Remember 2018? Or 2017? Everyone was supposedly getting rich off of bitcoin and only YOU were missing out.

How time puts things in perspective. The current price of bitcoin stands at $3,364, down from an all time high of $19,891 reached on December 17, 2017, a drop of 83%. This drop was after a run up of nearly 2000% from the beginning of 2017 at which point, the currency really caught the world’s attention and the mania fully took hold. Coin miners set up computers in their basement and spent thousands on hardware and electricity to mine bitcoins. Exchanges sprung up overnight all over the world to meet the demand. Just as soon as it started however, it was over. A number of larger more efficient miners manage to scratch out a living in places like Russia or China but the days of the little guy getting instantly rich are gone.

Just as the dotcom crash of the 2000’s created an opportunity to pick up great names like Microsoft at bargain prices, could this be a new trough that we will look back on and say that bitcoin was steal then? The below chart in the drop of bitcoin looks eerily similar to the price of the Nasdaq index in the early 2000’s.

Bitcoin Price in USD

Source: google.com

Before trying to answer that question, I want to take a step back and ask a bigger question? Why is bitcoin worth anything and can we even consider it money, let alone an investment?

What is Money?

I will admit I was skeptical of bitcoin from the start for a few reasons, one because I am a natural skeptic, two because I had the fundamental question on is it even money and three because it wasn’t regulated at all, which left the door open for old school market manipulation.

To try to answer the first issue, think of the basic concept of money. According to prevailing economic theory, “money” has the following properties:

• Serves as a Medium of Exchange – Meaning it is widely accepted as a payment of goods and services. In the case of bitcoin this is a “kind of” yes answer. There are many places I am sure would not accept bitcoin but there is a community that accepts it as a medium of exchange that has grown over time.

• It Serves as a Unit of Account – Prices, bank balances, etc. can be quoted in the item we want to consider money. This is a yes for bitcoin as its price in dollars, or any other currency, can easily be converted to bitcoin.

• Not Easily Reproduced – In order to be accepted, people have to be sure that what their getting hasn’t just been created in someone’s basement from cheap materials. That would destroy the value of anything being used by money since almost anyone could create it. In this case due to the encrypted block chain technology, bitcoin checks this box.

Serves as a Store of Value – It has to reasonably maintain its purchasing power over time. This is in order to be able to gives buyers and seller flexibility in terms of the timing of purchases and sales. It also makes contracts and financial instruments based in the currency viable and efficient. Here is where bitcoin has failed lately.

This last point was key in my argument to friends and colleagues that bitcoin was not necessarily a money…yet. There needed to be some general consensus established around how to value bitcoin.

In terms of valuation, a lot of the discussion has hovered around the marginal cost of mining a bitcoin. This makes some economic sense, you can either buy a bitcoin for cash, or buy the computer and the electricity needed to mine one yourself. The price should settle around the cost to mine it in terms of hardware and electricity.

From the point of view of the small guy though, you have to take into account that bitcoin is a global currency and the price of electricity varies widely across the world. According to a study by JP Morgan, the lowest cost seems to have settled around those of some large miners in China who are able to directly negotiate cut rate electricity sold in bulk from aluminum smelters who experiment big swings in demand for electricity and therefore end up with excess power to get rid of.

The Hash Rate and the Potential Cliff

Additionally, the number of bitcoins which can be produced is fixed. As more of them are mined, the cost to mine more increases and this was much of the logic that analysts used to argue that the price would continue to gradually increase in the coming years. This is the so called hash rate. The increasing complexity of the blockchain as more coins are mined increases the computing power, and thus the marginal cost to produce another coin. As an example take a look at the chart that researchers at Wisdom Tree used to plot this theory.

Source: Wisdom Tree

Notice that’s a log scale on the left, nice.

At some point though, we will approach the fixed limit of coins that can be mined. Although this limit is not necessarily going to be reached for another hundred years, analysts expect that barring any dramatic changes, 99% of bitcoins will have been mined by 2027. Once almost all have been mined, I have not seen much discussion of how they will then be fairly priced as the marginal cost argument will pretty much has disappeared. Could the price then fall off another cliff?

My hunch here is that no one really knows so it is complete guesswork. If bitcoin even sticks around that long, which it may we’ll do since it just sits in the digital universe, how then will people value it? It’s a big question that remains. If we assume it’s viability, acceptability across the world and stability in price, I would think that the price would tend to grow more in line with inflation of the worlds major currencies, with some fluctuations for large political events or economic crisis. In this sense, I still believe it could act as a store of value similar to gold but the difference being that very little if any will be mined as opposed to gold miners who can stop and start operations that affect the global supply of gold.

The Potential for Duplication

Although bitcoin itself cannot be counterfeited as far as I am aware, there is the real possibility of very similar alternatives popping up, which is exactly what we saw with the imitators like ethereum and litecoin. The mania hit the ceiling when celebrities like Paris Hilton and Floyd Mayweather started issuing their own bitcoins and cashing out via initial coin offerings or ICO’s.

In this sense, the crypto world is acting much like a country with competing currencies. Although one or two may dominate, there is no limit to smaller players coming along and issuing their own which may also be used. Why buy bitcoin when ethereum or litecoin is just as secure and doesn’t inflate like cash?

In the US we had this phenomenon in our past as banks issued banknotes before there was a widely circulated national currency. Once a national currency was issued and recognized, bank notes were outlawed and disappeared.

I don’t think the less popular crypto currencies will disappear but the irony of part of the point of bitcoin: to create a decentralized currency with no government control that people actually use, it may have to be recognized by most world governments as a legal medium of exchange.

Conclusion

There are a number of benefits to having a decentralized truly independent currency: governments in places that may be hostile to its people’s money (which gives them their own personal power) cannot necessarily get their hands on it, or countries dealing with high inflation can offer an alternative store of value for its people. For these people the freedom of bitcoin and crypto currencies can help to keep profligate governments in check and help keep them in line if people have an easy viable alternative.

But price stability is going to be key, and if there is a drop off in new coins no one knows where that is headed? Invest in bitcoin? Only if you weigh the possibility that it may fall out of favor as well as be worth something in the future. Which is just speculation in my book.

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