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Fjordbit
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 July 09, 2012, 03:24:08 PM

I want to talk a little bit about what gives Bitcoin it's exchange rate. The simple answer is the meeting of the supply/demand curve, but it is important to look beyond this and figure out what exactly drives the demand for purchasing Bitcoins from a fiat currency, and where the supply of coins comes from as well.

First, I'd like to simplify in order to exaggerate some of the effects of different actors in the Bitcoin economy. Imagine a Bitcoin economy that has only one buyer, one seller, and one miner. The buyer wants something, the sellers produces something with some fixed costs (say \$30) and sells it for another price (say \$50), and the miner keeps the network running. The buyer regularly buys from the seller by putting his fiat in an exchange and the seller always sells his Bitcoin for fiat at the same exchange. Let's call each buy-sell a "cycle". The miner also uses his rewards to buy from the seller.

We can see here that if the miner is making more than \$20 per cycle then the seller will go bankrupt, because only \$20 of value is being injected into the economy every cycle. In fact, even at \$20, the seller would close up shop and sell elsewhere because they would be making no profit. So this is the first complexity: how much of the sellers profit are they willing to turn over to the miners. Because of credit card fees, we know that sellers can be willing to turn over 3% gross, which can be up to 10% net to a processing company. This tolerance for sharing profit is part of where the value comes from. So let's say the seller will tolerate 3% of \$50. This means that the miner should be earning only \$1.50 per cycle.

Bringing it back to reality, there are many buyers and many sellers, and different people have different tolerances on their transactions, and people aren't even very aware of what is happening so it smooths out over time. But the overall thing that you need to look at is how much is being traded per block (hard to know but can be deduced from the blockchain), and how much people are willing to give up to the miners (impossible to know. but we can guess at 3% gross).

Finally, you have to factor in how much is being net saved (also impossible to know, but blockchain analysis might give an order of magnitude). If a miner makes 50 btc on a block but saves 25 of them, then this, over time, will factor into the price going up. Similarly, if someone decides to take 100 btc out of savings and buy something, the price will get a pushed down. Putting it all together, let

E = exchange rate of bitcoin
m = average amount in dollars being exchanged in a block
t = average tolerance of sellers to give to processing fees (percentage)
R = average block reward
S = average net saving per block

At equilibrium, we would expect this to be:
E = t * m / (R - S)

So for example, if t = .03, m = \$5625/block, R = 50 btx/block, S = 25 btc/block, then we get E= \$6.75/btc.

This highlights that the most important thing when considering price is the amount of money being truly exchanged in an average block.
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thezerg
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 July 09, 2012, 03:56:57 PM

Hmm... your calculations illuminate an interesting interaction but are simply one dimension of a complex interacting system and so are unlikely to be predictive.  What is beyond the supply/demand curve, "driving" demand is a lot of human factors.

One issue with your reasoning is that the seller is not paying the miner the 50 btc.  The mined coins devalues everybody's BTC, so essentially all holders of BTC "pay" for each block, proportionally to his/her % of the total supply.  You could modify your equation to include this but since there is no "choice" involved (the network cannot choose to NOT mine a block in a given 10 minute period & so save the 50 BTC) I'm not sure if the relationship you propose is determinative.
Raw235
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 July 10, 2012, 11:44:31 AM

The price of Bitcoin is set by supply and demand, just like the price of everything else.

Hey there!
Boussac
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 July 16, 2012, 10:50:38 AM

Hmm... your calculations illuminate an interesting interaction but are simply one dimension of a complex interacting system and so are unlikely to be predictive.  What is beyond the supply/demand curve, "driving" demand is a lot of human factors.

One issue with your reasoning is that the seller is not paying the miner the 50 btc.  The mined coins devalues everybody's BTC, so essentially all holders of BTC "pay" for each block, proportionally to his/her % of the total supply.

In "perfect knowledge economics", since the maximum quantity of bitcoin and money creation algorithm are know to buyers beforehand, the current price of bitcoin incorporates this expectation.
Therefore, IMO the price of bitcoin is not pulled down by the creation of new blocks.

Inflation occurs when there is uncertainty surrounding the money supply growth like with central money (asymmetric information), not so with bitcoin.

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Sant001
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 July 16, 2012, 02:32:51 PM

1. Bitcoin demand. It comes from what people are using if for now, such as:

- Store of value

There might be many other things, these 2 are just the most obvious to me.

2. Bitcoin supply. Depends on among other things:

- Available coins
- People's sentiment of whether it will be go up in the short term seems to play a very important role in determining if they'll sell it or hold on to it
johnyj
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Beyond Imagination

 July 17, 2012, 08:49:29 AM

Supply is limited, this is maybe the single entity on this planet which have limited supply (Nature resource also have the same character but difficult to move)

Super liquidate, can act as a store of value due to it's limited supply nature, and the credit is backed by mathematics and networks, both have almost become religion for people living on this planet

weex
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 July 17, 2012, 09:02:49 AM

I like that you're looking at this versus the 2-4% charged by credit card companies but you can't say with certainty which part of a transaction is the spent money and which is the change.

