Tag Archives: bitcoin value

You don’t understand Bitcoin because you think money is real

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Maria Bustillos is founder of the blockchain supported publication, Popula. I stole the title of this post from her essay at Medium.com (linked below).* I hope that Maria considers it a tribute rather than title-plagiarism. Her article is blocked by a pay wall, so allow me to explain a concept that confounds even a Nobel Prize winning economist. My take on the issue is somewhat different than Ms. Bustillos.

The difficulty understanding or appreciating Bitcoin boils down to a misconception that the dollar is backed by something more tangible, such as gold, guns or the promise of redemption. Not only is this an illusion, but Bitcoin is backed by something far more tangible, intrinsic and durable.

The illusion that “real” value emanates from government coupled with a robust consumer economy has been woven into our DNA for millennia. But, the value we attribute to a Dollar, Euro, or Yuan is a result of conditioning rather than any intrinsic value. That same conditioning has led us to believe that there is something sane and inherent in a nation that controls its money supply and its monetary policy.

Most public works projects—power generation, space ships, or the telephone network—were controlled by government in the past. If not, they were regulated as a licensed monopoly. This creates a choke point, a lack of competition, and a gaping opportunity for inefficiency, mismanagement or graft. It defies a free market economy and it concentrates power in the hands of politicians. But, at one time, it seemed necessary.

You might assume that government controlled these industries because they relate to areas of critical infrastructure and public welfare. That’s part of it, but it’s not the real reason. In each sector, a distributed or free market solution was prevented due to technology limitations or issues of scaling and geography.

Government issued money exists because in the past, we had no mechanism to arrive at a consensus on the value of something that is portable, fungible, secure, anti-forgeable and easily transmitted. Not even Gold fits the bill (pun intended). Prior to 2009, the only thing that met the criteria for money in a modern society was government issued fiat. At least someone, somewhere said that this is money and that this is what we must use to pay our taxes.

Today, there is no more reason for a government to control its money supply than there is for it to control communication networks, space travel or package delivery services. Today, a free and competitive marketplace benefits all of these industries and even government itself. And here’s the kicker: No harm will come to a government that uses a completely trusted, transparent and decentralized currency, rather than firing up a printing press whenever a group of transient politicians spends beyond their means.

The economic order facilitated by the blockchain is not as radical as it seems. Aristotle lamented the lack of an accounting tool that we can now address via the clever combination of encryption and a communications network that is both instant and ubiquitous.

I am not smarter than the average bear, nor am I clairvoyant. Once in a while, I recognize a truth before the masses—and before its time. It’s time to clearly and succinctly illuminate business, banks, consumers, creditors and government:

  1. The value we attribute to the dollar is an illusion
    ..
  2. Bitcoin is not just fair and cost effective. It is tangible and durable. It is good for consumers and good for governments.

Bitcoin ushers in an era of accountability and more fairness. It does not facilitate crime, nor interfere with a government’s ability to tax, spend or enforce tax collection.

Bitcoin is a cryptocurrency with a firmly capped supply. Will it lead to deflation? Could governments lose control over their own monetary policy? Yes to both questions…

But, these are each good things. Capping the money supply and decoupling a nation from monetary policy not only eliminates inflation—it increases access to capital, retires debt more quickly, reassures creditors, imposes transparency and honesty—And it accelerates economic growth, rather than retarding commerce.

Dispelling three millennia of conditioning can be confusing and unsettling. I hate understanding something before my peers. Let’s please get ahead of the curve on this one. I want to enjoy the benefits of using real money in my lifetime.

Related Reading:

* I wrote the first article more than 7 years ago. It is a simple explanation of a geeky, new economic mechanism. Bitcoin had not yet entered mainstream media nor gained attention of Wall Street investors. But consider the similarity to Maria’s tutorial in the 2nd article. Perhaps Maria and I think alike!

