Investors and economists have spent much time discussing the ‘real’ worth of bitcoin, which should ultimately be reflected in its price. This is easier said than done. At the simplest level, the floor ‘value’ of a bitcoin is the amount of electricity it takes to mine it. This is increasing all the time, as mining hardware has to work ever-harder to ‘find’ new coins. (Once the cost of buying hardware is taken into account, it’s by no means a given that miners will see a return on their outlay.)

On the other hand, bitcoin’s real value isn’t in the electricity consumed to maintain its ecosystem. It offers a low-cost, fast, secure way of transferring funds anywhere in the world, completely outside of the control of any centralised banks or governments. How do you put a price on that? If it is widely adopted, the all-time-highs of 2013-14 could be dwarfed. If another contender rises, that better achieves the same ends, bitcoin could eventually be all but worthless.

Future potential

Calculating the future potential of bitcoin is extremely difficult (if it was not, then this future potential would already be priced into the market to some degree). It’s fair to say that if it is widely adopted then prices will naturally rise steeply: the laws of supply and demand dictate that more buyers mean higher prices. At the moment, the number of people who own bitcoins in any meaningful amounts is probably somewhere between 500,000 and 2 million, depending on the method and criteria you use to estimate ownership. Clearly there is huge room for growth – 10, even 100 times, or more. However, if the number of bitcoin owners rose 10 times, this does not mean that prices would rise by the same number. It could be much less; it could be much more.

Supply and demand

Look at it this way. Suppose you have a village of ten families. The village baker makes 10 loaves of bread and sells them for $1 each. Every family has just enough. Supply and demand balance. But suppose one family leaves the village? Then there is over-supply. No one really wants or needs the tenth loaf, so to get anyone to accept it the baker must drop his price far below $1. Conversely, what happens if an eleventh family arrives? Suddenly, there is an under-supply and the hungry families are each prepared to pay much more than the original $1. The same is true of bitcoin. The price won’t simply follow the number of adopters: it will be a function of the gap between supply and demand. And that is far harder to judge.

A global payment system

It may be possible to establish some basic parameters for bitcoin’s value. A floor value is the cost of electricity and mining hardware, since if it’s not economical to continue mining then the miners will concentrate their efforts elsewhere – probably on another cryptocurrency in its infancy, that offers better short-term returns. Beyond that, consider what might happen if – as its advocates claim – it becomes the default way of transferring money online. What would a minimum value be? Well, if the value of one bitcoin was only $1, then the total value of all bitcoins in existence, once they were all mined, would be only $21 million. That would mean that no transaction larger than $21 million could take place. That rules out any large sales such as real estate or medium-sized companies. In fact, even the highs of $1,000 mean that the total ‘market cap’ of bitcoin would only be $21 billion. That’s not much for a global means of exchange used by tens or hundreds of millions of people.

Deflation

Bitcoin is deflationary in nature. The supply is capped at 21 million coins. Coins will be lost as time goes on, meaning that it becomes an ever-scarcer resource. Unlike inflationary fiat currencies, that will push the price up over time, rather than down. Add to that the fact that fiat currencies in debt-laden Western economies are already groaning, and the value of any non-inflationary currency (such as gold, silver and bitcoin) starts to look at lot higher in comparison, especially over the long-term.

Monetary base

Establishing a lower limit is one thing; an upper limit is far harder. In fact, it is all but impossible. Once again, comparisons are useful for framing the boundaries of the question rather than answering it clearly.

The US’s monetary base – all the money in cash and checking accounts, in its most liquid (spendable) form – is around $4 trillion. Bitcoin’s monetary base is 21 million bitcoins – and at the time of writing, only 12 million of these have been mined. No one (at least, no one credible) is suggesting that bitcoin will replace the US dollar as the default means of exchange or the global reserve currency. However, the fact that the amount of liquid cash in the US stands at something like 300,000 times the current number of bitcoins gives some indication of the gains bitcoin might make if it captures even a tiny fraction of the dollar’s market share. That’s without even taking into account the share other global currencies such as the Pound, Euro and Renminbi.

Bitcoin has immense potential. Whether it will reach it is yet to be seen.

 

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