Bitcoin – How Low Can We Go?

As the price of Bitcoin continues to fall (which still isn’t the point, by the way), some may find themselves wondering – where will it bottom out? Is there a point at which the fall will stop itself? As it happens, this is an interesting case study of the value of a currency in an inflationary market.

Normally when this happens to a currency, it’s because of a rush of liquidity: a central bank has printed an enormous amount of money, and injected it into an economy with a high velocity of money. This produces a runaway effect in which people, watching the value of their money drop, become more likely to sell it in the future, leading to a further drop in value, etc, etc.

In the case of Bitcoin, there’s been no sudden rush of liquidity – a bubble of speculation has simply burst, and the price is following to more closely resemble an actual market equilibrium – which leads to the interesting question: Where does that equilibrium lie?

First, let’s make some assumptions. We are imagining a future world in which nobody has any interest in hoarding Bitcoins: nobody believes that they are going anywhere, but down in the future, so they buy only enough Bitcoin to make the purchases they want to make in the immediate future. The price of Bitcoin is entirely set by simple demand and supply: how much Bitcoin people want to spend for goods and services in a given day, and how much Bitcoin exists. We’re also going to be trying to establish a lower bound: there’s going to be some guesswork involved, so, when we have to pick, we’re going to choose the more pessimistic figure. The result is a figure that may wind up being too small by a factor of several, but will give us an idea of the order of magnitude of the answer. We’re also going to assume that the same loss of faith in Bitcoin will apply to all other altcoins as well: we’re only interested in the price that is sustainable via the Bitcoin demands for tangible goods and services, meaning that we can’t use the statistics from Bitcoin exchanges to bolster our numbers.

Let’s get started. A good proxy for the total number of Bitcoins being spent on goods and services is the total traffic going through the two largest Bitcoin payment processors, Coinbase and BitPay. Commerce is, of course, done elsewhere (this doesn’t include Bitcoin payroll for businesses), but the two together do probably make up more than half of the total business done: all of the largest Bitcoin merchants do their business through Coinbase or BitPay.

Unfortunately, both of these businesses are pretty cagey about their exact business figures. The good news is that, by reading between the lines, we can make a pretty good guess. For example, we know that BitPay made $100 million by the close of 2013. We also know that they made $3 million worth of transactions in 2012. As the company was founded in 2011, it seems reasonable to guess that BitPay did at least $94 million worth of transactions in 2013. Coinbase has not released similar figures, but both parties do state the number of merchants they partner with: “Over 30,000” for BitPay,  and “31,000” for Coinbase. If we assume that the average total payments processed per merchant are similar, it seems likely that their incomes are pretty similar. We’ll just go ahead and call both of them $100 million/year businesses, or $300 million/year total, leaving a generous 50% margin for all “goods and services transactions” that don’t occur through those two payment processors. In reality, these figures are probably somewhat higher, as growth will almost certainly continue into 2014, but it’s difficult to put a magnitude on that growth, so we’ll leave it alone and just assume that the $300 million figure will hold for 2014.

$300 million would make up only about 5% of the approximately $6 billion Bitcoin market cap at current ($474) prices. In other words, if 95% of aggregate demand for Bitcoin is speculative, and goes away, given our conservative assumptions about the price, we can set a lower price bound of $23.00 before natural market forces will stop the price from falling further.

Let’s sanity check that figure. During the same time period (2013) that our approximate figures on BitPay and Coinbase traffic came from, our colleagues at CoinDesk figured out how much traffic was represented by the top three Bitcoin exchanges. Bitcoin exchange traffic is going to be largely speculative buying and selling (plus trading for altcoins) – very little “goods and services” commerce would be represented. At the time, the top three exchanges (Mt. Gox, Bitstamp, BTC-e). made up 93% of the Bitcoin market cap, leaving 7% unaccounted for, in which our 5% estimated real commerce fits comfortably.

Will Bitcoin actually fall to that $23.00 level? Probably not. Odds are pretty good that our assumption that neither BitPay nor Coinbase has grown in 2014 is just plain wrong. Overstock, Dell, and Newegg all happened in 2014 – the real values could be several times higher. It’s also unlikely that people will completely lose interest in hoarding Bitcoin and various altcoins. This is likely a pretty low lower limit, but it does give us an idea of where the market equilibrium likely lies, and just how unsustainable current Bitcoin prices actually are.