The Fundamentals of Bitcoin’s Price

One of the unique things about Bitcoin is that its supply and demand can actually be teased out and measured. Not for a particular day but over a period of time. This is true because of the following facts:

  • The issuance of bitcoin is predetermined and predictable (1800 per day presently, halving every 4 years)
  • There are 3 classes of market paricipants: Miners, HODLers, and traders.
  • Miners that produce bitcoin do so nearly always at a cost below market price and are incentivised to sell, and repeat. They are not speculators, they are in the business of electricity vs bitcoin arbitrage. Miners offer SUPPLY.
  • Traders are SUPPLY/DEMAND Neutral: Traders can push the market price of Bitcoin up or down temporarily, but when a trader enters AND later exits, he/she has not actually added or subtracted any bitcoin to the market, and so does not contribute to supply or demand for the time period of that trade. However there is some small contribution to supply/demand, from the fact that if a profit is made it will take money out of the system (and effectively reduce money from someone else to buy bitcoin), and if a loss is made it will add money into the system (increasing the wealth of someone else who will buy bitcoin). Overall, some traders win, some lose, and they generally cancel each other out, so this effect will be ignored. Excluding traders greatly simplifies the calculations of supply and demand, and makes understanding price much easier.
  • HODLers create DEMAND. They soak up the supply from miners. Traders that keep profits in bitcoin are also part-HODLers and add to demand.

If the above is accepted, then the following conclusions can be made, and interesting calculations can follow:

Supply of bitcoin is from 2 sources:

  • Miners selling newly created coins — miners all over the world are currently rewarded a total of 1800 bitcoin a day which is distributed proportional to computer power invested. They sell nearly the whole amount. If the price of Bitcoin falls sharply, unprofitable miners stop mining and the remaining miners share 1800 bitcoin. In response to hash power dropping and block times becoming too long, the Bitcoin protocol difficulty-adjustment makes mining easier (and thus cheaper), because some competitors have left. All remaining miners are generally profitable (unless they are irrational), and the amount of bitcoins sold per day remains unchanged. Note, if it is unprofitable to mine bitcoin, and a miner wants more bitcoin, it is rational to buy bitcoin on the market rather than mine.)
  • HODLers reducing (or losing when trading) — HODLers are interested in holding bitcoin by definition, and generally are believers in Bitcoin, so they rarely reduce. They may have a component that they trade, in which case, that component is considered separately as “trading,” as explained above, and is not included in supply and demand calculations for a studied interval.

Demand for Bitcoin is from 3 sources:

  • New HODLers — these are new investors in Bitcoin purchasing coins they are not planning on selling in the near future.
  • Old HODLers accumulating more — a proportion of HODLers continue buying bitcoin regularly, dollar cost averaging (DCA), or intermittently buying when funds become available, usually regardless of price. These special people keep a floor to the Bitcoin price and their numbers are always growing.
  • Miners not selling — If a miner produces bitcoin and doesn’t sell it for profit, then he wants that bitcoin. It has been paid for with electricity. This is still demand and contributes to soaking up supply, even if it was not bought on the open market.

The Calculations:

If we take a period of time, we can calculate the average price. For simplicity, let’s say it is 10,000 USD as an example.

The supply is 1800 bitcoin per day from miners, plus any HODLers reducing. Let’s assume the latter is zero which is probably close to reality but not precise.

Then, the supply in dollar terms is 1800 x $10,000 = 18 million dollars per day.

If the price was steady during the studied interval, then, we can deduce that the amount of new money injected into Bitcoin is 18 million dollars per day. (It will be slightly different if you get picky, but this is close enough).

18 million dollars comes from new HODLers, accumulation from old HODLers, and miners holding on to the supply (but paid for below market price so this causes a small error in the calculation).

To actually know that 18 million dollars per day is being invested into Bitcoin as new money is only interesting when you consider the fact that supply in the future is predictable.

At block 630,000 (around May 2020), the issuance will halve to 900 bitcoin per day. If the demand remains the same (it has been increasing since 2009), then price MUST double. As price doubles, we can expect interest to increase as the number of people investing in Bitcoin is very small. Price pumps always attracts attention.

But isn’t the halving priced in?

Absolutely not. For 2 irrefutable reasons:

The weaker reason is that very few people know about Bitcoin let alone the future of the supply. And let alone how important that is.

