Investors and economists like to think that there is a fundamental basis for valuation — for how much you pay for something.
Financial types often do a calculation called a discounted cash flow (DCF) analysis, or also called a net present value (NPV) calculation. These methods use known financial metrics such as earnings or cash flow and forecast what those metrics will be in the future. More importantly, they know that money promised in the future is worth less than that money today. So, accountants will discount future promised earnings by some amount. That discount depends on things like the current and future cost of money — how much do banks charge to lend money since they are acutely aware that the future value of money is lower than the value today — and will charge accordingly.
Let’s say banks charge a 10% interest rate for a 1-year loan. You promise to pay me $100 a year from now, for a widget my company makes. On my books, the cost of the widget goes off my current assets (inventory) because it now belongs to the customer, you. I record your promised $100 as an asset, but I don’t value it at $100. Instead, I discount it by 10% and I say I have $90 on the books.
Money in the future is less valuable than money today. A bird in the hand is worth two in the bush, and all that.
That is the hard basis of true valuation. (That hard NPV calculation does have some squishy assumptions. But at least they are all listed clearly in the spreadsheet and people can argue and arm-wrestle over those assumptions and come up with a range of NPV calculations accordingly.)
If the assumptions prove wrong, and the cash flows or earnings exceed the assumptions, the NPV calculations go up, and financial types are willing to pay a higher price. If the assumptions go down instead, then the NPV calculations also go down, and the financial types want the price to go down accordingly.
However… The price of things like cars, homes, stocks, tulips and Bitcoins, can skyrocket far above those hard-nose financial calculations of NPV. That excess is pure froth, the work of emotions which urge the customer that they “Must” have that pair of Nike shoes, or that cute home, or that Van Gogh painting, or that tulip or that Bitcoin. Most people do not perform NPV calculations to determine what the true value of something is.
The valuation of Tesla is based on a foundation, NPV calculations, and then a big cushion of usually emotional froth sits on top of that. That froth is actually not as thick as many assume, because there are people who short stocks whose values skyrocket too high, and those competing bets on the long and short side of a stock act like people playing tug-o-war.
The valuation of Bitcoin, however, has no fundamental part. There is no future cash flows, no earnings. Bitcoin is vaporware. It is an idea, some ones and zeros, on which people try to bet their life savings.
That is how people get hurt.
Finances get broken, and lives get destroyed.
If the amount you put into Bitcoin is something you are willing to lose and won’t miss if it evaporates, by all means go ahead and “play” Bitcoins as entertainment like you would play the lottery.
