On The Gas Balloon Model of Bitcoin Value

The Effects of Hodling/Hoarding and Transaction Volume on Price

It seems like there are two schools of thought on what drives the price of bitcoin. On one side are those like Daniel Krawitz, who believe that the value of bitcoin stems from hoarding/hodling/saving. And on the other are guys like Chris DeRose, who attribute bitcoin’s value to its transactional usefulness for gambling, acquiring illegal drugs, etc.

Near the 38:00 mark of DeRose’s excellent interview with Andrew Lee of Purse.io, Lee bridges the two schools by thinking about bitcoin’s value in terms of classic thermodynamics. As an air balloon can be inflated by adding more molecules or by adding more heat, bitcoin’s value increases when more hodlers join or when more transactions occur.

In effect, Lee is comparing the rate of bitcoin transactions to the temperature of a gas.

The reason a balloon gets bigger with the addition of heat is that hot molecules move faster, so they exert a greater force when they bounce off the inside of the balloon. A balloon “discovers its volume” when the forces on its inside and outside are equal.

Similarly, bitcoin discovers its price (*2) at its boundary: the exchanges where fiat and bitcoin are traded.

The difference between the two models is their rate of dispersion. If heat is added to molecules in, say, the middle of the balloon, that heat quickly disperses until there is a uniform temperature throughout the balloon.

Bitcoin transactions, on the other hand, can increase or decrease in the middle of the bitcoin ecosystem without affecting exchanges until much later.

Eventually, changes in transactional velocity will affect the price, but there can be significant lag time. For example, the rate of physical gold transactions has probably dropped by more than 99% from the 1400’s, however the price (in terms of how much labor an ounce can buy) has only dropped 90%.

There can also be lead time. Satoshi and Hal Finney made numerous transactions before anyone recognized a non-zero bitcoin price.

(*1) or work through the mining process, and also, maybe, through any type of useful work done by people or machines.

(*2) I use the term price discovery because it is commonly used and understood. However, lately I’ve come to believe that what is actually happening is value discovery.