Bitcoin Forum

The whole point of the Speculation forum - trying to make some sense of the market.

Why does Bitcoin have the value it currently does?
What will Bitcoin's value be tomorrow?

Something I think we all fall victim to, at least occasionally, is to miss the forest for the trees.  We assess its value based on just one or two pieces of information.  Bitcoin's value is determined by a free market. There are many moving parts, some pushing the value up, while others push the value down. Any complete valuation of Bitcoin needs to take all these factors into account.

It's all about fear and greed.  Please note - this remains a gross oversimplification.  The main focus here is to define a simple paradigm, a structured way to look at Bitcoin when trying to assess its value.  I would encourage everyone to tailor this model to themselves, most importantly because your belief in the power of certain market forces will invariably be different than my own.


Fear  - Belief that Bitcoin's future price will be lower than the current price.
Greed - Belief that Bitcoin's future price will be greater than the current price.

Let's say you have been watching market prices, and each day for the past 20 days, the price has gone up $1.  There's a good chance you are going to expect it to go up $1 tomorrow.  You're basing that belief on activities that have taken place within the market. That makes it a technical indicator.

Now let's say you just read an article in your Bitcoin news feed - "Amazon to Start Accepting Bitcoin".  If you're at all like me, you're buying up bitcoins with every spare penny you've got, the first instant you can.  You'd be basing your belief on a news event that you think will lead to greater acceptance (and therefore demand) of Bitcoin.  This would be a fundamental indicator.

Please bear with me as I make up a few terms, so that we can talk about the fear- and greed-based fundamental- and technically-based indicators.  Then we'll be able to put it all together.

Fundamental Indicators

Legitimacy (Greed) - Confidence in Bitcoin's long term future, acceptance, and adoption.
Nullification (Fear) - Fear of illegitimacy (i.e. one or more countries defining Bitcoin to be illegal)

Technical Indicators

Oversold (Greed) - Belief that the market's valuation of Bitcoin is too low, and will correct upwards.
Overbought (Fear) - Fear that the market's valuation of Bitcoin is too high, and will correct downwards.

Let's walk through an example to put this all together.

It's March 18, 2013. The article I've been waiting nearly two years for shows up - the Treasury has just announced that it will regulate Bitcoins.  The significance to me is in what they did not say. They did not say they were coming after it. Implicitly, they said they accept it. The Legitimacy indicator has just skyrocketed.  Viewing Bitcoin purely as a commodity, the likelihood of its future value going to zero has just been signicantly reduced. The valuation of Bitcoin has increased.

Time to do due diligence, and scan over each of the four kinds of indicators. Are there any other new forces that might counterbalance the news? Other news that might magnify the value gain? Going through one by one...

Legitimacy - If I remember correctly, a small handful of other positive news stories had broken around this same time.
Nullification - No new threats.
Oversold - The rally was underway, but was controlled, and already looking stronger by the day.
Overbought - No new threats. (The previous all-time high had been cleared, and the order book was solid.)

New Price = Current Price + Fear Adjustment + Greed Adjustment

Factoring in all the variables, there are new, strong upward forces, with no new downward forces.  Everything pointed to an upturn.  I went all-in, and committed to buckling in for the ride.  And whaddaya know, the surge to $266 commenced.

I love the quote, "Plans are worthless, but planning is everything."
Was my assessment correct? I'll never know. Maybe I got lucky, and the price bump was entirely due to the new mining rig surge, or Cyprus, or some other factor I'll never understand.
What matters is that you do it. Then afterwards, reflect on your decision, and learn from it.

This is a great first step towards moving out of emotional investing, and towards structured, findings-based decisions. As you do this more, you'll hone your trading instinct. Learn what you overreact to, relative to the market. Figure out where you tend to see the value ahead of the market. These findings will grow your skill (and gains) as a trader.  It's hard work...but it can sure be worth it. 

Hey!

I see what you're doing here:  you're trying to inject rational thinking into the bitcoin community.

WTF is wrong with you?

 :D :D :D

₊₁

There's more to it than government prohibition, I think. Fear of illegitimacy would include anything that would fundamentally get in the way of using coins you have bought. This includes bugs and market problems, whether people in the future will actually be taking BTC for things you care about, whether you'll be able to transfer two dollars without waiting two days for it to get confirmed...

