Bitcoin could become a major means of payment for e-commerce and may emerge as a serious competitor to traditional money-transfer providers, BofAML notes in a report today, adding that as a medium of exchange, Bitcoin has clear potential for growth, in our view. Despite Greenspan's inability to find "value", BofAML prefers not to call the crypto currency a bubble, and assigns a maximum fair-value of $1,300, but does warn that the 100 fold increase in Bitcoin prices this year is at risk of running ahead of its fundamentals.
Via BofAML's David Woo,
How to assess Bitcoin’s fair value?
The value of Bitcoin has risen 100 times over the past year, raising the question of whether it is a bubble. To answer this question, we need to be able to assess its intrinsic value. We don’t offer a forecast for Bitcoin, but below are our preliminary thoughts on how to approach the fair value question. Bitcoin’s is both a medium of exchange as well as a store of value. In our view, it is easier to think about fair value by treating these two purposes separately.
Value as a medium of exchange
As we have argued already, Bitcoin has some attractive attributes as a medium of exchange, especially for e-commerce. What could be the fair value of Bitcoin if it were to become a dominant medium of exchange for e-commerce that accounts for, let’s say, 10% of all the payments for B2C transactions? Let’s do the following exercise:
- US personal consumption expenditures totaled $11trn in 2012
- Household checking deposits and cash totaled $0.7trn in 2012
- Dividing the former by the latter, we get 0.07 (which we will refer to as velocity from now on)
- Velocity has been rising since 2008, likely reflecting cash hoarding behavior that is likely temporary. To smooth it, we take an average of the velocity of the past ten years to arrive at 0.04 — we assume US households are holding 4 cents in their cash/near cash balances for every $1 spent over the course of the year
- In 2012, total B2C e-commerce sales in the US totaled $224bn
- If we were to assume that the velocity for on-line sales is the same as the velocity for all US household spending, then households would want to setaside $10bn for their on-line shopping
- Given the assumption that Bitcoin will grow to account for the payment of 10% of all on-line shopping, this would suggest that US households would want to have a balance of $1bn worth of Bitcoins
- What about for the whole world? US GDP is about 20% of World GDP. If we were to assume the same degrees of penetration of e-commerce for the rest of the world and that spending by households outside the US has the same velocity, we get to $5bn worth of Bitcoins for the total desired cash/noncash balance of global on-line shopping.
The above is a very rough calculation and we have made a lot of big assumptions. Moreover, B2C is only one dimension of total e-commerce and we cannot rule out that Bitcoin can become a dominant medium of exchange for B2B transactions. Nevertheless, the exercise shows that if Bitcoins remains only as a medium of exchange, there appears to be a clear upside limit for its value.
It has been argued that Bitcoin may become a popular means of payment for illicit trade. We don’t have an informed view on this subject but the fact that all Bitcoin transactions are publicly available (and therefore can be tracked in theory by law enforcement agencies) and that every Bitcoin is defined by its unique transaction history (making it difficult for criminals to cover their tracks6) may limit the growth of its use in the black market/underworld.
In addition to its role as a mean for payment for on-line commerce, Bitcoin can be used for transfer of money (e.g. immigrant worker in the US sending remittances back home). This can be done very cheaply and fast (online settlement in under 10min if the sender is trustworthy like family member or 50min settlement for strangers). How do we assign a maximum fair value to this role of Bitcoin?
Western Union, MoneyGram, and Euronet are the three top players in the money transfer industry (with about 20% of the total market share). Let’s assume that Bitcoin becomes one of the top three players in this industry. What does that mean for Bitcoin valuation? Given Bitcoin’s supply is fixed, when one buys a Bitcoin, one is acquiring not only a medium of exchange but also an investment in the enterprise value of Bitcoin. From this point of view, Bitcoin's market capitalization could be viewed, with a little leap of faith, as its enterprise value. With the average market capitalization of Western Union, MoneyGram and Euronet at about $4.5bn, we will add this number to the maximum market capitalization of Bitcoin’s role as a medium of exchange.
Bottom-line: maximum market capitalization for Bitcoin’s as a medium of exchange = $5bn (for B2C e-commerce) + 4.5bn (means for payments) = $9.5bn
Interestingly, our $9.5bn estimate is below the current actual market capitalization of Bitcoin at $13bn. This suggests that the current market value of Bitcoin assumes either that Bitcoin will account more than 10% of market share for ecommerce, will have more than 10% market share of the money transfer industry (Chart 7)., or will have significant value as a store of value.
