There has been sparse discussion on the impact of the BTC halvening on the BTCUSD price…*ahem*…

Well, no, there has been some, but not enough, and largely supply-side driven. Not much on the demand side, so I will add my 2 Pesos worth.

There are two sides of every market, buyers and sellers, consumers and producers, and one thing is for certain is that the relative increase in BTC available for sale will begin to increase at a decreasing rate starting later this weekend. Although this is not technically a decrease in supply, but slightly more accurately a decrease in the rate of increase in supply, I will hereby outline the event as if it is actually a decrease in supply, for simplification purposes. I understand that this detracts from any contribution of this analysis, but I think it may be suitable to present a few relevant ideas.

Also, let's remember that the incremental increase in adoption and popularity of bitcoin is an increase in demand. What I am trying to better understand is the current elasticity of demand, or the slope, in the short-run demand curve.

Bitcoin Demand

The demand for Gold is driven by speculation and fabrication. Consumers purchase gold for use in industry, jewelry, central banking, technology and investment. In an extreme case, if Jay-Z and Kim Kardashian simultaneously decry that platinum is superior to gold as a wearable status symbol while platinum distributors convince the public that gold is no longer suitable for engagement bands, the demand for gold will decrease accordingly. One of its primary use cases would be undermined. These proportions are relatively understood by analysts and so an adequate adjustment in price would be expected according to changes in expectations as trends emerge, according to the perfect market hypothesis.

Bitcoin experiences a similar market in that it has some well known use cases. However, altercations in the structure of the demand side is effectively unobservable. The nature of BTC as a cryptocurrency makes it difficult to know what portion of demand is supported by actual use cases and what is merely speculative. This unknown element contributes to price volatility as the perfect market hypothesis is pretty much out of the question. Therefore, analysts who focus on the supply side are left to wonder about demand. I will propose a few possible scenarios of the BTC demand structure and then hypothesize how each would be affected by a declining rate of an increase in supply, as determined by the subsequent halving of the miner reward.

Scenario 1: Inelastic Demand

Commodities with an inelastic demand are genuinely those which are needed by consumers and where there are limited substitutes. This means that a huge increase in price would not cause a huge decrease in the quantity demanded. Conversely, a large downward shift in price would not trigger a massive buying spree.

There are reasons to believe that this may be true. For one, I will mention that BTC does many things better than other currencies and commodities (which the intended audience of this blog would happily list at length). The primary transactional use cases are those that are illicit where users require a high degree of discretion. These consumers will likely use BTC for their purposes even at high prices as the system has been stress tested to be suitable for their needs more than other cryptos. Also, it was not too long ago when the price for BTC was half of its current value at $650, and the system did not see a huge uptick in quantity of transactions at these price levels. In fact the relationship is positively correlated and not negative. It could also be argued that speculators regard BTC as a valuable holding asset and due to its depreciating nature, would still be inclined to purchase it even at elevated prices (to the moooooon!!). If indeed the market for BTC is inelastic, than the halvening may have the following effect:

In the short-run, the decrease in the rate of new BTC supply will shift the supply curve from S1 to S2. The implied affect would be a large increase in price ($1 to $2) while the quantity demanded would decline relatively less (Q1 to Q2).

However, there is evidence to suggest that the BTC market is not inelastic, but rather, elastic.

Scenario 2: Elastic Demand

One of the major factors which are characteristics of an elastic demand curve is the quantity and quality of substitutes. Although there are many superior qualities of BTC compared to its substitutes, these benefits have yet to be completely actualized. There are over 550 competing crypotcurrencies, most are garbage but others are gaining in esteem. PayPal, credit cards, Western Union, and other payment and transfer services have an infrastructure in place which makes them exponentially more viable in the internet space currently. With the addition of cash, these economic technologies are more reasonably versatile in the brick-n-mortar world as well. Gold, and other precious metals, are readily available with mature markets and have a longer historical capacity as a store of value. Also, the extent to which the illicit demand exists may help to steepen the demand curve, but potentially only to a modest degree. Remittances, not likely a big demand-curve-steepener either.

If indeed the demand curve for BTC is elastic than the halvening may have the following impact:

If this is the case than the decline in the rate of new BTC supply will have a relatively small impact on its price ($1 to $2).

Scenario 3: Price Drives Speculation, then a fall

Let’s assume for this scenario that the demand for BTC is neither elastic nor inelastic. Undoubtedly, the price of BTC draws headlines: when it moves, journalists write about it. The halvening has experienced a high volume of comments and it will likely continue into, and after, the event itself. This publicity could draw the public’s attention to the scarcity aspect of BTC to such a degree that the market experiences a large influx of consumers/speculators. This scenario may look something like this:

The halvening takes place and moves the S-curve from S1 to S2. This will increase the price from $1 to $2.

· The publicity of the event brings many to see BTC’s scarcity element and in a herd mentality, shift the demand curve from D1 to D2. This increase in demand has an upward pressure on the price moving it from $2 to $3.

· At the higher price, BTC hoarders (hodlers) may be enticed to enter the market as sellers, shifting the S-curve from S2 to S3, resulting in a downward pressure on price from $3 to $4.

Evidence for this behavior has been seen during 2013 (even though “Satoshi” bought some BTC at $1,000+) as well as the drops of recent months at various peaks. Sorry Veblen…

Conclusion

It should be noted that none of these scenarios are likely true and that my only intention for posting this is to encourage some further critical analysis to the effect of the halvening as it pertains to demand. Is the demand curve elastic? Inelastic? Curvilinear? Parabolic? What are the characteristics of the demand components?
The US Federal Reserve has dramatically increased the money supply since 2008 and has not triggered a massive devaluation of the US Dollar, as inflationists had predicted. This is partly due to commodity price declines, but also because the demand for US denominated debt and assets, coming largely from China, has increased since the 2008 crisis because these are viewed as safer instruments to store value. Demand matters.
It will be interesting to see what happens to the price of substitutes in the following months after the halvening. Gary North, please don’t reply, thanks…