Chad Arroyo

@chadarroyo

The Case for the $1 Million Dollar Bitcoin

Bitcoin is going to $1 million dollars! Well that’s what Bitcoin maximalists are saying. But is that true? Is it even possible? As the proverbial experts debate the future of money and the real value of digital assets, there is a genuine business case to be explored. Rather than just recklessly speculate and encourage investing all of your savings into this digital asset, let’s objectively discuss some of the underlying facts, assumptions, and general requirements needed for the possibility of this seemingly unreasonable price to be assigned to one single Bitcoin.

Before I begin, I would like to disclose that I have no insider knowledge, I have not run advanced prediction models, nor did I previously predict with any degree of certainty the current price of today’s Bitcoin. And even if I did, I would like to caution that the market is going to do what the market is going to do.

What the 1 Million Dollar Bitcoin Implies

In order for there to be a 1 million dollar Bitcoin, we must consider the forces that are currently in play and as well as differentiate between price of Bitcoin and its perceived value. These are inherently not the same. Price is what someone is willing to pay. Essentially, it is the monetary cost of something. Value on the other hand, derives its meaning from benefits and overall usefulness. Price is the point of focus for this discussion. And while there are price factors that are tied to the perception of value, I will concede that it is too easy to derail the dialogue by debating value when it comes to Bitcoin.

The price of Bitcoin upon writing this piece is $18,500. At that price point the market cap was $294 billion. If Bitcoin were to be priced at $1 million per coin, that would reflect a percent increase of 5400%, a return of 54x. In layman’s terms that would mean you give me $1 and I give you $54 in return. I know this seems exceptional. But with irony at its best, I originally started this blog post during the Thanksgiving holiday, just 3 weeks ago. Then…the price of Bitcoin was $8,200. At that price point the market cap was $137 billion. If Bitcoin were to be priced at $1,000,000 per coin then that would reflect a percent increase of 12,100% (or 121x). Hence you give me $1, and I give you $121 dollars in return.

Snapshot CoinMarketCap 12/17/2017. As you can see the price has jumped yet again.

That seems more unlikely and exceptional wouldn’t you say? Truth be told, this market has continued to displace the largest of skeptics and while it is impossible to know if this bubble will burst, it is even less possible to predict when it will happen.

The $1 million dollar Bitcoin argument predicates that the total market cap of Bitcoin in the world would amount to $16.5 trillion. This compensates for the approximate 4.5 million Bitcoin that have been lost and are now unrecoverable for various reasons.

Understanding $16.5 trillion dollars

While $16.5 trillion is a very large number, let’s put it in perspective. There are a number of comparative figures we can look at when considering large financial numbers, but for the purposes of this article, let’s visit the global money supply, global stock markets, the world’s largest companies, and 50 of the worlds richest people. Additionally, I feel it would be helpful to consider Gross Domestic Product (GDP) and, my personal favorite, money held in offshore accounts.

With the assistance of the infographic below authored by Jeff Desjardins at the Money Project, the some of the aforementioned figures are more easily digested.

Now that we have an orientation for some of these comparative figures, let’s consider what a $16.5 trillion dollar Bitcoin market cap looks like in relation to them.

2017 Figures, various sources

To highlight some comparative figures, given this assumed Bitcoin market cap, it would be equivalent to 13% of Global GDP, 23% of the value of Global Stock Markets, and be equivalent to 45% of the Global money supply.

The amount of money held in offshore accounts is estimated to be $21 trillion USD. Bitcoin’s market cap at $16.5 trillion would represent an equivalent value of 79% of those assets today. Offshore account figures are symbolic because Bitcoin is considered to be a “non-seizable” asset. Short of your computer getting hacked or you personally being held captive until you give up your private keys to your Bitcoin, no authority can technically take your Bitcoin from you. As long as this holds true, it is very possible that offshore money may be converted into Bitcoin and other cryptocurrencies.

These figures are staggering and to compare a digital asset such as Bitcoin to them requires a leap of faith in the first place. And at this exceptional market cap assumption, it becomes an even more difficult concept to fathom as reality. Overall, these comparisons should now give you a reference for the implications associated with having a $1 million dollar Bitcoin.

Ecosystem Forces

Bitcoin has been alleged to be deflationary as the supply of the currency is finite. As long as demand for Bitcoin is stable or expanding, the purchasing power of Bitcoin increases over time. When compared to fiat money such as US dollars the supply and printing of dollars is theoretically infinite, and hence the purchasing power of the US dollar tends to decrease over time.

In addition to this key monetary difference, there are a number of systematic forces that must also be highlighted before we can pursue our investigation of the 1 million dollar Bitcoin argument. These forces are inherent the Bitcoin blockchain and the way the ecosystem operates today. The supply of Bitcoin, the release of new Bitcoin into the market, and how computationally difficult it is to gain access to new Bitcoin all play an integral role in a new field that has emerged known as cryptoeconomics. I will highlight some key points about Bitcoin’s cryptoeconomic framework here for reference purposes.

