What's the Value of Bitcoin? Who Knows
(Bloomberg View) -- OK, bitcoin sure looks like it's a bubble. For one thing, there's that chart:
For another, if you follow the Investopedia definition that a bubble "is created by a surge in asset prices unwarranted by the fundamentals of the asset," there's the unsettling reality that this particular asset has no fundamentals. That is, there's no stream of income or collection of assets attached to ownership of a bitcoin. Bitcoins have no intrinsic value.
This last statement, which I have made before, tends to irritate some bitcoin partisans. It shouldn't! The U.S. dollar has had no intrinsic value either since President Richard Nixon unlinked it from gold in 1971. Yet dollars remain useful as a means of exchange, and people are willing to accept them as payment for more tangible things. Come to think of it, gold doesn't have much intrinsic value either. Sure, you can make nice jewelry out of it and it has some industrial applications, but that's not why it sells for $1,248 an ounce. It sells for that much because people have over the millennia come to accept it as a durable store of value.
During an earlier bitcoin bull market in 2013, Bank of America Merrill Lynch currency strategist David Woo tried to identify a fair value for the cryptocurrency by estimating its potential both as a means of exchange and as a store of value. He figured it would come to account for 20 percent of global ecommerce transaction volume, which he estimated would require $5 billion in bitcoin market value, then added to that the average market cap of the three biggest money-transfer companies, $4.5 billion, to get a means-of-exchange value of $9.5 billion. That was still well short of bitcoin's $13 billion market cap at the time, so Woo speculated that bitcoin had the potential to be a store of value on a scale similar to silver, and that all the U.S. silver eagle coins minted to date had a market value of $8 billion. Round that down to $5 billion, add in the $9.5 billion, and "we get a number that is somewhere around $15bn." Yes, bitcoin valuation bears some resemblance to sausage-making.
As of midday Monday, bitcoin's market value had risen to almost $275 billion (a market price of $16,403 times 16.7 million bitcoins in circulation). This certainly isn't because bitcoin has surpassed expectations as a means of exchange. The total number of bitcoin transactions over the past year added up to less than one-tenth of 1 percent of total ecommerce transactions, and by all appearances the great majority of bitcoin transactions these days involve buying and selling bitcoin, not using them to acquire pizza.
You can't really blame bitcoin owners for this: In the very first bitcoin-to-real-world transaction, in 2010, programmer Laszlo Hanyecz exchanged 10,000 bitcoins for two Papa John's pizzas. With the chain's current limited-time offer of any large or pan pizza for $10, that many bitcoins would now buy more than 16 million large Papa John's pizzas. In currency terms, this is staggering, economically crippling deflation. Nobody's going to want to spend a currency that keeps rising in value like that. And just think if you had borrowed bitcoin to start a business that involved pretty much anything other than holding onto bitcoin -- you'd be hopelessly bankrupt.
It must be bitcoin's potential as a store of value that's driving up the price, then. Only, silver seems to have been the wrong comparison. So maybe ... gold? The current dollar value of all the gold ever mined is about $7.5 trillion. What percentage of that would be a fair value for all the world's bitcoin? The analysts at Bank of America Merrill Lynch, in case you're wondering, have thrown in the towel on such questions, declaring in an October report that "a true value for cryptocurrencies may be impossible to assess." Bitcoin enthusiasts are less shy, intimating that it could someday not just approach gold in total value but surpass it. For example, here's a fun exercise at Bitcoinist to "determine at what price point will Bitcoin match the total money supply value of global reserve currencies and the market cap of precious metals such as gold."
To the question of why an intangible currency of recent origin should surpass the value of the most tangible and durable of currencies, I guess the only answer is, why not? Well, I guess one other answer is that bitcoin's supply is limited. Only 21 million of the coins can ever be created, unless something goes terribly wrong, and that limit will be reached a bit more than a century from now. One time-honored way for investment bubbles to deflate is for clever and greedy entrepreneurs to create more supply of the asset that has gotten so expensive -- dot-com stocks, triple-A-rated collateralized debt obligations, etc. That's certainly happening these days in the cryptocurrency scene. But bitcoin itself remains scarce. I think this is what former software entrepreneur John McAfee was trying to get at when he tweeted last week:
Hodlers is bitcoinspeak for holders; hyperbitcoinization is sort of the bitcoin version of the Rapture, only in this case all the sinful fiat currencies will depart this earth and the one true currency will remain. I do not believe that this day is coming, and if the only choice is between valuing bitcoin as equivalent to all economic activity on the planet and valuing it at zero, I'd have to pick the latter. But if enough of those hodlers do believe in it, they can keep prices high for a while yet.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Justin Fox is a Bloomberg View columnist. He was the editorial director of Harvard Business Review and wrote for Time, Fortune and American Banker. He is the author of “The Myth of the Rational Market.”
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