A euphemistic way to describe the development in the price of Bitcoin is ‘volatile’. Still in relative infancy, revealing its true value is hard, if not impossible. But, if you really want to have a go at determining the value of Bitcoin, try to look at it as a technology, not as a currency.
Not a regular currency
To look at Bitcoin as a currency is understandable. There is an increasing number of places around the world that would accept your bitcoins. Hence, Bitcoin functions as a means of payment, one of the main characteristics of regular currencies. But, here, the comparison probably ends. Bitcoin’s volatile character prevents it, at least for now, from being a stable store of value, another main characteristic of currencies. Bitcoin does not ‘behave’ like a currency, and therefore, trying to value it, as if it were, is pretty undoable.
The valuation of currencies is a relative game. It’s about the value of the euro or the yen against the dollar. This is different from the valuation of traditional asset classes like equities or bonds, which are valued on a stand-alone basis, using a discounted cash flow model. Within this relative currency game a fixed number of factors are of great importance. First, are the central banks, which steer supply and demand. Just take a look at the relative size of the balance sheet of the Fed against that of the European Central Bank. The former has massively increased the supply of currency (dollars) by implementing an enormous amount of quantitative easing, while the latter has, so far, refrained from such a move. The result has been a steady rise of the euro against the dollar.
Second, the value of currency pairs is heavily influenced by the relative pace of inflation and interest rates. A quick example; when interest rates in the US are higher than in the Eurozone, investors will shift their money towards the US, creating extra demand for dollars. The dollar will rise, offsetting the difference in interest rates between the two regions.
It is exactly this relative relationship between countries or regions that makes it impossible to value Bitcoin as a regular currency. There is no such thing as Bitcoin inflation or interest rates. There is no central bank managing supply and demand. Quite the opposite! It is the absence of a central bank, or any central authority for that matter, that makes Bitcoin stand out.
So, forget about valuing Bitcoin as a currency. Try technology, instead. Bitcoin represents a new way of getting money, value, from A to B. As many have dubbed it recently, Bitcoin is like an IP address for money, it’s a money-related technology. Hence, we should try to value it, accordingly.
Now, I realize that this does not make things easier, but try to compare it with determining the value of 3D printing or driverless cars. There is no holy grail here, given the great dispersion in expectations about 3D printing. But ‘tangible’ factors like (potential) market size and share, adaptation, convenience, cost and substitution are of relevance. I am no expert on this, there are people that do have some clue of the convenience and potential Bitcoin offers as a money-related technology, or the impact of possible regulation and competition by altcoins.
Already some attempts to value Bitcoin as a new technology have popped up. Last year Joshua Seims, an angel investor from San Francisco, posted an article on techcrunch.com in which he distinguishes a number of markets that Bitcoin might capture, if it succeeds. These markets are store of value, the global currency market and the black market. A nice feature of the article is that, after establishing the markets in which Bitcoin could penetrate, Seims, then, lets you push the buttons. An interactive calculator uses your own predictions to determine the value of Bitcoin. The underlying math, though, is not visible.
More recently, Bank of America also had a go at revealing the value of Bitcoin. Its analysts try to determine Bitcoin’s value as a medium of exchange by estimating its possible market share of the e-commerce and money transfer markets. Assuming Bitcoin will account for the payment of 10% of all on-line shopping and if it were to match the 20% market share in the money transfer industry of Western Union and MoneyGram, they arrive at a market cap of USD 9.5 billion. In addition to that, they estimate that if Bitcoin also became a more stable store of value, like silver (not gold), Bitcoin’s value could rise another USD 5 billion. A market cap of USD 15 billion would represent a current value of Bitcoin of USD 1300.
Now, to be very clear, this kind of analysis comes with a great deal of uncertainty. The ‘true’ value of Bitcoin will almost certainly deviate quite significantly from that in the two examples that are described above. But, at this point, the price estimate itself is of less importance. It is the technology-related approach that makes the examples useful, because Bitcoin just can’t be valued like a regular currency. There is good reason why Bitcoin behaves more like 3D printing companies and less like currencies.
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