Thinking in Bitcoin — Bitcoin’s True Valuation
Should I invest in Bitcoin in 2021?
This post tries to address bitcoin’s true valuation. In the process, it will answer related questions, including:
- What is the distinction between ‘Money’ and ‘Currency’?
- Aren’t ALL electronic payments also ‘Digital’ ? So, why is bitcoin’s digital payment any different?
- Does Bitcoin have any intrinsic value (as Money or a medium of exchange)? Does Bitcoin have any intrinsic value (as a store of value)? Is there a test to determine whether Bitcoin’s valuation is based on an intrinsic worth?
- What drives bitcoin’s valuation?
- What were some things that Bitcoin was the FIRST to do? (What is Digital Uniqueness? Why is this Bitcoin’s most notable accomplishment?)
I am a developer/architect who writes mostly about software technology — so, why write about Bitcoin?
Well — bitcoin IS technology — in that it is software at it’s core. To understand bitcoin, you do need to understand a couple of key software related developments. One of Satoshi’s greatest faux-pas was naming both — the ‘currency’ — and the ‘payment network’ — Bitcoin — leading to confusion ever since.
Thinking in Bitcoin (Valuation of Assets in BTC)
The richest person in the world is the person holding the most bitcoin. Not the person with the most dollars or the most Tesla Stock. Simply the person holding the most bitcoin.
There are two contenders for this title. The first is the anonymous Satoshi (the creator of bitcoin). The second is the venture capitalist, Chamath Palihapitiya, who had disclosed his purchase of 1 million BTC (at the price of $80 per coin).
Back to the original Question — What is Bitcoin’s True Value
If you want to skip to the end, this post will argue that BTC’s value will settle at AT LEAST half a million dollars, IF you measure it’s worth in Dollars. But that would be like measuring the worth of Gold in silver coins. They are different — and one is noticeably superior.
What I would advise readers is to NOT measure BTC value in Dollars.
BTC is a competitor to the dollar and all other currencies out there. And thus, every asset in the world, should be measured in BTC itself.
- This football field costs 10 BTC.
- This contract will pay me 0.01 BTC.
- My house is worth 0.5 BTC
You see, when the dollar faces competition, a natural question is ‘Will the dollar win, or will it be sidelined by the competition’?
So, you are saying that bitcoin is a currency? Isn’t it digital gold?
With ALL bitcoin conversations, there are TWO completely different starting points.
The first is the ‘currency argument’ as discussed above — Bitcoin is a competitor to traditional currencies and the entire ecosystem built around those currencies (banks, atms, financial intermediaries…).
The second is the ‘Digital Gold’ conversation.
Is bitcoin becoming a superior Store of Value (Gold)?
The sum of those two aspects (replacement for ALL traditional currencies and replacement for GOLD), is what leads to this high valuation.
So — is it currency or is it Gold?
This post will argue that while the ‘Bitcoin as a Currency’ acceptance is still weak at best, ‘Bitcoin as a superior GOLD’, is well on it’s way.
Given that Gold is a $10 trillion asset class by itself, and bitcoin is still just shy of $1 Trillion (still larger than all of Berkshire Hathaway), there’s a long way for the price of Bitcoin to go.
Gold will not become obsolete, but will eventually be seen as an inferior form of Bitcoin.
The dollar will not become obsolete, but it will be an inferior currency to BTC (as will the Euro, Yuan…and all others).
Money versus Currency. Digital Currencies vs. Decentralized Currencies
Bitcoin is both — a technological breakthrough as well as a financial breakthrough
Bitcoin, the software, is a technological breakthrough (more on this later).
Bitcoin, the underlying payment network, with built-in settlements, is a financial breakthrough.
Admittedly, the likes of Visa and Citibank had been struggling with the concept of a fully digitized payment network with settlements built in.
Where they failed was where Bitcoin's progenitor made a breakthrough. And that was the well known ‘double spend’ problem. In layman terms, it can be dubbed the ‘authenticity’ problem.
How do I know that the bitcoin you sent me is ‘unique’ and not a digital copy of someone else’s bitcoin (think mp3 songs — how do you know that the Michael Jackson mp3 you are listening to is ‘unique’ and not a copy from someone else’s purchase? You don’t!
No one had found a way to prevent ‘copying’ of digital assets, until Satoshi’s discovery of ‘hack proofing’ the copying ability, by making it practically difficult.
Bitcoin is the first currency with it’s own ‘built in’ payment network.
That merits repetition.
Bitcoin is the first currency, which has it’s own built-in payment network!
