The Economic Analysis of Demand for Bitcoin

[webtricks]

It's been a while since I had a reasonable discussion in Economics section. Hence, I decided to create my own thread. In this thread, I am using the Keynesian Theory of Demand for Money to highlight the similarities as well as differences between the demand for Money and demand for Bitcoin. This thread will be little longer as I am going in full-depths but this is not copy/paste material so don't ignore it on that grounds. This is my personal analysis and every bit of it is my original work except obviously the contents from Keynesian Theory:

According to Keynesian theory of demand for money, also known as Liquidity Preference Theory, people prefer holding money for three motives:

1. Transactions Motive

The transaction motive for holding cash relates to the need for cash for current transactions for personal and business exchange. Such need arises because there is lack of synchronization between receipts and expenditure. You may receive money at different point but spend it at different point. The transaction demand for money is directly related to the level of income. Higher the income, higher the transaction demand for money. The equation could be written as:

L_r = kY

where L_r is the transaction demand for money, k is ratio of income kept as money for transactions purpose and Y is total income.

Now coming to Bitcoin. Since we are talking about transaction motive, it is very short-term utility of money so we have to assume return on Bitcoin as constant. But the difference between buying price and selling price surely effects the transaction motive for holding Bitcoins. For example, I receive my income in Bitcoin on 1st of every month and I visit my grocery store on 10th of every month. But the price on 1st was $8K which drops to $6K on 10th, I may postpone my expenditure for few days expecting bitcoin to rise again. Thus difference in buy-sell price has manipulative effect on transaction motive of Bitcoin. Hence, I reached to following equation for demand for Bitcoin for transaction motive:

L_r = k(Y*X)
X = |(S-B)/B|

where L_r, k and Y are same as above equation and S is the btc price when bitcoin was used for expenditure whereas B is price when bitcoin was received as income. According to my analysis, higher the value of X, longer the person will hold bitcoin.


2. The Precautionary Motive

Many unforeseen and unpredictable contingencies involving money payments occur in our day to day life. Thus people keep a portion of their income to meet such unanticipated expenditures. The portion of money kept by individual depends upon various factor such as income, political and economical conditions, personal characteristics of individual, etc. Keynes wasn't much clear on the factors, hence didn't give any equation.
Now coming to Bitcoin. In precautionary demand for money, income was the biggest determinant but in case of Bitcoin, personal characteristics and market condition are the more prominent ones. Since Bitcoin is High-Risk, High-Yielding investment, conservative person is less keen to hold bitcoins for precautionary motive than the radical one. Also, person will be more inclined to hold Bitcoins for precautionary motive if the market condition is favorable and bitcoin is in green zone for long.

3. Speculative Demand for Money

To analyse the Speculative demand for money, Keynes has taken two factors into consideration:

• Interest rate on market securities
• The expected rate of capital gain

According to Keynes, people have notion regarding the interest rate of securities which they consider to be normal. Such interest rate is known as critical interest rate. When the current interest rate is more than the critical interest rate, people convert all their money into securities because:

• 1. They can earn more due to high rate of interest.
• 2. Interest rate and the market value of security have an inverse relationship. So when the current rate of interest fall below critical rate, people will make capital gain as the market value of security will rise as compared to the price at which they bought the security.

On the contrary, if the current rate of interest is lower than the critical rate, people will convert all their securities into cash.
Now coming to Bitcoin. Bitcoin does not follow the principle of speculative demand as laid down by Keynes because its characteristics are very much similar to the securities considered by Keynes for this analysis. Hence speculation demand for bitcoin has different approach. Its speculation demand depends upon the relative rate of return. If the anticipated return on Bitcoin is higher than other securities, people will hold Bitcoins for speculation motive and vice-versa.

Any suggestions, questions, different approaches, views, doubts are welcome.

[1714496956]

1714496956

[chaoscoinz]

   The thing about Bitcoin is this, If the price ever reaches a certain height, chances are that the altcoin market will also follow the move. What then will happen to the worlds economies if everyone decided it was a good time to cash out? Do you think the banks will allow people to suddenly withdraw all of their Bitcoin and altcoins? Surely it would crash the planet. Bitcoin and crypto-currency in its current state is unable to reach the mass everyday consumer. All these statistics are great, but the only way for the  real mass demand for crypto-currencies will be if for some reason people suddenly started to abandon their government based fiat system. Even then, I don't see that happening, especially not any time soon.
   How crypto-currencies appease the Luddites of today's society, and those who are tech illiterate or impoverished? What can crypto do for them that wouldn't be more of a staple convenience than fiat? The only way I truly believe that the common folk of society will demand Bitcoin/crypto-currency is if it makes fiat obsolete, and not just act as a digital store of value.