But the PROOF comes from the argument that:

  1. News can be priced in by influencing supply and demand.
  2. The halving is not just news, it is SUPPLY.
  3. You can’t price in supply. If, for example, the news of the halving influences supply and demand such that the price increases, when block 630,000 comes around, supply will still halve regardless, causing price to increase if demand stays the same. So the price appreciation in this example was not actually “priced in.”

Futures Manipulation?

There is belief in the community that the powers-that-be can suppress the price of Bitcoin through the futures market and kill Bitcoin. Let me debunk that here with pure logic from 2 reasons:

Firstly, selling bitcoin doesn’t kill it. It simply moves it from weaker to stronger hands. Only the price changes. To kill Bitcoin, you need to either wipe out the human race, or destroy communication through worldwide coordinated totalitarianism. Both of these scenarios are improbable.

Secondly, when Bitcoin is demanded, it is bought on the open market, and the available supply generally comes from a miner. Cash settled futures can influence price and mining profitability. As time goes on, the mining supply will fall. Then, when a new HODLer is interested in acquiring bitcoin, who does he buy it from? It will be on the open market, but (most likely) it will come from a HODLer reducing to that market, as the mining availability will be too low. How is someone who wants to acquire and secure his own bitcoin, going to do that through a cash settled futures market? You can only earn fiat on that market. If you want bitcoin, you have to get it from a HODLer. Assuming demand for Bitcoin ownership continues, it will cause a decoupling of price from the futures market, and cause that secondary market to be irrelevant.

Interestingly, falling supply from miners will also eventually cause exchanges to collapse. People will transact and earn in bitcoin peer-to-peer through the lightning network. And once miners start paying for electricity in bitcoin, supply to the market will vanish. Suddenly, no one will want to sell bitcoin for fiat. The order book on the sell side will be empty and to acquire bitcoin, one would need to sell an asset to a HODLer peer to peer, or earn it. The demand for fiat will vanish as it continues to inflate.

How to value Bitcoin?

This depends on what Bitcoin becomes. Bitcoin has all the properties to become world reserve currency. Every incentive is in place, and one can argue that it is almost inevitable. Saifedean Ammous does it well in his book, “The Bitcoin Standard”, and so do many others. I will not repeat these arguments here, but I strongly believe them to make sense, and be true.

Assuming this happens, what will the price be? Firstly, it will not have a “price” as fiat will probably disappear.

1 Bitcoin will be worth 1 Bitcoin.

A better question is, what value will be stored in Bitcoin? To calculate this, you need to sum up all the value stored in the world (cash of all countries, silver, gold, commodities, altcoins, art, gems, stocks, property, and the big one derivatives). This can only be estimated. Here is a good article discussing this: Link

Let’s take a round figure of 1,000,000,000,000,000 (1 quadrillion, or 1 trillion x 1000). If all that value is stored into Bitcoin, then you divide 1 quadrillion by the supply of Bitcoin (21 million) which is close to 50 million dollars value per bitcoin. The estimate would be higher because many bitcoin have been permanently lost (approx 3 million lost). So any estimation should be increased by 15%.

It is important to realise that Bitcoin can not absorb ALL value away from real world assets, just the store-of-value component. For example, if a house is priced at 1 million dollars today, a significant portion of that comes from the fact that property is currently a store of value. If the house was priced based on its intrinsic value as shelter, and perhaps some scarcity value for good location, it may only be worth $200,000 for example. That means $800,000 would be available to be soaked up by Bitcoin. Property would not be expected to appreciate if the world accepts that Bitcoin stores value satisfactorily. The way for property to become more valuable would be for it to somehow get better, or for the population to increase, making the house more scarce.

But Bitcoin isn’t money yet

Bitcoin needs time to evolve into money, it can’t be forced, and it needs time. It is only 11 years old, and came from nothing. Gold must have taken hundreds of years to become money. In the digital age, this will happen faster.

The price of Bitcoin TODAY represents the price of an asymmetrical bet on the future that Bitcoin will become money. It has the risk reward properties similar to an option call without an expiry date. A $10,000 premium will either become zero, or $50,000,000. There is no realistic scenario where it hovers at an in-between price forever.

The beautiful thing is that, assuming Bitcoin will become money, it is never too late to get in. Even the day when it is worth $50,000,000, any fiat you have left, it would be rational to convert it to Bitcoin. If you were earning an income, it would be rational to earn it in Bitcoin. If you had any surviving altcoins, it would be rational to sell them for Bitcoin — IF you can find anyone who would part with their Bitcoin for an altcoin, good luck!

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