Relative Scarcity and Bubble Dynamics

There is widespread awareness about the relative scarcity of BTC compared to the ever-expanding fiat money supply, but it seems to us that the dynamics underlying their relationship are largely ignored. The scarcity argument underpins a lot of speculative activity in BTC and other cryptocurrencies – hence ignoring the related dynamics is probably not a very good idea.


One of the features of bitcoin people find enticing  – by no means the only one to be sure – is the fact that its supply is strictly limited (well, sort of – see our comment on “forks” further below). We have highlighted the currently circulating and the eventual total supply above. Keep in mind that the “free float” of BTC is even smaller: there are a number of very large wallets which apparently never trade, and quite few BTC have been lost forever – we are pretty sure that the UK resident who famously threw away an old hard disk drive that held his BTC wallet is not the only person who has disposed of his bitcoin in such a decidedly painful and unprofessional manner.


BTC is not a general medium of exchange, or putting it differently, regardless of whether it has the potential to become money (and it presumably tends to be purchased by people who believe in this potential), it is not money right now. This is something it has on common with gold at this juncture: it is a financial asset with various monetary characteristics, a “money in waiting”, so to speak (of course gold no longer needs to prove to us that it can be money; we are aware of the differences).

As such it is valued in terms of currently widely used media of exchange, i.e., the above-mentioned fiat currencies, and its valuation obviously does not develop independently from the latter. Take a look at the following chart of the broad true US money supply TMS-2. We would posit that the rally in BTC vs. the USD had a lot to do with the madcap expansion in TMS-2 that happened concurrently.


The true US money supply has grown enormously since BTC was created. Since January 2008 it is up by roughly 147%.


Obviously, a 147% increase in the broad money supply since 2008 is quite a lot and it has had far-reaching effects, particularly on asset prices. However, the important thing is not just the amount of new money that has piled up, but the manner in which it percolates through the markets and the economy, as well as its growth rate. The chart of the cumulative money stock shown above doesn’t convey how volatile said growth rate actually is.


Leads and Lags

Below is a chart showing year-on-year TMS-2 growth rates over the past three, or rather 2.5 business cycles (the current cycle is only half cycle, as the bust is still to come). We have drawn two horizontal lines on it that indicate roughly the  levels of money supply growth associated with bubbles and where roughly the “danger zone” begins – when the growth rate falls below this threshold after an asset bubble has expanded for an extended time period, the air is getting thin.

What is also obvious is that there are very sizable leads and lags, the duration of which cannot be determined with precision in advance. Nevertheless, certain patterns emerge which are consistent with both theory and experience. After peaks in money supply growth rates are reached, it takes quite some time for the new money to spread out and exert its full effect on prices. When the growth rate slows down to the danger zone, it again takes a while for the effects to fully express themselves – contingent circumstances are apt to either slow down or speed up the process.


Peaks and lows in y/y TMS-2 growth. We have picked the two threshold levels based on the past few cycles. Following a peak, asset prices will tend to expand even while money supply growth begins to slow down; it is only after the slowdown has become very pronounced that asset bubbles begin to run into difficulties.


What is inter alia noteworthy here, is that all it took for the last two asset bubbles to burst (pre-bitcoin era) was a slowdown in the growth of money and credit (the two are intertwined most of the time). It was not necessary for the money supply growth rate to turn negative. To illustrate the lead-lag relationship discussed above a bit better, we have made an overlay chart that shows the TMS-2 growth rate together with the Wilshire total market index.


Wilshire total market index and TMS-2 y/y growth rate


Since BTC only exists since 2009 we have not yet seen how it will fare over a complete cycle and whether its behavior will be similar. We cannot even be certain that its cycle peak has been put in already – perhaps that is yet to come. Mind, the probability seems low to us, but we want to keep an open mind about this, not least due to the fact that a truly gigantic amount of new money has been poured into the economy in the current cycle (note the three distinct growth peaks in TMS-2 since 2008).


