Bitcoin & Ethereum: Prices are Down More than the Fundamentals

To follow is a very rough analysis, zoomed out to give us perspective on Bitcoin’s 10 years of life, and Ethereum’s 3+ years. If you disagree with my approximations, I encourage you to perform your own exploration of fundamentals vs. price and share your findings with the world.

Before going on Bloomberg or CNBC, I always run through the fundamentals of the network(s) I’ll be talking about. When doing this last, I realized that fundamentals of quality cryptonetworks are down less than prices, and significantly so.

For me, fundamentals of a cryptonetwork come down to the health of the supply-siders and demand-siders. Supply-siders are the folks who provision the network’s service (currently, the most common form of supply-sider is a miner), and demand-siders are the ones who consume the service. For this post, I’m going to focus on Bitcoin and Ethereum, comparing prices to fundamentals. You can do the same for other networks, so long as they actually exist (many ICOs still do not have operating networks).

As a more accurate representation of price, I’m going to use network value (“Network Value” = “Price per Unit” x “Units of the Cryptoasset Outstanding”), as this shows the aggregate value the market is placing on a cryptonetwork at present.

In terms of demand-side and supply-side fundamentals, here are the simple ones I’ll showcase:

Bitcoin Demand-Side: Number of Daily Transactions (#), Estimated Daily Transaction Value (USD), Daily Unique Addresses Used (#).

Ethereum Demand-Side: Number of Daily Transactions (#), Total Daily Gas Used (if you don’t know what gas is, read this).

Bitcoin & Ethereum Supply-Side: Hash Rate.

In the graphs that follow, I’m going to contrast how fundamentals and network values have performed since 12/17/17 and 1/13/18, for Bitcoin and Ethereum respectively. These two dates were the peak network values for both assets, per Blockchain.info and Etherscan, which is where I sourced all data.

If a fundamental is down since those dates, then we’ll look at how down and compare it to how much network value is down. If the fundamental is not down, then we already know it’s outperforming the market :-)

Number of Daily Transactions (Demand-Side)

Blue Line = Network Value, Orange Line = # of Daily Transactions
Blue Line = Network Value, Green Line = # of Daily Transactions

Bitcoin is currently processing ~250,000 transactions per day, and Ethereum ~500,000. Looking at the tail end of both charts there is a clear divergence, where network value has continued to slide over the last few months, but the number of daily transactions is stable to ticking up.

From peak, Bitcoin’s and Ethereum’s network values are down 81% and 93%, respectively, whereas daily number of transactions are only down 41% and 52%, respectively.

To derive a proxy of value from network activity, I’m going to use a very simple interpretation of Metcalfe’s Law [1], squaring the network activity that remains.

In the case of Bitcoin, 59% of the network activity remains since the peak, while for Ethereum only 48% remains. The proxy of value for Bitcoin is then 0.59², or 0.35, which implies a 65% drawdown in network value is justified, much less than the 81% decline in Bitcoin’s network value we currently witness in the market.

In the case of Ethereum, 0.48² = 0.23, implying a 77% drawdown in network value is justified, again much less than the 93% drawdown we currently see.

Native Functionality (Demand-Side)

Blue Line = Network Value, Orange Line = Estimated Daily Transaction Value ($)
Blue Line = Network Value, Green Line = Total Daily Gas Used

The two charts above are my favorite, as they show what I consider the most native demand-metric of each network. For Bitcoin, that’s securely moving value, and for Ethereum, it’s processing smart contract computations.

Bitcoin continues to regularly process over a billion dollars in transactional value a day (NOT trading volume), and it’s clear how tightly the orange line of this fundamental is coupled with price. Meanwhile, developers and consumers using Ethereum’s smart contracts continue mostly unabated, as witnessed by another divergence between this fundamental (green-line) and network value.

Since their respective peak prices, Bitcoin’s and Ethereum’s network values are down 81% and 93%, respectively, whereas demand for their respective native functionalities is down 74% and 7%, respectively.

In the case of Bitcoin, 26% of the network activity remains since the peak, while for Ethereum 93% remains. The proxy of value for Bitcoin is 0.26² = .07, which implies a 93% drawdown in network value is justified. In the case of Ethereum, 0.93² = 0.87, implying a 13% drawdown in network value is justified, jaw-droppingly less than the 93% drawdown we currently see.

Bitcoin’s daily transactional value is the only fundamental metric I encountered in the brief analysis that constituted this post, which actually justified the market reaction we’ve seen. It led me to look at daily active addresses (which I would have done for Ethereum as well, but that data is harder to find — I’d ask DAR, but it’s the weekend!).

Below is what I found for Bitcoin:

Blue Line = Network Value, Orange Line = Daily Unique Addresses Used

Bitcoin is currently in the 300,000–500,000 daily unique active addresses range, with current values down 51% from the December 2017 peak. Once again, deriving the proxy for value, we have 0.49 of a network that remains. That network’s implied value of 0.49² = 0.24, implying a justified drawdown of 76%, close to the 81% that we currently see in the market, but still less :-)

Hash Rates (Supply-Side)

Both Bitcoin and Ethereum’s hash rates are higher now than they were at both of their peaks. Yes, hash rate is (usually) a lagging indicator that follows price, and both Bitcoin’s and Ethereum’s hash rates are on negative slopes which require us to keep a close eye on them. But right now, this fundamental is outperforming price.

At this point, I’m running out of steam. To round out the supply-side investigation, it would be good to look at the number of nodes supporting the network, and miner revenues for both networks (transaction fees + block subsidy).

While I haven’t posted the data here, developers are a core component of the supply-side (though often forgotten), and from Placeholder’s internal analysis developer metrics are outperforming the market as well (some of this makes its way into demand-side metrics, most obviously with gas use).

Conclusion

Few people believe cryptonetworks have fundamentals. Even fewer have thought through how to quantify those fundamentals. Then, even fewer consistently have access to blockchain level data to perform the actual calculations [4]. Placing these points in the context of the idea that theory follows price, price follows theory,it’s clear to me that Mr. (Crypto) Market has only a vague idea of what he’s doing right now.

Most asset classes have widely agreed-upon models to value them; analysts just bicker over the inputs to those models. In crypto, we currently bicker over both the models and the inputs, hence the insane whiplash of the markets. Data availability for the inputs is also not great, though services like Blockchain.info, Etherscan, Coinmetrics, and CryptoCompare are helping — that said, we’re still a ways off from the Bloomberg of crypto.

Fortunately, as the fundamentals of these networks grow, and their services become more mission critical to the world, swarms of analysts will converge upon models and inputs that will give Mr. Market better control over his tantrums. For now though, all the babies are out with the bathwater.


[1] See here for Clearblocks’ exploration of different ways to apply Metcalfe’s Law to valuing cryptonetworks.