Bitcoin, one way to look at it

Bitcoin is a divisive topic; some believe in it, and others think it is just another example of a speculative bubble, the likes of which we have seen before in history. Many friends asked us about our views on Bitcoin, of which, to be honest, I sit in the sceptical camp. My colleague Rob Murphy has tried to apply some logic to one way one could try to value the asset. This is purely a mathematical exercise, but it makes for interesting reading from which you can draw your own conclusions, and plug in your own assumptions.

Bitcoin – could it be worth?

Bitcoin rose last week to a new record high above $100,000. President-elect Donald Trump is a fan, and Senator Cynthia Lummis has introduced the BITCOIN Act to the Senate. Meanwhile, Michael Saylor’s MicroStrategy Inc. is issuing $42bn in equity and convertible debt to buy Bitcoin in the market over three years. This all begs the question of whether there is some real value driver for the cryptocurrency or if it is just another speculative bubble.

To the extent that Bitcoin can be considered a currency, one can try and estimate a value for a Bitcoin using the well-known quantity theory of money equation MV=PT. Where M is the money supply, V is the velocity of money (how rapidly it circulates in an economy), P is the average price, and T is the number of transactions. PT is estimated as nominal GDP (i.e. what is spent in an economy), and V can be estimated as nominal GDP divided by the known money supply in any country. V is currently 1.4 in the USA, 0.5 in Japan and around 1.0 in Europe we will use 1 as a simplifying average.

Global GDP is $100tn. We assume velocity is 1, and there will be a maximum of 20m Bitcoins in circulation (i.e., 1m of the 21m is lost). If Bitcoins replace all other global currencies for all transactions, we get a maximum value per Bitcoin of $5m! ($100tn/1/20m). So, in theory, it can still go up 50x if it takes over the world.

Currently, however, Bitcoin transactions are apparently are 0.6m per day on average. That compares with 2bn daily transactions across the major card networks (Visa, China UnionPay, Mastercard, American Express, Discover) and cash will be roughly another 20%. So perhaps 2.5bn daily transactions globally, which means Bitcoin represents only 0.025% of all transactions. This is perhaps not surprising given the limit of only 7 transactions per second, relatively high fees and that Bitcoin is banned in some countries like China, Pakistan and Saudi Arabia. Plugging the 0.025% figure into our equation gives a value of just $1,250.

So our scientifically derived currency value is between $1,250 and $5,000,000. Turning things around and plugging in the current value of $100,000, we get an implied transaction share of 2% or 80x current usage, which is impossible given the limit of 7 transactions per second.

Fans may point out that another coin, Bitcoin Cash, is an example of overcoming some of the technical limitations as it can process 100 transactions per second. But this exposes the vulnerability of betting on any one technology, such as Bitcoin, which could be superseded by something better. Moreover, Bitcoin Cash was itself created from a ‘hard fork’ from Bitcoin, meaning you received one Bitcoin Cash for every Bitcoin held for a maximum issuance of 21m. So perhaps the 21m maximum number of Bitcoins is not really a limit after all…

If Bitcoin is not a currency, does it have any other intrinsic worth? Historical price volatility suggests that it is not a reliable store of value, and unlike, say, gold, it appears to have no alternative use.

Finally, it may be noteworthy that Microstrategy Inc. now owns 402,100 Bitcoins, worth around $149 per diluted share, while the stock trades at $395, which may be evidence that ‘animal spirits’ are running high.