The price of bitcoin is determined exactly like stock prices
Stock prices are anchored to the expected discounted present value of firms’ profits. Bitcoins have no anchor. Think of it this way: If the market went crazy and valued Apple at zero you would do very well to buy the entire company for $1000. But if the market decided to value Bitcoins at zero, you would not want to buy them all up for $1000.
My understanding was that it started as a minor bubble in tulips, expanded into a massive bubble in tulip contracts, then collapsed massively. Is that different?
Stock prices are anchored to the expected discounted present value of firms’ profits.
By the same mechanism by which bitcoin price is anchored to the expected discounted present value of the goods and services you can buy with them. And since there are goods and services you can buy with bitcoin that value is no more nor less arbitrary than the profits generated by some company (maybe not Apple).
Nice try but this approach is consistent with bitcoin having many, many different possible prices including price=0. Think of it this way, if I create a company that does everything Apple does I’m a billionaire, but if I invent a cyber-currency that does everything Bitcoin does I have nothing of value.
I seriously don’t get it. If I have a company that makes products nobody wants, I also have nothing of value. Are you claiming that Apple products are inherently valuable? I don’t see that. Apple get’s money because people want their products and bitcoins have value because people want them. And the price of both Apple stock and bitcoin is determined by how many people want to buy and hold them in expectation of future profits.
If I have a company that makes products nobody wants, I also have nothing of value.
This is not true. Your company, presumably, has some assets—maybe a factory, maybe an office building, maybe some inventory, likely some cash in a bank account, etc. If you were to shut down the company which makes products nobody wants and sell its assets, you would end up with some sum of money. This is the company’s residual value or (assuming the accounting is broadly in line with economics and you’re not selling at firesale prices) its book value.
And some liabilities. Apple e.g. in 2013 had 8.71B cash + 1.76B inventories and 16.96B debt. So if suddenly nobody wanted Apple products anymore, guess what the shareholders would get.
According to Yahoo! Finance Apple’s total assets are about $200B and their total liabilities are about $80B. (Or were in late September 2013, the latest for which they give figures.)
(Curiously, the figures there match yours for inventory and debt, but they give a much larger figure for “cash and cash equivalents” than yours. But as the totals indicate, the numbers you mentioned are very far from telling the whole story.)
So, it looks as if Apple has about 6 billion shares, and their net assets minus liabilities are a bit over $100B. So if people suddenly stopped buying their products (in some way that didn’t change the value of their assets, which would be a bit hard but never mind) then each share would be worth about $17.
[EDITED to fix an idiotic factor-of-1000 error; oops. Thanks to Lumifer for pointing it out.]
Of course. It’s perfectly possible for a company to have zero or negative book value. Your Apple numbers are quite a bit off, though—look here for example.
The issue, however, is not what the price is determined by—for all tradeable goods in a more or less free market the price is determined by supply and demand and, yes, it is true for both bitcoin and AAPL shares, but it’s also true for tulip bulbs and old baseball cards. The issue is that you said that that bitcoin prices are “anchored” in the same way the equity share prices are anchored and I don’t think this is so.
That only puts an upper limit on the price of a bitcoin. The lower limit is set by what they are useful for, and how much more useful than the 500 or so other cryptocurrencies: transactions and contracts with security and anonymity properties that ordinary money does not provide.
I don’t understand what does “anchored to a cost” mean.
In crude terms, things have value and they have a cost to produce. If the value is above the cost, more things like that will be made. If the value is below the cost, no one will make these things. Nothing in that speaks to “anchoring”—the cost does not “anchor” the value.
Bitcoins certainly have a cost to produce (and it’s growing, by design), just like gold. If the value of bitcoins falls below that cost, no one will produce new bitcoins any more.
If there is a fixed cost to produce something, then if the value ever moves above the cost, more will be produced until the value falls to the cost. This means that the value is anchored to the cost. Bitcoins do not have a fixed cost. It would be more accurate to say that the cost of bitcoins is anchored to the value.
This means that the value is anchored to the cost.
Wouldn’t it be capped by the cost (+usual profit)? There is nothing about the cost of production that prevents the value from falling below the cost and all the way to zero.
Bitcoins do not have a fixed cost.
Why not? It’s not hard to calculate the cost of production (cost of hardware and electricity) for bitcoins. That cost changes with time, but that’s normal for most everything.
Wouldn’t it be capped by the cost (+usual profit)?
That probably would be a better term. I should add that I haven’t been educated much in economics, and if “anchor” is economic jargon, I don’t know it. I was just going by the normal use of the term and the context to guess what the OP was trying to say. Also, pointing out that it’s only anchored from above pokes a hole in the OP’s comment, but since someone else already addressed that I didn’t bother.
