Lots of posts on Bitcoin recently as the price continues to rise. I don’t want this to be a Bitcoin only blog, but I do have a long position, it’s a hot topic and I have done some thinking on this so I’ve got some value add here (pun intended). This post will be on value. The next one some thoughts on government regulation which I think is really the most important topic surrounding Bitcoin.
So lets put a value on Bitcoins! Should you buy Bitcoins? Well I’m long so you know my opinion. However the main reasons for me starting this blog are:
- Force myself to articulate my thoughts to help ensure I’m making sense. Sometimes your write things down and it just doesn’t look right.
- Get feedback! I’m not always right and I can be swayed. I’m searching for intelligent life.
So here is why I’m long. Lets calculate the expected value (EV) of buying a Bitcoin. In “probability theory” expected value is calculated by taking all the possible outcomes multiplied by their probabilities of occurring and adding them together (here is an example with dice). In our case the output of the expected value calculation represents the price below which we should be buying Bitcoins and above which we should be selling.
First lets list the possible outcomes and approximate what the Bitcoin price should be in each of these outcomes:
- Disaster! A bug or hack results in utter loss in confidence of Bitcoin system. Or governments uniformly ban Bitcoin. Price goes to $0.
- Mediocrity. Merchants don’t universally adopt Bitcoin. Some folks use it as a store of value, but as a medium of exchange the results are well…medium. Price end up around $100.
- Success! Bitcoin becomes a commonly accepted medium of exchange competing w/ major currencies although not replacing them. Bitcoin grows to be as used as the US dollar. There are 1.2 trillion dollars in circulation and there will never be more than 21 million BTC so 1.2T/21M = $52,381 per Bitcoin.
- Massive Success! Bitcoin becomes the primary currency used world-wide. As of 2008 Wikipedia has global currency circulation at around $4T. USA had 20% of the share so lets assume that share stayed the same making the worlds total circulation is $6T (1.2T/0.2). So $6T/21M = $285,714 per Bitcoin.
Thats right, there is a chance each Bitcoin that is currently trading at a paltry $125, could be trading at $285K each! I’ve seen estimates for 100K-1M per Bitcoin, not sure how So lets chuck these numbers into a spreadsheet and see what they look like when we probability weight them. I’ve provided 2 sets of what probabilities, one optimistic one pessimistic to illustrate my point.
|Scenario||Bitcoin Price||Optimistic Probability||Optimistic EV contribution||Pessimistic Probability||Pessimistic EV contribution|
|Optimistic EV||$8,115.24||Pessimistic EV||$561.37|
So according to these calculations a the price of Bitcoin should be somewhere between $561 and $8,115. I certainly wouldn’t call $125 a bubble. Of course as new information comes in probabilities change and therefore so does the EV. Obviously I’m winging it on the probabilities here, but I think if you are honest with yourself it’s pretty hard to say there isn’t a 1% chance of the “Success!” scenario occurring and munging the numbers to get the EV below $125 is really, really, hard.
So dump all your savings into Bitcoin? Obviously not. This is a speculative bet w/ at least a 69% chance of losing ALL your money, but the upside is tremendous for the other 31% so a small bet could pay big dividends.