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In the first episode of "the bit," FundStrat Global Advisor co-founder Tom Lee explains different methodologies for valuing bitcoin. Lee shares his short-term and long-term bitcoin price targets based on these valuation methods. Following is a transcript of the video.
Tom Lee: I'm here with Sara to talk about why we believe bitcoin could reach $25,000 in 5 years.
Sara Silverstein: So you actually have a few research notes about this.
Lee: Yes.
Silverstein: And you’re — can you talk about your short-term model first. Where do you see bitcoin going and what valuation method are you using?
Lee: Yeah, in the short-term we think bitcoin has really followed very closely the idea of acting like a social network. Meaning the more engagement there is, the greater the value rises. And in the short-term, we think bitcoin will reach at least $6,000 by mid-2018.
Silverstein: And you’re using Metcalfe’s Law, can you explain that?
Lee: Yeah, so Metcalfe’s a professor. He actually came up with a theorem based on George Gilder, which is the value of a network is the square of the number of users. And so if you build a very simple model valuing bitcoin as the square function number of users times the average transaction value. 94% of the bitcoin moved over the past four years is explained by that equation.
Silverstein: Wow. Just to use an example, so this explains the network effect. Like one fax machine is worthless because there's nobody you can fax. But once all of your friends have fax machines, it becomes very valuable. So has this been effective in valuing things, in the past, that have a strong network but weren't producing any money?
Lee: Yeah, so three use cases — or businesses — where Metcalfe’s Law really explain the growth of the market value, is Facebook, Alibaba, and Google. And these are all examples where the number of users — like if you double the number of users, you're more than doubling the utility value. It's a little bit like the commercial in the 70s, you know, Prell. When you tell your friends, and they tell their friends, and so on.
Silverstein: And so your long-term valuation model — you’re looking at it — bitcoin, as a substitute for gold, as an alternative currency?
Lee: Yes, that’s right, and it's really — what we were trying to do is recognize that the creation of value in the future is in the digital world. I mean, all future great business are going to be digital. And with that concept, bitcoin represents a store of value because it's an encrypted — personal encrypted database, that for seven years hasn't been hacked. I mean, that is a way to store value. And if personal information is our gold, bitcoin is our digital gold. So we think that the gold market, which is 9 trillion, and for a generation of investors gold was their store of value. I think this next generation of young people view bitcoin as their store of value. And if it captures 5% of the gold market, it's worth at least $25,000 per unit.
Silverstein: And that’s the big number, that your — the $25,000 per unit hinges on the 5% of the money going into gold, going into bitcoin. So how do you come up with the 5%?
Lee: We explain this in our research. It's a very — it's actually the most conservative collection of elements to get to the 5%. Because number one, we assume that gold only appreciates essentially a nominal GDP. So there's no inflation. And we assume that money supply grows at slower rates than it has historically. And then the 5% number, really reflects the assumption that investors will allocate in their blended portfolio only 5% to alternative currencies. Today, that allocation is much greater, it's closer to 10% or 15% in some portfolios. So, but at a 5% allocation that would value bitcoin at $25,000. You could easily get to $100,000, $200,000 numbers.
Tom Lee: I'm here with Sara to talk about why we believe bitcoin could reach $25,000 in 5 years.
Sara Silverstein: So you actually have a few research notes about this.
Lee: Yes.
Silverstein: And you’re — can you talk about your short-term model first. Where do you see bitcoin going and what valuation method are you using?
Lee: Yeah, in the short-term we think bitcoin has really followed very closely the idea of acting like a social network. Meaning the more engagement there is, the greater the value rises. And in the short-term, we think bitcoin will reach at least $6,000 by mid-2018.
Silverstein: And you’re using Metcalfe’s Law, can you explain that?
Lee: Yeah, so Metcalfe’s a professor. He actually came up with a theorem based on George Gilder, which is the value of a network is the square of the number of users. And so if you build a very simple model valuing bitcoin as the square function number of users times the average transaction value. 94% of the bitcoin moved over the past four years is explained by that equation.
Silverstein: Wow. Just to use an example, so this explains the network effect. Like one fax machine is worthless because there's nobody you can fax. But once all of your friends have fax machines, it becomes very valuable. So has this been effective in valuing things, in the past, that have a strong network but weren't producing any money?
Lee: Yeah, so three use cases — or businesses — where Metcalfe’s Law really explain the growth of the market value, is Facebook, Alibaba, and Google. And these are all examples where the number of users — like if you double the number of users, you're more than doubling the utility value. It's a little bit like the commercial in the 70s, you know, Prell. When you tell your friends, and they tell their friends, and so on.
Silverstein: And so your long-term valuation model — you’re looking at it — bitcoin, as a substitute for gold, as an alternative currency?
Lee: Yes, that’s right, and it's really — what we were trying to do is recognize that the creation of value in the future is in the digital world. I mean, all future great business are going to be digital. And with that concept, bitcoin represents a store of value because it's an encrypted — personal encrypted database, that for seven years hasn't been hacked. I mean, that is a way to store value. And if personal information is our gold, bitcoin is our digital gold. So we think that the gold market, which is 9 trillion, and for a generation of investors gold was their store of value. I think this next generation of young people view bitcoin as their store of value. And if it captures 5% of the gold market, it's worth at least $25,000 per unit.
Silverstein: And that’s the big number, that your — the $25,000 per unit hinges on the 5% of the money going into gold, going into bitcoin. So how do you come up with the 5%?
Lee: We explain this in our research. It's a very — it's actually the most conservative collection of elements to get to the 5%. Because number one, we assume that gold only appreciates essentially a nominal GDP. So there's no inflation. And we assume that money supply grows at slower rates than it has historically. And then the 5% number, really reflects the assumption that investors will allocate in their blended portfolio only 5% to alternative currencies. Today, that allocation is much greater, it's closer to 10% or 15% in some portfolios. So, but at a 5% allocation that would value bitcoin at $25,000. You could easily get to $100,000, $200,000 numbers.
Link to the video and the full script: http://uk.businessinsider.com/bitcoin-price-how-to-value-fundstrat-tom-lee-2017-10?r=US&IR=T