Hello, this is James D’Angelo welcome to the
Bitcoin 101 Blackboard Series. Today we’re going to be looking at modelling the price
of Bitcoin. Specifically we’re going to be looking at trying to answer the question,
“Could there be a 50 thousand, 100 thousand or a million dollar Bitcoin?”
And when you go to model Bitcoin, clearly it’s important to realize that you cannot
model Bitcoin accurately. You will come up with no models that will predict the exact
price of Bitcoin. That’s just plain impossible. But models are really great for building understanding,
and indeed we’ve built a model that we’re going to show you in a few minutes, that really
does help understanding how all these different variables might affect the price of Bitcoin.
And here we have a Financial Times article suggesting that, well there are a lot of models
already out there but most of them are private so a lot of investors use models.
They build their own models to try and determine if it’s a good time to invest, buy Bitcoin,
or even sell. So let’s run through a quick list of sort of the major concerns from one
might have if you’re going to model the price of Bitcoin. And again it’s important to realize
that today we’re focusing on price. There are so many wonderful amazing things
about Bitcoin: distributive public ledgers; frictionless low-cost decentralize payment
systems; But price it turns out is actually a very magical piece of data. And for some
it’s the most compelling reason to be involved in Bitcoin. In fact, Bitcoin as an asset has
outperformed any other asset on earth over the last 5 years and perhaps even in history.
Okay so price with Bitcoin is a very magical thing indeed. And when you go to model price,
there’s a problem because arguably everything in the world goes into the price of any individual
item. So if there’s a war overseas or here at home, that will affect the price of all
goods, commodities, services, labor etc. and should affect the price of nearly everything
in the world. So wars, or pensions, regulations, politics
– all can come into play with the price of Bitcoin. You start to see how many variables
a real model might have to take in account. Clearly we’re not going to put in all these
variables. We’re going to put in the big salient ones.
And one of the biggest ones is transaction volume. Transaction volume is the amount of
Bitcoins that are being moved around in the system. And fortunately, especially with Bitcoin
because it’s so transparent, you can actually track transaction volumes. And so here’s July
12. Here we are today sort of at the end of June, and you can go and kind of move your
mouse around and see the transaction volumes that are happening, per day.
And then you can even sum them up over a year or 6 months or however you want and today’s
transaction volume is somewhere around 60 million dollars worth of Bitcoins that are
being sloshed around. And this is really important when you’re looking at Bitcoin.
Clearly if one dollar is being sloshed around, well it’s not really an act of currency or
your payment system okay so 60 million dollars is certainly nowhere near the US dollar or
anything else. The transaction volume, as we’ll see later, really comes into play.
In fact you see it up here in the numerator of this little equation right here. And so
the market value of Bitcoin must be enough to support transaction volumes.
Clearly if you want to buy an 80 billion dollar item right now, you can’t do that in one foul
swoop with Bitcoin because there aren’t enough bitcoins at the current price to buy an 80
billion dollar item. So if you’re talking about doing 80 billion dollars in transactions
in a day, Bitcoin’s not yet the best option. Though, still possible because as we’ll see
the velocity of Bitcoin does affect a lot the ability to increase this transaction volumes
even in a given day. Another big issue with Bitcoin is sort of this optimism about the
future. And so price increases as Bitcoin’s prices
has gone up. It’s more of reflection not of usage but of optimism about Bitcoin’s future
use. So if you see Bitcoin coming in may be taking
over Amazon’s 38 billion dollars worth of transactions well then you’re pretty bullish
on Bitcoin and you’ll see the price going up.
But what really happens is people are reading the news each day, they see new regulations
and they get this sort of uncertainty about the future. They see the possibility maybe
of Bitcoin taking over big section of transactions. But then some days they won’t feel as sure
about it and they might go and sell. And this uncertainty about future translates into present
exchange rate volatility which is obviously a big concern with people dealing with Bitcoin,
especially if you’re looking at Bitcoin as a store of value. So something that might
replace goal. You don’t want the price flying all over the place if you’re going to put
your money in there to sort of hold it for a while.
