A lot has been said and written about the Bitcoin Halving event, which took place early this week. Most people argue that it is positive for the price, but I have always been lacking true fundamental arguments, why this is the case and which impact exactly it could have.
The Stock-to-Flow model is often used to argue why the halving has a strongly positive effect on the pricing of Bitcoin - but while I believe in the general argument that scarcity has the potential to drive value - I think that the derivative of a concrete value forecast is simply not feasible.
Therefore, I have though about an alternative model, which tries to build on conventional economic theory:
Supply, Demand and the Market Clearing Price
Let's start with the classical supply and demand model, which was first described by Antoine-Augustin Cournot (1801-1877) and later made popular by the British economist Alfred Marshall (1842-1924).
The theory states that the supply of any given goods and services will increase with a rising price. For produced goods this is mainly related to the expected return a producer will generate on producing the goods, which results in an increased volume being offered. For securities and cryptocurrencies the argument is that more people will be willing to sell their holding when the price increases.
For the demand side, the opposite is true. With a falling price, demand tends to increase. This is due to the fact that for consumers, goods become more attractive relative to others at a lower price. Demand for securities and cryptocurrencies on the other hand increases as more investors consider the price as attractive when the price falls and are thus willing to buy.
According to this theory, the price for goods and services should be the one, which brings supply and demand into equilibrium. This is what economists call the market clearing price.
What impact does the Halving have on Supply and Demand
Most miners will likely be short term oriented businesses, which are targeting to make a profit in FIAT currency instead of HODLing what they mine. The vast majority of the mined coins is thus likely being being sold - no matter what the current price is. This supply is thus what is called inelastic. In the diagram, the price elasticity of supply and demand can be seen by observing the steepness of the curve. The steeper the curve, the more elastic supply or demand react to price changes.
Cutting the supply from miners by half will result in a parallel shift of the supply curve to the right. This means that the new equilibrium price should rise. But by how much?
Which factors influence the magnitude of the positive price impact of the Halving?
Price elasticity of supply
One important driver of the price impact is the steepness of the remaining supply - or in other other words the price elasticity of supply. The lower the price elasticity of demand, the higher the positive effect on the new equilibrium price. HODLer are by definition extremely price inelastic - they do not sell no matter what the price is. While reality has shown that even HODLer typcially have a threshold at which they will eventually sell, I would still argue that these investors are very price inelastic. The higher the share of HODLer in the investor base one could thus argue the higher the positive price impact.
The share of miners of total supply
The higher the share of the miners of the total supply, the higher the impact on pricing will be. Given that this ratio should decrease with each Halving event, the positive impact of each Halving should decrease over time.
Price elasticity of demand
Finally, the price elasticity of demand also influences the impact of the Halving on pricing. Again, the flatter the curve, the stronger will be the positive impact.
The equivalent to the HODLers on the supply side are on the demand side the steady investors, which invest a more or less equal amount on a regular basis - no matter what the price is. The higher their share of the total demand, the lower the price elasticity of demand tends to be - and the higher would be the positive impact of a shift in supply.
Momentum investors driven by FOMO
Economic theory assumes that humans act rationally - unfortunately, in reality they tend to be the opposite. This prove true especially in the world of cryptocurrencies, where we continue to lack a sound fundamental framework on how to value cryptos. This results in the fact that investor are willing to change their assumptions of a fair price drastically withing a very short time frame. Additionally, any large change in prices is likely to attract a lot of media attention, which in turn attracts new investors. This often leads to exaggerated price developments - driven by what is referred to as FOMO - Fear Of Missing Out.
Conclusions for the Bitcoin price
Based on this analysis I would conclude that the Halving is for sure positive for the Bitcoin price in the medium term. However, deriving any forecasts from historic events is in my view leading to exaggerated expectations, as the impact from the reduction in inflation should decline over time. Also, it is far from clear that the positive impact will also materialize in the short term. The Halving was known in advance and for sure some investors have bought before the event to benefit from the future positive effects. Some of the recent price increase might thus be related to this pre-buy effect, which could normalize again in the next weeks.
That being said, the reduction of inflation is only one factor influencing the price of Bitcoin - but there are also many other driving forces. Especially the current tendency observed in many countries to finance the costs of the COVID-19 pandemic with the banknote press is in my view a key driver for the acceptance of a digital currency, which is completely independent of any political intervention.
What can we learn for HIVE
The inflation if hive is still relatively high - more than 7% p.a. compared to Bitcoin's current inflation rate of 1.8%. Including also the proceeds from the Hive DAO, this rate is increased even further. While I would argue that the share of inflation going directly to the market is lower than in the case of Bitcoin, still a fair share is being sold immediately. If we were to cut the inflation by 50% I would thus expect the Hive price to react much more positively than the Bitcoin price. In the past, we have seen already which negative impact the constant selling of Steem by STINC had on the Steem price and I am convinced that the fact that this is now over on Hive is one of the reasons why the Hive price is significantly above the price of Steem some months ago. Reducing the inflation could result in an additional boost to the Hive price, which would likely attract new investors and users. Indeed, I remain convinced that halving the inflation could result in an increase of the Hive price, which would over time for content producers more than compensate the loss from lower inflation.
Disclaimer: This is no financial advice, I am merely offering my own opinion.