Bitcoin supply. There will only ever be 21 million Bitcoin in existence. As of today, there are approximately 16.7 million currently in circulation, thereby leaving 4.3 million more Bitcoin to be released.

Rate of release of new Bitcoin. New Bitcoins are released as a reward every time a Bitcoin blockchain block is created. The rate of block creation is adjusted every 2016 blocks to aim for a constant two-week adjustment period (equivalent to 6 per hour.) The number of bitcoins generated per block is set to decrease geometrically, with a 50% reduction every 210,000 blocks, or approximately four years. It is currently estimated that the last Bitcoin will be released by the year 2140. (identify what the current release of BTC per block, currently to give some perspective)

Changes in Bitcoin Mining Difficulty. In order for the Bitcoin network to release more Bitcoin as well as write new transactions to the Bitcoin blockchain, encryption functions must constantly be solved. There are two main factors that affect this. These factors are known as difficulty and hashrate. This can get mathy very quickly and to avoid making this piece too technical, the general concept that needs to be understood is the more quickly that blocks are being solved for, the more difficult it is to mine the next block in the Bitcoin blockchain. When difficulty increases, the network generally requires more computing power, in the form of hashrate, to combat the increasing difficulty. The below Bitcoin Controlled Supply Timeline shows how we arrive at the max issuance of Bitcoin by approximately 2140 and adjusts for an increase or decrease in hashrate.

Some readers may be unfamiliar with the label on the x-axis. The Bitcoin block height is an expression of how many Bitcoin block precede the existing one. For example the first block or genesis block is considered to be 0.

Bitcoin Distribution

The distribution of Bitcoin is also a major point of discussion in the existing market environment. Bitcoin ownership is NOT evenly distributed. While Bitcoin was founded on the premises of libertarian undertones regarding wealth distribution and efficient decentralized flows of capital, there are a small number of wallets that hold in excess of 100 BTC. According to the Bitcoin distribution chart below, this concentration is so high that approximately 18,000 wallets hold just over 10 million Bitcoin (assuming that no Bitcoin has ever been lost, this represents 47.5% of all Bitcoin that will ever exist). At today’s price of $18,500, that means that $185 billion worth of Bitcoin is concentrated in somewhere close to 18,000 participants. (Note that is difficult to ascertain how many people are actually attached to these wallets as one person can have many wallets or conversely be “sharing” the custody of wallet)

BitInfo Charts

Stakeholders and Incentives

Now that we know more about the Bitcoin ecosystem, we need to talk about stakeholders and incentives. At their core incentives motivate individuals or organizations to partake in certain activities. And in the nearly 9 years that Bitcoin has been existence, it has managed to create a number of stakeholders, each of which have their own individual rationales for participating. This participation can be at the micro-retail participant to the larger Bitcoin Whale or financial institution.

Miners. The earliest adopters of Bitcoin were the miners. They run Bitcoin network nodes and validate transactions. In order to run a node they have a computer system that has the entire Bitcoin ledger downloaded to it. In addition to running a node, the miners run software that allocates computational processing power to solve an encryption problem for the next Bitcoin block that can be written to. The miners that find the next block are compensated in Bitcoin as a reward. Assumably, as long as Bitcoin has value, and the economics of mining work in the miners’ favor, there will be a healthy supply of miners. This graphic of Active Nodes in the Bitcoin Network show just how global the Bitcoin network is. And while it can be exciting to mine, it is not an effortless process as it requires maintenance and upkeep.

Retail Owner/Investor. Retail holders of Bitcoin can range from the young millennial to the older retiree. For the most part, they are investing and hoping for price appreciation. In the early days of Bitcoin, the stories of how people got involved with Bitcoin are laudable. For some they found out on social media, they played games that were settled in Bitcoin, and yes, some even participated in the Dark Web and engaged in illicit activities on the once notorious Silk Road. Today’s adopters, are more likely to have heard from mainstream media outlets. Regardless of how these retail participants started out, many have found that their hobby could have been a life-changing event.

Institutional Owners, Investors, and Traders. In the latter half of 2017 we have seen the explosive growth of institutional participation in Bitcoin and cryptocurrency at large. This asset class is new, sexy, promising, and befuddling to many non-techies. Regardless, it has caught the eye of larger banks, family offices and hedge funds. There have also been a number of cryptohedge funds that have launched further demonstrating that there is a specialized market opportunity for direct engagement in this digital asset space.

