Topic: Research paper on Bitcoin Fundamental Value & Decision to Mine (Read 2237 times)

Agreed, if you see the updated paper it pays a lot of heed to subjective valuation, the fact that people hoard, sentimental or speculative reasoning etc. The low cost producer will earn excess profits if subjective demand drive the price up. What the cost of production ends up being is a lower bound, so let's say the opposite happens and there is very little market demand for bitcoin - the price will drop as there are few bids. After time, miners will just stop mining instead of incurring daily losses. Eventually supply will meet demand at whatever low price it may be. Obviously the supply of bitcoin itself is regulated at 25 per 10 minutes or so currently, so what I mean more accurately is the supply of miners will be reduced - and the lowest cost producers would be the only which remain. Bitcoin also has the feature of difficulty adjustment - so again assume the demand and price both drop causing miners to exit. The network hashpower will drop and it will take longer than 10 min. to find blocks on average, resulting in a lower difficulty. The lower difficulty has the same effect as raising the price in terms of $ x BTC/day. You can either raise the price or raise the # of BTC expected per day to induce miners to return.

The reason somebody wouldn't produce gold with a cost of $1M per oz. is they would quickly go out of business providing there are many other gold producers who operate at a marginal profit.

As for demand spurring investment this is almost certainly true - the issue is that it can lead to 'mal-investment'.  A good example is happening now with shale oil producers.

How do feel about the fact that production costs can actually follow demand?

Look at gold, for instance, as more people store it away arbitrarily as a store of value, they arbitrarily increase the price of the item, and as this price increases the amount of money companies are willing to spend to extract an OZ of gold increases commensurately.

This shouldn't happen, accorded to your assertion that the price of something is informed by it's production cost. If the price of a product overshoots the production cost (Because of ignorant consumers.) then the price should gravitate back down. It doesn't.

Consider also that the production cost of gold can be arbitrarily high. There's no reason we couldn't be spending $1,000,000/oz for gold. This could be accomplished through highly inefficient or efficient methods, it makes no difference.

The only conclusion one can come to is that production costs do not inform the price of a product. Price is a function of various factors, not the least of which is the subjective valuation of it's consumers.

So, getting back to the subject at hand, it's impossible to say what the price of bitcoin should be based on it's production costs alone, even if I granted that production costs have any effect on bitcoin's price whatsoever (It doesn't, since "production costs" are simply the redistribution through inflation of the currency at a fixed rate.).

This could be that for a long while at the beginning, bitcoin mining was NOT a competitive producer's market. There were also many less miners than now.  Until GPU rigs were cobbled together and set to mine in a dedicated fashion, CPU mining did not perhaps extract much more electricity than the computer was already using to run. Many have attributed the introduction of ASICs to the sudden spike and subsequent drop in market price.
Another, smaller factor was that the block reward was twice as large as it is now.

The model put forth only describes reality to any degree if bitcoin mining is a competitive process and that requires a great many competing producers.

And again, a tendency is just that. Real market prices may fluctuate violently around that tendency, and in fact may never get there.

This is a very interesting phenomenon worth debating

In traditional economy, people tends to think that more efficiency means more production for given resource, and more production will bring more wealth. When many people first learn about bitcoin, they focus on how to produce it from a manufacturing point of view. Thus comes so many companies trying to build miners and mine coins. For these people, the exchange rate of bitcoin makes it a sell-able goods, they make bitcoin just like make an iphone

Then they learned that no matter how efficiency they are, the daily coin generation is fixed (the quick rise in difficulty and miner efficiency just showed how much excessive production capacity there is in today's society). Then mining becomes a tournament, it is getting harder and harder. As a result the reward gets more expensive, those who paid so much resource to get his reward will not easily sell his coin at a price level lower than his cost, it just does not worth it. They'd rather hold it and wait until the next reward halving to sell at a better price, this is especially true when bitcoin's long term potential can be as high as moon

How then do you explain the fact that while miner efficiency increased by a factor of 10,000 from 0.1 MH/J to 1000 MH/J, the price also increased by a factor of 10,000 going from $0.10 to $1000? Shouldn't the price have decreased by a factor of 10,000? You have provided nothing to support your assertion, but even if what you say is true, the effect must be so small that it can be completely ignored.

