Topic: How to value a currency (Read 5324 times)

Well, it's tough to say when you are valuating a relatively new and deflationary currency with an old and outdated deflationary currency that is teetering on the brink of hyperinflated collapse. Given those facts alone, it's hard enough to determine a "Spot price", when you start talking future value, you are trying to quantify adoption rate of the new currency, and inflation of the old one at the same time. But it's not even that simple either, because bitcoin is global. The shittyness of many of the world's currencies needs to be factored in. How soon until the next Euro bailout? 'Cause that will add about $60 value, apparently. Currency war coming? Hmm, tack on another $50? $100? Shit, I don't know. At some point it's futile to even measure a BTC vs USD. Has anyone bothered to figure out how many shells a BTC is worth? My guess is nobody cares, and if they still had a portion of their savings in shells or pelts, they would probably trade it all for 1 BTC.

Not saying your wrong just saying what I felt after a short read threw I have to go over the thread again before I had any real questions to ask.  Thanks for offering to explain further.

"For every complex problem there is an answer that is clear, simple, and wrong."

--H. L. Mencken

I'd be glad to explain in greater detail anything you don't get, but I'm afraid there's no simple equation you can plug some variables into to get the value of a currency. Value is subjective, and each person will value a currency a different amount. The purchasing power/price of a currency is a result of these subjective valuations interacting.

P.S. This also explains why people are hoarding BTC rather than spending them. The expected future value of a BTC is higher than its value today--so why spend it today?

I think Sword Smith's analysis that fair USDBTC is $50 is probably about right.
The reason USDBTC is now trading at $100+ is because of the expected growth in Q.

It's a bit like a growth stock--the PE ratio is higher because of expected future growth.

My conclusion: the current price on the exchanges of $100+ is about right for now, given that we think that BTC is likely to be adopted ever more widely.

Thanks for the analysis.

After briskly reading a few posts I'm liking the premise of this thread, it's very intriguing and makes one think deeper of the value of a currency and how we view what that value truly is based on. 

I appreciate the equation you gave to explain your points, very helpful and interesting breakdown.  Much of what I've read here makes sense.  Some stuff leaves me a little confused but overall a good debate I tend to side with the OP as I feel I get more explanations for the viewpoints given.  All in all it's good to here opposing arguments on the topic. 

My apologies. I'll address it now.

Not if nobody wants your goods or services. I say again, value is a measure of how much someone wants something.

If USD gains any value from you accepting it, it's not from the objects which you are willing to trade for it, but rather from your desire for it.



Hmm. Even if I were presenting an either/or, this still wouldn't apply. Since I'm not presenting an either/or, you're wrong here, too. Not running a very good track record, I'm afraid.

What you are presenting is a false dichotomy.

Great. And I believe I am the one educating you. You failed to address my main argument:

Not at all necessarily. If a lot of people wanted USD, but not very much, then the value of USD would be low. If very few people wanted USD very much, then the value would be high. Value is a function of how much people want something, not how many.

No, I am educating you. That you are getting emotionally involved in the education is unfortunate, since it reduces the likelihood that you will listen to what I am trying to teach you. Your idea was bad. This does not mean you are bad.

It wasn't intended as an argument, but to illustrate yours. You want a currency so you can buy something (person A lifts person B). You can buy something because someone else wants the currency (person B lifts person A). Therefore, the value of the currency is based on the purchasing power (and off they go into the sky).

The only reason you can buy something with a currency is because someone else wants that currency. Purchasing power might be a good way to measure the value of a currency, but it certainly does not determine the value.

Great! Now you have accepted that the reason that I accept USD is that I can buy stuff with it. And here comes the central point: USD becomes more valuable since the goods and services that I can produce can be traded in USD!! The value that it gains this way is proportional to the worth of the goods that I can produce and am willing to trade in USD. USD gains value since the same amount of dollars can now be traded for more goods, i.e. Q has increased by me accepting USD. What applies to my sevices or good also applies for other people so Q is one of the determining factors of valueing a currency. A currency is a network and its value increases when more people adopt it.

Are you trolling me? If so, it is working 

And your silly picture is just that, silly, and not an argument.

OK, that's why you want USD. To buy stuff. But you're missing the point. The only reason you can buy stuff with it is because people want it. And yes, part of why people want a currency is so that they can buy stuff with it. But that does not determine it's value. How much people want it is what determines it's value, and trying to base the value on purchasing power is like trying to get to space this way:

You see only what you want to see. I told you that I would value the Rai stone according to, among other things, its purchasing power. This you chose to ignore. I honestly think that the arguments speak for themselves and that it is up to anybody to go through our discussion and make up their own mind. I only value US dollars for one reason. I can buy stuff with it. Either by travelling to the US and pay my living expenses there or by buying Danish kroner with the US dollars. There is no other reason for me than the fact that I can purchase stuff with USD to value them - purchasing power impacts value but, as I have admitted, other factors may influence my subjective value as well.

Fixed.

Value determines purchasing power. Not the other way around. This is self-evident if you examine what the terms mean:

Value: How much people want A.
Purchasing power: How much B you can get for A.

