14 May 2018 · 3 min read

Venture Capitalists Teach Buffett How to Value Bitcoin

Warren Buffett: When you buy bitcoin, “you aren’t investing…you’re speculating”. VC’s argue Buffett don’t understand what cryptoassets are.

Source: iStock/matejmo

Warren Buffett, the legendary stock investor and long-time bitcoin skeptic, reignited the discussion how to best value bitcoin and other cryptoassets.

Many attempts have been made to apply valuation formulas from the world of traditional finance onto cryptoassets, but most of these attempts have failed when it comes to understanding the real value drivers behind this new class of digital assets.

In a recent interview with Yahoo Finance, Buffet argued that bitcoin and other cryptocurrencies could not be considered “investments” since they do not “produce anything.”

According to the Prophet of Omaha, traditional investments like “a farm, apartment house, or an interest in a business” can be expected to deliver a return by itself, which is what makes it an investment per definition.

“Now if you buy something like bitcoin or some cryptocurrency, you don’t really have anything that has produced anything. You’re just hoping the next guy pays more,” Buffet argued.

“You aren’t investing when you do that. You’re speculating. There’s nothing wrong with it. If you wanna gamble somebody else will come along and pay more money tomorrow, that’s one kind of game. That is not investing,” the legendary stock investor continued.

What cryptoassets produce

Not everyone agrees with Buffet’s reasoning on that.

Fred Wilson, a New York-based venture capitalist, takes on Buffet’s claim that cryptoassets don’t “produce anything” by pointing out in a blog post that “cryptoassets produce decentralized infrastructure.”

“Bitcoin has produced a transaction processing infrastructure that looks a lot like Amazon Web Services (something I am sure Buffett would agree is extremely valuable),” Wilson wrote on his popular technology and investing blog AVC.com.

Wilson does agree with Buffet, however, that it is very difficult to determine the intrinsic value of bitcoin. For that, most people in the community today relies on models developed by Chris Burniske, a partner at Placeholder, a New York venture firm that specializes in cryptoassets, and others, laid out in a book Cryptoassets: The Innovative Investor’s Guide to Bitcoin and Beyond.

Determining Bitcoin’s Intrinsic Value

Firstly, Burniske is not alone for arguing that the term “market cap” is misrepresenting when it comes to cryptoassets, and that a more appropriate term to use is “network value,” since cryptoassets are not companies, but instead represent a new asset class.

According to Burniske, the valuation formula we should then use to determine the intrinsic value of cryptoassets is “network value-to-transactions ratio,” or NVT.

To calculate the NVT of a cryptoasset, the network value is divided by the transaction volume of the asset we want to examine.

The reasoning behind this valuation method is that transaction volume is to a cryptoasset what GDP is to a country. In other words, we must look at the underlying activity to understand the intrinsic value of a token. This is where the true value of a cryptoasset comes from, not revenue and profits as the case is for companies.

Burniske shared his approach to crypto valuation during the Business of Blockchain event hosted by MIT Technology Review recently. Although he acknowledges that the science behind determining an intrinsic value of cryptoassets is contentious at best, he argues that the best approach we have at the moment is the NVT.

Also, Burniske adds: