Will Bitcoin go higher?

As of December 16, Bitcoin has increased by about 195% year-to-date, topping $23,000, but what is driving this meteoric rise? The reasons for its appreciation vary, but Bitcoin has grown from what was once considered a scam by many into something that has matured into a viable investment made by famous billionaire investors, large institutions, and retail investors alike. Why are these investors so bullish on Bitcoin even after it has surpassed all-time highs?

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Inflation and the Lowering Purchasing Power of the Dollar

Since the gold standard was removed in 1971 by Richard Nixon the amount of circulating dollars has steadily increased. Between the year 1975 and just before the coronavirus hit, the total money supply has increased from $273.4 billion to over $4 trillion as of March 9, 2020. Since that date, the total money supply has gone from $4 trillion to over $6.5 trillion as of November 30, 2020, largely due to coronavirus related stimulus bills.

Congress is currently in talks to pass another stimulus bill of nearly $1 trillion, aimed to help those suffering from the coronavirus. Should this new stimulus bill be passed it would mean that since the onset of coronavirus, around 50% of the world's total supply of US dollars will have been printed in 2020.

While there are certainly people suffering from a lack of jobs and businesses shutting down, the increase in money supply has significant long-term implications for the purchasing power of the dollar.

The stimulus spending has led many to fear far greater inflation rates, and rightfully so. To hedge against this inflation investors have sought assets that either maintain value or appreciate in value. Over the course of 2020, this search for a store-of-value asset to hedge against inflation has brought them to Bitcoin. Why?

There are many assets that are considered a store-of-value. Perhaps the most common assets that come to mind are precious metals like gold or other things that have a limited supply. With gold, we know that it is a scarce resource, but we cannot verify with complete certainty how much exists. And, while it may seem far fetched, gold exists outside of earth and may one day be obtainable via asteroid mining as technology advances.

Why this Matters to Bitcoin

This is where Bitcoin differentiates itself. It is written into Bitcoin’s code how many will ever exist. We can verify with certainty how many exist now and how many will exist in the future. This makes Bitcoin the only asset on the planet that we can prove has a finite and fixed supply.

In Investopedia’s Express podcast with editor-in-chief Caleb Silver, Michael Sonnenshein, a board member of the Grayscale Bitcoin Trust, said: “The amount of fiscal stimulus that has been injected into the system in the wake of the COVID pandemic to stimulate the economy and get things moving again, I think has really caused investors to think about what constitutes a store of value, what constitutes an inflation hedge and how they should protect their portfolios.”

Sonnenshein elaborated further saying: “It's important that investors think about that. And I think a lot of them are actually thinking about the juxtaposition between digital currencies, like Bitcoin, which have verifiable scarcity and thinking about that in the context of Fiat currencies, like the US dollar which seemingly are being printed unlimitedly.”

Part of Bitcoin’s price appreciation can certainly be attributed to fears of inflation and its use as a hedge against it. With further money printing on the horizon from stimulus packages, as well as talks of student loan forgiveness from the Biden administration, it is fair to say that inflation will continue, making the case for store-of-value assets more compelling.

The Halving

To further understand why Bitcoin has a verifiable finite limit to its quantity it is important to understand the mechanism built into its code known as the Halving. Every 210,000 blocks that are mined, or about every four years, the reward given to miners for processing Bitcoin transactions is reduced in half.

In other words, built into Bitcoin is a synthetic form of inflation because a reward of Bitcoin given to a miner adds new Bitcoin into circulation. The rate of this inflation is cut in half every four years and this will continue until all 21 million Bitcoin is released to the market. Currently, there are 18.5 million Bitcoins in circulation, or about 88.4% of Bitcoin’s total supply. Why is this important?

As discussed before, the rising inflation and growing quantity of the US dollar lower its value over time. With gold, there is a somewhat steady rate of new gold mined from the earth each year, which keeps its rate of inflation relatively consistent.

With Bitcoin, each halving increases the assets stock-to-flow ratio. A stock-to-flow ratio means the currently available stock circulating in the market relative to the newly flowing stock being added to circulation each year. Because we know that every four years the stock-to-flow ratio, or current circulation relative to new supply, doubles, this metric can be plotted into the future.

Since Bitcoin’s inception, its price has followed extremely close to its growing stock-to-flow ratio. Each halving Bitcoin has experienced a massive bull market that has absolutely crushed its previous all-time high.

The first halving, which occurred in November of 2012, saw an increase from about $12 to nearly $1,150 within a year. The second Bitcoin halving occurred in July of 2016. The price at that halving was about $650 and by December 17th, 2017, Bitcoin's price had soared to just under $20,000. The price then fell over the course of a year from this peak down to around $3,200, a price nearly 400% higher than Its pre-halving price. Bitcoin’s third having just occurred on May 11th, 2020 and its price has since increased by nearly 120%.