Since you have to get B from someone, how much they want A will be the deciding factor in how much B they're willing to give up for it.

Fixed

So you see, now, that purchasing power is not the determining factor in the value of a currency? That it is actually the other way around?

In fact, from the Rai stone article:

The story determines the value. Just like you would love one, "just because it would be cool to say that I owned one."

I would love a Rai Stone!! Besides, my computer is from primo 2009.

i would value a Rai stone according to the purchasing power that it could give me and how much I value that purchasing power on Yap. I might value it at a discount since it was on some remote island. And maybe I would also value it just because it would be cool to say that I owned one.

No, it isn't. If I tried to buy your computer from you using Rai stones, you'd run me off, because you don't want Rai stones. This, despite the fact that on the island of Yap, one could conceivably buy a large estate and the livestock (and wife!) to go with it. You don't value Rai stones, so you won't sell me anything for one, no matter how much you could buy with one.

That is an excellent point which does not completely make my calculations irrelevant, though. The reason that he can change back from BTC to fiat is that other people also value BTCs because they can buy stuff for it.

It is just as much common sense to state that people value it because they can buy stuff with it. It is, as mentioned above, not wither or. It is both - a feedback process.

Nearing one, perhaps.

Q doesn't play a part in many user's valuations, though. For instance, the person who only wants to get his 5 million dollars through border checkpoint without being hassled won't give a shit that you can buy tea with it. He just wants a few thousand coins to keep in a brainwallet to avoid having to explain why he's carrying 5 million dollars.

People value a currency for many other things than just what you can buy with it. As I said before, you've got it backwards. You can buy stuff with bitcoin because people value it. Not the other way around. People have to value a currency, and desire it, before you can buy things with it, or else, they wouldn't offer to sell things for it. It's common sense.

Neither statement is sufficient. It applies both ways: I value it because I can purchase things for it and you can purchase things for bitcoins because I value it. I value fiat currency because I can purchase things with it. The same goes for bitcoins and I expect to increase my purchasing power of any bitcoin holding I may have. A currency like Bitcoin is like a network and the network value rises when more people join that is, when you can trade more things with bitcoins.

Did you even read my OP, Myrkul?

Do I sense that we are reaching some kind of understanding? An expectation of a large future Q is what drives this investment strategy:
http://youtu.be/NG1qooBzE2w

I wasn't stating it was wrong because the market fluctuates, or even that he failed to derive the same value as the market. I was requesting that he explain, using his equations, why this is so.

I can explain why this is so, simply by stating that the people who use bitcoin value it enough to exchange $92.45 for it. When Bitcoin was in it's infancy, people valued it less, and fewer people valued it. Thus, the price was lower.

I've been stating all along that he was wrong because he based his calculations on a flawed premise: That bitcoin's value comes from what you can purchase from it. He's got it backwards. You can purchase things with bitcoin because people value it.

In other words, people think that it is worth buying, so they buy it.

What drives the speculative valuation of $/BTC is an expectation that Q will become large, that M is contained and that V is also relatively stable.

It started at less than a dollar since no one was trading anything in bitcoins. Q = 0 for 2009 as far as I have understood. I already stated that the uncertainties on all values are huge and that speculation also plays a roll and that speculation is hard to contain in the equation of exchange.
Maybe so but you will have to come up with some better arguments than what you have come up with so far. From what you two are saying, the price is completely arbitrary other than what people demand and from your perspective it might as well be 1 cent as 1m dollars. At least my estimate is in the correct order of magnitude. And since I was able to recognize your argument as Austrian you should also recognize that I am not completely ignorant to their arguments and ideas.

Mr. Market can be crazy at times

Additionally it was also at less than a Dollar because Q changes over time.

I'm not saying $50 is the correct valuation. I have no clue how to value a currency. But stating that something is incorrect because a (by definition) speculative market trades it at a different price is just silly.

So, what is the "intrinsic value" of a bitcoin? You give the number of $50/BTC up there in your OP. Would you care to explain, then, why it's currently trading at $92.45? And why it started at less than a dollar?

You should listen to Smoothie. For that matter, you should listen to the Austrians. They both have a track record of being correct in their predictions.

I don't even know where to start responding to this nonsense. Too much unreflected Austrian theory in here.

I am stating that this prescribes a fundamental analysis. Just like you can analyse stocks from a P/E perspective, Net Present Value or intrinsic value, you can analyse a currency from the equation of exchange. This may not give the full picture but just like a stock is unlikely to be traded below, say, 50 % of intrinsic value, so is a currency also unlikely to deviate too much from this equation although I realise that speculation is very to account.

According to your claims, the price of a currency is totally arbitrary and has nothing to do with the for instance M. Well, what is the problem of printing money then?

People give something value, not a set of formulas.

Indeed I am. Value is subjective, and each user of the currency values it differently. To see this quite clearly, look at the other threads here in Speculation. Some bitcoin users value it quite highly, and laugh at people who sold. Others value it less, and laugh at people who bought.