You want that to kind of to be seen. You want to be something to rely on and with even transaction’s
volatility, though, some people say it has no effect at all, really does have an effect.
So someone’s got it eat the cost of these volatility issues.
A lot of times you’ll see someone like Coinbase or BitPay trying to eat the volatility cost
to provide a sort of a stable payment service and indeed so far they’ve been doing that
pretty well and so volatility, in turn, limits Bitcoin’s use today as a medium exchange and
a store of value. So the more volatility there is, the more
unlikely people are going to be comfortable using it or storing value with Bitcoin. What
people are concerned about this idea of volatility, if prices are going up and down, what we’re
really saying is that the price is floating. For many Americans, this whole idea of a currency’s
price floating is kind of a new idea, but if you were living in Europe especially in
the 90’s or before, you’re very use to this idea of currencies floating because if you
went from Italy and just cross the border into Switzerland, immediately you’d be changing
your money for the Swiss Franc. And you would be looking up immediately the current exchange
price. And every few minutes that price might change
but certainly over a week or so you’ll see those prices moving. Sometimes you see those
prices moving a lot, so even a dollar versus the euro over the last 10 years has been fairly
volatile. So it’s hard to say whether the euro is volatile and floating a lot or the
dollar’s volatile or if it’s just a combination of the two, but indeed they float.
Now Bitcoin is unike the dollar and the euro because there’s no Central Bank trying to
control the volatility of Bitcoin. So it could be argued that it floats even more than other
currencies. Of course there’s this idea of the spot price which is really just the current
market price what Bitcoin’s being sold at right now.
But the interesting thing about a spot price when you’re talking models is a spot price
is actually a pretty good model. Okay so if you want to determine the price of Bitcoin
in the future, you just take the price today and say that’s the price in the future.
And statistically it turns out if you looking at corn or any other sort of commodity, the
current spot price is indeed does better than many expert mathematical models, because it’s
always important to at least respect the current spot price.
And today were hovering around $590. So you could make a very simple model of Bitcoin
which just says that the price of Bitcoin in one year’s going to be $590 because that’s
the price today. And your model will likely do better than
many models that are being developed because remember that the spot price is actually a
combination of all these individual bets. If we knew the price of Bitcoin was going
to be higher next year, will the price today should go up. It should reflect that same
optimism for that same confidence. And in fact the current price is really the
combination up all bets for and against Bitcoin. We’re starting to see the ability to short
Bitcoin so millions of dollars now are being put into this market where we can actually
short or long Bitcoin in places like Bitfiinex.com etc.
So things have really changed. It’s starting to get these financial derivatives, these
instruments that you’re able to play around with the price of Bitcoin and make bets for
and against it. And this will change the volatility and the sum suggest will actually control
the volatility of Bitcoin. We’ll see. Okay, and so Bitcoin is global, anonymous
and programmable. And really just to throw those all together they don’t seem like they
belong together but the fact that anyone on earth can just roll dice, get a private key
from that, build a public address, and start receiving bitcoins means that this is a truly
global currency. It is open to everyone to use today.
In fact all 7 billion people on earth could hold hundreds of Bitcoin accounts and not
only can they hold them but they can keep them anonymously. This really changes the
game of how we might analyse or model a system like this or how money is being used.
And even worse, Bitcoin’s programmable so you’re not just sending links to money; you
can actually send money using computers. So we’re going to see things that are much
faster to change much quicker than ever before. And so, all of this combined really makes
it difficult to model especially because we’ve never seen anything like this before.
Okay we’ve already talked about volume which is a transaction volume which is up here in
the numerator on this equation right here and then there’s a supply ratio.
So how many Bitcoins are there out there? And just like transaction volumes which we
can only make a real guess at, because remember if you have transactions where someone’s sending
bitcoins to themselves, that really shouldn’t be included in your price model. Okay, so
even the purchase and selling of dollars with bitcoins might not be something that you want
to consider when you’re looking at modelling Bitcoin’s price.
