Do you believe John McAfee is right about Bitcoin hitting $500,000 in 3 years? originally appeared on Quora: the place to gain and share knowledge, empowering people to learn from others and better understand the world.
Answer by Vladimir Novakovski, 8.5 years in hedge funds, on Quora:It’s interesting that almost all existing analysis of cryptoassets are from the point of view of fundamentals (or lack thereof). It’s often useful to look at things quantitatively instead.
So here, what we really want to understand is the probability of bitcoin reaching $500,000. There are a few ways to do that.
First, we can assume a completely random process and take a “gambler’s ruin” perspective. What is the probability that a random process will hit $500,000 before it hits $0? Given that the price as of Dec 2017 is about $15,000, we’d get $15,000/$500,000 = 3%.
Another approach is to model price as a lognormal process, which is a reasonable assumption to make for a broad set of assets. See Why do prices and income follow a log-normal distribution?
We’d then need to estimate volatility and expected return of bitcoin. Expected return is harder to estimate — we can use the historical return, but that’s a pretty biased estimate. For example, if you pick a stock that performed the best out of the S&P 500 in the last 5 years, would you expect that stock to have the same expected return going forward? Mostly likely not. Same with bitcoin — unless you already made a prediction of its expected return before the really high realized return we see now, your Bayesian prior should be lower.
With that said, the general methodology of how to estimate distribution with a lognormal process for asset price is described here: John Young's answer to What is the bitcoin price prediction for 2019?
Based on this, depending on how liberal you are about estimating expected return, you’d be looking at a probability in the 1–10% range of reaching $500,000 in the next year.
Further methods would involve looking at option prices. Right now, there’s not a particularly liquid market for options yet, but with bitcoin futures opening today, that may change soon. With option prices, you’d actually be able to trade a call option with $500,000 strike, and the price of this option would roughly be proportional to the probability of reaching that level by a certain maturity date.
So — to summarize, we are probably looking at a range of 1–10% probability of reaching $500,000 in the next year, depending on how you model it. Beyond that, it’s harder to know, with changes happening to the market like introduction of futures, but eventually there may be a liquid market for making such predictions through options.
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