Introduction
The dynamics of a marketplace, be it one for commodities like fruits and vegetables or more complex markets such as those for financial assets, revolve around the principle of supply and demand. What this means is that prices for items sold are determined at the point where the supply (or availability) of a product meets the demand (or the desire) for it.
Understanding Market Dynamics using Everyday Examples
Consider a simple grocery item – tomatoes. If you walk into a supermarket to buy tomatoes and find out there has been a flood, leading to a shortage in the supply of tomatoes, the price you pay at the till would likely be higher than what you would usually expect to pay. This is a simple example of how scarcity of supply can drive up the price of a product.
If, however, the supply of tomatoes remained the same, but for some reason, the demand for tomatoes went up— say, because twice the normal number of customers wanted to buy them, the price would also go up. This is an example of how an uptick in demand can drive prices higher.
The Effect of Supply and Demand in the Financial Market
The concept of supply and demand is not confined to tangible products alone; it also plays a role in the financial services market, such as mutual funds. In an unlimited system, where the supply of a mutual fund is unlimited, the price of the fund does not change irrespective of demand.
For instance, if a mutual fund’s capitalization is $100 million and it has 10 million units valued at $10, if an investor wants to invest an additional $10 million, the fund simply issues 1 million more units at the $10 value, thereby increasing its capitalization to $110 million.
Estimation of Fair Value Price of Financial Assets
In an unlimited supply situation like the one described above, determining the price is pretty straightforward. However, it becomes more complex when there is a limited supply, such as in the case of shares. If there were only 10 million shares available and more investors wanted to buy these shares, they would have to find willing sellers. Here, the price may not remain at $10 but would depend on what the buyer is willing to pay and how much the seller wants.
This situation could lead to considerable price fluctuation, often significantly exceeding the “true” or “correct” value of the share due to uneven supply and demand. When an asset is in high demand, its price can obviously go up, sometimes significantly more than its real value. But how can you determine the correct price?
Estimating the Fair Value Price – the Logic
The previous mutual fund example comes in handy in understanding how to estimate the correct value. The capitalization of a fund is given by the number of units outstanding multiplied by the price (or NAV). Similarly, a fund’s capitalization could also be estimated as the number of investors in the fund times the average amount held by each investor.
Calculating the Fair Value Price for Bitcoin
Applying this logic to Bitcoin, if we can estimate the average amount held in each wallet and multiply this by the number of wallets in circulation, we can also estimate the capitalization of Bitcoin and calculate its price. This is possible because the transparency offered by the blockchain allows us to collect much of this information with a high degree of reliability.
Estimation Steps:
- As shown in the graph, we can monitor fluctuations in the average amount (in USD) held in wallets due to supply and demand effects and calculate the price range (or range between the 90th percentile and the 10th percentile).
- The next step is to estimate the growth curve of wallets in circulation (on a logarithmic scale) from which we can then calculate the range within which Bitcoin’s price should move.
- Despite the model’s simplicity, it’s effective because the correlations allow for a high degree of certainty even when we don’t know if a user owns multiple addresses or if a single address is shared by multiple users— as in the case of a cold wallet of an exchange.
Applying the Estimation Model to Market Behavior
The simplicity of this model is its strength. While we do not always know if a user owns multiple addresses or if a single address is shared by different users (like in the case of a cold wallet of an exchange), we can still derive a reliable estimate by relying on these correlations. Especially when these are considered in terms of large numbers and over a complete price cycle.
During the end of a crypto winter, for instance, an increase in withdrawals from crypto exchanges coupled with a decrease in balances on these platforms is typically observed. Since holding crypto assets in third-party custody is considered risky, this trend can be interpreted as bullish, indicating a preference among investors for long-term Bitcoin positions.
This trend is usually accompanied by an increase in addresses, due to withdrawal from a few collective cold wallets to many individual addresses. This behavior lays the groundwork for a cyclical price appreciation that is based on the model I described in this article.
Forecast of Bitcoin’s price
According to the data collected from this model, it could be predicted that the price of Bitcoin may reach a ceiling of $130,000 (or possibly more) in autumn 2025. However, it is important to note that this forecast is not financial advice—it is just an estimate based on a set of assumptions.
Various other predictive models have also suggested similar price growth possibilities. For instance, the recent interest shown in this asset class by institutional players such as BlackRock, the world’s largest asset manager seeking approval for a spot Bitcoin exchange-traded fund, is indicative of their faith in these models.
About the Author
Daniele Bernardi is the founder of the Diaman Group, which is dedicated to developing profitable investment strategies. He is also the Chairman of Investors’ Magazine Italia SRL and Diaman Tech SRL, and the CEO of asset management firm, Diaman Partners. Bernardi manages a crypto hedge fund and has authored The Genesis of Crypto Assets, a book about cryptocurrency. He has also been recognized as an “inventor” by the European Patent Office for his European and Russian patents related to mobile payments.
This article is for general information purposes and is not intended to be, and should not be taken as, legal or investment advice. The views, thoughts, and opinions expressed in this article are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