When you get your transaction volume numbers from our chart on Blockchain.info, you might
want to take these numbers and decide to have them, quarter them, who knows? Because we
don’t know exactly how many of these transactions are really being used for goods and services.
And that’s a very different from someone sending Bitcoins to themselves where it really doesn’t
mean anything for the Bitcoin economy. But you could have millions of bitcoins moving
around each day. And that would appear here on the transaction volume but not affect the
economy. If you’re trying to determine transaction
volume, you’re going to have to make a lot of assumptions but here, the same thing is
true with the supply. We know the current supply of Bitcoin. There’s something like
13 million out there, but we don’t know how many of those are lost.
So it’s possible some people have suggested that Satoshi Nakamoto has burned all his coins
so he doesn’t use or he lost them all. We’re talking about a million Bitcoins, one-thirteenth
of the current amount that we don’t know if they’re active so that he could use them or
if their lost and so that does affect the supply. And again even with supply you’re
going to have to make some assumptions. And that’s what we’re saying here that volume
is speculative but so is supply ratio. And then there’s this whole idea of liquidity
and velocity. Velocity being very important it’s here in the denominator. So this is the
velocity and velocity in particular with Bitcoin is very important because velocity is the
amount of times that you can use one coin, for example, in one day,
And with Bitcoin depending on these systems like Coinbase which allows you to do instant
off chain transactions, you should be able to use one bitcoin millions of times inside
the coin-based network. As soon as you can send it, it should arrive.
And so this is an enormous velocity. What we’re seeing in practice though is that the
velocity’s a little bit slower. People are not all using coin based and staying
internal to Coinbase. Their sending the old fashion way and so what you do is you really
have to wait 6, 10 confirmations and that slows things down so the velocity of Bitcoin
in that case is the ability to do one transaction every hour. This is still much faster than
we’re familiar with the US dollar. In terms of velocity terms, that give these
things numbers, the US dollar has a velocity up 7. Bitcoin is likely to have a velocity
more like 50 to a 100. So it’s much faster, and this drives the price down surprisingly.
Even though it’s a great feature, the ability to use the same currency over and over really
quick for remittances, for example, means that you might be able to handle all of the
world’s remittances with just a few bitcoins, so it doesn’t drive the price up even though
people are adopting Bitcoin. So you’re just using it as rail to transfer
money back and forth very quickly. So it doesn’t create a lot of demand for more units at the
currency. It’s very important to understand velocity. Another big idea of course is this
idea of liquidity. Liquidity often in Bitcoin is referred to
as volume. And it’s just the amount of coins they’re actually able to be used at any given
point. And so you have some people who are just hoarding their bitcoins so their coins
are illiquid. Those who are using it to spend and buy things,
merchants who take the Bitcoins in and sell them immediately back, those are the liquid
bitcoins. It turns out the liquid bitcoins are always much less than the M1 which is
all the current extant Bitcoins. If you have say, 13 million bitcoins right now and maybe
you have 1 million lost bitcoins, you’re down 12 million.
You might consider the fact that over half or maybe even 90% of these 12 million are
being hoarded because people are going ‘long’ with Bitcoin – their holding them because
they think the price will go up. So you might end up with a volume of only about 2 million
bitcoins or less. These are very important things to consider
when you’re looking at a currency because if you really want to use this currency, you
will use only 2 million coins in existence so it actually would drive the price up, if
there’s a lot of demand for the currency. And it’s 90% illiquid for example at the same
time. Another thing that’s very difficult to model
– in fact it’s absolutely impossible to model – are human emotions. People, television,
newspapers, they all get excited for various reasons and it’s not always clear that those
are factually based decisions. You see a lot of speculative hype. You see a lot of people
buying because other people are buying. You have people talking about it in parties.
It’s not always something where they understand how the block chain works or how prices move
or etc. or whether they really see something like the adoption of Bitcoin by overstock.com
as being a price mover. They’re just buying because of excitement
and with human emotion you end up with a lot of wild varieties of excitement. One piece
of bad news could have much worse effect than good news could have much more effect or the
opposite. It’s important to realize it’s just impossible
to model human emotion so hype, unit, fixation, excitement, speculation, etc. Even if you
had access to unlimited information, so you had 10 thousand people all gathering information
for you about Bitcoin, it would still be impossible to make a perfect model Bitcoin.
