Patrick Watson delves into the supply and demand of bitcoin and concludes the crypto-currency has a kind of inflation risk

Patrick Watson delves into the supply and demand of bitcoin and concludes the crypto-currency has a kind of inflation risk

By Patrick Watson*

You know that awful feeling when you think you lost your wallet? Now imagine you had $75 million in it. What would that feel like?

Fortunately, I don’t know, but some unlucky people do. They’ve lost access to the digital wallets that hold their bitcoins - and without it, their cryptocurrency windfall is gone forever.

Or is it?

This is a deeper mystery than it may seem, with some unexpected conclusions I’ll describe below.

Photo: Getty Images

Cash in the trash

Somewhere in the Newport, Wales garbage dump is a computer hard drive that local resident James Howells discarded in 2013. He had spilled lemonade on it and thought it wasn’t worth fixing.

Howells forgot that the hard drive contained the codes to access some bitcoins he had “mined” beginning back in 2009. He had about 7,500 bitcoins, worth $75 million assuming a $10,000 bitcoin price.

Howells naturally wants to recover the lost device. He’s offered the Newport council 10% of the proceeds if it will let him dig into the landfill. So far the answer is “no.”

Stories like Howells’ are popping up everywhere. People who mined or purchased bitcoins, sometimes years ago, can’t access it.

The reasons vary: some forgot the password, others lost the memory stick, or their hard drive with the codes on it crashed. Some people died unexpectedly and took their passwords to the grave.

Whatever happened, a lot of value is missing as bitcoin’s price zooms higher.

Some of the desperate would-be millionaires have even tried hypnotism to recover forgotten passwords. Others are hiring hackers (honest ones, hopefully) to rifle through their files for clues.

And these individual owners are only the first level. The accumulated pile of inaccessible bitcoins could lead to systemic consequences.

Source: Getty Images

Phantom bitcoin

Bitcoin’s anonymous inventor(s), Satoshi Nakamoto, designed the program to allow mining of only 21 million bitcoins by the year 2140. Miners have dug up about 17 million bitcoins in total so far.

study last year by digital forensics firm Chainalysis estimated that somewhere between 2.78 million and 3.79 million bitcoins are lost.

That means as much as 22% of the existing bitcoin supply might as well not exist. For all practical purposes, it’s gone.

The real bitcoin supply that is available for transactions isn’t 17 million - it’s 17 million minus those lost millions. So maybe as little as 13.21 million, using the higher Chainalysis estimate.

Does that affect the bitcoin price? It should.

Imagine if these were shares of stock, and the company bought back two or three million of 17 million outstanding shares. The price would rise because supply dropped.

But are the lost bitcoins really lost? For some of them, we can’t be sure.

Source: Getty Images

Satoshi’s million

“Satoshi” mined some 1 million initial bitcoins. They’re on the blockchain ledger, so we know Satoshi hasn’t touched them. We don’t know who Satoshi is, whether he/she is still alive, or whether he/she still has access to those one million bitcoins, or may have given access to others. Satoshi might even be a group of people.

In any case, Satoshi’s stash represents 5.9% of existing bitcoin supply. Their existence affects the value of all bitcoins… but maybe it shouldn’t, if a bus hit Satoshi and they are effectively gone.

But Satoshi is/was pretty clever. Maybe some time-delay mechanism will distribute the one million bitcoins to Satoshi’s favorite people on a designated date. Or maybe Satoshi will retire and finally liquidate them next year. We can’t assume they are permanently gone.

Similarly, many of those other “lost” bitcoins may not remain so. Maybe that council in Wales will let Howells dig for his hard drive, and he’ll find it. If so, the total bitcoin supply won’t change, but the available supply will rise.

Or maybe scientists will invent brain-computer interfaces that let people recover forgotten passwords. Available bitcoin supply will then grow some more.

Source: Getty Images

The law of supply and demand applies everywhere, even to bitcoin. More bitcoins in circulation means more bitcoins available when someone tries to buy bitcoins with dollars, yen, gold, or whatever.

In theory, at least, that should have a bearish influence on the bitcoin price.

Sound familiar? It’s what we would call “inflation” in a fiat currency. The value of each dollar drops as more dollars enter circulation.

Bitcoin’s float

So bitcoin is vulnerable to a kind of inflation.

Granted, it’s less vulnerable than a fiat currency, thanks to that hard supply limit of 21 million. Central banks have no such limits. They can debase their currencies to nothing, as is happening in Venezuela right now.

A better comparison might be shares of stock. Companies know exactly how many shares they’ve issued and retired, so they can always tell you the number “outstanding.”

There’s also something called “float,” which is the outstanding shares minus restricted shares that owners can’t yet sell. Float is the tradable inventory.

Then there’s a “fully diluted” share quantity: outstanding shares plus the new shares the company would have to issue if all option holders - typically employees or early investors - exercise them.

We can map those same concepts to bitcoin.

  • Outstanding bitcoin is the number that have been mined, around 17 million.
  • Bitcoin’s float is 17 million minus Satoshi’s million and all those “lost” bitcoins - maybe as little as 12.2 million.
  • Fully diluted bitcoin is 21 million, which can’t happen until the year 2140.

The bitcoin float could unexpectedly increase if Satoshi sells his/her million or owners recover significant quantities of “lost” bitcoins.

Source: Getty Images

This would look much like the share dilution when a company issues new equity. Usually, the share price drops.

That may never happen to bitcoin, but it’s not impossible. That means bitcoin buyers and sellers should consider it in their valuation.

The broader point: Bitcoin has a kind of inflation risk.

Just like monetary inflation, this risk grows with time. The longer people search for lost bitcoins, the more likely they’ll find some. Technology will be giving them better tools as time passes too.

Bitcoin has many risks, so this is a relatively minor one. It’s small, but above zero.

Small risks add up when trading stocks, bonds, or currencies. The traders who survive are the ones who watch for them.

Bitcoin traders should take note.


*Patrick Watson is senior economic analyst at Mauldin Economics. This article is from a regular Mauldin Economics series called Connecting the Dots. It first appeared here and is used by with permission.

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Inflation is a bit of a downer, especially as it is not just Bitcoin in the race any more. Bitcoin is now only roughly a third of cryptocurrency trade. There are over 1000 different market tracked currencies to each have their own risks and increase supply across the board. With more being added all the time there is an infinite supply of coins for speculators. Often this increases the competition and even businesses are turning to other cryptocurrencies before working with Bitcoin.

Then there is the dust problem, where small amounts of cryptocurrencies left in exchange accounts cost too much in fees to move so they are effectively stuck until more money is pumped in. Bit of a bugger as that will also add to the total loss or gain. The general rule is to try to get & store as much as possible off the exchanges & network connected devices in case of issues and security hacks.

The interesting bit though is how the exchanges effectively manage and tap control over access. Some are vanilla exchanges and only offer the big 3 or 4 trading pairs. Some look at spreading to a modest range of alt trading pairs and some look at an extensive range (with new ones even added through user voting). This does mean however that often exchanges (as unregulated as many are) can just shut down trading pairs as they like, charge excessively high fees for certain pairs etc and leave users again with little way to regain access to their funds. Like the dust problem it creeps up and when considering the total becomes a substantial figure temporary or totally inaccessible. Those exchange fees nimble off at the edges and scrap millions from users.

Thank you for the article! Really very interesting.

There's a lot of useful information here —