Bitcoin: The Wild West Years

Anybody following bitcoin will know that the cryptographic currency had a huge run up recently that has brought with it an increase in fraudulent activities, including a DDoS attack on Mt. Gox and an epic theft of $3.5 million worth of bitcoin described in Felix Salmon’s long pieceI have been skeptical about bitcoin because of the built in deflation and because I have a growing concern about the use of crypto more generally. And it is entirely possible the bitcoin will be to crypto currencies as Napster was to P2P filesharing.

But there is also another possibility: the current “Wild West” period might be just what Carlota Perez has identified as the installation phase of a technology. During this phase much money will be made and expended in putting the infrastructure in place. Historically that phase has ended with a massive crash for many other technologies (including the bursting of the first Internet bubble). So there is no reason why it should be different here!

Appendix:

Separately I have been thinking about how much a single bitcoin would have to be worth if the currency succeeds. I had previously cited a number of $2 million per bitcoin but didn’t spend much time looking at the math the author had done. To estimate the value of a single currency unit we need to take the size of the economy and divide it by the amount of currency multiplied with its velocity.

The size of the global economy is about $80 trillion. If bitcoin were to account for 1% of that would make the bitcoin economy about $800 billion. There is a hard limit of 21 million bitcoin in the protocol (for now) and coins can get lost forever. Let’s work with 20 million coin as a round number. We still need an estimate for velocity though. The velocity of the US dollar seems as good a guess as any.

According to the St. Louis Fed, the velocity of M2 is a bit above 1.5 right now but has been as high as 2.1. So let’s use 2 but we need to keep in mind that M2 is not the right comparable because the 20 million coin number is closer to what is called “currency” or M0. Fortunately the Fed publishes tables that let us make this adjustment.  M2 to M1 is about 4x and M1 to currency is about 2.5x. So if we expressed velocity in terms of M0 it would be about 4 * 2.5 * 2 or 20.

We can now calculate the value of each bitcoin as follows $800 billion / (20 (velocity) * 20 million bitcoin) = 800,000 million US$ / 400 million bitcoin = $2,000/bitcoin. While that is still almost a 15x increase from the current price of $130/bitcoin it’s not as crazy a number as $2 million/bitcoin.

PS I just rushed through these calculations as I suddenly remembered that I have an 8am breakfast, so there may be a grave error in here and if so, I hope someone points it out!

Posted: 4th April 2013Comments
Tags:  bitcoin

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