Valuing Bitcoin Using Metcalfe's Law

Just over a month a go we discussed Frank Homes, CEO of US Global Investors, who had returned from the LBMA/LPPM Precious Metals conference in Barcelona after giving the key note address on Day 2, “Quant Investing: From Gold to Cryptocurrencies.” Homes’s presentation was voted the best – no doubt helped by the topical subject matter – and he was the recipient of an ounce of gold.

Seeing a role for both gold and cryptocurrencies in portfolios, he aimed a couple of blows at recent Bitcoin detractors, including you know who from JPM. As we noted at the time, however, it was Homes’s observations on Metcalfe’s law, i.e. the economics of network effects, which we particularly enjoyed.

This was his take on the surge in the price of Bitcoin...

“Metcalfe’s law states that the bigger the network of users, the greater that network’s value becomes. Robert Metcalfe, distinguished electrical engineer, was speaking specifically about Ethernet, but it also applies to cryptos. Bitcoin might look like a bubble on a simple price chart, but when we place it on a logarithmic scale, we see that a peak has not been reached yet.

In an article, Bitcoin and Metcalfe’s Law, Stephen Powaga of ETF Momentum Investing acknowledges the challenges of valuing Bitcoin and has also turned to Metcalfe’s Law.

With the recent run up in the Bitcoin price, cryptocurrencies have been garnering much greater attention from the public at large.


A rapid price rise like this presents a difficult situation for potential new investors into the space. On one hand, this price action appears to be a classic asset price bubble, but on the other hand investors can wait years for a meaningful drawdown, all while missing out on the intermediate price appreciation.


How then can one determine a benchmark value for Bitcoin? On the most basic level Bitcoin is a distributed payment network, and like all networks should be subject to Metcalfe’s Law.

Powaga continues by leading us through some of the basics of Metcalfe’s Law.

Metcalfe’s Law states that a network’s value is proportional to the square of the number of users. For instance, it’s obvious that if you’re the only person with a telephone then that network would have no value, when one additional person gets a phone the network has achieved a tiny bit of value, and if virtually everyone has a phone, then the network becomes extremely valuable. This relationship has been observed in many industries where increased adoption boosts the network’s overall usefulness, such as European internet usage, Facebook’s value, and more recently Tencent’s value.

A recent white paper by Ken Alabi finds that blockchain networks also appear to follow Metcalfe’s Law, in his paper he states, “it was demonstrated that the growth in the value of the network was related to the number of unique addresses”. This intuitively comports with our understanding of how Bitcoin’s value should operate, if you’re the only holder of Bitcoin it’s not very valuable because there is no one to exchange it with for goods and services, however if many people hold Bitcoin then it should be much more valuable since there are now many people to potentially exchange it with.

As Powega explains, he can show us how Bitcoin’s valuation has traded over time based on Metcalfe’s Law principles.

Given this information, what can Bitcoin’s network size tell us about its value and the size of the current bubble? Utilizing Alabi’s method we can arrive at Bitcoin’s Metcalfe Value through time and compare historic Price-to-Metcalfe Value ratios for Bitcoin.


This is somewhat analogous to price-to-book ratio in public equity analysis in that a higher ratio implies investors expect a given network to create more value from a given number of users.

As you can see above, the Price-to-Metcalfe Value ratio seen in the previous Bitcoin bubble of 2013/14 was far larger than where it currently stands.


Obviously, the future is unknowable, but given the enormous growth that Bitcoin has seen in its user base, the recent price appreciation may not be as “bubbly” as it appears.

What Powaga can’t tell us, however, is what is the intrinsic value of Bitcoin now, or what it might be in the future. Who knows? As we discussed, high-profile cryptocurrency investor, Mike Novogratz, sees Bitcoin at $40,000 at the end of 2018. In contrast, Peter Tchir, is taking some Bitcoin chips “off the table”.


Laowei Gweilo Schmuck Raker Tue, 11/28/2017 - 23:36 Permalink

this is the dumbest thing I've read on ZH all week, a week of which included Clinton news, bitcoin-to-gold analogies, and that article acting surprised at international trade deals contianing political influence o.0there's a reason why the theory of Metcalfe’s Law was adjusting from nodes to users.... because it relies on each user having a practical very best, Metcalfe’s Law could be applied to Bitcoin only if you counted the number of people genuinely using it to purchase products or transfer money between decentralized networks or systems. including every single 'account' (read: those aren't users), let alone speculators (read: also not users) pretty much  contradicts the entire point of the Metcalfe’s Law argument that systems establish value through utility demand.Metcalfe’s Law is actualy a practical way (and pretty smart idea... I want to reinforce that this is a GREAT article to post because I think it's a good idea and could lead to a great way to value blockchain, so I'm not saying it was dumb of ZH to post -- just that the logic used by the cited author is dumb) to value a blockchain, but it's incredibly important that you're selective of who you're defining and counting as users because current blockchain users in no way are even remotely analagous to theoreticzed Metcalfe’s Law system users.