Photo by Chris Li

Additionally, there are a number of structured financial products that are launching to trade on the price of Bitcoin. While it is unlikely that a number of these financial players actually want to hold Bitcoin, they are showing quite an appetite to trade on it. The respective organizations that are providing these derivative instruments include the Chicago Board Options Exchange (CBOE), the Chicago Mercantile Exchange (CME), and the NASDAQ. The US is not the only player in this landscape as the Moscow Stock Exchange has made a proposal for trading Bitcoin Futures. For the time being The Russian-based product has been rejected pending the adoption of a regulatory framework.

There is also a push for Bitcoin to enter the highly coveted Exchange Traded Fund (ETF) market. Many Bitcoin bulls are frothing at the mouth in the hopes that a ETF market for Bitcoin will be launched. ETFs trade as conventional stocks on open markets and in order to list a Bitcoin ETF, many believe that the funds will need to hold Bitcoin to manage their fund thereby pushing demand for the token.

To many, these products represent the legitimization of the digital asset as well as promoting the token’s visibility. As these products and markets form, many believe that Bitcoin will continue to be highly volatile. If the price moves, you can bet the Wall Street and financial institutions in general can find a way to make money on it.

The Banks. When considering banks and financial service providers, Bitcoin and cryptocurrency stand to disrupt conventional business operations. According to Investopedia, the banking system functions by “accepting deposits from customers, raising capital from investors or lenders, and then using that money to offer loans, buy securities and provide other financial services.” If people are using Bitcoin and other cryptocurrencies to move their money essentially being their own bank, they are circumventing the usage of their banking institution for traditional banking needs.

Influencers and the Media. A number of Bitcoin and cryptocurrency influencers have arisen as it has become a fashionable way to gain notoriety on this hot-button conversation. The media loves a story, and Bitcoin has given them one they can run wild with. Whether it is Bitcoin’s mystique, the get rich quick angle, or the naysayers, as long as it is good for ratings, it is good for the media.

The Sovereign State and the Role of Government. It is not possible to overlook or underestimate the nature of sovereign states as it relates to cryptocurrency in general and especially Bitcoin. Each nation state whether they hold Bitcoin at an organizational level or not has been forced into this dialogue as Bitcoin has the potential to impact banking, capital controls, monetary policy, and even the law enforcement and national security. We have seen in countries that are experiencing hyperinflation such as Venezuela that Bitcoin has become part of the national conversation as the people there struggle to maintain a stable store of wealth and secure medium of exchange. Bitcoin has been a partial solution to that problem. And in the case of China, the country has maintained very tight capital controls that Bitcoin has poked a hole in thereby creating a financial regulatory enforcement issue there.

Of course, we can define additional stakeholders and interests of various shapes and sizes, but regardless of where these players fall in the ecosystem, Bitcoin has become a phenomena where it is nearly impossible not to take a stance. Not knowing more about this conversation is becoming socially reprehensible.

For the Bitcoin Bull to Run

There are a lot of Bitcoin bulls out there, but many of their arguments are either undisclosed or purely based on hype. Few of them are actually discussing barriers need to avoided or mitigated in order for Bitcoin to continue to thrive.

Favorable Regulatory Environment. Bitcoin and cryptocurrency need to remain in a favorable or at least permissible regulatory environment that does not curtail or stifle adoption and interaction with Bitcoin. The crypto industry hopes for fair and balanced regulation that will allow for continued growth of the larger blockchain-based cryptocurrency markets and the tech solutions that they are bringing to market.

Collaboration with Banks. Banks need to support transactions to companies such as Coinbase. If banks prohibit fund transfers to and from these institutions, they are effectively blocking the linkage between the crypto-financial and fiat-financial world. We have already seen a number of banking institutions globally that have limited or no relationship with cryptocurrency-based businesses.

Long-Term Technological Success. To date the Bitcoin network has not been hacked. Yes, there have been a number of hacks which have resulted in the loss of Bitcoin to individual users and companies, but more importantly, no fatal flaw has been acted on in the Bitcoin network. There is a Bitcoin network vulnerability called the 51% Problem, but it is very difficult to act on with out mass collusion from the malicious actors on the network or operationalized quantum computing assets that have not yet been built.

Institutional Support. Bitcoin is currently a sexy asset to talk about and trade. When people are making money they tend to be giddy and enthusiastic about their winner. If Bitcoin falls out of favor with institutional players, they will likely decrease volume in their newly created derivatives markets, sell off their actual Bitcoin holdings and effectively drive down the price of the asset.

Media Support. While Bitcoin is not a company, it has enjoyed an unprecedented amount of media hype, prompting people to learn more and in some cases consider adding Bitcoin to their retirement portfolio. Regardless, the more Media pushes the issue, the more people will be compelled to talk about it. The more people talk about it, the more they are likely to invest. If the media promotes fear in this space that is founded on actual loss, this could introduce a mass sell-off.