Just my two cents  

[binhvo1505]

On the contrary, if the current rate of interest is lower than the critical rate, people will convert all their securities into cash.
Now coming to Bitcoin. Bitcoin does not follow the principle of speculation demand as laid down by Keynes because its characteristics are very much similar to the securities considered by Keynes for this analysis. Hence speculation demand for bitcoin has different approach. Its speculation demand depends upon the relative rate of return. If the anticipated return on Bitcoin is higher than other securities, people will hold Bitcoins for speculation motive and vice-versa.

Any suggestions, questions, different approaches, views, doubts are welcome.

But the fact that everyone wants to hold bitcoins will create a big hole. You should know that all the value of bitcoin is now manipulated and its price is very high. Think about it, for those who hold several thousand bitcoins, they always expect people to increase the demand to buy bitcoins to sell at high prices.
In fact, bitcoin has no value but it is manipulated. Everyone knows this, so it is not right that many people want to buy bitcoin.

[NathanJB]

On the contrary, if the current rate of interest is lower than the critical rate, people will convert all their securities into cash.
Now coming to Bitcoin. Bitcoin does not follow the principle of speculation demand as laid down by Keynes because its characteristics are very much similar to the securities considered by Keynes for this analysis. Hence speculation demand for bitcoin has different approach. Its speculation demand depends upon the relative rate of return. If the anticipated return on Bitcoin is higher than other securities, people will hold Bitcoins for speculation motive and vice-versa.

Any suggestions, questions, different approaches, views, doubts are welcome.

But the fact that everyone wants to hold bitcoins will create a big hole. You should know that all the value of bitcoin is now manipulated and its price is very high. Think about it, for those who hold several thousand bitcoins, they always expect people to increase the demand to buy bitcoins to sell at high prices.
In fact, bitcoin has no value but it is manipulated. Everyone knows this, so it is not right that many people want to buy bitcoin.

Define manipulation before anything else. The Bitcoin market is always manipulated by different factors. But only a portion of it is directly manipulated by the whales. Billions of USD are being traded 24-7 on so many crypto exchange sites all over the world by millions of different traders. The value of Bitcoin is largely dependent on these trades because these trades are the ones that determine the demand of Bitcoin. Everybody wants the price of Bitcoin to increase but because no one can manipulate directly the market at all times, there are unavoidable dumps every now and then.

[odolvlobo]

1. Transactions Motive
...
According to my analysis, higher the value of X, longer the person will hold bitcoin.

It might be helpful to show your analysis. It is not clear how your conclusion is related to the transactions motive.

2. The Precautionary Motive

Many unforeseen and unpredictable contingencies involving money payments occur in our day to day life. Thus people keep a portion of their income to meet such unanticipated expenditures. ...

It seems to me that this is just an extension of #1 with a longer time frame and some uncertainty.

3. Speculative Demand for Money

To analyse the Speculative demand for money, Keynes has taken two factors into consideration:
...
When the current interest rate is more than the critical interest rate, people convert all their money into securities because:
...
On the contrary, if the current rate of interest is lower than the critical rate, people will convert all their securities into cash.
...

"All" is an exaggeration. The fact that all is not converted means that the actual effect can be quite different from your narrative.

[AniviaBtc]

It's been a while since I had a reasonable discussion in Economics section. Hence, I decided to create my own thread. In this thread, I am using the Keynesian Theory of Demand for Money to highlight the similarities as well as differences between the demand for Money and demand for Bitcoin. This thread will be little longer as I am going in full-depths but this is not copy/paste material so don't ignore it on that grounds. This is my personal analysis and every bit of it is my original work except obviously the contents from Keynesian Theory:

According to Keynesian theory of demand for money, also known as Liquidity Preference Theory, people prefer holding money for three motives:

1. Transactions Motive

The transaction motive for holding cash relates to the need for cash for current transactions for personal and business exchange. Such need arises because there is lack of synchronization between receipts and expenditure. You may receive money at different point but spend it at different point. The transaction demand for money is directly related to the level of income. Higher the income, higher the transaction demand for money. The equation could be written as:

L_r = kY

where L_r is the transaction demand for money, k is ratio of income kept as money for transactions purpose and Y is total income.

