Bitcoin Valuation: Understanding the Difference Between Transactional Demand and Speculative Bubble
Prominent voices have expressed notably diverse opinions about Bitcoin, from sceptics calling it “the mother of all bubbles” and “a Ponzi scheme” to enthusiasts hailing it as “the flagship of a new asset class” and “digital gold.” The recent surge in the Bitcoin price to record-breaking levels has reignited the debate about cryptocurrencies once again.
Financial analysts struggle to determine which side of the debate is correct, as traditional asset pricing theory falls short when it comes to analyzing cryptocurrencies that do not pay dividends in fiat currency. Cryptocurrencies can be used as a means of payment, generating transactional demand, while financial securities typically cannot serve this function.
In a recent study, a formal model was introduced to shed light on the beliefs underlying both sides of the bubble debate about cryptocurrencies. This model builds upon the classical framework for rational bubbles, allowing for scenarios where an asset appreciates solely due to a widespread belief that the price will continue to rise.
The model explores the concept of baseline equilibrium to derive the exchange rate of a cryptocurrency, considering factors such as transactional demand and investor expectations. It shows that a zero price for a cryptocurrency is not an equilibrium outcome, indicating that investors expect some level of transactional demand now or in the future.
Critics who claim that bitcoins are worthless are contradicted by the baseline equilibrium, which demonstrates that a zero price can only be justified if there is an absolute absence of any transactional demand. This analysis provides a structured approach to understanding the complexities of cryptocurrency valuation beyond intuition and informal arguments.