The intrinsic value refers to the actual value of an asset based on its fundamental characteristics, rather than its market price. For example, in traditional finance, the intrinsic value of a stock is often determined based on factors such as profits, cash flows, and growth potential.
In the cryptocurrency field, evaluating the intrinsic value is not as straightforward. Since cryptocurrencies are not tied to physical entities or stable income streams like dividends, determining the intrinsic value requires a combination of technological, economic, and utility factors. In simple terms, the intrinsic value answers the question: What makes this cryptocurrency valuable beyond its trading price on the exchange?
The intrinsic value of cryptocurrencies is formed by factors such as:
- Utility: What problem does this cryptocurrency solve?
- Scarcity: Is the supply limited or inflationary?
- Network Value: How large and active is the ecosystem?
- Security: How well can the blockchain withstand attacks?
For example, the intrinsic value of Bitcoin lies in its fixed supply (21 million coins), decentralized network, and security through the Proof-of-Work (PoW) mechanism.
On the other hand, Ethereum primarily derives its value from its role as a platform for Decentralized Applications (DApps) and smart contracts.
Three Common Methods to Calculate the Intrinsic Value of Cryptocurrencies
Let's go beyond the theory and explore three commonly used methods to estimate the intrinsic value of cryptocurrencies.
1. Metcalfe's Law
Concept: Metcalfe's Law states that the value of a network is proportional to the square of the number of active users. In other words, as the number of users increases, the value of the network grows exponentially.
Application: This method is particularly suitable for cryptocurrencies with a strong ecosystem and a high number of active users. The network value is calculated using the formula:
Network Value = (Number of Active Addresses)^2
Example: Ethereum
Ethereum is a vast ecosystem comprising developers, Decentralized Applications (DApps), and Decentralized Finance (DeFi) projects. Its value is reinforced by thousands of active developers building on this blockchain and millions of users interacting with the applications. Specifically, the number of daily active addresses can be seen as a proxy for the "network size".
As of December 13, 2024, according to YCharts, the number of daily active addresses on Ethereum reached 543,929. Applying Metcalfe's Law:
Network Value = (543,929)^2 = 296,086,104,84
Or approximately 296 billion units (a relative measure, not USD).
This shows that the network value grows exponentially as the number of users increases. If the number of daily active addresses on Ethereum increases, the network value will also grow at a faster rate.
Challenges in Applying Metcalfe's Law
- Oversimplification: Metcalfe's Law does not consider the quality of user interactions. A network of 1,000 inactive users may be less valuable than a smaller network with active engagement.
- Data accuracy: Estimating the number of "active" users is challenging, especially with the presence of bots and spam accounts that can skew the data.
- Limited comparability: Some blockchains may have fewer users but offer faster transaction speeds. Metcalfe's Law does not capture these differences.
2. Production Cost
Concept: This method calculates the intrinsic value of a cryptocurrency based on the cost to produce or mine it. For blockchains using the Proof of Work (PoW) mechanism, like Bitcoin, the costs include electricity, hardware, and operational expenses.
Application: The production cost serves as a "floor" for the value of the cryptocurrency, as miners will stop operating if the market price falls below the production cost.
Example: Bitcoin
The intrinsic value of Bitcoin is often tied to its mining costs.
- As of December 13, the average mining cost of Bitcoin is $86,303, while the market price is $101,523. This suggests that the intrinsic value of Bitcoin, based on mining costs, is at least $86,303. When the market price exceeds this level, mining remains profitable, encouraging miners to continue operating and protecting the network. Conversely, if the Bitcoin price falls below the production cost, some miners may be forced to stop operating due to lack of profitability, affecting the network's security. The $15,220 difference between the market price and mining cost reflects a healthy market where mining is still incentivized, and the network is maintained in a stable manner.
- During the market downturn in 2022, the Bitcoin price dropped to as low as $16,000, lower than the production cost for some miners (around $20,998). The negative $4,998 difference caused those miners to lose money on each Bitcoin mined. When this occurs, less efficient miners may be forced to shut down, leading to a decrease in hashrate and impacting the network's security. The system will automatically adjust the difficulty to balance the costs with the market price.
Challenges:
- Regional Variations: Mining costs vary globally. For example, miners in Kazakhstan or Texas benefit from low electricity prices, while in Europe, these costs are higher. However, an increasing number of miners are turning to renewable energy sources like solar or wind to reduce costs and move towards more sustainable development.
- Market Volatility: Bitcoin prices can temporarily drop below production costs, especially during market downturns.
3. Discounted Utility Value Model
Concept: This method estimates the intrinsic value of a cryptocurrency by forecasting its future utility, such as trading volume or adoption rate, and then discounting that value to the present.
Application: Analysts evaluate potential use cases, adoption rates, and transaction activity, then discount the future benefits using a specific discount rate.
Example: BNB
BNB derives intrinsic value from its role in the Binance ecosystem.