In fact it would still be impossible to make a model that you could guarantee predicts
a price better than our good friend, the spot price which gets things right 50% of the time.
So, even with unlimited information you’re just hoping to do better than that. And if
you can do better than that and you really know you’re doing better in that, well then
you should be investing, buying or selling whatever based on the prices you are predicting.
But important to realize that almost all models require assumptions, assumptions, assumptions,
assumptions. So we have to make assumptions about velocity. We have to make assumptions
about transaction volume, we have to make assumptions about supply, and assumptions
about how many folks are going to use Bitcoin as a store of value, or look at it as medium
of exchange. And all these assumptions basically add up
to, well your models just something to help you understand the scope of the problem and
some other possibilities. Clearly with a model you can understand that a Bitcoin’s unlikely
to go to 1 trillion dollars apiece. But beyond that, almost everything else is based on some
of these assumptions. And there’s a lot of myths of Bitcoin’s price.
Okay we’ve talked about some of them already but more use doesn’t always increase value.
And we spoke about this already with respect to velocity.
Remember, if the coins are being turned over really fast and being used immediately, again,
just because you have a high transaction volume doesn’t mean you’re going to have a high price
and indeed velocity is here in the denominator with supply so the more coins you have, the
less your price is going to be. So we have assumptions based on how many coins
there actually are. So, Bitcoin seems like this perfect system where you know exactly
what’s in the system but we will never know if some those bitcoins are lost.
Indeed we know that thousands of bitcoins have already been lost but we don’t know how
many. It could be 3 million. We don’t know. When you talk about velocity, in theory one
bitcoin could handle all the world’s remittances. In theory, it’s impossible to do today but
you could see in the future that if you build it on a sort of a Coinbase rail or maybe Circle’s
new product or something like that, we’ll be able to send bitcoins infinitely fast.
If one bitcoin is worth ten thousand dollars, well you just got to send it fast enough to
do 500 billion dollars of remittances a year. That’s quite doable actually. We spoke on
a little bit about M1 which is the amount of currency in a system. The current M1 of
Bitcoin is theoretically 13 million. At its max it’s going to be 21 million There
will never be more bitcoins than 21 million. Current M1 of the US dollars is the amount
of currency that’s actually printed. M2 and M3 start to look at lending of money and fractional
reserves. When you’re actually a bank is lending out
more money than they have, and so you’re increasing the money supply without actually increasing
an amount of printed currency. With Bitcoin, M1 is the amount that is already been distributed
to miners and that today is around 13 million. We’ve already spoken about margin trading
a little bit but, again, recently, very recently you can now short Bitcoin, which basically
means you loan bitcoins today, you sell them immediately for US dollars, and you hope for
the price of Bitcoin to go down. Say it goes down to $10. We take the cash
that you just made by selling your loaned bitcoins and now you buy up all the bitcoins
for $10 apiece. You keep the cash difference, and you send back those bitcoins to the person
who was going long on bitcoins. So this idea of shorting in and being able
to go long margin trading really does play with the value of Bitcoin’s price. Right now,
the market for margin trading of Bitcoin is somewhere in the order of maybe 20 million
dollars. It’s very small, but that’s increasing exponentially and so that’s something that
will affect a lot of Bitcoin’s price. We’d already mentioned they’re endless unpredictables,
regulation, hacking, fraud, media who knows what, human emotion. This is always included
and that is impossible to model. And we’ve already mentioned e-commerce adoption this
is one of the big markets so we’re going to be showing our model.
go there immediately to this link right here. But this model takes in from blockchain.info
the current amount of bitcoins, the current price – If I refresh the page maybe that’s
changed a little bit – and today’s the big sell-off of the Silk Road coins. Everyone’s
kind of worried about price so indeed it’s gone down a dollar and a half since an hour
and a half ago. It’s not that bad. This is kind of standard volatility. And here’s
the market cap. If you take the price of each Bitcoin and just multiply it by the amounted
of extant bitcoins, you get the market cap which is $7.59 billion. And these are up-to-date
prices. Now here we, have our model price and this
model prices just based on numbers that we’ve already put in so if you look over here these
are default numbers of our model. And down here we have important variables. So here
you see the number of bitcoins in the system so these are the mined bitcoins so you can
update that. So there’s a 12.95 million mined bitcoins.
