Bitcoin graph

Here's a logarithmic graph of bitcoin prices to date. The long term trend is clear. Bitcoins prices grow as a straight line over time. Since this is a logarithmic plot, that means the prices are actually growing in a consistent exponential.

Put another way, the percentage returns are huge and consistent. How huge? Do the calculation yourself. Print the graph, draw a fit line. Measure the slope. You will see that the price multiplies by 10 every 13.5 months. That works out to consistent 675% returns.

What does this mean for the investor? It means the sellers are irrational. If you managed to buy at the peak, don't sell in the panic. Just keep your bargain and wait 18 months to get your money back.

Bitcoins III

Ok, so my previous post was a little extreme. This time I am going to try to be as conservative as I can and estimate a price point.
 
First, let's compare to other currencies and precious metals. There are around 10T each of Dollars and Euros. There is around $10T worth of gold in the world. There is around $1T worth of silver.

Some bloggers have argued that Bitcoins are not viable as an everyday currency as they will be subject to deflation and hoarding. I think this is a little extreme too. They are disadvantageous from a monetary policy perspective, but that won't matter to the ordinary people who will ultimately decide the future of Bitcoins. How many people do you know who can clearly explain why fiat currency is better than the gold standard? And what exactly is the inherent value of gold or silver. Does anyone really believe the inherent value of gold is $1600/oz? All but a small fraction of that is scarcity and momentum.

Even if Bitcoins are purely used for hoarding (which I think is nonsense; people are using the things for transactions already) they would be analogous to gold or silver today; and if they reach equilibrium, their total value will be somewhere in between. Let's just say $3T.

Meanwhile there are considerable risks. They have been discussed thoroughly elsewhere, so I won't repeat them here. I will take a conservative position that there is a 10% chance they will reach equilibrium, and a 90% chance they will become worthless.

That still leaves a price point of $15,000.

So why does the market not respond immediately? It's because the cost to produce them is so low. The marginal cost today is $0.10 each. So why should anyone pay $140? Think of the Bitcoin market as a bunch of natives who want to sell dumb shiny yellow rocks for what they consider a fortune, to colonists who are happy to take advantage of the natives' ignorance. The natives will compete against each other, and the colonists will too, and the colonists could choose to try and mine the rocks themselves. Both sides are actually rational, the price will fluctuate somewhere between the two prices, and things will only really stabilize once the mines effectively run out and the mining price reaches the market price.

BTW, I just saw a wicked scam. They are offering ASIC mining rigs, in stock, with a very legit looking website. Never mind that the real ones are backordered by around 12 months. The catch? You can only pay using Bitcoins. Good luck getting your coins back when you get nothing! But why run a scam when you can just buy some coins and get rich while you sit on your couch?

Bitcoins II

Bitcoins are trading today at $90, six times what they were worth when I last wrote about them more than a year ago. That works out to a 180% annualized return. But a graph of price vs time is very volatile. That's because of the vast disparity between the cost to produce them and their future value discounted back to the present day (or not discounted as I explained before). There are a series of exponential increases followed by crashes.

If you take the attitude that Bitcoins are a fad and have no intrinsic value, then the spikes are classic asset bubbles. But if you assume Bitcoin is a legitimate currency, then the speculators driving up the price are the truly rational players. One day many papers will be written about this price graph.

Once the price reaches equilibrium with the dollar, the volatility will go down, and will approximate the situation under the gold standard. We may lament the reduced ability of the government to stabilize financial panics using monetary policy.

It seems likely that the Euro will be the first currency to be replaced by Bitcoin. This is party because of its fragility, partly because of boneheaded decisions such as confiscating Cypriot deposits, and partly because Europe will lead in development of Bitcoin transaction infrastructure due to its progressivist tendencies.

When people begin converting Euros to Bitcoin en masse, the Euro will experience hyperinflation, which will exacerbate these forces. The transition will probably begin almost as soon as the infrastructure is widely available. Bitcoins will then represent the same Money currently denominated in Euros. A Bitcoin will thus be worth approximately $500,000. I'm estimating conservatively using M2, but M3 is theoretically more accurate, since Bitcoin banks will continue to leverage loans against long term deposits.

When the Dollar converts, the value will increase to approximately $1,000,000 in today's Dollars. This may follow the Euro conversion quickly as there will certainly be a circus atmosphere surrounding the vast wealth generated by early adopters. On the other hand, it is possible the Dollar and/or Euro will survive as an alternative currency once equilibrium is reached.

Let's assume the value of the Dollar is wiped out by hyperinflation. Since US debt is denominated in Dollars, it will be wiped out too. The US government would be forced to start borrowing in Bitcoin. Since much of US wealth is dependent on the inertia of a global financial system based on Dollars, there is potential for a global economic depression and political and military upheaval. It is very hard to make solid predictions of this type, but if rogue states wish to destabilize the Pax Americana and become financial powers at the same time, they would do well to invest in Bitcoin.

There will be huge investments in mining. Bitcoins are mined by computation, essentially converting electricity to cash. The total energy cost of producing all that currency is hard to calculate without a good model of the price curve, but we can get a rough order of magnitude by assuming the amount spent mining is similar to the amount of currency produced. The result is roughly 6 months worth of the total global energy output. There will be quite a gold rush.