Friday, December 11, 2015

Natural price levels for Bitcoin

Bitcoin is the strangest form of currency ever developed in the human history. Starting from January 2009, it rose to the levels over $1000 in January 2014. After that, its price crashed drastically and stayed around $250 throughout the first ten months of year 2015 but of late, it has started again rising and volatility is very sharp. It jumped to nearly $476 in a very short period of around a week and then dropped around to nearly $370. This is pretty sharp shift. (See Picture) Those interested in bitcoin tend to ask, “What barometer should be used for predicting bitcoin prices?
There is no definite answer to this question. Some people say that Chinese investors are rushing in to buy Bitcoin as many of them assume it to an excellent method of capital flight. Many rich Chinese who have amassed huge wealth want to shift it abroad and bitcoin enables them to avoid all forms of capital control. This may or may not be true because majority of bitcoin transactions happen in North America and Europe. The share of Asia-Pacific is very small in that. If Chinese elements were really active, the price of bitcoin would not fall rather it would have kept rising on and on. There is one more explanation being offered behind this sudden rise. As the crypto-currency ecosystem is maturing, the institutional support mechanism for bitcoin payments is falling in place. Merchants are adopting bitcoin as a mode of payment, more bitcoin wallets are being downloaded, more exchanges are being opened, more companies are entering crypto-money infrastructure like those in sidechains & altcoins and more banks are turning receptive to test the bitcoin space. This is a better reasoning though it only explains a part of the question. The real question is how far Bitcoin can rise and should rise. There is currently no framework for this answering this question.
If bitcoin is regarded as digital gold that works peer-to-peer
Let us try to answer this question. It is true that dollar is the world’s reserve currency but this is true more for the governments as they need dollars for international trade. For people, the true global store of value is gold. The second half of 19th century and in the 20th century till 1971, gold remained both the defacto and dejure global reserve currency as pound first and then dollar was pegged to it. People still regard gold as the true asset for hard times because it is acceptable to populations in all corners of the world. It is the true form of peer-to-peer money in a traditional sense. Bitcoin is called “digital gold” as its supply is fixed and any fresh incoming of this digital currency is through mining. So, like gold, bitcoin is a scarce unit of money. It is divisible and portable but bitcoin is more than gold in certain terms. It is a tradable gold. It is a technology platform too and a peer-to-peer network too. It can travel to any corner of the world without any chance of getting checked by any intermediary. In a way, it is a complete self-sustainable payment network for the entire world. What gold cannot do in terms of movement, bitcoin can do. It is censorship-resistant payment system that can work for multiple segments of global population. There are 200 million immigrants who send remittances to their native lands regularly. There are global telecom players who want a parallel revenue stream in addition to their sagging profits in voice and data market. If fiat currencies have cash-based network and they are yet to jump on to digital payments, the gap can be filled by mobile networks or message apps-driven systems of social networks like Whatsapp or Snapchat. The global hawala route may also jump on to this. Very few governments can counter the decentralized nature of bitcoin network. This is a great asset in the age of digital money. For a peer-to-peer exchange, bitcoin is a better bet than gold. So, it can be safely assumed that bitcoin would acquire at least the equivalent if not more than value of gold. 
Let us assume that true value of bitcoin should have been equivalent to one gram of gold. It comes down to around $40. This is the price that bitcoin crossed in year 2011. It means that in terms of gold, next barrier of 10 gm (1 Tola) should be tried. It comes down to around $400. This is the current market price range of bitcoin but we should not forget that bitcoin had touched over $1100 earlier. It means that an ounce of gold is the price limit that bitcoin has already touched. So, there are three gold-reference price barriers that bitcoin has already breached. That is why to guess a reasonable price level of bitcoin is not an easy task but the trajectory of growth in bitcoin prices does gain weight in terms of gold price references. That is why the popular consciousness assumes that price of bitcoin is expected to rise in direct proportion to its value in terms of gold. 

If we assume pound of gold as the next price barrier, this value comes down to around $17600 if current prices remain constant. If we go further to one kilogram of gold as the last price barrier, this would reach to over $38,000 apprx. Of course, this may seem a blatant case of speculation in short run but if people tend to regard bitcoin as digital gold, the long-term bet at these kinds of prices is not misplaced. What do we mean by long-term? It may be any period from 15-25 years from now. It cannot be predicted as to what price would be there in which year but it only reflects what people may think in terms of long-term positions on bitcoin.
If bitcoin market cap is regarded as equivalent to that of gold
There is another method of reaching a probability of price. Let us find what amount of gold is available for international trading. Let us evaluate in terms of market cap of gold. As per Wikipedia, the total gold reserves of the world were around 171,300 tonnes.
Source: Wikipedia
If we exclude gold used in jewellery, central banks and industrial categories and assume only half of gold in the investment and unaccounted categories, that amounts to over 18,000 tonnes. This is a very simplistic method but it can give us a rough market cap of gold that is being traded around the world. We should not forget that bitcoin is going to attract forex traders also where a single percent of investment can touch hundreds of billions but for the time being, let us only consider market cap of gold that flows across the trading platforms. This can become a good reference point as far as the price levels of bitcoin are concerned. At current prices of gold, this amounts to around $700 billion. This seems a figure that is the likely target of bitcoin market cap but when would it happen? If we give at least 25 years to above possibility, the average price would come out to be around 1Kg of gold (assuming constant price of gold) by the year 2040. Nobody knows whether it would happen but this kind of exercise of predicting future rise of bitcoin is an important one.
Utility and scale of Bitcoin wil drive its price 
Are we not over-estimating the potential of bitcoin? Is this framework really accurate? The answer is that even $700 billion market cap (if it happens) would make only a small fraction of existing monetary base of the world and further much smaller fraction of the global money supply. It is not to say that bitcoin would replace fiat currencies. The focus is price matrix with respect to gold and it is only to state that it can turn out as a good alternative as global store of value the way gold is. This may be off the mark but we should not forget that same thing could have been said four years back too but the reality is that number of bitcoin transactions have jumped 100 times in the same period. Today, the daily transactions are touching nearly 200,000 and to expect this figure to reach 20 million in next 10-20 years is not an impossible target.  This will definitely affect the price too. Nobody can predict bitcoin price in short term and nobody should. This blind game may be counter-productive both to the trader and the bitcoin itself too but long-term price trend is positive. This needs to be understood in the context of some related developments that are going to become major trends in coming years. The internet of things, cloud-based nature of software services, evolution of smart contracts, inherent weaknesses and inflationary nature of fiat currencies, real-time payments, universal adoption of smartphones by 2020 and 4G networks by 2025 are all the emergent features of global life that will make bitcoin a very acceptable solution. Let the critical mass around this technology be fully developed. As number of bitcoin transactions increase and its usefulness is proven beyond doubt, a natural mode of evolution will raise its price. Bitcoin is a true version of a global currency that has emerged from the grass-roots. The decentralized nature of its blockchain technology makes it a sustainable and scalable solution in the digital age. How far it would go is not clear but it would remain the most disrupting monetary phenomenon ever happened in human history.
(This was published on Economylead on 9th December, 2015)

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