The Power of Scarcity

Usage of Money

The three main uses for money are to be a medium of exchange, a store of (nominal) value, and a unit of account. Bitcoin does not work well as a medium of exchange, particularly to buy goods or services with relatively small prices, because of the transaction costs and the slow settlements of each transaction. It does not work well, either, as a unit of account as the Bitcoin’s price tends to be quite volatile, so there are problems to clearly determine prices for goods and services in Bitcoin units in a stable way.

SoV - Store of Value

However, unlike fiat currencies like the US dollar, the euro, or the pound, Bitcoin is a much better way to store value over time, that is, to avoid the harm of inflation in the value of the money people hold. As central banks like the Federal Reserve in the United States or the Bank of England tend to print more and more money on a daily basis, the money a person holds is condemned to lose purchasing power over time, as prices go up because of the increasing relative abundance of money. In fact, fiat money is a store of nominal value as a 10-euro bill will always have a 10-euro value, but that does not mean it is a good store of real value (the purchasing power of how much goods and services we can buy with that 10-euro bill). As prices continue to go up, that 10-euro bill will buy less and less goods and services because of the effect of inflation.

As Bitcoin has a maximum production capacity of just 21 million Bitcoins through mining, Bitcoin will experience the same fate of assets that have limited production: a continuous appreciation in the long term. We can take the example of the masterpieces of famous dead artists like Leonardo Da Vinci or Rembrandt. No matter how valuable their works of art were as they were alive, it is almost always true that their works will appreciate even much faster once they have died, because of the relative scarcity of their works as they do not live anymore, and there will not be more works made by them. Art lovers and investors can only trade the existing works of art in a complete state of scarcity as it is impossible to have a new masterpiece made by them anymore.

We can classify Bitcoin as an anti-inflationary asset, unlike fiat money. As Bitcoin becomes more and more scarce because the mining process produces less and less new Bitcoins as we approach to the maximum 21-million Bitcoin production cap, Bitcoin will become a more valuable asset.

Hyperinflation

This is especially important for investors as we are in the middle of a strongly expansive monetary policy in most countries in the world. For instance, the Federal Reserve in the United States is flooding the world with a cheap dollar, as that policy is supposed to increase liquidity in the markets, reduce interest rates, increase the availability of credit, increase investment by firms, and increase consumption by households. This is currently the goal of the Federal Reserve because of the harsh economic downturn in the United States and the world because of the Covid-19 crisis and the negative effects of lockdowns and economic restrictions.

However, this massive printing of money is undoubtedly going to generate more and more inflation in the future in the United States with the undesired side effects of higher costs of living, lower real returns (as inflation deteriorates the returns of investors and lenders), and so on.

Buying Spree

On the other hand, the massive printing of money gives more liquidity to investors in the short term, so they rush to buy financial assets like shares, corporate bonds, and more recently cryptocurrencies to desperately look for higher expected returns as interest rates go down (interest rates are the price of money, so if the money supply increases, interest rates decrease in the short term, as long as inflation has not gone up yet). This is one of the reasons for the current appreciation of many financial assets like stocks, bonds, and cryptocurrencies. The higher liquidity means more money to put in many financial and non-financial assets. Then, prices go up for most assets as there is a higher demand for them.

As long as the negative effects of the Covid-19 pandemic continue to affect the societies with recessive economies, higher unemployment, increasing poverty, etc., we can expect central banks to keep interest rates low, which means a continuous massive printing of money that leads to a continuous appreciation of financial and non-financial assets like cryptocurrencies.

In this scenario, we can obviously expect Bitcoin to continue to appreciate in the near future, as the ability to produce more and more units decrease, while the fiat money is issued generously by the central banks. Bitcoin can now prove its useful characteristic of being an asset that seems to be immune to inflation over time.