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Bitcoin's own valuation measure is meaningless

07 December 2017Andrew Evans, Schroder Global Value Team
Andrew Evans, fund manager at Schroder Global Value Team.

Andrew Evans, fund manager at Schroder Global Value Team.

Aficionados of bitcoin and other so-called ‘crypto assets’ have started to refer to their own kind of valuation measure – the NVT ratio. The only snag being it tells people nothing about valuation.

As the perceived worth of a single bitcoin crisscrossed its way around the $10,000 (£7,455) mark for much of last week, a quick look at previous months where one bitcoin respectively cost around $2,779 and very nearly $6,000 – revealed that each time, the primary concern was that there seemed to be no way of assessing its true value.

This is according to Andrew Evans, fund manager at Schroder Global Value Team, who says that one of the most basic ways of assessing how a company is being valued by investors is to look at its price/earning (P/E) ratio – that is, its share price divided by its earnings-per-share – and comparing that, for example, with history, with its peers or with the wider market.

Evans says that lately, aficionados of bitcoin and other so-called ‘crypto assets’ have started to refer to their own kind of P/E ratio. “At first glance this might sound odd – after all, bitcoin and the others do not actually produce any earnings – but, on closer investigation … well, it is odder still,” he says.

“The measure’s actual name is the Network Value to Transactions (NVT) ratio, which – to take bitcoin as an example – is essentially the market value of all the bitcoins in the world divided by the US dollar value of transaction activity.”

He says that the first curious thing about the NVT is it includes a reference to the value of the crypto-asset on both sides of the equation, which is redundant.

Another curiosity, Evans points out, is that the ratio effectively boils down to considering the value of an asset relative to how much speculation there is in it – meaning, if you want the NVT valuation of a bitcoin to fall, you just need to trade it more and more.

The metric fuels more speculation and more interest

Evans believes that this may be why bitcoin investors are so keen on the metric – the more they speculate, the ‘cheaper’ their favourite asset becomes and the more they can encourage fresh interest in the market.

“As an example, according to Woobull.com, the bitcoin’s NVT stood at around 60x in June, close to 100x in October and is currently back down to around 60x,” says Evans.

While its advocates may argue the NVT ratio is similar to the P/E ratio, Evans says it is actually akin to looking at the market capitalisation of a company – put simply, its size – divided by the value of the shares being traded daily.

Doing the maths on three arbitrary well-known companies tells us GlaxoSmithKline, Centrica and Proctor & Gamble are respectively on 550x, 193x and 321x – in other words, just random numbers.

“So we would argue that, while the NVT may be gaining greater currency among crypto-asset investors, it does not tell anyone a great deal about anything – or at least not about the asset under consideration.

“It might, however, tell us something about the human race’s inherent need for reassurance they are not doing something silly,” he concludes.

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