Pricing bitcoins

Bitcoin functions as a a quasi-commodity currency and I believe it can be priced according to particular factors, variables, instead of simply by the supply and demand in the exchange order book.

The pricing of bitcoins reminds me of the days before options contracts had a standard pricing mechanism. Today, options are valued popularly by the Black-Scholes equation, and no matter how many buyers and sellers there are for an option, that contract will always have a particular known and predictable price, with one variable (Implied Volatility) to account for mispricing outside of that formula. Options of course, are derivatives of an underlying asset and an infinite number of the contracts can be created. Bitcoin on the other hand behaves more like commodity futures to their spot price, where there is a known quantity and a known amount of effort to acquire them.

Ignoring the overly simplistic idea of "supply and demand" imbalances, bitcoin is influenced by the following factors:

the rate at which new coins can be currently mined
the future rate at which new coins can be mined, based on perception of mining hardware and how that will affect network difficulty rates
how many bitcoins remain to be mined

I think these factors can be a greater influence than the speculators currently are, but it would require these factors to be reduced to a formula, as bitcoins are converging to a particular amount. This would allow for changes in volatility (wild swings in bitcoin price) to occur only in anticipation of real world events related to bitcoin.

Has anyone put any effort into pricing bitcoins or cryptocurrencies in general? Perhaps this is an area of study that you might be aware of

CQM

Posted 2013-03-07T03:32:41.153

Reputation: 1 472

By rate, do you mean bitcoins/hash, or bitcoins/week? Because the latter is fixed. – Nick ODell – 2013-03-07T05:40:42.820

@NickODell bitcoins/week is fixed no matter what the difficulty is? lets say 3000 bitcoins can be mined a week, if the difficulty rises above hardware capabilities, 3000 will still be mined? I'm not sure I am familiar with the entire constraints of the algorithm, so if you could elaborate... – CQM – 2013-03-07T06:53:22.353

1The difficulty adjusts to keep pace with hashpower. This is also why there are timestamps on each block. The client looks at those timestamps, and if they are too close, then difficulty goes up. If they are too far apart, then difficulty goes down. – Nick ODell – 2013-03-07T07:50:36.960

1I don't think your analogy works because buyers who want Bitcoins to perform actual transactions are competing for a fixed supply of Bitcoins. If, say, the government only permitted a million options to be sold a year, you could no longer price options using anything as simple as Black-Scholes. (I believe what you're suggesting would be truly revolutionary if possible, but my gut intuition is that with significant research, you might be able to do a bit better than conventional methods.) – David Schwartz – 2013-03-13T07:43:54.577

@Nick ODell The network aims at a fixed number of blocks per week, but this doesn't happen if the network hashrate is decreasing significantly or (as now) increasing significantly. Difficulty will lag in these cases. From the 2nd June to 9th June, for example, over 1300 blocks were solved instead of the expected 1008. – organofcorti – 2013-06-11T15:55:06.603

The real answers to this question are almost surely not in the open literature. – Nate Eldredge – 2013-09-09T18:38:15.907

Answers

The market prices bitcoins, just as anything else (on a free market) according to supply and demand. Supply and demand is prices (expressed in any other good) and amounts. Example 10 bitcoins for USD 140 and 20 bitcoins for USD 139. That is, the lower the price a buyer can get, the more he is willing to buy. This is a value scale. All the users' value scales added together, is the universal value scale. Where the demand prices are higher than the supply prices, exchanges will take place and clear the market, after that new trades will occur when some individual's valuation changes. The price is the last trade. There is no defined value.

Bitcoins have no direct use value, only value for indirect exchange. The only reason to have some, is that others want them. Therefore it is money, since there is no use value, it is a very refined type of money. Since the supply is restricted, and they can be backed up, hidden and transferred in no time over the internet, I think the money qualities of bitcoin are extremely good.

