There are several economic principles that govern the price of Bitcoin, because at its core; Bitcoin’s price is determined by a market like any other asset or commodity. Markets consist of a constant churning of supply and demand created by buyers and sellers. The inherent scarcity in stocks, commodities, or any asset is a huge factor in determining value. In the universe of Bitcoin, there is only one way to create circulating supply – and that is through mining.
Miners Determine Supply, Adoption Determines Demand, and Halving Events Create Inherent Scarcity – The Ingredients to a $100,000 Bitcoin
From an economic standpoint, there are many factors forcing the price up Bitcoin upwards, and this is one of the premises Laissez Faire is based on.
Bitcoin is a decentralized currency asset that can only be created through proof-of-work provided by miners. It has utility currently as a digital cash, voting system, banking system, store-of-value, digital gold, and as a trust-less money system. Bitcoin allows users not only to have absolute freedom over their money, but also to become the bank themselves. Bitcoin is the internet of money.
Bitcoin is inherently deflationary as it is difficult to create, scarce, subject to a finite supply, and exponentially scarcer every 4 years. This makes the price of bitcoin prone to large increases.
Supply and Demand, Bitcoin Miners:
Miners are at the heart of Bitcoin, in fact Bitcoin’s first big adoption came from miners creating hash-power. Hash-power is a measure of computational energy used to make the Bitcoin network function. Miners are constantly dedicating their computing power and providing utility, and they are rewarded for this in Bitcoins. Mining is the only way to create bitcoin. These computations for finding the blocks are basically mathematical puzzles that a miner cannot just guess without a lot of computation. This brings us to the concept of Proof-of-Work.
Proof of Work:
In order for Bitcoins to be created, a miner has to “mine bitcoins” using electricity and computing power. While doing so the miner processes transactions by verifying them to be true. Hypothetically, if there was no stake (the work put into mining); coins could be double spent or transactions could be duplicated. This is impossible because of the consensus of miners all mining the same blocks all around the world for the same reward: Bitcoins.
This creates an incentivized, self-perpetuating network where users can send bitcoins to any other user almost instantly, for almost no fees, peer-to-peer, without needing trust or a third party.
Miners are the only creators of the circulating supply of Bitcoin. There are a finite number of Bitcoins available at any given time according to how much are being mined and sold on exchanges. Inherently they become more expensive as they become more rare, so when miners are selling less on the market; the price often goes up.
One of Bitcoin’s fascinating mechanics is that it has a hard cap of 21,000,000 BTC. There will never be more than 21,000,000 BTC mined, and it will take roughly another 50 years for all of the BTC to be mined.
So not only does Bitcoin have a hard limit on it’s total supply that will ever be created, it also gets harder and harder to bring more coins into circulation overtime from mining. This is where the halving comes in.
The Bitcoin block mining reward halves every 210,000 blocks or roughly every four, the coin reward will decrease from 12.5 to 6.25 coins during the next halving in 2020. As explained earlier, the miner’s are rewarded for processing bitcoin transactions and solving prove of work in Bitcoins. During the first cycle of bitcoin; the block reward was 50 BTC, then 25 BTC after Dec 2012, then 12.5 BTC after July 2016. The halving is intrinsically deflationary because it changes the breakeven price of miner profitability. Miner’s mine Bitcoin for profit – not for some utilitarian or philanthropic agenda, if they are no longer generating profit mining BTC, they stop mining. The halving makes it half as rewarding to mine Bitcoins which makes some miners stop mining. This chokes the supply of Bitcoin and inevitably forces the price up to match the needs of miner profitability.
Because the monetary base of bitcoins cannot be expanded, the currency would be subject to severe deflation if it becomes widely used.
2010: Block Reward, 50 BTC, Price of BTC/USD: $0.12
2012: Block Reward, 25 BTC, Price of BTC/USD: $12.00
2016: Block Reward, 12.5 BTC, Price of BTC/USD: $700.00
2020: Block Reward, 6.25 BTC, Price of BTC/USD: $???
Is Bitcoin a Digital Gold?
Every day there seems to be more evidence that Bitcoin could be a reserve asset, similar to gold. In the past, countries hoarded gold to back their paper issued currencies. In 10 years, could Governments back their fiat currency with a digital store of value that is even more scarce, and even harder to create than gold bars? Bitcoin has utility that challenges the use of gold, and even fiat currency in some aspects.
More recently, Bitcoin has been following the price of Gold with a relatively strong correlation. Similar markets trend together… so does this mean Bitcoin is a digital replacement to gold?
Another important aspect to understand is the magnitude of deflation behind Bitcoin. Nearly 85% of Bitcoins have already been mined, and they are mined half as quickly every four years. As long as adoption continues while supply shrinks, the deflationary phenomena will continue.
Adoption Determines Demand:
In order for Bitcoin to succeed, it must be used by people, institutions, businesses, and even governments. The network effect is occurring in Bitcoin currently, and it’s going through an adoption curve like many influential technologies – but where do we lie on the curve? If Bitcoin really is going into a phase of existence where it begins to replace gold or currency as a digital monolith; it still may be in it’s early stages. At the moment, Bitcoin is mostly useful as a store of value, and a faster, trust-less, and more fungible form of money. Whether it will be a changing force in world economies in the future remains hypothetical.
Examples of other adoption curves in technology over the last 100 years:
Quantifiable data based on the number of google searches for “Bitcoin”, about 3x every year on average.
The reality of the bitcoin price phenomena revolves around supply and demand, inherent scarcity and shortages, and the adoption of the technology themselves. Whether it replaces gold, the dollar, or becomes something completely of it’s own; it’s very likely Bitcoins will continue to become more valuable.
Bitcoin contains all of the ingredients to become a store of value phenomena that will undoubtedly change the landscape of the world in some way, and is highly likely to increase over time with more adoption, an ever-diminishing supply, and the way it is designed is inherently deflationary, and the pressures of use cases and adoption constantly lurch it forward and higher.
The recipe for a $100,000 Bitcoin is already on the counter, now the question is; will the world cook it?