Bitcoin Economics vs Market Psychology

It's more determined than you might think.

I am convinced that the price surge of Bitcoin is a very simple example of supply and demand, where demand is very high and channels for access to Bitcoin are very constrained.

In Wall Street terms, the volume of traded Bitcoin is relatively low. For example. on NASDAQ, a typical day would show about 1.8 million trades. Until September, Bitcoin never got more than 750,000. Try to remember that Wall Street has figured out something called ‘front-running’ (which is illegal) in which I could profit if, knowing what you’re about to do, I traded a security 1 second before you. Bitcoin trades each cost 10 minutes to process. Compared to regular stock trading, or regular Visa transactions, Bitcoin is slow and sparse. When it comes to volume, Visa is 14 lane autobahn, Bitcoin is a two lane road in the outback of Australia.

So what if suddenly millions and millions of people all over the world now find it interesting to buy and sell Bitcoin? You have a massive traffic jam on that two lane highway. And the exchanges & miners gleefully rub their hands together and charge a higher toll. The deeper economics of cryptocurrency pricing, particularly of Bitcoin, have shown that congestion of the networks that create blocks are a large determinant of the price of the currency. And remember that the price of Bitcoin is deflationary because everybody knows there are a fixed number of blocks that are ever going to be made. Other cryptocurrencies don’t have this feature. Look at Ripple. There are 38 billion coins out there. The price is about 50 cents each. No big deal.

So it stands to reason that when (duh) more than 21 million people are bidding to possess something there will never be more than 21 million of, it doesn’t matter how smart they think they are or are not, the price is going to go up.

Limited supply + congested infrastructure + huge demand = high prices.

None of this is surprising to financial professionals who do this for a living, or to economists. The fact of the matter is that they are just now beginning to take the entire phenomenon seriously. The trading volume of Bitcoin has reached historical highs this year, even greater than when the price spiked at around $17,000 in December of 2017. That reflects serious demand. And some of the existing Bitcoin exchanges are having to halt trading because they can’t keep up. That reflects limited accessibility.

This formula for Bitcoin in particular and popular cryptocurrencies in general will continue to bump up the price until there are more mainstream financial institutions participating in the market. The limited supply part of the equation will always be there. Bitcoin stops making coins when there are 21 million. Today there are about 18

.5 million. For other currencies, not so much. The congested infrastructure will remain a factor until current exchanges and miners decide to up their game, but it’s clearly in the interest of miners to have some congestion. The huge demand is just human nature. People investing in Bitcoin think they’re smart the way people who installed their own Linux had to be smart back in 1999. Nobody came up with a one disk installation like Ubuntu back then. Somebody will make buying and selling Bitcoin idiot-proof. That won’t change demand, it will change accessibility.

So in summary, no I don’t think the price of Bitcoin is overly determined by the psychology of Bitcoin investors. I’m convinced that it is primarily determined by the size and shape of the market, the rules of Bitcoin itself, and the economic interests of exchanges and miners.

It is inevitable that a small project like Bitcoin, as it has gotten hugely popular has been called a ‘bubble’ by financial experts. I say it’s just viral and economists don’t get it. But yeah you might say that demand for Bitcoin might be affected to people’s reaction to the word ‘bubble’.