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I have seen many economists saying that bit-coin is highly overvalued and on the verge of a massive corrections. What are the most popular models being used to determine the proper price for bit coin?

I find it very hard to believe that these economists would base these opinions on this purely on conjecture based on the fact that bitcoin is a new technology, or not backed by a government.

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I'll draw from John Cochrane's article and working paper, which provide some great points.

Bitcoin doesn't provide dividends or an interest rate, there isn't any payment or reward for saving in Bitcoins by itself. Therefore, it has 0 expected value of dividends and should have a price of 0. But it has a positive price in real life. There are two reasons for holding a 0-expected value asset:

  1. Convenience yield. That is, they provide some convenience, like cash for making transactions. The convenience is especially linked to illegal transactions. This already has a model to describe behavior: Baumol-Tobin (which is also a model for storage and logistics). There's a huge lack of information to apply it (who knows enough about money laundering to make a prediction?)

  2. Rational bubble. This is where all models break apart. Speculators don't care about the future value, just volatility now (because that's how they turn a profit), much like they don't care about a bond's yield but for changes in its price. In the short term, supply is limited: Bitcoins aren't being created fast enough, competitors like Ethereum or even Dogecoin have still to catch up and there are no derivatives that allow betting against Bitcoin prices (Bitcoin futures have only recently started being offered). Demand is also limited because speculators are buying the asset for short-term profit, not for keeping it long-term.

Add this with huge information asymmetry and you'll get a highly volatile, high-rising price. As long as (1) doesn't change too much, it's a bubble.

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There are two ways to look at the value of a financial instrument. One is the underlying asset base, the other is the yield.

Bitcoin has no underlying asset base and no yield.

Therefore, its only value is whatever people imagine it to be.

In other words, it's completely overvalued. But that does not mean it is on the verge of massive corrections. There is an old saying (attributed, as they often are, to Keynes) that the market can remain irrational for longer than you or I can remain solvent.

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  • $\begingroup$ Wait, if its value is whatever people imagine it to be why is it "overvalued"? Wouldn't that depend on expectations? $\endgroup$ – Giskard Dec 10 '17 at 21:22
  • $\begingroup$ Also, isn't the ability of anonymous payment a service with some underlying value? $\endgroup$ – Giskard Dec 10 '17 at 21:23
  • $\begingroup$ I get that bitcoin is a fiat currency. That does not prevent other fiat currency models from predicting a proper valuation. Or is your answer that the skepticism is not based on any models just pure conjecture? $\endgroup$ – Chad Dec 11 '17 at 2:02
  • $\begingroup$ @Chad it's not a fiat currency in the usual sense. A typical fiat currency is backed by a real-world legitimate economy and a government. $\endgroup$ – EnergyNumbers Dec 11 '17 at 6:40
  • $\begingroup$ @denesp where the anonymous payment is primarily a facilitator of illegal activity, AIUI that's not viewed as having positive value from a social-cost perspective. $\endgroup$ – EnergyNumbers Dec 11 '17 at 11:26

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