Some Bitcoin Related Thoughts

I had a great conversation with some colleagues in Madrid this week about Bitcoin, Blockchain, crypto currency, and the like. The kindly reminded me that I had written an email to our group on January 9th 2017 that they had found useful and that I should share. I'll just drop it here to share again outside the group. I have no idea if many of these opinions are correct or not. They are just thoughts and I certainly value all constructive input on the matters at hand.


Hi Mike, Fun questions. Been on variations of PTO for the last bit around the holidays. Here are my thoughts and opinions regarding your questions. Anywhere there is math, check it.. I did it back of the napkin and it could use validation.

Will Bitcoin be the dominant cryptocurrency?

I think yes. But, it’ll be a bit different from what people currently think of as currency. Bitcoin itself (meaning one or many bitcoin) will be more behind the scenes as a transfer and storage medium of value for many asset classes including, but not exclusive to national fiat currency. Also, Bitcoin can represent value for other cryptocurrencies. That means it becomes the new decentralized central (yes, irony) bank. There will be no need for an actual “central bank” in the future. There will still be a strong need for a guiding board-like organization to govern. Whether or not any organization exists or not that could do this is probably up for debate. The wallet is the bank and trusted intermediaries are no longer technically necessary.

Is a central bank likely to use bitcoin as a reserve currency?

Probably not without a fight. It’s just too scary and too many unknowns right now. Who needs a central bank anymore? That question is rhetorical today but in the future, not so much.

What do we expect the USD/ Bitcoin rate to be by year end?

When I hear this question I think of two other questions, “How much-monetized value is there in the world?” and “Can bitcoin come to represent a substantial portion of that value at any given point in time?”

Note that Bitcoin is, in a way a very special purpose “smart contract.” It is literally a piece of software code stored in a database, the blockchain. These “contracts” today are not technically legally binding in any jurisdiction.

I assert that Bitcoin is a superior technology for the transfer and storage of representative value than has ever existed before in human history. It’s better than large stone disks, gold, or national fiat currencies. But, that it has not yet reached broad adoption and our cultural experience with this sort of thing is very minimal. So, this might take a while.

If Bitcoin becomes the default transfer and storage medium between all or most digital currencies, most fiat currencies eventually become digital, which they are, and physically assets like gold, houses, cars, and shares of business ownership then it’ll be very well could become worth that percentage of the entire global money supply.

So, back to those questions, how much is the global money supply? Well, estimates vary. This article, which I liked, somewhere in the range of $630 trillion to $1.4 quadrillion.1 After some research, I’d say that pegging the global value of what bitcoin can represent is most alike to the global value of the derivatives market which is also a bit mysterious. But, we can say it’s probably similar to that number I just mentioned. To make things easy, let’s just say it’s one(1) quadrillion USD equivalent today.

Only 21,000,000 bitcoins will ever be mined. As of this writing, bitcoin’s market capitalization in USD is just shy of a $17 Billion USD (it’s pretty volatile still so changes all the time). Bitcoin is exceptional at the transfer and storage of monetary value, and new technologies continue to drive the cost of transactions to very, very low (near zero marginal cost, see Rifkin2). If we use the value of the global derivatives market as a basis of the total addressable market and if bitcoin were to assume a significant portion of that addressable market, bitcoin’s market capitalization would surpass all current estimates of future single bitcoin value by many orders of magnitude.

A top-down approach might say that the global derivatives market is worth $1 Quadrillion USD. Just 5% of that would be 50 Trillion dollars.

At a valuation of 100% of the global derivatives market of $1 Quadrillion USD, each bitcoin would have to be worth $47.6 Million USD. If you use the 5% number, then each bitcoin would be worth $2.4 Million USD. All of this assumes today’s dollars. While bitcoin is not guaranteed to go up in value over time, all nation-state based fiat currencies are guaranteed to go down in value over time. That alone is interesting if you like to hedge. But, if a bitcoin is worth so much, how can it possibly be currency?

