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 earnings, cash flow, and growth potential.
In the cryptocurrency field, assessing intrinsic value is not that straightforward. Since cryptocurrency assets are not tied to physical entities or stable income streams like dividends, determining intrinsic value requires a combination of various technological, economic, and utility factors. Simply put, intrinsic value answers the question: What makes this cryptocurrency valuable beyond its trading price on exchanges?
The intrinsic value of cryptocurrency 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 resilient is the blockchain against 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.
Meanwhile, Ethereum primarily derives its value from its role as a platform for decentralized applications (DApps) and smart contracts.
How to calculate the intrinsic value of cryptocurrency: Three common methods
Let's go beyond theory and explore three commonly used methods to estimate the intrinsic value of cryptocurrency.
1. Metcalfe’s Law
Concept: Metcalfe's Law states that the value of a network is proportional to the square of the number of its active users. In other words, as the number of users increases, the network's value also increases exponentially.
Application: This method is particularly suitable for cryptocurrencies with strong ecosystems and high numbers of active users. The network value is calculated using the formula:
Network value = (Number of active addresses)^2
For 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 representative of the 'network size.'
As of December 13, 2024, according to YCharts, the number of daily active addresses of 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 in USD).
This shows that network value increases exponentially as the number of users grows. If the number of daily active addresses of Ethereum increases, the network value will also rise faster.
Challenges in applying Metcalfe’s Law
Oversimplification: Metcalfe's Law does not account for the quality of interactions between users. A network of 1,000 inactive users would be less valuable than a smaller network with active interactions.
Data accuracy: Estimating the number of 'active' users is challenging, especially with the presence of bots and spam accounts skewing the data.
Limitations of comparison: Some blockchains may have fewer users but offer faster transaction speeds. Metcalfe's Law does not reflect these differences.
2. Production costs
Concept: This method calculates the intrinsic value of a cryptocurrency based on the costs to produce or mine it. For blockchains using Proof of Work (PoW) mechanisms like Bitcoin, these costs include electricity, hardware, and operational costs.
How to apply: Production costs act as a 'floor' for the value of cryptocurrency, as miners will stop operating if market prices fall below production costs.
For example: Bitcoin
The intrinsic value of Bitcoin is often linked to its mining costs.
As of December 13, the average mining cost of Bitcoin was 86,303 USD, while the market price reached 101,523 USD. This indicates that the intrinsic value of Bitcoin, based on mining costs, is at least 86,303 USD. When the market price exceeds this level, mining remains profitable, encouraging miners to continue operating and securing the network. Conversely, if the price of Bitcoin drops below production costs, miners may cease operations due to lack of profit, affecting network security. The 15,220 USD difference between the market price and mining costs reflects a healthy market where mining is still incentivized and the network remains stable.
During the bearish market phase of 2022, the price of Bitcoin fell to 16,000 USD at one point, below the production costs of some miners (around 20,998 USD). The negative difference of 4,998 USD led to miners losing on each Bitcoin mined. When this happens, inefficient miners may be forced to cease operations, leading to a drop in hashrate and affecting network security. At the same time, the system will automatically adjust the difficulty to balance costs with market prices.
Challenges:
Regional fluctuations: Mining costs vary worldwide. For instance, miners in Kazakhstan or Texas benefit from low electricity prices, while in Europe, these costs are higher. However, more miners are increasingly turning to renewable energy sources like solar or wind to reduce costs and move towards more sustainable development.
Market fluctuations: The price of Bitcoin may temporarily drop below production costs, especially during recessionary market phases.
3. Utility-based discounted value model
Concept: This method estimates the intrinsic value of cryptocurrency by forecasting future utility value, such as transaction volume or acceptance level, and then discounting this value back to the present.
How to apply: Analysts evaluate potential use cases, acceptance rates, and trading activity, then discount future benefits using a specific discount rate.
For example: BNB
BNB derives its 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 processes approximately 3.795 million transactions daily. Analysts can calculate the discounted value of these transaction fees over time to estimate the intrinsic value of BNB.