This is why I prefer to just take the transaction itself as the fundamental value being provided by the network. You can then look at the (cost of all coins mined + txn fees per unit time) vs. the number of transactions the network carried during that time. Looking at it historically you'll see a range of \$2.5 to \$5 per transaction before and after the bubble of 2011 and with the recent increase in transactions, we may be seeking a lower stable range more like \$1-\$2 per transaction.

What do you think?

notme
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 July 17, 2012, 04:12:58 PM

I like that you're looking at this versus the 2-4% charged by credit card companies but you can't say with certainty which part of a transaction is the spent money and which is the change.

This is why I prefer to just take the transaction itself as the fundamental value being provided by the network. You can then look at the (cost of all coins mined + txn fees per unit time) vs. the number of transactions the network carried during that time. Looking at it historically you'll see a range of \$2.5 to \$5 per transaction before and after the bubble of 2011 and with the recent increase in transactions, we may be seeking a lower stable range more like \$1-\$2 per transaction.

What do you think?

Just keep in mind that the marginal cost per transaction is MUCH lower.

https://www.bitcoin.org/bitcoin.pdf
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FreeMoney
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Strength in numbers

 July 17, 2012, 08:22:06 PM

Also the network provides more than transactions. It acts like a nearly unlimited number of secure vaults.

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Fjordbit
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 July 17, 2012, 09:41:05 PM

Also the network provides more than transactions. It acts like a nearly unlimited number of secure vaults.

It only acts like this if the value of BitCoin continues to stay up. If the value falls, it's like having someone inside every one of those vaults.

My work above is to show where this value comes from and how, during a period of monetary inflation, can BitCoin be experiencing deflation.

Part of it is the savings. There are a lot of people putting away their coin. Especially with a rise from \$2 to \$8 in a few months, it makes people think twice about spending. But an important aspect is the transactions and what the network will tolerate to give up to the miners. While the reward is close to fixed, the value is not and this value on average is reflected into the price of bitcoins.
Narydu
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 July 18, 2012, 04:16:08 AM

Human behavior is the clue with this shalow market, were ONE man can drive a strong price change with small investemts such as 250k.

enquirer
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 July 18, 2012, 05:03:07 AM

The cost to buy 51% of hashing power, halt the block chain and render all BTCs completely useless is between \$1M and \$10M.
Thus true value of bitcoin is less than 0.51 * \$10M / 9M = \$0.57
John (John K.)
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Will read PM's. Have more time lately

 July 18, 2012, 05:28:19 AM

The cost to buy 51% of hashing power, halt the block chain and render all BTCs completely useless is between \$1M and \$10M.
Thus true value of bitcoin is less than 0.51 * \$10M / 9M = \$0.57

LOL where did you get that number? If you're basing it on BFL's ASICS', just remember that:
A) They have not released their product yet.
B) The hashing power will grow infinitely, and anyone is free to buy their own ASICs too.

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FreeMoney
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Strength in numbers

 July 18, 2012, 06:09:19 AM

The cost to buy 51% of hashing power, halt the block chain and render all BTCs completely useless is between \$1M and \$10M.
Thus true value of bitcoin is less than 0.51 * \$10M / 9M = \$0.57

The value of a thing is what it costs to destroy it? Can I have your house for a match a gallon of gasoline?

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enquirer
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 July 18, 2012, 10:10:46 AM

The cost to buy 51% of hashing power, halt the block chain and render all BTCs completely useless is between \$1M and \$10M.
Thus true value of bitcoin is less than 0.51 * \$10M / 9M = \$0.57

The value of a thing is what it costs to destroy it? Can I have your house for a match a gallon of gasoline?

Your cost calculation is a bit off. You forgot to add the price of spending a few years behind bars.

Continuing the analogy,  why do you trust that a \$100 bill you just received is real and not counterfeited? Because you know that secret service protects it. It costs only a few \$M to set up a money printing factory and render all USD in circulation useless, and believe me there are plenty of people that will be happy to do that, but to operate such a factory freely one would need to overthrow the us government, not a cheap endeavor...
enquirer
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 July 18, 2012, 10:33:01 AM

LOL where did you get that number? If you're basing it on BFL's ASICS', just remember that:
A) They have not released their product yet.
B) The hashing power will grow infinitely, and anyone is free to buy their own ASICs too.

the production cost of an asic is only a few dollars. It is true, that anyone is free to buy one, but what that means is if you buy \$X worth of BTC, you should also invest comparable amount in the mining equipment, to make it secure.
davidspitzer
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 July 18, 2012, 06:57:33 PM

By Christmas it will be over \$15 - my WAG - with absolutely no basis in fact and or analysis of any kind
notme
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 July 18, 2012, 07:00:02 PM

LOL where did you get that number? If you're basing it on BFL's ASICS', just remember that:
A) They have not released their product yet.
B) The hashing power will grow infinitely, and anyone is free to buy their own ASICs too.

the production cost of an asic is only a few dollars. It is true, that anyone is free to buy one, but what that means is if you buy \$X worth of BTC, you should also invest comparable amount in the mining equipment, to make it secure.

The production cost of the chip is only a few dollars, add in the circuitry and assembly and you up to tens of dollars.

https://www.bitcoin.org/bitcoin.pdf
While no idea is perfect, some ideas are useful.
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