The supply is fixed in the long run, any further supply is known in advance, and is therefore already priced in. The demand comes from the actors' preferences in their minds. If someone thinks it is a good inflation hedge, he wants to have more than just what is needed to do commerce. This is also called reservation demand, just like a car seller may want to keep a car over some time if he can not immediately get the price he wants. Since all demand pairs are added together, the number of people knowing and using bitcoins is a crucial parameter.

tl;dr It is impossible to know exactly, as the value comes from the minds of the thousands of users, but we (the current users) think that the number of users will expand and therefore the price will rise.

cMenger

Posted 2013-03-07T03:32:41.153

Reputation: 21

1Unfortunately, I already propose that the free market theory of bitcoin pricing is very naive, just like how one wouldn't price an options contract by "supply and demand" because that would also be very naive. I propose that there is a formula which can also account for variance in the pricing and I would like other theories based on a formula – CQM – 2013-10-09T14:50:00.387

Is this regarding a pricing model now or 10 years from now?

Bitcoin is less than 5 years old and has progressed through several stages already; some of which contemporary economists have never seen in the wild before.

As people still consider the most relevant "price" of a bitcoin to be its external exchange rate value against a fiat currency; I don't think that the supply and demand aspect can be entirely ignored. Especially if the pricing of bitcoins is not hermetic to mining output but also involves its purchasing power in other currencies.

The supply aspect can't be entirely reduced to the release schedule and energy consumption of newly minted blocks; as there is a dead pool of many many early blocks. Any change in the hoarding habits of these bitcoin owners (if private keys haven't been lost) will distort the mining rate/pricing calculations. Even whether miners choose to mine at a given rate depends on their ability to recoup hardware and electricity costs in US/EUD/CNY/etc currency; as ASIC fabricators and energy companies won't accept bitcoins directly until local exchange liquidity is extremely high (too many downstream vendors for these industries).

The demand is influenced, whether we acknowledge it or not, by speculators and illegal drug transactions as bitcoin still lacks the scale and merchant acceptance to compete with popular fiat currencies. If bitcoin survives long enough then both speculators and illegal merchants will be flushed out of the currency, by volume if nothing else.

I suggest people should be careful in applying elaborate derivatives on a young and volatile market - even though the volatility makes these derivatives tempting. The inherent assumptions and the uncontrolled independent variables of such mathematical models essentially result in information being lost about the true past and future behaviour of the market and the actors in that market. The GFC occurred in part because information about risk was accidentally or deliberately lost. Very large and long-term pre-existing markets can handle the inaccuracies of these models because the models fit the market instead of the other way around. Although sometimes Goldman Sachs can sell an instrument so widely as to warp the market towards the model.

LateralFractal

Posted 2013-03-07T03:32:41.153

Reputation: 901

Hmm, you said that speculators would be flushed out of the currency by volume. Is this even possible? Looking at fiat, the total influence of speculators on them is no small amount right? – Pacerier – 2013-11-26T09:11:39.220

@Pacerier High volume currencies are used so widely as to suppress the impact of currency speculators. Most old-school speculation we hear of is of stock or commodities as the volumes of these can be low enough for the equity of speculators to influence the price. The tricky problem is that the utility of mainstream currencies mean that they reflect the broader economy - which is influenced in a variety of covert ways by private equity investment; of which some hedge funds could be considered aggressive (speculative). Lower volatility "flushes out" most speculators as margins decrease. – LateralFractal – 2013-12-13T10:02:03.700

I think pricing bitcoins will be influence by one more factor at last, the competition market of transaction fees between users and miners.

Here is an explanation and the simulation:

The value of bitcoins is the sum cost of keep transactions moving, but I think this great feature is not obviously revealed in current market. Bitcoin provide a way of low cost(low power to compute) to keep transactions smooth, ex the sum power cost is X. And people in developed economic activities can afford to provide low transaction fees, ex Y.

The lowest transaction fee is a constant value price in a period.

Then, the volumes sum of bitcoins should be equal to X, and X equals 2.1 * 10^7 BTC.

1BTC = X* 10^-7 / 2.1 = 1X/(2.1Y) * 10^-7 *Y

The more mining power join BTC, the bigger X is, and the pricing of BTC will go up.

Current Y/X is too high, because of kinds of reasons, ex two many middleman like Wall Street.

HackFisher

Posted 2013-03-07T03:32:41.153

Reputation: 351

Okay, can you plug in real variables to rationalize current or future bitcoin prices? – CQM – 2013-03-13T13:12:19.380