I appreciate your feedback and criticisms. I really do ! That is the whole point of inquiry and understanding.

I have made edits to address many of the concerns raised including referring to the cost of production as an intrinsic value, which is a shaky assertion at the least.
Instead, I wish to draw attention to the break-even models put forward as well as the fact the cost of production based on energy efficiency is what will largely determine the objective decision to mine or not mine. I still assert that as efficiency increases it will provide downward pressure on price, but acknowledges this is only a tendency and there are a number of other subjective and technical issues at work including the propensity to hoard mined coins instead of selling each one immediately in the market and the linear rate of block production, once every 10 minutes.
Also as an aside, I am presenting bitcoin production as commodity production and not as money issuance--
You can check the link at the beginning of this thread for the latest version.

If mining cost nothing, then the cheapest way to get coin will always be mining, no one will buy, the cost of zero will bring the coin value down to zero. In fact, if the demand rises and there is not enough daily generated coins to satisfy that demand, the mining cost will always rise due to competition. Mining cost is a good indicator for demand, since mining usually is the lowest possible cost to get coins

Value comes also from the fact that it is difficult to do something. Many people spend millions to just win the price of a tournament, psychological motivation is a great part of the value foundation, and for bitcoin many enthusiasts mining at a loss just for fun

In fact there are lots of feed back loops in the valuation of bitcoin, it is even driven by religious behavior, can't use a single profit based model to analyze it. What is the profit to be your own bank? What is the price for realize a dream of freedom?

Stopped reading there and realised it's worthless, thanks for saving my time.

You've assumed your conclusion, also called "begging the question".

"Right now if the average efficiency suggests a price around $200..." So you already know the market clearing price and therefore anything that follows can't help us understand where the price "begins". The down bidding of someone with more efficient energy production in an existing market of prices doesn't help us understand where the initial price comes from; You wrote that it either begins with supply or demand. I wrote that it begins with neither.

To illustrate my point; In a chain consisting of two links, A and B, which link initiates the "Chain"?

Obviously the answer is neither. The concept of the chain arises in relationship to both links at the same time. It is the same way with market prices. Prices arise in a bidding process with two or more people with perceived (Real or imagined) supply and demand.

Emphasis mine.

http://mises.org/library/how-should-prices-be-determined

http://www.cavemannews.com/Supplysidevsdemandsideeconomics.htm

Miners will compete with each other to mine the limited number of bitcoins available to them. As long as the cost of mining is below the price of the mined bitcoins, they will devote more resources to mining more bitcoins. The result is that the cost of production as a whole will rise to the value of the mined bitcoins. In other words, it will never cost only $1 to mine $200 worth of bitcoins because somebody will be willing to pay $2 to mine those bitcoins.

Furthermore, newly mined bitcoins are only a small part of the market. The market behavior of miners will have only a small effect on the price of bitcoins. Even if miners gave away there 3600 BTC/day for free, it will have little effect on the the price of the remaining 200,000 BTC/day.

Here's your competition: https://www.youtube.com/watch?v=K8kua5B5K3I#t=498
 

If it costs next to nothing to produce on average then yes competition will drive the value down.
Right now if the average efficiency suggests a price around $200 but you get extremely cheap electricity from your own hydro-plant out in the backyard, then you will earn excess returns. If everybody gets extremely cheap electricity because they also have a hydro-plant out back then each will compete with each other to drive the price down. If it costs all of us $1 and the price is $200 I will offer $199, and then my neighbor will offer $198 and so on until it approaches $1.

If you don't understand the simple mechanism of competitive markets, then I can't help you understand much else.

Perhaps the break-even price is better thought of as a price floor for an individual miner:

If the value is 100 and the market price is 102 I can produce for 100 and sell for 102 earning a profit
If the value is 100 and the market price is 98, I stop producing.
If somebody else can produce at a lower cost they will continue to produce and sell until it reaches their break-even.
If nobody else can produce at a lower cost everybody will stop producing, and the difficulty will drop making it once again profitable to begin mining.

That is the mechanism.
It doesn't predict a price, rather it sets perhaps a lower bound.

