory Policies: Government bans or supportive policies on cryptocurrencies can cause rapid and dramatic market impacts.
• Macro-Economic Environment: Inflation, economic cycles, and international trade dynamics can alter investor preferences for crypto assets.

In summary, while Metcalfe’s Law primarily measures value based on user numbers, it overlooks the diversity of user behavior and application scenarios. Additionally, the cryptocurrency market is known for its volatility, and Metcalfe’s Law cannot fully explain short-term price fluctuations. Investors are advised to combine Metcalfe’s Law with other methodologies, such as technical and fundamental analyses, for a more comprehensive evaluation.

Mining Cost-Based Valuation Model

The process of generating Bitcoin, known as “mining,” involves miners validating transactions by solving complex mathematical problems to earn block rewards. Mining requires significant electricity consumption, specialized hardware, and ongoing operational costs, making mining costs a key indicator of Bitcoin’s value.

The mining cost-based valuation model posits that Bitcoin’s value should be greater than or equal to its production cost. For miners, Bitcoin is a “business,” and when Bitcoin’s price falls below the break-even cost of mining, less efficient miners may become unprofitable and eventually exit the market.

Total Mining Cost Per Bitcoin（Source: macromicro)

Based on data from Cambridge University, this chart estimates the average cost for miners worldwide to produce one Bitcoin by analyzing global Bitcoin “electricity consumption” and “daily new issuance.”

When Bitcoin’s price exceeds production costs, mining becomes profitable, potentially leading to the expansion of mining operations or the entry of new miners, which increases mining difficulty and raises production costs. Conversely, the opposite occurs when prices drop.

Over the long term, Bitcoin’s price and production cost tend to align, as any discrepancy causes miners to either enter or exit the market, leading to convergence between price and cost trends.

Mining Costs

1. Electricity Costs

• Electricity is the primary expense in mining, with energy consumption directly impacting profitability.
• Electricity Cost = Power Consumption (watts) × Time (hours) × Electricity Price (per kWh).
  • Energy prices vary by region; for example, Iceland and Texas are mining hubs due to low electricity costs.
  • Energy Efficiency: Mining machine efficiency (energy consumption per hash) also influences energy use and cost-effectiveness.

1. Hardware Costs

• The cost of purchasing mining equipment and installing and maintaining cooling systems.
• Equipment Efficiency: Mining machines’ hash rate (hashes per second) and energy consumption ratio directly affect mining profitability.
• Equipment Lifespan: The longevity of mining equipment and the pace of technological updates have long-term impacts on mining costs.

1. Mining Difficulty

• Bitcoin’s network dynamically adjusts mining difficulty based on total hash power. As more miners join, mining difficulty increases, raising the cost of mining a single Bitcoin.
• When Bitcoin’s price rises, more miners participate, increasing the hash rate. This dynamic adjustment acts as a stabilizer amid price fluctuations.
• As difficulty rises, less efficient mining machines may be phased out, leaving only high-efficiency equipment profitable.

1. Block Rewards and Transaction Fees

• Miners’ income comes from two sources: fixed block rewards and transaction fees.
• Halving Mechanism:
  • Bitcoin undergoes halving every 210,000 blocks (approximately every 4 years), reducing block rewards and increasing mining costs.
  • The halving mechanism also enhances Bitcoin’s scarcity, potentially driving competition among miners.

1. Labor and Other Operating Costs

• Labor expenses for running mining operations and maintaining equipment, including facility rent, repair costs, and loan interest.
• When capital investment in mining is equivalent to forgoing other investment opportunities, direct coin holding may be more attractive during periods of low Bitcoin prices.

Limitations of the Mining Cost Model

The Model Ignores Other Critical Factors

• Market Supply and Demand: This model focuses solely on production costs and overlooks the volatility of market demand.
• Investor Sentiment: Bitcoin prices are significantly influenced by investor confidence and market expectations, which cannot be captured by this model.
• Technological Advancements: Innovations such as new consensus mechanisms could alter mining methods and cost structures.
• Macroeconomic Environment: Global economic changes (e.g., inflation, interest rate fluctuations) that affect Bitcoin’s value are not considered in this model.
• Regulatory Policies: Changes in government regulations and tax policies may have a greater impact on Bitcoin prices than mining costs.

Difficulty in Accurately Measuring Mining Costs

• Electricity Cost Fluctuations: Electricity prices vary frequently due to region, season, and energy policies.
• Hardware Cost Variability: Constant updates in mining technology lead to significant price fluctuations, making hardware costs difficult to quantify precisely.
• Maintenance Cost Differences: Costs vary depending on the location, size, and management quality of mining operations.

Overlooks Bitcoin’s Non-Monetary Attributes

• Digital Gold Attribute: As the “gold” of cryptocurrencies, Bitcoin’s value is influenced by its scarcity and hedge functions, not solely its mining costs.
• Technological Value: As a flagship blockchain technology, Bitcoin’s applications and innovations impact its market value, aspects not accounted for in this model.

Conclusion

This article provides investors with diverse perspectives, ranging from the scarcity analysis of the Stock-to-Flow Model and the network effects of Metcalfe’s Law, to the baseline price reference offered by the Mining Cost Model. Each model offers unique insights into Bitcoin’s market value but also has its limitations, making it challenging to comprehensively reflect the complexities of the Bitcoin market when used alone.

Relying solely on a single model may be overly simplistic for investors. Combining multiple valuation models with technical indicators (such as moving averages, trading volume, and macroeconomic data) is recommended. A multidimensional analysis can help reduce risks and improve the accuracy of investment decisions.

Bitcoin is often regarded as “digital gold” due to its decentralized, scarce nature and its functions as a hedge and store of value. However, its long-term value will inevitably depend on whether it becomes widely accepted as a global digital currency. Bitcoin still faces significant challenges, such as whether its high volatility makes it suitable as a medium of exchange and the impact of regulatory policies. Readers are encouraged to share their perspectives on these topics.

Comparison of Valuation Models