What is a Bitcoin worth?

Thomas Belsham

The price of Bitcoin is currently around $57,000 (see Chart 1). But what is the price of Bitcoin based on? It’s just a bunch of code that exists only in cyberspace. It’s not backed by the state. There’s no recourse to a central authority. There’s no underlying asset, no stream of income. There’s just the thing itself. But does that mean it has no inherent worth? The code on which Bitcoin is based does give it scarcity value. Only 21 million Bitcoin will ever be created. And that might be worth something. That scarcity is why some people refer to Bitcoin as ‘digital gold’. But the very scarcity on which Bitcoin is based might also be its undoing. Its scarcity may even, ultimately, render Bitcoin worthless.

Chart 1: Bitcoin price in US dollars

Source: Blockchain.com

Satoshi Nakamoto said in his/her/their (the creator or creators remain anonymous) canonical paper, ‘Bitcoin: A Peer-to-Peer Electronic Cash System’, that ‘a peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution’. This was the driving force behind Bitcoin: create a payments system outside of the existing official financial architecture – a form of digital money, with no official entity standing behind it, just the strength of the underlying computer code.

Now, so far, Bitcoin has not performed well as money. Quick recap: money issued by central banks, fiat money, acts as a ‘store of value’ – it preserves the spending power of income and wealth, so that you can be confident that a pound, say, will buy about as much in a year’s time as it would today. It’s also a medium of exchange – you can use it as payment. And, largely by dint of satisfying those two criteria, the denomination of money – be it in the form of dollars, pounds, seashells, whatever – tends also to be used as a unit of account (a means of pricing other things in general). Figure 1 shows the traditional functions of money, based on this hierarchy.

Figure 1: Functions of money

Now, Bitcoin is far too volatile to act as a reliable store of value. The average 30-day standard deviation of Bitcoin has been a whopping 3.5% since 2015, four times higher than the S&P 500 over that period. It’s not used widely for payments – just try spending it at your local supermarket. And it’s not used as a unit of account (consider the last time you saw something priced in terms of Bitcoin).

But if there is one thing that Bitcoin was designed to be, it was a unit of account. In Satoshi’s vision for a peer-to-peer electronic cash system, Bitcoin is nothing more, or less, than the unit of account in which transactions are denominated. You can’t have an altogether new payment system, separate from fiat money, without its own unit of account. What is incidental, in the case of traditional forms or money, is fundamental, in the case of Bitcoin (Figure 2).

Figure 2: Functions of Bitcoin

The problem is that, unlike traditional forms of money, Bitcoin isn’t used to price things other than itself. As Bitcoiners themselves are fond of saying, ‘one Bitcoin = one Bitcoin’. But a tautology does not a currency make. Put differently, simply being recorded on a ledger does not render something a unit of account in a general sense – which is the important meaning here – any more than having a record of staff leave balances in the HR system makes a days’ leave a unit of account. ‘One-days’ leave = one-days’ leave’, but that doesn’t make it money. Does it also mean that Bitcoin has no inherent worth?

To understand whether Bitcoin does have inherent value, we need to understand what Bitcoin is. A Bitcoin is a unit, a one, on a distributed ledger – a shared database maintained by multiple participants, with no central repository. The ledger is comprised of a series of batches, or blocks, of transactions, each of which references the block before, in a chain (hence blockchain). If you were to compile all the information stored on the blockchain, you might think of it as like a spreadsheet of accounts. Now, given that anyone can edit their version of the chain, to avoid version-control problems (and cheating), a network of computers (miners) continuously confirms the validity of changes to the ledger, only adding a new block if agreed by a majority.

Importantly, in reaching consensus, new Bitcoins are emitted – currently 6.25 Bitcoins every 10 minutes, approximately. Those Bitcoins are awarded to the lucky miner that was first to combine, or hash together, the information contained in a new batch of transactions in such a way as to generate a single numeric output that satisfies the requirements for the block to be added. It can take a lot of tries, or ‘work’, before a satisfactory output pops out. The reward for generating this proof of work – the evidence of the effort put into helping maintain the integrity of the ledger – is the newly emitted Bitcoin.