“A Satoshi is the smallest fraction of a Bitcoin that can currently be sent: 0.00000001 BTC, that is, a hundredth of a millionth BTC. In the future, however, the protocol may be updated to allow further subdivisions, should they be needed. So, I’m pretty sure someone was planning ahead here. A trillionaire would only need to own between 21008 and 416667 Bitcoins.

Further examples of BTC related units”3

BTC Amt

Transl. Sub Currency

Currency

1 BTC

1,000 mBTC

millibitcoin

1 BTC

1,000,000 μBTC

microbitcoin

1 BTC

100,000,000 Satoshis

Satoshis

1 mBTC

100,000 Satoshis

Satoshis

Again, the following is likely very important! There will only be 21,000,000 bitcoin ever. The Bitcoin creators have left the door wide open to keep creating smaller and smaller subdivisions over time. I suppose you could compare this to a stock split or B class shares such as BRK-A and BRK-B. In 20 years, few people will deal in whole bitcoins just has few people pick up a single share of Berkshire-Hathaway A (BRK-A) at $245,394, the price on 6 January 2016. It won’t make sense for most people. Most will deal in millibitcoin, microbitcoin, or Satoshis on a regular basis.

There is no reason bitcoin cannot replace the entire derivatives market technically speaking over time. It’s technically superior to the way it is done today in several ways. Especially security and transparency (veracity). I don’t expect the existing powers that be to welcome this change with open arms.

“As of 6 February 2016, there are 15.2 million bitcoins circulation of a capped total of 21 million. … That means over 72% of all bitcoins are already in circulation. Currently, there are 25 new bitcoins produced (mined) every 10 minutes.”4

In summary, if you use the global derivatives market as a baseline for valuing the potential market cap of bitcoin then you might say it is likely that one(1) bitcoin will be worth between $2.4 Million and $47.6 Million USD equivalent (Jan 2017 USD’s) over some period. And, an interesting quote I heard says that while bitcoin is not guaranteed to go up in value over time, all national fiat currencies are guaranteed to go down.

Is Bitcoin replacing gold?

Not exactly. Gold is physical, a nice store of value, and dug out of the ground. It has very different economics. And, it’s heavy. As a result, we won’t be putting it on rockets and sending it to Mars. It is just too heavy. Of course, there may be some on the moon or in asteroids. Bitcoin or currency pegged to it are likely to become the medium of transfer of ownership of gold. If I happen to come to own an asteroid I assure you, I’d like my title recorded on the blockchain for all to see everywhere for all time. So, you can still be on Mars and have your gold reserves on earth or in an asteroid to be extracted later while ownership is evident and validated. That is better than some piece of paper in a lockbox on one planet or another and the promise that maybe there is some gold somewhere? Or, as some do that like to own the gold, little gold bars or coins in a safe in your house.

As an aside, one of the issues with gold vs. Bitcoin is the way the price is managed. The two could not be more different. But, there is room for both in the world, I do believe. Just like there will be room for many special purpose cryptocurrencies.

DOES BITCOIN AND THE PROSPECT OF MANY MORE CRYPTOCURRENCIES EXPLAIN ANOMALOUS BEHAVIOR OF THE VIX INDEX (IE THE ‘ FEAR INDEX’)?

I have no opinion on this one.

Sources:

  1. http://money.visualcapitalist.com/all-of-the-worlds-money-and-markets-in-one-visualization/ ↩︎
  2. https://www.amazon.com/Zero-Marginal-Cost-Society-Collaborative/dp/1137280115/ ↩︎
  3. http://bitcoin.stackexchange.com/questions/114/what-is-a-satoshi ↩︎
  4. https://www.google.com/webhp?sourceid=chrome-instant&ion=1&espv=2&ie=UTF-8#q=how%20many%20bitcoins%20are%20there ↩︎