An updated Expected Value (EV) analysis for Bitcoin

[pleaseexplain]

Hi

Counting the major surges alone, we have set a new ATH at $32, $266 and $1242

I do not know the reasons for surge 1 and 2 ( and would by the way like to know) but it seems clear that gox used manipulation to achieve the third. I know speculators came in but I see it as different somehow.

ie as the market either gets more regulated and/or wiser to being conned there will be less manipulation and less effect when it happens in places like exchanges

so should in trying to forecast you should only be using "genuine" speculation movements? I realise they may be moving the price on false external information but at least it is not the exchange itself that is doing the manipulating?

[ElectricMucus]

Hi

Counting the major surges alone, we have set a new ATH at $32, $266 and $1242

I do not know the reasons for surge 1 and 2 ( and would by the way like to know) but it seems clear that gox used manipulation to achieve the third. I know speculators came in but I see it as different somehow.

ie as the market either gets more regulated and/or wiser to being conned there will be less manipulation and less effect when it happens in places like exchanges

so should in trying to forecast you should only be using "genuine" speculation movements? I realise they may be moving the price on false information but at least it is not the exchnage itself that is doing the manipulating?

How would you do that when there is a fat chance it's all Bullshit?
This was originally posted around the time of the 2011 hype: http://nerdr.com/bitcoin-exchange-scam-bitcoins-are-worthless/

[rpietila]

How would you do that when there is a fat chance it's all Bullshit?

+1. You never know. So leaving out any of the datapoints because of alleged bullshit is not good.

Many astute guys have a theory that TPTB are bullshitting us the final last time with a move that goes to high-5 digits, sucking their money in the game, crashing the price, and gaining a public record of all the people who are thinking independently enough to buy in, but are not paranoid enough to realize that it was a bankster/government con all the way from Satoshi to the FEMA camp.

Do I believe that? It's certainly a possibility. Instead of burdening my mind too much about the probabilities of the scenarios, I have found it much more helpful to group them under "harassment" and develop my skills to cope in the odd chance that 8 government guys want to raid your house and confiscate everything, or lock you in an institution, deny your lawyer and force-feed psychiatric drugs, or sue you over Kafkan made-up victimless crime allegations, or make up a national televised sex scandal over your employee you never even kissed.

After going through those, my interest in nitpicking about how likely it is for Bitcoin to reach the ATH exactly, is pretty pointless. It is more important for a person, whether he is denied Internet access or not, than whether he has a few million more or not. In western countries you may be denied Internet and lawyer without fair trial, and that is a human rights issue.

I am always ready to bet, though, if the odds are good enough. To get to $1,000/BTC from here, we need it to go up 4x. So if I have $1,000, I'd be at $4,000 when the price is $1,000. I also get to benefit from the close cases, for example $500 means a double. So, in USD terms, I'd probably not bet $1,000 unless I got $15-20k in the event of Bitcoin hitting $1,000. Actually it's more likely that you find the other side of the bet more interesting! Anything goes for me. I don't hope, I do the maths.

[rpietila]

we neither have the probabilities for the outcomes nor do we have any kind of estimate for a successful or unsuccessful outcome do we?

We do. See OP. Just adjust the scenarios or the probabilities thereof.

This is a very simple case really, there is a timeframe, and the assumption that BTC will have a price in USD. It always holds true, because "no price" == 0 USD, and "USD fails" == inf USD, in which case the calc reverts to the purchasing power instead.

Estimating the probability is difficult, of course. Few actually placed their bets in 2011 based on the conviction that the price would go up 500x in 2 years. If I had needed to think about it in detail, I would have given "$2->$1200+ in two years" a probability of ~1%.

Of course we cannot know in retrospect what the probability was, but we know the outcome was 500x. And we can consider that perhaps the probability was higher than my estimate, and certainly higher than the majority's estimate.

take the following example: bitcoin fails in 99,9% of the cases and in 0,1% it reaches gold parity: it would give you an expected value of one bitcoin of 451,x $ in 2020 [all factors staying constant]

This is the beauty of EV. If there is a positive case good and probable enough, it makes it all worth it.

