In the previous article, we looked at the two dimensions of money — base money and credit money. We also looked at the different kind of monetary systems that existed in the...
In the previous article, we looked at the two dimensions of money — base money and credit money. We also looked at the different kind of monetary systems that existed in the last 5’000 years and possible scenarios for the future.
The key question is — will it be different this time? Will we enter a phase of crypto-based money without having some form of crypto-credit money or will credit money be included in the crypto sector?
Classification
Here is the summary of the monetary systems from the past 5’000 years.
The first conclusion from the previous article is that monetary systems are not static, but are ever evolving:
The monetary system started with commodity-based money and decentralized credit money.
The next phase was sovereign coin-based money and decentralized credit money.
The next phase was national-based money (either from the sovereign or central bank) and private-credit money.
The next phase was the current central banking based money and its central credit money system.
The second conclusion is that the decentralized credit money system has existed for thousands of years without central intermediaries.
How did decentral credit money worked in the past?
As we are in the crypto age, let’s analyze how decentralized credit systems worked in the past.
It was all based on the bill of exchange — these are legal documents enforced by the court system. Anyone can issue a bill of exchange, it has only 8 attributes, including the wet signature of the borrower. The borrower has to pay, not to the issuer, but to the owner of the bill of exchange. This gives value to every bill of exchange as they are backed by the borrower’s obligation to pay. This allows the use of bills of exchange as a mean of payment:
Bills of exchange are enforced by the court system — there is no court hearing, there is only validation of the evidence, analysis of who has to pay whom, and a court decision. It is as simple as that.
The bill of exchange system is a P2P system backed by the court system. Every lender can create new credit money — the bills become the credit money, till they are paid back to the holder. One doesn’t need banks to create the credit money, every person can do this via a bill of exchange.
This system works as well today, even without the blockchain. This system has been the basis of all decentralized credit money systems in the last 5’000 years.
But there are limitations to this system:
Wet signature has to be used — digital signatures are not accepted by the court system.
Nominations of the bills were arbitrary — tokenization was not possible.
Time periods on the bills of exchange were different.
Insurance mechanisms were missing, except the strong support from the court system.
Bill of exchange networks could become arbitrarily complex, with multiple borrowers, lenders, and holders. But without central middlemen:
How could it work in the future
Here is a more detailed view of how it could work:
Elastic crypto credit money is created in P2P borrowing/lending transactions.
Elastic crypto credit money is destroyed when the loan time period is finished.
Bitcoin, Ether, and stablecoins serve as base money.
A pulsating supply of elastic crypto credit money is placed on top of the base money.
It would work very similar to the bill of exchange system, but it has to address the weaknesses of the previous systems:
Bills of exchange cannot be used because of wet signatures — We have to use standard contract law.
Different nomination issues — Tokenization of loan obligations via standard ERC20 contracts.
Different time periods of the bills of exchange — Tokenization via standard ERC20 contracts help here.
Insurance mechanism is missing — Decentralized insurance mechanism will be introduced.
Forecast
Our forecast for the future is the following:
There will be a national crypto-base money like Venezuela’s Petro.
There will be a decentrally created crypto credit money on top of the national base money.
In parallel, there will be a global base money (BTC, ETH, …).
In parallel, there will be a global decentralized credit money.
This future does not depend on central bank based money creation or commercial bank credit money creation. Instead, it will be an alternative financial system. However, it’ll not really be a new system as it has existed for the last 5’000 years. Only this time it will be empowered by the blockchain.
Roadmap
Our forecast roadmap:
It all started 10 years ago with the creation of decentralized crypto-based money — Bitcoin.
5 years ago, decentralized programmable smart contracts were added.
Now we are in a phase where stablecoins are emerging.
In 5 years, there will be decentralized elastic crypto credit money
Summary
This time
will not be different, there will be crypto credit money as well. It’s
not yet there, but it might be there faster than anyone is anticipating.
During presentations about money, we usually hear that money has to be durable, portable, divisible and fungible. We fully agree with this distinction. However, there is a bigger picture. Money...