Why not?
Bitcoins are produced at a rate that halves every two years. It doesn’t matter how much effort you put into mining them. Putting more effort into bitcoin mining does not increase the amount of bitcoins, and thus does not decrease the price. The price is not dependant on the cost to produce. On the other hand, if the price doubles, then people will put twice as much effort into mining them, and the cost to produce will double. The cost to produce is completely dependant on the price.
No, I’m using words in standard meanings: “anchoring” means limited to the vicinity of a particular place or value, and “capped” means can go down but cannot go up above a certain limit.
The price is not dependant on the cost to produce.
Yes, under the assumption of many separate agents. However people can cooperate if there are sufficiently large incentives for that and there’s no anti-trust authority to stop them in the Bitcoin world. One mining pool already got over 50% of world capacity at one point—it quickly backed down for obvious reasons, but my first guess at an attractor point (equilibrium in econospeak) would be a duopoly where two mining pools control most of mining and they may or may not collude.
How are you suggesting they manipulate prices? While there are a number of security flaws, none of them allow counterfeiting. You can’t increase the supply beyond what it should be no matter what you do. You can destroy bitcoins by sending them to invalid accounts and cause deflation that way, although I have no idea why you’d want to. You could get over 50% of mining capacity and frequently use it for the 51% attack, causing people to lose trust in bitcoins and making the price fall, but again, it’s not going to help you.
Not prices, but the cost of production. With increased prices normally you would have increased mining efforts which, through competition, would make cost of production rise towards the price. If you control the amount of mining, you can avoid that and keep the mining effort at the same level. Your profit (price—cost) then stays high.
First, the cost to produce them is greatly influence by how many people engage in mining which is itself determined by the market price of bitcoins, meaning that by this metric there are multiple equilibria.
Second, for any fiat money there is always an equilibrium with price=0.
Second, for any fiat money there is always an equilibrium with price=0.
That’s not technically correct. If the athourity issueing the fiat money collects taxes than that creates demand for it up to the amount required to pay outstanding tax bills (ie 1% of land value in the case of a property tax). Since property doesn’t produce fiat money itself property owners need to sell goods or services to get money.
So there are low equilibria for fiat money, and unstable equilibria for fiat money, but zero is typically not a natural equilibria
No, that does not apply to gold. The cost to produce more gold is influenced by how much people have engaged in mining in the past, and thus extracted the low-cost gold. If everyone but you stopped mining gold, the cost for you, personally, to produce as much gold as was previously being produced would be approximately the same as the cost everyone shared before. If everyone but you stopped producing bitcoin, it would be much, much cheaper for you to produce just as much bitcoin as previously.
Gold is not bitcoin. There are differences obviously. But there are analogies too.
For one the effort to mine a bitcoin intentionally rises by how much people have engaged in mining in the past.
I’m pretty sure the effort (processing power) required to mine a bitcoin is independent of the history of mining, and depends exclusively on how much processing power is currently being spent trying to produce bitcoin. Unless I’ve drastically misunderstood the algorithm for difficulty, which I’m relatively sure I haven’t (thinking of this page specifically).
The consequences of this seem obvious to me; bitcoin is only difficult to acquire when it is perceived as worth acquiring, meaning that a loss of confidence that it has value leads directly to it being much easier to acquire even without having to purchase it from people who have lost confidence.
What you seem to mean is the cost due to competition: Multiple miners trying the same block and the first one succeeding making all the work of the other mineres on this block worthless.
I meant the increase in difficulty for later blocks inherent in the algorithm.
One could—though I agree that it stretches the analogy—compare the first to gold miners competing in the same physical location—as has happened during the gold rush. This causes competition not exactly for the same gold veins but for the physical space and other resources around.
The second (algorithmical) increase can be compared to mines becoming sparser and sparser—you have to dig deeper.
I’m pretty sure the effort (processing power) required to mine a bitcoin is independent of the history of mining
The bitcoin supply is limited by design and as you approach the last bitcoin which could be mined, the effort needed increases. That makes the effort needed dependent on the “history of mining”, or, more precisely, on how many bitcoins have already been mined.
Stock prices are anchored to the expected discounted present value of firms’ profits. Bitcoins have no anchor. Think of it this way: If the market went crazy and valued Apple at zero you would do very well to buy the entire company for $1000. But if the market decided to value Bitcoins at zero, you would not want to buy them all up for $1000.
At least with tulip bulbs you can, like, grow tulips.
In five years the go-to example for speculative bubbles that popped might be bitcoins rather than tulip bulbs.
