Credit Suisse analyst Damien Boey has developed a valuation method for Bitcoin combining two seemingly unique factors: the size of the bitcoin network, and the yield spread on BBB rated bonds.
Bitcoin slumped below $US10,000 overnight in the wake of the latest market meltdown, but a short time ago prices had rallied back above $US11,000.
The Credit Suisse model settles on a fair value that is “almost half” that — at $US6,000.
To start with, Boey tested the thesis put forward by Fundstrat analyst Thomas Lee in November — that Bitcoin increases in value as more people use the network, similar to a social media giant such as Facebook.
Lee said his model — which is based on the number of Bitcoin users and average transaction value — accounted for around 94% of Bitcoin’s price movements over the past four years.
But Boey raised doubts about the statistical robustness of Lee’s equation. He said the evidence suggests that sometimes Bitcoin’s price leads the number of users, rather than the other way around.
So Boey added an extra feature: He found that Bitcoin prices have a strong negative correlation to BBB credit spreads — the difference between the yield on BBB rated debt US government bonds.
“A 1% widening (narrowing) of BBB credit spreads causes a 100 logarithmic point decrease (increase) in Bitcoin’s value,” Boey said.
“In the extreme, this could imply that leverage has been used to fund Bitcoin investments through time.”
“Alternatively, it could simply mean that Bitcoin’s valuation is highly sensitive to whatever has driven credit spreads over the past few years (e.g., quantitative easing from central banks).”
In view of that, Boey offered a word of warning to Bitcoin investors, noting that there’s significantly more upside risks to credit spreads as global central banks begin to withdraw monetary stimulus.
“Perhaps unwittingly, Bitcoin investors have taken on extremely leveraged positions on credit spread compression,” Boey said.
“We believe they ought to be aware of their underlying exposures.”
Boey said there was a hint of irony in the fact Bitcoin’s mysterious creator — Satoshi Nakamoto — created Bitcoin as an antidote to central-bank controlled monetary systems prone to manipulation.
However, based on Bitcion’s correlation to credit spreads, it appears the quantitative easing programs of global central banks may in fact have served to prop up Bitcoin’s value.
Despite that, Boey said central bankers “seem a little threatened” by Bitcoin, highlighting RBA Governor Lowe’s recent comments calling it a speculative bubble.
If yield spreads widen and regulatory authorities continue to crack down on cryptocurrency usage due to the threats posed by alternative payment systems, then Bitcoin’s price may fall significantly further.
Until then, Boey said Bitcoin represents a trading opportunity if investors can find a way to effectively model the dynamics of the market.
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