What is most striking about the economics of bitcoin is the juxtaposition of the certainty of supply and the uncertainty of demand. The rate at which bitcoin is bitcoin rise and fall has been highly predictable and, unlike almost any other asset, currency or commodity, its ultimate supply is a known quantity, fixed in advance. There will never be more than 21 million coins.
This feature makes bitcoin supply almost perfectly inelastic. In this report we analyze the economics of the bitcoin marketplace by finding parallels in the world of commodities to understand what it means to have an inelastic supply. Then, we move to the relatively more difficult task of demand analysis to complete the bitcoin economics picture. Economics of Supply Inelasticity The supply inelasticity explains in large part why bitcoin is so volatile.
Items with inelastic supply show a greater response to demand shifts than items with elastic supply. The same is true of demand: the more inelastic the demand, the greater the price changes in response to small fluctuations in either supply or demand. Take as an illustration the case of natural gas. Natural gas is a classic example of a market with highly inelastic supply and demand. Natural gas demand is therefore highly inelastic. Figure 2: Inelastic Expansion and the Slowing Growth of Bitcoin Supply. The same is true of natural gas supply.
If prices double, which for natural gas is not all that uncharacteristic, producers will likely not be able to supply a great deal more of it in the short term. Similar relationships hold for crude oil, although are less dramatic. Meanwhile, consumers will find ways to use them more efficiently in response to higher prices. Bitcoin’s limited and highly inelastic supply is also a major factor driving its price appreciation, a rise so spectacular that it can only be appreciated when seen on a log scale. In bitcoin’s first four years, supply grew by roughly 2. Even then prices were rising as the user community grew.