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Bitcoin valuation (2) and scarcity

by | Dec 4, 2019 | 0 comments

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The true intrinsic value of most of crypto currencies is uneasy to determine, including for Bitcoin (for which the number of ‘units’ to be created is perfectly known) and the speculative value is essential for explaining the price formation. We are analyzing today the concept of scarcity as an ‘objective’ approach for the  valuation of  Bitcoin.   

Looking at the 3 classical functions of a currency   (unit of account, medium of payments and value storage ) :

1-  Bitcoin is a unit of exchange as it can be used to measure  the value of a good.

2-  Bitcoin is also used as a medium of payment to exchange value.

3-  Bitcoin is a store of value, thanks to its technology  and advanced cryptography that allow  digital storing. The limited number of bitcoins to be created  is a mechanism that makes Bitcoin an asset comparable to precious metals in a digital form.

However, Bitcoin is not officially listed and is not regulated. Lastly and thanks to the  blockchain, Bitcoin is managed in a decentralized environment under a permanent consensus of its users  while fiat currencies are under the control and the centralization of central banks. Then, the  nature of Bitcoin and the commonly used fiat currencies is radically different. 

In the first article dedicated to the valuation of Bitcoin, we have seen the concept of valuation based on the Network Value. Having said that, it seems that Bitcoin price is reasonable given a network using success. Let see now how to analyse Bitcoin on the basis of the scarcity concept.

Scarcity value ( safe haven)  

To believe that resources on earth are rare is a misunderstanding about scarcity  as a key concept in economy. In the humanity history, we never missed any commodity or resource and resources prices stay  almost ever below their historical prices, thanks to technological progress productivity. The only blatant scarcity so far, is the needed time  that we have to exploit natural resources, manufacture goods and services, etc…  The dilemma that we have to face is how to store for the future the economic value that we are creating today. While today’s modern economies  have created ‘keynesian’ central banks that claim fighting inflation while they are gradually (or even quickly) deteriorating the intrinsic value of their currencies, they have also quit Gold as a standard (US dollar in 1971). Thanks to its physical characteristics and scarcity, Gold has always been a State’s  structural imbalances last resort as currency policies have always finally been inflationist

With Bitcoin, for the first time, we are using  a commodity with a limited supply. Whatever is the number of users or whatever is the  network frequency, we will never have more than 21 million available bitcoins (see our previous article about the ‘halving’and the mining ).As Nassim Nicholas Taleb, author of ‘Black Swan’, has written  « Bitcoin has no owners and  no authority can decide for him. Bitcoin is owned  by the community, their users. Bitcoin credibility is confirmed  now by a multiyear track record, enough time to be taken seriously…Its existence is enough to constitute an insurance policy that reminds  to the State that it didn’t own the monopoly of the currency hence forth, the currency being the last thing that the’ establishment’ controls. For all of us, it is an insurance  policy against an ‘orwellian’ future.. »  

Bitcoin price in USD since 2013

Cours du bitcoin depuis 2013

Bitcoin price and equivalence to the dollar money base

Given  those elements,  we can define the hardness of a currency  (meaning that is hard to increase its supply , instead of an ‘easy’  currency , characterized by  an elastic supply). We can look this through 2 criterias :

1) The  stock :  it is the existing amount of all that has been produced  less all that has been consumed or destroyed (annually). It is a measure of abundance.

2) The flow  which represents   the additional production over the coming  year.

A  weak  stock to flow ratio means  an easy currency  and a high stock to flow  ratio means ‘hard currency’. For instance,  Bitcoin will reach  a stock to flow ratio higher  than the stock to flow ratio of gold in 2022 and will be twice as high in 2025. In 2140, there won’t be any additional supply  of bitcoins, so the stock to flow ratio will  become infinite. This will be the first time for a commodity.

But how to  valuate Bitcoin  as a scarcity value  ?

That refers   to the major central bank currency  (for more than 90 years), the US dollar which is the first reserve and trade currency,  we can proceed to the calculation of equalizing the dollar money base to Bitcoin, taking the assumption of a changing ‘currency standard’.

This calculation has been precisely done in 2018 by UBS research  department for a specific study. On the basis of a US dollar monetary base of roughly  3800 billion dollars, the price of  Bitcoin equalizing the US money base should reach  USD 213 000 ! Furthermore, if the reference shifts from the US dollar money base to the whole aggregated global money  bases (more than USD 25 trillions),Bitcoin should be priced above USD 1 400 000 USD  ! 

Global money  creation(USD) / Number of bitcoins

Global money  base (billion of USD)

On the basis of the respective evolutions of all the aggregated  money bases since the creation of Bitcoin (2009) compared to the cumulative bitcoins creation,  the respective increases are favorable to Bitcoin price (let remind that the Bitcoin market capitalization of USD 150 billion is a very weak number compared to the  USD25 trillion of the global money base –see charts) .From now, the new Bitcoin supply will grow very slowly while accommodative central bank monetary policies are increasing very fast  the fiat supply. Then, it is clear to see the difference between ‘easy currency ‘ (inflationary) and ‘hard currency’ (deflationary) .

Even if we consider that the Bitcoin weight stays at an equal proportion of its current weight of the global money bases  (only 1%), a quick calculation shows that the price should move into the spread of USD 10 000 / USD 17 500.

                             

The gap is widening between the governance of central bank currencies (unbridled  money creation and liquidity massive injection) and Bitcoin, a new major innovative  and conceptual technology as a decentralized currency with a limited supply. In the future, we should see an increasing ‘haven’ footprint of Bitcoin as a  storage of value. Traditional fiat currencies are going to coexist with Bitcoin and the coming new forms of digital stores of value and medium of payment. Moreover, the relevant old Gresham law saying that « bad money drives out good » will still apply.   

Face to this, as a store of value, Bitcoin is destined to a strong revaluation.

Bitcoin Capitalization since 2013

About the editor…

A passion : Economics, behavioural finance and emerging digital assets

Yves started his career in the asset management in 1986 where he worked at different positions as manager of equity funds and diversified funds. at Crédit Commercial de France and later, at Barclays group in Paris. In 1998, he took the lead of equity funds and diversified funds, then of the whole fund management business at the French team of the Dutch Robeco group  before joining Natixis Asset Management in 2012 as Director of the Equity Investment business unit. Yves left Natixis AM in 2018 to start as an independant player for professional investors and corporates (advisor and fund raiser).

He likes to engages in sports that test his endurance like running and swimming, Yves is also fascinated by social sciences, and more specifically by history and economics. But this is the economics mechanisms behavioural aspect and the markets behavioural analysis that are a constant source of thought and discussion. Since few years, the blockchain issue and emergence of crypto assets is a new field of passion and opportunities for him.

Yves Maillot

Financial markets and asset management

Yves Maillot

RFinancial markets and asset management

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