So, if a Bitcoin is just a 1 on the ledger, what is a 1 on the ledger worth? Why might anyone want to own it? The only real intrinsic feature that Bitcoin has is scarcity. There will only ever be 21 million Bitcoins created, finite supply being a cornerstone of the design of Bitcoin. The hope was that by having a hard-coded limit on the number of Bitcoins ever to be produced, the value of a Bitcoin couldn’t be inflated away by an endless supply of new coins.

If it is true that there may be some inherent value in Bitcoin, is it also conceivable that it might one day gain acceptance as a medium of exchange? There are certainly already a few places willing to accept it as payment. Elon Musk famously caused Bitcoin to rally in March, when he announced that Tesla would start accepting Bitcoin, and then to fall, when he reversed that decision, due to environmental concerns – the mining process uses vast amounts of energy (about ½% of total world energy consumption, according to the Cambridge Bitcoin Electricity Consumption Index). It might even start to be used to price other things – become a unit of account in the general sense. ‘One pint of milk = 0.00001249 Bitcoin’, or 1249 satoshis (sats), the affectionate term given to one hundred millionth of a Bitcoin, the smallest possible fraction permitted by the code (55p, in case you wondered).

It’s even possible that Bitcoin will one day become an effective store of value, once adoption plateaus, speculative gains and purported diversification benefits are exhausted, and the price discovery process has run its course – assuming it ever does. Bitcoin might eventually trend (up, down or sideways) to some non-zero equilibrium value and be relatively stable (see Figure 3), rising in line with other nominal things, or acting as a simple proxy for generalised risk sentiment.

Figure 3: Bitcoin price forecast (up, down or sideways)

There is a problem, however. And the problem lies in precisely the thing that gives Bitcoin value: its scarcity. At some point, the last Bitcoin will be mined. There are nearly 19 million in circulation at present (see Chart 2). Estimates suggest that the 21 millionth Bitcoin will be emitted sometime in February 2140. What happens then? There’s nothing in the code to deal with what happens next. Simple economics points to some potential outcomes, though.

Chart 2: Bitcoin in circulation

Source: Blockchain.com.

For one thing, it’s likely that transaction fees will rocket, as miners try to replace revenues no longer provided by the emission of new Bitcoins. Past episodes of high transaction volumes have seen transaction fees rise as high as $60 (see Chart 3). While the numbers vary, day to day, the current fee per transaction is around $1.88. With miners receiving around $47.8 million per day in block rewards and transaction fees, and only $402,000 of that coming from fees, replacing lost block rewards would require fees to rise to over $223 at current prices.

Chart 3: Average fee per transaction

Source: Blockchain.com.

Fees of that size would make Bitcoin much less useful (useless, really) as a medium of exchange. Transactions might even become prohibitively expensive, and dry up altogether, with many balances effectively stuck on the chain, uneconomic to move. An overnight fall in revenues – due to the combination of no new Bitcoin and a fall in transaction volumes – would probably cause at least some miners to switch off their computers. Miners aren’t providing a public service, after all; they’re in it for the profit.

A sufficiently large decline in computing power would undermine the security of the ledger, perhaps catastrophically. The hash rate – number of tries at finding a winning block – per second is currently around 158 million trillion per second (see Chart 4). If enough miners leave, a single entity could gain control of over half of the hash power on the network, enabling them to reorganise the balances on the blockchain at will. The integrity of the whole ledger could disintegrate.

Chart 4: Estimated daily terahashes per second

Source: Blockchain.com.

That being so, and absent some intervention by the disparate group of developers and miners that preside over the Bitcoin codebase, simple game theory tells us that a process of backward induction should, really, at some point, induce the smart money to get out. And were that to happen, investors really should be prepared to lose everything. Eventually.

