How is bitcoin scarce?

Bitcoin BTC -2.34% has been making headlines for years now, with its price the subject of extreme volatility and market interest as it rocks up and down. One of the key features that sets bitcoin apart from traditional currencies is its scarcity, and unlike fiat currencies, which can be printed endlessly by central banks, there is a finite amount of bitcoin that will ever exist.

But how exactly is bitcoin scarce, and what implications does this have for its value and adoption? In this article, we'll explore the concept of scarcity on the Bitcoin network and what it means for the future of this revolutionary digital currency.

The limited supply of bitcoin

Bitcoin's scarcity is an integral part of its appeal and value proposition. The cryptocurrency mimics the properties of precious metals, such as gold, by having a finite supply, and the total number of bitcoins that will ever exist is limited to 21 million. This cap was implemented by Bitcoin's creator, the pseudonymous Satoshi Nakamoto, to create a deflationary asset.

This scarcity stands in stark contrast to traditional fiat currencies, which are inflationary and can be produced in unlimited quantities by central banks. This scarcity is further augmented by the process of Bitcoin halving, a crucial part of the mining process which occurs approximately every four years and reduces the rate at which new bitcoins are created and released into circulation, effectively enhancing its scarcity.

For instance, the most recent halving in 2020 slashed the block reward paid to miners from 12.5 bitcoins to 6.25 bitcoins, thereby slowing down the creation of new bitcoins and enhancing scarcity.

Lost bitcoin can also add to its scarcity, with the cryptocurrency's early history full of stories about people who lost their private keys. Once it's gone, it's gone forever, and that means that the maximum supply of 21 million bitcoin will never be fully available.

It's important to note that while bitcoin's scarcity is a significant driver of its value, it's not the only factor. Demand, utility and market sentiment also play critical roles in determining bitcoin's value. Yet, the interplay of fixed supply and halving creates a unique economic model that is different from traditional fiat currencies.

Bitcoin's scarcity can present challenges, however. The capped supply and halving events put pressure on miners, who may find it less profitable to mine bitcoin over time. This could potentially lead to a decrease in the number of miners, impacting the network's security and transaction speed.

While scarcity contributes to bitcoin's appeal, it also introduces potential risks that need to be managed.

The challenge of Bitcoin's scarcity

While bitcoin investors tout the coin's scarcity as an argument to invest in it, the changing tokenomics could have an impact on the network's security.

Over time, bitcoin miners will produce fewer bitcoins during the mining process. If the price of bitcoin remains flat or declines, this will result in reducing revenues for these miners. This means that the incentive to mine new blocks could decline over time and miners could drop off the network — ending up in a lower overall hash rate.

Unless there is a corresponding increase in transaction fees — which would replace the lost mining revenue for miners — this might mean that the network's security could weaken and it could become more susceptible to 51% attacks.

Bitcoin proponents typically claim that either the price will increase, maintaining the value of the mining rewards, or that transaction fees on the network will rise to supplement any declining revenue. If this happens, the network's security may remain strong. If not, the network might need to reconsider the way it's kept secure.

The influence of scarcity on bitcoin's value

The stock-to-flow (SF) model is a popular tool used by investors to assess bitcoin's scarcity. The SF model indicates the number of years it will take to attain the current stock at the current production rate.

Gold currently has a higher SF ratio than bitcoin, which comes in ahead of silver in the number two spot. That could change, though, after the next halving, which might make the digital gold officially more scarce — in a relative sense — than its real metal counterpart.  

While the stock-to-flow model has been correlated with bitcoin's price in the past, it's worth noting that it only considers bitcoin supply and not its demand. If demand for were to drop significantly, its price could fall despite its high SF ratio. Critics also say the model doesn't accurately predict future prices.

As bitcoin matures as an asset, macro factors will increasingly influence its price. The cryptocurrency market is still relatively young and volatile, and is subject to regulatory changes and technological advancements that could impact bitcoin's value. If a more efficient and secure blockchain technology were to emerge, it could also potentially challenge bitcoin's dominance in the cryptocurrency market.