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Could there be a $50,000 bitcoin?

Posted on Thursday, 20th February 2014 @ 07:03 AM by Text Size A | A | A

Could there be a $50,000 bitcoin?

In the last year, and with increasing intensity following the early December price spike that briefly put Bitcoin above $1,200, critics have sounded the alarm that the price is a bubble. Some, like Felix Salmon, have recognized the value of the cryptocurrency, but argued that it is simply overvalued, much like pre-2008 real estate.

Others haven’t stopped there, claiming that bitcoin is all bubble, at the center of which is little or no intrinsic value — something closer to a Dutch tulip mania than a real estate bubble. Those making the latter case have included Nobel Laureate Robert Shiller and former Federal Reserve Chairman Alan Greenspan.

It seems reasonable enough to be skeptical of a digital currency unbacked by any state or real-world goods. But bitcoin optimists argue that what “backs” bitcoin is the functionality of its frictionless, low-cost, decentralized payments system. As Circle CEO Jeremy Allaire put it at fact-finding hearings held by the New York Department of Financial Services in January, “The growth in the value of bitcoin is a put option on its adoption as a payments platform.”

An anonymous viral e-mail circulating among bitcoin watchers and partisans lays out a few simple hypothetical usage and adoption scenarios, and their consequences for bitcoin’s price. If Amazon.com (AMZN) adopted bitcoin for all payments, its volume of $38 billion, divided by a supply of (at the time of the email’s writing) about 7 million bitcoin, would make each bitcoin worth $5,400. If $300 billion in international remittance was conducted in bitcoin, that volume alone would push the price to $42,000. Adding these, along with online poker and gas station transactions, would lead to a total transaction volume of $602 billion — and a bitcoin, even at today’s expanded supply of 12 million coins, worth $50,000.

“Those numbers are good ones to start with. In some sense, that’s like a maximum,” says Susan Athey, a professor of economics at the Stanford Graduate School of Business who has been studying bitcoin. Few would realistically argue that bitcoin will service 100% of even these silos in the near term, but the volume/supply ratio is the starting point for understanding bitcoin price — as more consumers or organizations choose to use bitcoin, increased volume will drive the price up.

Building from that basic formula, Athey adds a variety of variables to build an analytic framework. The first is velocity — how frequently a bitcoin can be spent. Because bitcoin, unlike paper money, is very low-friction, there’s the possibility of a very high-velocity bitcoin, if, for example, vendors or traders only held bitcoin very briefly, cashing it in and out to government currencies on either end of transfers. That, Athey says, would allow a small volume of bitcoin to process a large volume of payments, keeping the price of bitcoin relatively low.

Then there are even less predictable and higher-risk variables. Obviously, bitcoin’s future price depends hugely on the adoption rate of the cryptocurrency model. Athey believes that the cryptocurrency model of distributed ledgers is “a really simple, powerful technology that is superior to existing technology,” and there are major drivers that point toward wide adoption.

One fascinating adoption scenario frequently floated among bitcoin adherents is specific to retail. Online retailers’ razor-thin profit margins get a huge boost when they pay a bitcoin processor’s fee of about 1% instead of credit card fees of 2-3%. How long will it be, some ask, before a major retailer offers a discount for those paying in bitcoin, as a way to maximize that increased profit margin? Such a discount could drive significant bitcoin adoption in a very short timeframe.

Still, Athey believes that cryptocurrency also faces challenges that could kill it in its crib, above all from government regulations. “There’s [only] a small number of big countries,” and adverse regulation in just a few of them could render cryptocurrency far less functional in the long term.

It’s just as uncertain whether, even if cryptocurrency becomes part of how we transact, bitcoin will be the only, or even the most adopted. “There’s a big probability that there’s a zero market share for bitcoin” in the future, says Athey, as competing cryptocurrency systems integrate desired features, better functionality, or simply more effective marketing campaigns. The price plunge following recent revelations about “transaction malleability” in the bitcoin code point to the dangers of even perceived systemic flaws. A division in the cryptocurrency market could keep future values of individual systems, including bitcoin, relatively low. (Disclosure: Athey consults with Ripple Labs, creators of a competing cryptocurrency system.)

The outcomes of all of these risks are still very hard to predict, and Athey thinks this explains the current volatility in bitcoin’s price. “There’s no reason to think right now that all reasonable people should agree on the regulatory reaction of various governments. [And] even if everyone was just broadcasting the fundamentals, a lot of information has been coming out about the fundamentals. It’s not surprising that the value should be changing.”

Still, this is much different than the impression from some corners that the price of bitcoin is nothing more than a shared fantasy. While the email pointing to a $50,000 bitcoin is imprecise to say the least, it’s a starting point. A more rigorous mathematical model integrating demand projections with probabilities of certain make-or-break contingencies isn’t just possible — it likely already exists, in various versions, across various investors’ hard drives.

For Susan Athey, though, the question of a specific cryptocurrency’s value seems less exciting than contemplating the broad changes that bitcoin’s innovation will bring to finance. “When you really think about what we do today in the banking system … it’s kind of stunning that that’s the way we do business in 2014. It seems very natural that things will change. It’s only surprising that they haven’t changed already.”

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Source – http://finance.fortune.cnn.com/2014/02/18/50000-bitcoin/

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