Understanding Bitcoin’s Scarcity and Value Proposition
Take a closer look at Bitcoin's scarcity and the reason why its value proposition makes it one of the most valuable assets for investors.
There is no denying that cryptocurrencies are steadily entering the mainstream audience in the past year. To date, there are over 15,000 different cryptocurrencies in existence. However, there is one crypto that leads the headlines and media – and that is Bitcoin. With BTC prices continuing to climb, it begs the question – what is Bitcoin’s value proposition? What makes it such a valuable asset?
Anyone that is into bitcoin will probably know that one of its main value propositions is its scarcity. As of Q4 2021, Bitcoin’s value retains its position as one of the top 10 assets in the world by market cap, right between Tesla and Meta (formerly Facebook).
In this article, I’ll be going over the value proposition of Bitcoin by evaluating its scarcity.
Before we dive into Bitcoin’s value proposition, it’s important to get the fundamentals out of the way first. So, let’s get a simple working definition of what it is.
Bitcoin is a decentralised digital currency that is designed to enable global peer-to-peer transactions with very little friction, by using a distributed public ledger known as a blockchain.
Blockchain technology enabled investors, holders, and all participants to verify the current supply of bitcoin, the current inflation rate per block, and the total capped supply of bitcoin.
Because of this, it has what we call predictable inflation. Anyone can calculate a rough estimate of how much bitcoin is to be added to the current supply in a day from now, a week, a year, or even 10 years from now.
Learn more: Be sure to read our complete guide on Bitcoin.
Easy vs hard money
The hardness of money is determined by how difficult it is to increase the supply of that money. If it is very difficult to increase the existing supply of a particular money, it is considered hard money. In contrast, If the supply of that money is amenable to large increases, it is easy money.
This is important as in economics we learn that the price of anything is determined by supply and demand. If two assets have the same demand and same supply, the harder of the two assets will retain more of their value over time, and vice versa.
Gold has been hard money for thousands of years and has slowly gained in value over time against easy paper monies. This is because it is very difficult to produce gold.
In contrast, it is very easy to produce more paper money. Mining gold involves finding an area rich in gold deposits, building capital-intensive mines here, going underground to begin drilling, blasting and hauling.
Then the mined material must be taken to the surface so that they can crush the ore, process it, and smelt it into the gold we use. As you can imagine, this is a very lengthy and difficult process.
Bitcoin is similar to gold as it is very hard to produce more bitcoin. To better understand the hardness of bitcoin, we will look into bitcoin blocks, their issuance, and halvings.
Bitcoin blocks, issuance of bitcoin and bitcoin halvings
Bitcoin consists of a chain of blocks that contain transactions that take place within a period of time. A new Bitcoin block is created approximately every 10 minutes, and each block rewards its miner with newly issued Bitcoin, thus increasing the supply of Bitcoin. This is known as the block subsidy. At first, miners received 50 Bitcoin per block that they mined.
Every 210,000 blocks, or around every 4 years, the block subsidy is cut in half. This is known as the halving event. The halving of bitcoins issuance is a prevalent factor contributing to the scarcity of bitcoin.
At the moment, after 3 bitcoin halving events, 6.25 brand new Bitcoin is issued per block. This number will continue to decrease as bitcoin’s supply gets closer to its cap.
Why bitcoin is the ultimate scarce asset
Bitcoin is the ultimate scarce asset as its issuance requires one key resource: time.
For a thought experiment let us think about silver. The issuance of silver, a precious metal, requires energy. If the price of silver increases dramatically, miners have an incentive to increase their rate of production. This increase in production will increase the overall supply of silver and its inflation rate.
Since Its issuance requires energy, the increase in silver’s price will compensate for the extra energy expenditure. This is bad for silver holders as with an increase in price, there is an increase in supply, therefore bringing the price back down due to the economic theory of supply and demand.
Using this logic, you may ask: if the price of Bitcoin increases and more miners consequently join the network, will blocks be mined faster, and therefore increase the supply faster than normal?
The answer is no, thanks to how bitcoin is designed. The network has something called a difficulty adjustment.
Every 2016 Bitcoin blocks, or approximately every 14 days, the measure of how difficult it is to mine a new bitcoin block adjusts to either an increase or decrease in hashing power (this is basically how much energy/money is going into bitcoin mining).
This means that if bitcoins price increases drastically, and many new miners or hash rates join the network to reap the benefits, it will only become more difficult to mine bitcoin.
This ensures that a new Bitcoin block is mined approximately every 10 minutes, and the overall supply and issuance rate will not increase with an increase In energy expenditure.
In essence, bitcoin’s supply is strictly limited. No matter how much the price of bitcoin increases, and no matter how big the network grows, there will only ever be 21 million bitcoins with a predictable rate of inflation.
Saifedean Amouss explained this concisely in the Bitcoin standard when he said “there is no technical possibility for increasing the supply to match the increased demand. Should more people demand to hold Bitcoin, the only way to meet the demand is through appreciation of the existing supply”.
Why does this all matter?
Bitcoins issuance matters because we live in a world where the cost of production of the currency we use every day is near 0 and has no physical or natural cap on its supply.
Issuers of money can even profit from printing money when the face value of the currency is higher than the cost of production, this is called seigniorage. There is a huge problem with government money, namely that its hardness depends on those in charge not to inflate its supply.
As the supply of a currency increases, there will be a devaluation of said currency. This expropriates the wealth of anyone holding it and this wealth is essentially reallocated to those who issue it and those who receive it earliest. It is much easier to increase the supply of fiat currencies than bitcoin.
If the supply of fiat currencies increases more than that of bitcoin, this currency will become more abundant than bitcoin, resulting in more paper monies to chase a set amount of bitcoin.
Bitcoin is hard money, possibly the hardest money we know. Everyone knows the exact supply and inflation rate of bitcoin and can rely on it to stay constant. In a world of easy government-issued money, bitcoin can be a hedge against this fiat money madness.