Thomas Belsham works in the Bank’s Stakeholder and Media Engagement Division.

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15 thoughts on “What is a Bitcoin worth?

  1. £500?. It is a number of lines of code. Bitcoin supposed scarcity argument while true is negated by the ready availability of Alt-Bitcoins which from an economists POV can be regarded as substitutes.

  2. “about ½% of total world energy consumption” … I think you mean electricity, not energy

  3. Please explain the passing comment that fiat money defining a unit of account is “incidental”. Wasn’t the pound historically defined as a unit of account? Even if for centuries no pound-object existed, transactions being settled in land, gold, goods, labour or a mix thereof, depending on the scale of transaction. Another query: cyber advocates may say a bitcoin = a bitcoin, implying that belief in it as a UoA; however much of their interest seems to be in its value, vis-a-vis fiat monies. Not store of value in a static sense, but increase of value, relatively. Volatility good, just hang in there, they say. So to critique it by pointing to volatility become like water off a duck back, surely.

  4. In his paper “Money is Memory”, Kocherlakota, president, makes a case for understanding money as a primitive form of memory of past transactions. DLT could be a representation of memory. What do you think about? that?

  5. Thank you for writing an interesting post.

    I find the deflationary aspect of Bitcoin to be as much a negative as a positive. I think that could be its undoing.

    Re the environmental concerns, what would you say to this?

    “Bitcoin electricity expenditures priced in dollars don’t look very large. Bitcoin uses something like 100 Terra Watt Hours (TWH) of electricity annually (depending on the price of Bitcoin) but a TWH costs less than $100 million (10 cents per KWH times 1000000000). Thus, Bitcoin spends say $10 billion on electricity annually. (In fact, it’s less than this since bitcoin miners can be located in places where electricity prices are especially cheap.)

    $10 billion in spending isn’t a lot. It’s less than the world spends on toothpaste ($30b), much less than the US spends on cigarettes ($80b), and considerably less than the US Federal government spends in one day ($18.65 billion).

    If we think of the $10 billion spent by Bitcoin as a security budget (as the spending secures the blockchain) it also compares reasonably to US bank spending on cybersecurity. Bank of America alone spent more than $1 billion on its cybersecurity budget and the total financial security budget is much larger.”

  6. Frankly id be more worried what the pound is worth in 2140 or will even exist then ! There are no guarntees with government issued money at all; its not worth the plastic or paper its printed on and there is an endless supply of it. Fix the money system and Bitcoin will most likely disappear long before 2140.

  7. Thanks for your article! Several thoughts I want to add:
    1) The model described to judge if sth. is fit to be a currency is – as all models – a simplification of the complex reality, and in that case it might be to simple to predict 2040.
    2) Even within the model, Bitcoin doesn’t have to meet all three criteria to become useful = valuable. It would be sufficient to be just a value storage, as gold is right now (that is equally impractical for payments – and much harder to safely store than Crypto).
    3) The fees may rise. But so do fees for physical gold transactions – and we found solutions around that. There are currently updates planned, so we can exchange (sth. like) contracts on BTC, while the actual BTC blockchain remains untouched for most of the time, reducing actual transaction fees to an affordable amount.
    4) Even if BTC proves unfit to all possible needs – the idea of Crypto might not. BTC showes a certain potential, and there’s no reason why mankind shouldn’t move on one day and focus on a crpyto that fixes the problems you address (as I said, with planned updates, BTC is already moving there).
    5) FIAT currencies are backed by – yes, governments. But nothing more, since we left the gold standard. And currencies backed by people in institutions have always been vulnerable to fraud – BTC isn’t.
    6) The so-called “smart money” and the traditional institutions led us to several financial catastrophies. Many of them initiated by – human greed. This will stay a fundamental flaw in all human-controlled financial systems. I don’t find it likely that mankind will ever fix this. Crypto is ahead here.
    7) Going back to a scarce currency like BTC can help to protect peace. Leaving the gold standard in the 20th century helped nations to quickly print money so the could finance the seemingly endless resources for two wold wars. You could argue that since then manking had its most peaceful time in history. But nevertheles we lost one safety system, protecting us from throwing endless resources (e.g. bombs) on each other. I’d like to have that back.

