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Why There's Confusion Over Valuing Bitcoin

Bitcoin presents a new type of nontraditional, highly technical, experimental, and global digital instrument to our already complex world. That fact should not conjure fear. It should engender excitement.

When I caught wind of Bitcoin as a newly minted MBA in the summer of 2012, I immediately scoffed. At the time, one bitcoin was trading at around $10, with a total market cap of about $50 million, which I thought was outrageous. It was a new, unregulated, "imaginary" Internet currency. Even though I initially rejected the idea as utopian, it stuck with me for some time thereafter.

Fast forward to early 2013, when the European banking crisis was reaching a fever pitch and Cyprus was on the verge of the first modern bank "bail-in." As the bitcoin price began to rise rapidly on a daily basis, and the situation in Europe continued to deteriorate, I decided to remove my "I know everything" MBA grad cap for an "I know nothing" crypto dunce cap. And, boy, am I glad I did.

The more I read, watched, and listened to bitcoin experts attempt to explain the most confusing and thought-provoking advancement since the Internet, the more fascinated I became, not only with the idea of frictionless transactions, but also by the idea of stateless currency.

Given the complexity of bitcoin (economic, financial, political, ideological), there are many topics of discussion that deserve specific attention in their own right. The Digital Currency Council does an excellent job of providing an overview of these issues in its free courses. In today's piece, we will focus on one of my favorite, and most misunderstood, topics: bitcoin valuation.

Valuing bitcoin: A traditional perspective
First, I think it is important to give readers an idea of just how difficult it is to categorize bitcoin for valuation purposes. Unlike equities, bonds, and real estate, bitcoins create no cashflow. Most traditional financial analysis is based on terminally valuing an asset's or entity's discounted cashflows in order to determine a fair present value price for those future cashflows. In the case of equities, the earnings of a particular company that are distributed as dividends can be theoretically extended in perpetuity and discounted at current "risk-free" interest rates, thus creating what is knows as a discounted cashflow (DCF) valuation. Since bitcoin has no cashflow, this method of valuation is not useful.

With regard to stocks, thousands of companies in hundreds of industries provide a pool of potential comparables to value companies from a comparative and/or historical perspective. Again, there is only one bitcoin (and it is the first of its kind), so there is no use for this methodology, either. There are "altcoins," but they are not proper comps for bitcoin. (That is a topic for another day).

Moving to bonds or other interest-bearing instruments, they too provide steady and somewhat predictable cashflows due to the interest coupons that holders of the securities collect at set periods of time. Once again, we run into a problem with bitcoin due to the lack of regular cash payments, though this can be programmed into the blockchain as an added protocol layer. (Again, that is for another time.)

Lastly, real estate projects -- at least those purposed for investor profit and not for proprietor dwelling -- also produce steady cash revenue in the form of rents and homeowners' fees that act just as dividends and interest payments. No surprise that bitcoin cannot fit into this category, either, given its currency/commodity-like properties.

So the obvious question is still "What is the value of a bitcoin, and how do we derive it?"

Valuing bitcoin: A commodity perspective
The Austrian economist's answer to this question is "It's worth what someone else is willing to pay for it, and that value is derived from the individual's economic utility at any given point in time," but this is a little too philosophical for our purposes. However, it does provide a nice segue from viewing bitcoin as a traditional cashflow-producing asset to viewing it as a hybrid virtual commodity/currency, similar to gold and silver but without the physicality.

This approach makes sense, given the scarcity element, which is inherent in both metals and bitcoin, as well as the lack of counterparty risk when holding the assets directly (i.e., not with a bank, custodian, or exchange). For these reasons, bitcoin and precious metals are sometimes viewed as relative stores of value.

Unfortunately, this is where the similarities end. Gold is corporeal, and bitcoin is virtual. Gold is difficult and costly to store and transport. Bitcoin is free to store and cheaper than a nickel to send. Gold has been used to store and transmit value for thousands of years. Bitcoin has had a monetary value for less than five years. Finally, gold is not beholden to electricity or connectivity, while bitcoin fails if either of those goes down.

It is obvious that both gold and bitcoin have unique advantages and disadvantages, and both have a place in a diversified portfolio. However, this insight still does not give us a decent basis for valuing a single bitcoin, especially since we can't even determine the fair price for troy ounce of gold.

Does bitcoin have a fair value?
So does bitcoin have a fair value at all at this point in its infancy? Is price influenced by geography, demography, or politics? Are high transaction volumes and merchant adoption more important to sustainable success than hoarding? This early in the game, these questions are yet to be answered. However, the circumstances leave us with a once-in-a-lifetime opportunity to develop new academic and operational models based on real-time information from the bitcoin blockchain and ecosystem.

