Why the value of bitcoin is destined to fall.

Rampant speculation and publicity drove up the price of BTC (in dollars) in 2013. As early adopters began cashing out, the price began falling and has been falling steadily since. See chart below courtesy of coindesk.com.

Coindesk.com chart


Suspicion
has been recently that the dropping price is a result of the increased number of merchants accepting bitcoin (leading early bitcoin enthusiasts to begin spending their saved coins) and the lackluster adoption of new consumers. Those merchants in turn sell their bitcoin almost immediately, driving down the price, because of lowered demand.

Much of the bombastic speculation on the price of bitcoin uses faulty math to justify outlandish prices. Dividing the volume of Visa transactions by the number of available bitcoins does not tell you it’s price potential. The price is intersection of supply and demand, simply put. You have to account for the velocity that money can change hands. Fortunately, for bitcoin, there is a built in floor. Money in the bitcoin system can only change hands once every 10 minutes.

Let X be the total value of all the bitcoins in the world. Let’s say that X is held by consumers who then purchase products at merchants. 10 minutes later, the merchants sell those bitcoins back to the consumers. Repeat ad nauseum. There are 52,560 10 minutes intervals in a year. The numbers vary greatly, but lets suppose, the credit card networks process about 7 trillion dollars a year. That’s approximately 133 million dollars in transactions every ten minutes. There are currently 13 million bitcoins in circulation. Instantly, if bitcoin replaced all credit card transactions, the value of bitcoin would need to be $10 per coin. Actually, double that because the coin has to be paid the merchant and then get back to the hands of the consumer. So we’re looking at $20 per coin.

There are a couple of caveats. First, there are far less than 13 million bitcoins in actual circulation. That’s because some have been lost and many more are currently being hoarded by speculators. Secondly, bitcoins won’t only replace the credit and debit card networks but there are many other transactions, especially high value transactions. The Federal Reserve estimated that in 2013 there were $79 trillion (in the United States) in non-cash transactions. Assuming the US represents about 20 percent of worldwide transactions, that would put the entire world at approximately 400 trillion US dollars in non-cash transactions. Simple back of the napkin calculations would put the transaction volume about 7.6 billion dollars every 10 minutes. If the total money supply switch hands every 20 minutes, the value of bitcoin would be about $1170.

Now, there are some wild assumptions in that calculation
1) Bitcoin would have to replace ALL non-cash transactions. More likely Bitcoin would become one of many payment options, altcoins not withstanding.
2) Clearly the number of bitcoins in increasing but also the volume of transactions worldwide is increasing.
3) I haven’t factored in cash based transaction of which some volume bitcoin is bound to replace.
4) Not all bitcoins will change hands every 10 minutes. Just as soon as you get money, you don’t go out and spend it within 10 minutes. This will no doubt increase the relative value.
5) I’m only talking about today’s $, and not considering inflation of the US currency. In other words, purchasing power. A bitcoin could be worth a billion dollars one day, but that billion dollars may buy you a loaf of bread.

It would be foolish of me to speculate on the value in the short term, since many factors will determine the relative supply and demand of bitcoins (what % of transactions are done in bitcoin, how long bitcoins are held, etc..). In the long term though, it is clear that ultimate value of a bitcoin will probably be fairly low.