In this article, I’ll develop a simple model on how to value Bitcoin.
Valuation thesis: Bitcoin will replace the SWIFT bank-to-bank settlement protocol.
Valuation methodology. Bitcoin is now the largest, most decentralized, and most secure international monetary network in the world. This makes it a perfect candidate for bank-to-bank settlements of high-value transactions. Currently, these are performed using the SWIFT system in a complex multi-hop transfer protocol where each “hop” means a credit+debit transfer operation between two banks. There are three reasons why Bitcoin is superior to SWIFT:
- SWIFT is costly: each involved bank and SWIFT as the orchestrating central entity take a transaction fee.
- SWIFT is slow: it can take up to multiple days due to the involvement of multiple banks.
- SWIFT is centralized: this makes it more untrustworthy by design.
Bitcoin offers a decentralized, trustworthy, reliable, highly available, cheap, and fast way to transfer large amounts of money (potentially: trillions of USD!) between two entities that don’t trust each other or any intermediary.
First, let’s look at the USD volume of daily transactions handled by the SWIFT messaging network:
“SWIFT messages direct the transfer of nearly $5 trillion worldwide each day.” (source – US.gov)
This means that on a yearly basis, a transaction volume of approximately $1825 trillion goes through the SWIFT network.
Say, banks used the superior Bitcoin network instead to settle these payments. The Bitcoin network currently allows for approximately 300,000 transactions per month—and it is not expected to increase the number of transactions significantly over time because the strength of Bitcoin is its decentralized security, trust, and availability that comes at the expense of the number of transactions.
This means that the Bitcoin network can handle 3.6 million transactions per year. Each transaction can have an arbitrary settlement value as determined by the price of Bitcoin and the average number of Bitcoins per transaction.
If Bitcoin replaces SWIFT as a means to settle bank-to-bank transactions, it would have to transact $1825 trillion with 3.6 million transactions in a given year. This means that the average per-transaction value is $506,944,444. Let’s make it $500 million.
As more and more dollar volume will be transacted due to an inflation of fiat currency, this number is likely to increase over time.
To move $500 million in a single transaction, we have to look at the average transaction size in BTC, how much BTC is moved per transaction?
- If 1 BTC is moved per average transaction, we’d get a price of $500 million per BTC.
- If 10 BTC are moved per average transaction, the price would be $50 million per BTC.
- If 100 BTC are moved per average transaction, the price would have to be at least $5 million per BTC.
This relationship is demonstrated in the following table examining transaction sizes up to an (overly pessimistic) average transaction size of 21 million BTC per transaction.
|Average transaction size (BTC)||BTC valuation|
21,000,000 is the maximum number of Bitcoin in the network. Assuming an average 21,000,000 BTC per-transaction value is completely unrealistic. So, what is a more realistic number of Bitcoin per transaction?
According to Blockchain.info, the average Bitcoin transaction size is relatively stable over time so that we can get a conservative estimation for it:
A conservative assumption based on historic data would be that on average 160,000 BTC are exchanged in a given day which yields 58.4 million BTC total transaction volume (turnover) in a given year. The fact that Bitcoin assets are currently widely spread over the network and there are hundreds of millions of wallets indicates that the average transaction size in Bitcoin is unlikely to grow significantly over, say, 20 BTC per transaction.
In fact, using the 3.6 million number of transactions per year figure, we’d obtain an average transaction volume of 16 BTC.
If this average transaction volume remained stable, we would move an average transaction volume of 16 BTC and $500 million which yielded a price of $31 million.
This would result in a total market capitalization of the Bitcoin asset class of $651 trillion.
In this article, we calculated a possible price per Bitcoin using the following reasoning:
- Bitcoin replaces the current SWIFT bank-to-bank transaction protocol due to its superior properties such as decentralization, trust, and cost reductions.
- SWIFT is currently responsible for $1825 trillion with 3.6 million transactions in a given year leading to an average per-transaction value of $506,944,444
- To handle this per transaction value in the Bitcoin network, assuming a stable average BTC transaction volume, each Bitcoin would have to carry $31 million in value.
Note that we didn’t consider the effect of inflation of fiat currencies and productivity gains, as well as additional non-bank-to-bank transactions. All of these factors would contribute to an even higher expected price under the above assumptions.
This is not investment advice but a financial-mathematical analysis based on the outlined assumptions. Here’s how you can adopt Bitcoin as a treasury reserve asset as discussed in this article.
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