An econ 101 take on bitcoin price movements

TAGs: Bitcoin, digital currency, Editorial

Remember when segwit, then named bitcoin, first broke $1000 late in 2013? We thought it was an earthquake back then but compare it to what’s happening now and the beast that was once the 2013 spike now seems like it was shot by trigger happy elephant hunters armed to the teeth with tranquilizer guns.

An econ 101 take on bitcoin price movementsIt can be fun to play the technical crypto game and try to really wrap our heads around the technological gauntlet that underpins the world of digital currencies, but it’s not called crypto for nothing. Understanding fully everything behind all the forks and upgrades can give owners a deeper sense of security in their own bitcoin (BCH) and segwit (BTC) holdings, but it’s a stretch to say that perfect knowledge of what’s going on in the mining community can help us predict price movements

Being no “cryptographer” but rather a lowly economist, I can only analyze this from a supply and demand perspective. Economics 101 still applies to digital currencies, as luck would have it.

The demand for any digital currency depends, among other things, on transaction costs, in other words the price of using the currency. The higher the price, the lower the demand for something, as in any other good or service. Transaction costs depend on the supply and demand for miners to complete the transactions in the blockchain. A relatively high transaction cost simply means that the demand for miners (really the demand for transacting) is high while the supply of miners is low.

This problem can be solved by either adding more miners, or increasing the efficiency of miners so they can handle more transactions with the tools at their disposal. This is the equivalent of better capital goods increasing production efficiency in a factory, which causes the prices of those goods (transactions in this case) to fall. The capital goods of the cryptocurrency world is basically the software that underpins the system.

The bitcoin/segwit fork gave bitcoin the better capital, the better factory for producing transactions. So miners started migrating to that platform, creating a dearth of miners (factory workers) at the old factory. Less miners and inferior capital goods mean transaction costs rise.

Then, the segwit2x fork was announced on the segwit blockchain, originally scheduled for November 16. Those who wanted lower transaction costs knew that they needed a better factory, better capital, and they thought they would get it with segwit2x. All they had to do was buy segwit and they’d get free segwit2x at the fork. Why buy bitcoin straight with the better mining capital and lower transaction costs when you can buy segwit and end up with both segwit and segwit2x after the fork?

But then the fork was cancelled, and suddenly all those who bought segwit in anticipation of having its capital upgraded and transaction cost reduced, had to go somewhere to find what they wanted. Since they already owned segwit, they exchanged it en masse for bitcoin, and bitcoin’s gain came at segwit’s expense. Segwit collapsed about $2,170 a coin while bitcoin skyrocketed about $2,300 a coin.

For segwit to compete with bitcoin long term, it will have to upgrade its software. This will happen eventually as it just did with bitcoin. Remember that the digital currency universe is still in its infancy and resembling the movement of dot com stocks at the turn of the century. There will be a few winners and lots and lots of losers. The winners will be the currencies with the best software that can process the most transactions for the least amount of money. This is real monetary competition, not just taking bets on which central bank will inflate the least. So if you’re a long term bitcoin or segwit investor, or both, this is what should be focused on. Keep in mind that Yahoo, the original bitcoin of the dot coms, eventually bust, or nearly so. Doesn’t mean it will happen here but it could.

What Next?

A few years from now we will probably be relating to the volatility in the digital currency space as we relate to the initial break of $1,000 in 2013. It will look like a tiny bump in the road. The big volatility will come as the end game of government versus private money takes center stage. Digital currency is still mostly an oddity for governments. When it’s a threat, this is when the real epic battle will play itself out. When will that be? Hard to say, but here’s a guess for what it’s worth.

The total annual transaction volume of a digital currency in dollar terms is like its GDP. Not exactly, but close enough. As the collective transaction volumes of all privately managed digital currencies encroaches on global GDP, governments will start to lose control of money and they will fight back. There will probably be some kind of global summit to address the problem of governments globally losing control of money markets, and there will be some cockamamie idea to institute one global world digital currency managed by some mega global central bank that can inflate the supply at will. What’s the fun of managing a money supply if you can’t create more of it for yourself to spend?

Governments will attack exchanges worldwide, characterizing them as fly-by-night shady outfits enabling mass drug deals and stealing money from public schools and hospitals by evading taxes de facto. Think of the children. Everything bad in the world will be blamed on cryptos. The idea of one global world digital currency managed by the World Bank or some other group of intellectually sounding nitwits will be promoted by talking heads all over the media as the savior of the world. It will probably be centered on the Massachusetts Institute of Technology. All the worst Fed bankers come from there.

For loose timing on this eventual Battle Royale between government fiat and private digital currencies, track the combined annual transaction volume of all digital currencies in the world compared to global GDP more or less. Bitcoin plus segwit plus ethereum right now, based on daily transactions multiplied by 365, is about $12.41 trillion. Global GDP is about $75.4 trillion. Digital currency GDP is already about 16% of the fiat currency GDP. This is a very rough estimate but it gives us a ballpark.

When it hits 50%, get ready for a government onslaught, if they’re not yet bankrupt by then.


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