Now coming to Bitcoin. Since we are talking about transaction motive, it is very short-term utility of money so we have to assume return on Bitcoin as constant. But the difference between buying price and selling price surely effects the transaction motive for holding Bitcoins. For example, I receive my income in Bitcoin on 1st of every month and I visit my grocery store on 10th of every month. But the price on 1st was $8K which drops to $6K on 10th, I may postpone my expenditure for few days expecting bitcoin to rise again. Thus difference in buy-sell price has manipulative effect on transaction motive of Bitcoin. Hence, I reached to following equation for demand for Bitcoin for transaction motive:

L_r = k(Y*X)
X = (S-B)/B

where L_r, k and Y are same as above equation and S is the btc price when bitcoin was used for expenditure whereas B is price when bitcoin was received as income. According to my analysis, higher the value of X, longer the person will hold bitcoin.


2. The Precautionary Motive

Many unforeseen and unpredictable contingencies involving money payments occur in our day to day life. Thus people keep a portion of their income to meet such unanticipated expenditures. The portion of money kept by individual depends upon various factor such as income, political and economical conditions, personal characteristics of individual, etc. Keynes wasn't much clear on the factors, hence didn't give any equation.
Now coming to Bitcoin. In precautionary demand for money, income was the biggest determinant but in case of Bitcoin, personal characteristics and market condition are the more prominent ones. Since Bitcoin is High-Risk, High-Yielding investment, conservative person is less keen to hold bitcoins for precautionary motive than the radical one. Also, person will be more inclined to hold Bitcoins for precautionary motive if the market condition is favorable and bitcoin is in green zone for long.

3. Speculative Demand for Money

To analyse the Speculative demand for money, Keynes has taken two factors into consideration:

• Interest rate on market securities
• The expected rate of capital gain

According to Keynes, people have notion regarding the interest rate of securities which they consider to be normal. Such interest rate is known as critical interest rate. When the current interest rate is more than the critical interest rate, people convert all their money into securities because:

• 1. They can earn more due to high rate of interest.
• 2. Interest rate and the market value of security have an inverse relationship. So when the current rate of interest fall below critical rate, people will make capital gain as the market value of security will rise as compared to the price at which they bought the security.

On the contrary, if the current rate of interest is lower than the critical rate, people will convert all their securities into cash.
Now coming to Bitcoin. Bitcoin does not follow the principle of speculation demand as laid down by Keynes because its characteristics are very much similar to the securities considered by Keynes for this analysis. Hence speculation demand for bitcoin has different approach. Its speculation demand depends upon the relative rate of return. If the anticipated return on Bitcoin is higher than other securities, people will hold Bitcoins for speculation motive and vice-versa.

Any suggestions, questions, different approaches, views, doubts are welcome.

Bitcoin is not stable like other currencies. If it goes up, there's an opportunity for the altcoin in the market to take action. If this happens, many people will cash out and the bank will not let this to happen. They will not allow all the people to withdraw ther bitcoin. That's the disadvantage of crypto, when demands come the world can't make them withdraw simultaneously.

[webtricks]

....

Did you even read what I had to say? It looks like I am talking about Apples and Bananas and you explaining why water would be the main reason for World War 3.

But the fact that everyone wants to hold bitcoins will create a big hole. You should know that all the value of bitcoin is now manipulated and its price is very high. Think about it, for those who hold several thousand bitcoins, they always expect people to increase the demand to buy bitcoins to sell at high prices.
In fact, bitcoin has no value but it is manipulated. Everyone knows this, so it is not right that many people want to buy bitcoin.

No doubt that Bitcoin's demand is highly manipulated in practical world. Same is true for money. Money becomes dearer to holder as the amount of money spent by him increases but to study demand for money, we consider that every unit of money is equal to holder. Similarly, higher the units of bitcoin locked by whales from market, more dearer the rest of units become to investors. But I consider that factor negligible for my analysis.

[webtricks]

1. Transactions Motive
...
According to my analysis, higher the value of X, longer the person will hold bitcoin.

It might be helpful to show your analysis. It is not clear how your conclusion is related to the transactions motive.

Higher the value of X, more willing will be the people to postpone their expenditures. Excluding necessities, let's say I visit cinema hall to watch movie on 15th of every month but the prices of bitcoins fall 30% from the day I received till the date of my movie visit. Then, I may not spend my bitcoins for transaction motive and rather hold those. Thus X is additional factor that impact bitcoin's spending on transaction motive which is not present in case of money.

2. The Precautionary Motive

Many unforeseen and unpredictable contingencies involving money payments occur in our day to day life. Thus people keep a portion of their income to meet such unanticipated expenditures. ...

It seems to me that this is just an extension of #1 with a longer time frame and some uncertainty.

Yes, it is!
Keynes regarded the precautionary balances just as balances under transactions motive as income elastic and by itself not very sensitive to rate of interest.
Except that, both motives are quite similar.

