Is Bitcoin good money? Economic properties of Bitcoin

Economic properties of the bitcoin network mainly relate to the new coin supply system. As mentioned earlier, mining computers create new blocks of transactions for which they are rewarded with new coins. The mining difficulty adjustment system ensures that a new block of transactions is calculated every 10 minutes on average. The supply of coins thus comes into circulation with the help of block mining. This is not an arbitrary process, but is determined by a predetermined algorithm based on a simple logarithmic equation. The algorithm determines that approximately every four years (210,000 blocks) the reward for miners is halved.

The initial reward for a newly calculated block of transactions was 50 bitcoins in 2009, but this dropped to 25 bitcoins in 2012, 12.5 in 2016, and 6.25 in 2020. The next halving will occur in the first half of 2024, and only 3.125 bitcoins per block will be issued. There are 32 such halvings, after which the issuance of new coins ends and bitcoin becomes the first monetary system without inflation. The last halving is said to have occurred sometime in the first half of the 22nd century. The total number of issued coins will be just under 21 million. Due to the mining algorithm, the Bitcoin network represents the only asset whose monetary policy is completely transparent and predictable. This means that we can know at any moment how many coins are in circulation and what their current inflow is.

The economic consequences of this technological phenomenon are unknown: it is the first commodity whose supply does not adjust to demand, but operates according to a predetermined schedule. As the system halves the annual inflow every four years, ceteris paribus, the market price of bitcoin automatically begins to rise. Selling pressure from miners is cut in half because the same amount of miners are fighting for a smaller amount of coins. With constant demand, this creates buying pressure, and bitcoin enters a new business cycle of rising prices. The increase in value is also influenced by external macroeconomic factors: inflationary monetary policy of central banks, commercial use of bitcoin, development of the network and improvement of the user experience.

STORE OF VALUE

Why Is Bitcoin’s Coin Offering So Special? As we have already established, the algorithm for issuing new coins is a logarithmic function. This means that the amount of new coins compared to the existing supply decreases exponentially with each halving. The amount of newly issued coins in the current four-year period is thus twice as low as in the previous period, where the block reward was twice as high. This ensures that in the first bitcoin mining period, where the reward was 50 coins, 50% of all coins were issued. In the next four year period, where the reward was 25 coins, 25% of all coins were issued , etc. This means that already in the third period more than 75% of all coins were issued, and in the current fourth period there are already more than 19,000,000 bitcoins available, or 90% of the entire supply.

The new coin inflow in the current period is 6.25 bitcoins per block, 900 per day and 328,500 per year. This means that the current inflation of new bitcoins is about 1.73%, considering the total supply of 19,000,000 bitcoins. With the transition to a new mining period, in which 3,125 coins will be issued per block, 450 per day and 164,250 per year, the inflation of new coins will drop to less than 1% compared to the stock of already issued coins. This means that bitcoin will become the most inflation-resistant commodity in the world, whose only competition is currently gold, whose annual inflation is somewhere between 1 and 2 percent.

What are the implications of this feature of the bitcoin network for its users? The limited supply means that the entire economic value held in the bitcoin network in the form of digital coins loses less than 1% of purchasing power per year, a figure that halves every four years. Already in the coming period, the inflation of new coins is negligible, and bitcoin preserves our purchasing power over time better than any other good in the economy. This allows participants in the system to keep assets and accumulate savings, the purchasing power of which grows over time, as every year the supply of goods on the market increases, and the inflow of bitcoins decreases. Our assets thus gain value over time, while the price of goods in bitcoin units falls. This turns the current economic reality on its head, as the supply of new dollars and other fiat currencies increases every year, and money loses purchasing power. The price of goods on the market in currency units thus increases every year, despite increased production, which makes savings and saving impossible, and thus forces unreasonable consumption.

Bitcoin encourages saving and accumulation of capital, which can then be invested in production processes that improve quality and increase the quantity of new products on the market. This is true because we have invested a larger amount of capital in production processes than we would have in the absence of savings. Headless investments lead to bad investments, in which the capital is not invested optimally, and this leads to a smaller amount of lower quality products.

MEDIUM OF EXCHANGE

In addition to being an extremely good store of value, bitcoin also represents a very efficient payment network with its own means of payment. Many critics point to bitcoin’s limited capacity as a payment medium, as transactions are only carried out every 10 minutes, and their volume is limited to a few thousand, which is much less than the number of transactions processed by the Visa or MasterCard networks. These critics do not understand the structure of the Bitcoin ecosystem, which contains several layers: the first layer represents the main Bitcoin network with a block chain, which really does not allow for high transaction liquidity. The charm of the technology lies in its upgradeability with the help of higher layers, which give the network enormous dimensions.

The second layer of the ecosystem contains payment channels that allow transactions to flow parallel to the blockchain and are simultaneously attached to it in such a way as to maintain compliance with the rules of the bitcoin network. This payment network is called Lightning and refers to a payment technology that relieves the main block chain with the help of payment channels and enables a practically unlimited amount of transactions of any value . We open a channel by writing a transaction to the main blockchain, which locks our coins into the network and allows us to send them across all the Lightning Network channels we’re connected to. Only the first transaction that opens the payment channel and the coin balance at that time is recorded in the main blockchain, and the last transaction that closes the channel, unlocks the coins and updates the balance. This system is similar to the payment system in restaurants, where food and drinks are recorded, and everything is settled only when we leave.

The Lightning Network is just one type of upgrade to Bitcoin’s ability to process payments. At higher levels, centralized alternatives can also do this, including conventional payment networks such as Visa and MasterCard. It is true, we can connect the bitcoin network to already existing payment networks and give it wings in this way.

UNIT OF ACCOUNT

A final important economic dimension of the bitcoin network is its pricing efficiency. We named the smallest building block of the bitcoin network a satoshi, in honor of its creator, and it represents 0.00000001 bitcoin. In other words, 100,000,000 satoshis make up one bitcoin. This is more than enough for the needs of the current economy; however, when the value of one bitcoin grows to the point where one satoshi would be too large to account for low-value goods, the decimal point can be moved back n places with a few software changes. This property of the network represents another major difference with the existing fiat system: Bitcoin’s supply is strictly limited upwards, while its divisibility is unlimited downwards. On the other hand, the supply of fiat currencies is unlimited upwards, while their divisibility is limited to only two decimal places. From this it follows that these two monetary systems are fundamentally opposite, which also represents the opposite implications of their adoption.

The fiat system, through inflation, allows wealth to be redistributed from the hands of the poor to the hands of the rich, who are closest to the fiat trough, while at the same time monetizing debt and encouraging users to borrow and spend more. Through deflation, Bitcoin forces users to save and accumulate capital, thereby enabling investments without borrowing and at the same time increasing the purchasing power of all its users over time. As the value of bitcoin increases relative to the value of other goods, all users benefit, as their share of the total coin supply does not decrease due to the absence of inflation.