Bitcoin’s achievements are undeniable. It has brought into the mainstream both blockchain technology and the concept of a decentralised network, which in theory reduces the need for middlemen and gives users more control of their data. The fact that its enigmatic creator Satoshi Nakamoto has convinced so many people to assign so much value to it is remarkable, whatever you think bitcoin is worth.
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That said, it does have design flaws, one of which relates to transaction speed. It is said that the bitcoin network can process around 4.6 transactions per second, compared to more than 1700 on the Visa network. Nakamoto and other bitcoin advocates promote its use as a micropayment tool, but this is simply impractical, at least right now. It not easy to open a wallet, and transaction costs often exceed $10. The reason these fees are so expensive is the nature of the blockchain network. Verification of transactions (also known as mining) is done by computers on the network competing to solve complicated mathematical problems.
There are two major question marks over the sustainability of this process. It is not clear what will incentivise this verification process once all the bitcoins are mined or if the price of bitcoin drops below a certain level. (This point may already have been reached, see below.) There are also major sustainability issues with respect to the environment since the energy consumed by computers doing these calculations is said to be equivalent to the electricity consumption of some medium to large countries.
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Consider the cost of a country such as Denmark’s electricity consumption against the value of bitcoin yet to be mined. We estimate the latter to be $87.4 billion, using a bitcoin price of $37,000 and assuming that there are 2.4 million more bitcoins to be mined. Using a discount rate of 1%, we estimate that the net present value of Denmark’s electricity spend until 2140 (the year in which the last bitcoin is expected to be mined) is approximately $127.8 billion. The value of the remaining bitcoins is therefore lower than the cost (in present value terms) of mining them. If correct, based on the current price it would not seem to be economically viable for miners to verify transactions.
Despite these flaws, many people have assigned great value to bitcoin, and other cryptocurrencies. But how might we value them? The ‘market cap’— i.e., the number of coins outstanding, multiplied by the price — is one of the traditional metrics. The chart below shows how tiny the market cap of bitcoin is compared to metrics such as US GDP, money supply or the market cap of the S&P 500. It does seem that bitcoin and many other cryptocurrencies are hugely overvalued. There is no reason, for example, why the market cap of bitcoin should far exceed that of PayPal.
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Ether is the second largest cryptocurrency and it has significantly outperformed bitcoin since the start of the year. There are two possible reasons for this. First, it is the currency used on the Ethereum network, which allows the creation and trade of fast-growing smart contracts. Second, the ether currency and Ethereum network are evolving in ways that will reduce transaction costs, improve speed, and lower the environmental impact of verifying the blockchain transactions. For more information on ether and bitcoin, contact Fathom Consulting.
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