The Economics of Bitcoin
The foremost of cryptocurrencies, Bitcoin has created accidental millionaires and has seen investors gone bust. Let’s explore the economics of Bitcoin.
Bitcoin is a digital asset designed to work as a currency. The foremost of cryptocurrencies, it is commonly referred to as digital cash, virtual currency, electronic currency or digital gold. Bitcoin has brought with itself numerous benefits — it has eliminated the need to rely on a central authority for transactions, offered privacy and a widely accessible medium of exchange. But it also has its fair share of shortcomings — volatility, limited adoption, network speed and transaction costs.
The difficulty of mining Bitcoin
Bitcoin is supported by blockchain technology, devised by the creator of Bitcoin, Satoshi Nakamoto. The simple technology of blockchain is bringing upon a revolution far beyond money — information shared on the network is shared and exists as a constantly updated database which isn’t stored in a single location, but everywhere.
Since Bitcoins are not regulated or controlled by a central bank or government institution, it is not distributed like paper money but ‘mined’. It is important to remember that the supply of Bitcoin is limited to 21 million.
In the process of ‘mining’, recent transactions are compiled into ‘blocks’ and the participant gets to place the next block on the blockchain and claim the rewards. With each mined block, there is an amount of new Bitcoin released called ‘block reward’. The block rewards halve every four years and will continue to fall, until all 21 million Bitcoins are mined, which is predicted to take place by 2140.
Why are Bitcoins limited in supply?
Bitcoin was designed with a ‘hard cap’ of 21 million and this design is immutable and plays a monumental role in determining the value of cryptocurrency. This can be broken down in three parts:
Circulating Supply — This refers to the coins that are available at the moment — coins that are in circulation or actively held.
Total Supply — This refers to the sum total of coins, that may or may not be in circulation at the moment.
Maximum Supply — This refers to the hard cap and fixes the maximum number of coins that will be in existence.
The exact reason why it was capped at 21 million coins is obscure, but there are solid explanations that explain why. Economically speaking, as the currency is infinitely divisible, the precise amount of coins doesn’t matter as long as there is a ceiling to it and it remans fixed universally. The important aspect is not the number of Bitcoins, but in the process of mining and the salient features of the cryptocurrency that will keep it relevant even after the last Bitcoin is mined is the transaction fees.
A ‘transaction fee’ is awarded to Bitcoin miners along with Bitcoins. Thus, when there remain no Bitcoins to be mined, the rewards will be earned in the form of transaction fees per block, which are bound to keep it afloat. This process will substantially reduce the number of Bitcoin miners in the market — but it is projected that people will be willing to pay more to get their transactions confirmed faster.