Wednesday, November 20, 2013

Two ways to value Bitcoin

I really should find something to write about besides Bitcoin, but while I'm figuring that out …

Timothy B. Lee of the Washington Post has an interesting take on Bitcoin (now trading around $370 as I write this, off its all-time high of $395 -- and now more like $325 as I proofread), modestly entitled Everything you need to know about the Bitcoin "Bubble".  The gist appears to be, "No, Bitcoin is not and will never be a reserve currency, but that doesn't matter.  It can still be intrinsically worth something."

The basis of this is an analogy with the internet.  Like Bitcoin, the internet was once the province of cutting-edge technophiles and other such.  Like the early internet, Bitcoin has a few adventurous players trying to build commercial applications on it.  And, Lee argues, like the early internet, Bitcoin is an open platform.  Specifically, Bitcoin is a payments platform, and companies like Bitpay and Coinbase are working to build payment applications on top of that.

Because Bitcoin isn't really acting as a currency -- but rather, businesses using Bitcoin price in other currencies and convert back and forth to Bitcoin -- the usual arguments against Bitcoin as a currency don't really matter.  The deflationary aspect of a fixed money supply doesn't matter because no one's savings or salary are denominated in Bitcoin.

The price volatility doesn't matter greatly because Bitcoin transactions are ephemeral.  As the payments systems become more mature, the amount of time between the money -> Bitcoin transaction and the Bitcoin -> money transaction should become shorter, and if volume is decent, there are ways of netting out most transactions and minimizing one's exposure to swings in the price.

That's fine, but it says little or nothing about what the actual price of Bitcoin should be.  As long as there are enough Bitcoin in circulation, keeping in mind that there is good incentive for parties using Bitcoin in payment to minimize the amount they keep on hand, it hardly matters whether a Bitcoin is worth $1 million or a penny.  This makes me particularly skeptical about Lee's assertion that "[I]f Bitcoin becomes an important part of the global financial system, its value would need to go a lot higher to accommodate the millions or billions of Bitcoin-based transactions that might occur in the future."

The current dollar value of all Bitcoin is around $325 * 12 million, or just under $4 billion.  By comparison, MasterCard moves about $1 trillion per year, or around $3 billion per day.  Since the same Bitcoin can be re-used over and over again in different transactions, it seems very likely we have well more than enough dollars worth of Bitcoin in circulation right now to last for a very long time, even assuming it becomes a major factor ["same Bitcoin" is not quite accurate, but I believe the point still holds -- we care about the maximum amount in a payment handler's account, and that will deliberately be kept low].  By comparison the current background level of Bitcoin trading, when it's not in a speculative froth, is a small number of millions of dollars.

In any case, how much is a platform worth?  If the analogy is to the internet and the web, how much is HTTP worth?  I'd argue it doesn't have a value, per se.  People make money writing applications that use it, and producing better implementations of it and other protocols, by providing bandwidth for it to run on and so forth, but you can't buy or sell HTTP.  Even if it were patented -- in which case it would almost certainly not be the universal standard it is today -- the value of the patent would only be indirectly related to the value of the business being done on it.

Likewise, just as you can put a value on a company like Bitpay or Coinbase, by looking at how much actual money they bring in, you can't really put a value on Bitcoin as a platform.

Which brings us back to the same two ways to value Bitcoin:
  • How much dollar value needs to be in circulation for it to work as a payments platform -- something
  • How much speculators are willing to pay for it -- a lot
It's not that Bitcoin can't have intrinsic value.  It does, just not very much compared to its current speculative value.  Who knows what that value will be tomorrow, or a year from now?  Could be in the thousands, could be next to nothing.

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