We’ve been working on accepting Bitcoin for gruvr tickets, so an explanation of bitcoins is in order.  When friends then ask whether bitcoin is a good investment, the answer tends to unreel slowly and get tangled.  What is bitcoin, and how valuable are they?

Bitcoin is the first successful implementation of a virtual currency, and is attracting attention due to its early application and rapid price rise, from a around $3 to 75  in months.

In the past year bitcoin has seen lots of progress.  People are debating whether distributed cryptocurrency technology will succeed, speculators are daytrading the coins, and investors wondering what price to expect.    Can a virtual commodity have any inherent value, especially as a currency  cannot be controlled and isn’t “backed” by any goverment?  Is the recent rise just a bubble, like the  brief 2012 peak of $32, destined to pop and head to zero again?

Equities are often evaluated for long-term investment by analyzing the ‘fundamentals’ of the business represented by a stock and any news impacting the company. Technical analysis of stocks examines the chart, or price pattern, which also is generated by traders’ reactions to fundamentals and news. Bitcoin isn’t a stock, but let’s see what happens if we pretend it is and apply similar reasoning to come up with valuations – long term targets, and present value.

Modern currencies are tokens  tied to a value by a government which issue decrees to establish the token as the official intermediary – so called ‘fiat currency’.   Without such decree, nothing would ensure the tokens are universally accepted.   Fiat currency tokens exist in cash and virtual form. Cash may be exchanged anonymously in person, but online exchanges of fiat currency require financial intermediaries like banks to execute and record payments.


Innate value of virtual currency.

The inherent value of any paper token is negligible, but the issuing authority may also tie it to a material like gold.  This ‘backing’ has the effect of limiting the rate at which tokens are created.   But what does it mean for a government to ‘back’ a currency, when the same authority can also dilute the value of existing tokens by creating more at will?

Since fiat tokens cannot by themselves record who owns them or changes in ownership, they require an intermediary, e.g. a bank, to keep a ledger and authorize transfers. Financial intermediaries thus perform the function of reliably recording transfers – at a cost.

By contrast, Bitcoin is a virtual commodity.   By design , it may be exchanged securely and anonymously,  directly between peers. No central intermediary is used in a transaction.   Once the network confirms a transfer of bitcoin, it’s impossible to undo a  or counterfeit a payment.   It is also unfeasible to trace the identities of the parties, as everything about each bitcoin is represented numerically.

The inherent value of a bitcoin arises from its innate ability to perform the banks’  function:   reliably recording transfers of value. Yet bitcoin does so without national boundaries, risk of arbitrary dilution, without forcing users to reveal personal information.   For free!


Estimating the raw value of bitcoin

What value  can we assign to tokens that perform the same function as banks?

Even ‘virtual’ bitcoins do have a physical form, albeit as a pattern of electrons in silicon.  Electrons are much easier to transport than gold, are not subject to destruction by acids, and don’t need to be trucked around and stored in vaults.

Like precious metals, bitcoins are in limited supply due to laws of nature:  they are anchored to computation of increasingly large and difficult hash values.

A ‘bottom up’ valuation would be to tally all costs of issuing and carrying coins, plus other overhead costs embedded in transfers of fiat currency.  Each bitcoin transfer yields some savings due to the lack of overhead costs of managing the currency supply, so its innate value is like the face value of a reusable discount coupon.  As a simple example:  do 1000 wire transfers of $USD and you’ll pay perhaps $20 each.  Do the same transfers using bitcoin,  and you’ll have saved the same $20,000, plus other costs arising from regulation, taxation, and bank operations.  Hence bitcoins are worth at least as much as they save in overhead costs.


Projecting bitcoin demand by vertical industry 

A more ‘top down’  conjecture is to imagine cases in which bitcoin use is adopted by additional industry segments, and ask “what if  bitcoin were used for x% of the total transactions for, say, online gambling?”   The parties in these transactions must acquire  the equivalent amount of bitcoin to effect these purchases.   We’d  take the net value that bitcoins would represent, and divide by the number of bitcoins actively in circulation,  to get a magnitude estimate of the necessary bitcoin price.

