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[Re-Running] Bitcoin Fair Value: A First Assessment


We model this assessment on David Woo's December 2013 report: "Bitcoin: a first assessment" (Bank of America / Merrill Lynch). Mr. Woo begins with an extensive and apt summary of the bitcoin ecosystem, and we highly recommend reading his report. He goes on to analyze bitcoin's fair value using an equity-equivalence framework. We re-run Mr. Woo's value analysis (and then some) below, using what we consider more appropriate methodology and comparative metrics for a currency/commodity hybrid such as bitcoin.

We agree with Mr. Woo that bitcoin is both a medium of exchange and a store of value. We also agree that it's easiest to assess fair value by treating these uses separately. Additionally, we would like to note that the below analysis represents various bitcoin success-scenarios which may or may not occur, and that fair present value is therefore some weighted discount to the below success-case values. We treat this further in our conclusion.

Value as a medium of exchange

To assess bitcoin's potential value as a medium of exchange, we will look to existing fiat money flows and supplies, and ask what total value of all bitcoin is necessary to support various fractions of that economic activity. We do this as a starting point for rational, data-driven determination of bitcoin's fair value, and will leave it to the individual reader to decide whether our underlying assumptions and reference points are sensible.

Economic Activity, Money Supply, and Velocity

To determine the supply of money necessary to sustain a certain amount of economic activity, we must look at how quickly that money changes hands. This concept of monetary velocity is a key value for modern economies. Let's look at velocity in the bitcoin ecosystem.

We can see from blockchain data that average daily transaction volume for bitcoin over the last 6 months is roughly 200,000BTC:


while total supply of bitcoin averaged ~10,000,000BTC over the same period:


That yields an annual velocity of roughly 7.3*. This is much higher than the monetary velocity of dollars, which averages under 2.0. In our view, this seems a natural consequence of bitcoin being a far more frictionless medium of exchange compared to fiat money such as Dollars or Euros. Since bitcoin requires no third-party settlement intermediary, it's simply easier and cheaper to send/receive; thus, one would indeed expect it to move around the economy more quickly than other currencies.

The other side of the equation when determining value of a single unit of something is supply. Due to the algorithmic nature of bitcoin, we know the supply exactly; there are currently 12,151,075 bitcoins in circulation as of this writing (see chart above, or visit blockchain.info/charts for real-time data). Additionally, we know that there will never be more than 21,000,000 bitcoins ever issued. We will use this latter supply figure in value calculations below.

* Money Velocity, V, is defined as: V = T / M, where T is the aggregate value of all transactions over a given period, and M is the avg total money supply over that same period. In our discussion, T = (200,000 * 365) = 73,000,000, and M = 10,000,000. Thus, V = 7.3.

Bitcoin as 10% of remittance market

In contrast to Mr. Woo's comparative equity/enterprise-value analysis, we think it's more relevant to analyze bitcoin's potential share of the remittance market as a currency, not as a single corporation/equity. The equity comparison Mr. Woo undertakes is ultimately vague and difficult to justify since bitcoin is not a company. Luckily, since bitcoin is used as a medium-of-exchange (ie, currency), we can look directly at existing demand for currency and determine what value bitcoin must have in order to satisfy various slices of that demand. Using such methodology, the calculation is simple:


Chart source: World Bank

Global remittances in 2012 totaled $478 Billion according to the above World Bank data. If bitcoin accounted for 10% of that activity, the equivalent of $47.8B worth of bitcoin would need to be transacted. Using our monetary velocity of 7.3 from above, the supply of bitcoin would need to be $47.8B / 7.3 = $6.55B.

Table 1. Bitcoin Money Supply Summary 1
Domain Domain Penetration Supply Required
Remittance Market 10% $6.55B

In our view, it seems reasonable that bitcoin eventually becomes widely used in the remittance market due to its frictionless, borderless, and near-zero fee properties. For these reasons, we see 10% of this market as a conservative reference point.

Bitcoin as 10% of "black-market" transactions

Total black market transactions have an estimated annual value of $1829B. 10% comes to $182.9B, yielding a total necessary supply of bitcoin, at our money-velocity of 7.3, to cover this economic activity of $25.05B.

Table 2. Bitcoin Money Supply Summary 2
Domain Domain Penetration Supply Required
Remittance Market 10% $6.55B
Black Market Transactions 10% $25.05B
Total: $31.60B

Like Mr. Woo, we offer no opinion on whether or not bitcoin is suited to black-market transactions, but merely provide the above analysis as a reference point for potential data-driven valuation discussion.

Bitcoin as comparable to one medium-sized nation

We'll (subjectively) use a GDP of $200B as the definition of "medium" for our purposes here. That roughly corresponds to the GDP of countries such as Algeria, Peru, Kazakhstan, and the Czech Republic.