Bitcoin: up 120% in less than 2 months

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At the end of October, I delivered a keynote speech at the Cryptocurrency Expo in Dubai. That was just 5 weeks ago. When I left for the conference, Bitcoin was trading at $6,300/BTC. But in the next few weeks, it reached $10,000. Last week, I liquidated part of my investment at just under $13,000/BTC. Now, Bitcoin is about to cross $16,000. (I began writing this 10 minutes ago… But it has risen another $1600.00 since then. Now, it is $17,000).

Dear Reader: I believe in Bitcoin. Yet, there is a “But” in the last paragraph below…

I believe in Bitcoin. Its rise is not fueled solely by investor hysteria. Rather, it is a product of delayed appreciation for a radical, transformative network technology.

In the mid 1970s, the microprocessor was spreading to every consumer gadget. It started a trend toward tools that added power and enjoyment to all facets of life. And they were quickly becoming faster, lower-power, lower-cost and more ubiquitous. If you understood the potential of the computer chip before mainstream investors, you couldn’t really invest directly in the microprocessor. After all, it is a platform improvement. But you could come very close—You might have invested in Intel, Fairchild or Texas Instruments.

Jump forward 20 years: In the mid-1990s, the Internet was spreading to every class of citizen and to all corners of the earth. But just as with a computer chip, you could own a web site, but you couldn’t own a piece of the internet’s market potential. You can’t invest in an idea, unless you are the inventor and you hold a patent.

But, 5, 6 and 7 years ago, many individuals saw the future. They understood that Bitcoin is transformative. They recognized that—contrary to popular misconception—Bitcoin is backed by something more tangible than dollars, Euros and Renminbi. More importantly, it exhibits the potential to become the global reserve currency. And it continues to do so, even as internal bickering threatens its utility as a consumer payment instrument. That’s because it diverts liquidity away from gold and national FIAT. Ultimately, it forces governments to be transparent and accountable to its citizens. This is further reinforced by rampant inflation in countries around the world and a growing list of trading partners who seek alternatives to the US dollar.

But, just like real estate, the supply of Bitcoin is capped. No one can produce more. It’s the math, stupid! Even if you only realized this one year ago, you still would have reaped a 2000% return on your investment as of this morning. (I am cherry-picking here, but Bitcoin had just crossed $630 on October 20 2016).

Let’s be clear: This is not a dot-com bubble or a 17th century Dutch tulip bulb mania. It is far more comparable to the 19th century California gold rush. The only frenzy is to acquire a functional instrument that is still trading for far below par value—but with the strange caveat that hoarding retards liquidity and the ‘functional’ adoption that we need to sustain long-term value.

The Bottom Line

In the grand scheme of things, Bitcoin is still undervalued—even at $17,000/BTC. It will fall and it will rise, but it will certainly be valued higher years from now.

…But, I must admit that this sudden and urgent race into outer space is a bit unsettling. From an investor perspective, it is not rational to leave when I recognize that the exuberance is rational. Yet, here we are at $17,000. I am taking some bitcoin off the table—A bit of bitcoin. I have taken some Bitcoin off the table.

What Fraction of Bitcoin Value is Driven by Speculators?

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At Quora, I occasionally play, “Ask the expert”. Several hundred of my Quora answers are linked at top right on this page. Today, I was asked “How much of Bitcoin’s value is driven by speculation”. This is my answer…

This is a great question! While the value of any commodity is determined by supply and demand, speculation is one component of demand. Another is the unique utility value inherent in a product or process. This is sometimes called ‘intrinsic value’.

It’s ironic that when a high fraction of value is driven by speculation, short-term value becomes volatile and long-term value becomes less certain—and less likely to produce returns for those same speculators.

Editor’s Note: In the past few weeks, a significant spike in Bitcoin’s value and trading volume relates to a pending regulatory decision expected at the end of next week. This activity is certainly driven by speculation. But for this article, I am considering periods in which the demands of individual events are less clear.

