By John Hawkins
There are many claims that Bitcoin’s price will go much higher based on “fundamentals”. But examining these claims shows they are flawed. It seems Bitcoin is a speculative bubble.
The “market value” of cryptocurrencies has fallen from a peak of over $3 trillion in November 2021 to less than $2 trillion.1
But the media still breathlessly report claims that their prices will soon go “to the moon”, as the crypto fans put it. One of the latest such claims was from President Trump’s short-lived spokesperson Anthony Scaramucci, now heading Skybridge Capital. He claims Bitcoin will rise from its current $43,000 to over $100,000 in the next couple of years, undaunted by having made the same prediction last year for the end of 2021.
There are many who regard the fundamental value of Bitcoin as zero. Nouriel Roubini, one of the few economists to predict the GFC, said its fundamental value is negative, once account is taken of its environmental impact.2 Bitcoin has been described as a “bubble” by Nobel prize winners Richard Thaler, Paul Krugman, Robert Shiller, Joseph Stiglitz, James Heckman and Oliver Hart.3 The BIS general manager has called cryptocurrencies “a bubble, a Ponzi scheme and an environmental disaster”.4
Many of the claims of Bitcoin’s price being set to more than double seem to represent nothing more than extrapolation or wishful thinking. But what about some of the estimates that have tried to apply more rigorous thinking?
Bitcoin’s claimed potential as a medium of exchange
Cryptocurrencies have been hyped as the future of payments for as long as they have existed. But they are making very little progress. The only company that most people are aware of that accepted even one of them is Tesla, and they stopped doing so.
Standard Chartered Bank’s Kendrick, Graham and Chan argued that the Bitcoin price would reach $100,000 by early 2022, roughly double the then-prevailing price. They contended that Bitcoin “may become the dominant peer-to-peer payment method for the global unbanked”. Assuming that Bitcoin “captures all of the US$20 trillion of transactions in the unbanked sector”, they applied the ratio of the market capitalisations of the credit card companies to their transactions to give Bitcoin a market capitalisation of $1 trillion. Dividing by the eventual 21 million bitcoins prices Bitcoin at around $50,000.5
But is the “market capitalisation” of Bitcoin comparable with that of shares in credit card companies, whose owners earn dividends from the (very high) interest and transaction fees earned by these companies? And how long would it take for Bitcoin to be used for all these transactions?
Widespread use seems unlikely when half of the unbanked lack internet access, many are illiterate and many of the rest are too poor to need banks and/or live in China, where Bitcoin is banned.
Furthermore, the Bank for International Settlements’ 2018 Annual Economic Report described how the limits on scalability caused by ledgers having to contain a record of all transactions will prevent a cryptocurrency becoming a dominant means of payment:
To process the number of digital retail transactions currently handled by selected national retail payment systems, even under optimistic assumptions, the size of the ledger would swell well beyond the storage capacity of a typical smartphone in a matter of days, beyond that of a typical personal computer in a matter of weeks and beyond that of servers in a matter of months. But the issue goes well beyond storage capacity, and extends to processing capacity: only supercomputers could keep up with verification of the incoming transactions. The associated communication volumes could bring the internet to a halt, as millions of users exchanged files on the order of magnitude of a terabyte.
But even before these problems become an issue, the volatility of Bitcoin is why so few people use it for payments and why it is virtually unknown for goods and services to be priced in Bitcoin. It is a large multiple more volatile than gold or share price indices, let alone exchange rates.
This valuation approach also assumes that Bitcoin is the only cryptocurrency that becomes widely used for payments. Bitcoin is still the largest and best-known cryptocurrency. First-mover advantage and network effects can be important, but they are not a guarantee. Before 2008, MySpace was a bigger social networking site than Facebook. Bitcoin’s share of the cryptocurrency market has been falling. From 100 per cent in 2008, it was down to 70 per cent by mid-2017 and is now around 40 per cent. In terms of trading volumes, Bitcoin is often exceeded by Ethereum and the stablecoin Tether.
Another challenge to Bitcoin’s aspirations to being a medium of exchange is that its carbon footprint already exceeds that of many medium-sized countries, due to the energy wasted creating it. The process also generates e-waste equivalent to that of a country like the Netherlands, and it is growing.6 Tesla’s suspension of accepting bitcoins was claimed to be a response to Bitcoin’s carbon footprint.
Central bank digital currencies are also looming as a superior alternative to Bitcoin for payments. Already the sand dollar can be used to make payments in the Bahamas, and DCash in the eastern Caribbean. A BIS survey shows that most of the world’s central banks are either trialling or investigating the possible issue of CBDCs. There are also studies into linking them to facilitate international payments.
Even accepting the other extremely optimistic assumptions in this valuation approach, if Bitcoin only keeps its current 40 per cent share of the crypto market and only half the unbanked people (i.e., the estimated proportion with mobile phones) adopt it, rather than all of them, then the valuation falls from around US$50,000 to US$10,000.
Bitcoin’s potential as a store of value or inflation hedge
The supply of Bitcoin, which will plateau at 21 million, is likely to grow slower than the US-dollar money supply. This has led some to call it an “inflation hedge”. This is a gross abuse of the term. An inflation hedge is an asset, such as an indexed bond, whose price moves with the general price level. The ridiculously volatile Bitcoin does no such thing.
Inflation has increased notably over the past year, but the Bitcoin price has fallen by about a third.
Nor does it operate as a “safe haven” in times of global uncertainty. The Bitcoin price fell after the Russian invasion of Ukraine.