At least some recent research suggests that the Dutch tulip bubble was in fact a tulip contracts bubble, which expanded when legal changes converted commodity futures contracts to options and collapsed when authorities halted trading.
Is there an important difference between a tulip contracts bubble and a tulip bubble?
Sure, there’s the question of whether any actual tulip bulbs were exchanged.
My understanding was that it started as a minor bubble in tulips, expanded into a massive bubble in tulip contracts, then collapsed massively. Is that different?
By the same mechanism by which bitcoin price is anchored to the expected discounted present value of the goods and services you can buy with them. And since there are goods and services you can buy with bitcoin that value is no more nor less arbitrary than the profits generated by some company (maybe not Apple).
Nice try but this approach is consistent with bitcoin having many, many different possible prices including price=0. Think of it this way, if I create a company that does everything Apple does I’m a billionaire, but if I invent a cyber-currency that does everything Bitcoin does I have nothing of value.
I seriously don’t get it. If I have a company that makes products nobody wants, I also have nothing of value. Are you claiming that Apple products are inherently valuable? I don’t see that. Apple get’s money because people want their products and bitcoins have value because people want them. And the price of both Apple stock and bitcoin is determined by how many people want to buy and hold them in expectation of future profits.
This is not true. Your company, presumably, has some assets—maybe a factory, maybe an office building, maybe some inventory, likely some cash in a bank account, etc. If you were to shut down the company which makes products nobody wants and sell its assets, you would end up with some sum of money. This is the company’s residual value or (assuming the accounting is broadly in line with economics and you’re not selling at firesale prices) its book value.
And some liabilities. Apple e.g. in 2013 had 8.71B cash + 1.76B inventories and 16.96B debt. So if suddenly nobody wanted Apple products anymore, guess what the shareholders would get.
According to Yahoo! Finance Apple’s total assets are about $200B and their total liabilities are about $80B. (Or were in late September 2013, the latest for which they give figures.)
(Curiously, the figures there match yours for inventory and debt, but they give a much larger figure for “cash and cash equivalents” than yours. But as the totals indicate, the numbers you mentioned are very far from telling the whole story.)
So, it looks as if Apple has about 6 billion shares, and their net assets minus liabilities are a bit over $100B. So if people suddenly stopped buying their products (in some way that didn’t change the value of their assets, which would be a bit hard but never mind) then each share would be worth about $17.
[EDITED to fix an idiotic factor-of-1000 error; oops. Thanks to Lumifer for pointing it out.]
That’s billions (thousands of millions), not millions.
Apple’s book value per share is about $20.
Of course. It’s perfectly possible for a company to have zero or negative book value. Your Apple numbers are quite a bit off, though—look here for example.
The issue, however, is not what the price is determined by—for all tradeable goods in a more or less free market the price is determined by supply and demand and, yes, it is true for both bitcoin and AAPL shares, but it’s also true for tulip bulbs and old baseball cards. The issue is that you said that that bitcoin prices are “anchored” in the same way the equity share prices are anchored and I don’t think this is so.
Most of those goods that you can buy are pegged towards the dollar and not towards bitcoin. As a result they don’t provide for a floor for prices.
Bitcoins are achored to the cost to produce them. Same as with e.g. gold. E.g. a gold-rush means that for some time gold is ‘easy’ to come by.
That only puts an upper limit on the price of a bitcoin. The lower limit is set by what they are useful for, and how much more useful than the 500 or so other cryptocurrencies: transactions and contracts with security and anonymity properties that ordinary money does not provide.
Same as for e.g. gold (at least for those crypto-currencies that use proof-of-work).
They are produced at a set (and exponentially decreasing) rate. The cost to produce them is however much people put into it.
Same as for gold in a gold-rush.
In other words, bitcoins are not anchored to a cost. Same as with e.g. gold.
I don’t understand what does “anchored to a cost” mean.
In crude terms, things have value and they have a cost to produce. If the value is above the cost, more things like that will be made. If the value is below the cost, no one will make these things. Nothing in that speaks to “anchoring”—the cost does not “anchor” the value.
Bitcoins certainly have a cost to produce (and it’s growing, by design), just like gold. If the value of bitcoins falls below that cost, no one will produce new bitcoins any more.
If there is a fixed cost to produce something, then if the value ever moves above the cost, more will be produced until the value falls to the cost. This means that the value is anchored to the cost. Bitcoins do not have a fixed cost. It would be more accurate to say that the cost of bitcoins is anchored to the value.
Wouldn’t it be capped by the cost (+usual profit)? There is nothing about the cost of production that prevents the value from falling below the cost and all the way to zero.