Scarcity Revisited

When discussing the relative scarcity of bitcoin, it is hard to ignore “forks” which can be used to create daughter currencies and are apparently fairly easy to implement. These new currencies use the same blockchain and hashing algorithm, and as far as we can tell, they essentially differ only in terms of certain technical details from BTC*.

Perhaps we are not assigning enough importance to said differences, but to us it looks almost as if the supply of BTC can simply be doubled overnight, almost on a whim. As we understand it, market participants have to provide some degree of support for a fork to succeed – users, miners and exchanges all need to play along to some extent –  but why wouldn’t they? Superficially it is like getting an unexpected dividend after all, a.k.a. “free money”.

Moreover, the barriers to entry for creating other cryptocurrencies based on blockchain technology are evidently very low. Maintaining the BTC valuation premium may eventually become challenging in view of this, but obviously that remains open to question – the first mover advantage and name recognition effect were so far sufficient for BTC to maintain its top spot.

Actually, there is more to it than just that; we plan to revisit this issue when we post our views on bitcoin and monetary theory. For now we mainly want to note that it has to be expected that similar to other investment assets, the valuation of cryptocurrencies in terms of fiat money will definitely partly depend on money supply growth rates.


Incrementum Cryptocurrency Report

Lastly, our good friends at the Incrementum Fund, Ronald Stoeferle and Mark Valek, who our readers know as the authors the annual “In Gold We Trust” report, have released the inaugural issue of their new Crypto Research Report this December in cooperation with Demelza Kelso Hays and several other contributors.

We offer it a bit belatedly for download, but want to assure our readers that it remains an extremely interesting read despite the delay. The report is going to be published on a quarterly basis from now on (see the accompanying press release for details, which can be downloaded below as well), so if this report is to your liking, there will be a lot more interesting research to look forward to.

As the report inter alia notes, while the 2017 run-up in BTC had all the hallmarks of a major bubble and big setbacks have to be expected, in many other ways we are witnessing an experiment that is only at its very beginning and will offer a great many opportunities. We definitely agree with this sentiment.


Download 1: Incrementum Press Release on the new Crypto Research Report (pdf)

Download 2: Crypto Research Report Issue 1, Dec. 2017 (pdf)




* one of the “post-fork” currencies alluded to above, Bitcoin Cash (BCH), seems actually superior to BTC, as its transaction costs are much lower and its transfer speed is much faster – and yet, it trades approximately at an 80% to 85% discount to BTC. This makes absolutely no sense to us.


Charts by:, St. Louis Fed


PS: Bureaucrats Weighed Down by Sincere Regrets

As a little aside, perhaps the FBI, the IRS, the NSA and other government agencies prone to magically “lose” their most interesting emails at crucial junctures in history might want to consider putting their conversations on a blockchain for preservation reasons. They would be encrypted, and losing them would be real hard – and there would be far less “sincere regret” in this world. Just saying!


 New NSA toy: airborne sincere regret conveyor




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6 Responses to “Cryptonite 2”

  • Hans:

    Excellent piece, Mr Tenebrarum. You are so correct that the
    entry barrier is quite low. In the past month, over a hundred
    new cryptocurrencies have been officially listed.

    A salient point as to why Bitcash values is so significantly less
    that Bitcoin having identical supply? I suspect the latter will,
    in the future, have a similar value as the former based on market
    demand and supply.

    Hardpoint, there is nothing that constrict the current supply of Bitcoin;
    unless I am incorrect.

    And how much legitimacy would CC have, if they were back by precious

    My main concern for Bitcoin, is the latest report, that it has undergone
    a massive form of manipulation.

  • jks:

    Bitcoin miners are paid the block reward plus transaction fees. The block reward halves about every 4 years. It started at 50 BTC per block and is now 12.5 BTC per block. Despite the reduction in block rewards over the years, there is no shortage of hash power to secure the network. There has to be some fair way of initially distributing money in a new payment network, like bitcoin, and the block reward is an elegant way of getting money into the network. Eventually, the block reward will decrease to zero. The last bitcoin will be mined sometime in 2140 and miners will get paid transaction fees only from then on.

    • HardMoney:

      Thanks jks. You obviously understand this far better than I do.

