Demand Dips For Bitcoin Are Temporary; But Lack Of Supply Is Permanent
From the “Double Spend” scare of January 20, 2021 to the flight to the relative safety of cryptocurrency’s decentralized trading platform on January 30, 2021, a ten day window in the life of Bitcoin illustrates the power of fixed supply versus variable demand on prices.
When rumors surfaced of a possible glitch in the blockchain system supporting Bitcoin, buying interest in the megacrypto briefly waned. In all markets, any seed of doubt, especially in a still nascent, somewhat hard to understand asset, will send some investors to the sidelines. This is what happened for about a week in the Bitcoin markets, and prices pulled back. But when instability hit trading platforms in the wake of the Reddit inspired investing frenzy in heavily shorted securities, resurgent demand for Bitcoin popped prices back up towards their all time highs, largely because Bitcoin supply did not increase rapidly enough to meet demand.
The “double spend” Bitcoin rumors were unequivocally proven false, stemming from a naturally occurring but extremely rare bifurcation in the resolution system for blockchain transactions that basically self corrects as blockchain activities progress. (At least that’s the best way I can describe things with my very limited understanding of the process. Suffice it to say, in plain English, that the system is rock solid and Bitcoin lives on unscathed.)
Market prices decline when there is a lack of demand; buyers pull back and those needing to sell, being more motivated for whatever reason, have to chase prices lower in order to cash in their holdings. In Bitcoin’s case, the double spend rumors temporarily chased buyers away and left those needing to sell searching for buyers at lower prices. When the sellers had completed their initial round of selling, prices for Bitcoin had dropped around 15 percent from their peak in the early morning hours of January 20, 2021 to their trough in the evening of January 21, 2021. This is what happens when demand for something dries up. Prices go lower.
Prices also go lower when supply of something exceeds demand. In Bitcoin’s case, this rarely happens, because Bitcoin’s current supply is known, the rate of Bitcoin’s possible added supply (from mining activities) is also known, and the ultimate supply of Bitcoin is fixed at 21 million. In a macro sense, the supply of Bitcoin, being fixed, can’t really ever keep up with demand, so long as demand keeps rising.
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And while one-off events like the double spend rumors may negatively impact demand for Bitcoin temporarily, in the long term scheme of things demand for Bitcoin has more reasons to keep rising than can be reasonably enumerated in this article. But one reason stood out on January 30, 2021 more than others.
The actions that Robinhood and other brokerage houses took to limit the ability of investor participation in trading certain securities sent shockwaves through the retail investing world, seeding doubt, uncertainty, and anger amongst millions of new traders. Many of these new market participants came to the first time realization that the free market system isn’t actually as “free” as they thought, and legions of them sought refuge in the still wild-west like, largely unregulated arena of cryptocurrencies.
Bitcoin, the king of the crypto world, saw demand rise again, and that demand rose faster than supply. In just 10 days’ time, the world saw the impact of fluctuating demand in a fixed supply market.
When demand for something goes up: prices go higher, but only if supply does not increase to meet demand. This “price rationing” is what makes markets work efficiently. Crypto markets are as efficient as any market in the world right now, which means they will behave according to the basic free market precepts of supply, demand, and pricing.
This is what happened in the case of Bitcoin, and it’s what will keep happening for the foreseeable future so long as Bitcoin keeps gaining popularity in the investment world. All of this suggests Bitcoin prices will likely go up over time, because price rationing is what ultimately balances the imbalances created by fluctuations in demand and supply. If demand rises and supply does not rise correspondingly, then prices will rise until demand is curbed.
Investing in Bitcoin will remain interesting, challenging, and volatile, because while Bitcoin’s ultimate supply is known and its rate of added supply is also known, demand is still the main variable that will move prices in the future. The events of the past 10 days have provided a valuable real time lesson in supply and demand economics.