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Posted January 8, 2020
After reading Fernando Nieto’s comments (Fernando Nieto) about his cost of preservation, I have been digging into the models used to value commodities which have to do with assesing the cost of transportation and storage mainly and so far it is the best framework I’ve come across to value Bitcoin.
If you think about it, the potential demand for Bitcoin is stratospheric, as there is nothing more valuable than the utility of exchange.
Nobody in his right mind doesn’t demand the ability to exchange utility over time. We want to make sure that whenever a need arises, we will be ready to satisfy it.
It doesn’t make sense to acquire all the goods and services now, as they deteriorate over time and the need doesn’t happen at the same time as the availability of a good or service that satisfies it. As a result, having the ability to postpone that utility of exchange at whatever time, is extremely valuable.
You can do two things:
- Preserve a good into the future that satisfies a need inmediately
- Exchange a good inmediately that satisfies a need in the future
The former is a present good and the latter is credit.
As Nick Szabo explains the Selfish Gene theory in his “Shelling Out” paper:
If the exchange of favors (or the exchange of utility) is not inmediate, and even then, either party can cheat and as it turns out, they usually do. That’s why it is so important that for money we use present goods, and not credit. With credit of the Central Bank, as fiat money is, we are trusting strangers that don’t pay the consequences of their mistakes.
As Fernando Nieto puts it, the cost of friction of owning a commodity is something like:
CoE1 + CoP*t + CoE2
where CoE1 is the cost of buying (acquiring) it and CoE2 is the cost of selling it whereas CoP*t is its cost of preservation as a function of time, which includes its deterioration, inflation, cost of storage and custody, transaction validation, ability to remain safe from thieves, etc…
Note: Fernando has kindly corrected an error, as the cost of transaction validation is obviously a CoE and not a CoP as I stated above
Whether the CoE or CoP of a medium of exchange are high or low, determines the time frame you will be eager to keep it for.
For example, for how long do you tend to keep your USD or EUR paper notes with you? What % of your wealth is into this? USD paper notes have very low CoE yet very high CoP because of its inflation mainly even if they are in the form of deposits. That’s why we keep small amounts of it and that’s why its actual value is on the order of a couple trillion dollars.
On the other hand, what % of your wealth is into real estate, or financial products or even gold? Its CoE is way higher but its CoP is way smaller than with paper notes, so you tend to keep them with you for really long periods of time.
If its kept (hodled) over long time frames, its value is very high and indeed it is as the real estate market is worth $210tn (even if only 10% of its demand is as a medium of exchange, we are talking about $20tn), $70tn for financial products and $8tn for gold, not to mention the estimated $20tn-$30tn in offshore money.
This means that given Bitcoin’s extremely low CoP, Bitcoin is meant to be kept for very long periods of time. In really long periods of time it is a good idea to invest a small allocation of your portfolio, as an insurance for very bad events.
If it’s meant to be kept for really long periods and it is a small allocation of your portfolio, volatility won’t be a problem.
The more people understand this, the more Bitcoin becomes a self-fulfilling prophecy, the more it appreciates creating upwards volatility which is an even smaller problem than volatility itself and the more people are attracted to what in my opinion is the best form of money we have ever seen.
More people will decrease volatility and that small allocation will turn into a larger one.
With that in mind, if we add those $21tn + $70tn + $8tn + $20tn and divide them between the 21million btc — 3million lost, we will have a rough number of $6m-$7m per bitcoin