What’s the most you would ever pay for a pizza? Chances are it is not $500 million.
But on 22 May 2010, a developer by the name of Laszlo Hanyecz logged into the Bitcointalk forum and paid another forum user 10,000 BTC for two Papa John’s large pizzas.
At current bitcoin prices, those Papa John’s pizzas would be worth $540 million. Enough to own nearly 10% of Papa John’s itself!
Back then, bitcoin was a niche interest. Just look at the worldwide Google search volume for ‘bitcoin’ early on:
Source: Google Trends
Bloomberg estimates bitcoin was then selling for ‘less than a penny’.
The bitcoin pizza purchase was a giddy experiment by cryptocurrency enthusiasts wishing to stretch the applicability of the fledging blockchain technology.
In 2010, Laszlo Hanyecz commented on the forum that ‘I just think it would be interesting if I could say that I paid for a pizza in bitcoins.’
How far have things come since that interesting pizza transaction?
iPhones replaced iPods. Australia went through five prime ministers. The number of cryptos ballooned to over 10,000.
But one thing hasn’t changed. The perennial question of what one bitcoin is worth.
What is bitcoin worth?
In the very early stages, when Satoshi mined the first coins, bitcoin’s value was essentially zero.
Satoshi was even reported to have handed out bitcoins to interested people for free, along with an explainer on how they can mine more.
In late 2009, the bitcoin community decided on a clever way to quantify the dollar value of a bitcoin.
A bitcoin was to be equal to the cost of electricity required to mine a coin. At the time, this was about 0.08 US cents.
Since the encrypted proof-of-work calculations were less intensive back then, the computer power demanded was lower too.
But as more users were added and more transactions were made, the code took longer to run and the cost to mine bitcoin rose in line with the price.
These computational costs associated with mining have escalated in tandem with bitcoin going mainstream.
In fact, a paper in the Journal of Economic Perspectives noted in 2015:
‘As miners update the block chain, their computational efforts carry significant costs. In particular, the computerized proof-of-work calculations are quite power-intensive, consuming more than 173 megawatts of electricity continuously.
‘For perspective, that amount is approximately 20 percent of an average nuclear power plant (World Nuclear Association 2015), or approximately $178 million per year at average US residential electricity prices.’
This could indicate that the rising costs of mining could put a floor on the price of bitcoin.
Now that it can’t take just any person with a PC to mine a coin, we can expect the bitcoin price won’t fall far below the costs dedicated miners incur.
After all, why would modern-day, sophisticated miners bother if the bitcoins can’t cover their expenses?
But the mining cost valuation method is dark on the price ceiling of bitcoin. Is $50,000 too high? Is $10,000 too low?
Metcalfe’s Law, network effects, and bitcoin
While the rise in users increases the required mining processing power, it also suggests a further way to tackle bitcoin’s value.
One such way is to apply what’s called Metcalfe’s Law to the question of bitcoin’s worth.
The law is accredited to Bob Metcalfe, the inventor of Ethernet and founder of the computer networking company 3Com.
Essentially, Metcalfe’s Law says that a network’s value is proportional to the square of the number of its users.
For instance, having a Facebook account is useless if you’re the only one with an account. But Facebook’s value rises the more users join. Under Metcalfe’s Law, this growth is non-linear.
In the journal article ‘Metcalfe’s Law as a Model for Bitcoin’s Value’, financial analyst Tim Peterson argued that network effects can be harnessed to value bitcoin.
Peterson thinks this can be done by tracking the number of bitcoin wallets. For example, in late 2011, there were about 370 wallets and BTC was around US$2.
In late 2017, bitcoin was about US$4,000 with over 20 million wallets.
In March 2021, there were about 60 million bitcoin wallets and bitcoin’s price was hovering around US$50,000.
In a summary on Metcalfe’s Law, MIT Technology Review said that ‘in the context of financial transactions, larger networks would seem to have more value than smaller networks.’
Source: Timothy Peterson
There are caveats, of course.
Statistical analyses of network effects frequently rely on correlation, from which we should not imply causation.
Further, as MIT Technology Review pointed out, other researchers have used Metcalfe’s Law only to find that bitcoin was ‘significantly overvalued’.
So it seems the question of what bitcoin is truly worth remains.
Tomorrow, we will look at other ways thinkers have approached the valuation question and see what some economic Nobel Laureates have to say.
But in the meantime, if you would like to delve further into the world of cryptocurrency, blockchains, and the reimagining of the financial system, I recommend checking out our new service, New Money Investor.
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