Inelastic Supply
Wed Jul 06 2022
There is nothing in the world with a supply as inelastic as Bitcoin. Bitcoin has a mathematically calibrated issuance rate of one block every 10 minutes. The number of Bitcoin generated per block is not impacted by external circumstances. Regardless of the price or hash power or the difficulty level, Bitcoin issuance rate remains fixed. It is determined by an internal parameter which cuts the block reward in half every 210,000 blocks or roughly 4 years for 32 halving — reaching 21 million BTC in the year 2140 or so. The supply does not respond to demand. As demand rises, price skyrockets; as demand falls, price plummets. When the block reward is cut in half (every 4 years), the supply rate halves and creates a supply scarcity which drives price upward roughly every 4 years. The 4 year cycle has demand-driven extreme volatility which will forever be part of the bitcoin pricing.
Not your grandfather’s commodity
Bitcoin is a terrible short term investment. The price fluctuates up to 20% a day and 80% over a year. High volatility is due in part to the relatively small market cap of Bitcoin. (Currently at 400B, compared to Apple at 2.3T) Another factor is the hyper-inelastic supply which does nothing to dampen the impact of demand swings.
The high volatility makes Bitcoin a terrible collateral. Leveraged positions both long and short get wiped out regularly which exacerbates volatility. Bitcoin also is a terrible method of payment with few upsides to spending your bitcoin. Bitcoin transactions can be traced making anonymizing impossible.
In the early days, people believed that Bitcoin would be a peer-to-peer electronic cash — a native internet currency that would make PayPal obsolete. Early Bitcoin based illegal dark web marketplace Silk Road was born out of this ideology. People assumed Bitcoin was anonymous enough and Bitcoin took off as the currency of the dark web. The end of Silk Road marked an end of an era. New decentralized Bitcoin marketplaces never took off.
Most Immutable
Alt coins arrived on the scene promising better payment scalability and anonymity. Bitcoin positioned itself as the most secure, most immutable cryptocurrency. Bitcoin has survived more than 10 years of attempted protocol changes. As a result, Bitcoin is the most immutable blockchain and has the best future guarantee of immutability.
The popular narrative became “Sound Money”, a feature distinguishing it not only from other cryptocurrencies, but also from Central Bank’s FIAT. The “Sound Money” narrative looked at Gold supply cap as a point of reference for determining possible price of Bitcoin. Since Bitcoin is as scarce as Gold, has all the fungible properties of gold, is cheaper to store than gold, has easier validations than gold, it should be able to play the role that gold has played through human civilization — as an immutable unit of account. With Gold market cap at 12T, Bitcoins should be worth $500k once most people agree that Bitcoin can be a store of wealth like Gold.
Bitcoin and Inflation
With recent inflation and crash in Bitcoin price, many have wondered why Bitcoin is not hedging against inflation. Bitcoin short term price is a measure of demand, not inflation. Increases in money supply increases demand for Bitcoin, but Bitcoin does not care about CPI index. As the Fed fights inflation, money supply is being decreased, dropping prices of assets across the board. Bitcoin experiences this restriction more acutely due to it’s hyper-inelastic supply.
Inflation also brings demand for assets since no one wants to hold cash long term. The Fed rate hikes will be priced in and absorbed by the market. Those who sold for cash at the start of the rate hikes will be looking for a better store of wealth. Bitcoin can fill that role along with Real Estate.
Disaster, then Stability
Many Austrian School Economists and Techno-Libertarians oppose big government, and money printing by the Federal Reserve. Some dreamed of a day when central banks would be on sound footing again by using Bitcoin as their reserve currency. In that scenario, demand for Bitcoin would skyrocket as central banks compete for limited inelastic supply. By driving the price up, would be sellers would rather hold, limiting availability of coins further.
Central banks who adopt Bitcoin first are in a position to print significantly more FIAT as Bitcoin reserves rise in value. But prices don’t rise forever, and as prices fall, FIAT will need to be destroyed to keep up with the falling reserve value. This whiplash of inflation and deflation of FIAT is undesirable and will cause economic havoc until the price of Bitcoin reaches its equilibrium.
Bitcoin is a more pure unit of accounting than Gold. Gold has intrinsic value as industrial and fashion material. Bitcoin has no demand other than as a unit of accounting. It is an optimized unit of accounting that needs no reserves. It is a fixed point that measures demand with price. A world which uses Bitcoin as reserves will be a multi-modal world where the US no longer dominates by leveraging USD.