Before we delve into the valuation of Bitcoin, first, some definitions might be in order:
What is the difference between ‘Money’ and ‘Currency’?
People use these terms interchangeably. Currency can be anything — I can define my own currency today — $varmadollar — and it could hold meaning in my Universe (i.e. I could make my friends accept it, trade with it etc.). However, it isn’t backed by anything except my own reputation — and for the most part, the currency will not ‘stick’ (be adopted universally). And hence, since it isn’t backed by anything ‘BIG’, it doesn’t qualify as money.
Money is a currency that is ‘backed’ by something. That something can be the U.S Government (dollar), the European Union (Euro), precious metal (gold), gems, stones — anything that the world, as a whole, perceives as ‘stable’. Certainly, governments can be labeled as ‘stable’. After all, the U.S. government has survived major financial and military crises. As has Gold. Hence, these are all deemed as sound backings for their respective monies.
And that gets to the heart of the bitcoin debate — does the world, as a whole, conceive something generated purely through number crunching (and tons of electric power), valuable and stable?
First — the Stability of Bitcoin
Believe it or not, Bitcoin is at least as stable as your printed paper money. Wait! What? How is that possible?
What backs bitcoin is the Bitcoin Network.
The network is nothing more than a set of computers all running a specific version of the bitcoin software.
More importantly, the software and the network are both, virtually unhackable.
There has been ONE intrusion — in the entire 11 year history of bitcoin, and that too, during it’s very initial days. This ‘bug’ was detected in record time (matter of minutes) and also fixed in record time (a matter of hours). Since that initial bug, there hasn’t been any compromise of the bitcoin software or the network.
How much you trust this underlying network is key to whether or not Bitcoin can be treated as ‘money’.
Remember, Money is something that is BACKED by something STABLE.
You are free to NOT trust the underlying network — and therefore NOT treat Bitcoin on the same footing as money. However, what matters is not YOUR opinion, but that of the majority.
Should the majority start conceiving this network as stable, and start treating bitcoin as money, then it will start functioning as money.
As an aside, there are already several examples of bitcoin being used in real world monetary transactions — including payments (soccer player sign on bonuses), purchase of real estate and other commodities.
Bitcoin as a Unit of Transaction (Medium of Exchange)
You may accept the underlying network as stable — and start treating Bitcoin as money.
However, a question still remains. As money, is it in any form superior to other monies — such as the US dollar or the Euro?
It turns out, that as a unit of transaction (think dollars), bitcoin does work extremely well. In some ways, it works better than even traditional money. Try sending $10,000 (or Euros) overseas and see how long it takes (typically 3 days to a week, even with SWIFT, since a lot of clearances are required). With Bitcoin, the same transaction can be finalized and settled in a matter of minutes. Again, because of it’s built in payment network (including settlement).
However, to present the dollar’s appeal, unlike most other units of transaction (other monies), there isn’t any structure that one can impose on TOP of bitcoin.
Say — you needed to take out loans in bitcoin, set up payment structures etc…that’s not possible with native bitcoin (although several DeFi projects are changing that — so it is possible to earn interest on your bitcoin and even take loans on your BTC).
Bitcoin as a Store of Value
A store of value is something like Gold, which is not used for ‘day to day transactions’, but holds it’s value over time.
Is Bitcoin a good ‘store of value’?
Here are what the bears might say:
- It hasn’t been around long enough to qualify.
- It’s price is far too volatile (at this time) to qualify.
Eventually, though, it’s price WILL stabilize.
If you look into the history of GOLD, it too, fluctuated wildly before settling on a stable value.
Isn’t Bitcoin ‘Digital Gold’?
Bitcoin has all the properties of gold — it is scarce, it has to be ‘mined’, it does not tarnish, it is ‘fungible’ (one ounce of YOUR gold is the same as one ounce of MY gold) and any other characteristic you can think of.
Except, it’s not a metal. It cannot be molded into jewelry.
However, if you look at Gold as primarily a ‘store of value’, then, yes, Bitcoin can be called, in all good faith, ‘digital gold’.
Is Bitcoin Inflationary or Deflationary?
Bitcoin is deflationary by design. Once the supply is exhausted, each bitcoin becomes worth more and more.
Now, economists will disagree on whether this is a good thing or a bad thing. It seems that some level of inflation, is a necessary evil that sustains all growth. To that end, Bitcoin doesn’t provide you with any inflationary mechanism (even in principle).
Aren’t ALL electronic payments also ‘Digital’ ? So, why is bitcoin’s digital payment any different?
