Supply, Demand and Volatility

[theZerg]

People who are mathematically/economically "challenged" just assume that a halving of the supply equals a doubling of the price. However that is very naive. The effect on the price depends on the slope of the demand curve. In English, this means that it depends on how much people can do without the item as the price rises. For example, in the 70s we learned that USA's need for oil was VERY inflexible. People still had to drive to work every day after all. So a small change in supply caused a large spike in price.

We need to debunk this "supply halves, price doubles" silliness whenever redditors post it

So what is the demand flexibility of Bitcoin? Well, the knee-jerk logic assumes that demand is very flexible. After all, there are plenty of existing vehicles for payment and savings that can be used if Bitcoin supply dries up.

However, I believe that demand is in fact very inflexible. The reason why is simply because blue-sky but rational (based on a small % of penetration in a variety of existing markets) valuations of Bitcoin put the price of a coin up in the 10k to 100k USD range. So when a medium or long term buyer enters the picture, what does he care that Bitcoin is up 5, 10 or even 50%? Its mostly the short term traders that are affected by daily price appreciation. But they don't have a big effect on price week over week. Its the medium or long term buyers that soak up supply.

In fact, to some degree (like the last 2 months) demand creates more demand (people buy because they see the upward trend). This behavior is inexpressible in the traditional supply/demand curve.

And note that the last halving of supply saw an approx 10x price appreciation so this interpretation fits available data.

Ofc, the logic works in reverse too short term. A lot of the BTC is being held long term for value storage. Its not being used on a daily basis to transfer money. So when the Bitcoin price starts to fall, what's stopping people from selling now and buying back in a few weeks? Not much; only the fear that they are misreading the market and the pain of keeping track of it for taxation.

But don't just apply this to the halving. Supply dries up due to a surge in demand as well. That is what we've been seeing in the last few days.

So we get these vertical ups and downs

 

[Georg Engelmann]

I generally agree with this post. We can predict the maximum amount of BTC in circulation, but we don't know how many of them are being sold or bought.

You shouldn't say "supply halves" when the rate at which new Bitcoins are created is reduced.

Some people also falsely assume that if someone loses access to 100,000 BTC it's a good thing, because the supply is lower. In reality investors would lose confidence in BTC if that happens.

 

[theZerg]

You are right better to say your sentence or the shorter but still less accurate "new supply halves"

 

[Erdogan]

Generally: The demand is the number of coins people want to aquire for a certain price.
The supply is holders that wants to hold less and therefore offers some for a price. (not the total number of coins in existence).

The value is cleanly speculative at all times, there is no fair value. You could say that some car's fair value is a tad higher compared to another car with less power for instance. Bitcoin has no fair value as the value is general over the specter of possible products, therefore general. It goes for all money types.

Since the value is always future looking (a choice to buy something now or later, or just have the general value of the money in reserve for a rainy day), the prospect of the future value greatly affects the present value.

There is no hope of computing the value, all we have is the possible future aggregate demand to hold a cash balance. I think it goes in the general direction of up.

I can speculate what the other actors think of the halving event. It might not mean anything to me, but if it means something to other people, it affects the value, and therefore it means something to me.

Lots of circular reasoning, I know, and I think that is a source of volatility.

 

[MonadTran]

The primary use for Bitcoin right now is saving. How much a Bitcoin adopter has to save, does not depend on the price. Whether 1 bitcoin costs $1 or $1000, I am still willing to put, say, 10% of my money into Bitcoin, no more, no less.
Miners dump bitcoins onto the market, they bounce off the speculators, they end up in the hands of the hodlers.

If we assume the new $ demand from hodlers remains constant, and the mining supply halves, then we have the same amount of $ chasing half as many bitcoins, and the price doubles.
The $ demand from hodlers does not remain constant, however. As soon as the price starts to grow due to reduced supply, speculators gradually turn bullish, and it grows up even more.
When the price growth becomes noticeable, it attracts attention, and increases visibility. More people are converted into hodlers, the $ demand grows.
Now we have the old hodlers, the new hodlers, and the speculators all jump in with everything they have.
Sooner or later though, the speculators take profit, and the bubble pops.

The new hodlers, however, remain, they just become more careful. The supply remains halved.

So, I would say, the price doubling prediction is too conservative and unrealistic. We'll have the price double, quadruple, increase 8 times. Then it will pop, and the long-term effect of the halving would be maybe 3x, maybe 4x, maybe less, maybe more. But not less than 2x.

 

[Pecuniology]

@theZerg

"So what is the demand flexibility of Bitcoin? Well, the knee-jerk logic assumes that demand is very flexible. After all, there are plenty of existing vehicles for payment and savings that can be used if Bitcoin supply dries up."