In reply to by Schmuck Raker

QueeroHedge Laowei Gweilo Tue, 11/28/2017 - 23:36 Permalink

You've come along way zh, I remember when it was 100% neg bitcoin coverage focsuing on the impact it might have against gold. Since then you have become the best place for bitcoin news, and you've persuaded many a reader dip their toes into the crypto market. Kudos  Crypto haters of zh: we lead you to the water, we grabbed your head and dunked it right in there we can't do much more than that. Unlucky

In reply to by Laowei Gweilo

Laowei Gweilo QueeroHedge Tue, 11/28/2017 - 23:41 Permalink

haha yeah I remember back in 2011-2012, I'd have probably bought more Bitcoin if it wasn't for all the negativity I read on ZH lolfirst it was pro-gold, anti-BTCthen pro-ETH, anti-BTCpro-BTC seemed to start somewhere in the spring.. 2016 was mostly pushing ETH and then sort of after Dec16 Chinese regulation and the news about BTC ETF SEC approval, and after that cleared sort of through Feb-March-April, somewhere in there ZH must have went long BTC haha :P

In reply to by QueeroHedge

Dame Ednas Possum MillionDollarButter Wed, 11/29/2017 - 03:59 Permalink

It is interesting to see comments such as the one further up from 'QueeroHedge'. Beyond the obvious trolling name, this commenter has been a member for 5 weeks and has elected a profile description stating 'i was heavily molested as a child.'  One has to stand back and wonder why someone would go to such effort to troll the range of legitimate 'average Joe' ZH users? Who is supporting these agent provocateurs? What is their agenda?  I mean, if you were waiting on delivery of your Gulfstream... would you be here trolling ZH.  My observation is that they seem very intent in ridiculing Gold Bugs in particular with the purpose of chasing people away from our prescious pet-rocks for the 'new normal' of becoming a muli-Lambo gazillionaire high on crypto fiat dreams.And yeah yeah... I'm a tin-foil hat wearing whack-job. Sure. Whatever. If TPTB will drop billions of paper to smash the paper price... it is nothing to run a troll farm similar to the hasbara shills.  

In reply to by MillionDollarButter

OpenThePodBayDoorHAL Dame Ednas Possum Wed, 11/29/2017 - 04:25 Permalink

This article is stupid.As it states, Metcalfe's Law is based on the number of users.But people buying a Bitcoin from Coinbase are not users of the Bitcoin network. They have 13M customers but only a handful of Bitcoin addresses.In fact, almost no one is using Bitcoin, it's just buy-and-hold.Ask the people at BitSpark, good guys with a decent company who tried to build a remittances company on Bitcoin. They have now abandoned Bitcoin. It's too slow, and too volatile.But everybody talks about "adoption". A network is not being adopted when it just has more passive owners.You're welcome.

In reply to by Dame Ednas Possum

Michigander Dame Ednas Possum Wed, 11/29/2017 - 07:54 Permalink

Why does everything have to have an agenda with you? If we have even an agenda it’s to get you to open your fucking eye’s. Very few pro- crypto folks have suggested selling all bullion. Most say there is room for crypto in one’s portfolio and maintain their stash, but refuse to add to it. On the other hand, know-it-alls such as yourself will only acknowledge the shiny metals. I just don’t get how you can know that you are absolutely, positively, beyond a shadow of a doubt, right. That you know precisely how things will play out over time. I’m just not that smart. You actually, aren’t either. Hedgeless at your own peril I guess.

In reply to by Dame Ednas Possum

De Wilde Weldoener QueeroHedge Wed, 11/29/2017 - 07:34 Permalink

The best place for Bitcoin news? hardly.The amount of Bitcoin misinformation and nonsense posted on ZeroHedge is staggering and hilarious.I just browse this page to keep up with commenter sentiment and have a laugh.If you want Bitcoin news you should read these:… of which can be incredibly biased, but at least most authors there know what they're talking about.

