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What determines the price of Bitcoin?

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Bitcoin has lost more than half its value in less than 6 months. Just before Christmas, it was trading at over $ 19,000; today, it's only $ 8,299. Not surprisingly, the Bitcoin investors they were & nbsp; predictable the meteoric rises will start again from one day to the next. But Bitcoin has so far refused to cooperate, remaining stubbornly stuck under $ 10,000 in the last two months. How can we know when – or if – will it rise again?

PARIS, FRANCE – MAY 16: In this photo illustration, a visual representation of Bitcoin Digital Cryptocurrency is displayed on May 16, 2018 in Paris, France. Bitcoin is an electronic currency that has seen an incredible increase in 2017, its price has increased up to 20,000 euros, but since the beginning of 2018, a sharp decline has seen more than half of its value lose. (Photo by Chesnot / Getty Images)

Cryptocurrency analysts Fundstrat think they have found a way to predict the future price of Bitcoin. They used the expected path of Bitcoin's break-even mining costs to predict that Bitcoin will reach $ 36,000 by the end of 2019:

Fundstrat Executive SummaryFundstrat on Twitter

But this method has been the subject of considerable criticism from the Bitcoin community. On Twitter, Samson Mow, Chief Strategy Officer of Blockstream, argued that the Fundstrat forecasts were based on a controversial economic theory:

Samson Mow on Twitterchirping

The "labor value theory" essentially says that the price of a good or service is determined by the work required to produce it. It is popular among Marxist economists, but most other schools of economics have abandoned it in favor of "subjective evaluation" which says that the value of a good or service is anything anyone will pay for it, regardless from the effort that has been made to produce it. Mow's argument is that subjective evaluation is the right way to understand the price dynamics of Bitcoin, not the value theory of labor.

Of course, if the producer appreciates the effort that produces the good or service that is higher than what the market will pay, he will stop producing it. Therefore, when prices fall, marginal producers tend to withdraw, reducing supply and therefore increasing the price. Manufacturers who have stocks to run out and / or reserves sufficient to allow them to run at a loss can continue production for some time. But over time, more and more producers abandon until prices rise enough because the market is free.

Likewise, when the price of Bitcoin decreases, the marginal miners retreat, as the cost of bitcoin mining begins to outweigh the benefits. However, this creates a security risk. As the mining reserve declines, predatory attempts to take control of the pool (a 51% attack) become more attractive. Bitcoin therefore has an automatic adjustment mechanism to discourage miners from leaving the pool when the price drops. The algorithmic puzzles that the miners have to solve become more difficult when the price of Bitcoin increases and less difficult when the price goes down. This keeps the bitcoin production rate constant, at about 1 block every 10 minutes, while allowing the hahrate (the computing power needed to solve the puzzles) to fluctuate with the Bitcoin price.

Since the hashrate is indeed a measure of the use of electricity, which is the main component of the mining cost, the miners' break-even costs tend to follow the price of Bitcoin. The Fundstrat chart (also from Twitter) clearly demonstrates this:

FundstratFundstrat

Since the price set by the difficulty adjustment ties the cost and the breakeven price together, the break-even price trend is a reasonable indicator of the future price of Bitcoin. The criticism of Samson Mow is therefore a bit unfair. Fundstrat has not been based on the theory of the value of labor, although its synthesis somewhat misleadingly implies that the cost of mining rather than the adjustment of difficulty supports the price.

Obviously, the support is asymmetrical: the price of Bitcoin is supported on the downside, but not limited to the upside. This is because it is not necessary to defend against 51% attacks when the mining pool expands. However, it does not seem that anyone has come to mind that the massive increase in break-even costs creates huge barriers to entry that translate into concentration of the mining basin. There can not be a 51% attack, but if the mining market becomes dominated by a small number of large players, the effect is more or less the same. Particularly if those players cooperate.

And there's also a second problem. Bitcoin Exchanges very similar to a commodity. In the long term, the market price of raw materials tends to their marginal cost of production. Putting this in another way, mining profits end up falling to zero. As I noted earlier, when profits fall to zero, producers eventually stop producing.

