The Creeping Fundamental Growth in Bitcoin Price

This article will cover one major, long-run driver of the increasing bitcoin price. In the past, I have echoed a fact which is well known in the bitcoin community (the community pretty much being Reddit.com/r/bitcoin and Bitcointalk). The fact is that ever since the creation of bitcoin, not a year has gone by without a new record high price. For that reason, I have been predicting (and still maintain, btw) that bitcoin will top $1000 by December 2014. In fact, the btc price bump has begun even a bit sooner than I expected. That's fine by me. The price per coin has exploded recently, surpassing $650 today. There have been rallying cries about how the price will continue to soar, but without any prominent explanations as for how or why. Let me first agree that the price will continue to increase. Let me even grant that we don't need to know why the price will increase in order for it to increase. But we do know some of the reasons behind bitcoin price movements. Amidst all the bubbly excitement, let's go back to basics for a minute.

The quantity theory of money is the idea is that the number of transactions and velocity of money are held constant in the long run, so a change to the quantity of money simply changes the price.

I would possibly take the classic theory a step further and say that the exact transactions, not just their aggregates, would remain the same if the only change was the amount of money in an economy and we assume an even distribution of that money, but that is not the point here.

Bitcoin is known to be deflationary in the long run, but we are going to start feeling the real effects of what that means soon. It means appreciation of the price per coin.

Half of all bitcoins were mined around December of 2012. Now, nearly 13 million of the maximum 21 million coins have been mined. This means each coin which currently exists may be subject to as much as a 32% reduction in value due to inflation (1 - 13/21), in contrast to the previous possibility of a 50% reduction.

Importantly, the block reward will be decreasing soon. A decreased block reward means a slowing in the production of bitcoins and this will create a deflationary, or appreciatory, pressure on the bitcoin price. Fundamentally, not as a matter of cyclical or speculative effects. Even before the block reward halves, every newly mined block can be less inflated than earlier blocks.

The block reward will halve on the mining of block number 420,000, which could occur around August 2016. The current block number is 303,747. A block takes about 10 minutes to mine. When this occurs, the rate of money creation will be halved; that is, the change in M with respect to time in the equation MV = PQ. Some other time, we could actually predict the exact expected increase to the rate of change of the bitcoin price.