During presentations about money, we usually hear that money has to be durable, portable, divisible and fungible. We fully agree with this distinction.
However, there is a bigger picture. Money doesn’t have just one dimension, it actually has two — the base money and the credit money. The notes and coins in your wallet are the base money. The money what you have in your bank account is actually the credit money.
This article:
Analyses how base money and credit money work today.
Analyses how base money and credit money worked in the last 5’000 years.
Discusses credit money in the crypto sphere.
Below is a picture of the first known credit money, from Mesopotamia, from ca 2’500 B.C., now in the possession of the British Museum in London:
The intuitive answer to the key question of this article will be — yes. Since credit money has been around for so long, it will be around in the future as well.
But how?
The crypto sphere today does not have any form of credit money. Bitcoin, Bitcoin Cash, Ether, etc. can only be used as base money because credit money has to be dynamic. Credit money is elastic; it is created and destroyed every time we perform economic transactions.
Base money versus the credit money
Let’s start with how they work today. Base money is created by central banks and credit money is created by commercial banks. Base money constitutes about 3% — 7% of today’s money, the rest is credit money.
Credit money is elastic, it’s amount grows and declines together with economic transactions. More economic transactions result in more lending which results in more credit money and vice versa.
This elasticity parameter is the key reason why we say that Bitcoin, Ether, etc. are not a form of credit money, but base money.
The supply of credit money also rises and falls — additional economic activities lead to additional demand for credit and reduced economic activity to reduced demand.
Credit money is, by principle, rather temporary. However, in our current monetary system, we create more credit money than we destroyed, resulting in the continuous growth of the total credit money available circa 5% — 7% per year.
How is credit money created today?
Credit money is created by commercial banks in the lending process (no, commercial banks are not lending your grandma’s deposits, they create credit money by the so-called “balance sheet extension” procedure).
Credit money is created every time you receive a loan from a bank and destroyed every time you pay back a loan. The money, which you have in your bank account, is not as durable as you might have thought — there are continuous cycles of destruction and creation happening in the background.
Banks create credit money and protect it with their reserves (for example, the Deutsche Bank which has a balance sheet to equity ratio of 100:1) and there are national deposit insurances as well (for example, the Swiss deposit insurance, which has reserve funds to cover 4% of all Swiss deposits).
In practical terms, banks do the following:
Banks protect the value of the credit-money which they have created with this mechanism.
Well, what happens if this mechanism fails? No problem, it’s fixed by creating more of the same (creating more credit money):
The central banks will create additional base money and push it into the circulation via commercial banks. (Quantitative Easing) or
Lending criteria are simplified (for example, Federal Reserve interest rate is reduced or the balance sheet to “mark to model equity” requirements are relaxed) so that more and more credit money will be created via lending. Or
Governments will take on more debt and try to pump it into the real economy to stimulate the multiplication effect (this only works in cases of real investments, doesn’t work in cases of just spending).
Obviously, this mechanism will result in inflation (sooner or later) or in deflation (if no-one wants to borrow anymore), but as this happens later, then this is someone else’s problem.
Some people say that this system reminds them a little of the “musical chairs game”. We think that’s wrong — it IS the musical chairs game.
Monetary systems now and in the past
Monetary systems have always been made up of base money and credit money. The differences lie in:
Who is creating base money?
Who is creating credit money?
Our current fiat monetary system is actually not very old, it started in the time period between the Federal Reserve creation (1913) and the gradual gold standard abolishment (1933 — nationalizing gold in U.S., 1944 -Bretton Wood agreement, 1971 — removing gold backing from USD base money, 1992 — removing gold backing from CHF base money).
Our fiat system looks as follows:
How did it work before our fiat system? Through the following:
Practically, commercial banks created their own private credit money, which was exchangeable for physical gold.
Central banks created the national base money, which was backed by and exchangeable for gold.
This system started to emerge around the time period of the creation of the first central banks (in Sweden and England in 1660’s) and lasted until the Federal Reserve was created in 1913.
