Generally, Bitcoin holds up fairly well in the above categories when compared against fiat currencies. So what are the challenges facing Bitcoin as a currency?
One of the biggest issues is Bitcoin's status as a store of value. Bitcoin's utility as a store of value is dependent on its utility as a medium of exchange. We base this in turn on the assumption that for something to be used as a store of value it needs to have some intrinsic value, and if Bitcoin does not achieve success as a medium of exchange, it will have no practical utility and thus no intrinsic value and won't be appealing as a store of value.
Like fiat currencies, Bitcoin is not backed by any physical commodity or precious metal. Throughout much of its history, the current value of Bitcoin has been driven primarily by speculative interest. Bitcoin has exhibited characteristics of a bubble with drastic price run-ups and a craze of media attention. This is likely to decline as Bitcoin continues to see greater mainstream adoption, but the future is uncertain.
Bitcoin's utility and transferability are challenged by difficulties surrounding the cryptocurrency storage and exchange spaces. In recent years, digital currency exchanges have been plagued by hacks, thefts, and fraud.
Of course, thefts also occur in the fiat currency world as well. In those cases, however, regulation is much more settled, providing somewhat more straightforward means of redress. Bitcoin and cryptocurrencies more broadly are still viewed as more of a "Wild West" setting when it comes to regulation.
Different governments view Bitcoin in dramatically different ways, and the repercussions for Bitcoin's adoption as a global currency are significant.??
Bitcoin Worth vs. Rival Fiat Currencies
In order to place a value on Bitcoin, we need to project what market penetration it will achieve in each sphere. This article will not make a case for what the market penetration will be, but for the sake of the evaluation, we'll pick a rather arbitrary value of 15%, both for bitcoin as a currency and bitcoin as a store of value. You are encouraged to form your own opinion for this projection and adjust the valuation accordingly.
The simplest way to approach the model would be to look at the current worldwide value of all mediums of exchange and of all stores of value comparable to bitcoin, and then calculate the value of bitcoin's projected percentage. The predominant medium of exchange is government backed money, and for our model, we will focus solely on them.
Roughly speaking, M1 (which includes M0) is currently worth about 4.9 trillion U.S. dollars, which will serve as our current worldwide value of mediums of exchange.
M3 (which includes all the other buckets) minus M1 is worth about 45 trillion U.S. dollars. We will include this as a store of value that is comparable to bitcoin. To this, we will also add an estimate for the worldwide value of gold held as a store of value. While some may use jewelry as a store of value, for our model, we will only consider gold bullion.
The U.S. Geological Survey estimated that at the end of 1999, there were about 122,000 metric tons of available above-ground gold. Of this, 48%, or 58,560 metric tons, was in the form of private and official bullion stocks. At an estimated current price of $1,200 per troy ounce, that amount of gold is today worth upwards of 2.1 trillion U.S. dollars.
Since there has in recent years been a deficit in the supply of silver and governments have been selling significant amounts of their silver bullion, we reason that most silver is being used in industry and not as a store of value, and will not include silver in our model. Neither will we treat other precious metals or gemstones. In aggregate, our estimate for the global value of stores of value comparable to bitcoin, including savings accounts, small and large time deposits, money market funds, and gold bullion, come to 47.1 trillion U.S. dollars.
Our total estimate for the global value of mediums of exchange and stores of value thus comes to 52.1 trillion U.S. dollars. If Bitcoin were to achieve 15% of this valuation, its market capitalization in today's money would be 10.8 trillion U.S. dollars. With all 21 million bitcoin in circulation, that would put the price of 1 Bitcoin at $514,000.
Difficulties of Valuing Bitcoin
This is a rather simple long term model. Perhaps the biggest question it hinges on is exactly how much adoption will Bitcoin achieve? Coming up with a value for the current price of Bitcoin would involve pricing in the risk of low adoption or failure of Bitcoin as a currency, which could include being displaced by one or more other digital currencies.
Models often consider the velocity of money, frequently arguing that since Bitcoin can support transfers that take less than an hour, the velocity of money in the future Bitcoin ecosystem will be higher than the current average velocity of money. Another view on this though would be that velocity of money is not restricted by today's payment rails in any significant way and that its main determinant is the need or willingness of people to transact. Therefore, the projected velocity of money could be treated as roughly equal to its current value.
Another angle at modeling the price of Bitcoin, and perhaps a useful one for the near-to-medium term, would be to look at specific industries or markets one thinks it could impact or disrupt and think about how much of that market could end up using Bitcoin. The World Bitcoin Network provides a nifty tool for doing just that.
This will be the topic of four of four in a four part series. I hope you enjoyed the blog and learned a few new facts, thank you for reading.