What is a Bitcoin worth?
A thought experiment on the potential value of a unit of the new currency
Bitcoin Basics (aka rehash of Wiki article, skip if you’re familiar)
Introduced in 2009, Bitcoins are “created as a reward for payment processing work in which users offer their computing power to verify and record payments into the public ledger.” Currently there are ~13M coins in circulation created at 1.3M/year with creation rate halving every 4 years. Arbitrary limit of 21M is expected to be reached in 2140. Creation rate drops so much that by 2014 ~19M coins will already be in circulation.
Thought Experiment to Value Bitcoin
Bitcoin, like other currency, derives it value from fiat: it has value because we all believe it does—after all, even a dollar is just a piece of paper. Each Bitcoin has certain value that can be used to trade for goods and services like “real” currency that can be calculated:
We know the total quantity of Bitcoin at any given time. The value of global transactions can be estimated. We can assume a certain proportion of global transactions are conducted through Bitcoin (e.g. 10% in 2024), the result should arithmetically give us the value of a bitcoin.
The value of a Bitcoin = (estimated total global transaction value * Bitcoin share of transactions)/total number of Bitcoin
Detail on Assumptions (Skip to next sections if you just want the answer)
To calculate the value of a Bitcoin today, I estimated the value of the formula above in 2024 and discounted it back. I think a discount rate >25% is reasonable given the risk involved( For context, public equities have ~10-15% discount rate, private equity investments ~20-30%, and VC investments ~25-35%).
Global GDP is estimated to be ~$101T by 2024 based on projected growth rates. To get velocity of money, we have a few estimates. Velocity of M2 (cash + demand deposits + savings + money market accounts) estimated by the Fed hovers around 1.8x GDP, depending on biz cycle. M1 (cash and demand deposits) is closer to 6-7x GDP. Arguable if Bitcoin will be used more as M1 vs M2—truth is likely somewhere in between.
Results & Sensitivities
The value of a Bitcoin based on the above calculation can vary wildly depending on the underlying assumptions, but I think most reasonable cases put the value well below the current price of ~$620.
Hence, to make a fair return by holding BitCoin, you have to believe that >50% of global transactions will go through BitCoin AND it is less risky than a normal alternative investment. Note this doesn’t even take into account the BitCoin alternatives that may take share (e.g. LiteCoin, Dogecoin) nor potentially lower adoption and money velocity in international economies.
Verdict
All this goes to say that there is likely no significant upside to owning BitCoin by itself. However, BitCoin does solve a lot of world payment problems and creates value by reducing transaction fees for cross-border transactions, micro payments, etc. So from an investor’s perspective, the value of BitCoin is not in hoarding the coins but in the business eco-system the currency generates (e.g. wallets, storage, payment systems, exchanges).
Edit: I found a good Investopedia post using a similar train of thought after I wrote this, but I still think my work is additive rather than redundant.
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