But while the raw materials would still be exchanged if the mine had ceased, Bitcoin would have died instantly. This is because the true work of miners is not the production of bitcoins, but the verification of transactions. Without transaction verification, bitcoins can not be bought, can not be sold, can not be spent, can not be earned. If the mine ceased, the existing bitcoins would become immovable – and a real estate has no value. So, unlike a commodity, if the mining profits have dropped to zero, even the value of all existing bitcoins.

The adjustment of the difficulty artificially preserves the profit margins of the miners to ensure that a sufficient number of them continue to extract mines. This protects Bitcoin from attacks, but has serious implications for Bitcoin's financial sustainability as a transaction system.

At the moment, the new bitcoins are part of the mining prizes. But the new bitcoin component of the mining reward is halved every few years. Eventually it will reach zero. As the difficulty adjustment forces mining profits to remain positive, falling profit margins – due to falling prices or halving – must be offset by the increase in transaction fees. Users of the system will have to pay the miners increasing amounts of bitcoins to keep them mining honestly.

In my opinion, this means that displaying Bitcoin as a commodity is wrong. Miners provide a service – transaction verification – on which Bitcoin users are critically dependent. Without that service, Bitcoin would have died. But miners also depend on their profits by the willingness of users to make transactions. If the commissions increase too much, users would stop using Bitcoin for transactions and Bitcoin would die. The equilibrium transaction fee would be the point at which there are sufficient users to provide a reasonable volume of verification transactions and sufficient miners to make honest checks.

Ultimately, what determines the value of Bitcoin is whether people are willing to make transactions using this. This includes the purchase and sale of bitcoins, of course, since trading is making transactions. But will the price of Bitcoin continue to rise quickly enough to allow users to continue paying higher transaction fees? Or in the end there will be a "spiral of death" triggered by falling prices when users abandon the system en masse, followed by miners who give up while the collapse of transaction volumes leads to zero commissions?

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Bitcoin has lost more than half its value in less than 6 months. Just before Christmas, it was trading at over $ 19,000; today, it's only $ 8,299. It is not surprising that Bitcoin investors have predicted that the meteoric increases will resume from one day to the next. But Bitcoin has so far refused to cooperate, remaining stubbornly stuck under $ 10,000 in the last two months. How can we know when – or if – will it rise again?

PARIS, FRANCE – MAY 16: In this photo illustration, a visual representation of Bitcoin Digital Cryptocurrency is displayed on May 16, 2018 in Paris, France. Bitcoin is an electronic currency that has seen an incredible increase in 2017, its price has increased up to 20,000 euros, but since the beginning of 2018, a sharp decline has seen more than half of its value lose. (Photo by Chesnot / Getty Images)

Cryptocurrency analysts Fundstrat think they have found a way to predict the future price of Bitcoin. They used the expected path of Bitcoin's break-even mining costs to predict that Bitcoin will reach $ 36,000 by the end of 2019:

Fundstrat Executive SummaryFundstrat on Twitter

But this method has been the subject of considerable criticism from the Bitcoin community. On Twitter, Samson Mow, Blockstream's chief strategy officer, said Fundstrat's predictions were based on a controversial economic theory:

Samson Mow on Twitterchirping

The "labor value theory" essentially says that the price of a good or service is determined by the work required to produce it. It is popular among Marxist economists, but most other schools of economics have abandoned it in favor of "subjective evaluation" which says that the value of a good or service is anything anyone will pay for it, regardless from the effort that has been made to produce it. Mow's argument is that subjective evaluation is the right way to understand the price dynamics of Bitcoin, not the value theory of labor.

Of course, if the producer appreciates the effort that produces the good or service that is higher than what the market will pay, he will stop producing it. Therefore, when prices fall, marginal producers tend to withdraw, reducing supply and therefore increasing the price. Manufacturers who have stocks to run out and / or reserves sufficient to allow them to run at a loss can continue production for some time. But over time, more and more producers abandon until prices rise enough because the market is free.