That's an impossible debate. You can't have a price a-priori demand or supply, so they are both demonstrably wrong.

If you don't have any supply of a thing then you can't have demand for it, and no market clearing price could exist.

If you don't have any people that demand a thing, then the supply doesn't matter, and no market clearing price could exist.

If I come up to you and want to buy your shoes, is the price determined by the supply of your shoes, or is it determined by my desire for them? The correct answer is that neither of those answers are correct. We would arrive at a price at which we both feel we have gained in the bargain, or no transaction takes place. That process is informed by objective factors, including the properties of the shoes, the general market demand for them, and so on, but it is nonetheless also based on subjective valuations of both parties (Or groups in a more macro sense.) that evades neat mathematical algorithms.

But that's a red herring. You seem like you're not willing to defend your assertion in the abstract of your paper that the value of bitcoins will likely trend toward zero as the cost of production approaches zero (Due to increased efficiency in mining methods.), so have you conceded that this idea is wrong?

Your paper states that value (as defined by you) affects price, but you still have not described how. What is the mechanism?

Generally, a change in the cost of production affects the price because it shifts the supply curve. Is this your line of reasoning? Bitcoin production is different because the cost of production has no effect on the supply curve.

Supply and demand controls price. Cost of production controls value (or call it break-even level)
As for the carts and horses, this is a huge matter of debate amongst economists - whether prices are set supply-side vs. demand-side.
Supply siders say the horse is production sets prices initially.
Demand siders say the opposite.

So you're saying that the cost of production does not determine price. Price controls production.

In which position is the horse in relation to the cart? You're not being very consistent.

Not necessarily, I am only saying the tendency is to a falling value, not that it will be the case.

Consider iron ore extraction. Every year, it becomes harder and harder to extract iron ore from mining operations since every ton of ore is marginally more difficult than the previous one (one average). It is either deeper in the mine, or it is coming from less productive veins or there is less percentage of iron in the rocks being mined. All the easier ore has already been mined. So every year the difficulty increases, and yet the world gets a fairly steady supply of iron ore -- the cost of production has gone up.

But technological progress as also made it cheaper to mine for the difficult ore over time. Competition between ore producers in order to get a competitive advantage invests to develop machinery and technology to obtain the ore faster and more efficiently. Even though the ore is more difficult to mine - the same ton of earth has less ore in it to extract - it is still cheaper to produce that difficult ore than it was to produce the easier ore using yesterday's technology, which may now be obsolete. Mining the difficult ore with picks and shovels would be fruitless.

What I am saying is that technological progress leading to greater efficiency in mining may outpace increases in difficulty, which on net will reduce the cost of production.

The price of ore in the world market IS the cost of production. Why? because there are many competing ore producers each trying to undercut the next guy. If your cost of production is say $1000 per pound of ore and mine is $900, I will start by selling it at $999. Somebody else that can produce for $900 will come in and offer $998. I will react with $997 and so on. The dance will go on until $1000.01 is reached (in theory of course). And what of demand? Well if there isn't enough demand then the price will drop below $900 and I will stop producing. If there is more demand, we will all be incentivized to expand our operations to produce more and that will lead to making our operations more efficient. It all stabilizes.
Bitcoin production is the same --- BUT this assumes that producers are selling what they mine. And that is a big But. If miners hoard it won't work.

The paper models a theoretical process, not reality. Does the cobb douglas production function or the solow-swan growth model accurate describe reality? of course not.

This;


Directly contradicts this;

If you adhere to mainstream neoclassical economics then yes you are absolutely right
If you adhere to a post-keynesian or keynesian point of view then cost of production = value in competitive markets.
I am not suggesting a Marxian labor theory of value, and again do not confuse value with market price which is determined by supply and demand. Market price and value may never meet, it is only a point of gravitation, and this is only from the perspective of miners who produce bitcoin and not necessarily from the perspective of any other user of BTC.

As for your second point, ultimately you are correct: Once the block reward is tiny, the value will become very high. But if the efficiency becomes very low that will counteract that factor as well. But even after the last block is mined, there will still be electric consumption to verify transactions in order to earn tx fees. Or at least that's how it's supposed to work.

The thing is, if you look at historical price data and compare it with the model, it does a really good job-