The true value of a bitcoin (by )

The recent bubble-and-crash cycle in the price of bitcoins leads, logically, to wondering what their "true value" should be.

The idea is that there is a true value - some amount of something else that 1 bitcoin is actually worth - that the market will be trying to tend towards; but the market price is being distorted by irrational people buying them at above that true price, and panic-sellers willing to sell them below the true price.

So what might this true value be?

Utility to buy stuff right now

Bitcoins have some utility right now in that you can actually buy stuff with them. That's perhaps the most fundamental utility of a currency; my pound Sterling is valuable to me thanks to the fact that it can pay my mortgage, feed my family, and buy me shiny computer toys to play with.

Generally, things bought with bitcoins are really priced in the local fiat currency (usually US dollars), and then sold at the equivalent bitcoin price based on current market exchange rates. However, the buying-stuff-utility-value of a bitcoin is not just the current market exchange rate, because there's only a small fraction of things that can be bought with bitcoins; and some of those, due to having to be bought from a more limited range of suppliers, also attract additional costs in shipping. On the other hand, the reduced costs of doing business in bitcoins result in the base dollar prices being slightly lower to begin with; but the main problem is the narrow range of products and services available in bitcoins, which means that the buying-stuff-utility-value of a bitcoin is arguably a fraction of the market price.

This will rise as bitcoins become more widespread, both in terms of people holding them and wanting to spend them, and more shops accepting them, which will feed each other - but the end result will just be to peg the buying-stuff-utility-value of a bitcoin as slightly better than the market price for them (thanks to the reduced transaction costs of bitcoins). Which gets us rather into a circular argument when trying to define the true market value in terms of the ability to purchase things.

The value of the money supply

What really defines the value of any currency, let alone the bitcoin? You can look at it in terms of supply and demand for the currency unit as a means of exchange. Of course, the actual size of each currency unit is rather arbitrary - we can measure the same amount of money in pounds or in pence; in dollars or in cents, and get different numbers. Likewise, "one bitcoin" is just a handy way to handle a hundred million Satoshis, and those Satoshis can be made sub-dividable in future.

So a more interesting measure is to value the total amount of the currency in circulation. That's not as easy as you might think - we can estimate the number of actual pounds Sterling in circulation as coins and notes, but that's just a small fraction; most people are paid by direct bank transfer, and pay their monthly bills in the same way, then make purchases on their debit cards. Only a small fraction of my monthly spending happens in cash. So economists talk about "M0" and "M1" money supplies, which roughly correspond to the coins and notes in circulation (M0) and that plus money in standard bank current accounts (M1). There's an M2 that includes savings accounts as well.

Bitcoin could be counted as an M1 money supply, I think, and as part of M2 in that its deflationary nature makes it an attractive place to put your savings. But as a first approximation, let's say that in a community in which Bitcoin is the primary currency, the total number of mined, and not lost, bitcoins they hold would be their M1 money supply.

So as a rough approximation, we can say that if the entire world switched to using Bitcoin right now, then the the size of the world M1 money supply - which is, roughly, a measure of how much value the world wants to have in circulating and easy-circulated money, rather than tied up in pensions and investments and equipment and proprety - would remain approximately the same, just change units.

The current world M1 money supply is hard to gauge - you need to work out M1 for each currency in existence, and then convert them to a common currency such as the dollar at current exchange rates. I've found an estimate that world M0 is about $4 trillion, while the CIA world factbook lists an estimate of the "stock of broad money" worldwide at $82 trillion. If all of the 21 million possible bitcoins are in circulation (none are hoarded or missing), and bitcoin totally replaces all other currencies, then we'd expect one bitcoin to be worth about the same as ($82 trillion ÷ 21 million = ) about $3.9 million. Other currencies remaining in use will reduce this, and bitcoins that aren't in circulation will increase it, as will the economy as a whole having grown during the time those changes take to happen, but we might consider that the final value of a bitcoin as a unit of exchange, based on supply and demand for liquid money, might represent at least a hundredth of that; $40,000 and upwards.

The value as an investment

However, that's a very theoretical value; it's a projection of a future value, based on many assumptions, and downright approximate even if all those assumptions hold.

But even if it is a true measure of the eventual price of a bitcoin in a few decades, what can that tell us about the price now? I don't have the economics background to understand theories of futures pricing, but there's some maths that can be used to assign a theoretical current value to an asset whose future value (or an expected statistical distribution thereof) is known, but I don't understand it well enough to try to apply it here. In principle, that could be used to work out a measure of the value of bitcoin now, as an investment for its future price.

So what is the true value of a bitcoin?

In all honest, the current true value will be a combination of the above, weighted by how important each use is to the market as a whole, plus other factors I've omitted as they really can't be measured (bitcoin has value as an interesting geeky novelty, or as a way to Stick It To The Man as an act of protest about the conventional financial system; people are willing to pay over the odds for something, for those kinds of reasons). The correct weightings to use between the different values are hard to gauge, as they would require an objective way of measuring the motivations of current, and potential future, bitcoin users. Oh, boy.

So what's a bitcoin's value to me?

Somewhere between the current market price (which I sometimes buy them at, indicating that I think the true value is above it) and a vague idea that it'll be worth tens or hundreds of thousands of dollars in future.

Except where I can usefully spend them, I just buy them to hoard for my future retirement fund, but no more than I can afford to risk on a very uncertain future. When opportunities to spend things in BTC arise I will do so, and then use the pounds sterling I have therefore not spent to buy more. If they rise in value fast enough, I might retire early - but I'm still saving them for my retirement!

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