Value as a store of value
The value of Bitcoin has been recently outstripping the growth of the nonspeculative transactions using it (Chart 8). This fact alone would suggest that the price appreciation has been more about Bitcoin as a store of value or investment than as a medium of exchange.
How can we assign a value to Bitcoin’s role as a store of value? This is a very difficult question. Given Bitcoin does not pay any interest and that there are no investment instruments (equities or bonds) that are denominated in Bitcoin, the value of its store of value role appears limited. From this point of view, as a store value, its closest cousins are probably precious metals or cash (Table 1), in our view.
Bitcoins and gold have three important common attributes: neither pays any interest, the supply of both is limited, and both are more difficult to trace than most financial assets (except cash). The current outstanding value of gold bar/coins/ETFs is about $1.3trn. Can Bitcoin reach the same market capitalization as gold? We are doubtful.
First of all, Bitcoins are much more volatile than gold, which makes Bitcoins a riskier asset to own. Over the past two years, the volatility of Bitcoin has been on average five times higher than that of gold (Chart 9). All else being equal, this means Bitcoins are five times riskier than gold. Unless Bitcoin volatility declines sharply or gold prices increases sharply, it is reasonable to think that it will be difficult for the market capitalization of Bitcoins to go above $300bn.
Furthermore, the reputation of gold as a unique and safe store of value has been growing for the past ten thousand years. It will take some time for Bitcoins to acquire that reputation. We don’t know how to quantify the value of gold’s reputation, but this reputation is probably the main reason that its value is 60 times that of silver. If we were to assume that Bitcoin were to eventually acquire the reputation of silver (which is an extremely ambitious assumption), this suggests that Bitcoin market capitalization for its role as a store of value could reach $5bn. By the way, $5bn is not too far from the current value of total US silver eagles minted (since 1986), in our view probably the most relevant comparison to Bitcoin, that is around $8bn (12k tons).
Bottom-line: maximum market capitalization for Bitcoin’s as a store of value = $5bn
Bitcoin’s has one advantage over gold in that it is easier to transfer. That said, we don’t think this is a big advantage given the advent of gold ETFs and the ability to move such ETFs in-between accounts. We would not assign any additional value for Bitcoin in this respect.
Clearly, market perception of the Bitcoin’s fair value also depends importantly on the outlook for unconventional monetary policy. If Federal Reserve’s quantitative easing does not end over the next year, as is generally expected, the demand for safe haven assets (like gold and Bitcoins) would increase supporting their value. We expect Fed tapering to begin in Q1 next year and the USD to slowly regain its credibility as the world’s reserve currency, especially as the US continues to reduce its fiscal deficit that will likely fall below 4% of GDP next year. Bitcoin as a store of value likely will struggle to gain traction if our bullish USD view for 2014 turns out to be correct.
Final tally:
When we add our estimated maximum market capitalization for Bitcoins for its role as a medium exchange with that for its role as a store of value, we get a number that is somewhere around $15bn. Although this does not mean that Bitcoin price cannot rise further (as an object of speculation), we think the recent rise of Bitcoin price could soon run ahead of its fundamentals. Our current view implies a:
Maximum market capitalization for Bitcoin = $15bn
Maximum fair value of Bitcoin = 1300 USD
Conclusion
There is much speculation that Bitcoin may help avoid high taxes, capital controls, and confiscation. The correlation between CNY's share of volume of all Bitcoin exchanges and price of Bitcoin is rising. That said, the fact that all Bitcoin transactions are publically available and that every Bitcoin has a unique transaction history that cannot be altered may ultimately limit its use in the black market/underworld.
Bitcoin’s role as a store of value can compromise its viability as a medium of exchange. Its high volatility, a result of speculative activities, is hindering its general acceptance as a means of payments for on-line commerce.
Is Bitcoin a bubble? Assuming Bitcoin becomes (1) a major player in both ecommerce and money transfer and (2) a significant store of value with a reputation close to silver, our fair value analysis implies a maximum market capitalization of Bitcoin of $15bn (1BTC = 1300 USD). This suggests that the 100 fold increase in Bitcoin prices this year is at risk of running ahead of its fundamentals.
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