The rational price of bitcoin is an open question.
But with bitcoin BTCUSD, +2.11% futures now trading in CME BTCF8, +2.57% and CBOE XBTF8, +2.63% and a NYSE-traded exchange-traded fund likely, informed bitcoin traders over time will determine rational prices based on expectations of the success of blockchain technology and the role bitcoin will play in it.
That said, it is impossible to accurately predict the outcome when dealing with such a new paradigm. The speed at which people have moved from being reluctant to share credit card information on the internet to e-commerce becoming a bonafide threat to shopping malls, for example, is not something investors could have factored into projections of Amazon.com’s AMZN, +1.28% free cash flows two decades ago. The company had real options (unknown valuable opportunities) that only came to fruition in later years.
Similarly, in valuing bitcoin, we should not pretend to know what path bitcoin ultimately might take. Like any new technology, bitcoin has many valuable real options.
The entire spectrum of investors — from those who believe bitcoin is a fraud to those who argue that its price will reach $1 million — agrees that the blockchain is a transformational technology that will increase the speed, efficiency, cost, and transparency of many transactions. But many of these investors do not see a connection between blockchain the technology and the cryptoassets. They do not see how the holders of cryptoassets (including bitcoin) will benefit financially from blockchain becoming a dominant technology.
Many of the cryptoassets have been issued as a utility token, to be used for conducting transactions. That is fundamentally different from a traditional centralized platform company where the owners are entitled to a fee for all transactions carried out on their platform.
Consider Uber, a traditional centralized platform company. Every time it connects a rider to a driver, the company receives a portion of the fare for making that connection. In contrast, a decentralized protocol version of Uber, say “UberB,” would directly connect the rider to the driver without the need for an intermediary, and consequently without any associated transaction costs.
So if this is a decentralized peer-to-peer transaction and no transaction fees are generated, what possible monetary benefits could exist for the holders of UberB tokens? The answer lies in the role the UberB tokens (or more broadly, cryptoassets) will play in this peer-to-peer decentralized platform.
Continuing with the UberB example: UberB tokens will be needed to hail rides and/or for drivers to register on the platform. As more people start using UberB that requires tokens and the number of tokens is limited — the value of the token will increase and the holders of tokens will benefit from capital appreciation.
One way to generalize this example is to think of bitcoin as a commodity in limited supply, that currently has no (limited) use. Once a technology is developed that requires the use of bitcoin, its demand and consequently its value will increase. Holders of cryptoassets are investing in whether the blockchain protocol has an economic advantage over the existing ways of doing business, is scalable, and will meaningfully limit the supply of coins. If the usage of the protocol increases, the value of the coins needed to participate in it will also increase.
Bitcoin may well play a highly important role in this ecosystem by being the dominant asset that can be readily converted to different utility tokens — think of a “bitcoin standard” similar to the once-respected gold standard. In the Uber example, there could be a mechanism whereby users would convert bitcoin to UberB tokens to hail a ride and pay for it. Once paid, the driver would convert the UberB tokens to bitcoin.
So, much like we carry dollars when we travel that can be readily converted to most local currencies, bitcoin could become the global currency of the blockchain era, which businesses and individuals carry digitally and convert into utility tokens as needed to procure goods and services.
Bitcoin has a first-mover advantage as the first viable blockchain currency. It cannot be devalued by governments; a wide variety of fiat currencies can be readily converted to bitcoin at many exchanges (or even at bitcoin ATMs); it can be readily converted to other cryptoassets; it is divisible so can accommodate micro transactions (the smallest denomination is 0.00000001 of one bitcoin, known as a “satoshi”); companies can hold it without assuming price risk because they can hedge their positions in the bitcoin futures market XBTF8, +2.63% Moreover, bitcoin itself is secure (generally considered unhackable), and has had perfect uptime since its launch on January 3, 2009.
Bitcoin could be replaced by a superior future iteration of itself with lower transaction costs.
Still, bitcoin could be replaced by a superior future iteration of itself with lower transaction costs (for example, Roger Ver, a.k.a. “Bitcoin Jesus,” the CEO of bitcoin.com and an outspoken proponent of bitcoin, has started favoring bitcoin cash), or a stable coin whose value is tied to the U.S. dollar DXY, +0.07% or a basket of currencies, or even a government-issued cryptocurrency.
Clearly, the range of possible outcomes for bitcoin is broad. Any price appreciation will depend on the extent to which the blockchain technology becomes mainstream — and if bitcoin continues the premier blockchain currency.
Undoubtedly, a large majority of today’s cryptocurrencies will one day be worthless — the Pets.coms of the blockchain era — while some might become an integral part of Web 3.0, with accompanying astronomical valuations. And bitcoin may or may not become the dominant blockchain currency.
Until at least some of the uncertainty is resolved, bitcoin is likely to have a higher level of volatility than traditional assets. This heightened volatility is just a part of the price discovery process. Until recently, only bitcoin believers were able to participate in the market because buying bitcoin was cumbersome and there was no effective way to short it.
However, with markets for bitcoin more complete with futures (and soon ETF) trading, informed investors can now make their different views known. There now can be a tug-of-war between the bulls and the bears — those who believe bitcoin is a disruptive blockbuster and those who believe it is a “geek fad.” This will ensure the price of bitcoin better reflects its fundamental value.
Atulya Sarin is a professor of finance at Santa Clara University. He is the co-author of “Foundations of Multinational Financial Management” (Sixth Edition)(Wiley) and has worked extensively as a valuation expert.