Hi all
first post
I wrote this after trawling through every Bitcoin valuation model I could find on the internet. There is what I consider one really important factor that most of them have not considered, or at best have only brushed over. That is; the velocity of money and how it has the potential to seriously increase with cryptocurrency.
The most common way I have seen to calculate a valuation for Bitcoin typically looks something like this; estimate the future market cap of Bitcoin then divide this by the number of Bitcoins we know will have been mined at that time to arrive at a figure of what one BTC is worth in dollars. The term ‘market cap’ is commonly used but this term relates Bitcoin to listed companies. As we are valuing a currency not a company I prefer to use the term ‘money supply’ or ‘monetary base’. But ‘money supply’ in this context can also be potentially confusing as the ‘supply’ of Bitcoins is mathematically predetermined, what is not yet determined is the total value of those coins. So to avoid this confusion I will use the term ‘monetary base’ instead. The tricky part of such a valuation comes in all the assumptions that need to be made to determine the size of Bitcoin’s potential monetary base. What proportion of ecommerce will Bitcoin take over? Will it take a share of the Gold market as a long term store of value and by how much? What if it takes over just the credit card industry or PayPal? Assumptions also need to be made on the supply side. We know exactly how many coins have been mined into existence but how many coins have been lost and what ever happened to Satoshi Nakamoto’s 1 million coins.
For the purpose of simplifying my argument lets fast forward to some future Bit-topia. Where all of our most optimistic predictions have come true and Bitcoin has been adopted by every person, business and government in the world, a bunch of altcoins have come and gone leaving Bitcoin the sole survivor, we know the exact total number of mined coins and some genius has worked out an algorithm to estimate the number of lost coins. So valuing Bitcoin in this scenario should be fairly easy right? Add together the monetary bases of every currency in the world (leaving aside for a moment that every country has a different method for measuring this), convert them a base fiat currency then divide by the total number of coins in circulation. I don’t have the time or resources to do this accurately but plenty of other people have done just this and made it available on the internet if you care have a look. The figures I have seen range from impressive to staggering. But before we get too excited I think there is one important factor that has been forgotten.
We can break down the demand for a currency into two parts; demand for use in transactions and demand for use as a store of value. Compared to fiat as we currently know it Bitcoin has the potential to be a far superior store of value. That’s obvious to anyone and offers a massive potential to increase the price of Bitcoin. My argument only relates to money’s use as a tool for facilitating the transfer of one asset to another between two parties. Take the monetary base of any economy and divide it by the total wealth of the economy. What proportion of that wealth needs to (or should be) represented as currency? Wealth that is held as currency is not being utilised in its most productive way. To achieve maximum efficiency an economy needs to keep the fraction of wealth held in currency as low as possible. Consider the concept of frictional unemployment, where even in an economy running at full output there is still some unemployment due to people in transit between jobs being technically unemployed. Fiat money as we know it today is frictional in the same sense; it is ‘unemployed’ wealth. So if Bitcoin is a frictionless currency, how much currency do we really need?
Imagine you got paid your entire salary in one lump sum at the beginning of each year. Overall you wouldn’t be any richer or poorer, your expenses would be no different but you would have a much larger proportion of your total wealth held as currency. Now compare this to sometime in the not too distant future where bitcoin allows you to be paid in real time as you work. Your car insurance, mortgage, etc. can also be paid in tiny increments as soon as you have been paid for your work. How high will your bank balance ever get to now? A well run company only keeps as much cash as is necessary for day to day expenses. Any extra cash that is not used to pay down debt or equity holders or to invest in new projects is not being used optimally. Soon a retail store can receive payment from a customer paying with Bitcoin and receive that payment almost immediately instead of waiting maybe 3 days for it to clear. The store might have an automated inventory system which can then order more stock from the wholesaler but instead of using some other cash they had set aside they can use the exact same cash they received from the customer minutes earlier. The wholesaler can then receive that order and immediately pay their suppliers for their next order and so on.
What is occurring in my examples is an increase in the velocity of money. Velocity being the number of times a unit of a currency turns over within a given time period. Although it might seem counterintuitive to you at first a higher velocity of currency actually brings its price down. Because the currency is able to be used so many more times over within the time period we don’t need (or demand) as much of it as we do with slower currencies.
Trying to estimate Bitcoin’s future monetary base by using a measurement of our current system is like someone 20 years ago trying to calculate how much internet bandwidth will be needed once everybody has an email address by looking at data from the post office. The invention of frictionless mail allowed us to send more mail but the invention of frictionless money will allow us to use less money.