  8. This is a very well-thought article, but I think it makes one assumption about BTC worth considering, and one broad omission about crypto-currency in general in my humble opinion.

    The assumption made is that scarcity will change the worth of BTC, which is true. But doesn’t that assume it is always going to be a commodity/speculative asset? If it is a currency, or could be a currency, would we not be dicussing inflation/deflation, not scarcity? Of course, this may/would require some sort of central agency to manage interest rates to control this inflation/deflation. If we do not ever have that central agency, is Bitcoin always doomed to be a commodity/speculative asset?

    GBP is as scarce as the Bank deems it to be, and as we have seen these last few years, the Bank can ‘print money’ to affect that. Of course, scarcity is just a self-appointed rule of BTC, another crypto currency may be more flexible and realise it needs to not have a limit to become a currency. Again, that would require a central agency to maintain that flow.

    For me, the key issue this article ignores is trust. One of the key tenets of fiat currency is trust. We trust the Bank of England and the state will ‘back’ that a £10 note is in fact worth £10 (it even says it on the note!) and in affect, the UK economy continuing to work every day backs that promise – our GDP ensures the worth of that note, essentially. Of course if a state fails, a currency can also fail, or become depreciated and we have seen that many times in history. One could extrapolate this and see that much of human politics and nation states is based on the protection and continued ability to ‘back’ the fiat currency we mint and retain the trust of the people.

    With BTC and crypto, the trust is in the blockchain, not a state. The blockchain says your line of code is worth X BTC, and that is impossible (or very difficult) to mainipulate or counter if we all agree that the code is immutable. And because the blockchain is decentralised, we’re all buying into that trust by using it. In a way, this theoretically make a true crypot-currency immune to politics, war and famine and is a worthy goal to try and attain.

    By focusing on the in-built issue of scarcity, then we’re affectly admitting BTC will never be a currency. But, if we are to focus on the idea of trust and on crypto-currency more broadly, there is no reason why a crypto-currency couldn’t supercede fiat currency one day.

    I think these are crucial debates to have. Could a future crypto-currency unite the world, bring down borders and herald world peace, creating a decentralised capitalist global state? Perhaps, but it’s clear that BTC isn’t the vehicle to do that, and is instead at best a speculative asset.

  9. Isn’t it likely that as new Bitcoins cease to be created, Bitcoin will increasingly be divided into smaller pieces. In “equilibrium”, the new supply of Bitcoins needed in a particular year (say a 5 pct increase) would be provided by division of coin – in this case to provide 5 pct more coins with an average “denomination” value 5 pct lower. And the price of a whole Bitcoin should (in an “efficient” Bitcoin market) rise by 5 pct leaving the increased number of divided coins trading at the same price as before.
    In other words new supply of tradable coins can be continuously created through whole Bitcoin price appreciation as demand increases. And surely this is how it is working today?

  10. BTW, would you rather hold an SDR or a Bitcoin. Quite an interesting comparison. Both are created out of thin air (no backing of any kind). But Bitcoin has a limit on the total creation amount unlike the SDR. And Bitcoin has a ready exchange market. The only SDR buyers are rich countries buying on a charitable basis (because the SDR is worthless in the hands of a rich country – no one will buy SDRs from them).
    SDRs are created through loans and matching deposits unlike Bitcoin. Some people think they have a certain “value” equal to the basket. But no one is a buyer of any resort at this value, certainly not the IMF. There is no basket of currencies backing the SDR.
    The creation of the SDR also involves mission creep. The way they are used now (for pandemic spending) was not what was originally intended. They were supposed to be “virtual” liquidity instruments, only to be “drawn” (from rich countries) in a crisis (and presumably “paid back”).
    Surely one day this funny (free gift) money will be exposed?

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