How to apply the utility-based discounted value model to estimate the intrinsic value of BNB:
Assuming the average fee per transaction is 0.10 USD, the total daily transaction fee will be:
3,795,000 × 0.10 = 379,500 USD or 0.3795 million USD per day
This is equivalent to an annual transaction fee of:
379,500 × 365 (non-leap year) = 138.52 million USD/year
To calculate the intrinsic value of BNB over the next 10 years, you can apply a discount rate of 10%. Using the discounted value formula below, the total discounted value of projected BNB transaction fees over 10 years is 851.13 million USD.
Below are the discounted values by year based on the annual transaction fee of 138.52 million USD, with a discount rate of 10% over 10 years (the values input into the formula above):
This hypothetical example illustrates how to apply the discounted value model to estimate the intrinsic value of BNB, assuming transaction fees remain constant over time. However, in reality, transaction fees may fluctuate, and factors such as the BNB discount rate, account level, and transaction type play crucial roles in determining accurate costs.
Challenges:
Speculative data: Predicting future transaction volumes and acceptance rates contains many speculative factors.
Sensitivity of the discount rate: Small changes in the discount rate can significantly impact the valuation results.
Changes in the ecosystem: If Binance faces legal issues or competition, the utility of BNB may decrease, making previous forecasts inaccurate.
Why does fiat money lack intrinsic value?
Fiat money, such as the US dollar (USD) or Euro (EUR), has no intrinsic value in the traditional sense. Unlike gold or silver, fiat money is not backed by any physical commodity. Its value comes from factors such as 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 token with no intrinsic value, not backed.'
No tangible backing: Fiat money cannot be exchanged for gold, silver, or any physical assets. The 'gold standard' system has been abandoned by most countries for decades.
Value based on trust: The value of fiat money depends on people's trust in the government's economic management and debt obligations. For example, the US dollar is trusted due to the economic and political stability of the US.
Unlimited supply: Governments and central banks can print fiat money at will, making its supply unfixed, unlike BTC or gold. This makes fiat money susceptible to inflation, gradually reducing its purchasing power over time.
You may wonder how fiat money works. Let's find out!
How is the value of fiat money maintained?
Although fiat money has no intrinsic value, it still functions effectively due to the following factors:
Legal tender laws: Governments require the use of fiat money for tax payments and debts. For instance, in the UK, taxes must be paid in pounds sterling.
Economic utility: Fiat money is highly liquid, widely accepted, and easy to use in everyday transactions, enhancing its practical value.
Backing from organizations: Central banks and financial systems create 'trust' by controlling the issuance of fiat money and ensuring its stability.
The debate over whether fiat money or cryptocurrency has 'real' value often revolves around the following differences:
Aspect Fiat Money Cryptocurrency Intrinsic Value None (based on trust and legal regulation) Diverse (based on scarcity, utility, network value) Supply Unlimited (can be printed by government) Fixed or limited for most cryptocurrencies Backing Backed by government and central banks Based on decentralized networks or specific use cases Inflation Risk High, due to uncontrolled printing Low for cryptocurrencies with fixed supply
To better understand the aforementioned differences, consider the definitions presented in the Oxford Handbook of Value Theory (page 29). The book defines intrinsic value as 'what is valuable in itself, by itself, as a final end, or by its nature.' In contrast, extrinsic value is 'what is valuable as a means, or for the purpose 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 properties that make it independently valuable, such as scarcity (capped at 21 million Bitcoins), decentralization, and its utility as a trustless peer-to-peer network.
While fiat money relies on trust in centralized institutions, the value of Bitcoin stems from its unique self-sustaining properties, fueling the debate about the intrinsic value of this asset class.
Why intrinsic value matters
Understanding intrinsic value helps investors distinguish potential projects from speculative ones. During the ICO boom of 2017, thousands of tokens were launched but had little intrinsic value. Many projects collapsed due to a lack of fundamental factors—utility, security, or scarcity—to maintain long-term demand.
Focusing on intrinsic value allows you to make informed decisions and avoid getting caught up in hype. For example, Bitcoin maintains its dominant position due to its strong intrinsic value reflected in scarcity, network effects, and utility, while many other tokens gradually disappear.
Finally, to understand the intrinsic value of cryptocurrency compared to fiat money, you need to grasp the difference between intrinsic value and extrinsic value, as well as how they apply to different types of assets.
