Amidst Bitcoin's surge to record highs, a recognized forecast model suggests that the cryptocurrency's fair value is only half of its current price. Could a downturn be on the horizon?
The recent ascent of Bitcoin to all-time highs might not accurately reflect the true value of the cryptocurrency. It could merely be random fluctuations above and below Bitcoin's fair value.
To calculate this fair value, investors can turn to Metcalfe's Law, as proposed by Claude Erb, a former commodity portfolio manager at the TCW Group. This model relates Bitcoin's price to the number of users, a methodology that has proven effective in the past, warranting special attention.
About six months ago, the model signaled that Bitcoin's fair value was $31,400, which was 16 percent higher than its price at the time. However, the subsequent rally to prices above $72,000 appears to be excessive, according to the model. Currently, the fair value of the cryptocurrency is estimated to be around $35,000.
Historically, the model has issued warnings when Bitcoin reached unsustainable levels, and it indicated when prices were too low. For instance, at the end of 2020, when Bitcoin was on the verge of tripling from around $20,000 to over $60,000, the model suggested that such a price surge was unjustified, and indeed, Bitcoin subsequently fell back below $20,000.
Despite these extremes, the model implies that these fluctuations are merely periodic and random oscillations of the cryptocurrency on both sides of its fair value. For those who view an increase from $20,000 to over $60,000 as more than just a ""random fluctuation,"" it's worth noting that Bitcoin's fluctuations relative to its fair value are no more extreme than those of other assets. Over the past decade, Bitcoin's ratio to fair value has ranged from 4.8 to 1 (in December 2017) to 0.3 to 1 (in September 2016). Currently, the ratio stands at 1.9 to 1.
If Bitcoin indeed follows Metcalfe's Law, it suggests that the cryptocurrency will eventually fall back, reaching or dropping below approximately $35,000 in the future.