The problem is that the blockchain technology is so new that the academic and intellectual underpinnings to develop such models are still evolving on a daily basis. This is yet another opportunity to do good and make money.

As far as the actual bitcoin price, at this point the most effective and widely used method of valuation by cryptocurrency professionals is pure technical analysis (historical price/time data analysis) and correlation analysis (correlations to stocks, gold, fiat currencies). Though they are suboptimal, these methods still work well in an inefficient and illiquid market such as bitcoin, but they too will soon need to evolve.

Though bitcoin presents a new type of nontraditional, highly technical, experimental, and global digital instrument to our already complex world, that fact should not conjure fear. It should engender excitement. Those willing to jump down the rabbit hole will be greatly rewarded financially, intellectually, and ideologically for taking the dive into Bitcoinland. They also just might be making the world a better place.

Adam K. Wyatt is Chief Analyst and Editor at BullBearAnalytics, a division of Digital Currency Research LLC, an informational financial publishing firm focusing on digital currency trading, investing, and education. Adam graduated with a BA in Economics and Political Science ... View Full Bio

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Greg MacSweeney
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Greg MacSweeney,
User Rank: Author
12/18/2014 | 2:05:55 PM
Re: Suicide Cult
The fluctuations in BitCoin are definitely concerning, and are keeping many investors on the sidelines. However, certain big name companies have gotten involved. I wonder how these large companies can justify the risk associated with bitcoin?
NealPalmquist01
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NealPalmquist01,
User Rank: Apprentice
12/18/2014 | 12:47:27 PM
Re: Suicide Cult
It's not Easter (you know when we celebrate the resurrection of the messiah, Jesus? Jesus didn't even need to take money from innocent people to use for cryogenic freezing! So my prophet beats your prophet, Hal Finney.) so let me get that egg for you guys. The losing streak has gone beyond one year and the high was $1217 two Novembers ago.

 

"Btw, let me know, can you also pay with gold in your pockets, or even with fake virtual bank gold in your account using a smartphone qrcode scan?" Bitcoin transactions are paid with real money from the pockets of people waiting to finance your transaction at the exchanges. Nobody needs bitcoin as a pre-requisite to use a qr code. All this technology you guys are talking about can and will exist in a universe with a dead bitcoin fad. 

Bitcoin transactions require 3 parties

-a merchant

-a customer

-a fool at the exchange with cash who finances the purchase in exchange for absolutely nothing called bitcoin. Blockchain is nothing more than an inventory management system for thin air and is being abused to be a ponzi scheme.
NealPalmquist01
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NealPalmquist01,
User Rank: Apprentice
12/18/2014 | 12:06:10 PM
Re: Suicide Cult
Bitcoin is a varied and generally intelligent, progressive and generous community that lost over 70% value in the coins they bought last November and is a community growing to become more "intelligent" every day until the day they are all flat broke. Bitcoin is, in fact, infinitely divisible. I am not the one creating altcoins out of thin air so I can sell them for bitcoins to get the real money from stupid people. And GOOD LORD! Everybody knows that what a Bitcoiner wants more than anything else in this world is United States Dollars! You are fooling nobody, Leo. If the USD is going to sink, it certainly won't drown in a sea of bitcoin flavored kool aid.

OF COURSE IT WAS POINTLESS TO CREATE AN INFINITELY DIVISIBLE CURRENCY! You don't have to tell me. Tell Satoshi! And while you are at it, tell him it was uber pointless to create more than one infinitely divisible bitcoin. You are making my point. There never was any honest reason to create more than one infinitely divisible bitcon.

Gold and everything else has value automatically. Bitcoin doesn't because it is nothing and because there is nothing more abundant than nothing. The mathematical representation for nothing in all applications is always zero. No matter what you are talking about, if you are going to work with nothing then that place is represented mathematically with zero. And bitcon has the unique mathematical property of infinite divisibility because only a zero can be infinitely divided without losing it's properties.

Bitcoin is zero divided by infinity no matter how many tens of millions of them you want to make and no matter how many atoms of gold (or anything else) have been mined.
laurent 1
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laurent 1,
User Rank: Apprentice
12/18/2014 | 9:03:43 AM
Re: Suicide Cult
Thx Coin Brief. So lets take your computation to its ultimate consequences:

gold price per kilo is 38000$ (see goldprice.org/gold-price-per-kilo.html)

165 M kilos of gold vs 21 M bitcoin

If BTC market cap equals that of gold, one bitcoin equals 38000 * 165 / 21: 300 000$

If BTC only takes 10% of the gold market, 1 BTC is still 30000$.

Btw, let me know, can you also pay with gold in your pockets, or even with fake virtual bank gold in your account using a smartphone qrcode scan?

