Method #3. Medium of exchange
An alternative method of determining the fundamental value is much less developed due to its complexity and inability to fully collect all the necessary data. We are talking about the hypothesis of determining the fundamental value based on demand for crypto currency as a medium of exchange.
The most interesting, in our opinion, interpretation of this approach is reflected in a series of lectures by Princeton University on the topic of cryptography and bitcoins.
The economic model, presented by Pr. Edward Felten, is based on the following assumptions:
1. Demand for bitcoins is based on the need for transactions (as an alternative to fiat transactions) and the investment attractiveness of bitcoin;
2. The supply of bitcoins (without taking into account bitcoins, which are retained as long-term investments) is a constant value;
3. Transactional demand for bitcoins is determined by the sum of the fiat currency unit, to which the transaction is to be made at that moment and the bitcoin transaction rate.
Given the assumptions, we get that the number of bitcoins available at a given second can be expressed as:
S/D`
where S is bitcoin supply (in bitcoins), and D is the duration of the bitcoin transaction (in seconds).
The number of bitcoins needed at a given second can be expressed as:
T/P`
where T is the transactional demand (in dollars per second), and P is the price of bitcoins (in dollars).
Adopting the form of equilibrium in the market, we can conclude that:
S/D=T/P, or P= (T*D)/S
Assuming that the supply of bitcoins is constant, just like the length of the transaction, we can conclude that the price depends only on the transaction demand. Evaluation of transactional demand can be used to determine the fundamental value of bitcoins as a medium of exchange. The problem is only that, first, it is extremely difficult to assess the transactional demand. Secondly, supply in the market of bitcoins is not permanent. In my opinion, it is decreasing, as more and more investors buy bitcoins as a long-term investment, thereby withdrawing these units from circulation. These difficulties, however, do not influence the logic be behind the model which is sound and reasonable.
Summing up, we considered two most popular and, in our opinion, logical methods of fundamental value of bitcoin. The first one relies on computational power required to mine bitcoin, and the second one relies on money-like properties of the cryptocurrency. These hypotheses are based on a certain economic and theoretical basis and give us at least some understanding of what the price of bitcoins and crypto-currencies bears in themselves. Do these methods reflect the real picture? Probably not. Fundamental value is not always a good benchmark for valuing an asset. You can recall a tulip fever, The South Sea Bubble or, a more modern one, a dot-com bubble. For this reason, it is worth remembering these methods, but do not rely too much on their results during periods of violent emotional instability.
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