The value of Bitcoin is influenced by:

  • Day traders who buy and churn
  • Long-term speculators who buy and hold. This includes me.
  • Criminals who hope that cryptocurrency transactions can be more easily hidden than government backed currencies
  • Early adopters who use Bitcoin as a payment instrument or to send money
  • Vendors who accept the coin in exchange for products and services
  • Vendors who retain a fraction of revenue in Bitcoin (rather than exchanging to Fiat). To avoid a round trip, they seek to purchase materials, pay staff or settle debts with the Bitcoin they earned.

Here’s the rub: Bitcoin will not become a store of value unto itself (i.e. a currency), and it will not gain a significant fraction of the payment instrument market until the transaction volume of the first two user categories in the above list are overtaken by the the ones further down. Likewise, Bitcoin will not enjoy an adoption growth-spurt until the last two items swamp the others as a primary motive for acceptance and use.

Put another way: Long term value must ultimately be driven by organic adoption from actual users (people who buy and spend Bitcoin on other things)—not just HODLers.

In another article, I expand on the sequence of events that must take place before Bitcoin grows into its potential. But make no mistake. These things will happen. In tribute to the brilliance of Satoshi, the dominoes are already falling.

In response to the question, I estimate that at the beginning of 2017, 85% of Bitcoin value is still driven by speculators. I have not analyzed wallet holding periods compared against the addresses of known vendors. Furthermore, it would be difficult to understand the relationship between the number of speculative transactions and the overall effect on value. Therefore, my figure is more of a WAG than an calculated estimate. But it’s an educated WAG.

The fraction of speculative transactions will drop significantly in the coming months—even as late speculators jump on board. That’s because uptake from consumers and businesses is already taking off. The series of reactions that lead toward ubiquitous, utilitarian applications has begun. Bitcoin’s value will ultimately be driven by use as a payment instrument and in commerce.

Because it is a pure supply-demand instrument, Bitcoin will eventually be recognized as currency itself. That is, it needn’t be backed by precious metal, pegged convertibility or a redemption promise. When that happens, you will no longer ask about Bitcoin’s value. That would be a circular question, since its value will be intrinsic. Instead, you will wonder about the value of the US dollar, the Euro and the Yen.

As a growing fraction of groceries, gasoline and computers that you buy are quoted in BTC, you will begin to think of it as a rock, rather than a moving target. One day in the future, there will be a sudden spike or drop in the exchange rate with your national currency. At that time, you won’t ask “What happened to Bitcoin today? Why did it rise in value by 5% this morning?” Instead, you will wonder “What happened to the US dollar today? Why did it drop in value by 5%?”

Calculate Bitcoin Value: Modest assumptions

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December 2017 Update:
In a major update to the article below, I describe a different methodology for determining Bitcoin fair value. Since Bitcoin is gaining traction as a reserve currency rather than a daily payment instrument, it presents a more accurate method of predicting Bitcoin’s eventual fair market value. [Switch to updated article]

Bitcoin is a popular investment at the moment with many people looking at this guide to buying Bitcoin with credit card in order to find out how they can profit off the buzz. An experienced investor recognizes a speculative instrument or commodity. Depending upon your frame of mind and your opinion about its future, Bitcoin is either a payment instrument or a commodity. But either way, its supply is capped (not by edict, but by an indisputable mathematical formula), and so its value is a product of simple supply and demand economics.

Value: What assumptions are reasonable?

Value: What assumptions are reasonable?

I would never claim the foresight to predict the value of a bitcoin five minutes from now, let alone five years from now. Yet, I am baffled by its dollar exchange value today ($450 as I write this Wild Duck article). A reasonable and conservative calculation suggests that it should be-not $1200, as it was in late November 2013-but rather 100 times its current value.