The “stock-flow” model
A recent beginners’ guide to crypto commented that “one of the most widely used charts for predicting Bitcoin changes is the ‘stock-to-flow’ model developed by Plan B, who has over half a million Twitter followers”.7 He claimed that gold holds its value because its existing stock is much higher than the flow of new gold mined. The stock of gold is about 60 times the annual production, compared to around 20 for silver. At the time of writing, the stock of Bitcoin was around 25 times its annual production. Since the halving of the Bitcoin creation rate in 2020, the stock has been over 50 times the annual production, approaching that of gold. This is the basis for claims that the stock of Bitcoin should be as valuable as the stock of gold. This would imply that the Bitcoin price should rise about tenfold.
The stock/flow model seems to have no theoretical basis. Economics would say that prices should depend also on demand, rather than just supply. Another problem with it as a justification for buying Bitcoin is that the same reasoning should apply to the various Bitcoin clones with very similar supply paths. They should all have around the same value and so should all be more attractive buys than Bitcoin.
Kendrick et al. also argued that an optimal allocation of global portfolios would see 2.3 per cent allocated to cryptocurrencies. Applying this to the $400 trillion of financial assets under management amounts to $9 trillion. Allocating a third of this to Bitcoin gives $3 trillion. Dividing this by the 18.8 million of Bitcoin on issue gave a price of $175,000.
These calculations are notoriously sensitive to assumptions of returns and the stability of previous correlations. An IMF study showed that Bitcoin has become increasingly correlated with other risky assets, making it less useful for diversifications.8
The estimated return is derived over a short time period during which Bitcoin more than doubled. So it is really just a circular argument that if fund managers expect the Bitcoin price to double, they will buy more of it and this will drive up the price.
The cost of production
Like an updated version of the labour theory of value, Hayes valued Bitcoin at its cost of production, which is mostly based on the amount of electricity consumed.9
But Bitcoin is not a battery. There is no way to retrieve the energy used in making it. The cost of creating a new Bitcoin is related to the price, because competition among miners will drive the complexity of the computation up to the point where the cost approaches the price. But, once produced, the costs of doing so cannot affect the market price.
Bitcoin and gold
A surprisingly common argument is that Bitcoin is “digital gold” and so the stock of Bitcoin should be worth the same as the amount of gold on issue. J.P. Morgan’s Nikolaos Pangirtzoglou was widely reported as saying in May 2021 that this calculus would lead to “a long-term theoretical Bitcoin price at $146,000”.10 Much less reported was his comment that, as Bitcoin is four times as volatile as gold, the “fair value” is $37,000.
These arguments are akin to an Esperanto supporter arguing that, as the language is more efficient than English, it “must” become spoken by at least 10 per cent as many people, so the number of speakers will rise to 150 million.
There are parallels between the cryptocurrency bubble and the dot.com bubble of 2000. Both were driven by over-
enthusiasm about new technologies. In both cases, optimistic assumptions were used to drive up the price of rivals when it was never plausible that all could be successful enough to justify the valuations. And, just as a few stars such as Amazon emerged from the dot.com bubble, so it is likely that applications of the blockchain technology developed by the inventor(s) of Bitcoin may have some enduring utility. But it would be a big gamble to assume that cryptocurrency will be one of these applications, let alone that, of the thousands of cryptocurrencies, it will necessarily be Bitcoin that endures.
About the Author
Dr John Hawkins is a senior lecturer at the Canberra School of Politics, Economics and Society at the University of Canberra. He holds a master’s in economics from the London School of Economics and a PhD from the Australian National University. He previously worked at the Bank for International Settlements.
1. “Market value” is, not uncontroversially, calculated by multiplying the current price of each coin by the number on issue and is taken from the CoinMarketCap website as at 10 April.
2. Roubini, N., 2021, ‘Bitcoin is not a hedge against tail risk’, Financial Times, 12 February.
3. Wolff-Mann, E., 2018, ‘Only good for drug dealers: More Nobel prize winners snub bitcoin’, Yahoo! Finance, 28 April.
4. Carstens, A., 2018, ‘Interview with Basler Zeitung’, 4 July. (https://www.bis.org/speeches/sp180704a.htm)
5. Kendrick, G., Graham, C. and Chan, M., 2021, ‘Bitcoin investor guide’, Standard Chartered Bank, 7 September.
6. De Vries, A. and Stoll, C., 2021, ‘Bitcoin’s growing e-waste problem’, Resources, Conservation and Recycling, vol. 175, December.
7. Morris, M., ‘Crypto land is confusing. Here are five things I wish I knew before buying’, ABC News, 18 September 2021; ‘Plan B’ 2019, ‘Modeling Bitcoin value with scarcity’, https://medium.com/@100trillionUSD/modeling-bitcoins-value-with-scarcity-91fa0fc03e25; Cuthbertson, A., 2021, ‘Bitcoin prize prediction model remains “amazingly accurate” with less than 1% error – and forecasts record end to 2021’, The Independent, 30 September 2021.
8. Iyer, T., 2022, ‘Cryptic connections: spillovers between crypto and equity markets’, IMF Global Financial Stability Notes, no. 2022/01.
9. Hayes, A., 2019, ‘Bitcoin price and its marginal cost of production: support for a fundamental value’, Applied Economics Letters, vol. 26, no. 7, pp 554-560.
10. J.P. Morgan, 2021, ‘Bitcoin, blockchain and digital finance: fintech goes mainstream in the Covid-19 era’, 27 April.