Metcalfe and the future of Bitcoin

Using a formula by Robert Metcalfe, Tom Lee claims to have found a way to explain Bitcoin’s price fluctuations. He compares Bitcoin to a social network whose value increases with the number of users.

The calculation method is based on Metcalfe’s formula, which says that the value of a communication network increases proportionally to the root of the number of participants in a network or the number of possible connections between the participants.

After that, a course correction should take place

So far, Bitcoin has been traded at a price above the formula. FundStrat is optimistic in its analyses, but considered a price correction, as it seems to be taking place at the moment, to be realistic.

„Using a very simple formula to calculate the benefit of Bitcoin as a square function of the number of participants and the average transaction value, 94% of Bitcoin’s movements over the last 4 years can be explained,

Tom Lee, co-founder of FundStrat, a financial research institute in an interview with business insiders.

94% Accuracy with Metcalfe

A fax machine can be used as an application example for Metcalfe’s law. If only one person on earth owned one, it would be quite worthless and above all useless. The faxes that this person would send to himself would probably have only limited value even for him. However, the more people who own a fax machine, the more valuable it becomes.

This law can be easily transferred to social networks. Facebook isn’t necessarily that valuable because it’s technically outstanding or innovative. The main value and benefit of Facebook is that so many people use it. So Metcalfe’s law applies: the value of a network is proportional to the root of its number of subscribers. So the value in terms of benefit increases with the number of participants:

„If you double the number of participants, you increase the benefit many times over, not by half.“

Lee says the law can also be applied to Bitcoin. FundStrat took a closer look at the network and found out that the root function of clearly assignable addresses as an indicator for users can explain 63% of the Bitcoin price fluctuations since 2013.

„From a previous point of view, everything suggests that Bitcoin is very much like a social network. The more activity takes place, the more the value increases. And in the short term, we think that Bitcoin will at least break the $6,000 mark in mid-2018.“

That’s what he said in October.

After Metcalfe’s law could only explain 63% of the fluctuations, they added the transaction volume as a factor to the already described model. The accuracy rose to 83%.

Finally, FundStrat has developed a formula that offsets the Bitcoin price with both the root of the unique addresses and the transaction volume per user. This model actually explains 94% of the price fluctuations since 2013.

Metcalfe’s Law and the Future of Bitcoin
Finally, FundStrat can use this formula to estimate the future value of Bitcoin. You need an estimate of the number of unique addresses (or their roots) and an estimate of the transactions per day. Lee comes to the conclusion:

„Bitcoin’s trend is positive in the long run. But in the short run the price seems to be limited, the risk of a price correction seems to grow.“

The current price fluctuations seem to prove Lee right so far.

What happens next?
According to this law, more and more participants would have to discover the crypto currency for themselves in order to let the price rise further. Lee shows parallels between Bitcoin and gold. He assumes that Bitcoin will be the digital gold of the future generation. With the most cautious estimates, he predicts a price of 25,000 US dollars per Bitcoin.

The price could ultimately also be subject to extreme fluctuations. This is the case, for example, when investors discover the crypto currency for themselves. Since they can suddenly pump a large amount of money into the cycle, the overall value can rise sharply for a short time. This is because, in this sense, they are still regarded as a single user, even though they represent a large number of people. Therefore, after a high price increase, corrections can occur again and again. Whether the future will prove Tom Lee right remains to be seen. It remains exciting.