Is there a way to predict the value of a crypto-asset like Bitcoin? In their March 2018 paper entitled “An Equilibrium Valuation of Bitcoin and Decentralized Network Assets”, Emiliano Pagnotta and Andrea Buraschi model the value of Bitcoin and similar blockchain network tokens via a model that characterizes:
- Demand, described by current/future number of users and their strength of preference for privacy (trustworthiness), reflecting the economic strength of the network and its tokens.
- Supply, described by number of miners in the associated proof-of-work competition and cost of mining, reflecting network trustworthiness.
They consider a quantitative version of the model calibrated to the properties of the Bitcoin network at the end of 2017. Based on mathematical derivation/interpretation and the properties of Bitcoin at the end of 2017 (price $14,200), they find that:
- On the demand side, bitcoin price increases with: current number of network users; average expected future number of network users; and, average strength of user preference for privacy.
- On the supply side, bitcoin price increases with number of miners and decreases with cost of mining.
- Relationships are non-linear. Applying the model to Bitcoin calibrated as specified above:
- Tripling current number of network users raises price from $14,200 to $77,627.
- A 100% increase (90% decrease) in mining cost, lowers (raises) price to $13,330 ($14,970).
- With an infinite number of miners, price increases only moderately to $14,974.
- Price shocks introduce self-reinforcing loops that drive volatility. For example, a price drop reduces the incentive for miners to provide network trustworthiness. Expectation of falling trustworthiness reduces value and may reduce expected future network size, thereby further reducing value. Conversely, price jumps introduce a positive feedback loop.
In summary, modeling suggests that the value of crypto-assets such as Bitcoin are much more sensitive to demand variables than supply variables, and that the difficult-to-measure demand for privacy/trustworthiness is critical to price dynamics.
Cautions regarding findings include:
- As noted in the paper, the model presented does not account for potentially important factors such as speculative demand and proliferation of alternative crypto-assets.
- The state of the Bitcoin network at the end of 2017 may not be representative of network equilibrium conditions.
See also the recent “Crypto-asset Research Survey”.
