Elementary Bitcoin economics: from production and transaction demand to values

Abstract: In this paper we give an elementary analysis of economics of Bitcoin that combines the transaction demand by the consumers and the supply of hashrate by miners. We argue that the decreasing block reward will have no significant effect on the exchange rate (price) of Bitcoin and thus the network will be transitioning to a regime where transaction fees will play a bigger part of miners' revenue. We consider a simple model where consumers demand bitcoins for transactions, but not for hoarding bitcoins, and we analyze market equilibrium where the demand is matched with the hashrate supplied by miners. Our main conclusion is that the exchange rate of Bitcoin cannot be determined from the market equilibrium and so our arguments support the hypothesis that Bitcoin price has no economic fundamentals and is free to fluctuate according to the present demand for hoarding and speculation. We point out that increasing fees bear the risk of Bitcoin being outcompeted by its main rival Ethereum, and that decreasing revenues to miners depreciate the perception of Bitcoin as a medium for store value (hoarding demand) which will have effect its exchange rate.