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An Economics 101 Lesson: Why Bitcoin Price Will Increase

Michael Hudson
14 October 2015

The law of supply and demand. One of the fundamental economic principles applied at macro and micro levels. Simple concept, right? Demand and supply curves indicate that as supply decreases, demand increases. And vice versa. As supply decreases and demand increases, prices increase. So what’s this got to do with bitcoin - and in particular its price? Everything! Let’s have a look at the supply and demand curves for bitcoin, shall we?

The Scope of Bitcoin Supply

One of Bitcoin’s unique features is that, unlike fiat money, it can’t be minted or printed at the whim of a central bank. It has a finite supply. Encoded in the algorithm that ‘controls’ Bitcoin, is the ‘stipulation’ that there will only ever be 21 million bitcoins supplied. No more, and no less will ever be created. However, there are 2 interesting

Firstly, issuance is predetermined and predictable. Bitcoins come about as a result of Bitcoin miners successfully solving mathematical equations to process and verify bitcoin transactions. As an incentive, miners are offered 25 bitcoins for each block they add to the blockchain. The underlying algorithm adjusts the difficulty of the equation to maintain an average block creation rate of around 10 minutes.

Secondly, it’s deflationary. The Bitcoin protocol includes pre-programmed milestones that state the number of bitcoins earned per block halves for every 210,000 added. Loosely this equates to a halving every 4 years, until the last bitcoin is mined. Based on current computational power, the next reward-drop is expected to occur in the latter half of 2016.

The Demand for Bitcoin

To understand the appetite for bitcoin, we can look at key market metrics. If we compare the current fundamental metrics such as the number of wallets, transactions, and accepting merchants against their values 2 years ago, we see a marked increase in adoption. There’s been a 483% surge in the number of user wallets, the daily transactions have increased from around 40,000 to 140,000, and the 711% more merchants are accepting bitcoin as a means of payment.

From a development perspective, the interest shown by engineers has swelled by 376% over the last 2 years, and we’ve seen a dramatic boost in the number of Bitcoin-related APIs available in the market. We also know that’s there’s ongoing and increasing venture capital being pumped into businesses building commercial opportunities and services in the Bitcoin space. A conservative estimate is that close to US$1b dollars of venture capital has been invested thus far, which is incidentally significantly higher than what was being pushed into the Internet at a similar stage in its lifecycle.

The Supply-Demand-Price Relationship of Bitcoin

So, economically speaking, what are we looking at?

Firstly there’s the anticipated moderation in supply. We know, unequivocally, that come late 2016 the number of bitcoins introduced into the market on a daily basis will drop from 3,600 to 1,800. The law of supply dictates that,

Secondly we have evidence to suggest that the demand curve is one that’s far from stagnant. All key metrics point to steadily growing adoption and interest. Based on these primary principles of economics, it’s reasonable to conclude that the combination of a sharp squeeze on quantity, and a positive demand trend, will produce a steady climb in the bitcoin price. And for savvy investors, this means impressive returns on current market prices.

Photo credit: Tiffany Bailey on Flickr

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