This is our weekly blog about what Bitcoin really is.
In Part 1 explained what problems bitcoin solve, if you have not read it you can read it here. In Part 2 we talked about how it manages to be a great censorship resistant payment network, you can read that here.
This week, in Part 3, we will talk about how Bitcoin manages to be such a great store of value.
The first thing we need to understand, is what makes something a great store of value.
For a good to keep its value over time it is necessary for it to be hard to create in large amounts. As Saifedean Ammous explains in “The Bitcoin Standard”, a good store of value should have a high stock-to-flow ratio. The stock being the amount in existence of the good, and the flow being the amount of it that is created over time.
The reason it is necessary for a good to have a low stock to flow ratio in order for it to be a good store of value, is because if a good can easily be created, the good will never be able to appreciate in value significantly. this is because if more of it can be created it will always be created and sold as the price of the good increases, depressing the price.
A great example of a high stock-to-flow good is gold. Gold has a high stock because it has been mined for thousands of years, and it has a low flow ratio because all the easier gold to mine has already been mined, and no more gold can be easily mined or created. This makes gold a hight stock-to-flow ratio good, probably the best one in existence before Bitcoin.
If the price of gold magically doubled today, miners would work harder to mine more gold. Even though the gold miners would increase their efforts into mining gold, the gold market overall would not be significantly affected by the amount of gold flowing into the market, since this new flow would only be a small part of the total existing supply.
The stock-to-flow ratio in Bitcoin is even higher than the stock-to-flow in gold. There are currently about 17 million bitcoins in existence, and only another 4 million will be generated in the next 100 years.
Bitcoin was designed to allow a maximum number of 21 million bitcoins from its inception and will likely remain like that; due to its decentralized nature, no single person or group of people in the network can change that on their own. For the future supply of Bitcoin to be changed the all of the users of the network would have to agree on it; it is very unlikely all the users on the network will ever agree on changing the amount of bitcoins that can be generated, because it would reduce the value of their bitcoins. The amount of bitcoins that it is possible to generate will be cut in half every 4 years, until no bitcoins will be generated 100 years from now.
Bitcoin is not known to be the most stable store of value at the current time. The fluctuations are likely an effect of large players trading on the current relatively low total money supply value of the network. As the network value grown it may become more stable, but even if it doesn’t Bitcoin will still be a great long term store of value because of its high stock to flow ratio. The value of Bitcoin will appreciate over time even though it may be subject to fluctuations in the short term.
If you would like to read more about what makes Bitcoin a great store of value I would recommend Saifedean Ammous’ book “The Bitcoin Standard”. In the book he goes into detail about why Bitcoin is the best form of money that exists and what the problems with current government currencies are.