What is Bitcoin’s Intrinsic Value?

Bitcoin has seen a remarkable surge up to around $20,000 USD and an equally impressive drop right back down to around $8,000 USD presently. But what is the coin actually worth? I recently came across an interesting article by Frank Chaparro where he discusses how two economists have calculated why they believe Bitcoin should be valued at $20 per coin. Richard Jackman and Savvas Savouri, two economists from the London School of Economics and Toscafund Asset Management respectively, claim that bitcoin’s value should be based on its demand as a medium of exchange. Their logic is as follows:

“The supply of bitcoin increases only slowly towards its famous fixed limit and is now around 15m. The use of bitcoin as a means of payment is currently around $100m per month, or $1,200m a year. Were bitcoin just like ordinary money each bitcoin would be used around four times a year in making transactions. So we have 60m bitcoin payments supporting $1,200m worth of bitcoin transactions, which requires that each bitcoin is worth $20.”

It will be interesting to see if that is how cryptocurrencies that survive the digital arms race actually end up being valued in the future. With no physical assets to back them, their value is based entirely on consumer perception, which seems to be at an alBitcoinstock3.jpgl-time high. The massively inflated valuation of bitcoin can therefore be attributed to this perception, however it is difficult to determine whether that will continue. Jackman and Savouri’s idea is very plausible for how future currencies are valued as the marketplace for cryptos becomes competitive enough. These competing currencies could then be forced towards their equilibrium values based on their individual demand’s as mediums of exchange.

I think one major flaw, or in this case over-simplification, is the fact that one bitcoin would be used four times per year just like ordinary money, otherwise known as the velocity of money. This number four simplifies an extremely complex concept and would be a major cause of volatility in the intrinsic value of any cryptocurrency. The velocity in an economy typically ranges from 1.4-2.2 per quarter, or 5.6-8.8 annually (1). As credit cards, direct debits, and e-transfers have fundamentally changed the way we transfer money, the number of transactions that are done per person have increased and continue to increase every year (2). This has created a misconception that the velocity of money has increased, however we are actually in a historically low-velocity environment today based on major economic factors such as interest rates and the money supply. These fluctuations in the velocity of money make valuing a cryptocurrency by this criteria much more speculative, but lays an excellent groundwork in what could happen in the future.

An article by Kyle Samani called The Blockchain Velocity Problem addresses this issue of velocity of money with cryptocurrency. He describes an application of blockchain technology in a ticket exchange website. How it works is as follows:

  1. Someone decides to buy a ticket online from an individual seller
  2. They select to buy that ticket and their money is exchanged into crypto-tokens
  3. Those crypto-tokens are sent to the seller and immediately exchanged back to cash
  4. The buyer receives their ticket and the exchange is compete

These tokens are only in existence for the time it takes to complete the exchange, a matter of seconds or even fractions of a second. This reduces the price volatility of the tokens that would occur by holding onto them, while consumers gain from increased fraud protection.

In this case, there is a proprietary token that nobody wants to hold due to price fluctuations. This velocity will be constant and will increase linearly with total transaction volume. Since velocity is calculated as the Total Transaction Volume/Average Network Value, when we calculate the average network value: no matter how big the marketplace grows, the value of the network stays constant. This is a problem almost all utility tokens suffer from.

One of the ways to combat the problem is to give the currency an expectation that it will increase in price, therefore providing an incentive to hold onto it. Theoretically this will slow down velocity and drive up the value of the network, and is exactly the model that bitcoin operates on. There is no intrinsic value, just a speculative belief that the value will continue to rise, therefore people are willing to hold onto it.

It’s impossible to say what will happen to bitcoin in the future, or whether it will be valued based on this speculation or based on its intrinsic value as a payment system. Whatever happens to it, there will still be people trying to convince you, and by doing so reassuring themselves, to trade the clothes off your back for BTC.

References:

(1) https://fred.stlouisfed.org/series/M2V?cid=32242

(2) European Central Bank – Statistical Data Warehouse http://sdw.ecb.europa.eu/reports.do?node=1000001390

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