I 100% agree with you, Qoheleth.  I struggled with trying to keep it simple without glossing over major points.

I think of the fundamentals as being predictors of greater market adoption, usage, acceptance. These things will lead to a greater number of bitcoins being transacted each day - increased demand.  And supply, on a relative scale, remains largely unchanged.

Going in the opposite direction - you gave a great example of why you would use different considerations for different time scales.

When making decisions for my long-term funds, I would be holding the long view - what are the present risks of Bitcoin completely failing? What indicators are there that widespread adoption is imminent? What is the vector, up or down?

When making decisions for my short-term funds, I would be considering fundamentals more like you are mentioning.  What effect has Mt Gox's crashes had? How do I want to respond the next time one occurs?  What do I think will happen to prices now that Mainstream Market X has opened, and allows for shorting?  These things will affect price on a shorter timeframe, but then equalize into the price long-term.

On the fundamental side, my take is:

• Decrease from the Coinlab/MtGox lawsuit fiasco (short term if resolved amicably, otherwise, permanent small-to-medium downward adjustment)
• Decrease from recent regulation stories (short term, mostly fear-based, no new legitimate threats)
• Increase from China's increased awareness/adoption (short term large, long term based on total money that remains in market)
• Increase from favorable statements/awareness by Bill Gates, Eric Schmidt (small)

Technically speaking, I think we've got one more downturn, then it's time to strap in, and hold onto those Bitcoins.

I'd welcome other's opinions on overall valuation, and where they feel it stands today, as compared to recent past.

Thank you for sharing. But how do you quatinfy Fundamental indicators?

Good thread. Thanks OP. However, what about chance variables?

The unthinkable happens quite often I'd say.

Well, the market considered it to be very bad news the possible regulation by the commodities chamber two days ago.

That’s the tricky part. Bitcoin is uncharted territory, so we’re making it up as we go.
If you look at existing markets, they have precedents.  Making up some numbers, let’s say a company starts releasing Widget X. They expect it will earn an additional $1,000,000 per year.  In general, the value of that company can be assumed to have gone up 10 times that annual revenue, or $10,000,000.  Different sectors have multipliers that may be higher or lower, but news generally prices in the same way.

The important thing is to realize, in this equation, we are the tail, not the dog.  Here’s a recent example.  I saw a few mentions about the Japanese banking holiday.  The largest holiday for them of the year!!! Funds won’t be available! My knee-jerk reaction to this was, wow, this could dry up funding, cause a short term dip. Thinking more deeply…Japan is one country. And we know from other data that they do not represent a significant percent of bitcoin users.  So while this news will be significant to anyone in Japan, it is very unlikely to affect the overall market value.

Some fundamental valuations are cut and dry.  All other things being equal, if you double the amount of users/money using Bitcoin, then the value of a Bitcoin will double.  Take this, and put it up against the recent news re: China.  We have seen an increase in wallet downloads in China following the news story.  We have seen a surge in mining. These are the facts. The rest is speculation.  Absent facts, you speculate, and live with your right-ness or wrong-ness.  Will Bitcoin be used to store corrupt money of officials in China? No one knows for sure.  But we do know this: There is alleged widespread corruption at this level, and the amount of money we’re talking about is large.  I can see this news potentially helping bitcoin. Possibly on a massive scale. On the other side, I don’t see it as posing any risk to the value of bitcoin.  I’m not terribly concerned about putting a specific number on this, because my plan is the same either way:  Close any positions in the next 1-10 days, then plan on holding bitcoins until I can look at the impact with the benefit of hindsight.

As time passes, these valuations will start to have precedents, and become more predictable.  Right now, no one knows, so the market defines, then redefines these impacts.  What is true today won’t be true tomorrow.  As long as we learn from our mistakes of yesterday, our valuation tomorrow will probably be more accurate. In my mind, that’s the best you can do – create a self-correcting system of valuation, and stick to it. Incrementally improve. Profit.  It’s enough to make an underpants gnomes jealous.

Thank you again. I enjoyed your posts. Let me know your positions went. and good luck making some money.

I enjoy your deconstructions of market input - but you missed the boat on this one.

The point of the assumption in re Japanese holidays having an over-all depressing effect on liquidity is this:  MtGox is the majority of the trading market > MtGox is a Japanese company with a Japanese bank = difficulty in money transfers being finalized = temporary low liquidity.