Let’s consider one way to approach a calculation of the exchange rate necessary to support a low ball likelihood of its future utility…

Conservative Assumptions

  • Let’s say that Bitcoin never achieves the status of a currency-and that eventually, the expectation of enthusiasts that it will become its own “value store” turns out to be wishful thinking. Let’s assume that exchange rate mania was no more than the Dutch tulip-mania.
  • As a result, let us further assume that all speculative “investment” ends. Let’s just say that in 5 years, no one is interested in holding on to a bitcoin based on the expectation that its value will rise.

But, clearly, Bitcoin is very cost-effective when used simply to transmit money for a purchase, loan, gift, or exchange. Even if both parties expect to convert back to regional currency after a short time, it reduces cost and leads to increased retained revenue.

Furthermore, it’s cost effectiveness is maximized as users retain their receipts in Bitcoin pending their own purchase of goods and services. In this way, they avoid any cost associated with a round trip exchange.

  • So let’s assume that consumers and businesses eventually hold 10% of their receipts in Bitcoin longer than a day. In this way, a certain amount of “coins” are required just to cover circulation.

Now, for more of our facts & assumptions…

  • Today, 85% of transactions are US dollar denominated.
  • Each day, the world needs about $3 trillion dollars to float current transactions. Additionally, the currency markets require another 3.98 trillion dollars for banks, exchanges, escrows, reserves and other activities driven by currency “markets”.
  • Let’s further assume that these 2010 figures never grow. Despite China’s massive growth and significant recover in the west after the 2010 recession, we will effectively freeze the world economy at 2010 levels.

There is no reliable data on the turnover rate of purchase and settlements, cash reserves-or how long a dollar typically stays in an individual’s pocket.

  • But if we assume that each dollar is turned over twice each day, we still require more than $3 trillion to grease the world’s daily needs. And that’s just US dollars.

Now, let’s make some reasonably conservative assumptions.

• Let’s assume that in 5 years, the faction of global transactions conducted online amounts to about 5% by value. (I believe that it is already far past this, but I am striving to be very conservative). If you have a business that deals with global transactions, you may want to look at global payment processing software to help with this.

• Let’s further assume that 5% of these transactions use a new age cryptocurrency built on Satoshi’s model.

• My boldest assumption is that Bitcoin will be the market leader in virtual currencies. If any become viable, Bitcoin will be involved in 90% of digital currency transactions. That’s because it has already attained critical mass as evidenced by media frenzy, attempts at regulatory action, and the comparative market caps for various “coins”.

For these reasons-and the mechanisms of a two-sided market effect, it is unlikely that two parties will find it quick, simple and inexpensive to designate an alternate cryptocurrency for their transaction.

Finally, here is a fact rather than an assumption.

• There are currently 12.6 million BTC in circulation (the Bitcoins that have been mined to date, less a few that have been lost). But the total number of Bitcoins that can ever be available is 21 million. That’s it. There will never be inflation. No one can mint additional coins to cover national debts, public works bonds, or war reparations. It simply cannot be done. Bitcoin is product of math and not of monetary policy.

O.K. So, where does this leave us? It leaves us with a fairly straightforward calculation. Let me set up the calculation this way:

If there are eventually 21 million “units” divided amongst a daily liquidity requirement for $6 trillion dollars. And, if we divide the liquidity assumption by our very conservative assumptions, how thin must you slice the unit to buy a house or a hamburger? Or, more specifically, what fraction of a bitcoin will be equivalent to $1 of purchasing power?

If I were to complete the calculation, my Blog subscribers would think that I have lost my senses! The resulting value of Bitcoin dwarfs any speculative assessment that I have seen-even those that don’t restrict their analysis to conservative assumptions. But just because I am copping out of the final numbers crunch, don’t let it stop you! Play with the assumptions and the numbers…Just don’t play with the facts!

Now, it’s your turn to speak up. Where do you think that Bitcoin will be in 5 years?

– Worthless?
– Still around $450/BTC?
– Or very much different?

Others perspectives on the value of a bitcoin:

Disclosure: AWildDuck and its editors are charter members of the Cryptocurrency Standards Association.