All high school economics textbooks lay out the law of supply and demand — as supply increases or demand decreases, the price of a good or service drops. As supply decreases or demand increases, the price of that same good or service increases. Both factors play a role in value.

Every commodity, currency, or asset on earth is subject to this type of market response. Both supply and demand play an active part in appreciation or depreciation.

For example, precious metals and gems are valued based on their limited supply (scarcity) and high demand. However, the supply of diamonds, for example, could change massively if a new large diamond mine was suddenly found.

In a similar way, a fixed amount of currency in an economic system, say USD for example, produces a relative value of a single dollar. Should the Federal Reserve choose to print more dollars, the relative value of that dollar would adjust downward, creating inflation in prices because of an increase in supply.

Bitcoin Alone

However, Bitcoin functions in a very different way. From an economic perspective, Bitcoin has a fixed supply. There can never be more than 21 million BTC — ever. Once all coins are all mined, no more can ever be generated. No central bank can create more. The supply is fixed.

This means that Bitcoin does not respond to changes in supply, but only to changes in demand. The movement of demand produces an immediate and far greater response in price since supply cannot fluctuate.

Because the supply is fixed digitally and is built into the original protocol itself, there cannot be any fluctuation in supply in any way. Even the most scarce items on the planet cannot be said to have absolutely fixed supplies. In this way, Bitcoin stands alone as the only possible asset which changes value with only demand as a variable.

The implication is therefore clear. Demand for Bitcoin leads to immediate and exponential price response.

Positives and Negatives

The implications for this economic reality are interesting. First, this closed loop response system means that an increase in demand will yield a corresponding increase in price appreciation.

This cycle can be very dramatic. When the price rises, the mood of investors rises in a corresponding way, and the fear of missing out (FOMO) can cause substantial speculative investment. Such investment demand drives further appreciation, and the cycle continues.

At the same time, the reverse is also possible. When demand drops or a fear of loss moves investment out of Bitcoin, the price responds negatively. As with increasing demand, this drop in price causes greater fear in the market, and the price continues to decline exponentially.

A version of each of these markets has occurred in the past 18 months.

Inbuilt Bumps

These large-scale swings, both up and down, are built into the concept of Bitcoin. Such volatility can often cause new users substantial concern. However, swings in price are a sign of increasing adoption of Bitcoin as a viable asset.

For the price to increase so dramatically, a large number of users must enter the market, driving increasing demand. While many of these users may then exit the market entirely, resulting in price decline, some remain. Each successive interest and adoption cycle brings new users into the Bitcoin market, moving demand steadily forward.

While the large peaks and low valleys of the Bitcoin chart may be concerning, these are simply related to the inbuilt nature of Bitcoin. Instead, a long view of Bitcoin proves that a progressive increase in demand will ultimately produce increases in price, volatility notwithstanding. Smart investors are therefore those who buy and HODL — something the original cryptophiles have long known.

Do you think Bitcoin is set to continue its slow march upward? Will it track back to zero? Let us know your thoughts in the comments below!

[Disclaimer: This article is not financial advice and should not be taken as such. Always consult with a trained or certified financial professional before making any investment decisions.]