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Bitcoin: A Trillion Dollar Opportunity?

December 3rd, 2013 Leave a comment Go to comments

Bitcoin, the virtual currency little more than four years old, just crossed the $1,000 mark this past week.

You may have heard of Bitcoin, the virtual currency that has potential to become an accepted store of value not controlled by any central authority. The distinction with Bitcoin versus other types of value stores is that Bitcoin is store of value that is virtual instead of physical.

For investors, if you want a store of value outside of currencies or other kinds of paper assets (like bonds or stocks), the typical place to go is for an actual physical asset of some kind. Gold, silver, or even real estate or cigarettes. The reasoning is that a physical asset has better value retention because physical things are necessarily limited in supply.

Fiat currencies, which are not backed by any asset, can be created in unlimited supply. So, you see the problem here. How do you create a store of value that doesn’t require you to store a physical asset such as gold in your basement?

Enter Bitcoin

Bitcoin tries to solve these issues plus it provides other benefits. Here are some of the main benefits of its design:

  • Limited supply. Right now, there are 11 million Bitcoins in existence, and the maximum that can be created is 21 million. No one can ‘print’ anymore and no central authority controls it. The designers created a software ‘mining’ equivalent that can create coins over time by solving mathematical equations. Over time the equations get more difficult (just like in the real world, it gets harder to mine gold as time goes on, e.g.).
  • Hard to Copy – physical currencies can often be duplicated by copying paper currency. Bitcoin is an encrypted entity that can’t be duplicated, though it obvious can still be stolen or misplaced.
  • Low cost – Owning physical assets has costs that are often high. Bitcoin has essentially no cost to own, though, third parties will charge transaction fees to convert to currencies.
  • Easy Trading – Bitcoins transcend national boundaries and can be traded or used across the world with fewer limitations than currencies or gold, etc.

Bitcoin Opportunity

The question is, how will this play out and what will the future be for Bitcoin?. Of course, nobody knows for sure. Bitcoin, like other currencies doesn’t actually give the owner any claim to anything. Currencies can only work if the parties involved have confidence in the value of the paper. Think about it, what is the value of the currency in your pocket? Nothing, really. The value comes because you have confidence that another party will take it in exchange for something of value.

So, tomorrow Bitcoin could be worthless because people don’t think it’s worth anything.

This appears to be less likely to occur. The U.S. Federal Government has recently held hearings on Bitcoin, and they appear to be skeptical of the currency but there isn’t any effort to try to shut it down. One could say that the hearings have given Bitcoin some more legitimacy.

If Bitcoin gains widespread acceptance, I would make the case that there is still value here buying it now. Here’s why. Let’s compare Bitcoin to gold.

Gold has many of the traits of Bitcoin, but it is not an exact match, but fairly close. The question is, how much gold is there above ground in the world? There are estimates that vary, but there is at least 150,000 tonnes of Gold out there above the ground. This roughly equates to about 5.3 billion troy ounces. At $1,250/ounce, all the Gold in the world is worth about 6.2 Trillion dollars.

All the Bitcoins in the world are worth about (11M * 1,000) or 11 billion dollars. The maximum value of Bitcoins there can ever beĀ  (at today’s price) is 21 billion dollars.

So you can see where I am going here. If Bitcoin gains legitimacy as a transaction entity and store of value, demand will dictate its price. If investors decide to put 15% of their Gold reserves in Bitcoin, that’s a Trillion dollars worth of Bitcoins. There can only be 21M Bitcoins, so it makes sense that the coins would increase in value to about $50,000.

Bitcoin has an additional advantage over Gold in that it can function like a currency (retailers generally don’t accept Gold for obvious reasons, such as veracity). There are retailers already that accept Bitcoin. This will offer the possibility of additional demand.

If Bitcoin becomes too expensive, there will be no choice but to partition it into 1000ths or even smaller units to facilitate transactions. This will be easily done (as opposed to fiat currencies that go in the other direction – taking out small denominations).

Will any of this happen? Who knows, but it appears quite possible.

 

 

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