As a casual economics thinker, I thought, what is the BTC really worth?
Forget all the bubble crap, forget the deflationary stuff, and forget all the nonsense about governments and whatever. Forget about what everybody says, and just look at the fundamentals.
I realize that many people have an opinion one way or the other, but I am trying to be as objective as possible. Full disclosure, I own some BTC.
How is a BTC generated? Work, from electricity, nothing more fundamentally. Sure, you can get into the whole crypto stuff, but at the end of the day, BTC represents electricity spent. You can also consider the initial sunk cost of the equipment, but in the long run, that cost becomes irrelevant.
The only thing that matters in the long run is the marginal cost. As long as the barriers to entry are low, which they are VERY low, many people can enter the market to compete the profits away.
BTC is in its infancy, has very little widespread acceptance, is somewhat price "sticky," has low volume and is moderately easy to convert to other currency.
What does this mean? It is great for the early adopter. Let's look at how much a BTC costs.
Some assumptions that make sense in the long term and short term, possibly not the midterm:
1. The cost of electricity is the ONLY relevant cost. Why? In the short term, your equipment has a high resale value; the money lost is negligible, and can be summed up as simple transaction fees. In the long term, the cost of the equipment is spread out over such a long period of time that it is also irrelevant. Especially after you consider the price of electronics approximately halves every 18 months, it is not a significant factor in determining the cost of a BTC. (Even still, I will add a 20 percent rate of return so that miners can recoup some of the costs for purposes of the calulation.) Additionally, after mining become unprofitable for some, they still have a perfectly functional computer that still has utility.
2. The average cost of electricity will be assumed to be $.1 per kwh. Some places more, some less, but if you don't like this assumption, take your own number and replace it, just multiply my final result by whatever factor.
3. Using the latest growth rate of 8 percent a day, I assume linear growth. I do NOT believe this to be a legitimate assumption, but it works for purposes of this exercise.
4. I assume the highest efficiency of 2.5 hashes per joule. Not realistic, but it gives a conservative estimate. Also, assuming that the majority of the computing power is done by the most efficient computers is pretty valid assumption, especially considering the recent surge of computing power is most likely due to new miners seeking to capitalize on the insane profits, so it’s probably up there.
So currently, at a difficulty of about 244000, the electricity cost per BTC is about $.28.
28 cents! Are you kidding me? As of right now, the price is 8.77. You input .28, and you get out 8.77, nearly 32 times your input! That’s insanity. But is it?
The wonderful thing about this is difficulty increases. The next difficult increase will nearly be double, and will happen sometime tomorrow (16 hours or less by my calculations as I’m typing this). At an 8 percent growth rate, that is also growing itself, the computational power will double every 9 days, and the difficulty will lag behind. This means the difficulty will ALWAYS be less than it should be, until the price of the BTC sticks at a certain price.
SOOOOOOO. . .
If we extrapolate out 2 months, assuming linear growth (which is conservative, personally I think it will be more exponential), and a lag in difficulty, then difficulty will increase approximately 1.75 times every round. (Personally, I believe it to be more, but I’m being conservative here).
Therefore, in 64 days, instead of the 28 cents of electricity per BTC, the price will be $25 per BTC. So, it is not unreasonable to pay 8.77 NOW for something you think will be worth at LEAST $20 in two months. That’s a whopping 768% annual IRR!
Now, I believe all these assumptions to be reasonable, but I cannot tell the future. Currently, speculation is driving the price. Although, I have to admit, the speculation is not completely unreasonable.
Conversely, there is nothing supporting the BTC. It is ALL speculation. I very much doubt the majority of BTC are being spent toward any form of economy. It would be foolish, given the insane recent price increases.
As for now, it is clear that price drives the difficulty. The price spike attracts people who enter the market and compete away profits. This will continue to happen as long as a BTC is worth more than the electricity it costs to make. It also attracts speculators, which also drive up the price. As long as people keep demanding, the price will keep rising, because supply can only decrease.
The thing we have to worry about however, is a panic. There will be a price ceiling that people will not be able to resist selling at. It’s mass psychology, and it happens in every (dare I say it?) bubble. In order for BTC to survive, it needs to gain significant economic traction: people need to USE BTC, SPEND it on goods and services. There needs to be a fundamental utility to the BTC outside of speculation. And in order for that to happen, the price spikes need to stop, but if that stops the majority price driver for the BTC will stop, the BTC will plummet, people will lose faith and not accept the BTC, further driving down the price etc.
It’s a catch-22. The only way out is moderation. If we moderately control the price, we can reach equilibrium, and the BTC will have a steady price, thus allowing people to SPEND BTC and for BTC to gain economic traction. Fortunately, we have difficulty increases! It is a very robust and smart system. However, I believe the difficulty changes should happen on a shorter period, but that will all take care of itself in the LONG run.
I do know this: there WILL be an end to the speculation, and ultimately the BTC will stabilize and be priced at the marginal electricity cost, in the LONG run. As to when that will happen? I don’t know. But I do know that the valuing the BTC at 32 times its marginal cost is NOT sustainable, is driven by speculation, and if it continues will only lead to a crash, dooming the short-term market to a crisis of confidence and slow growth. However, given the robust nature of the system, worldwide spread, and huge available market, I believe in the LONG term the BTC is a viable currency, at a price slightly above marginal electricity cost (a price that would allow a 10 - 20% annual IRR on equipment).
TL;DR
The marginal cost of a BTC is only $.28. The current price is $8.77. If growth trends continue, in 64 days the marginal cost of a BTC will be about $23. Will the market continue to value the BTC at 32 times marginal cost? Doubtful.
