Tuesday, December 05, 2017

A Literal Economic Intepretation of Bitcoin

Participate with me, if you will, on a simple mental exercise about supply and economics. 

As bitcoin approaches $12,000 (may have even passed it by now) there is much hubbub and discussion about it, from some economists that are old and don't understand crypto-currencies to vested-interest parties who will champion cryptocurrencies to enrich themselves.  But to more simply understand bitcoin (or any crypto-currency) let us simply do what we all learned in the 4th grade and....

divide.

To be literal, the exchange rate for all currencies should be a simple division between the global supplies of currencies.  You take the number of yen, you take the number of dollars, you divide them into each other and you have the LITERAL exchange rate of the currency pair.  You take the number of Euros, the number of Rubles, divide and that's the literal exchange rate.  Naturally there's other future-looking variables that determine the value of a currency.  If you're a leftist moron living in Venezuela or an idiot tyrant who hates white people in Zimbabwe, you'll just print off more money (because that always worked) and that will negatively affect the exchange rate of your currency.  But in a literal sense the global supply of any two things should be their literal and mathematically precise exchange rate.

Carats of diamonds to tons of dirt.
US dollars to barrels of oil.
Silver to cement. 
It can be done for anything.

However, bitcoin presents an even easier calculation.  Whereas the amount of cement made and the ounces of silver mined is yet to be determined, bitcoin is finite in that there will only be 21 million of them ever in existence.  So you only need to take the supply of any currency and find out how many units of that currency there is globally per bitcoin and you in theory have a price (inter-currency demand differences duly noted).  And with roughly 4 trillion in US dollars in circulation that gives us

$186,000 US dollars per bitcoin.

Now there are other arguments as to why bitcoicn and cryptocurrencies have value.  And (though I own bitcoin) I'm not terribly sure it has yet reached the full faith and acceptance as a universally accepted medium of exchange.  But to introduce some simple math into the debate we need to realize we HAVE tripled the money supply since the financial crisis and the debate I contend is not so much the value of cryptocurrencies or bitcoin, but rather the declining value of paper money we keep printing off. 

This isn't to say that tomorrow the price of bitcoin should be $186,000.  It may or may not.  I'm merely pointing out there's 186,000 dollars out there in the world for every bitcoin...and that number is increasing as we print ourselves out of financial deficits.

I'll leave the speculation about bitcoin's price to the rest of you to discuss.

7 comments:

Glen Filthie said...

If I understand Bitcoin correctly - it has the advantage of being paid without any number of gov't/tax/banker slobs getting a cut. If that is true, they will move to kill the currency and no bones about it. I've heard China is making moves against it. The question then becomes - how do you steal it? Or control it? It would be the wet dream of 'aggressive accountants' looking to launder dirty money.

Consider the ramifications of that: In order for me - say an IRS slob - to make sure rogue economists aren't hoarding bitcoins and evading my righteous theft...er...taxation - I am going to have to dispense with his rights to privacy in order to make sure he isn't screwing me out of my cut! I will need to be able to track his financials, probably his computer activity, hire people to put boots on the ground for actual physical surveillance... why, we'll need a whole new law enforcement agency AND bureaucracy to investigate and prosecute cryptocurrency crime!

We truly live in a brave new world.

Tucanae Services said...

I have to say I have been lucky with BTC. I bought early when it was down there at $10/BTC. I generally use BTC as a medium of exchange to buy international goodies. The transaction costs make it worthy for that purpose. Those BTC's that are in my ewallet have appreciated far beyond my fevered expectations.

Tucanae Services said...

"Consider the ramifications of that: In order for me - say an IRS slob - to make sure rogue economists aren't hoarding bitcoins and evading my righteous theft...er...taxation - I am going to have to dispense with his rights to privacy in order to make sure he isn't screwing me out of my cut! I will need to be able to track his financials, ... "
--Glen Filthie

Dude, read the bottom of the full 1040. The signature line already gives you that power.

Tucanae Services said...

"If I understand Bitcoin correctly - it has the advantage of being paid without any number of gov't/tax/banker slobs getting a cut. If that is true, they will move to kill the currency and no bones about it" -- Glen

First of all, at least for me, it would be enumerated on my Schd B as capital appreciation. Then those that I did utilize I would average down as FX currency exchange. Still at capital tax rates. But the opportunity you miss is asking BTC holders if they have filed the proper foreign assets declaration. Depending on what BTC exchange they are using they could be in violation.

Black Poison Soul said...

Apmex (one of the silver/gold/platinum bullion companies) now accepts payment in bitcoin.

I got an email about 3 hours ago, linking to an announcement on their website.

Anonymous said...

@Glen Filthie Bitcoin is simply trading as a commodity. The government doesnt have to worry about Bitcoin because the government issues what is legal tender in the United States. Crytocurrency cost more to process than a centralized system. So their really is no benefit to society, other than not allowing the government to control the currency.
If the government really wanted to they could convert the dollar into a decentralized currency. That is why there is nothing proprietary about bitcoin. There is already 1000 different types of cryptocurrencies. Now bitcoin was the first one to the table so people have more faith in it. But at the end of the day, it is just another commodity. The supply increases slowly but the price has skyrocketed. The exchanges are just hyping up bitcoin and flooding it with money. China controls a large amount of all the bitcoins in circulation. Expect a huge crash in cyptocurrencies in the future. When the miners feel like cashing in their chips, they will flood the market with bitcoins. The market cap for crytocurrencies could easily reach in the trillions of dollars.

YIH said...

I've been saying Bitcoin is not (and can't be) ''a currency'', well, I'm not the only one, Steam (the online game marketplace) is now saying it too:
In the past few months we've seen an increase in the volatility in the value of Bitcoin and a significant increase in the fees to process transactions on the Bitcoin network. For example, transaction fees that are charged to the customer by the Bitcoin network have skyrocketed this year, topping out at close to $20 a transaction last week (compared to roughly $0.20 when we initially enabled Bitcoin). Unfortunately, Valve has no control over the amount of the fee. These fees result in unreasonably high costs for purchasing games when paying with Bitcoin. The high transaction fees cause even greater problems when the value of Bitcoin itself drops dramatically.

Historically, the value of Bitcoin has been volatile, but the degree of volatility has become extreme in the last few months, losing as much as 25% in value over a period of days. This creates a problem for customers trying to purchase games with Bitcoin. When checking out on Steam, a customer will transfer x amount of Bitcoin for the cost of the game, plus y amount of Bitcoin to cover the transaction fee charged by the Bitcoin network. The value of Bitcoin is only guaranteed for a certain period of time so if the transaction doesn’t complete within that window of time, then the amount of Bitcoin needed to cover the transaction can change. The amount it can change has been increasing recently to a point where it can be significantly different.

Those fees? Yeah, that's another problem, the original model of ''people will use their computers to process Bitcoin transactions and as compensation will receive Bitcoin as payment for their time, electricity, and hardware cost'' is dying. It's ''baked into the cake'', the more Bitcoins that exist, the harder (more transaction processing) it is to ''mine'' them. The costs to ''mine'' them are rising, and the rewards for doing so are not rising in proportion to the production time and cost - even with the meteoric rise in Bitcoin. So how do the ''miners'' get compensation for all those transactions they have to churn through? Same way the banks do, by charging transaction fees.