Could the widespread adoption of bitcoin cause its value to fall? A quick look at the quantity theory of money suggests that may be the case.
The Impact of Velocity in the Quantity Theory of Money
The Quantity Theory of Money produces a simple equation: M(V) = P(Y). M is money supply, the amount of money in an economy. V stands for velocity, the rate at which money is spent, or the number of times a single unit of money changes hands. P represents prices and Y represents production, or real GDP.
M(V) = nominal GDP = P(Y).
In a traditional fiat-based economy, Y grows quite slowly over time, so in any given year its change is quite limited. Velocity is also relatively constant, averaging about seven in the U.S. (That is, every dollar in the U.S. economy is spent seven times). If Y and V are, for all intents and purposes, constant, then the cause, (at least in this branch of economics), of price inflation is a rise in money supply. Money supply is government, or reserve/federal bank, determined.
In the case of bitcoin, M is also fixed, at 21 million. But if we consider the velocity of bitcoin, any rapid rise in its use would lead to a rapid rise in velocity. With a fixed M and Y, then, a rise in V would mean a rise in P, or prices. A rise in prices in relation to the value of bitcoin, means bitcoin will deflate. The basket of goods and services I could buy with one bitcoin last year would now cost more bitcoin this year as bitcoin’s velocity rises.
The Call For the Widespread Adoption of Bitcoin
Bitsonline’s William Peaster recently wrote an excellent summary of forces potentially driving the mass use if bitcoin and crytpcurrencies. Brian Armstrong, CEO of Coinbase and long-time crypto advocate recently argued that more than ten percent of the global population would be using crypto within five years.
And of course, there are many companies, such as VegaWallet, working on mobile POS payment apps that would enable that very thing: using crypto to make everyday purchases. But what it does to bitcoin’s price might not quite be what we expect.
The Perception of Scarcity
There is also a more subtle dynamic at play here, which is the perception of scarcity. It is widely understood that diamonds, for example, are not as scarce as De Beers would have us believe. The company has deliberately under-supplied diamond to the market so as to raise its value. It is perceived to be scarcer than it is.
And let’s not kid ourselves. If Saudi Arabia stops sucking crude out of Ghawar Field, oil would become scarcer, both perceptibly and in reality. It is still there, of course, but not floating around our economies.
If the widespread use of bitcoin in everyday life were to become a reality, then, the perception of it as a scarce resource would be risked. This would potentially place downward pressure on its price. Perhaps unintentionally, Ethereum co-founder Vitalik Buterin touched on this problem:
Hoarding and Hodling: The Scarcity Proxy
Currently, many bitcoin holders are not spending it because it is difficult to spend and also because they are rationally holding an asset they believe will be more valuable in the future. Perceived depreciation of prices delays purchase decisions. Why buy that bag of potatoes today when you expect it to be cheaper tomorrow? This is the cause of deflation.
Where bitcoin is involved in this, that bag of potatoes will be cheaper tomorrow, in bitcoin terms, if bitcoin’s price rises. The hoarding of bitcoin creates a false scarcity that theoretically makes it more valuable than it otherwise might be. Bitcoin whales become the De Beers of cryptocurrency.
Perhaps the widespread adoption of bitcoin is not the panacea to the current bear market that crypto enthusiasts hope it will be.
Have your say. Do you believe that the expanded use and widespread adoption of bitcoin will dampen, rather than propel, its value?
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