Among Bitcoin’s principal tenets is the idea that its baked-in scarcity makes it valuable. Bitcoin’s algorithmically determined rate of increase certainly makes it scarce when demand for the bitcoin cryptocurrency is rising, though not so much when it is falling. Furthermore, the fact that the algorithm provides for bitcoin’s supply to stop increasing about 120 years from now means that its supply is finite. Unless the code is changed (and that raises questions about what “Bitcoin” even means), there can never be more than 21 million bitcoins.
As I will show, however, bitcoin’s scarcity doesn’t stem from its finite nature, but from potentially infinite – though fickle – demand. And its legendary volatility is linked less to its scarcity or its finite nature and more to its inherent inflexibility. These distinctions may sound slight, but I argue they amount to important revisions of our understanding of this technology.
Scarcity is hardly unique to bitcoin. All assets are scarce. Indeed anything that has a price is scarce, by definition. If there is no scarcity, there is no price. Things that are so abundant that everyone can have all they want are free, even if they are objectively valuable to humans. Air, for example, is free, though it is so valuable to humans that we can’t exist without it.
Price is the mechanism by which markets equilibrate the supply of, and demand for, scarce objects. When there is more demand for a product than supply, the price rises until demand falls sufficiently for supply to be adequate. This means some people’s demand for the product will be partly or completely unsatisfied. In a free market, it is normal – indeed necessary – for people to be priced out of the market.
Conversely, when there is a greater supply of a product than demand, its price falls until demand rises sufficiently to mop up the excess. In retail markets, price falls might take the form of discounting and special offers.
Sometimes there is no demand for a product at any price, even a negative one. “You can’t pay people to take it away,” as the saying goes. There may be a limited supply of these things no one wants, but it is ridiculous to call them “scarce.” There are far too many of them. When there is an over-supply of a product, it becomes not simply worthless but costly to the holder because it incurs storage and disposal charges.
This brings me to what I regard as the fundamental problem with the definition of scarcity used by Bitcoin’s advocates. They confuse “scarce” with finite. It’s not necessary for something to have a fixed supply for it to be scarce; and things whose supply is constantly increasing are not necessarily abundant.
The passenger pigeon
To illustrate the difference between abundant, scarce and finite, let’s consider the sad story of the passenger pigeon, a bird once native to the U.S. but now extinct.
Back in the 19th century, passenger pigeons were so abundant that observers described them as “darkening the sky” in flight. They were a serious nuisance to crops but a free source of meat and eggs. So people were paid to kill them.
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As people killed passenger pigeons by the millions and destroyed their forest breeding grounds, their numbers crashed. Lawmakers did not believe that something so abundant could ever become scarce, so attempts to protect the bird with legislation failed, The carnage continued and the species went into terminal decline.
The last wild bird is thought to have been shot in 1901. The birds survived in zoos for a few more years, but breeding proved impossible. The last passenger pigeon, Martha, died in the Cincinnati Zoo on Sept. 1, 1914. She was (and remains, since after her death she was stuffed) a bird of infinite value, the last of her kind and the icon of her species.
While passenger pigeons still existed in the wild, their supply was not finite. They nested, laid eggs and brought up chicks. But the rate at which they reproduced could not keep up with the rate at which humans were destroying them, so they became scarce. If humans had stopped shooting them and stealing their eggs, their supply would have increased again. In contrast, if bitcoins are lost, they can never be replaced. The supply is permanently reduced. So bitcoins are finite, but the passenger pigeon was not.
The passenger pigeon became scarce not because it had a finite supply, but because demand for it far exceeded the rate at which its supply was increasing. And because humans refused to believe it was becoming scarce, its price failed to rise to match supply and demand. The “stickiness” of the passenger pigeon’s zero price ensured its demise. This is a type of market failure known as the “tragedy of the commons.” As Joni Mitchell sang, “You don’t know what you’ve got till it’s gone.”
Towards its end, the passenger pigeon became both scarce and finite because it would not breed in captivity. That ultimately is why it became extinct. But had the zoos been able to establish successful breeding programs, the passenger pigeon would not have been finite. It might still be with us today. And like all endangered species, it would now be protected by law. Endangered species aren’t finite but they are so scarce and valuable that people risk their lives to protect them.
So it is not a finite supply that creates scarcity. It is a persistent excess of demand over supply. In a well-functioning market, if demand for a product rises faster than its supply, its price will rise even though its supply is increasing.
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For some kinds of good, there are natural limits to demand: Everyone needs water, but there is a limit to how much water people can drink. However, drinkable water is scarce and the population is growing. Even if the supply of drinkable water increases, therefore, it will remain scarce as long as the rate of increase is the same or lower than the rate of increase of the population.
But for other types of good, such as gold and bitcoin, demand is potentially insatiable. The price of these things should therefore rise continually even if the supply is uncapped and continually increasing, provided the rate of increase is not so great that people lose interest. So it's possible to continually create more of something without making it so abundant that it becomes worthless.
What this means for bitcoin
And this brings me back to bitcoin. Bitcoin’s 21 million supply cap does not make it scarce. After all, 21 million of things no one wants is abundance (or “oversupply”), not scarcity. Like every asset, bitcoin is scarce when demand for it exceeds the available supply. When demand crashes, as it did in 2014 and 2018, bitcoin can’t really be said to be scarce, even though the supply hasn’t increased.
However, Bitcoin’s supply algorithm does affect the price because it makes it impossible for bitcoin’s supply to respond to demand. Just as passenger pigeons couldn’t increase their rate of reproduction to compensate for the rate at which humans were killing them, so Bitcoin can’t increase or reduce its rate of production to compensate for changes in demand for bitcoins. And in a well-functioning market, when supply can’t respond to demand, the price must adjust.
Bitcoin is therefore intrinsically volatile, not because of its scarcity or its finite nature but because of its inflexibility. As the size of its market increases we might find its price swings becoming less frequent but much larger, just as a young bubbly stream becomes a meandering river that periodically overflows its banks. While bitcoin’s supply remains inelastic, its price will remain subject to change without warning.