Wednesday, November 20, 2013

The Theoretical Price Limit of Bitcoin

Permit me a very simple mathematical observation.

In my previous post I pointed out how bitcoins were more like diamonds in that there is a limited supply of them, and bar some industrial uses, really have no practical value.  Ergo, if you want to compare the value of diamonds to dirt, diamonds are valuable because they are scarce and dirt is cheap because it is not.  This ratio of "diamonds to dirt" would by math give you the exchange rate.

So, why not dollars instead of dirt?

You can choose your poison of which measure of the US dollar supply you want to use, but since bitcoin is only going to have 21 million units produced you can calculate their theoretical dollar exchange rates quite easily:

M1 Money Supply - $2.6 trillion
Implied Bitcoin Value = $123,809

M2 Money Supply - $10.974 trillion
Implied Bitcoin Value = $521,319

For this super awesome economic analysis you can read one of my books.


Boom said...

Capt, bitcoin is worldwide currency.

Thus, you must use the global money supply.

Here it is as of 2010 (scroll down to the chart for est. global monetary aggregates):

Global M1 = ~$25Trillion
Implied Value of One bitcoin = ~$1,190,476.19

Global M2 = ~$60Trillion
Implied Value of One Bitcoin = ~$2,857,142.86

Of course, this assumes that bitcoin eventually replaces all fiat money in circulation...which is a tall order.

Furthermore, if bitcoin or some other crypto-currency ever starts to replace most fiat money, then it will have to start being traded against commodities, like gold or silver, in order to maintain its relative value.

August said...

Then there's the fact people can lose them, like losing cash in a fire. Bitcoin is deflationary. Assuming it can withstand the legal assaults, its implied value can go higher than what you suggest.

And on top of that, there's network value. I don't buy into Metcalfe- I think Odzyklo's model is more accurate. n log(n) rather than n squared. Much more reasonable, especially in the early stages.

Dollars will not last forever. I don't know whether or not Bitcoin will either. I think the rise in it's price reflects growing confidence as the government fails. Much remains to be seen. Will they ban it? How much effect will a ban have? If a ban has little to no effect, and the network becomes more efficient (like if Cody Wilson & co can deliver an anonymous and slick user experience housewives could use without worrying about getting caught by law enforcement) then your theoretical price limit makes about as much sense as if you did it with beanie babies vs bitcoins.

There is already some adoption in China. The chinese version of Google (Baidu, I think) is supposedly using them, and one assumes a large Chinese company checks with the government before they start fooling with such things. The Chinese are the people to watch because they hold so much of our paper that they still have some interest in seeing the dollar propped up, but they see this train is going to wreck at some point. If they figure out how to transfer out of dollars- and I am sure they are brainstorming about it (already Australia and China have agreed to do direct trades, bypassing the internationally agreed upon dollar as reserve currency)- the dollar will be devalued fast.
Additionally, when the U.S. government, casting about for revenue, starts to go after pensions, 401ks, and IRAs in earnest, they'll end up tanking the stock market, which up to now they've managed to prop up. But all the people they screw with any assets in Wall Street will sell.

You might make a better comparison with dirt. At least you can grow food in good dirt.

Anonymous said...

another observation: the only good thing about bitcoin is that it removes the taxman and the policeman from the game, they are called the law enforcement. But other than that, the way bitcoins are produced is ineffective. If I want right now to pay someone in bitcoins, I dont have any, just like many others. They also proved that bitcoins can be gamed, it has a flaw. But there is one thing I can do: I can convert money to bitcoing by buying them - this way I avoid the law enforcement, so they are free to block my Paypal Google Checkout accounts, it does not matter.

lets hope another system better that bitcoin comes along, like any software. popularity is good.

Anonymous said...

bitcoin has no intrinsic value.
Furthermore it is not scarce - it is infinitely replicable.

What do you think is going to happen to the value of a bitcoin as soon as someone else comes along and creates another virtually (heh) identical encryption-based currency? Given the huge advantage and monetary reward to the developers and early adopters, as soon as one person shows that it can be replicated, expect a torrent (heh) of copycats all trying to cash in with similar ponzi schemes.

bitcoin is currently an interesting speculation as long as you can accept the very real risk that you may lose most or all of your investment. i.e., Caveat emptor

Enjoy the bitcoin bubble while it lasts - if you dare.

Dave said...

Bitcoins work fine as long as people just buy and hoard them. In the world's first-ever case of hyper-deflation, the currency's value doubles every week, so no one wants to spend any.

Let's suppose speculators don't ever get bored and decide to cash out. What if people start using Bitcoin as a real currency?

By design, every node must receive and archive every Bitcoin transaction ever made. To support any serious use of Bitcoin (e.g. 0.1% of the world's daily financial transactions), each node would require a Google-sized server farm in a location with abundant electricity and network bandwidth. Such nodes would be very easy to tax, regulate, and spy upon. You might as well use SWIFT.

Anonymous said...

And the virtual currency copycats start:

Given that this is the closest thing a non-sovereign can do to 'mint' money, expect a lot more until sovereigns start to get serious about protecting their seniorage. Really, really serious.

August said...

Bitcoin has already shown it holds up well despite the fact you can replicate it- because you have to replicate the whole network. So bitcoin has the innovator's advantage, and since it already has an established user base, it tends to be considered more valuable. We can deal with multiple virtual currencies, just like we deal with multiple real word currencies, and the primary driver of value is the integrity of the currency, not how many competitors it has.


Why is this a problem for bitcoin and not, say, a problem for email?
Bitcoin is decentralized, so everyone who uses it will be keeping transactions. Why would we need server farms when the work is already farmed out to all the users? I can see there could be a theoretical limit where there are too many transactions for the bandwidth available to handle, but what's the math on this?

I am mainly just hopeful something works and figure the only real way we will know if bitcoin is going to work is if the government attacks it with everything it has, and fails.

Anonymous said...

Bitcoin is decentralized, so everyone who uses it will be keeping transactions.

Actually not so decentralized as you might think. That is to say, yes, bitcoin itself is designed to be decentralized, but the way it is most often used adds an element of centralization, which can create security weaknesses:

Anonymous said...

Peter schiff on bitcoin:

Dave said...

> Why is this a problem for bitcoin and not, say, a problem for email?

Because an e-mail message is passed on to the recipient's computer and then forgotten. It does not have to be validated against every other e-mail message ever sent.

The work of storing and verifying transactions is not "farmed out to the users"; it's duplicated by each individual user.

Since the Silk Road takedown, the US government owns 1/8 of all Bitcoins in existence. They can pop this bubble any time they want.

Anonymous said...

Then use an anonymous email, not connected in the US. Problem solved. There are more and more countries that simply wont tolerate NSA spying anyway.

JoeAmerica said...

I was wanting to become a market maker for Bitcoins several years ago but never found the time. Bitcoin has hit 1200. If you look at the price chart of Bitcoin it is totally parabolic. This is very big, what would be the volatility on that? It would be a nightmare to trade something like that. What is the reason behind this huge demand for bitcoins? I am thinking Japan. Japan is by far the biggest debtor nation in the world with hopeless demographics to boot. There bond markets are in there worst turmoil in its history. If Japan essentially defaults as the third largest economy in the world will make the Greek default look like child’s play, this will have a huge impact on the global economy. Japan will implode, it is only of question of when. It looks like that day may be soon approaching, get ready for the next recession.