BTC Books - 100% agree. I completely missed the point on this one.  I'm glad it didn't bite me. 

Thanks for the correction. You've helped me again improve my process.

I never ran this potential fundamental news past my Trading Buddy (https://bitcointalk.org/index.php?topic=181076.msg1890117#msg1890117 (https://bitcointalk.org/index.php?topic=181076.msg1890117#msg1890117)).
Because, on my own, I had brushed it off as inconsequential.  A false negative!

In the future, I should probably validate those with my trading partner.  Maybe 99% of the time it will yield no change in strategy, but in cases like these, where I was forgetting a crucial detail, it could dramatically change decisions.

Thanks again!

Chainsaw,

Thank you so much for your valuable post. I enjoyed it very much.

I also read your other posts. I like your trading buddy idea as well as your free wealth consulting advise, as well as your buddy's bitcoin rally song :)

I'm sorry for the negative responses you got on the free wealth consulting offer. Some people are just plain rude and acting out. I learn to use the ignore button for those. It makes the experience here more pleasant.  

I hope to read more from you! :)

Well I never got a reply so let me rephrase: Is there any way to quantify risk over time?

The chance of something drastic happening like GOX getting DDOSed or something of the sort increases over the time doesn't it? Therefore the longer a price has risen or had steady growth doesn't the chance of a crash or downturn increase? Or is that faulty logic?

LOL

Good stuff. The speculation forum needs more posts like this.

Thanks for the kind words, all.


Reaper,

I honestly don't know whether the risk increases as a function of time.  My guess would be yes. 

I tend to think of that risk as being more strongly, positively correlated to the value of Bitcoin.  If the value of Bitcoin increases tenfold, a criminal has ten times as much to gain by somehow pulling off the same theft.  In the end, it serves as a balance. Price goes up, likelihood of negatively perceived event goes up, price finds new, lower equilibrium after pricing in the new news.

While I think that's how things work, I don't really base trading decisions on it.  I think by definition, these events are reactive.  You make or lose money on these events by assessing what the market will price the news at, more accurately or more quickly than other traders.

I see. Thank you for this insight. I suppose there may be some risk mathematics out there, but short term evaluation is probably best when trading. I'll keep learning more and working at this on my own.

Nice start Chainsaw, it's encouraging to see an attempt at a rational framework. I don't expect any of us are on top of it all, but maybe together we can get better. So we agree greed and fear drives markets. I would add supply and demand too are another way to view it. IOW there can be demand without greed. Let's say I want to buy a house, and that owner has said he will only sell it to me in BTC. I now need to convert USD to BTC to buy the house. That's demand driven purchasing. While this scenario currently probably does not represent much volume, that may change in the future. FWIW SR was/is significant in this regard.

So moving on, if we accept the formula:

BTC price = Fundamentals + Technicals (i'm not sure the equation concept itself makes sense in this context, but lets ignore that for now).

An issue here is that Fundamentals are not news articles. They are facts. Let's look at one of the most accomplished fundamental macro investors in the world, Ray Dalio of Bridgewater (http://en.wikipedia.org/wiki/Bridgewater_Associates). The company has about 1000 employees who's job it is to research the fuck out of claims and opinions, in order to turn them into facts. He then takes these facts and models them against each other to create a blueprint for how the global economy works.*

*(If you can do that over 30 years, you too could be sitting on a $100b hedgefund)

So to be more specific. Fundamentals might look like this:

- During April $300 USD was wired into Mt Gox and $30m USD was wired out.
- 3600 BTC are mined daily

Those facts or fundamentals affect supply/demand. Stories about Coinbase raising $5m etc, probably add to the narrative but let's not confuse that with fundamentals.

Good question.  One way to look at it I suppose is one day at a time.  Would you say that on any given day the odds of something drastic happening is the same as any other day?

If so, I'd say thinking the odds of the event increasing would be falling for the gambler's fallacy.

http://en.wikipedia.org/wiki/Gambler's_fallacy

Where can you see that?

Well I said those were examples of what fundamentals might look like. But having said that, I did try to base those examples in reality.

