How cryptocurrency scarcity affects value

There is evidence to suggest a correlation between scarcity and price. However, for cryptocurrencies, this extends beyond the simple concept of supply and demand.

Bitcoin
Source: Bloomberg

Utility and scarcity giving value to cryptocurrencies

Value has two prerequisites, utility and scarcity, both of which are inherent in cryptocurrencies. Utility refers to the use that these cryptocurrencies have and the problem they are trying to solve, or what current process could they do better. Scarcity on the other hand, relates to the number of digital coins or tokens in circulation.

When it comes to utility, you can use bitcoin as a store of value, ether to execute a pre-programmed code via smart contracts, and litecoin to pay for goods and services. Whether or not you believe in cryptocurrencies and their current valuations in the long term, these cases of real world use, and an increase in adoption are slowly increasing, which shows us that there is at the very least an interest to see if they can replace our current systems.

Scarcity on the other hand - and each individual coin’s nuanced approach to what constitutes scarcity - is worth exploring if you are looking at trading cryptocurrencies. This is because the scarcity of a particular cryptocurrency such as bitcoin, ether or litecoin, may have an effect on price action. This is especially true when we take into account bitcoin's halving event, and the ethereum protocol's ‘ice age’.

Cryptocurrencies ‘base’ scarcity and the effect on price

There are big differences between each cryptocurrency, but in almost every case there are planned limitations to the potential supply of digital currency units. We’ll take the two largest market cap cryptos, to explain what we mean.

Bitcoin and ether handle supply very differently. According to the rules of bitcoin, a total of 21 million tokens will be mined ever– with just over 16.5 million coins mined so far. Roughly every ten minutes, the bitcoin network will produce a reward for miners. Ethereum has a different reward structure, with five units of ether created every 15 to 17 seconds. Currently there are about 99 million ether circulating, but there won’t be a finite supply, as use of the network itself causes ethers to be destroyed naturally.

Although at some point in the future ether may be worth more when it comes to market cap, you need to have a base understanding about the total circulating supply when you are making your trade ideas. To put this in perspective, if bitcoin had the same supply as ether does currently, but maintained the same total bitcoin market cap, each coin would have a price of closer to $1450.

Scarcity and price elasticity of cryptocurrencies

Interestingly, cryptocurrencies have a unique quality that no other commodity or currency currently has: a near perfect supply inelasticity. This basically means that no matter how much demand there is, they will still get mined at exactly the same rate.

When you look at things such as oil and gold, or even major currency pairs such as the USD, EUR or GBP, if there is prolonged and elevated demand, supply will aim to catch up. More oil rigs start to come online, while central governments can print money via quantitative easing (QE). However, this can’t happen with cryptocurrencies such as bitcoin.

You may see a price increase prompting more miners to dedicate resource to these cryptos, but that doesn’t create faster production. This inelastic nature of many cryptos is what allows crypto bubbles and volatile market conditions.

How halving events also impact the value of crypto

Currently the bitcoin network rewards miners with 12.5 bitcoin every ten minutes. However, this started at 50 and has gone through a halving event four years to bring it to the current number. This means that about 1800 coins are created each day, with the next halving event scheduled to take place in June-July 2020.

The maximum number of bitcoins created under current rules is expected to be around 2140, however 99.9% should be mined by the 10th reward era in 2044. There should be a total of 34 halving events over the full period, up to 2140.

These halving events probably have a bigger impact on the price than is generally acknowledged. Although there will be knock on effects to things like hash rate and short-term price fluctuations whilst some unprofitable mining rigs are pulled offline, the propelled interest and effect of a deflationary monetary system will have a larger impact in the long run. The two halving events we’ve had so far provide evidence to suggest this is true. Many experts suspect this will cause an increase in price for the cryptocurrency, however that will only be seen in 2020

Find out more about mining and how it affects the value of cryptocurrencies

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