RESEARCH NOTE 22 March 2021
Using Metcalfe’s Law to Forecast Digital Asset Returns Metcalfe Value, specifically Price-to-Metcalfe Value, has been predictive of forward returns up to 18 months out. Using the approach presented here, Bitcoin’s price range in 18 months would be between $30,000 and $150,000. Ethereum’s price would range between $1,000 and $3,000.
Price-to-Metcalfe value provides information useful in the construction of efficient portfolios. These outputs include positive and negative expected returns and probabilities of gain or loss. For example, when Bitcoin’s nominal price-tovalue is about 2, the risk of loss skyrockets.
leads fundamentals and assets can therefore appear over- or underpriced for long periods. Aside from fundamentals, there are many other factors that affect short and long-term prices movements, and these factors could cause the ratios to diverge from their long-term trend as well.
Cane Island’s Metcalfe Model Metcalfe’s Law is a concept used quantify the value of a network. Metcalfe's Law states that a network's value is related to the square of the number of nodes 2 (or users) in the network (n ). For example, if a network has 100 nodes, its inherent value is close to 100 × 100 = 10,000. The end nodes can be computers, servers and/or connecting users (Figure 1).
Valuation Ratios as Predictors of Future Performance DJ Ineternet Composite Index
Figure 1: Metcalfe Value of the Internet and DJ Internet Composite Index
The use of a price ratio to assess relative value and predict future performance is a widely used and respected practice. Kenneth Fisher [Fisher, 1984] pioneered the use of the Price-to-Sales ratio in 1984. Robert Shiller’s work on a Cyclically Adjusted Price-toEarnings ratio won a Nobel prize [Campbell, 1988]. Buffett’s [2001] Market Capitalization-to-GDP ratio is highly regarded. Peterson [2018] found that modified price ratios of equities to gold were predictive of future returns for both stocks and gold. When the ratio is high, it indicates the asset may overpriced. When the ratio is low, it indicates the asset may be underpriced. In theory, these ratios will follow a long-term trend and revert to their trended or mean values. However, that reversion may take years. An overpriced asset may appreciate further still, and an underpriced asset may continue to lose value. Because the metric is a ratio, future price may not be affected at all. The ratio may adjust by improvements or degradations in the denominator, which usually represents a fundamental value. Because prices tend to be forward looking, it is often the case that price
1000 800 600
Dow Jones Internet Composite Metcalfe Value
15
10
400 200 0
5
0
Metcalfe Value of the Inernet
Executive Summary
Sources: Dow Jones S&P, Internet World Stats
Cane Island’s estimate of Bitcoin’s value uses Metcalfe’s law exclusively. It is a proprietary model that directly incorporates the following factors:
network growth rate [Peterson, 2019]; Metcalfe Affinity (diminishing value per user) [Metcalfe, 2006]; available Bitcoin supply net of irretrievably lost coins [Cane Island, 2020]; and price elasticity of demand [Hall, 2019].
Value is generally calculated as