The source of for that estimation you quoted above, comes from a 23 April Reuters interview with Gox CEO, Mark Karpeles (MagicalTux).

http://www.youtube.com/watch?feature=player_detailpage&v=LLjlOw3TVc8#t=173s

Was actually an enjoyable read. Thanks

What I'm curious about is how does it go from $30-stable to a stable $100+ price. The only event around that time was that March article you mentioned. So was that really enough faith put into the system to cause the stable price to more than triple?

Massive amount of new USD flowing in?

This is a great distinction to make.  I have a nasty tendency to into too much detail, and sometimes I overcompensate. Taking the example I used above:


I didn't follow each fact or speculative idea to ground.  I completely agree that if in the end, the news will not somehow affect the fundamentals of the market, there will be no effect.  But if A => B =>C => D, then we can simplify to A => D. Above, I stopped at identifying potential conclusions, some of which were certain, some possible. Completely making up numbers:

-Miners in China have recently increased.
-Wallet downloads have increased.
-National awareness of the concept of Bitcoin in China, a significant percentage of the world population, has increased.

More miners:
-Added risk of a 51% takeover from an up-and-coming chinese mining guild, causing a major catastrophe: < 1% No change to positions.
-Larger number of Bitcoin-committed people in the world. Miners have a vested interest in the long term success of Bitcoin. This should add stability. Minor positive increase to valuation.

Wallet download increase:
-Significant influx of new users still in early data discovery phase in Bitcoin. Estimate an increase in adoption and usage, with a minimum of two weeks until those users begin to show up with any real numbers, full impact may be as long as a month. When this occurs, a smooth price increase linearly proportional to the percentage increase in market cap added by these users. Let's assume this initial wave could add 10% to 200% market cap. (All values, IMHO, are positive. I'm not entertaining moving funds into a leveraged positions based on the news, so I don't need to pin it down more than that, here.)

National awareness increase:
-A long term bullish indicator.  On a larger percent-of-total-population scale, we are now introducing more people to the concept of Bitcoin. For every wallet download, there are likely 10 to 50 people still in the undecided phase. Bitcoin is now in their heads, and they've not yet acted.  So in a week, or a month, this won't seem to have had any change.  But the power of a nationally-shown, favorable, 30 minute documentary on Bitcoin, in shaping citizens' view of the currency? That could be a million more users who are now between 1 month and 3 months from dipping their toes into bitcoin. When they do, demand increases, supply remains the same, price goes up.

These are all examples where the news could result in some long-term change to the ultimate value of a Bitcoin. In a perfect world, a story would break, all participating members would instantly become aware of the news, interpret the value change identically, and the price would jump directly from Point A to Point B.  But of course, that never happens.  People have different opinions on what news will mean. That give and take is reflected in the price charts, as the market searches its new equilibrium, between all the people that disagree on how much a price should move up or down.

Still more frustrating - the market doesn't say "Hold on guys, this China news just broke. No one else do or change anything until we decide what this means." So in the end, it's really tough to ask yourself: In hindsight, what impact did this news actually have in price?

If you're still with me (and this is where I wish my ability to explain were better), it is precisely this imprecision and uncertainty that creates the opportunity for profit.  There's a great saying, knowledge is power.  I disagree with that.  I prefer - exclusive knowledge is power.

How does this apply to the example above? Putting my money where my mouth is...I view the benefits from "the China news" to be favorable, but in a timeframe that is far longer term than the market seems to believe.  In short, I feel the current run-up from $79 to $124.90 was premature. Said differently, I feel the market over-reacted to this news. So, I incrementally sold my very-short-term funds in increments as the price potentially topped at $102, $104, $108, and $112. I've got a manual stop limit defined. The trade is set, and barring a change in the market fundamentals that set up the trade, I just wait to find out if I was right or wrong this time. (Again, skipping the details of the technical indicators, but they contribute here as well.)

I could be completely off the mark. I may be unaware of an underlying driver causing a run-up. I may have underweighted the impact of some other game-changer.  But these are unknown unknowns - you do the best you can, and post-mortem the decision win lose or fail afterwards.

That's me. I'm not saying the process is perfect - I'm certain it's not.  While I've been trading for 15 years or so, I'm a self-taught, weekend warrior.  I learn from my experiences, from books on the subject, and from asking questions of the professionals that DO do this for a living, managing a stock portfolio.

wamatt, it sounds like you've got a lot to add to the valuation discussion.  At this high level, I don't have a ton more to add.  I'd love to see a more exhaustive writeup on any/all thoughts you have related to this topic.