There were several sub-phases during this time — free banking areas, gold-based systems, some countries introduced central banks earlier, some later. In some cases, the central banks were “independent”, in other cases there were state treasuries, etc.
The key to this phase was however
Base money was backed by a commodity — gold.
Commercial banks created their own private credit money, which they protected with their reserves.
The earlier phase started around 500 B.C. and lasted until 1660. The first coins were created around 500 B.C. — this was the time when the standing armies in Europe, India, and China had to be financed — they were financed with sovereign minted coins.
In the beginning, the coins were usually 100% gold or 100% silver. Then later the kings started to reduce the ratio of precious metals in the coins — this caused hidden inflation in base money. However, the coins were legal tender and one had to accept them.
In the time period when the Phoenicia, Islamic Trading Network, Mediterranean and Hanseatic Trading Networks existed. Decentralized credit money was created, in peer to peer transactions. Obligations to pay were used as bearer notes which could be used to pay third parties, who could pay fourth parties and so on. In the end, the borrower had to pay to the owner of the bearer note.
So, the key to this phase was:
Base money was created by sovereigns and was inflated slowly.
Credit money was created decentrally by people in peer to peer transactions.
But how did it all work before 500 B.C? There were many blossoming civilizations during that time and the following are common to all of them:
Commodities — gold, silver, grain, shells — were used as base money.
Credit money was created decentrally.
However, governments and sovereigns were not involved in the definition of what the base money had to be — the people decided it. Neither did they define how credit money had to work — the people also decided it. There was no government involvement. But there was a court system for enforcing contracts. And there was a government system for enforcing the court’s decisions.
The first known credit money is from Mesopotamia, from about 5’000 years ago. It was created decentrally, in peer to peer transactions. Mesopotamia used grain as their base money — the unit of account was a barrel of grain. On top of this was the decentralized peer to peer credit money, in this case, clay plates with the stamps of the borrowers.
Obviously, the barrels of grain were not easy to use in daily transactions. This facilitated the usage of clay plates based credit money even more.
Classification of the monetary systems
By using base money and credit money dimensions we can classify the monetary systems of the last 5’000 years as follows:
The current crypto sphere doesn’t have the credit money approach, but none of the civilizations in the past has survived without credit money. Which leads us to the next question:
How will it work in the future?
The first conclusion is that credit money has been always there. It has been created either as:
Decentralized peer to peer transactions.
Private credit money of commercial banks.
Central credit money of commercial banks.
The second conclusion is that we are presented with two different possibilities to create base money:
Controlled creation of base money — in this case, it’s created by central banks or sovereigns.
Uncontrolled creation of base money — in this case, commodities like gold, silver or grain are used as base money.
Uncontrolled creation of base money means that a commodity, which cannot be manipulated, will be used as the base currency. The Swiss National Bank has increased its amount of base money by 10x in the last 10 years since the Lehman crisis. One cannot do this with commodity-based base money.
U.S. Courts have defined Bitcoin as a commodity. Some people are unhappy about this. However, we are very satisfied with this — it allows us to move back to the commodity-based monetary systems (which are then by definition, non-manipulatable).
But what’s about the crypto credit-money? If we use the Bitcoin as our base money, who will create crypto credit money? In the end, there are 3 possibilities — decentralized credit money, privatized credit money or centralized credit money.
Summary
Credit-money has been around for the last 5’000 years. No key civilization from the last 5’000 years has survived without using elastic credit money of one form or another.
But credit money is currently missing in the crypto sector. Bitcoin, Bitcoin Cash, Ether, etc. have the characteristics of base money. They are missing various characteristics, the elasticity, the continuous creation, and destruction, and more of credit money.
So, who will create elastic credit money for the crypto sector?
Will it be created by the existing commercial banking infrastructure? Probably not since the crypto sector will not accept the “old world credit money”.
Will it be created decentrally without commercial banking? Probably yes!
