Why Bitcoin is mankind's scarcest commodity and what it means for the course

Economics deals with the question of how scarce goods can be distributed efficiently. Through the mechanism of supply and demand, goods receive a market price that provides information about the scarcity of the good. Bitcoin is the rarest commodity known to mankind. Why Bitcoin's scarcity is its ultimate value proposition.

"Time is money": Money is said to be a medium for quantifying and storing work done. In monetary theory, literature speaks of the so-called "value storage function". Individuals trust that the value of money will not decrease significantly in the long run and are therefore willing to exchange their limited time on earth for money (or work). Anyone looking to Venezuela, Argentina or Zimbabwe will notice that the value storage function of money is not always to be expected. Massive dilution of the money supply can lead to rising prices in the medium term and to a severe economic crisis in the long term, which completely destroys confidence in the currency. The result is often 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 central banks' expansive monetary policies. As a monopolist, 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 have a largely free hand.

Although 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. Given the stabilizing effect of monetary policy, this is justifiable. However, an annual devaluation of money of about two percent means a 20 percent loss in the value of savings after just ten years. And more: The low interest rates on sight deposits or time deposit accounts are driving savers to increasingly risky investments. Those who notice that the real value of the money they hold disappears into thin air over time park their money in more profitable - but also risky - investments.

The connection between low interest rate policy and rising real estate prices, for example, cannot be dismissed. "Betongold" is regarded as a store of value and an object of speculation.

Bitcoin as a hard currency alternative

Luckily, there's Bitcoin. For the first time in the history of mankind there is a good that, like human life, is demonstrably finite. With mathematical certainty it can be shown that never more than 21 million units of digital gold will circulate. This is an unbeatable argument for the value storage function of money. After all, at the time of their purchase, investors know exactly how much of a finite asset they have accumulated with their purchase. Thanks to the transparency of the blockchain.

For example, anyone who currently holds only a single Bitcoin knows that there can be a maximum of 21 million individuals who hold a similar share. 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. Source: https://bitinfocharts.com/top-100-richest-bitcoin-addresses.html.

Difficulty Adjustment as guarantor of scarcity

All historical funds have one thing in common: as soon as mankind agrees to use them as a store of value and means of exchange, their course logically increases. After all, as the number of users increases, so does the demand and thus the price. As a result, however, the supply side also reacts: A higher demand generates a higher supply, i.e. inflation.

In contrast to all other funds available so far, it is not possible to increase supply in the Bitcoin network if demand increases. It is possible that a high demand for Bitcoin will lead to the market entry of miners. However, due to the so-called Difficulty Adjustment, the Bitcoin money supply does not increase. Only the Difficulty, i.e. the computational difficulty of solving the cryptographic proof-of-work puzzles, increases. On average, despite increased hash power, one block enters the network every ten minutes and the money supply increases by (currently) 12.5 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 for Bitcoin than for gold. In short, an increase in demand is inevitably positively correlated with the price.

Stock-to-Flow Rate Decreasing - A Bullish Signal for Bitcoin

Bitcoin's value proposition as the rarest good of mankind (apart from lifetime) also manifests itself in the ratio of existing supply (stock) and the percentage of money added (flow). The ratio between stock and flow is called the stock-to-flow rate; and this is extremely low at Bitcoin.

At present it is 25 (17.5 million BTC, 0.7 million are added per year = SF 25). After the next Reward Halving (every four years the Coinbase Reward per block decreases by 50 percent) the SF rate is 50 and is thus almost as high as that of gold. The higher the SF rate, the more difficult it is to dilute the existing money supply.

Conclusion

For the first time in history, people have the opportunity to store value in an asset that is demonstrably in short supply. The more users that generate Bitcoin, the greater the confidence in its value storage function and the higher the price rises. Bitcoin is indeed digital gold.