Predicting Bitcoin Price Using Quantitative Models, Part 2

This is the second in a multi-part series that aims to answer the following question: What is the “core value” of Bitcoin? The first part deals with the scarcity value, the second part with the market movements in bubbles, the third part with the adoption rate and the fourth part with the hash rate and the estimated price of Bitcoin.

The market moves in bubbles

Much has been said about it in the past few months or even years Air bubbles that develop in the bond markets. The newspapers (both those involved in the financial world and those who do not) talked about it, and the specialized television networks and respected “macroeconomists” around the world discussed how current world debt has negative interest rates.

It is financially counterproductive to have to pay or lend money to someone, even if that person is a state. We are experiencing an absurd situation that has never existed in the financial market landscape. The main cause has to do with the tremendous liquidity that central banks inject into the markets, which they use as funding to avoid their own bankruptcy, and then prudently return it to states (even in trouble).

Predicting Bitcoin Price Using Quantitative Models, Part 2
Predicting Bitcoin Price Using Quantitative Models, Part 2

After all, the famous phrase of John Maynard Keynes says:

“The markets can keep their irrationality longer than you can keep your solvency.”

In reality, this nonsense made it possible to avoid the bankruptcy of the financial system, so it is welcome although it fuels irrational phenomena. such as negative-yielding bond markets (and thus senseless bond prices) and stocks that (not all, but most) hit new highs every day.

One phenomenon that is not really powered by central bank money, which everyone referred to as a pointless mega-bubble in 2017, is Bitcoin (BTC). Bitcoin price hit a high of $ 20,000 in December 2017, which coincided with the introduction of bitcoin futures by the Chicago Board Options Exchange and CME Group, the world’s two largest commodity exchanges, and effectively hit a low of around $ 3,100 in 2018 reached losing more than 80% of its value.

Does that represent the bursting of a bubble? For sure. Does it represent the end of Bitcoin? Of course not. Could there be more bitcoin bubbles in the future? Naturally.

As always, we want to approach the problem as analytically as possible. We are recreating the table created by the founder of Bitcoin. Satoshi Nakamoto, with Excel, to ensure that Bitcoin is a deflationary, not an inflationary, currency.

inflation

The US dollar (and indeed all of the world’s currencies, including the euro) are worth less and less due to inflation over time. We can better understand the phenomenon by thinking about the value of assets. Buying a car 40 years ago was about 13 times less than it is today. A good car that cost $ 10,000 in 1980 would cost $ 130,000 now.

This phenomenon is called Inflation, and it is induced by a rule linking the total value of goods in the world to the total amount of currency in circulation. When the number of dollars in circulation doubles, the same goods typically cost twice as much. It will “trend” as the currency is not a linear phenomenon and it may take some time for it to occur.

In the 1970s and early 1980s, inflation in the United States reached rates of nearly 12% a year. This creates many difficulties for those who do not have the knowledge and the means to counteract it.

deflation

Bitcoin was created using a deflationary logic that is more similar to that of commodities like gold and silver. This is why it is considered by many to be the new digital gold, as it has characteristics of value retention rather than depreciation like the dollar or the euro.

Let’s see how it was created and what effect that choice has.

Nakamoto decided that the maximum number of Bitcoin created and available should be 21 million. (The number 21 will appear many times. It is the Greek letter phme, which we will talk about later). It could have been decided to introduce a fixed amount of Bitcoin for each block to be mined, but this would not have created the exponential growth effect that characterizes Bitcoin, or at least not as pronounced as it is today.

As a result decided to cut the amount of newly issued Bitcoin in half every four years in order to have a very pronounced and interesting stock-to-flow effect that would drive the price higher and higher.

For the first 210,000 blocks, the miners received 50 BTC for each block added to the distributed ledger. At a time when the value of Bitcoin fluctuated from a few cents to a few dollars, the compensation was nothing like today’s, nor was it that difficult to win the challenge. In fact, in the early years, ordinary computers were enough to dismantle them.

