Just like any other product in a market, Cryptocurrencies prices are also determined by its demand and supply. If the supply is more than the demand, the price of cryptocurrency decreases. But if the demand is higher than the supply, the price of the cryptocurrency increases.
Let us understand how the supply of cryptocurrency affect its value in the market.
Cryptocurrencies like Bitcoin have a fixed supply of 21 million and as per April 2018, it was confirmed that 80% of the total Bitcoins was already mined. Although there is availability of newly mined Bitcoins known as Virgin Bitcoins, the supply is going to diminish over time. But it is estimated that the circulation of new bitcoin won’t end until the year 2140.
This finite supply over time creates a digital scarcity. Those in favor have argued that the fixed supply results in higher demand over time which in turn reflects as increased prices of the asset. It is also argued that this finite supply sets cryptocurrency apart from the regular financial system where new fiat currency can be printed by the central banks.
Those against this finite supply of cryptos believe that this will result in obstructing cryptocurrency from achieving mainstream adoption. They argue that limited supply will make people hoard the cryptos than spending it. This will also lead to no depreciation of the digital assets and the crypto owners will keep waiting for their goods to get cheaper.
Is Bitcoin Deflationary?
Deflation refers to the decrease in price that you pay for any goods or services. It is the opposite of inflation. Deflation is considered bad for any economy but in the crypto world, it may not be that dire. Though inflation is a problem as the $100 of your savings can end up getting you a lot less after a decade.
As explained by Brian Curran from Blocknomi, Inflation in market can result in “rampant debt levels” and force an economy to live beyond its means. It can also render currencies unusable if there is hyperinflation. Like in Zimbabwe, inflation soared from 59% in 2000 to 80 billion % in 2008.
Countries that have high political instability like Venezuela, have become the biggest cryptocurrency markets in the world. One trader said: Even though Bitcoin is volatile, it’s still safer than the national currency.”
Finite cryptos such as Bitcoin are compared to “digital gold” by some economists. As more currency is introduced in the market, the price of an asset falls. But in the case of finite cryptos, this may not be true. When more cryptocurrency is introduced in the market, it may lead to a simultaneous rise in its price. Advocates argue that today, Crypto is more stable than the global economy.
Currencies like Ethereum do not have a cap i.e. limit to how much Ether will be launched in the market. However, it does introduce new cryptos in the cryptosphere every year. Although, this results in inflation, but with the increasing circulation in the market, the prices are decreasing.
How fixed supply of cryptos affect its demand?
Due to inflation, it is believed that it is better to spend money now before its value decreases in the future. However, deflationary assets encourage consumers to save and spend their money wisely in case its value appreciates in the future. As explained by Jorg Guido Hulsmann, Austraian School of Economics, this does not mean the crypto holders would not spend any cryptocurrencies and wait for its value to appreciate. Even in the case of money, people will spend on essentials like food, fuel, etc. Plus, even if there is a chance of your money to increase its purchasing power, you will still sometimes spend on fine dining, bar, etc. Deflation does not mean the end of spending by consumers altogether. It will, however, make them think twice before making the spend.
What are the downside of this deflation?
A concept known as “deflation death spiral” is the main downside of deflation. Just like in hyperinflation, deflation can go to opposite extremes. Due to deflation, fewer people are willing to spend money which results in a decreased demand. It may lead to entire businesses shutting down. With low demands of goods and services and fall in wages, the economy will go into a downward spiral.
The Austrian School of Economics has a perspective that people will buy the essentials and if the economy is not based on debt foundations, the level of deflation can be stabilized to prevent a death spiral.
This raises the question that how can cryptocurrency be transacted in order gain momentum and mainstream adoption without loosing out on the opportunity to get more value if you hoard for the future?
There are numerous advocates that argue the use of crypto for purchases as a solution. Like ecurrencyholder, a Medium blogger feels that we can sue crypto for payments and then instantly buy newer cryptos using fiat currency. If smaller things like lunch and coffee are bought using cryptos, their demand will increase and more merchants will use crypto as a mode of payment.
What happens when the supply is exhausted?
Since it is estimated that Bitcoins mining may not be completed before year of 2140, we may not face that day.
However, this will impact the miners. Miner currently receive a block reward on mining a block for newer coins. But these rewards will decrease over time and will reach exhaustion. The founder of Bitcoin Satoshi Nakamoto himself predicted that in such a case, the plateau will shift from Block Rewards to Transactions Fees. Afterall, there will always be a need to get a transaction validated before going on the block. It will result in higher transaction fees charged from the consumers for getting their transactions completed quickly.
As the number of Bitcoins remains fixed and the prices fall, the divisibility is going to be a key factor to keep the supply in the crypto market strong. Bitcoin has 8 decimal places which means 1 coin can be divided to 1/8th of its value. On the other hand, Ethereum has divisibility upto 18 decimal places. This divisibility ensures that you don’t pay say a $5 for a $2 worth of goods without getting any change back.
In 2017, a report suggested that 3.8 million Bitcoins i.e. 18% of overall supply, were already destroyed most likely by theft, loss, etc.
Cryptocurrency as a replacement of Fiat currency
Cryptocurrency can be used to buy goods or services in today’s date. Some cryptos can only be used to buy something specific like collectibles, stocks, etc. And other crypto developers are introducing limited supply of coins in order to create a store value that appreciates over time.
The supply of the Cryptocurrency in the market does have an affect on the price of Cryptos. It generally follows the same principle as any other commodity i.e. with low supply and high demand, the price rises and with low demand and high supply, the price falls. However, in case of fixed supply currencies, they follow the deflation principle i.e. with an increase in supply may see a rise in prices.