Photo by Gabriel Matula

Growth of Value-added Blockchain Solutions. There is an entire ecosystem of software solutions that are leveraging the technology which the Bitcoin network operates on, namely blockchain. As more and more production networks and applications are built on this technology, the unique crypto assets that these projects launch generally been promoting speculation and in some cases blockchain software-based interoperability.

Wide-scale Tokenization. There is an early movement to tokenize real-world assets. These can include physical property such as cars and real estate, but it can also include financial assets such as stock and bonds. As more and more assets are “tokenized” in some form of cryptocurrency in a legally binding way, there is a greater chance that Bitcoin and other cryptocurrencies can be used to transact with and on behalf of real world assets.

More Commercial Use Cases. We have seen a handful of companies accept cryptocurrency as a method of payment. These include Overstock.com, OkCupid, Tesla, Shopify and others. For a larger listing see 2017 List of Big Companies that Accept Bitcoin & Cryptocurrencies. We have already seen some high end real-estate and vehicles such as Lamborghinis purchased with Bitcoin.

Addressing the Scaling Problem and Transaction Costs. Bitcoin has a scaling problem. It is not unusual to see over 100,000 unconfirmed transactions sitting in the Bitcoin queue. Additionally, the cost to transact in the currency has seen a stark increase along with the price of Bitcoin. There are efforts underway to address this scaling issue, but it will take time before it is successfully addressed.

BitInfoCharts

Keeping Bitcoin Forks in Check. There have been a number of forks to the Bitcoin network. Most recently Bitcoin Cash and Bitcoin Gold were created as derivatives of the Bitcoin blockchain. Essentially, the change represents a split in the blockchain. To avoid getting too technical here, the more pressing financial implication is that these forks have created new currencies out of thin air. These new forms of Bitcoin have tradeable value. If you held one Bitcoin going into a fork you should have been able to gain access to a derivative token — Bitcoin Cash and Bitcoin Gold post-fork. This introduces a dilutive effect to the currency model. While it seems exciting, Bitcoin forks can be a contributing factor to the destabilization of the digital asset.

Photo by Leio McLaren

Mitigation of High Risk Market Areas. There are a number of high risk factors that have developed in the crypto markets that are either directly correlated with Bitcoin or affect the price movement of Bitcoin. My top three include

  1. Weak Initial Coin Offerings (ICOs) that are fraudulent and clearly unable to deliver on their technology builds and execution roadmaps
  2. Stable Coin Management. The transparency and effective management of stable coins such as Tether, that is pegged 1:1 to the US dollar, which now touts a market cap in excess of $1 billion
  3. Bitconnect. Perhaps one of the most aggressive pyramid schemes ever created, Bitconnect alleges to be a self regulated financial system that enables the staking of your actual cryptocurrency for the promise of insanely high returns as long as you keep your crypto staked with them and don’t take it out. Despite this business model seeming too good to be true, it has attracted a lot of attention, and is a highly ranked cryptocurrency with a market cap of over $2 billion as of December 2017.

A Quick Look at Metcalfe and Reed’s Law

In discussions Tom Budd, a Blockchain Advisor and Consultant, the notion of Metcalfe’s law has arisen on several occasion. The Law states that the value of a telecommunications network is proportional to the square of the number of connected users of the system (n2). Tom is honed in on the framing that if you look at Bitcoin and cryptocurrency adoption as one that mirrors the performance of that of a telecommunication network, it becomes more understandable to see the rationale for the price movement along with the increase in adoption.

One notable author and scientist David P. Reed who published the paper called “The Law of the Pack,” proposed that Metcalfe’s Law actually understates the value of Group-forming Networks (GFNs). Reed’s Law indicates that the utility of large networks, particularly social networks, can scale exponentially with the size of the network. Hence Reed’s law has also been used to better understand the adoption and utility of social networking like Facebook and Reddit. The adoption and participation in the Bitcoin network could over time largely hold true with the findings of both Metcalfe and Reed’s studies.

Illustration: Serge Bloch — via Thoughts-Illustrated

Once might see some similarities with these curves when compared with the growth of the wallets on Blockchain.info a very popular Bitcoin Wallet Company.

In Closing

While it may at first seem shocking that we have arrived at a Bitcoin price of $18,500, having a firmer grasp on the points discussed in this piece should better assist your understanding of the road not only of the $1 million dollar Bitcoin, but any increase in price from hereon-in. The crypto space has proved to move quickly and if either Metcalfe or Reed’s law holds true on the future of this financial revolution, then we are clearly at an inflection point in the story of Bitcoin and cryptocurrency at large. I’m not saying that Bitcoin will go to $1 million, $100,000 or any astronomical price from this point forward. I am merely stating that this issue is complicated, and it’s going to be exciting to see what happens next!

Photo by NASA

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