Musing on transactions cost

or how to think about Bitcoin.

In the end, there is no free lunch when we talk about transactions cost.

Consider Bitcoin as a digital equivalent of gold. We don’t know the price of gold a hundred years out because we reckon that price in terms of fiat, and there’s no way we can predict what central banks will do. We could try to measure the value of gold in terms of man-hours, but still that won’t work because we have no idea what technological advances will take place (that’s in the realm of the unknown unknown), or even which fiat currencies will be around to use as a benchmark.

Ergo, we won’t know what the price of Bitcoin will be a century hence. If we don’t know that, then we don’t know what’s the ‘correct’ price of Bitcoin today. This is just a consequence of using a present-value calculation (the uncertainty on the proper discount rate is not even material).

What we do know is that Bitcoin has had a run-up in price because the players behave like a collective Ponzi. Imagine if the Ponzi players got enamored with gold the way they have with Bitcoin. Not so far-fetched, is it?

There is a difference, of course. Gold is a commodity with ‘intrinsic’ value as jewelry. Unless humans suddenly decide gold has no worth at all, the jewelry component will set a floor to the gold price.

Bitcoin, once mined, is just that: a digital bit sitting in a thousand computers. You can’t eat it, wear it, etc. You might argue that it cost a miner $1,000 to get his Bitcoin, but that’s just sunk cost. It doesn’t guarantee a price that the next guy will pay.

But an even greater difference is this. Anyone else can cook up his Bitcoin wannabe. If he succeeds, then you have an ‘alt coin.’ If you cook it up from an existing alt coin, it’s called a fork. Theoretically, you can then have an infinity of forks and alt coins. In practice, you need a society of nuts willing to see a particular alt coin as money. How many in this society? I don’t know, but a good guess is 1 million. With global population at 7.6 billion, we might have 7,600 alt coins. No wonder, every Ponzi-loving geek goes out to try his luck. Lots of suckers out there still.

What this means is a ceiling on the Bitcoin price, analogous with the floor on gold. Where is that ceiling? Only the god of Ponzis knows. Individually, alt coins including Bitcoin will fluctuate according to the vagaries of sentiment. If an alt coin’s underlying ‘consensus’ mechanism, which is human psychology and not a matter of algorithms, gets compromised, that alt coin will crash. Kindleberger wrote the books on manias and crashes, and he would say that all assets are susceptible.

Can Bitcoin have a floor? If you start from zero, and if everybody deserts you, that floor is zero. (How many penny stocks have come to naught?)

Can Bitcoin (or any alt coin) have a stable non-zero equilibrium price? Bitcoin started out billed as an alternative to fiat, and perhaps it may run a very long run equilibrium if, collectively, Bitcoin users are convinced that their Bitcoin is worth a certain (stable) amount of fiat. This would be paradoxical. You end up holding Bitcoin as just another form of fiat. As it is, the transactions cost of using Bitcoin is on par with that of fiat. So, why bother?

Unless, of course, you think you can still play the Ponzi.

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