Something like 80-85% of the world's population is unbanked or underbanked. The idea that Bitcoin users have ample alternatives means, in practical terms, that they can switch to altcoins. After all, if the banking system, credit cards, Western Union, and the like were viable options for individuals in Emerging Middle Income Regions of the world—including many areas within OECD member states—then they wouldn't be unbanked or underbanked.

However, the cryptocurrency market favors the longest blockchain, which is The Blockchain. This last point is lost on those whose economic thinking is still stuck in the Industrial Age. One example being this analysis and prediction: http://marginalrevolution.com/marginalrevolution/2013/12/how-and-why-bitcoin-will-plummet-in-price.html

I am working with several entrepreneurs in sub-Saharan Africa, who see Bitcoin as the most cost-effective option for them to engage in small-scale, cross-border transactions. In the same way that their parents leapfrogged from unwired to wireless with mobile phones, they are leapfrogging from unbanked to bank-free with Bitcoin on their smartphones.

"I believe that demand is in fact very inflexible."

That is my working hypothesis, as well.

 

[theZerg]

Great point. If you are using BTC for day to day payments demand is Inflexible. You have to pay your bills after all, you are not holding for long, and btc popularity breeds confidence. In this sense BTC may behave in a manner opposite to a commodity... demand creates more demand.

Also, I think that the GBTC price difference is an illustration of demand inflexibility of BTC when used as an investment. GBTC investors put a 100usd premium for btc in retirement acts. So they must expect near term price appreciation to exceed LT cap gains 100usd/20pct or $500

 

[cypherdoc]

Some people also falsely assume that if someone loses access to 100,000 BTC it's a good thing, because the supply is lower. In reality investors would lose confidence in BTC if that happens.

which is exactly what the Blockstream folks use as an excuse if one of their SC's fails taking 100,000 BTC with it: "oh no prob, everyone elses coin value will go up!"

 

[JVWVU]

Some people also falsely assume that if someone loses access to 100,000 BTC it's a good thing, because the supply is lower. In reality investors would lose confidence in BTC if that happens.

IMO this is a horrible assumption what about all the silver and gold that sunk in ships over last 600 years or any coins lost in Roman Wars over the last 2000 years.

The only investor who may lose confidence is the one who lost the coins, the others who feel more confidence as the Fed could not just reprint them if actually known.

 

[Georg Engelmann]

IMO this is a horrible assumption what about all the silver and gold that sunk in ships over last 600 years or any coins lost in Roman Wars over the last 2000 years.

A few tons of gold getting lost over a few hundred years is not a disaster. 100k BTC getting lost is like Germany losing their entire gold reserves at once.

Seeing that the biggest stakeholders can't store their wealth securely in an asset does affect the confidence of everyone.

 

[Pecuniology]

@chmod755

"Seeing that the biggest stakeholders can't store their wealth securely in an asset does affect the confidence of everyone."

One of the most fundamental relationships in finance is present value. In the simplest form, present value (p) equals expected future value (f) divided by 1 plus some discount rate that includes a market consensus time preference (called the risk-free rate) and a risk premium (r), with the denominator raised to the power of the number of units of time (t) until the median market participant expects f to be realized.

p = f / (1+r)^t

Anything that decreases perceived risk reduces the expected return (r) that the holder of the asset requires, in order to be induced to hold it. As r falls, p rises.

 

[rezzme]

@theZerg I think the word "supply" on its own is not doing empiricism any favors. It's just not accurate to me.

Supply in circulation =/= Supply mined.

Dormant Supply (Savings) +
Burnt Supply (keys lost or coins burned) +
Active Supply ("circulation," changing hands within a high velocity, relatively short period) +
Incoming Supply (current mining rate entering Active Supply within a proactive time frame mirroring that which defines "active supply" retroactively)
= Supply Mined

The active supply and incoming supply could probably be determined by analyzing velocity/time of new coins and some pattern of entering dormancy. I bet "active supply" in terms of time is something like a steep cliff at 90 days and another steep cliff at 120 days into "Dormant Supply."

The point of this ramble being:

The "real supply," that being in circulation, is the bitcoin that actually has a price. I would argue this supply is quite tiny compared to the total mined. I personally have coin I haven't touched in years that might as well not be considered "supply" at current prices. I will let it go to zero if it comes to it, and also never sell it for fiat. I do not think I am alone.

 

[TrevinHofmann]

IMO this is a horrible assumption what about all the silver and gold that sunk in ships over last 600 years or any coins lost in Roman Wars over the last 2000 years.

Unless coins were sent to outputs that provably cannot be redeemed, there's no certainty that the coins are lost or even difficult to recover. In most cases, the owner loses their private key. How can investors and traders know whether they lost the key or are lying in order to manipulate the price up?

I say that lost coins aren't technically a problem, but uncertainty of the available monetary base does result in less accurate price models.

 

[theZerg]

Boom! Supply squeeze turning into a huge pop...