Equation of Exchange: Simple Examples

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The Equation of Exchange

The equation of exchange, MV = PQ is foundational to the Eat Sleep Crypto valuation framework. The following articles explain each component in detail:

Equation of Exchange Examples

Imagine an auto mechanic needs to purchase $10,000 worth of parts from China. The seller demands payment in CNY, which is traded on exchanges.

To complete the payment, there must be at least $10,000 worth of Chinese Yuan in circulation.

If there isn’t at least $10,000 worth of CNY in circulation, there are two ways to make it so:

1) CNY is printed by some means, and acquired by the buyer to complete his purchase.

Or,

2) The entire circulating supply is bought up on order books until the buyer’s CNY is worth $10,000.

The first method acts on the supply side, increasing the circulating supply.

The second is based on demand, where the currency’s price appreciates to meet demand for its use.

Valuing Cryptocurrencies With the Equation of Exchange

Our microeconomic example of the equation of exchange using CNY works the same at scale, with a couple more moving parts.

Since cryptocurrencies can’t be inflated at will, the buying up of cryptocurrencies and tokens on exchanges for actual use cases is how price discover occurs.

Let’s say Bitcoin is used to buy $100 billion worth of goods and services annually. We’ll imagine that 10 million BTC are in the circulating supply – they not lost or otherwise unavailable. And we’ll say that each bitcoin moves between 5 people per year, on average (historical velocity of the dollar).

So our velocity is 5.

So we have M = $100 billion (PQ)/ 5 (V) = $20 billion

Applied to cryptocurrencies, this fundamental value is a *price floor* – the minimum sustainable price of a cryptocurrency, absent speculation. Dividing $20 billion by 10 million BTC to get the price per unit gives us a price floor of $10,000 per Bitcoin.

In the Investor Series articles, we find price floors of various cryptocurrencies using models with adjustable assumptions.