Rick Falkvinge of the Swedish Pirate party reasoned along these lines, using long term scenarios where Bitcoin represents some part of national economy GDP.   Similarly, Max Kaiser conjectures that bitcoin could take over 1-10% of Forex trades. Either scenario requires a price per bitcoinof  between $100,000 and $1M.

In the coming years we can make educated guesses about industries where adopting virtual currency would make sense, and project the impact of further adoption by the contraband and gambling industries where use is already spreading.   What would bitcoin price have to be to support, 1% of Amazon.com transactions?  How about 1% of airline ticket purchases?     Considering 1% of a multi-billion industry makes calculating easy: assume 10M bitcoins in circulation,  which is is 1% of 1 billion.  For the 10 million bitcoins to represent 1% of a $1 billlon market, their price would be $1 per bitcoin; $1BTC.  For 1% of a $100B market, it’s $100/BTC, and so on.


What follows is a handful of example cases.  I’m sure readers will come up with their own.


Example Cases

  • Drugs

The obvious place to start is with the early adopter markets: porn, drugs & gambling.  What if sites like Silk Road continue to grow to service over 1% of the global transactions for illegal drugs?

Silk Road is already doing over $22M in 2012 annual sales and growing rapidly.   The number of sellers doubled in 6 months.  Revenues grew from zero to about $2m revenues monthly – with no advertising, and no way to shut it down in sight.


Let’ say this growth continues by doubling revenues each year.  In 4-5 years, Silk Road (and similar sites) will have captured 1% of a $100 billion market for illegal drugs (estimates vary widely) worldwide.

To handle just this 1% of drug transactions, the price of bitcoin would have to add around $100 to $200.


  • Gambling

The next early adopter of bitcoins has been online gambling.  The currency is a perfect fit for many reasons.  Two early bitcoin gambling sites are already earning over $1M/year.    For bitcoin to be used in 1%  of the annual $417 Billion spent on online gaming, its price must add another $417.


  •  Wire transfers

It’s free to transfer bitcoins across national boundaries, as opposed to paying fees to Western Union.  Western Union does $81 Billion in transfers annually, which is only 18% of a $450 billion market.    Western Union is already aware of bitcoin, and looking at using virtual currency to do transfers more efficiently. It shouldn’t be hard to migrate an existing money transfer system to use a much simpler, faster, and free virtual coin.   It should also be much faster to simply build on existing bitcoin system than to spend years designing some proprietary coinage for internal WU use.  And if WU radically reduces their costs and improves their service, competitors will need to follow suit to stay alive.  What if bitcoin were to be used for just 1% of global wire transfers?   By our rule of thumb, facilitating the $45 billion in transfers would add around $450 per bitcoin based on the additional demand.

  • Air travel

The airline industry operates on razor-thin 0.6% profit margins, with cutthroat competion around efficiency.  They certainly deal with international payment processing and credit.  It’s possibly a competitive advantage to accept bitcoin payments.   About $650 billion is spent annually on plane tickets.  If 1 % of that were in bitcoins, the price of each bitcoin would need to add $650.


  • Online retail sales

Amazon.com and Ebay combine to generate about $65 billion annually in sales.  Amazon in particular is known to operate with razor thin margins and ruthless focus on efficiency.  It’s easy to imagine bitcoin being adopted for 1% of Amazon and Ebay purchases.  If so, it would require another $65 per bitcoin.


Other interesting markets include event tickets and their resale,  online outsourcing by sites like elancer and odesk.com.


Here’s a chart combining these conjectures to yield Bitcoin prices at the 1% adoption level for the above industries, in the nearer term:

Note that the totals on the bottom line represent bitcoin price projections if all of the example industry applications in the column above come true.

This is my attempt to suggest a way of assessing an innate value for bitcoins as well as conjecturing about possible future values, based on hypothetical industry adoption scenarios.  In most any combination, though, of a subset of these “1% adoption” scenarios, the BTC price ends up well above the $1000 mark.

I know that many of you will have different ideas!

This post is currently in rough draft form, so feel free to comment below with your input, and I may revise this after initial review before sharing it further.

What do you think?







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