Our thesis is that the pendulum will move back to where we started:
We will have commodity based base-money (Bitcoin, Ether, …).
We will have decentrally created elastic credit money.
The court system will be there for enforcing the agreements.
The government will be there for fulfilling the court’s decisions.
It will be the same as it was in Mesopotamia 5’000 years ago. But this time empowered by the blockchain.
In January 2014 we forecasted Bitcoin valuation of 10'000 USD in the Swiss CFA Charter Magazine. The value of Bitcoin reached a record high of $19,850 in December 2017. Given...
In January 2014 we forecasted Bitcoin valuation of 10’000 USD in the Swiss CFA Charter Magazine. The value of Bitcoin reached a record high of $19,850 in December 2017. Given the hype surrounding the value of Bitcoin, what could we expect its value to be in the future? The value of Bitcoin can be derived from the following as:
The value of Bitcoin can be derived from the following as:
Store of value like gold and other real assets
Means of payment
(Future) provider of smart contracts platform for disintermediation of today’s big corporations.
Price Development
The following graph shows Bitcoin price on a logarithmic scale
Number of Users in Crypto Sphere
Most users of Bitcoin will use the currency through the use of an ‘internal blockchain wallet” on the Exchange (e.g. Bitfinex, Bitstamp, Coinbase, etc.) rather than an “external bitcoin wallet” in the blockchain. After getting more experienced in Crypto, we expect these users will create their own wallets on the public Bitcoin blockchain. In this situation, they will be real owners of their Bitcoins (as opposed to having a claim with the Exchange who owns the private keys for the Bitcoins).
There are no user numbers available for Bitfinex which is the largest crypto exchange. However, data is is available for Coinbase (also known as GDAX), which is the second largest crypto exchange –. Coinbase is growing at the moment by 50’000–100’000 users per day. The following graph shows the number of Coinbase users. The graph is on a logarithmic scale and so the straight line depicts and exponential growth in a number of grand
Coinbase trades 10% of the total global Bitcoin volume and there are over one hundred exchanges. If Coinbase is growing 50–100,000 users per day and blockchain.info by 50–80,000 users per day, then we estimate conservatively daily growth rate of 200,000–300,000 users per day (users usually register not only on one exchange but on multiple exchanges).
We estimate approximately 20 million direct users of Bitcoin blockchain and an additional 15 million users who use Bitcoin through their exchange wallets. Not all of these users own Bitcoins many of them have moved into other cryptocurrencies. Many of the users own more than one address as well and we estimate 35 million active cryptocurrency users at the moment.
Transaction Volume
On 11.12.2017 there were approximately 400’000 transactions on the network and the total transaction value was 4.3 Billion USD. The following graph shows transaction volume on a logarithmic scale and exponential growth
Network Effect
One can see exponential growth in Bitcoin Price, in the number of Bitcoin users and in the transaction value over the Bitcoin blockchain.
To consider how to translate the growth into Bitcoin value, I consider the application of Metcalfe’s law, which states that the value of the network is not growing linearly but to the square of the number of users. The number of users has been growing more than two times every year. Currently, the network grows by 200,000–300,000 users per day. If we assume doubling the number of users of Bitcoin per year, this translates into value growth of two and four times.
Many cryptocurrency platforms (like Bitcoin and others) are instances of the “network economy”. These are not like traditional companies which grow through scale but where the value is linear to capital used. The network economy value is not driven by capital used and by scale effects but rather two parameters:
Number of users
Number of transfers/ relations/transactions between the users
Number of transactions
Bitcoin network received major re-design in August this year when the so-called SegWit protocol was initialized. The next step is to initialize the Lightning Network protocol. These protocols increase the throughput of the network by introducing “two-layer” transactions. There are transactions on the main blockchain and light transactions settled later on the main network. This will lead to a massive increase of transactions on Bitcoin network because current transactions fees which can exceed 50 USD are relatively expensive for users.
Adoption Curve
Every new technology such as fax, e-mail, internet, and even Bitcoin can follow the adoption curve. The following graph shows the Gauss bell-curve and the S-Curve, which both can be used for adaption.