But then we also have a slider over here for the amount of bitcoins that you might think
are loss. And you’ll see that that affects the price up there.
And clearly the fewer lost bitcoins, the lower the price. Indeed price is higher when things
are scarcer. So of more and more of the bitcoins are lost you see the price go up and that’s
exactly what happens. And then again, as more bitcoins get added
in the system, the prices go down and we see that and our models just a linear model. We’re
not doing a lot of logs or anything. This is just an alpha version of this model to
give people an idea for how these different variables begin to affect.
We didn’t include everything so we have suggestions down here for other things that you might
want to add to the model and even up here for different markets. So let’s play around
with it really quickly and see how it all works.
Here’s gold or store of value. The current market value of all the gold in the world
being used to store value is $8 trillion dollars and silver comes into play. And there are
other things that you can store money in but we just throw in $8 trillion right here.
Okay so it’s $8 thousand billion and we kind of just made this wild guess as to how much
of that market bitcoins actually taken over. And this is kind of weird round number and
we’re saying okay well that’s $4 billion of this total market cap of Bitcoin. It’s impossible
to determine if these initial values we put are too high or too low.
They’re just guesses, but when you start to play around with the slider you really do
get a picture for how things can work. Say Bitcoin’s volatility goes down and people
really start using Bitcoin for a store value and you can really see a sort of madness here.
It’s important to realize that this isn’t the entire market cap of gold.
We set the max conservably at 20%. So if Bitcoin takes over the gold market, just 20% each
bitcoin will be worth substantially more than it is today. It’s a $149,000 based on this
model. And we can set all the rest to zero. Let’s
say that there’s zero loss bitcoins then we update our amount of bitcoins to 12.95. And
then we can just play with the gold price. And you can see that per bitcoin, price goes
up to a $123,000 if bitcoin takes over 20% of gold store value mark. And this is just
a single variable. We haven’t put anything else in here. But you can go down here and
start adding some of the negatives right. Well let’s look at the risk.
The risk that bitcoin might fail, maybe it’ll be a 51% attack or something else sort of
hacking that will wreck bitcoin. What’s that risk? So you can sort of increase that risk
and watch the price fall. So if you believe that there’s a 50% chance that bitcoin will
fail. That should affect the price and indeed it does.
And you can play with all these variables. You’ll see that velocity doesn’t affect the
price because velocity really doesn’t have a lot to do with store value. You’re hoarding,
so you’re not looking to move bitcoins around a lot, but if you’re doing something like
e-commerce for example and you can see that that doesn’t affect the price as much as gold.
Gold is a much bigger market. But here’s Bitcoin’s acceptance by lots of e-commerce so there’s
already Dish, overstock.com and other companies, say it grabs Amazon and others to the tune
of 20% of all e-commerce. Well in price it will be around $8,000. But
then if you go down and look at velocity, well that should affect the price and indeed
it does. Now we don’t know the exact velocity. We don’t
know exactly how it affects price so this is just a simple linear model to give you
a picture but you can see that all of these things will affect.
Here’s merchant pressure. Remember, merchants are very different thing consumers. Merchants
usually want the US dollars. Some companies will accept the bitcoins for purchase and
hoard, but that’s fairly rare. Most merchants will take the bitcoins and immediately turn
them into US dollars. So they’re actually doing a lot of conversion
to US Dollars and not the other way around. So merchant pressures, more merchants that
are accepting bitcoins tend to drive the price down a little bit. We think of it as great
news but it’s got sort of a downward pressure on the price.
