Is Bitcoin in a Bubble? Why One Metric Suggests Otherwise

Bubbles are characterized by (1) rapid escalations in the prices of assets, (2) fueled by speculation, and (3) the escalation is not justified by the underlying fundamentals of the assets. Bitcoin satisfies the first prong and maybe satisfies the second. Everyone is talking about Bitcoin and extreme predictions about its future price are being made. The question is whether this price escalation is justified by the underlying fundamentals.

The Internet was a technological breakthrough. Blockchain technology is another technological breakthrough. The first application of blockchain technology was Bitcoin, which might compare to email being the first mainstream application of the Internet. Unlike email, which is unlimited and has no variable cost, there is a fixed amount of Bitcoin and a transaction fee to use the Bitcoin network.

Pretend that in the Internet’s infancy, you had to pay a fee for every email you sent. Assume that one email cost one “Email Token” and that there was a fixed supply of Email Tokens.  Although email would have grown more slowly and would have been used less, consider how expensive an Email Token might have been eight years later (Bitcoin was released in 2009). Emails would no longer cost one token, but rather a fraction, since the price would be higher. This can serve as an analogy for Bitcoin.

At its most basic level, Bitcoin allows value to be stored and sent from one party to another, anywhere in the world, without any third-party intermediary facilitating the transaction. To use the Bitcoin network, users pay a fee. Currently, people pay about $1.5 million/day to use the network. This does not include the value being transferred, which also requires Bitcoin, but rather how much people are willing to pay to use the service. This is an increase of about 1500% YTD and 4000% over the past year. These exponential growth rates are not new, as daily transaction fees grew threefold in 2015 and tenfold in 2016.

Going forward, if transaction fees grow at a rate comparable to 2015 (i.e. threefold annually), daily transaction fees would clear $1 billion six years from now. If the growth rate is closer to 2016 or 2017, it will happen much sooner. Bitcoin transaction fees historically average a little less than 1%, but for simplicity’s sake, assume a 1% fee. This would imply that $100 billion worth of Bitcoin would be transacted daily (currently about $10 billion).

There will only be 21 million bitcoin. Approximately 16.5 million exist, but experts estimate that at least one million has been lost forever. This and Bitcoin’s other uses, such as store of value, put downward pressure on the tradeable supply. Given the limited supply and potential growth described above, a supply and demand analysis suggests that Bitcoin’s price may not be so outlandish and may still have room to grow.