Does gold offer a technology with so many applications as the blockchain?

My bet is that BTC is still highly undervalued - unless it loses the competition agains a better alternative. But the blockchain tech is here to stay, and its potential market cap is huge.
Bruce Lee Roy
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Bruce Lee Roy,
User Rank: Apprentice
12/18/2014 | 9:02:10 AM
Re: Suicide Cult
you are wrong i wont begin to describe how wrong you are just do some research and stop being lazy ignorant.
Coin Brief
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Coin Brief,
User Rank: Apprentice
12/17/2014 | 2:25:04 PM
Re: Suicide Cult
Total number of bitcoins that can ever exist:

21 million (when mining ends in 2140...but even if Bitcoin lasts until 2140, lost coins will make that number smaller)

Total amount of gold that has been mined:

165,000 metric tons (tonnes)

Number of satoshis in 21,000,000 BTC:

2,100,000,000,000,000

Number of grams in 165,000 tonnes of gold:

165,000,000,000

Number of atoms in 165,000,000,000 grams of gold:

~3,057,000,000,000,000,000,000

 

The number of atoms of gold that have been mined is 6 orders of magnitude larger than the number of satoshis that can ever exist.

A satoshi would have to be broken down into units that are worth ~1/1,500,000th of a satoshi to create a number of units similar to a gold atom.

That IS possible, but would be completely pointless.  Those tiny units would be completely worthless, even if there was no other currency except for BTC, and the resources it would require to keep track of the extra digits wouldn't be cost effective.

Also, altcoins do not have any value automatically.  Their value is only based on what people think their potential could be.  Some do have legitimate advantages of Bitcoin that will need to either be integrated into Bitcoin at some point, maybe via a "side chain", or they will grow to be a competing currency (or, at least a currency with a specific use).

Think of it like USD vs foreign currencies.  USD is the most widely used currency in the world, at least for business, but that doesn't make it the only currency, nor does it negate the value of other currencies.

Finally, Bitcoin is not "the foundation" for altcoins.  The Blockchain is.  The Blockchain is the foundation for decentralized cryptocurrency, and other, related systems, in general...Bitcoin just happened to be the first one developed with it.  Satoshi created the Blockchain based on decades of research, and previous attempts to create a decentralized consensus system...but others were working on similar ideas.

 
LeoTreasure
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LeoTreasure,
User Rank: Apprentice
12/17/2014 | 12:45:07 PM
Re: Suicide Cult
1. Bitcoin is a varied and generally intelligent, progressive and generous community.

2. Bitcoin is not infinitely divisible.

3. You're conflating bitcoins and alt-coins.

4. The people claiming a satoshi will be worth fantastic amounts of money are not representative of the entire Bitcoin community.

5. Bitcoin is a technological breakthrough which you don't seem to appreciate. It is the hardest act to counterfeit a bitcoin. With fiat money, it's incredibly easy to perform a chargeback when it comes to electronic transactions. This is a problem that Bitcoin solves. That is why Bitcoin is real money. And no we're not pumping to get US dollars, that ship is going down.
NealP834
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NealP834,
User Rank: Apprentice
12/17/2014 | 10:33:37 AM
Re: Suicide Cult
Move over black scholes! I'm going to win the Nobel Prize! I offer the Theory of Relative Stupidity.

 

21,000,000/∞ = 21/∞ = 2/∞ = 1/∞

 

(21,000,000*0) / ∞ = BTC
NealP834
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NealP834,
User Rank: Apprentice
12/17/2014 | 10:00:23 AM
Suicide Cult
Bitcoin is a community of liars that wants to have everything both ways. They say the limited issuance makes it like gold, but when you divide a gold atom it is no longer considered to be gold. Bitcoin is infinitely divisible. You can divide bitcon as many times as you want to forever because it is created out of nothingness in a universe that was already known to be infinitely empty. They want it both ways, creating millions of new cryptocurrency coins out of thin air every day at the same time saying that the smallest denomination, satoshi, will grow into fantastic value and someday it too will need to become divided. The creation of tens of millions of bitcoins and the mathematical property of infinite divisibility are two self defeating and opposing forces that work against eachother.

If bitcoin is the foundation of all crypto currencies, then where do foundations go? 

Foundations go on the bottom. Altcoins are the bitcoin hoax applied onto the bitcoin itself. Altcoins are also created out of nothingness of thin air and are sold for bitcoins. The bitcoins are sold for the United States Dollars that everybody always wanted this whole time. These con artists know that any person who is stupid enough to give real money to buy the fake currency bitcon is also a person who is automatically pre-qualified as being stupid enough to spend those bitcons to buy altcoins in the hope of magnifying their wealth. Altcoins are "money for nothing" perfected.
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