Bitcoin Prospects

When I first heard about Bit­coin sev­eral years ago, I was dis­mis­sive that a cur­rency not backed by a cen­tral bank or valu­able com­mod­ity could suc­ceed as a cur­ren­cy. It still seems doubt­ful to me that Bit­coin could estab­lish itself as a proper world cur­ren­cy, but recent events have lead me to believe that it’s possible and that those involved are not nec­es­sar­ily par­tic­i­pat­ing in a de-­facto ponzi scheme. Bank of America seems to be get­ting into the game so Bit­coin looks to me like it might be on it’s way to legit­i­ma­cy. With this in mind, I thought I’d do some back­-of-the-en­ve­lope cal­cu­la­tions to see if I could fig­ure out the likely future worth of Bit­coins and the value of invest­ing in them at the present time.

The absolute max­i­mum num­ber of bit­coins 21 mil­lion. The algo­rithm which ‘mi­nes’ them is arti­fi­cially capped so that the quan­tity will never exceed that num­ber. This means that, in the future, the worth of an indi­vid­ual bit­coin will be one 21 mil­lionth of the mar­ket in which they are used. Rough­ly, the cur­rent global GDP is about 60 tril­lion US dollars. So in, the most opti­mistic case, with Bit­coin replac­ing all world cur­ren­cies, you could expect a bit­coin to be worth $2.9 mil­lion dol­lars. That’s dis­count­ing any poten­tial for growth or shrink­age of the world econ­o­my.

Now, I think it’s highly unlikely that Bit­coin will replace all cur­ren­cies, but it does have poten­tial in two areas: ille­gal trans­ac­tions and money laun­der­ing, and online retail and money trans­fers. Bit­coin already seems to have become a major player in money laun­der­ing and that seems to be driving most of its cur­rent real, non-spec­u­la­tive val­ue. While there are prob­a­bly many bil­lions of dol­lars of ille­gal trans­ac­tion every year, I don’t think that util­ity in money laun­der­ing is likely to turn Bit­coin into a real cur­rency or will even allow it to main­tain its cur­rent val­ue. The main rea­son is that if Bit­coin gets sad­dled with a rep­u­ta­tion as a tool for ille­gal activ­i­ty, it will likely get leg­is­lated again­st, which will kill its value and poten­tial. The Bit­coin sys­tem is dis­trib­ut­ed, which means that it can exist and func­tion with­out back­ing gov­ern­ment, but if you can’t exchange them in legit­i­mate mar­kets, their value is lim­it­ed.

How­ev­er, one plau­si­ble sce­nario is Bit­coin becom­ing a major player in online retail. Bit­coins are more con­ve­nient in some ways than Pay­pal or the credit cards that make up the cur­rent pay­ment sys­tem in online retail, so if retail­ers and the pub­lic were to gain con­fi­dence in it, Bit­coin could be a major and legit­i­mate play­er. Online retail sales in the United States in 2013 were 258.90 bil­lion dollars, so if Bit­coin were to become the pri­mary medium of exchange in that mar­ket, a value of $12,300 per coin seems plau­si­ble if very opti­mistic. Given that the US is only a frac­tion of the total online retail mar­ket, and that the mar­ket is likely to grow sub­stan­tially over the years, this num­ber could be larg­er.

Another note in Bit­coin’s favor is that while other cur­ren­cies are gen­er­ally infla­tion­ary, the banks which issue them tend to expand the sup­ply faster than the econ­omy grows, Bit­coin is deflationary; It’s sup­ply is capped and when it reaches the 21 mil­lion mark, the value of coins will increase with the size of the econ­o­my. This means that if bit­coins become a real play­er, their value has the poten­tial to increase indef­i­nite­ly. This means that Bit­coin could at some point be a much bet­ter invest­ment than cur­ren­cies issued by national banks.

Now, that’s my guess for max­i­mum mar­ket cap­i­tal­iza­tion. You’ll note that my cal­cu­la­tions are really hand-wavy and very opti­mistic. If true, it means that min­ing (or buy­ing) bit­coins now is still a poten­tially good invest­ment but it’s still a major risk. The Bank of Amer­ica ana­lyst I linked to ear­lier seems to think that $1,300 is a much fairer long term val­u­a­tion as a com­pet­ing cur­rency (I’ve been look­ing at it as a replace­ment cur­rency which is much less like­ly,) which would mean that bit­coins are already near over val­ued. I’m still uncon­vinced but I think I’ll revisit this soon.

    Last update: 06/12/2013

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