Consider 2 cases of extreme gambling with a very slim chance of winning, and very negative EV.

- Lottery
- Insurance.

In both, you can expect (EV) to get a 30-40% payout over a period of 5 years (so -60..-70% EV), with a microscopic chance of hitting it big. With insurance, the condition even is that you cannot really end up better off than in the beginning so that's even worse than lottery.

I'd much rather invest in something like Bitcoin. Anyone who knows about Bitcoin and continues to gamble off his fortune with insurance payments clearly does not have a clue what he is doing.

[Grafzep]

Many astute guys have a theory that TPTB are bullshitting us the final last time with a move that goes to high-5 digits, sucking their money in the game, crashing the price, and gaining a public record of all the people who are thinking independently enough to buy in, but are not paranoid enough to realize that it was a bankster/government con all the way from Satoshi to the FEMA camp.

Do I believe that? It's certainly a possibility.

Hilarious!

You do realise that those nagging voices are not "many astute guys"?


...Nurse!

[rpietila]

I realize many more things now than as little as a year or two ago.

It's called "experience". 

[inca]

I realize many more things now than as little as a year or two ago.

It's called "experience". 

I would be curious to know if you discussed future price movements at the recent bitcoin invite-only retreat rpietila?

[rpietila]

I realize many more things now than as little as a year or two ago.

It's called "experience". 

I would be curious to know if you discussed future price movements at the recent bitcoin invite-only retreat rpietila?

Of course I did. The whole thread is because of that!

The price is more behind the best-fitting trend than at any time in history, so either Bitcoin is going to die, or revert to the trend (or something in between ofc). The EV calc strongly favors investing now.

Another thing that strengthened my conviction was that some of the guys there were actually short. You know, when guys of that caliber are short, and they cover, it's going to have an effect on the price. They are not fools, they had better information and balls than I did a year ago, to actually go short instead of just lightening up, but also they are not fools to destroy themselves when the price goes back up. 300-350 was mentioned as the mental stop loss zone that marks the end of the downtrend and triggers short covering.

[HeliKopterBen]

Another thing that strengthened my conviction was that some of the guys there were actually short. You know, when guys of that caliber are short, and they cover, it's going to have an effect on the price. They are not fools, they had better information and balls than I did a year ago, to actually go short instead of just lightening up, but also they are not fools to destroy themselves when the price goes back up. 300-350 was mentioned as the mental stop loss zone that marks the end of the downtrend and triggers short covering.

Interesting that die-hard believers are actually short.  An epic short-covering rally may be in the cards if the short side of the trade is crowded. 

However, I wonder if they are short off-exchange because exchange data does not support the short-covering theory with 80% long and 20% short. 

[uvwvj]

As always Risto puts out good numbers but I honestly would rather this be calculated for another year 2021 versus 2020, with halving (unless having comes early) as the inflation drops below 2% and mined coins will be about ~85% completed.

IMO this is the make or break year for the "experiment" - if it passes we have a currency and not just an asset imo.

[inca]

Another thing that strengthened my conviction was that some of the guys there were actually short. You know, when guys of that caliber are short, and they cover, it's going to have an effect on the price. They are not fools, they had better information and balls than I did a year ago, to actually go short instead of just lightening up, but also they are not fools to destroy themselves when the price goes back up. 300-350 was mentioned as the mental stop loss zone that marks the end of the downtrend and triggers short covering.

Interesting that die-hard believers are actually short.  An epic short-covering rally may be in the cards if the short side of the trade is crowded. 

However, I wonder if they are short off-exchange because exchange data does not support the short-covering theory with 80% long and 20% short. 

Apparently it is possible to go long with btc and not just fiat. This might explain why the long position is so skewed. The price is actually correlated well with the fluctuations in the short contracts far more.

[Grafzep]

I realize many more things now than as little as a year or two ago.

It's called "experience". 

Every day is a school day, if we're lucky.

I love experience.