BNB is used to pay transaction fees, participate in token sales, and receive staking rewards. According to YCharts, as of December 14, the BNB Smart Chain processed around 3.795 million transactions per day. Analysts can calculate the discounted value of these transaction fees over time to estimate the intrinsic value of BNB.
Applying the discounted utility value model to estimate the intrinsic value of BNB:
Assuming an average fee of $0.10 per transaction, the total daily transaction fees would be:
3,795,000 × $0.10 = $379,500 or $0.3795 million per day
This equates to annual transaction fees of:
$379,500 × 365 (non-leap year) = $138.52 million per year
To calculate the intrinsic value of BNB over the next 10 years, you can apply a 10% discount rate. Using the discounted value formula below, the total discounted value of BNB's expected transaction fees over 10 years is $851.13 million.
The discounted values for each year based on the annual transaction fee of $138.52 million and a 10% discount rate over 10 years (plugged into the formula above) are:
This hypothetical example illustrates how to apply the discounted utility value model to estimate the intrinsic value of BNB, assuming constant transaction fees. However, in reality, transaction fees may fluctuate, and factors like the BNB discount rate, account levels, and transaction types play a crucial role in determining the actual costs.
Challenges:
- Speculative Data: Forecasting future transaction volumes and adoption rates involves many speculative elements.
- Sensitivity of Discount Rate: Small changes in the discount rate can have a significant impact on the valuation results.
- Ecosystem Changes: If Binance faces legal issues or increased competition, the utility of BNB may decrease, rendering previous forecasts inaccurate.
Why Fiat Money Lacks Intrinsic Value?
Fiat money, such as the US dollar (USD) or Euro (EUR), does not have intrinsic value in the traditional sense. Unlike gold or silver, fiat money is not backed by a physical commodity. Its value comes from factors like government regulation, trust, and its ability to serve as a medium of exchange. In academic literature, fiat money is often defined as "a type of money without intrinsic value, not backed by any commodity."
- No Tangible Backing: Fiat money cannot be redeemed for gold, silver, or any other physical asset. The "gold standard" system has been abandoned by most countries for decades.
- Value Based on Trust: The value of fiat money depends on the public's trust in the government's ability to manage the economy and fulfill its debt obligations. For example, the US dollar is trusted due to the economic and political stability of the United States.
- Unlimited Supply: Governments and central banks can print fiat money at will, making its supply not fixed, unlike BTC or gold. This makes fiat money susceptible to inflation, eroding its purchasing power over time.
You may wonder how fiat money functions. Let's explore that!
How is the Value of Fiat Money Maintained?
Although lacking intrinsic value, fiat money still functions effectively due to the following factors:
- Legal Tender Laws: Governments require the use of fiat money to pay taxes and debts. For example, in the United Kingdom, taxes must be paid in British pounds.
- Economic Utility: Fiat money has high liquidity, widespread acceptance, and is convenient for everyday transactions, increasing its practical value.
- Institutional Backing: Central banks and the financial system create "trust" by controlling the issuance of fiat money and ensuring its stability.
The debate over whether fiat money or cryptocurrencies have "true" value often revolves around the following differences:
| Aspect | Fiat Money | Cryptocurrency |
| Intrinsic Value | None (based on trust and legal regulations) | Diverse (based on scarcity, utility, network value) |
| Supply | Unlimited (can be printed by the government) | Fixed or limited for most cryptocurrencies |
| Backing | Backed by the government and central bank | Based on decentralized networks or specific use cases |
| Inflation Risk | High, due to uncontrolled money printing | Low for cryptocurrencies with fixed supply |
To better understand the differences above, consider the definition of intrinsic value presented in the Oxford Handbook of Value Theory (page 29). The book defines intrinsic value as "that which is valuable for its own sake, in its own right, by its own nature, as an end in itself, or in virtue of its own being." In contrast, extrinsic value is "that which is valuable as a means, or for the sake of something else."
Based on these definitions, fiat money has no intrinsic value; its value comes from the backing of the government and legal frameworks (extrinsic value). Bitcoin, on the other hand, possesses characteristics that make it valuable in its own right, such as scarcity (limited to 21 million Bitcoins), decentralization, and its utility as a peer-to-peer network without the need for trust.
While fiat money relies on trust in centralized institutions, the value of Bitcoin stems from its unique self-sustaining characteristics, sparking the debate about the intrinsic value of this asset class.
Why Intrinsic Value Matters
Understanding intrinsic value helps investors distinguish promising projects from speculative ones. During the 2017 ICO boom, thousands of tokens were launched, but most lacked intrinsic value. Many projects collapsed due to a lack of fundamental elements - utility, security, or scarcity - to sustain long-term demand.
Focusing on intrinsic value allows you to make informed decisions and avoid being swept up by hype. For example, Bitcoin has maintained its dominant position because it demonstrates strong intrinsic value through scarcity, network effects, and utility, while many other tokens have gradually faded away.
Ultimately, to understand the intrinsic value of cryptocurrencies compared to fiat money, you need to grasp the difference between intrinsic and extrinsic value, and how they apply to each asset class.