Speculation fever, when everyone’s excited sort of this positive optimism about future
value, should increase the price. Regulation pressure, right now it’s not so high but it
could increase. We could see some really nasty regulation around the world. And my model
here is kind of jumping up and down but it still doing the right math.
And volatility clearly is an issue as well the higher the volatility the lower the price.
So, really the idea here is just to play around get a feel for where bitcoin can go. You can
sort of push all this up a little bit and see their real powerful effect that they have
on bitcoin’s price. And then you can add some more of these numbers
around play with what you think might be realistic. Maybe we can look in to the future and see
you the price of bitcoin based on the day that we have 17 million or 18 million bitcoins
in the system. Perhaps a risk of failure at that point will go way down because we finally
decided to put in the protocol, something that will prevent 51% attacks, which we don’t
have it all right now which is absolutely absurd. We really need to do something code
wise to prevent these attacks or at least minimize these attacks. We have nothing in
the system right now so it’s really ridiculous. But the other nice thing is say you don’t
like the model well you can say, “Well, I don’t think Bitcoin will ever do anything
with remitances.” And you can just remove that.
But you think that the bitcoin will dive into the hedge fund market. And hedge funds, it’s
written down here, $2.5 trillion so you could put $2,500 billion right?
And then you can say “Add New Market” and you can just start sliding that round
with your heart’s content. And you can really see the effective hedge funds on Bitcoin and
similarly could add another market. You can say maybe it’ll take over the rice
and bean market, let’s say that’s a, I don’t know, a $20 billion market. You can add that
as well. And that will, how it’s affected over here
and the same with these variables down here. You can and variables that you might think
are more important than the ones up here. You can remove regulation pressure. You think
there’ll never be any regulation at all and you can start putting in your own variables.
The effect of film on bitcoin or media, and you think that maximum effect that it could
have on the price will be 50% – a really powerful effect of media.
And you could add that variable. You can start sliding that around. And in future versions,
you’ll see the ability to add variables that will go up or down. Right now I think it’s
just a negative variable. So films are not doing a positive thing here,
but in a future version you’ll be able to add a positive variable. Almost all the variables
we have here turn out to be fairly negative. Velocity and speculation fever actually goes
in the right direction so it increases the price. Merchant pressure drive it down, velocity
drives it down. Risk of failure clearly drives it down. Okay, so as we mentioned at the beginning
of the video, our question was, “Could the price of Bitcoin could be 50 thousand dollars,
100 thousand dollars or a million dollars?” and so we refresh the page on our model and
we’ll look at just sort of these big markets. We won’t even include things like hedge funds
and trillion-dollar offshore deposits which will all of course increase the price of Bitcoin
if it moves into any of those markets in a substantial way.
But we find out very quickly that even if Bitcoin just starts to take over gold’s position
as a store of value, the price of Bitcoin certainly could go to $40,000 per bitcoin
even with some of these variables set as negatives, even if velocity kind of goes much higher,
and even if the risk of failure increases. Even with a big risk a failure, you can see
the price of bitcoin indeed moving into much higher numbers. $50,000, $60,000, $80,000
really seems like a possibility. It’s not happening this year there’s no way that bitcoin’s
current volatility is going to take over gold’s position as a store value or even 10% of this
year. But as we look into the future and these ideas
of volatility might come to settle, well, this is something that could happen. Remittances
seem like something that everyone’s talking about. Will it raise the price? Will velocity
will have a lot to do with it? But you can start to see that the price of
Bitcoin could be indeed go over a $1,000, $2,000, $40,000, $100,000 maybe even more.
It’s possible. We’re not telling you it’s probable.
We’re not telling you that next year the price is going to be any higher than the current
price, the spot price. And remember, the spot price is also a very good model so the current
price of $584 is also a very good model price for the price next year.
So I hope that helps. I hope it really begins to help you understand the possibilities of
Bitcoin in terms of price. Please remember to comment, like and subscribe, do whatever
it is you do and we’ll catch you at the next video.