      So then the reasoning is correct – ie after some future point (2040?) there is no reward incentive to participate in transaction validation. At that point it is all transaction fees.

      So for btc to remain viable from that point the transaction fees need to be adequate incentive to participate. Not sure what the Implications are without – requires various assumptions and projections – and no doubt various people have done this (?).

      Intuitively though it still appears to me that if you need a gazillion people to validate a transaction and reward them for it – the transaction cost would be various multiples of what a centralized clearing function could this for. The benefits that accrue from uncentralized clearing (greater trust, ?) must therefore outweighs these additional costs.

      Would appreciate your thoughts on this – since you do seem to have a goid understanding of the bitcoins and blockchain.

      • jks:

        Bitcoin’s costs are far higher than Visa’s. The two payment methods have completely different security models. Visa’s network is secured by private communication links and tight security and very controlled access to centralized servers. It’s a closed, private network. In sharp contrast, bitcoin’s network is open. Transactions occur over public communication links (the internet) and transaction records are available for all users to audit. Blockchain technology makes the ledger simultaneously public and secure. Everybody can see the ledger but nobody can change the records.

        Visa has fast confirmation times and also has the advantage that a user can sometimes claw his payment back if he can convince Visa that he was cheated. It offers a margin of insurance to the user. With bitcoin, payments are final with no chance of clawing your payment back. On the other hand, with Visa, you must hold a state-sponsored currency that’s depreciating. In some countries the underlying currency is rapidly depreciating. In contrast, bitcoins are a deflationary currency. Visa won’t work for buying some items (such as music from Russian online music stores or prescription drugs from a Canadian pharmacy). Any number of government agencies can freeze your bank account and your Visa account and prevent you from buying anything. Visa won’t allow you to transfer value to people in certain countries. In contrast, bitcoin is permissionless and borderless.

        • HardMoney:

          Thanks again – this is helpful.

          So in summary
          – most likely maintaining a public ledger would have meaningfully higher transactions cost than centralized clearing
          – however, there are use cases for bitcoin/ cryptos where fiat currency is not an option so difference is transactions costs is not a consideration
          – to the extent the market ascribes value to bitcoin/ cryptos this value cannot be diluted or as easily confiscated

          Not sure what to conclude – different people will come to different answers, but in my mind the use of cryptos as a medium of exchange is for a limited set of economic activity. I am not sure if those holding them see their use as that limited when valuing it – so unless by something changes or their is an argument not already discussed here not sure if these valuations can be sustained.

  • HardMoney:

    A couple of weeks ago I spent some time understanding blockchain technology and bitcoin, and it seems to me that the terminal value of bitcoin is 0. Thus, regressing back it’s current value is 0, I.e., if value at n is 0 then value at n-1 is zero and so on all the way to today and so forth.

    As I understand bitcoin transactions are validated by bitcoin miners, and their incentive to participate in this validation is that they get rewarded with bitcoins.

    Now as remaining bitcoins become fewer the cost of must exponentially increase – as otherwise one would run out of unissued bitcoins pretty fast – so the value of bitcoin must countinue to increase at an equal or higher rate on average to incentivize miners to mine and participate in transaction validation.

    But logically the value of bitcoin is to some extent capped by the money supply of the world – the relationship is unknowable but it is undoubted that a relationship exists. Or at least in steady state the value cannot continue to increase exponentially.

    So at some foreseeable point miners not longer have an incentive to participate in transaction validation and this crap becomes useless. The regressing back from that point, etc., etc.

    To anticipate counter arguments
    – an alternative approach to transaction validation will come up. Well perhaps – but isn’t one of the strengths is blockchain tech the disinterested public validation of transactions.
    – the bitcoin cap will be pulled thus limiting mining costs. So aren’t people buying bitcoin because it’s supply is capped
    – other? Then let’s hear it.

    By the way I believe in May other reasons why bitcoin is not and is unlikely to be money – many of which have been discussed in the blogosphere – but this to me is arthmetic – as night follows day.

    Nothing like hard money.

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