Our analysis above estimates approximately 35 million active cryptocurrency users. Given the world population is 7.6 billion less young children, the elderly and people in state institutions. And if we assume half of the world population would be potential Bitcoin users, this translates into a worldwide adaption rate of 1%.
However, we could expect most of the cryptocurrency users are in OECD countries and contribute to 80% of its use considering that 80% of the number of Bitcoin nodes are deployed in OECD countries. Given the OECD population is 1’154 million, from which the economically active population is 700–800 million people, the OECD adaption rate is 3.5%.
This implies that the Bitcoin network has entered the early adopters phase on the S-Curve in OECD countries. This phase will be characterized by the development of real-world business use cases, by emerging “killer apps” and by increasing rate of adoption.
Value Adding Services on the Bitcoin Network
Bitcoin is a highly secure network, but it does not support “smart contracts”, which are supported by about ten different crypto-platforms. Smart contracts allow to build value-adding business applications on top of the crypto-platforms and generate additional usage on the platform. This translates into higher valuation given the value of the network depends on the number of nodes and on the number of transactions on the network. For example, Ethereum platform has thousands of so-called “decentral apps” which are often financed through Initial Coin Offerings — ICO’s.
However, through emerging sidechain technology it will become possible to connect Bitcoin with Smart Contract platforms such as the “Rootstock project”. This would build “decentral apps” which are connected to Bitcoin blockchain security and translate into a higher number of transactions on the network and higher value.
The Coordination Problem in Economy
“Decentral apps” offer the potential to build new business models through disintermediation. Today’s big corporations, which enjoy oligopoly or monopoly positions have been built through solving the coordination problem with hierarchical and process-based methods rather than through a market mechanism outside of the banks.
If one is dealing with digital goods, like in banking, media or insurance sectors, and if coordination mechanisms can be solved through blockchain and decentral app based marketplaces, then the need for big corporations, as we know them today, will reduce.
Adam Smiths’ “Wealth of Nations” describes the model of free market capitalism but was based on companies which would today classify as small companies. However, the coordination problem led to the emergence of large corporations, and through their oligopoly and monopoly market positions have moved away from the concept of free-market capitalism as defined by Adam Smith.
Disintermediation of centralized business models through blockchain and decentral apps will lead to significant value creation in new business models and at the same time to value destruction of today’s big corporations.
Bitcoin Valuation
We consider the valuation has three components:
Network value as a store of value
The number of Bitcoin users doubles every year and if we take the base price in 2017 at approximately 1’000 USD, then the price by the end of 2018 should be 2’000 and 4’000 USD.
The current price is higher and will lead to a short-term correction over the coming months. However, by taking 3’000 USD as current fair price and projecting exponential growth of the network, the price in four years would be expected to be between 50’000 and 750’000 USD.
Network value based on possibility to execute transactions between the users
Bitcoin network has reached its current throughput limits. However full implementation of Segwit and Lightning protocols will lead to massive enablement of the smaller transactions on the network, which will increase the network’s value.
This allows us adjusting the forecasted price in four years from 50’000 to 80’000 USD.
Network value through value adding services on Bitcoin Network
The Internet boom beginning of this century focused first on technology (telecoms, broadband, etc.) and then emerging companies such as Facebook, Google, and Amazon. The same trend is happening in crypto-sphere. — The current focus on underlying technologies will shift to network-based business models, which will result in newly created applications and lead to the major adoption of the platform.
Bitcoin enrichment with Smart Contract functionality facilitates further applications and will translate into additional Bitcoin network value increase at the same time.
This allows further adjustment in the forecasted price of Bitcoin in four years to 80’000 to 100’000 USD.
Summary
Blockchain technologies, which were first implemented with Bitcoin, will enable “Cambrian explosion” of new blockchain based business models, which started with simple use cases like “store of value” and “payment”. Adding “disintermediation” models allows real blockchain based killer-apps , and networked economy based business models. Bitcoin network will be the key beneficiary of this upcoming “Cambrian explosion“.