Yes. Demand/supply is by definition what determines the price since the price is defined as the last traded deal on a major exchange. But my willingness to accept a currency depends on how other people value it (that is my use of it) and thus on what I can get for said currency which is what the formula QP=MV describes. I think you are presenting the Austrian counter argument of my monetarist argument. My own understanding of this monetarist argument is that it describes a natural level for a currency around which the price can deviate due to speculative effects. And what you are describing is merely the definition of the price (a descriptive argument) and not some kind of fundamnetal analysis (a normative argument).

He is trying to quantify value, and I am pointing out that it is subjective.

How is this different than "from the objects that you can buy with it?" Should he have qualified it with the "quantity" of objects, or the "amount of different" and "quantity" of objects? In either case, it's in the same vein, and entirely sound.

I'm afraid you're wrong, here. Since the rest of your formula hinges off this flawed premise, it's interesting, but futile, maths.

A currency derives it's value from the desire of it's users to accept it. If the users of a currency really want that currency, it's value will be high, and you can purchase large amounts of other things for small amounts of the currency. If the users of a currency do not want that currency, it's value will be low, and you will require large amounts of currency to buy small amounts of other things.

These USD 100m should not all count in Q since many of them may be speculative and the result of daytrading and do thus not count as currency transactions. As others have pointed out, it is supply/demand that determines the value but the above calculations try to seek a more fundamental valuation than just the last traded price.

And that would make Q=1.2bn $ + 40 %(?) ~ 1.7 bn $ and thus val = 420 $/BTC all other factors held constant. Interesting. But the other factors have very large uncertainties though.

Edit: 40 % to take into account all those BTCs that are not traded on Mt. Gox.

But 100 million dollars per month on MtGox is.

How do you separate the dollars that are traded for bitcoin with the dollars that are not?  Just curious what the methodology is.

I believe you have misunderstood something... These trillions of dollars are not traded in BTCs.

I like this assessment, but still think $50 is too generous. Not by much, but still generous.

What about USD?  There are about a trillion dollars in circulation, and you can buy them with bitcoins, so it seems like your Q is off by several orders of magnitude.

A currency derives its value from the objects that you can buy with it. The total amount of tangible objects, services and charitable donations being handled in a currency within a year must be equal to the value of the currency (coins) being used for this trade. But each currency denomination can change hands more than once within a year so we must take account for this. If a currency on average changes hands two times a year, the currency needs only be half as much worth as it would have to be if it changed hands once a year to be able to handle the same kind of assets being traded in this currency. Also, if the amount of a currency increases, this would reduce the value of a currency unit since you have more units following the same amount of goods. These relationships are expressed in the equation of exchange which states

nT=M*V (1)

Where nT is the value of goods being traded in this currency, M is the amount of currency units and V is the velocity of the money - i.e., how fast each currency unit on average changes hand.

nT can be further divided into nT=P*Q where P is the price index (inflation is the derivative of P) and Q is the real value (something that is constant despite of inflation/deflation (CPI defined)).

P is inversely proportional to the value of a currency since when inflation rises, the value falls. So P=1/val. We are then left with:

(1) =>

Q/val = M*V (2)

Let's apply this theory to bitcoins! We will measure nT in Bitcoins traded per year, M in number of bitcoins and V in number of times each coin is traded per year. Q, we will value in dollars per year since the dollar can be considered stable compared to BTCs (bare with me Austrians).

So the unit of val becomes $/BTC as we would like.

(2) =>

val=Q/(M*V) (3)

Now, we should estimate these different values: Q, M and V.

M is the easiest factor to evaluate since we know that there are about 11m BTC in circulation but that only 4m of these are currently being traded - the rest are placed in "savings accounts" or may be lost, so we will, for the time being, exclude these from our calculation. M=4m BTC

V is around 1/year for fiat currencies so we will also guess that that is the case here. V=1/year

Q is the dollar value of goods being traded in BTCs. Silk Road has an overturn on about USD 1m per month I have heard, and Bitcoinstore has a revenue of 400k-500k dollars per month, I believe. This is 1.5m dollars per month. Let us assume that these two constitute a tenth of the total bitcoin trade. So the total BTC trade is worth 15m dollars per month that is 180m dollars per year, let us round that up to Q=200m $ per year.

Plugging these numbers into (3) yields:

val=2*10^8$/year / (4*10^6 BTC * 1/year) = 50 $/BTC

which to me sounds reasonable.

Now, the way to increase val is to increase Q since this is the factor in Equation (3) that can span the most order of magnitudes. V will probably be between 10 and 1/2 no matter what you do and M is also hard to change significantly (by destroying BTCs). So the way to increase the value of bitcoins is to increase the amount of goods traded in bitcoins. Only this way can the current and any future hopes of stratospheric prices be sustained.

I would love to see your own estimates on Q, M and V for bitcoins. I definitely believe that Q can become very large in the future since bitcoin is the optimal internet currency and could make many other payment systems obsolete. Maybe Q=USD 300bn/year in the future? USD 300bn is the size size of Denmark's GDP. I see no reason that Q cannot reach this value or a higher value.