[79b79aa8d5047da6d3XX]

Claim (A): Calculations of this kind, and the distributions over possible outcomes, broadly fall into 5 "classes", namely:
(1) "Bitcoin fails. Completely." - mass centered around near-zero to single digit USD values per coin.
(2) "Bitcoin will fail to gain any serious traction." - mass centered around values that will sound very low to current "bulls", i.e. single digits, at best double digit price, 5 years from now.
(3) "Bitcoin will be a success. Sort of." - mass centered around prices higher than now, but not vastly higher. High triple digits, low quadruple digits.
(4) "Bitcoin will either fail, or take over the world!" - mass centered around very high prices, high quadruple digits easily, but does assign some mass for "total failure" scenarios.
(5) "Bitcoin will take over the world. Practically ensured." Self evident what that one looks like.

Claim (B): A lot of Bitcoin supporters/investors/believers (lots of smart ones as well, Gavin said something to this effect as well, iirc) believe "Either Bitcoin will be worth *a lot*, or practically *nothing*!". In terms of my classification above, that would be distributions of type #4.

Claim (C): This belief, i.e. "scenario #4", is overestimated/overrepresented among investors. In reality, by the "law of the success of the mediocre", something like scenario #3 is more likely, and should be more widely held as the basis of EV calculations.

So much for the more abstract thoughts on this. Practically, like I said, I consider something like #3 to be the best approximation of what could happen in the future... Bitcoin will be a "qualified success". Maybe similar to Linux (occupying a niche for consumers, but also running the show behind the scenes, just not noticeable to most). Or maybe, it'll be more than a niche product, but mainly for functions that don't require extremely high total valuation of the network (i.e. used widely as "ledger", but not "store of value"). With those premises, I arrive at a value of around $2000 for a time period of ~5 years.

I agree about Claim (B): the scenario yielding Class (4), which once seemed reasonable, should not be the default expectation. Aminorex’s argument to that effect, IIRC, was: (i) even if Bitcoin fails, it is simply not conceivable that we go back to a world without an open source peer to peer digital cryptocurrency; (ii) so if Bitcoin fails, something better takes its place; (iii) if that happens, current Bitcoin holders will be in as good position as anyone to transition to the better system, which has improved chances of success. A catastrophic scenario is therefore not necessarily a wipe-out for attentive bitcoiners.

Of course, if a catastrophic scenario unfolds and Bitcoin gets replaced we would not be talking about the same thing anymore, so it’s futile to calculate EV. The point is only that Class (4) is ruled out. We might also agree that Class (5) should be ignored for the purposes of conservative valuation. So our question becomes one of giving decent estimates for what counts as Class (3), and of assigning respective probabilities.

With this in mind, let’s look at a simplistic scenario that strays as little as possible from rpietila’s original analysis, but gives (admittedly arbitrary) finer grained possibilities for the qualified success case than oda.krell contemplates, and no moonshot.

At the low end of qualified success would be, let’s say, ATH = $1200/BTC.
 
The high end of qualified success might be defined as: total market cap of BTC equal to half current market cap of AAPL (largest publicly traded company) =  $740B/2 = $370B. Since there will be ~18M BTC in circulation in 2020, this gives us ~ $20,500/BTC. Such a capitalization after 11 years would count as successful, but is neither world-conquering nor in some sense completely out of the ordinary (Google went from 0 to $400B in 15 years, although of course this is a different type of case).

Let’s take a third point at the average between the previous two: $10,850/BTC, and assign equal probabilities to each of the three.

The scenario, then, is:
1.  ($50) = 25%
2.  ($500) = 25%
3a. ($1,200) = 17%
3b. ($10,850) = 17%
3c. ($20,500) = 16%

50*0.25+500*0.25+1,200*0.17+10,850*0.17+20,500*0.16 = $5,466/BTC EV.  That’s ~ 23x current price.

