How does supply and demand work for crypto if there is a finite number of coins available?
Supply and demand is an economic model of price determination that is particularly relevant for cryptocurrencies because there is often a “hard limit” on the number of coins available. When trading crypto, it is important to understand how the fluctuations in supply and demand can affect prices and the role this should play in your strategies.
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Supply is one of the primary factors that affects the price of cryptocurrencies such as bitcoin. Due to the total supply of bitcoin being limited to 21 million coins, there is a greater demand for it, especially as BTC is the most popular currency by far. Since its release in 2009, the value of BTC has skyrocketed, even as the total number of coins has risen with it. According to recent data, around 83% of the entire bitcoin supply has been mined, which means there are approximately 18.77 million on the market.
While the final BTC coins are not expected to be mined until the 22nd century, traders know that there is a hard limit on the number of bitcoin and this increases the demand for it. In percentage terms, the supply of BTC dipped by 250 basis points to 4.4% between 2016 and 2018. There is also something called bitcoin “halving events”, which serve to reduce supply even further and increase prices.
While asset scarcity is a recipe for soaring prices, there are other factors that affect the demand for bitcoin. Experts often analyze economic and geopolitical factors to forecast shifts in demand for bitcoin. For example, when Chinese citizens were reported to be using crypto to get around state-imposed controls on money, this resulted in a spike in demand. The same trend occurred when people in developing countries turned to bitcoin in the face of surging inflation.
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All these factors can lead to a huge spike in demand. Generally with bitcoin, because it is so popular and seen as the de facto cryptocurrency, demand is always very strong, but there are still “boom and bust” periods where prices fall. The declines are driven by broader market factors such as measures enacted by the Federal Reserve, as well as those linked to risk tolerance and traders’ buying patterns. This was evident at the beginning of 2022 when bitcoin dropped after surging in late 2021.
The Fed’s decision to intervene and increase interest rates to combat inflation has had an impact on the demand for bitcoin. Crypto expert, Dr Richard Smith, says “liquidity is drying up” as the “excess stimulus” prevalent during the pandemic slowly grinds to a halt. When investors opt to buy into safer asset classes, this can reduce the demand for cryptocurrencies, even when supply is still limited.
Experienced crypto traders will be well aware of the ups and downs and understand that they will have to hold onto Bitcoin for the long term to ride the wave until it eventually soars in price again. Smith says notable falls are “completely normal” for Bitcoin and that is not something to worry about, especially when crypto is often volatile by nature. Bitcoin’s incredible rate of growth makes it a very attractive investment option for many traders. This is highlighted by the fact that BTC is currently valued at around $36,000, which is around four times higher than its price two years ago.
Finally, there are two crypto-based supply and demand concepts that traders should understand. When the demand for coins rises even when the “true” value remains unchanged, this is an “overbought” market and coins will usually be very expensive. In contrast, when coins are sold en masse without there being a major reason for the sell-off, the market is “oversold” and traders can get better value as the supply increases.
Supply and demand is an economic theory that is as true for cryptocurrencies as it is for other assets. However, the factors that influence both are slightly different. Demand for crypto often spikes when a currency has been endorsed by a popular figure, such as Elon Musk, or when it is highly publicized in the media. This is also set against the supply which has a hard limit. Understanding how supply and demand work will help you to make better trading decisions.