In reply to by QueeroHedge

Laowei Gweilo SafelyGraze Tue, 11/28/2017 - 23:51 Permalink

sure, but only insofar as that as FIAT became common, the value of all FIAT and their properities (portability, divisibility, uniformity, durability, acceptability) increases -- that value went upbut it didn't mean their nominal value in terms of 'wealth' went up, tooso, sure, as crypto 'tide' rises, it raises all shipsbut even if dogecoin benefits in terms of (portability, divisibility, uniformity, durability, acceptability) goes up in value, doesn't mean it wil go up in values in relative terms of USD or BTC or goldeven as all ships rise in terms of 'network' value, many or most could still lose wealth value as clear dominant currencies emerge (of which those may or may not even exist yet).imo =p

In reply to by SafelyGraze

QueeroHedge tmosley Tue, 11/28/2017 - 23:40 Permalink

You don't seem so results oriented when the results go against you. Cognitive dissonance? Oh but bch processes payments faster thn bitcoin, slower than every other coin, but faster than btc. That means something. If you weren't a johnny come lately maybe you'd have received free bch and wouldnt have to throw away your btc for bch pump and dump. oh well

In reply to by tmosley

GOLD AND SILVE… Tue, 11/28/2017 - 23:19 Permalink

Congrats to all the people who are making a killing on this, and for those of you feeling left out don't sweat it. Calling this insane rush 8-10 years ago is akin to winning the lottery, and even if you had put 10k down on bitcoin at $1 a coin, would you *REALLY* have held on this long...all the way to $10k? If you're feeling bad about being left out, just compare it to wishing you knew last night's winning lottery numbers. Living in the past sucks, but congrats to all of those who have done well!

Okienomics GOLD AND SILVE… Wed, 11/29/2017 - 00:26 Permalink

I was considering buying a "bitcoin or two" when it was in the $300's just out of interest in the new medium.  I remember why I did not, and the reason hasn't changed.  I am not confident enough in my tech savvy to be sure I won't be hacked or otherwise have my "wallet" (if that's what it's still called) electronically eviscerated.  No confidence in either my own skills or the goodwill of others who would 'hold' my wealth.  I remain a luddite, I suppose.

In reply to by GOLD AND SILVE…

QueeroHedge GOLD AND SILVE… Wed, 11/29/2017 - 00:30 Permalink

>>and even if you had put 10k down on bitcoin at $1 a coin, would you *REALLY* have held on this long...all the way to $10k? Hold onto most of it yes. I'd imagine you'd profit so much that you can take out 10% after each rally and be happy hodling the majority to hit 10k, at which point you take out 10% and hodl or chicken out knowing that the gov wont let it last forever... decisions..

In reply to by GOLD AND SILVE…

38BWD22 GOLD AND SILVE… Wed, 11/29/2017 - 00:51 Permalink

  Actually that is an excellent observation.Many of us have sold Bitcoin (or in my case, traded for gold) on its years long price rise.  I bought gold when BTC was less than $1000.  Over the weekend, I bought some at $9300.  A month or so ago at $63050 or so (ouch!).So, just having bought, say, a year ago or so at $1000 does not mean someone is still ahead $9000, it depends what they might have done along the way woth their BTC.  Example: I probably have a 2017 gold cost basis (I am *GUESSING*, I have only done the math for 2015 and 2016) of some $4000 BTC (gold perhaps averaging $1350 (actual price from jmbullion and providentmetals), so my profits -- particularly taking into account Capital Gains taxes -- are not as spectacular as one might suppose.I also BOUGHT some BTC along the way up, but not since $6400.It can be a bit confusing.  Keep your records.  I am accounting for my BTC trades for gold by "FIFO", using oldest BTC costs that I spend first.  My amended 2015 and 2016 records are ready for our accountant who will then pass them along to our friends at the IRS.Oh, the IRS is going to get a nice chunk from me when my 2017 returns are filed.

In reply to by GOLD AND SILVE…

ebworthen Tue, 11/28/2017 - 23:24 Permalink

Oh Jeebus.  Bitcoin COMEX options, Ethereum ("Ether" root word), and "to the moon" dreams!Just another part of the everything bubble.  Tangibles kids; your lives first.Not Black Tulips, not South Seas Co., not  Tangibles.

LetThemEatRand Tue, 11/28/2017 - 23:23 Permalink

I love the attempts to compare Bitcoin to something else.  Tulips.  Gold.  Now network value.  It's something completely different and there is no comparison.  Here's my equally cogent analysis: it's either going to go up or down.  

tmosley LetThemEatRand Tue, 11/28/2017 - 23:40 Permalink

You're wrong too.It's going to go both up AND down.Up due to all the dumb money pouring in plus the Tether pumps that materialize whenever the chart shows any weakness, and down due to the fact that Core has utterly destroyed the use case and the most ardent bulls tell people that actually want to use bitcoin to buy things to use some other coin. Or God help us, the Lightning Network.

In reply to by LetThemEatRand