Satoshi Nakamoto presented Bitcoin as an attractive and highly innovative digital currency. However, researchers and new users have difficulties understanding Bitcoin’s economics and design behind its existence. Since its introduction, Bitcoin has existed for over a decade now. And the internet is awash with publications attempting to examine whether Bitcoin is an efficient and effective payment method.
While some investors and traders know something about the economics of Bitcoin, ordinary people don’t know much about it. Currently, many people use crypto exchanges like the bitcoin system to purchase this virtual currency. These platforms also allow individuals to sell their tokens and get fiat money. However, most users know it’s a currency that exists online. Others see it as an asset worth investing in for future returns. So, what are the economics of Bitcoin?
Understanding the economics behind Bitcoin
Bitcoin has no central trust point or backing. However, being a decentralized virtual currency is a feature that attracts many people looking for a currency they can trade freely. Thus, people looking for the money they can use without relying on intermediaries like the government and banks find it attractive.
Bitcoin’s creation via mathematical algorithms gave it a fixed supply. Nevertheless, Bitcoin supply presents some problems despite being set. For instance, fixed supply can lead to a macroeconomic imbalance in case of an indefinite increase in transaction volume.
Additionally, Satoshi Nakamoto might have set Bitcoin’s supply, but the overall crypto market is not. While the world has over two thousand cryptocurrencies, developers are creating and launching more virtual currencies.
Some experts also argue that a fixed supply can cause deflation to yield high welfare and destroy volatility. And matching demand variation will indeed be a difficult task. For this reason, some experts recommend a flexible system to respond to changing demands.
Creating an adjustable currency supply rate and a decentralized voting mechanism are ways of creating a flexible system. Some researchers predict Bitcoin’s deflation possibility, while others hint at potential hyperinflation if central banks oversupply the currency. However, some people rule out the inflation and deflation scenarios because fixed supply can only affect the mining activity’s profitability if it causes a deflation-like situation.
Supply certainty and demand uncertainty
Something striking about Bitcoin’s economics is the juxtaposition of its supply certainty and demand uncertainty. Bitcoin has a highly practicable mining rate. That means people can predict the rate at which miners will introduce new tokens and generate the last coin. Thus, this predictability of supply differentiates Bitcoin from other commodities, currencies, or assets. Ideally, Bitcoin’s ultimate supply is a fixed quantity that people know because the world can only have 21 million bitcoins. And this feature makes this virtual currency’s supply almost inelastic.
Regardless of the increase in Bitcoin’s price, miners can’t produce more than Satoshi Nakamoto prescribed when introducing this virtual currency. Additionally, Bitcoin’s price increase may not incentivize the rapid mining of this virtual currency. And if it does, miners will generate more tokens one day and less in the future. That’s because they must produce the total amount by 2140.
On the other hand, Bitcoin demand drivers are not apparent. For instance, news that may affect the crypto industry can affect Bitcoin demand negatively. A move by the government to regulate this virtual currency can also affect its market demand. Thus, Bitcoin demand is relatively opaque, unlike supply, which is inevitable.
Bitcoin economics follows the supply and demand rules. However, the supply of this virtual currency is specific, while its demand is uncertain. What’s more, Bitcoin lacks a central trust point or backing by any authority. And this makes it a highly volatile asset.