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Bitcoin's own valuation measure is meaningless

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

05/12/2017

Andrew Evans

Andrew Evans

Fund Manager, Equity Value

As the perceived worth of a single bitcoin crisscrossed its way around the $10,000 (£7,455) mark for much of last week, here on The Value Perspective, we revisited articles from 20 June 2017 and 20 October 2017, when one bitcoin respectively bought you $2,779 and very nearly $6,000.

Each time our primary concern was there was just no way of assessing its true value – but could we have been wrong?

Assessing value

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.

Now it turns out 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.

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.

So the first curious things 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 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

This may of course, 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 at the time of our June article, close to 100x at the time of our October one and is back down to around 60x now.

While its advocates may argue the NVT ratio is similar to the P/E ratio, 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 (sorry) 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.

Author

Andrew Evans

Andrew Evans

Fund Manager, Equity Value

I joined Schroders in 2015 as a member of the Value Investment team. Prior to joining Schroders I was responsible for the UK research process at Threadneedle. I began my investment career in 2001 at Dresdner Kleinwort as a Pan-European transport analyst. 

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