Our forecast four years ago was that Bitcoin will be 10’000 USD. Our new conservative forecast will be that Bitcoin will reach 100’000 USD in next four years.
Bitcoin is digital currency which enables instant payments to anyone and anywhere in the world. There are many differences to other currencies: · Other currencies are issued by Central Banks...
Bitcoin is digital currency which enables instant payments to anyone and anywhere in the world.
There are many differences to other currencies:
· Other currencies are issued by Central Banks and have the role of legal tender. Bitcoins are issued de-centrally; there is no Central Bank, and they are not legal tender.
· Other currencies have some physical representations (bills). Bitcoin exists only digitally.
· Other currencies have central authorities. Bitcoin has no central authority; validation of transactions is done from Bitcoin Network.
· Monetary Base of other Currencies is continuously increased, which translates into inflation in the long term. But in Bitcoin Network will contain only 21 Million Bitcoins (smallest transferable unit being 0.00000001 Bitcoins), which translates into deflation in the long term.
Bitcoins is based on combination of several existing technologies:
· Peer to Peer systems (like bittorrent)
· Private / Public key Cryptography
· Application of this combination for creating a currency
First Private / Public key cryptography algorithms were published in 1977. First famous Peer-to-Peer system was napster, published in 1999. However, it took till 2008 when Satoshi Nakamoto (pseudonym) connected peer to peer systems with state of the art cryptography to create first crypto currency — Bitcoin.
Bitcoin has properties of currency — its unit of account; it’s portable, durable, divisible and fungible. However, Bitcoins are much more just as a simple currency. Satoshi’s ideas went much further — Bitcoin Network is a mean to describe economic contracts and transactions between the participants of the Network. Additionally, the distributed storage of transactions (Blockchain in Bitcoin terminology) can be considered as a public general ledger, where not only simple payment transactions, but many more complex economic contracts can be stored and easily distributed / published to any node of the network.
Bitcoin price development from Aug 2010 till Jan 2014 is described on the following graph. It follows a linear trend on the logarithmic graph.
There have been several price corrections, which have received quite some media attention:
· In 2011 from 31 to 2 USD per BTC
· In 2013 from 266 to 50 USD per BTC
· In 2013 from 1242 to 455 USD per BTC
However, we hardly recognize these price corrections on the logarithmic scale.
Will this logarithmic growth continue? Where will be the price of one Bitcoin in one year? How to calculate the fair value of Bitcoin? This article evaluates approaches for Bitcoin valuation.
Bitcoin Network has currently 2’400’000 addresses. One person can have more than one address.
Value of the network is not growing linearly but in square with the growth of network members (Metcalfe’s law). I.e. if we have 2 times more participants, then the value of the network grows 4 times; if we have 10 times more participants, then the value of the network grows 100 times and so on.
Currently network grows by 7000–8000 addresses per day. If we assume same constant growth for the year, then number of addresses will double in this year, implying the value of Bitcoin Network will grow 4 times this year.
As we are speaking of ca 2 million people using the network then we are still in early phases on the Bitcoin Network development. It can be compared to “pre-Mosaic browser” phase of the Internet — there were many enthusiasts on Internet, but most of them were “techies”. The breakthrough happened when Netscape introduced Mosaic Browser. The rest is history.
There are several discussions about intrinsic value of Bitcoin Network. One side has the opinion that Bitcoin Network does not have any intrinsic value; other side has the opinion that there is high intrinsic value.
Bitcoin Network is like Internet network. It’s not the Internet that has the value, but its diverse products and services on top of Internet network, which create the value of the Internet. It’s the same with Bitcoin Network — it’s the products and services on top of Bitcoin Network, which create value for Bitcoins.
The most exposed intrinsic value is Bitcoin Network as Payment Processor:
Bitcoin Network allows instant Bitcoin transfers between any locations in the world practically at no costs.