For comparison, as can be seen in the above chart, the GDPs of France, the UK, Brazil, and Russia are all more than 10 times higher, and the GDPs of Estonia, Uganda, Zambia, and Afghanistan are all 10 times lower.

Once again using our velocity of 7.3, we calculate that a money supply of $27.4B worth of bitcoin would be required to support $200B in economic activity; ie, the equivalent of a single "medium" sized country.

Table 3. Bitcoin Money Supply Summary 3
Domain Domain Penetration Supply Required
Remittance Market 10% $6.55B
Black Market Transactions 10% $25.05B
M2 of "Medium" Size Country 1 Country $27.4B
Total: $59.0B

Bitcoin as 10% of global eCommerce

Total eCommerce can be approximated as the sum of Business-to-Consumer (B2C) and Business-to-Business transaction volume. B2C is somewhat readily tracked; estimates for 2013 are about $1.3T. B2B figures are more difficult to reliably determine, but some studies (pdf) suggest B2B eCommerce volume is more than double B2C volume.

In our analysis, we'll assume equal volume for B2C and B2B transactions, yielding total eCommerce volume of ~$2.6T for 2013. To support 10% of that economic activity in bitcoin, the total supply of bitcoin would need to be $35.61B

Table 4. Bitcoin Money Supply Summary 4
Domain Domain Penetration Supply Required
Remittance Market 10% $6.55B
Black Market Transactions 10% $25.05B
M2 of "Medium" Size Country 1 Country $27.4B
Global eCommerce 10% $35.61B
Total: $94.61B

Bottom-Line: Estimated total value for bitcoin as medium of exchange = $94.61B

As the astute reader will note, the above figures are not necessarily fully additive, but we approximate to provide a reasonable upper-bound on bitcoin's medium-of-exchange value if bitcoin garners 10% of the markets noted above plus the general economic equivalent of one medium-sized country.

Value as a store of value

We further agree with Mr. Woo that bitcoin as a store of value most closely resembles precious metals (specifically gold) and cash balances since it generates no interest or dividends in and of itself, and is credibly scarce. We will treat each separately:

Bitcoin as 10% of gold's store-of-value demand

Here we will diverge from Mr. Woo, and instead look at bitcoin garnering 10% of gold's investment demand. While Mr. Woo instead looks at silver, arguing that bitcoin's volatility makes it inappropriate as a gold substitute, we note that we're evaluating potential success-cases and medium/long-run possibilities. As bitcoin gains further adoption and liquidity, its volatility will lessen. Thus, for the purposes of this valuation-grounding exercise, we believe it's both fair and interesting to look at bitcoin's value if it were to achieve 10% of gold's investment demand.

What's the total value of gold as an investment? It's estimated that 50% of gold is used as jewelry and about 10% in industrial processes, leaving 40% of gold consumption for investment purposes.

With ~174,000 tons having been mined, that yields a total above-ground investment-gold supply of $2.7 trillion.

Ten-percent of total investment gold is $270B.

Table 5. Bitcoin Money Supply Summary 5
Domain Domain Penetration Supply Required
Investment Gold 10% $270B

Bitcoin as 1% of "offshore accounts"

A headline-grabbing research paper from 2012 estimates that the world's high-net-worth individuals have hidden between $21T and $32T in untaxed "offshore accounts". While it's difficult to know much about the nature of this money or validity of the analysis, it's worth noting that bitcoin could eventually be seen as a potential vehicle for discretely storing liquid wealth.

Bitcoin is extremely confiscation-resistant, and essentially impossible to block from a flow-perspective. It is not anonymous, but its pseudo-anonymous/user-defined-anonymity properties seem likely to hold privacy advantages relative to traditional money flows. With the recent precedent of the Cyprus bail-ins, Portugal's pension seizure, and the IMF's musings on global wealth confiscation, we believe the world's wealthy may come to look toward bitcoin as a safe-haven for a small percentage of their non-public holdings.

Using the $21T lower-bound from the above report, we see that 1% of such wealth amounts to $210B.

Table 6. Bitcoin Money Supply Summary 6
Domain Domain Penetration Supply Required
Investment Gold 10% $270B
HNW "Offshore" Holdings 1% $210B
Total: $480B

Bottom-Line: $480B in potential store-of-value demand if bitcoin captures small fractions of existing store-of-value assets.

Final Tally

When we add our estimated market capitalization of bitcoin if it captures 10% of common medium-of-exchange uses to our estimate if it captures up to 10% of store-of-value uses, we arrive at a total market-cap of ~$574.6B.

