(This item originally appeared at Forbes.com on December 7, 2017.)
What is the fundamental value of bitcoin? It seems that even the Bitcoin enthusiasts themselves have trouble answering this question. Bitcoin does not have any assets, cashflow, cost of production or final consumptive demand, the traditional basis of most asset valuation techniques.
The market price of anything is determined by supply and demand, in the market. Buyers and sellers. This, by itself, does not mean too much. It just means there’s a price. However, we can then start to think about why people would demand (buy), or supply (sell) Bitcoin.
Bitcoin is a form of money. It is, arguably, not a very good form of money, as its value is intensely volatile. However, it is used as payment in monetary transactions. Goods and services are traded on one side, and Bitcoin is traded on the other.
Certainly, much of – probably, most of; perhaps, nearly all of – the present demand for Bitcoin is as an abstract trading sardine. Its buyers are not acquiring Bitcoin to later use it in some monetary transaction, like purchasing some goods or services. But, at least some of the demand for Bitcoin is for this purpose. (Most foreign exchange trading volume in regular currencies is also speculative, but most demand is monetary.)
Bitcoin has proved itself to be quite useful for certain things. It is a nearly-costless way of transferring value over long distances, and (supposedly) anonymously. It does not make use of the banking system, and does not leave a paper trail. It can be used by anyone with a smartphone, which includes millions – perhaps, billions – of people in places like India, Afghanistan, rural China, Cambodia, and all of Africa, who do not have bank accounts, and perhaps don’t want to have one. Other options for these people consist largely of in-person transactions involving paper money, and perhaps gold or outright barter.
Let’s imagine that some of these millions of people decided to acquire $100 of Bitcoin, not as a speculation, but simply as a means of payment. They want to buy something with Bitcoin. Perhaps the seller insists on it, or perhaps it would be better than alternative means. Maybe they just want to try it out, and see if it might be used to their advantage. Or, maybe they are sellers who want to see if accepting payment in Bitcoin is good for business. They start with $100 of Bitcoin, and gradually get more as payment for goods and services. Given the stark volatility of Bitcoin, perhaps they don’t want to hold onto this for too long. Once they acquire $1000 or so of Bitcoin, they trade it for $20 Federal Reserve notes, which they consider a more reliable store of value.
Let’s say that, over time, 100 million people – only about 1/70th of the world’s population – acquires $300 each of Bitcoin, for transactional purposes. Their individual holdings are going up and down, as they buy and sell things, but on average it is $300. They don’t really care too much about the value of Bitcoin in terms of dollars, because they are only holding $300 of it. The “demand” for Bitcoin that results is thus 100 million X $300, or $30 billion of Bitcoin market cap. Expand this up to 1 billion people, which is not too silly, and we have $300 billion of Bitcoin market cap.
Bitcoin’s market cap was recently $267 billion, at a price near $16,000/Bitcoin. So, we are already near that figure today, and I don’t think it is because there are a billion people holding $300 each. Speculative demand – demand which can turn into supply in an instant – probably represents most of that. But, I think the “fundamental” demand for Bitcoin (and its relatives) as a transactional tool continues to grow underneath.
Over time, I think people will realize that a highly volatile instrument like Bitcoin makes a great trading sardine, but does not make good money. We want money to be as stable and reliable as possible, to serve as a store of value and a basis for long-term contracts. Anyone who made a loan in Bitcoin at the beginning of 2017 would be ecstatic today – the value of their debt rising multiples in dollars – except that their borrowers would default, leaving them nothing. Anyone who was paid in an unchanging number of Bitcoins would be ecstatic, except their employer would be out of business. Probably, these themes will become a lot more prominent after Bitcoin falls in value, a lot (perhaps from much higher levels), or has a long period of whipping up and down while trending nowhere.
Oddly enough, I’ve found that the qualities of stability and reliability are not valued today. Interest in cryptocurrencies tied to dollars or gold, and which thus do not have dramatic increases in market value by design, has not been too great. The spectacular rise in market value of Bitcoin and its imitators has focused people’s interest in them; this interest in turn leads to exchange market liquidity, and broader adoption, for monetary purposes or just experimentation. I think this will pass in time – but that time may be still several years away. At first, people like to go with what other people are using. But, after the novelty wears off somewhat, there might be something of a shakeout, with the focus moving towards cryptos’ usefulness as a means of commerce, rather than a speculative toy.
The total market cap of all cryptocurrencies is now $414 billion. That is still quite a ways beneath M2 in the U.S. alone, a measure of “dollars” including bank deposit accounts, recently $13.78 trillion. Potentially, there is still great room for expansion, although there doesn’t seem to be any barrier to entry into this market. But, if cryptocurrencies are going to take the place of existing government currencies, they will need some of the properties of existing currencies, including enough stability of value to serve as the basis of contracts and basis of pricing.
