Bitcoin bubble or future currency: why both sides are wrong
Bitcoin has enjoyed an extraordinary surge in both value and public attention recently.
The rise in the price of a bitcoin in US dollars over the past few years has certainly created a strong divergence of views.
Most commentators seem to fall firmly into one of two main camps: the camp that says it is an obvious speculative bubble that will surely end badly, and the camp that says it is the global currency and store of value of the future, with considerable scope for further price appreciation.
There doesn't seem to be much middle ground - the equivalent of a broker "hold" call.
Clearly bitcoin isn't amenable to valuation in the way a company or bond as it doesn't produce any cashflows. Bitcoin's value is probably a function of the extent to which it is - or becomes - widely trusted and used as a unit of exchange. So, it's informative to think about it terms of the likelihood of that happening, and the implications if it does.
There are currently around 16.7 million bitcoins in circulation, and the hard limit to the number that can be created is 21 million, which gets us to a value per bitcoin of around $US200,000.
We can then arrive at an indication of the "correct" price for a bitcoin today by multiplying this high case number by the probability of the high case scenario eventuating.
Let's list some of the considerations that might be considered in arriving at an estimate. On the positive side we have:
- With a hard limit on the number of bitcoins that can be created, it is protected from devaluation via central bank printing;
- It offers a low-friction and potentially anonymous form of exchange; and
- While it is not yet widely accepted, the number of bitcoin transactions and accepting parties appears to be growing.
On the negative side we have:
- Governments may seek to regulate against the use of bitcoin, given concerns around anonymity, taxation etc;
- There are some technical questions that will need to be satisfactorily addressed, including the possible need for enhanced security and the implications for security once the hard limit of 21 million bitcoin is reached;
- Bitcoin transactions can take time, which presents difficulties for time-sensitive transactions; and
- While there are clearly network effects at play, and bitcoin has first mover advantage on its side, if a demonstrably superior alternative emerges, bitcoin could be overtaken by that alternative; and
- It may be hard for people to fully trust a cryptocurrency.
How you balance these sorts of considerations is a matter for personal judgement, but it strikes me that neither the "bubble" camp nor the "future gold" camp currently has a convincing case.
There is clearly a good chance that bitcoin implodes, but there is also some probability that it has a bright future, and that probability may well be enough to make sense of the current price.
If the end-point is a reasonably significant valuation, and the starting point is close to zero, then getting from the starting point to the end-point will naturally involve some eye-watering growth and extreme volatility.