After the explosive peak at the end of 2013 bitcoin languished for most of the time. But now it seems to come back!
The last weeks brought something like a breakout of a base that formed loosely after bitcoin draw renewed interest half a year ago.
Bitcoin is a new market and it is virtual. It’s difficult to pinpoint any fundamental drivers. I believe the current run is mostly psychologically induced and here is the catalyst:
A few weeks ahead there is a special event, the halving of the earnings miners receive for mining a bitcoin block. These rewards to miners are the sole source of bitcoin creation. Many believe that because of rewards becoming smaller then, the bitcoin price has to go up to “compensate” for this halving.
However, this seems to be a conundrum. The supply of bitcoins that arrives at the market may go down because of the halving of the creation rate of bitcoin itself and not because miners earn less and there is a compensation necessary.
So, will the supply of bitcoin that reaches the market go down immediately or over the long run?
The stream of bitcoins that flows to miners will become smaller at the halving, but it is not clear whether miners will sell bitcoins also at a smaller rate. They typically sell what they need to cover costs and hoard the remainder. Miners are not only creators but also investors. If the costs can’t be covered, they go out of business. In that case they probably stay invested and try something else bitcoin related.
That would lead to the idea that the dollar volume of bitcoins miners sell per time won’t change around the halving and price changes should be only psychological and short lived. Miners simply would have to sell a higher fraction of the bitcoins they earn but the same absolute amount to cover costs.
But if they were selling at a smaller rate and the buying rate from people investing in bitcoin were keeping up, prices should go also up until there is a new equilibrium reached.
In the long run bitcoin’s price is driven by the demand to supply ratio like in any other market. The special bitcoin twist is that this relation is dominated by the rates of new investment in vs new creation of bitcoin.
And here it gets interesting…
The creation rate is known to dry out to zero and that at a fast pace. That’s a matter of fact defined in the software code of bitcoin. Today about 74.57% of all bitcoins that will ever exist are already there. Somewhere in July 25 BTC will become 12.50 BTC for one mined block and the creation rate will also drop accordingly. In the distant future, vaguely around 2140, this rate will get set exactly to zero.
The investment rate is actually pure investment minus consumption. Bitcoin gets already used to buy and pay for goods. Consumers and miners are effectively selling bitcoins they have. Traders will mostly pump up the price at times, as most go long, but because a trader trades, this price support will be only temporary.
So, the creation rate gets halved every 4 years and there are already 75% of all bitcoins mined. The stream of new bitcoins is severely running dry. If the investment appetite keeps intact over time or is even growing, then…
In the short run, psychology is the most important factor of bitcoin’s price fluctuation. One could even argue that this is true also for long-term formation of prices simply because there is no real fundamental value in bitcoin. It is all speculation that bitcoin will become a real currency or at least will be used as such in the future. That may be good or bad for the investor, but it is clearly good for the trader.
Bitcoin is the perfect instrument for moon shots — completely decoupled from fundamental considerations.
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