Introduction
The following image shows the historical price changes of Bitcoin and some milestone events. These are the manifestations of Bitcoin, but what are the underlying factors that affect Bitcoin price changes? The question I hope to explore is: What are the underlying factors that influence Bitcoin price changes?
Immutable Bitcoin Fundamentals
Bitcoin was born after the 2008 financial crisis and was based on decades of development in computer science and cryptography. By combining various technological theories, the Bitcoin whitepaper was created, which consists of 8 pages explaining its technical fundamentals. Since its launch in 2009, there have been no major changes in the key technology. In other words, while Bitcoin has grown and developed, its fundamental aspects have remained almost unchanged, with the main changes occurring in the external environment.
Factors Driving Bitcoin Price Changes
In the process of increasing Bitcoin market value, there are only two main external factors:
- Increasing awareness and demand for Bitcoin among more people.
- Long-term depreciation of fiat currencies.
These two external factors are the main reasons driving the rise of Bitcoin, and they also mutually reinforce each other, ultimately highlighting the scarcity of Bitcoin.
Why are more and more people becoming aware of and demanding Bitcoin?
The main way to promote the progress of modern social productivity is through digitization, which has led to a high demand for programmers (technology professionals). This group of people's numbers and influence are constantly increasing. Bitcoin, as a digital currency and market, is naturally more easily recognized by this group.
Decentralization is an important source of demand for Bitcoin, as it allows individual users to achieve a level of defense comparable to sovereign nations through encryption technology and decentralized characteristics. Previously, sovereign nations could freeze fiat assets and confiscate physical assets, but with the help of blockchain technology, sovereign nations have no enforcement power over such assets. They can still control individuals through physical coercion to surrender their private keys, but as long as individuals remain steadfast and refuse to comply, sovereign nations have no ability to crack the private keys. Moreover, the enforcement cost of controlling the blockchain network is much higher than the benefits. A level of defense equality means that the weakest individuals and the most powerful sovereign nations have equal control over assets. What this will ultimately evolve into is unclear, but will it become more liberal and market-oriented?
Viewing currency as a marketplace for transactions, fiat currencies are marketplaces maintained by various sovereign nations, while Bitcoin is a marketplace maintained by code mechanisms. Maintaining a marketplace comes with costs, with sovereign nations relying on their military forces, while Bitcoin relies on encryption algorithms, distributed nodes, and historical block records (with mining incentives as salaries) as its violent institutions. Undeniably, the concept of currency is essentially a revolution against sovereign nations. Which is superior and which is inferior depends on which marketplace has lower costs and higher efficiency. From first principles, it seems that the cost of a digital marketplace is lower, but the reality is that the encrypted world is built on top of stable social governance and the normal operation of the Internet. Therefore, the answer to this question is ambiguous, but one thing worth mentioning is that the threshold for becoming a node that maintains the Bitcoin marketplace is estimated to be much lower than becoming a civil servant in a sovereign nation. As this marketplace grows and develops, the threshold for becoming a miner (civil servant) will also become higher and higher, and the dragon slayer will eventually become the dragon itself, which is human nature.
Long-term Fiat Currency Issuance
The monetary policies of various countries' fiat currencies are key variables that affect Bitcoin prices. For example, in the BTC/USD trading pair, the more volatile component is actually the value of the fiat currency in the denominator. Due to the global circulation nature of Bitcoin, under the assumption of free circulation of fiat currencies among each other, the denominator should represent the total quantity of all fiat currencies. The four major fiat currencies are the US dollar, euro, Japanese yen, and Chinese yuan.
M2 situation of the four major fiat currencies:
Absolute value of US M2: $20.8 trillion, note the vertical axis in the graph below.
https://www.yardeni.com/pub/monetagg.pdf
Absolute value of Chinese M2: around 270 trillion yuan ($36.9 trillion), but how much of this money is freely circulating fiat currency? By the end of 2022, offshore renminbi deposits and overseas entities' holdings of renminbi assets totaled more than 12 trillion yuan, which is actually a very low proportion. As an additional note, according to Ren Zeping's 2021 report, the estimated market value of residential properties in 2020 was $62.6 trillion.
https://www.yardeni.com/pub/chinam2bnklns.pdf
Absolute value of Euro M2: 15.1 trillion euros (16.04 trillion dollars).
