Economics deals with the question of how scarce goods can be distributed efficiently. Through the mechanism of supply and demand, the goods are given a market price that provides information about the scarcity of the goods. Bitcoin is the rarest commodity known to mankind. Why bitcoin’s scarcity is its ultimate value proposition.
“Time is money”: Money, they say, is a medium for quantifying and storing work done. In monetary theory, the literature speaks of the so-called “value storage function”. Individuals trust that the value of money will not decrease significantly in the long term and are therefore willing to exchange their limited time on earth for money (or work). If you look to Venezuela, Argentina or Zimbabwe, you will see that money cannot always be expected to store value. Massive dilution of the money supply can lead to rising prices in the medium term and to a tangible economic crisis in the long term, which completely destroys confidence in the currency. The result is not infrequently hyperinflation: a complete devaluation of money and, as a result, the destruction of savings for entire generations.
Central banks as monopolists of money creation
High inflation is often the result of expansionary monetary policy by central banks. As a monopoly, central banks control the key interest rate and thus have a direct influence on the amount of money in circulation, i.e. the inflation rate. Depending on the legislation, they are largely free to do so.
Although the inflation rates in democratic countries in the West are low, the European Central Bank (ECB) is also aiming for an inflation rate of just under two percent. An annual devaluation of the money of around two percent means a twenty percent loss in value of the savings credit after ten years – that is clear. And more: The low interest rates on sight deposits or time deposit accounts are driving savers to increasingly risky investments. Anyone who notices that the real value of the money held disappears into thin air over time, parks their money in more profitable – but also risky – investments.
For example, the connection between the low interest rate policy and rising real estate prices cannot be dismissed out of hand. “Concrete gold” is considered a store of value and an object of speculation, because buying houses on credit is cheaper than ever before.
Bitcoin as a hard money alternative
Fortunately, there is Bitcoin. For for the first time in human history there is a good that, like human life, is verifiably finite. With mathematical certainty it can be shown that there will never be more than 21 million units of digital gold in circulation. This can be checked by everyone participating in the network, provided they operate a full node. Don’t trust, verify is the bon mot of the Bitcoin scene for a reason. This is an unbeatable argument for the value storage function of funds. After all, investors know exactly at the time of their purchase what proportion of a finite asset they have accumulated with the purchase. Thanks to the transparency of the blockchain.
For example, anyone who currently only holds a single bitcoin knows that there can be a maximum of 21 million individuals who hold a similar stake. Members of the “21 Million Club” are already among the wealthiest 2.3 percent of all Bitcoin owners.
The Bitcoin Rich List lists the wealthiest Bitcoin owners.
Difficulty adjustment as a guarantee of scarcity
All historical funds have one thing in common: as soon as mankind agrees to use them as a store of value and a medium of exchange, their course increases logically. After all, the higher the number of users, the higher the demand and thus the price. However, this has the consequence that the supply side also reacts: A higher demand generates a higher supply, followed by inflation.
In contrast to all previously available funds, an increase in supply is not possible in the event of increased demand in the Bitcoin network. A high demand for Bitcoin may lead to the entry of miners into the market. Because of the so-called Difficulty Adjustments However, this does not increase the Bitcoin money supply. Only that Difficulty, i.e. the computational difficulty of solving the cryptographic proof-of-work puzzles, increases. On average, despite increased hash power, a block comes into the network every ten minutes and the amount of money increases by (current) 6.25 BTC.
In economics, one speaks of the price elasticity of supply, i.e. the supply-side reaction to demand shocks – and this is even lower with Bitcoin than with gold. In short: an increase in demand is inevitable positively correlated with the course.
Stock-to-flow rate declining – A bullish signal for Bitcoin
Bitcoin’s value proposition as the rarest commodity of mankind (besides lifetime) also manifests itself in the relationship between the existing supply (floor) and the added amount of money as a percentage (Flow). The relationship between stick and flow is called Stock-to-flow rate; and that is extremely low with Bitcoin.
It is currently 47.7. This means that Bitcoin is almost comparable to gold (SF 62) in terms of scarcity. The higher the SF rate, the more difficult it is to dilute the existing money supply. The S2F rate states how many years it would take to double the current supply, based on the current inflation rate.
Market analyst @planB has cobbled together a model course course, which we will deal with at this point.
Conclusion
For the first time in history, people have the opportunity to store value in an asset that is demonstrably scarce. The more individuals adopt Bitcoin, the stronger the trust in its value storage function and the higher the price rises. Bitcoin is indeed digital gold.
Disclaimer
Item was originally published on May 7, 2019, has been updated and reviewed for republication.