Table 7. Bitcoin Money Supply Summary 7
Domain Domain Penetration Supply Required
Remittance Market 10% $6.55B
Black Market Transactions 10% $25.05B
M2 of "Medium" Size Country 1 Country $27.4B
Global eCommerce 10% $35.61B
Investment Gold 10% $270B
HNW "Offshore" Holdings 1% $210B
Total: $574.61B

At full-issuance of 21,000,000 bitcoins, each bitcoin's fair-value would therefore be $27,381.


Our analysis determines that one bitcoin must be worth $27,381 in order to support 10% of common medium-of-exchange economic activity, plus well under 10% of existing common store-of-value demand. Whether bitcoin will achieve on the order of 10% market-share for those activities is another analysis entirely; one that is far more subjective, and requires a framework for evaluating both micro and macro economic dynamics, viral technology adoption, network effects, and other domains that are beyond the scope of our analysis.

That said, the following conclusions can be drawn from our analysis above:

1) If bitcoin achieves close to 10% market-share of the above uses, it is undervalued by more than an order of magnitude today.

2) The bitcoin market is either inefficient, or is assigning a probability of less than 5% for bitcoin to achieve the success-scenarios outlined herein.

Is Bitcoin a bubble?

The answer to this question depends entirely on how much bitcoin adoption, both as a medium of exchange and a store of value, grows in the future. From our analysis, it's clear that there is significant upside if bitcoin does continue to gain market-share.

To arrive at a fair value for today, one must determine the probability that the above 10% market-share "success scenarios" will occur. If we say there's a 10% of this success itself, then a simple analysis (ie, ignoring discount rates and duration), puts a fair value of one bitcoin at (0.10)($27381) = $2,738 today.

Debunking “Debunking Bitcoin”


I’ve had the recent pleasure of lively twitter debate with Phil Carney (@carneycapital) about bitcoin. His exploratory post, “Debunking Bitcoin“, is filled with the usual newbie (and gold-bug) criticisms, and I’m always more than happy to debate and debunk misguided or misunderstood ideas. I think Phil and I mostly understand each other at this point, but this is a bigger discussion than can be done 140-characters at a time.

With a background in both economics and computer-science, bitcoin is a bullseye for me intellectually. It’s often difficult for those without such dual perspective to grok something as complex as bitcoin quickly. But that’s why we have blogs and twitter.

Phil lays out several “problems” with bitcoin which lead him to the conclusion that it “IS another form of a fiat currency, albeit a digital one that is decentralized.” His main concerns, somewhat typically boil down to: “No Intrinsic Value”, “Divisibility”, and “Alt Coins”. I’ll debunk these one at a time.

But It Has No Intrinsic Value!

This is the most basic and obvious criticism. Phil defines it as follows:

“A bitcoin has no store of wealth, no intrinsic value, just like the paper dollars printed by Central Banks around the world. Many of the Bitcoin Illuminati are peddling the fallacy that it does have a store of wealth as physical gold does. That is FALSE and MISLEADING in my opinion.”

And goes on to say that

“Still you cannot melt a Bitcoin down to make Jewelry, use it in commercial products, and so it has no intrinsic value. This means it carries the same flaws the current Fiat Monetary system has.”

He’s right that you can’t make bitcoin into jewelry (or can you?) or use it in industrial processes. But what he and many gold-bugs miss is really why things have value in the first place. It’s simple: things have value because people want them. Usually valuable things are useful. They allow people to get something done, or get something done better. In the case of dollars, gold, and bitcoin, they all allow people to exchange goods and services more easily. They solve the coincidence of wants problem. They reduce the friction of exchange. This is what money is all about.

In our internet-connected lives, we need to send money electronically. Increasingly little of our day-to-day exchange is done by handing over physical paper-cash or metal-coin. We exchange online, usually with electronic dollars administered through some third-party account (our bank, a credit-card processor, paypal, etc), with the 3rd party taking a cut somewhere in the process.

Bitcoin is exciting because it’s the first thing to be able to do electronic exchange reliably without a 3rd party. It is electronic cash. No central body controls or issues it, and no 3rd party is explicitly involved when someone sends bitcoin to someone else. It also provides real transactional security, unlike easily-intercepted credit-card numbers and bank account numbers. And it is credibly scarce, with a mathematically limited supply (more on this later).

All of these properties make bitcoin very useful for our modern way of life. It is specifically useful at reducing the friction of exchange. Why? Because it requires no middleman, offers effectively instant settlement, negligible transaction cost, and it is both reliably scarce and cryptographically secure. These features add up to a near-ideal tool for facilitating online transactions. And that’s what money is all about – specifically reducing the friction of exchange for however a given culture desires to exchange. In the past, it was face-to-face. Now we want to transact instantly, across oceans, at near-zero cost, with confident security. That is bitcoin’s “intrinsic” value. There is no need to melt or wear it for it to have utility in our lives.