A more conservative variation would be to assign 0.25 probability to being at ATH in 5 years, and split the remaining 1/4 for the other two points. We might also lower the value of a coin in the worse case scenario to a merely symbolic $1.
1.  ($1) = 25%
2.  ($500) = 25%
3a. ($1,200) = 25%
3b. ($10,850) = 12.5%
3c. ($20,500) = 12.5%

1*0.25+500*0.25+1,200*0.25+10,850*0.125+20,500*0.125 = $4,344/BTC EV.  That’s ~ 18x current price.

[600watt]

[
I'd much rather invest in something like Bitcoin. Anyone who knows about Bitcoin and continues to gamble off his fortune with insurance payments clearly does not have a clue what he is doing.

this !

[oda.krell]

I agree about Claim (B): the scenario yielding Class (4), which once seemed reasonable, should not be the default expectation. Aminorex’s argument to that effect, IIRC, was: (i) even if Bitcoin fails, it is simply not conceivable that we go back to a world without an open source peer to peer digital cryptocurrency; (ii) so if Bitcoin fails, something better takes its place; (iii) if that happens, current Bitcoin holders will be in as good position as anyone to transition to the better system, which has improved chances of success. A catastrophic scenario is therefore not necessarily a wipe-out for attentive bitcoiners.

Of course, if a catastrophic scenario unfolds and Bitcoin gets replaced we would not be talking about the same thing anymore, so it’s futile to calculate EV. The point is only that Class (4) is ruled out. We might also agree that Class (5) should be ignored for the purposes of conservative valuation. So our question becomes one of giving decent estimates for what counts as Class (3), and of assigning respective probabilities.

With this in mind, let’s look at a simplistic scenario that strays as little as possible from rpietila’s original analysis, but gives (admittedly arbitrary) finer grained possibilities for the qualified success case than oda.krell contemplates, and no moonshot.

At the low end of qualified success would be, let’s say, ATH = $1200/BTC.
 
The high end of qualified success might be defined as: total market cap of BTC equal to half current market cap of AAPL (largest publicly traded company) =  $740B/2 = $370B. Since there will be ~18M BTC in circulation in 2020, this gives us ~ $20,500/BTC. Such a capitalization after 11 years would count as successful, but is neither world-conquering nor in some sense completely out of the ordinary (Google went from 0 to $400B in 15 years, although of course this is a different type of case).

Let’s take a third point at the average between the previous two: $10,850/BTC, and assign equal probabilities to each of the three.

The scenario, then, is:
1.  ($50) = 25%
2.  ($500) = 25%
3a. ($1,200) = 17%
3b. ($10,850) = 17%
3c. ($20,500) = 16%

50*0.25+500*0.25+1,200*0.17+10,850*0.17+20,500*0.16 = $5,466/BTC EV.  That’s ~ 23x current price.

A more conservative variation would be to assign 0.25 probability to being at ATH in 5 years, and split the remaining 1/4 for the other two points. We might also lower the value of a coin in the worse case scenario to a merely symbolic $1.
1.  ($1) = 25%
2.  ($500) = 25%
3a. ($1,200) = 25%
3b. ($10,850) = 12.5%
3c. ($20,500) = 12.5%

1*0.25+500*0.25+1,200*0.25+10,850*0.125+20,500*0.125 = $4,344/BTC EV.  That’s ~ 18x current price.

Very interesting post. I like the argument for/against some of the distribution classes.

In detail, I personally would consider slightly lower network valuations as sufficient to call it a "qualified success", in case the ledger function will be picked up widely, but only to the point where the network doesn't need to be secured by ultra high valuations. Practically, even with a network valued at just a few billion USD (and with the respective mining hardware behind such a valuation), nobody other than a few state actors can hope to brute force attack the network, which might be "good enough".

By the way, my EV calculations are intended to be: "EV per unit of Bitcoin, or an alternative cryptocurrency replacing Bitcoin in a manner that will be foreseeable to those who saw the value of Bitcoin in the first place".

I arrive at my "conservative" $2290 value for the qualified success scenario - a factor 10 increase - by the following (crude) approximation:

Code:

1$ 1%
10$ 5%
50$ 10%
500$ 21%
1000$ 26%
2000$ 21%
5000$ 10%
10000$ 5%
50000$ 1%