All free market valuations are driven by the balance between buyers and sellers at a given supply. This is no different for Bitcoin. Clearly in 2017 there have been greatly more buyers than sellers of the bitcoins available. Will there be more buyers than sellers in 2018? Let’s take a brief look at what is causing this imbalance that can send an investment from under $1,000 to $18,000 in 12 months.
Relative valuation is determined by only a handful of things. Let’s look briefly at each of these to see if it has driven the price of bitcoins up.
- The earnings generated and potential to pay a dividend (or interest). This is the traditional investment valuation framework. Revenues, P/E multiples, earnings growth rates, etc. are the guides. What has bitcoin done that justifies a valuation greater than Boeing, with its 140,000 employees, or New Zealand? Since Bitcoin has no underlying economic creation, this could not be relevant to its valuation.
- A reduction of supply for the existing market demand. A bad corn crop and corn prices go up reflecting the existing demand now facing a shortage. OPEC introduces a cartel in the early 1970’s to control petroleum production and gas prices go up from $0.25 per gallon, never to return. Since there has been nothing reducing the Bitcoin supply in 2017, it must be driven by an increase in demand, not a reduction in supply.
- Increased demand due to market need. This could have been the case if the transactional demand for Bitcoin had taken off. Imagine with the controlled supply of Bitcoins, if it became a mainstream transaction medium and people just needed more and more to handle transactions. This has not happened. Take a look at the difference between M-Pesa in Kenya and Bitcoin transaction volume in their first 5 years:
No, Bitcoin is not becoming a broad alternative to fiat currency. It cannot with the price volatility. A Big Mac cost $4.79 at the beginning of 2017 and was about the same at the end. In terms of Bitcoins, it was $4.79 at the beginning of 2017 and $92.53 recently. Explain this to your kids. Some, like Steam, have stopped accepting Bitcoin for just this reason.
- Valuation is a two-sided equation. The rise of Bitcoin could alternatively be the collapse of fiat currencies. The “disruption enthusiasts” could be high fiving because the world is finally realizing that fiat currencies are bogus and manipulated and the only true trustworthy currency is Bitcoin with no ability to manipulate its supply or value. This global currency devaluation, from the Swiss franc to the Argentine peso, may prove out over the next 50 years, but there is nothing in 2017 that has awakened the world to this.
- The final alternative for Bitcoin’s valuation is what former Fed chairman, Alan Greenspan publicized during the dotcom bubble as “irrational exuberance” (likely drawn from Nobel laureate Robert Shiller). I remember the time well since a group of us had just carved out Inter.net from PSINet to take public in early 2000 before the collapse. The valuations were being influenced by a lottery ticket mentality. For a small investment, there is a chance to win big. There is no rational underlying lottery ticket valuation that drives an acceptable price to the purchaser. The dotcom bubble collapsed in April 2000 triggered by an article in Barron’s written by Jack Willoughby in March 2000 titled “Burning Up, Warning Internet companies are running out of cash — fast.” Here it is for those interested in history repeating itself: https://www.barrons.com/articles/SB953335580704470544
Bitcoin’s valuation was between 0 and $1,000 for eight years. In the last couple of years the enthusiasm built for the underlying technology, the blockchain. There has developed Irrational exuberance for the blockchain with the ability to participate being mainly through ICOs. Even when beverage company Long Island Ice Tea changed their name to Long Blockchain Corp. their stock doubled.
This irrational exhuberance for all things blockchain worked its way back to Bitcoin as the easiest way to have a ticket in the lottery. Asset values build on irrational exhuberance can end pretty abruptly. This is not necessarily bad. As venture capitalist Fred Wilson quoted a friend as saying about the dotcom bubble, “Nothing important has ever been built without irrational exuberance.” The dotcom bubble gave us Amazon, Ebay and much more. However, there were a lot of tulips mixed in there too.