The first halving took place in 2012, that is, starting with block 210.001, the remuneration for each new block added to the distributed ledger was halved to 25 BTC. The second halving took place in 2016, when the remuneration was reduced to 12.5 BTC, and again the third halving in May 2020, which increased the remuneration for each block to 6.25 Bitcoin, which with the latest price correction to around $ 40,000 is still around $ 250,000.

The next halving is planned for 2024, if the remuneration is further reduced by 50%. It is planned to continue probably until 2140, Year in which the last halving is expected, which will distribute less than 1 bitcoin in the last year.

But, How does this halving phenomenon affect the price of Bitcoin? Does the halving of the so-called “flow” or the flow of new capital into the market affect the price of Bitcoin itself? As we saw in the first part, Bitcoin seems to follow the stock flow model. Therefore, a reduction in the flow rate for the same inventory should correspond to a price increase. Shouldn’t there have been more bubbles after three halves?

Do you know how many bubbles Bitcoin had in its short life? Three. They are shown graphically below.

These are the three bubbles Bitcoin has faced so far and in each of them the next all-time high got higher by at least 10. Of course, this is not a guarantee that it will in the future, but there are many factors that lead us to believe that the one we live in in 2017 will not be the last bubble: many more will be in the future consequences.

Can this information be used to determine a fair price for Bitcoin? Or at least a potentially achievable price under this model?

Indeed, if we look at this graph where the halving is highlighted by jumps on the X axis corresponding to the change in the halving state, we can We can estimate the fair price, that is, the correct price that Bitcoin could reach.

If Bitcoin’s price tends to return around the line described in the previous figure, it is clear that we can estimate Bitcoin’s future price target based on the halving that is waiting for us.

The graph shows that the price target for Bitcoin is between $ 90,000 and $ 100,000. This information is very useful not only because it guarantees that we will achieve these prices, but also because we need to consider our investment decisions because it could actually reach and even exceed these price levels.

Obviously, these estimates should be construed as an intellectual attempt to understand the dynamics of Bitcoin and cannot be viewed as a suggestion or investment advice from the author at all. It is not easy to understand how Bitcoin can achieve such prices, and anyone approaching this fascinating world for the first time will have a hard time imagining themselves as a seemingly worthless one Asset can be valued this highly, especially when it does fall into the trap of thinking that it is a currency similar to the dollar.

For this it is important to know the different aspects. One that is certainly crucial in determining the price of Bitcoin is the adoption rate, which is described in Part 3.

Ruggero Bertelli Y. Daniele Bernardi are co-authors of this article.

This article does not contain any investment recommendations or recommendations. Every step of trading and investing involves risk, and readers should do their own research in making their decision. ]The views, thoughts, and opinions expressed herein belong solely to the authors and do not necessarily reflect or represent the views and opinions of Cointelegraph.

Ruggero Bertelli is Professor of Financial Intermediate Economics at the University of Siena. He teaches courses in bank management, credit risk management and financial risk management. Ruggero is a board member of Euregio Minibond, an Italian fund specializing in regional bonds for SMEs, and a board member and vice-president of the Italian bank Prader Bank. He is also a consultant on asset management, risk management and asset allocation for institutional investors. As a specialist in behavioral finance, Ruggero participates in national financial education programs. In December 2020 he published The hill of Ciliegi, a book on behavioral finance and the financial crisis.

Daniele Bernardi is a serial entrepreneur who is constantly looking for innovation. He is the founder of Diaman, a group dedicated to developing profitable investment strategies. Daniele’s work focuses on developing mathematical models that simplify the decision-making processes of investors and family offices in order to reduce risk. Daniele is also President of Investors’ Magazine Italia SRL and Diaman Tech SRL and CEO of Diaman Partners wealth management company. He is also the manager of a cryptocurrency hedge fund. He is the author of The emergence of crypto assets, a book on crypto assets. He was recognized by the European Patent Office as the “inventor” for his European and Russian patents in the field of mobile payments.

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