Disclaimer: Opinions expressed in this article do not constitute investment advice from Bitcoin Reserve.
The bullish case for bitcoin isn't lacking in rationale. Bitcoin's long been heralded as an asymmetric asset capable of reducing risk within a portfolio with even the smallest allocation. But what exactly is behind bitcoin's unlimited upside, and what could that mean for the asset's future?
In past research pieces, we've touched upon bitcoin's inherent benefits and explored its value propositions. From a hedge against macro risk to a comprehensive global currency reset—bitcoin's possibilities are almost endless. But there's one narrative supporting bitcoin's value that stands out among all others: Scarcity.
Supply and Demand
Much like bitcoin, gold has a myriad of factors supporting its value ranging from opportunity cost to its historied role as a commodity. In the main, however, the rarest of the noble metals derives its value from precisely that—its rarity.
Typically, and to put it reasonably reductively, the less gold produced, the more valuable it's deemed. Couple that with demand, and you have a significant catalyst for price growth.
If, for example, gold supplies dried up overnight, the likelihood of a price hike would be reasonably high. Conversely, if an asteroid filled with gold were to strike the earth tomorrow, the precious metal would likely plummet.
The same principle applies to bitcoin. Unlike gold, of which its total supply is unknown, albeit estimated, bitcoin has a relatively determinable and finite supply. There will only ever be < 21 million BTC in existence.
However, bitcoin may be even more scarce than first thought. According to research from Chainalysis, between 2.3 and 3.7 million bitcoin are to be deemed lost—reducing market capitalization by between 13% and 22%.
Given that the research was published back in 2018, that figure is likely to be a lot higher today.
On the demand side, the reality of bitcoin's finite nature truly kicks in when allocating its total supply.
Per data from Statista, as of Q1 2020, there are currently 42 million blockchain wallets users—up over 7 million compared to a year prior.
Given this, if distributed equally, there would only be enough for 0.5 BTC per wallet—lost bitcoin notwithstanding.
Another significant element of bitcoin's supply and demand principle is the halving protocol.
As its name suggests, the block reward halving slashes the mining reward in half approximately every four years. This acts as a quasi-monetary policy, avoiding hyperinflation by way of limiting the circulating supply.
The act of reward halving acts as a supply shock, with the quadrennial event quite literally halving bitcoin's annual supply—continuing to do so until all blocks are mined.
Bitcoin and the Stock-to-Flow Model
The fundamental hypothesis of supply and demand and its impact on price is theorized within the stock-to-flow (SF) model. Typically used as a quality criterion for monetary commodities such as gold and silver, the SF model provides a measure of asset scarcity. Weighing circulating supply (stock) against annual production (flow) produces a ratio upon which to ascertain this scarcity. Gold, for illustration, holds the highest SF ratio at around 62. Broadly speaking, the higher the SF, the higher the market value of an asset.
The SF model has been applied to bitcoin to predict its long term value.
Before bitcoin's last halving in May, calculations set bitcoin's SF at 25—half that of gold. However, with the halving acting as a supply shock and severing its annual supply, bitcoin's SF ratio doubled. In theory, bitcoin's SF now sits tantalizingly close to that of gold's at around 50.
Based on past precedent, there's a particularly tight correlation between bitcoin's price, and it's ever-expanding SF ratio. This seems to prove the principle of supply and demand is as prevailing in bitcoin as it is gold.
One of the first mentions of the SF model in relation to bitcoin was in economist Saifedean Ammous' seminal work: The Bitcoin Standard. This has since been expanded upon by several analysts, including pseudonymous bitcoin analyst, PlanB, and the German state-owned bank, Bayern LB.
The report from Bayern LB was particularly bullish, concluding that bitcoin was created to be an "even harder asset than gold," and providing a theoretical price point of $90,000 once the latest halving is factored in.
Interestingly, the concept of hard money and a towering price point are both facets required of a global reserve currency. Ammous himself suggests that bitcoin's hardness, as well as its avoidance of government intervention, positions bitcoin as a viable alternative to the dominance of the US dollar.