https://www.yardeni.com/pub/eum1m2m3.pdf
Absolute value of Japanese M2: 122.94 trillion yen (8.2 trillion dollars), and the fluctuation of the yen exchange rate has not led to a significant increase in the US dollar-denominated Japanese M2.
https://data.ecb.europa.eu/data/datasets
Printing money is a mild form of exploitation that is in line with human nature and the collective interests of the top of the pyramid. Can a visionary government restrain its desire for expenditure while ensuring that each government self-restrains under the condition of holding power, maintaining the government's economic efficiency? What kind of institutional design can utilize human nature and constrain human nature to maintain the operation of the marketplace over a sufficiently long period of time?
Monetary policy is influenced by macroeconomic factors, but macroeconomic variables are complex, with various factors in full play, and the main contradictions are often unclear, with only clear variables in event-driven short-term situations, which may occur only once every few years. Making decisions based on predictions of the macro is something that is unlikely to have an advantage at the information and understanding level. It is more suitable to track and understand the factual knowledge of the economic situation and monetary policy, and to find and adapt to key variables that have continuity (although which variable is key is constantly changing).
Scarcity
In a world of massive fiat currency issuance, scarcity is the key to resisting inflation. How should scarcity be understood? Scarcity is reflected in bargaining power, which is a direct response to supply and demand. For example, if a company can produce a product that is needed by society and other companies cannot, then that product has scarcity, or if a company's equity has scarcity, it is the most accessible form of scarcity to the public. On the other hand, if an official has control over the allocation of key resources, such scarcity is almost impossible to circulate in the market and is difficult to access. Why do the values of artists' works often increase significantly after their death? It is because the supply is limited (death), while demand is increasing (the spread and recognition of the works has not been interrupted). In the actual market supply and demand relationship, it is important to pay attention to the importance of marginal changes, as marginal changes have a significant impact on bargaining power. In the modern world, basic needs have mostly been met, and creating marginal demand and supply has become a way to enjoy greater bargaining power, such as Apple and Microsoft, which have the largest market capitalization, as well as a host of companies pursuing technological innovation.
As mentioned earlier, blockchain technology gives individuals a level of defense against sovereign nations. This characteristic can also be provided by other cryptocurrencies (technically possible, but in practice, it depends on whether the nodes are sufficiently decentralized), and they can also impose restrictions on the total supply without changing the operation code of their nodes. They can even provide larger block space and faster block generation speed. So why Bitcoin? Unlike other cryptocurrencies, Bitcoin has several obvious sources of scarcity that are difficult to replicate by other cryptocurrencies.
- Originality: Bitcoin is the earliest cryptocurrency and application of blockchain, making it an antique in the encrypted world.
- It has attracted a community of individuals with a spirit of encryption punk, liberalism, and programming ability.
- Decentralized node distribution, widely dispersed chip structure, and no central controller (very important).
- A well-established history of stable operation over a long period of time.
- Brand, media attention, and social topicality. For example, Pan Zhixiong's article recorded his media coverage and free acquisition of 0.01 Bitcoin after being stolen in 2011.
The sources of scarcity mentioned above are some that cannot be completely replicated by other cryptocurrencies and require a historical time window and opportunities. Some sources of scarcity are extremely difficult to construct and require massive investment and accumulation. The sources of scarcity I have listed for Bitcoin are not comprehensive, and there may be some unknown sources of scarcity, such as the application of gray industries.
Regarding the sources of scarcity for Bitcoin, what are the facts or risk points that can be tracked?
- Are Bitcoin nodes sufficiently decentralized? Is the encryption algorithm of Bitcoin secure? The level of defense.
- Is Bitcoin still the narrative protagonist against fiat currency issuance? Is it still widely spread and covered by news media? Brand.
- On-chain activity of Bitcoin? Progress and transaction volume of the Lightning Network? Demand facts.
- The regulatory situation of Bitcoin? Does it suppress demand for Bitcoin? Based on my current understanding, as long as Bitcoin can provide individual users with a level of defense against sovereign nations, regulation only affects the speed of Bitcoin's development rather than its ultimate goal.
- Does the social trend represented by Bitcoin become more accepted by humanity? In the longer and deeper dimensions, this is the most important factor.