21 million Bitcoin: Why Does Supply Cap Matter?
You’ll often hear people say that the supply cap of Bitcoin is 21 million so there is no inflation after all Bitcoin are mined. But why does the supply cap matter?
Stock-to-flow ratio
For any asset, there is something called the stock-to-flow ratio. This ratio is the amount of an asset that already exists divided by the amount of the asset that gets produced annually. The higher this ratio is, the more scarce an asset is because the amount of the asset that already exists is not getting devalued as more is added to the system.
Why Gold and Real Estate have traditionally been used to store wealth
Gold can only be created during a chemical reaction in the universe. On top of that, in order for humans to get their hands on gold, we have to dig it out of the Earth. Digging and refining gold takes a lot of energy, therefore, the stock-to-flow ratio of gold is high because we are not able to dig much gold up and add it to the supply on Earth every year.
Similarly, there is only so much land on Earth in climates that people want to live in. Unless there is massive movement in the tectonic plates, we will not be able to create more land. The stock-to-flow ratio of land is high. People want to buy land and own land because (1) there is a cap on the supply, and (2) people need a place to live. AKA, there is demand for land and when there is demand + limited supply, the value of land will go up.
Bitcoin
Bitcoin is programmed to have a limited supply. There will only ever be 21 million bitcoin in all of history. Some people have already lost their bitcoin keys, meaning the number of accessible bitcoin in circulation is actually less than 21 million. Therefore, we know exactly how much bitcoin is being added to the system, when it’s being added, and how much bitcoin there will ever be in the system. The stock-to-flow ratio of Bitcoin is preset and predictable.
Fiat currency
Fiat currency, or the money supply, is controlled by the government. The government decides how much money there is in the system, which means there is no limit on the amount of money that can be created. When money is created, we get inflation and that lowers the stock-to-flow ratio. You do not want to hold wealth in an asset that has a low stock-to-flow ratio because as more of the asset gets added into the existing supply, every unit of the asset goes down in value.