All modern day financial transactions are already digital, in that no actual dollars or gold ever flows from the sender to the recipient.
All that happens is an adjustment of the appropriate ledgers to reflect the debit and the credit.
Bitcoin is no different — in fact, all it is, is a distributed (actually decentralized) ledger. A ledger with multiple copies of record, so no single copy need be the source of truth. A tally of all the registers provides veracity of transactions.
So, if everything is digital ledger based, how then is bitcoin different from say — Visa or PayPal?
The primary difference is that there are no intermediaries clearing or settling the transaction.
No banks, No escrow (although there is a ‘holding area’ for unconfirmed transactions), No Middlemen — and hence, none of the costs or delays associated with middlemen or banks.
The bitcoin equivalent of ‘intermediaries’ is a set of ‘validator nodes’ on the bitcoin network (not to be confused with ‘mining nodes’), who are responsible for approving or rejecting a transaction.
This approval / rejection is based on unique cryptographic signatures (in other words, it cannot be faked, just like your fingerprint cannot be faked).
This, in turn, enables a true peer to peer payment system with near instant ‘settlement’. And this is key to the discussion around intrinsic value.
Prior to bitcoin, there had been no reliable, almost instantaneous method of settlement. Which is why intermediaries were introduced to begin with. To provide both reliability and finality to a monetary transaction.
What is the difference between a DISTRIBUTED sytem and decentralized sytem (like Bitcoin)?
The difference is that in a distributed system (think Oracle RAC), the nodes all trust and know each other. In a decentralized network, most nodes do not even KNOW of the existence of the other nodes (they simply know some nearest neighbors).
Recap — What was Bitcoin the ‘first’ at doing? Why is it regarded as a technological and a financial breakthrough?
This is a list of some things Bitcoin was the FIRST to do:
- Provide true Digital Uniqueness (that could be measured and quantified). Using a unique solution to the double spend problem.
- Programmable money — Truly programmable currency — which can update it’s features, with new software releases.
- The first currency with a payment network (end to end — from initiation of transactions to settlements) built in. The settlement layer takes minutes as opposed to traditional settlements, which can take days, if not weeks.
- The first currency with an unbreakable security layer (unbreakable due to hash power required to break it).
- Private Money — as competition for public (government) money. Private money isn’t new — it had been tried — and was always shut down by the owners of public money (Governments). The reason it COULD be shut down was because it was offered through centralized entities. All one needed was to shut down the central private company and that was the end of their private money. Bitcoin, in contrast, doesn’t have a single centralized owning agency. It cannot, in principle, be shut down.
In short, Bitcoin is the first peer to peer (no central agencies) payment system that is hack proof, is low cost (for end users) and has near instantaneous settlements built in.
Companies such as Citicorp and large financial institutions had been struggling with some of these ‘digitization of cash’ problem for decades, and were unsuccessful at solving it (mainly due to the double spend problem).
What are some thing Bitcoin is NOT GOOD at?
There are a lot of smart financial gurus who remain unconvinced that Bitcoin can replace traditional ‘money’. Here are some things that Bitcoin cannot currently do:
- Payment Structures — For instance, how do you borrow and setup payment structures , like loans?
- The Ecosystem Argument — how do you stay only in crypto and not convert to fiat? Can you use Bitcoin purely for payments WITHOUT cashing into or out of Fiat?
- The Jewelry Argument — It mimics real money perfectly (by imposing an artificial limit) — but apart from mimicking, what good is it? Is it like an advanced video game, fun to play with, but completely disconnected from the real world?
- The Inflationary Argument — Isn’t some amount of inflation a good thing? And if so, Bitcoin is not poised to ‘grow an economy’ that uses Bitcoin as the primary ‘money’.
- Isn’t Mining Bitcoin a Terrible waste of resources? Again, a Bitcoin purist will argue that all the paper trails and physical bank locations are a BIGGER waste of resources. Bitcoin requires none of these — and still accomplishes the key functions (money transfers) equally reliably.
- What happens if I lose my wallet key ? — This is still an issue. While there are ways around it (multi sig wallets, paper trail wallet keywords…etc.), it is still true that YOU are your own bank. Lose your private key and you’ve lost your bitcoin.
- Fake Trading Volume — A LOT of BTC’s trading volume is ‘fake trades’. This does not mean that ALL of it is fake; in fact, 100% of the trading volume on CoinBase is ‘real’ trades. There are just far too many unregulated exchanges, that operate under the radar.
Bitcoin Adoption (Demand) — Starbucks, Microsoft, Kroger, Japan
In the end, it all comes down to adoption.