Which came from where? And is there any evidence to support that?

It seems to me that the news came out about the government not-regulating bitcoin, which should be a non-issue, and all of a sudden the price skyrockets. Which to me sounds like a bubble. Considering the huge barrier of entry that the exchanges currently are, with the verification and the fees and how difficult it is to actually by a bitcoin, you can't just use your credit card in 2-minutes and buy one, that means there wasn't a huge influx of people into bitcoin because of the news. So where is that money coming from?

This is a bit long-winded. It’s a walkthrough of my attempts to price the market over the past few days, recounting my errors, assessments, and processes. It concludes with my current market assessment (and in turn, position). Am I right? No idea. But that’s the game, isn’t it? You make your bets, and live with the results.

The last few days have been a wonderful opportunity to try to get ahead of the interplay between technical and fundamental indicators, with the goal of seeing the future just a little bit better than the other market players.

By sheer chance, I caught wind of the DHS seizure within a few minutes of it occurring. A friend of mine had just funded his account through Dwolla.  I immediately sold all my short term trading funds, getting an average price of 116.  The first few hours, there was a lot of uncertainty.  I was a greedy little bear, and failed to lock in any profits on the descent to 103 (mistake #1).

What ensued from there is a case study of keeping your composure amidst the storm.  For several hours, no one was able to give a clear, complete answer of what had happened, why it had happened, and what the implications to Bitcoin, Mt Gox, or its users would be.  About the same time this began to clarify, MtGox suffered a prolonged downtime.  While this was clearly a DDoS attack to anyone that was already familiar with recent fear-mongering tactics, its timing caused me to weigh its potential fear-creating significance far more strongly than recent attacks.

Glued to the chair for hours.  Watching Clark Moody, or Bitcoinity.  Ready to move with the market. Fully expecting, whichever direction it heads, it’ll be intense. Certain that when Gox comes back up, buckle up.  Checking bitcoincharts, it is evident that a price disparity is growing between Mt Gox and the other exchanges. A puzzling clue.

In my view, these are the relevant events of the past few days causing potential changes to the valuation of Bitcoin.
Most moves would be purely fear-based, with no change to the true fundamentals of Bitcoin.
The one exception - depending on the government intent from the shutdown, a medium term impact to Bitcoin’s price was a strong possibility. More significantly, a greater-than-0% risk of losing funds in Mt Gox existed.

Now, everyone in the market has this same information available to them. Yet when gox came up…nothing happened.  The tight trading range remained just as tight. Price didn’t move.  Orders stacked up on each side.

This brings us to the present moment.  Since there wasn’t a ton of price activity, I had a lot of hours to sit and think about a model or hypothesis that would explain all the moving parts.  I finally got there today. Based on it, I begrudgingly reversed my position, and am again 100% in Bitcoins.

I worked backwards from the key, unanswered observations. Something needed to consistently explain all the variables.
-Bitcoin prices on Mt Gox were fetching a several-dollar premium over the other big exchanges, for a prolonged period of time.
-Despite two notable news events related to Mt Gox, trading volume remained remarkably low.
-The annual conference begins soon (now less than a day), providing much greater opportunity for upside than downside.

The answer? Market participants remain gridlocked – no one wants to move first.  But when they do, they will move to the upside. This is because bears’ positions are unknowingly contradicting themselves. (BitcoinAshley talked to this at a general level, beautifully. I’m talking here about how it pertains specifically to this market condition.)

Mt Gox bitcoin prices are commanding a premium, because some percentage of the userbase is now fearful of DHS seizing their accounts. So they’d like to convert their fiat to bitcoins, transfer away from Gox, and then sell elsewhere. This explains the price differential.  But not the wait, and low volume. What explains that?

I think this is where game theory comes in.  People are expecting a downturn.

First let’s look at the bears.  Why on earth buy back in at 115, when you could get the same coins for 105 tomorrow? These bears are waiting for someone else to sell their coins. But damned if they’ll sell theirs, because that would mean getting fiat.  So the people you’d expect to sell, won’t, because we have a unique situation where the risk pertains to a market, and not the commodity, disincentivizing selling.

