Asset valuation and, in particular, Bitcoin valuation is hard. Although Bitcoin is empirically one of the best investments of the past decade, it remains controversial. It has simultaneously been compared to the internet revolution and to the Tulip bubble. Bitcoin is an experiment; failure is still possible.
What if Bitcoin succeeds? How much will it be worth 10 years from now?
Investors have well-established frameworks for evaluating assets like equities, credit, and real estate. Yet there is no clear framework for Bitcoin. My opinion is Bitcoin could have an enormous upside if it catches on. In this article, you will learn why Bitcoin could hit a $1M valuation by 2030 if the adoption continues to grow.
- Supply/demand balance of commodities such as oil and gold
- Supply/demand balance of Bitcoin
- Price prediction of Bitcoin: 3 scenarios
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The supply/demand balance of commodities
The first step of asset valuation is to understand fundamental economics. Equities, bonds, and real estate derive their value from cash flows (and future cash flows). Whereas commodities (such as oil, gold, or bitcoin) are utility-based, and their price depends more on supply and demand. No clear framework exists for them.
Oil supply/demand balance
Oil price is the balance between supply and demand. If the demand increases, you can expect the price to increase as well. If demand drops, price drops. The same goes with supply (in the opposite direction).
Human civilization requires a certain number of barrels of oil per day to function. That number can be estimated. On the supply side, it costs a certain amount of money to get the oil out of the ground (depending on the technology used, localization, and taxes). If it costs $50 to get a barrel worth of oil out of the ground, then the long-term oil price can't really go below that level for too long. If it does go below that floor price, oil companies will go bankrupt. Supply will decrease, and the price will correct back toward a new equilibrium level.
In the past months, because of Covid-19, the oil demand dropped (no planes, cars, less energy consumption in general) while the supply stayed the same. Oil price dropped.
The price stayed so low for so long that some oil producers could not cope with it and went out of business. The oil supply decreased, oil prices corrected and started to increase again.
The demand is still low; however, it is increasing. As more and more countries go out of lock-down. And with the vaccines coming, we see the end of the tunnel. Ultimately, my bet is the oil will not only get back to the previous level but also surpass them. Remember: Some oil companies went out of business, so the supply is lower than before the crisis. The demand is getting back to normal.
What applies to oil also applies to silver, gold, and bitcoin.
Gold supply/demand balance
Gold, unlike oil, is not consumed nor destroyed. Gold that existed thousands of years ago still is in circulation today. The global reserve of gold is, therefore, constantly increasing. For the price of gold to stay constant, you need a demand that matches the supply. There are two sources of gold supply:
- 75% come from gold mining. Approximately 2,500-3,000 tonnes per year.
- 25% come from recycling, most of it comes from jewelry.
According to the World Gold Council, about 175,000 tonnes have been mined since the beginning of existence. The new mining represents an inflation rate of the gold supply of about 1.7% per year.
The average inflation of the U.S. dollar is about 2-3% per year.
Bitcoin supply/demand balance
Bitcoin supply is different: it is predictable. It is set in stone and won't change even if most miners go out of business.
Bitcoin supply is halved every 4 years. No matter what. We can compute Bitcoin current and future average inflation rate and plot it against gold:
On May 11, 2020, the last Bitcoin Halving dropped Bitcoin's inflation rate from 3.6% to 1.8% and will soon cross gold's inflation rate. What does it mean? Bitcoin supply will grow slower than the gold supply.
As we've seen, scarcity is one of Bitcoin's (main) feature. There is a fixed supply of bitcoins that can ever be mined. Currently, there are over 18.5 million bitcoins in existence, and the theoretical limit is 21 million. There will never be more than 21 million bitcoins. Think about it: this is, at most, 0.003 bitcoins per human being.
This is key. Even gold does not share the same property: every year, tons of gold is mined. Yes, there is a limited supply underground, but there is also an unlimited supply in space. You think I'm joking? Look what NASA found.
Price prediction of Bitcoin: 3 scenarios
Bitcoin has significant headroom if it continues to gain broader acceptance. How big can it grow? I based my estimates on the current worldwide value of all mediums of exchanges and stores of value comparable to Bitcoin.
Let's dive into 3 different scenarios (by increasing order of optimism).
Future Bitcoin price if considered a store of value
The first milestone Bitcoin will reach the store of value status. Bitcoin does not have the history of gold as a store of value. However, do you imagine millennials buying and storing gold as some older generations did? Would they rather own Bitcoin instead? It certainly is easier to store, transport, buy, and sell. Gold does not have more reason to be considered a store of value as Bitcoin has.
For this first scenario, we compare Bitcoin's market size to gold's. Gold aggregate value is estimated to be nine trillion dollars (December 2020). If Bitcoin achieved that capitalization on a base of 21M coins, each coin would be worth ~$420,000.
Beyond complementing gold's investment demand, Bitcoin may also address broader store of value markets indirectly. Consider various collectibles like art or gemstones, some of which are owned primarily as stores of value. Or consider the empty NYC apartment owned by a foreigner interested in storing value outside his or her native country. Bitcoin could plausibly address subsets of these behaviors more effectively. As it is difficult to estimate, we don't include it in our scenario.
Bitcoin offers many more possibilities compared to gold. So, what are the next steps?
As you know, it is difficult to use gold as a medium of exchange. Transporting gold on the street to buy goods is impractical. However, using Bitcoin is entirely feasible. Therefore the market demand for an asset such as Bitcoin could vastly exceed gold. Especially given the prevailing direction of global monetary policy.
Future Bitcoin price if considered as money/medium of exchange: M1 money
The money supply is broken into different buckets: M0, M1, M2, and MZM. M0 refers to currency in circulation. M1 is M0 plus demand deposits like checking accounts. Since M1 is readily accessible for use in commerce, we consider this bucket as a medium of exchange. It includes:
- Physical currency (coins and banknotes)
- Demand deposits, travelers' checks, and other checkable deposits,
- Negotiable order of withdrawal (NOW) accounts
The global M1 Money stock by region is about:
40 trillion dollars is a conservative lower-bound for global M1 Money stock (which includes M0). If Bitcoin were to achieve a 10% market penetration as a medium of exchange, its market capitalization in today's money would be 4 trillion U.S. dollars. It would lead to a $190,000 price increase per bitcoin. So about $610,000 per bitcoin.
Future Bitcoin price if considered as Money of Zero Maturity
The money of zero maturity (MZM) is an even broader bucket. MZM has become one of the preferred measures of the money supply. It represents money readily available for spending and consumption. It includes:
- Our previously defined M1 money
- Savings accounts
- Money market funds
The global MZM Money stock by region is about:
100 trillion dollars is a conservative lower-bound for global MZM Money stock. If Bitcoin were to achieve 10% of this total estimate for the global value of mediums of exchange and store of value, its market capitalization would reach 10 trillion U.S. dollars. If Bitcoin achieved that capitalization on a base of 21M coins, each coin would be worth ~$920,000.
None of the above account for the dollar's inflation rate, which is about 2%-3% per year. It will easily bring the valuation to more than one million dollars per bitcoin.
"All models are wrong, some are useful." – George Box (Mathematician)
It is important to understand our framework's variables. From our model it is possible that Bitcoin's price will increase by orders of magnitude. But it all depends on Bitcoin's level of adoption: The most important question is: "Will people use Bitcoin?"
- What price will Bitcoin reach?
- Is Bitcoin the new Gold? Understanding Bitcoin and the history of money
- Money Zero Maturity (MZM)