Are you going to be able to use crypto without ever leaving the crypto ecosystem (i.e. without converting to some Government Fiat currency)?
True believers believe that bitcoin WILL be the new currency, so why would you sell the new dollar?
Bitcoin’s confirmed daily transactions have seen enormous growth since this time last year. Despite what everyone considers to be a long bear market, the confirmed daily transactions have grown from 196,422 on March 7th 2018, to 282,583 one year later. That’s how many Bitcoin transactions are confirmed every day on average!
Microsoft — “We’ve restored bitcoin as a payment option in our store after working with our provider to ensure lower bitcoin amounts would be redeemable by customers,” the spokesperson told the publication. Microsoft first started accepting bitcoin as a payment method in 2014.
Starbucks — Starbucks has started considering crypto as a payment for their products (Starbucks sells close to 4 billion cups of coffee each year)
What is backing bitcoin?
We addressed this question above, but it merits a deeper discussion. A country’s government backs traditional currencies like the US Dollar or the Euro. What is backing bitcoin.
The answer depends on whether you think of Bitcoin as a ‘medium of exchange’(think Dollars) or as a store of value (think Gold)
- Medium Of Exchange — The Bitcoin Payment Network (confusingly also named ‘Bitcoin’) is what backs Bitcoin as a medium of exchange. The network never goes down, is 100% reliable (no lost transactions) and is hack proof (due to it’s immense hash power).
- Store of Value — If you think of bitcoin as a true store of value (the way the dollar was when it was backed by Gold), then, the answer is different. What backs Gold? Nothing. Gold is THE BACKING commodity, because of it’s unique, untarnishable, limited quantity characteristics. In the same way, Bitcoin IS the commodity — Bitcoin will be backing other THINGS (be they gold, real estate or other assets). So, the answer is ‘Nothing’ — Bitcoin IS THE BACKING commodity.
Volatility of Bitcoin as a Store of Value
Would gold really be gold if it wasn’t a ‘stable haven’ whenever faced with economic uncertainty?
If you do think of Bitcoin as an eventual replacement for Gold (it is often referred to as ‘Digital Gold’), you have to address it’s volatility. Can any store of value truly store ANY value if it fluctuates 10% within a day?
Bitcoin supporters argue that the volatility is actually DOWN considerably. It was not uncommon for it to swing by 50% in it’s earlier days. Now, the swings are smaller. And, they predict, the swings will eventually become even smaller — 1 to 3% — same as any stock on any given day.
How does one counter that? In fact, within this question lies the true test of bitcoin’s value….
One Possible Test of ‘Whether’ Bitcoin has intrinsic value
It’s really simple. Bitcoin’s volatility can be driven by one of two things. Either:
a) Pure Speculation (i.e. no intrinsic value, just speculation)
b) SOME intrinsic value (and some speculation as is wont with any trading asset).
If it’s the latter, the price of bitcoin will eventually stabilize towards an average ‘intrinsic value’ (or a multiple thereof — and volatility will all but disappear).
If the former, the price of bitcoin will NEVER stabilize (or at best, stabilize at ZERO). So, the real test if to see if it’s price is following some sort (ANY sort) of stabilizing pattern. If so, Bitcoin DOES indeed have intrinsic value.
What then, could THEORETICALLY provide bitcoin with intrinsic value?
Answer 1- Scarcity
Scarcity is the most often touted argument. And while it is an important attribute, in and of itself, Scarcity doesn’t provide value. If the underlying resource isn’t secure, there’s no point in it being scarce. That leads to the main reason that this scarce resource has ANY value at all.
Answer 2 — Security of the underlying network
What backs the US Dollar? An entire Government and everything that the Government controls (e.g. the military, the history and resilience of a nation…).
So, if it’s not a company or a country, what backs Bitcoin?
The bitcoin network. Think about it — the reason we trust the country to back it’s currency is because the country ensures that the currency is never ‘counterfeited’, transactions are never ‘lost’ and any IOUs are honored.
It is exactly the same for the bitcoin network!
As long as the network is reliable (does not drop any transactions) and honest (no fraudulent transactions), the bitcoin network provides some value to the overlaying currency. The network, in turn, is considered stable since it hasn’t been hacked in it’s 11 year history (except at the very initial stages, when the hack was detected and fixed in a matter of hours).
So, while not backed by a country, Bitcoin is backed by a resilient and reliable network that guarantees both — honoring of transactions (instant settlements) and uniqueness (no counterfeiting).