The service fees of Payment processors (Visa, Mastercard, Paypal) will become obsolete
Micropayments worldwide will be supported; mobile payments worldwide will be supported too.
Additional intrinsic value of Bitcoin Network is the “base money” functionality and “value added services”.
Bitcoin enables payments just in time between any countries in the world it practically no fees. Bitcoin is current 9th biggest payment processor worldwide. Additional adoption of Bitcoin Network will result in reduced demand for the services of companies like Visa, Mastercard or Western Union.
Visa’s market capitalization is 140 B USD, Mastercard’s capitalization is 100 B USD, and Western Union is 9 B USD.
Let’s assume total market cap of these payment processors is 250 B USD, If Bitcoin Network would replace 1/3 of their businesses, then this result in price of 3929 USD per BTC.
Payment Processors total Market Capitalization (in B USD)250Substitution ratio with Bitcoins 33%Total Bitcoin Network Valuation (in B USD) 82.5Final Number of Bitcoins (in B USD) 21'000'000Value per 1 BTC (in USD) 3'929
Bitcoin can be considered as “base money”, it can be considered as gold — “crypto gold” in this case. One way to value Bitcoins is to compare the money supply of Bitcoins to U.S. money supply.
Current market capitalization of Bitcoins is 12 B USD. Current monetary base of U.S. is 4’000 B USD.
If Bitcoins would substitute U.S. monetary base, then their value should increase 4’000 / 12 times. However, let’s assume 10% of US monetary base will be substituted with Bitcoins. Money velocity of Bitcoins is much higher (let’s say 10 times higher than the velocity of fiat money); this would reduce the demand for the Bitcoin base money. This would result in following valuation:
U.S. Base Money (in B USD) 4'000Substitution ratio with Bitcoins 10%Increase in money velocity (in times) 10Total Bitcoin Network Valuation (in B USD) 40Final number of Bitcoins 21'000'000Value per 1 BTC (in USD) 1'905
However, Bitcoin is not national currency; it’s a supra-national currency. If we repeat the same exercise for the world monetary base and if we use substitution ratio of 5% then we get following valuation:
World Base Money (in B USD) 26'903Substitution ratio with Bitcoins 5%Increase in money velocity (in times) 10Total Bitcoin Network Valuation (in B USD) 135Final number of Bitcoins 21'000'000Value per 1 BTC (in USD) 6'405
Levers for valuation:
The higher the substitution ratio of base money, the higher the valuation.
The higher the Bitcoin velocity, the less demand for Bitcoin base money, resulting in lower valuation
The more QE, the higher price per Bitcoin
Bitcoin is not only payment mechanism; it allows building a stack of additional services and products on top of Bitcoin protocol.
It’s the same as Internet — what started initially as simple web browsing with Netscape Browser, developed into Google search and Web 2.0 — Facebook, LinkedIn and Twitter. All these products are based on Internet stack. However, it took 10+ years, till these Web 2.0 products emerged.
Bitcoin protocol allows moving asset ownerships into Bitcoin network — for example share registries and safe keeping accounts can be implemented as part of Bitcoin network. Ownerships of any assets (real estate, shares and cars) can be stored into Bitcoin network. Most public registries will become obsolete as all this information can be mapped into Bitcoin network.
We are still in very early phase of Bitcoin adoption; we are in “pre-Mosaic Browser” phase. We can expect many new applications on top of Bitcoin network — in the same way as it happened with Internet network. However, we are not able to quantify the value of these additional services. We just say — there will be many additional services.
We looked on three valuation approaches. All of them are complementary.
Ergo Bitcoin valuation is:
Bitcoin as Payment Processor 3'929Bitcoin as Base Money 6'405Bitcoin as Additional Services NAValue per 1 BTC (in USD) > 10'334
We foresee continuing network growth (based on Metcalfe’s law) and we foresee significant potential for Bitcoin price appreciation.
We recommend allocating part of alternate assets in investment portfolios into Bitcoins.
(This article was first published in Swiss CFA Society Magazine 2014 January Edition)