Likewise, when the price of Bitcoin decreases, the marginal miners retreat, as the cost of bitcoin mining begins to outweigh the benefits. However, this creates a security risk. As the mining reserve declines, predatory attempts to take control of the pool (a 51% attack) become more attractive. Bitcoin therefore has an automatic adjustment mechanism to discourage miners from leaving the pool when the price drops. The algorithmic puzzles that the miners have to solve become more difficult when the price of Bitcoin increases and less difficult when the price goes down. This keeps the bitcoin production rate constant, at about 1 block every 10 minutes, while allowing the hahrate (the computing power needed to solve the puzzles) to fluctuate with the Bitcoin price.

Since the hashrate is indeed a measure of the use of electricity, which is the main component of the mining cost, the miners' break-even costs tend to follow the price of Bitcoin. The Fundstrat chart (also from Twitter) clearly demonstrates this:

Since the price set by the difficulty adjustment ties the cost and the breakeven price together, the break-even price trend is a reasonable indicator of the future price of Bitcoin. The criticism of Samson Mow is therefore a bit unfair. Fundstrat has not been based on the theory of the value of labor, although its synthesis somewhat misleadingly implies that the cost of mining rather than the adjustment of difficulty supports the price.

Obviously, the support is asymmetrical: the price of Bitcoin is supported on the downside, but not limited to the upside. This is because it is not necessary to defend against 51% attacks when the mining pool expands. However, it does not seem that anyone has ever come to mind that the massive increase in break-even costs creates huge entry barriers that result in the concentration of the mining basin. There can not be a 51% attack, but if the mining market becomes dominated by a small number of large players, the effect is more or less the same. Above all if those players cooperate.

And there's also a second problem. Bitcoin works a lot like a commodity. In the long term, the market price of raw materials tends to their marginal cost of production. Putting this in another way, mining profits end up falling to zero. As I noted earlier, when profits fall to zero, producers eventually stop producing.

But while the raw materials would still be exchanged if the mine had ceased, Bitcoin would have died instantly. This is because the true work of miners is not the production of bitcoins, but the verification of transactions. Without transaction verification, bitcoins can not be bought, can not be sold, can not be spent, can not be earned. If the mine ceased, the existing bitcoins would become immovable – and a real estate has no value. So, unlike a commodity, if the mining profits have dropped to zero, even the value of all existing bitcoins.

The adjustment of the difficulty artificially preserves the profit margins of the miners to ensure that a sufficient number of them continue to extract mines. This protects Bitcoin from attacks, but has serious implications for Bitcoin's financial sustainability as a transaction system.

At the moment, the new bitcoins are part of the mining prizes. But the new bitcoin component of the mining reward is halved every few years. Eventually it will reach zero. As the difficulty adjustment forces mining profits to remain positive, falling profit margins – due to falling prices or halving – must be offset by the increase in transaction fees. Users of the system will have to pay the miners increasing amounts of bitcoins to keep them mining honestly.

In my opinion, this means that displaying Bitcoin as a commodity is wrong. Miners provide a service – transaction verification – on which Bitcoin users are critically dependent. Without that service, Bitcoin would have died. But miners also depend on their profits by the willingness of users to make transactions. If the commissions increase too much, users would stop using Bitcoin for transactions and Bitcoin would die. The equilibrium transaction fee would be the point at which there are sufficient users to provide a reasonable volume of verification transactions and sufficient miners to make honest checks.

Ultimately, what determines the value of Bitcoin is whether people are willing to make transactions using this. This includes the purchase and sale of bitcoins, of course, since trading is making transactions. But will the price of Bitcoin continue to rise quickly enough to allow users to continue paying higher transaction fees? Or in the end there will be a "spiral of death" triggered by falling prices when users abandon the system en masse, followed by miners who give up while the collapse of transaction volumes leads to zero commissions?

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