Now the bulls.  They’re waiting for that same downturn.  We’ve been in a trading range for a lot of days now.  There’s big money on the sidelines (just look at the order book).  People just drooling over the opportunity to pick up bitcoins for $100. Or dare I say it, $80? $50?  Too many people.  When the price takes a dip, volumes rush in.  The bulls are deferring their buying back in, because they’re also waiting for the bears to act. Why on earth buy back in at 115, when you could get the same coins for 105 tomorrow?

Here’s where it gets cute.

The longer Gox stays up, the more the risk of Gox ‘shutting down forever’ in the immediate term lessens.  As this fear abates, a previous bear will be immersed in a different way of thinking. One that says “Hey, going to fiat isn’t such a big risk. I guess I can sell now.” It is that same shift in sentiment that will cause them to no longer wish to sell.  They just can’t see it from their current reality.  Their position contradicts itself.  In short, time is on the bulls side. The longer Gox goes without a crash, without a downtime, without an apocalyptic announcement, the more bullish the position becomes.

If this all holds…it changes the game theory equation. It’s no longer a zero-sum game to wait and see what happens.  If time is on the side of the bulls, waiting is a detriment.  We know (okay, I have strongly suspected for weeks) that the breakout from this range will be violent. I believe that intensify grows as the duration of the trading range grows.  We’ve seen multiple failed attempts at crashing through support.  Massive orders are on the books.

All of the above leads me to conclude that we break out to the upside. Most likely without another substantive dip. (I had predicted an 80% likelihood of touching $100 again. I now put it as less than 25% likely we’ll even hit $103.) 

Medium and long term, I am incredibly bullish on Bitcoin. The risk profile changed, as time passed. Being in fiat as the potential negative outcome fails to come to pass, while marching towards a potential strong bullish indicator – that’s not the side of the trade I want to be on.  So now, I’m fully in.

I’m far from rock-solid on this.  But this model seems to cover, with a logical explanation, the actions of all the parties.  I’d rather guess bullish and be ready to reverse in the event of a crash than the opposite.

Right or wrong, I hope this gave you a few things to think about that maybe you hadn’t previously.  I welcome any comments aimed towards refining this theory, poking holes in it, further reinforcing it.

Interesting analysis from a game theory perspective, thanks. :) I also believe we are breaking out upwards, barring any further bad news. I'm giving it 50% of going up on the short term, 30% of further sideways trading within a narrow range (105-125), and 20% for hitting sub-100 again within the next couple of weeks.

Wow. Really a good read. I'm on watch list now. Thanks for sharing your thoughts!

You're very welcome! In the 3 hours since I posted this, action has supported the theory more than refuted it. We broke the local maximas in the 116.40 range, going from 115 to a surge to 118. More notably...the increases came predominantly from two large buys.

If I had that kind of capital, and it's sitting in fiat...how many more of those large-scale buys has to happen before I think "Oh man, this downturn ain't happening. I gotta get in before it really takes off."  The panic buy is a beautiful, beautiful thing to be on the right side of.  Every dollar increase further increases the likelihood of more gain.

The key, I think, is to keep a clear picture of which of your funds are long-term, and which are short-term.  If this run-up does end up getting ahead of itself, it would be healthy for the bitcoin economy (not to mention your wallet  ;D) to have your short-term profit exit points pre-set.  Greed is always a double edged sword.

great post/s.

I also see the positive news of founder funds and webmoney being a large element of a slowly coiling spring... it's a little too soon to act on after dwolla news, and still with no report from gox... but I imagine over the next 4 days there should be some interesting movement, expecially if there are positive announcements in relation to the conference.

I am also all in :)

Nice write up. One consideration, it appears "break-out" is a common expectation around here. What if we stay deadlocked for months?

Well, then I'd switch to a ranging trading strategy.  It's impossible to differentiate the two without hindsight. I feel that the cohesive picture, taking into account all the clues, more strongly supports a temporary log-jam that is, as we speak, relieving itself in the only direction it can.

The fundamentals have offered strong, conflicting signals. We've seen a failed opportunity for crash. We experienced a period of no-one-wants-to-go-first.  With each successive price increase, or large-scale buy, the likelihood that the above-posted theory was correct (Page 2, 6th post) increases.

Just for good measure, I gotta include a link to the Bitcoin Rally Song  :)
https://bitcointalk.org/index.php?topic=168163.0 (https://bitcointalk.org/index.php?topic=168163.0)