Recently, there was a newsletter that was released by the Federal Reserve Bank of San Francisco titled, ‘Making Sense of Bitcoin Price Levels’ by Joost van der Burgt. This report came out in April of this year (2018).
The purpose of this writing is to summarize, accurately, the contents contained within and then look at the broader implications of what this all means and also provide a critical, unbiased analysis of the report.
For some reason, a lot of media outlets ran with the report and even put out the false report that the raw estimate of the value of Bitcoin had been posited at $1,800. This is not the case, but an actual value for what the Federal Reserve Bank of San Francisco feels that Bitcoin is worth is given within the article.
Hope you enjoy!
Summary of the Report
The report begins by exclaiming how Bitcoin soared in popularity in December of 2017, noting that searches for the term, ‘Bitcoin’ had actually outnumbered searches for ‘restaurants’ on Google (it’s worth noting that restaurants see an, “acute decline in sales during the winter months”1).
After commenting on the cryptocurrency’s surge in popularity for another paragraph, the report then states, “When considering price levels, it is vital to understand the nature of Bitcoin’s value. Until now, Bitcoin has been labeled a currency, a security, and/or a commodity. Some even go as far as calling Bitcoin a bubble or scam. Depending on what type of asset you associate with Bitcoin’s behavior, different economic theories might explain the evolution of its price.”
This seems reasonable. The report then enters into another section titled, ‘Bitcoin Does Not Quite Behave Like a Currency’. The report notes that there are some features of Bitcoin that are similar to traditional fiat currencies like the dollar, euro, quid, etc., but there are noticeable differences that preclude it from being placed squarely in the same category as the aforementioned currencies here.
They bring up the commonly stated argument that, even for the sake of argument, if one were to agree with the premise that Bitcoin is indeed a currency like other traditional fiat paper currencies that we are used to, its ‘true’ valuation would be almost impossible to determine. The report mentions that normal monetary determinants cannot be applied to Bitcoin and that it is not tied to any sort of governmental system, its intrinsic value is more comparable to gold than any other ‘normal’ currency that’s used for day-to-day payments. One of the main reasons to support this conclusion is the fact that it has a fixed supply, which it has attributed to the high valuation of the cryptocurrency.
The report then asserts, “Given that the relative annual increase of the Bitcoin supply over the last couple of years was actually higher (4.4% annually on average) than that of gold, (1.5% annually) supply arguments cannot explain the recent surge of Bitcoin’s price against gold.” This suggests that the panel/Fed Reserve Bank in San Francisco believes that the price action of Bitcoin was idiomatic.
It is also asserted that there is no relative purchasing power that can be calculated for Bitcoin as well. The study also goes on to state that the future outlook on Bitcoin does not justify its price increase either. It believes that semi-recent events such as Mt. Gox and other hackings (although not directly related to the cryptocurrency/Bitcoin technology itself), indicate that there cannot have possibly been enough natural and sustainable faith in Bitcoin to justify its price increase up to December.
Perhaps the most notable and substantive part of the report is the analysis of the total trading volume (in terms of Bitcoin — not dollar value) of the cryptocurrency per day. The report states that, “The daily trading volume of Bitcoin has been at a historic low since January 2017. While during 2015–2016, the average daily transactional volume of Bitcoin was 1.74M, (11.7% of the total volume over that period) in 2017 this declined to an average daily volume of 379,000 (2.3% of the total volume over that period). For traditional currencies, this transactional volume is significantly higher and typically varies between 25% and 75%. Interestingly, the 2.3% daily turnover of Bitcoin is more aligned to turnover rates that characterize stock markets.”
The findings here provide numerous implications for bitcoin maximalists and essentially marks the underpinning of the argument made by the Federal Reserve Bank of San Francisco in their report suggesting that the price of Bitcoin, even after a 65–70% decline from its ATH in December 2017, is still grossly overvalued, and perhaps unable to gain true adoption as a currency (if one were to even consider it a currency — which the Fed Reserve Bank claims it theoretically cannot be).
The report then moves to a section called ‘Security Valuation’, where it explores the possibilities of analyzing Bitcoin in the context of being a ‘security’. It is noted that security valuation models cannot be applied to Bitcoin as well because of its anomalous structure and behavior and theoretical underpinnings that remove it from the conceptual constraints of what has come to be commonly understood as a security. This difficulty is noted in the statement, “There have been attempts to apply security valuation models to Bitcoin, although such applications do require some tinkering to make them suitable for virtual currencies since these do not generate interest payments, dividends, earnings or capital gains.”
Thus, the report concludes, the ‘terminal value’ of Bitcoin must be intrinsically linked to its future ‘monetary base’, as they call it. The Fed Reserve Bank tries to estimate Bitcoin’s fair market value by first using the premise that Bitcoin is a ‘typical VC undertaking’. It also states, “Unlike most traditional commodities that clearly fall in either the natural resources category or the currencies category, Bitcoin — like gold — might thus best be considered as a hybrid form between these two categories.” This statement is followed up by another in the report that Bitcoin has no ‘real intrinsic value’ from a ‘commodity valuation perspective’, which led the bank to estimate a “true” value based on its [Bitcoin’s] “production costs”.
It is then stated that, “Recent estimates regarding the energy involved in mining a single Bitcoin by professional energy-efficient mining rigs put it at $1,800 when mined in China (where 80% of the currently mined Bitcoins originate).” The “lower bound price” of $2,500 is then posited as a reasonable expectation for the value of Bitcoin when considering what would constitute a sufficient profit to motivate miners to continue mining Bitcoin.
Analysis/Criticism of the Report
There is a fair amount of criticism that I believe should be leveled against the report and the numerous assumptions contained within. However, I will try to do so in the most tempered, objective and non-bias manner possible. I am not a Bitcoin maximalist nor do I hold any stake or position in Bitcoin at this current point in time.