If you were awake in your economy class, you remember perhaps from Milton Friedman's classic theory: Essentially, Friedman argued that the general level of prices is directly proportional to the amount of money in circulation. We can apply the Friedmans logic to bitcoin and use it as a starting point for evaluation. The root of the understanding of the theory of the quantity of money is the equation of exchange, MV = PQ.
Ok, what does the formula mean again? MV = PQ.
M = The stock of money. How much money is in circulation?
V = The velocity of money. How fast does money change hands?
P = The overall price level.
Q = The production of the economy.
Then we can say that the PQ is nominal GDP or total expenditure. The price of all goods and services produced in an economy in one year.
So, Friedman's logic was this: the speed of money was stable and Q moved to a minimum. The actual output of an economy usually increases or decreases by only a few percentage points a year.
So the formula looks like this: M V = P Q ] . Because V and Q are relatively constant, an increase in the money supply, by a central bank, will lead to a proportional increase in the price level. In the long run, increasing the money supply faster than the real growth of the economy will always lead to inflation. True wealth can not be created by the printing press.
How can we take Friedman's ideas and apply them to the bitcoin ecosystem? The first M is constant. No central bank, dictator, politician or bureaucrat can increase the supply of bitcoin. The current market capitalization of around $ 250 billion proves that the code is good and the underlying idea that counterfeit bitcoin can not be made. We will also assume, like Friedman, that the speed of bitcoin is relatively constant. So the bitcoin ecosystem looks like this: MV = PQ. Now M and V are kept constant.
So we must now define PQ in the bitcoin ecosystem. Q is the global utility created using bitcoin. There are two identifiable groups of people who would benefit from the use of bitcoin: those who want to leave the grid and those who want to get into the grid. Internet gamblers, people who try to send money abroad from economically free companies and a lot of other people who use it for illegal activities.
In addition, there are people who do not have access to the global financial system. These are people from war-torn countries like Afghanistan, Syria or Iraq or people in countries where the monetary and financial authorities have let them down, like Zimbabwe or Venezuela. They will be allowed to enter the grid with use and access to bitcoin.
Q represents the actual output transactions that the whole world has to perform on and off the network. With M and V constant, the change in the market capitalization of bitcoin is directly proportional to the change in the use of the world and the need for this type of payment system.
The overall value of the bitcoin utility, in fiat currency (P), divided by the velocity, determines the market capitalization of bitcoin. M = PQ / V. Friedman argued that the general level of prices is directly proportional to the amount of money in circulation. The increase in the money supply pushed up prices. By applying it to bitcoin, we can say that changes to the world's bitcoin Q ecosystem will have proportional changes in the market capitalization of bitcoin. The roles are reversed now. The Q pulls the M instead of the M who pulls the PQ!
Then, if we can put numbers on Q and V, we can have a starting point for bitcoin valuation. The simple napkin calculation indicates that it should be much higher than $ 250 billion.
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