The main thesis of the article is that we argue why the bitcoin value is not and can never be zero. The alternative title of this article should be how to price a bitcoin with a mathematical formula.
It has been more than a decade since the bitcoin paper entitled “Bitcoin: An Electronic Peer to Peer Cash System” has originally floated into the online world by the mysterious founder, Satoshi Nakamoto on 31 Oct 2008. Since then, there are technical and business development tracks that led bitcoin into going mainstream. The original bitcoin concept is simple: decentralizing trust system using a peer to peer system, building digital scarcity by limiting the number of bitcoins in circulation and distributing the coin using a proof of work algorithm which many termed it as mining.
Yet till today, bitcoin is still as controversial as ever. It is originally designed as a currency for transaction but ironically, it become an asset that carries a value and behavior to gold. There is no intrinsic value for bitcoin because you can use the cryptocurrency to make any form of purchases. The mathematical model that Satoshi Nakamoto has illustrated with his groundbreaking bitcoin paper is sound and open and there lies no back doors to how the currency can be manipulated. The security of the cryptocurrency is one of the most under-estimated features when people discuss the advantages of bitcoin as an electronic cash system. Bitcoin is a triumph of creating a new monetary currency in the digital world in safe and secure manner to the ledger between financial transactions
There have been arguments put up by economists that bitcoin violates the efficient market hypothesis and what it means for the financial markets. The reason why it does is that the same economists who are arguing about this assigned zero value to bitcoin, i.e. it’s an object that has no inherent value, and coupled with common misconceptions about bitcoin in the general public, it creates an alarm that bitcoin might eventually become a Ponzi scheme that will rob the people who have made the purchases. However, there exist other investments in the main stream that is similar to bitcoin. Gold is probably one of the assets which does not have an intrinsic value. What sets gold apart from bitcoin, is that human societies have determined with their degree of belief that gold has an intrinsic value and can be priced to a non-zero value and it helps that you can see the gold bars. Whereas, there is no physical manifestation of bitcoin and hence it becomes a challenge for many to define the exact value of the bitcoin.
The main thesis of the article is that we argue why the bitcoin value is not and can never be zero. In some sense, what I want to offer is to find a method to price a bitcoin. In fact, I offer a simple way to price the value of the bitcoin:
Value of the Bitcoin = Degree of mistrust of the bitcoin holders against the current monetary institutions + price of the blockchain technology normalized over the investors who set the current value of bitcoin.
The two variables can be quantified in a simple way. First, the degree of mistrust can be interpreted as the degree of belief against the current monetary institutions. One of the key reasons why bitcoin flourished during the aftermath of the financial crisis in 2008 is that many people has lost faith in the traditional monetary institutions of power. The effect of bailing out the major investment banks has generated mistrust among the common populace towards the traditional monetary institutions of power. In fact, another way to look at this is to understand the decentralized nature of bitcoin. If two people agree that bitcoin is worth a value greater than zero, then the value will be there despite what many people would disagree to. The value of bitcoin has been positive because the amount of people who are holding a bitcoin has gone past the tipping point. In other words, bitcoin has gone beyond critical mass and move past the escape velocity. In order for the bitcoin value to be zero, it means that all the holders of the currency will ascribe to zero, and this is not possible unless regulatory bodies stepped in and made the cryptocurrency illegal. However, different governments have instituted different policies for bitcoin and hence as a result, bitcoin has achieved a non-zero value on that. In fact, I will hazard a conjecture that the bitcoin value will fluctuates in opposing directions of how the populace view the major financial institutions. If their faith is restored along the way, the bitcoin value will diminish because people will go back to the traditional fiat currencies instead of looking for alternative assets to hedge.
The other variable which was never priced into the value of bitcoin is the blockchain technology. What many failed to recognize, bitcoin is the first successful implementation of the blockchain technology. One can imagine the same argument can be made for Ethereum in the same way except that ether is being used more like an exchange trade funds because it pegs the price of most alt-coins in the markets after their initial coin offerings. That is not say that the price of the blockchain technology will be the same, increase of decrease. What we have learned with most technology disruptions is that the technology will eventually commoditized. If that is the case, it will settle to a low non-zero value.
The price of the bitcoin is currently hovering around US$3-4K, and surprisingly, for comparison, the price of gold is close to more than US$3-4K depending on price fluctuations. What this is telling us is that the people who are holding the currency have somehow inferred that bitcoin is the digital gold, both without intrinsic value, but yet we hold it as an asset that we can make exchanges if the current money system will to collapse.
Of course, the holy grail of finding a formula to price a bitcoin is still out there.