Answer 3 — Peer to peer payments with built-in settlements
The sheer ability for a peer to peer payment to be SETTLED within a matter of minutes, without relying on any bank or middlemen, is in itself, a huge technological advance.
Settlement is an important concept. Just because you got your direct deposit in your account does not mean the transaction is ‘settled’. Until all the intermediaries in between have had their part of the contract satisfied, the deal is not considered settled. It could take 3 to 4 days to ‘settle’.
Several bitcoiners believe that this near instantaneous settlement layer, in itself, imbues bitcoin with INTRINSIC value.
Summary — Supply versus Demand — Bulls vs Bears
In Bitcoin’s defense, the single use case of sending money near instantly, in a non-repudiatable manner (with settlements built in), is itself a technological breakthrough.
More than a technological breakthrough, it is a financial breakthrough, for never before was this even considered possible (Settlements were always assumed to be separate and ‘external’ to the actual value transfer).
Digital uniqueness, another great breakthrough that Bitcoin brought to the world, is something that has Google, Microsoft and all other tech leaders scratching their heads as to why THEY didn’t think of this first.
Nevertheless, technological prowess aside, is there a true demand for bitcoin outside of the crypto network? Is there a way to make it function as ‘money’ in the same way that you can ‘lend or borrow’ or set up payment structures? The answer is — yes — though these functions are still evolving. There are bitcoin loan mechanisms out there — but, in the end, they are all tied back to fiat.
In other words, is there any demand from the non-speculative section of the world?
Is anybody selling their gold to buy bitcoin? Is anybody dumping the entire banking system to go peer-to-peer on the Bitcoin network? Is anybody able to purchase anything with bitcoin (without first converting it to USD or Euros…)?
The point here is that, as purely a PAYMENT currency, BTC is not quite there — in that it still needs broader acceptance. With PayPal and Square leading the charge, it seems to be nearing that broad acceptance as well.
In terms of a store of value (GOLD), it seems to be already heading in that direction. Will it replace gold? If you ask a millennial which would they rather buy as a store of value, the answer will overwhelmingly be ‘Bitcoin’.
So back to the original question — What is Bitcoin’s true valuation?
If you are willing to assign valuation to a technological (and financial) breakthrough, then certainly, you can say Bitcoin has a non-zero valuation. It’s usefulness as a technology is beyond the realm of finance (Bitcoin can be used as proof of ownership, proof of asset — lots of uses besides finance).
In addition to innovation, if you consider Bitcoin as legitimate competition to the dollar (which, due to it’s deflationary nature, it is), then you can attach an even higher valuation onto it.
Lastly, if you are willing to consider it a store of value and legitimate competition to GOLD, then you can tag on an even higher valuation. Gold is currently valued at $10 Trillion globally.
Give me a number please!
Bitcoin’s Intrinsic Value = Value of the underlying Technological Innovation V + Value as a potential Currency (Dollar Competitor) + Value as a rare commodity (gold)
If we envision a $10 trillion BTC market cap, that puts bitcoin at roughly $500K per coin (there will be less than 17 million BTC in total circulation, as 4 million are considered ‘lost forever’).
That’s JUST accounting for it’s potential to replace Gold, and nothing else. If it ends up being a medium of transaction, it could be worth a lot more.
For example, if I was only willing to sell my house in BTC, I could care less what the dollar offer on my house is. Rather than take half a million dollars, I would only accept the equivalent in BTC. This would make BTC a ‘transactional entity’ as opposed to simply a store of value.
What about the volatility?
Before Gold settled on a stable valuation, it too fluctuated. Rapidly. And folks were unable or unwilling to buy such an unstable asset. However, as more and more people accepted the underlying value of Gold, it’s price started stabilizing.
To that end, I believe Bitcoin’s volatile price will stabilize as well. It is a loooong way from that stable value, which as one estimate would have it, is closer to half a million US dollars.
Switch to Valuing things in BTC
Rather than balk at this huge valuation, I would suggest that you consider it in currency neutral terms (i.e. non-dollar terms). That is, a bitcoin’s value is equal to ONE bitcoin. It is it’s own standard and it’s own standalone currency. Half a bitcoin is worth half a bitcoin. That’s it.
It is important to adopt this type of thinking, because if we keep converting BTC to dollars, we are still putting Dollar as the winner here (the currency to measure everything by). At some point , I believe we will switch to measuring everything in BTC.
This house is worth half a BTC. That building is worth 10 BTC, and so on.
Public Key Infrastructure (read this post to understand why PKI was as key an enabler for bitcoin, as was blockchain technology)