In sharp-contrast to a gold-bug’s sensibilities, it is bitcoin’s non-physical nature that allows all these benefits. In modern times, tangibility is a bug, not a feature.

Ok, Bitcoin is useful, but there are a gazillion units! It’s not scarce!

Phil’s next problem with bitcoin is that they can be divided into a hundred million pieces. He equates this with violating the notion that bitcoin is scarce money with a hard-cap of 21 million bitcoins. He elaborates:

“…there may be 21,000,000 total Bitcoins, there are, however, a massive 2,100,000,000,000,000 or 2.1 quintillion [sic] tradable bits that will be available when all the coins are mined. This figure also needs to be multiplied by the dollar value assigned to each 0.00000001 or “satoshi” highlighting the fact that its finite status is at best one hell of a stretch”

Phil and others who make this argument are missing several points:

1) Anyone who controls one bitcoin, will always control all divisions thereof. It’s like owning an ounce of gold. The owner can split it down to gazillions of individual gold atoms, but he still just has one single ounce of gold. No more gold has been created. Gold is no more scarce because each ounce can be divided into 10×10^27 individual gold atoms.

2) Perfect divisibility is a strength. It allows further precision in economic transactions, and that reduces friction. If I want to sell something for 1.23456789 bitcoin, I can do that trivially, with perfect precision. Try dividing an ounce of gold to a one-hundred-millionth of an ounce…without a state-of-the-art chemical lab.­ While this may seem academic, it will likely prove a major benefit in allowing bitcoin to flower into an underlying protocol layer doing the heavy-lifting for additional services requiring very detailed asset-registers (see Naval Ravikant’s excellent The Internet of Money for starters).

Divisibility is a feature, not a bug.

But anyone can create new crypto-currencies!

This is the most interesting concern that Phil and other critics raise. Phil states:

“Put simply, as time evolves, as more crypto currencies enter the virtual currency space, the Bitcoin phenomenon and hysteria may be eroded. Whilst it has dominated the virtual currency space, Bitcoins 2.1 quintillion [sic] bit supply may be finite to Bitcoin itself, the space for new virtual crypto currencies is growing.

Bitcoin is not special or unique.Bitcoin will be to the virtual Crypto world what the Euro, the Yen or The US Dollar are to the central bank world… FIAT MONEY WITH NO STORE OF WEALTH.”

Phil is right that anyone can create a new crypto-currency (go make your own here. See how well it catches on…). But he ignores the question of why anyone would use it. Why did humanity use gold as our primary monetary instrument and not silver? Or copper? The answer boils down to concepts familiar to those studying tech adoption or social sciences: network effects and first mover advantages.

When some convention or technology (or monetarily-appropriate metal) is adopted by enough people, it’s advantageous for everyone if the next person in line also adopts that convention. The new guy gets the benefit of exposure to the rest of the network, and the network itself expands, enhancing the value proposition for all existing participants as well as the next entrant. As long as no vastly superior new convention appears, new entrants are highly incentivized to use the existing status-quo. Like core internet protocols (IPv4, TCP, HTTP, SMTP), bitcoin is demonstrating strong and likely unstoppable network effects.

UPDATE: Erik Voorhees eloquently addresses these points as well, in his open-letter follow-up to his appearance on Peter Schiff‘s radio show.

So what *if* something better comes along? Well, we can look to adoption of previous technological protocols, specifically internet/networking protocols. New ideas appear continuously – just look at the list of internet RFCs – yet the internet essentially functions the same way as it did 30 years ago; ie, on the same core protocols. Generally speaking, new services are built atop the core, with core protocols evolving and incorporating new features as needed. This dynamic is already emerging in bitcoin, with Bitcoin Improvement Proposals serving as bitcoin’s RFC equivalent. By far the overwhelming tendency on the internet has been for the protocols to be evolved as needed, and it will likely be the same with bitcoin. For open systems on which infrastructure is built by diverse sets of individuals and companies, all spending their own energy on engineering, education, and process, it makes far more sense to evolve than to switch.

Part of the critique of this aspect of bitcoin, most typically from gold-bugs, stems from a fundamental lack of appreciation for how flexible and malleable technology can be. Bitcoin is not MySpace. It is far more fundamental, like the core packet-switching ideas that have underpinned computer networks since inception. In the past 30 years, the basics of packet-switching have been rapidly extended, patched, evolved, and layered on top of extensively. Bitcoin is equally fundamental, open, and extensible.

As with gold, malleability is a feature, not a bug.

Phil’s arguments are reasonable and fairly typical of non-tech gold-bugs. They fail to appreciate the dynamics and flexibility of technology; both how “real” and “hard” it can effectively be, as well as how beautifully malleable. Much of human interaction is moving to digital realms due to the friction-reduction and efficiency that it offers. The same is now happening with money, courtesy of bitcoin.

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