Why not? It’s not hard to calculate the cost of production (cost of hardware and electricity) for bitcoins. That cost changes with time, but that’s normal for most everything.
That probably would be a better term. I should add that I haven’t been educated much in economics, and if “anchor” is economic jargon, I don’t know it. I was just going by the normal use of the term and the context to guess what the OP was trying to say. Also, pointing out that it’s only anchored from above pokes a hole in the OP’s comment, but since someone else already addressed that I didn’t bother.
Bitcoins are produced at a rate that halves every two years. It doesn’t matter how much effort you put into mining them. Putting more effort into bitcoin mining does not increase the amount of bitcoins, and thus does not decrease the price. The price is not dependant on the cost to produce. On the other hand, if the price doubles, then people will put twice as much effort into mining them, and the cost to produce will double. The cost to produce is completely dependant on the price.
No, I’m using words in standard meanings: “anchoring” means limited to the vicinity of a particular place or value, and “capped” means can go down but cannot go up above a certain limit.
Yes, under the assumption of many separate agents. However people can cooperate if there are sufficiently large incentives for that and there’s no anti-trust authority to stop them in the Bitcoin world. One mining pool already got over 50% of world capacity at one point—it quickly backed down for obvious reasons, but my first guess at an attractor point (equilibrium in econospeak) would be a duopoly where two mining pools control most of mining and they may or may not collude.
How are you suggesting they manipulate prices? While there are a number of security flaws, none of them allow counterfeiting. You can’t increase the supply beyond what it should be no matter what you do. You can destroy bitcoins by sending them to invalid accounts and cause deflation that way, although I have no idea why you’d want to. You could get over 50% of mining capacity and frequently use it for the 51% attack, causing people to lose trust in bitcoins and making the price fall, but again, it’s not going to help you.
Not prices, but the cost of production. With increased prices normally you would have increased mining efforts which, through competition, would make cost of production rise towards the price. If you control the amount of mining, you can avoid that and keep the mining effort at the same level. Your profit (price—cost) then stays high.
It changes with time, but only because the amount being produced changes over time.
First, the cost to produce them is greatly influence by how many people engage in mining which is itself determined by the market price of bitcoins, meaning that by this metric there are multiple equilibria.
Second, for any fiat money there is always an equilibrium with price=0.
That’s not technically correct. If the athourity issueing the fiat money collects taxes than that creates demand for it up to the amount required to pay outstanding tax bills (ie 1% of land value in the case of a property tax). Since property doesn’t produce fiat money itself property owners need to sell goods or services to get money.
So there are low equilibria for fiat money, and unstable equilibria for fiat money, but zero is typically not a natural equilibria
I agree with your qualification.
The first also applies to e.g. gold.
I do disagree with the second.
No, that does not apply to gold. The cost to produce more gold is influenced by how much people have engaged in mining in the past, and thus extracted the low-cost gold. If everyone but you stopped mining gold, the cost for you, personally, to produce as much gold as was previously being produced would be approximately the same as the cost everyone shared before. If everyone but you stopped producing bitcoin, it would be much, much cheaper for you to produce just as much bitcoin as previously.
Gold is not bitcoin. There are differences obviously. But there are analogies too. For one the effort to mine a bitcoin intentionally rises by how much people have engaged in mining in the past.
I’m not clear what you are driving at.
I’m pretty sure the effort (processing power) required to mine a bitcoin is independent of the history of mining, and depends exclusively on how much processing power is currently being spent trying to produce bitcoin. Unless I’ve drastically misunderstood the algorithm for difficulty, which I’m relatively sure I haven’t (thinking of this page specifically).
The consequences of this seem obvious to me; bitcoin is only difficult to acquire when it is perceived as worth acquiring, meaning that a loss of confidence that it has value leads directly to it being much easier to acquire even without having to purchase it from people who have lost confidence.
What you seem to mean is the cost due to competition: Multiple miners trying the same block and the first one succeeding making all the work of the other mineres on this block worthless.
I meant the increase in difficulty for later blocks inherent in the algorithm.
One could—though I agree that it stretches the analogy—compare the first to gold miners competing in the same physical location—as has happened during the gold rush. This causes competition not exactly for the same gold veins but for the physical space and other resources around.
The second (algorithmical) increase can be compared to mines becoming sparser and sparser—you have to dig deeper.
The bitcoin supply is limited by design and as you approach the last bitcoin which could be mined, the effort needed increases. That makes the effort needed dependent on the “history of mining”, or, more precisely, on how many bitcoins have already been mined.
Or more precisely the currant year.