3. Speculative Demand for Money

To analyse the Speculative demand for money, Keynes has taken two factors into consideration:
...
When the current interest rate is more than the critical interest rate, people convert all their money into securities because:
...
On the contrary, if the current rate of interest is lower than the critical rate, people will convert all their securities into cash.
...

"All" is an exaggeration. The fact that all is not converted means that the actual effect can be quite different from your narrative.

Yeah! In Keynes's classic example, he talked about cash on one side and government bond on the other. As he considered only 2 variables, his analysis was easy as there can be only binary choices, one or the other. But same can't be used when we talk about market asset like Bitcoin which can have hundred of substitutes. There can be 100 different sets of choices which make the application of Keynes's speculative demand study impossible. Hence I reached to following conclusion:

Now coming to Bitcoin. Bitcoin does not follow the principle of speculative demand as laid down by Keynes because its characteristics are very much similar to the securities considered by Keynes for this analysis. Hence speculation demand for bitcoin has different approach. Its speculation demand depends upon the relative rate of return. If the anticipated return on Bitcoin is higher than other securities, people will hold Bitcoins for speculation motive and vice-versa.

[Coyster]

The only way I truly believe that the common folk of society will demand Bitcoin/crypto-currency is if it makes fiat obsolete, and not just act as a digital store of value.

Is this even an option, making fiat obsolete would not be possible even in a million lifetimes, and we do not need fiat to be dated before bitcoin can be appreciated by those who lack digital knowledge.

Rather than opting for the impossible, the only way to do what you propose is to educate them, the ordinary folks as you call them have probably not been exposed to what the bitcoin offers, they need to be taught how to use the bitcoin, the advantages and opportunities it brings, how it can be used with their fiat, without one making way for the other, etc.
I think education still is the best means to make bitcoin more and more acceptable.

[Beparanf]

The only way I truly believe that the common folk of society will demand Bitcoin/crypto-currency is if it makes fiat obsolete, and not just act as a digital store of value.

Is this even an option, making fiat obsolete would not be possible even in a million lifetimes, and we do not need fiat to be dated before bitcoin can be appreciated by those who lack digital knowledge.

Rather than opting for the impossible, the only way to do what you propose is to educate them, the ordinary folks as you call them have probably not been exposed to what the bitcoin offers, they need to be taught how to use the bitcoin, the advantages and opportunities it brings, how it can be used with their fiat, without one making way for the other, etc.
I think education still is the best means to make bitcoin more and more acceptable.

In our country bitcoin is consider as speculative investment only, you can choose to hold it or not, our government didn't create any statement on it that the demand is not too high. You'll only know when you research it or thru word of mount of someone you know.  It is not for transaction purposes yet since only limited establishments can use it and most banks are not accepting it. But surely the demand will goes high soon the more adoption occur.

[SvonioneFromMangoCoinz]

The only way I truly believe that the common folk of society will demand Bitcoin/crypto-currency is if it makes fiat obsolete, and not just act as a digital store of value.

Is this even an option, making fiat obsolete would not be possible even in a million lifetimes, and we do not need fiat to be dated before bitcoin can be appreciated by those who lack digital knowledge.

Rather than opting for the impossible, the only way to do what you propose is to educate them, the ordinary folks as you call them have probably not been exposed to what the bitcoin offers, they need to be taught how to use the bitcoin, the advantages and opportunities it brings, how it can be used with their fiat, without one making way for the other, etc.
I think education still is the best means to make bitcoin more and more acceptable.

I still do not agree with your comments. Bitcoin's widespread adoption will be a major disaster for many countries. You know, blockchain technology is very convenient, but it's also many times more convenient for terrorists and money launderers.
This is one of the things I'm very concerned about with the widespread use and acceptance of bitcoin in many countries. It just causes more crime and I hope countries will not continue education on cryptocurrency anymore. It will create bad people. What do you think about this issue ?

[huu78]

Bitcoin demand from the previous year was greatly improved because many people already know this cryptocurrency from time to time.
Where some countries have begun to make or adopt this blockchain for their governance in order to compete with other currencies. I think the future will more demand even though the market is bad though.

[tonyvo2017]

On the contrary, if the current rate of interest is lower than the critical rate, people will convert all their securities into cash.
Now coming to Bitcoin. Bitcoin does not follow the principle of speculative demand as laid down by Keynes because its characteristics are very much similar to the securities considered by Keynes for this analysis. Hence speculation demand for bitcoin has different approach. Its speculation demand depends upon the relative rate of return. If the anticipated return on Bitcoin is higher than other securities, people will hold Bitcoins for speculation motive and vice-versa.

Any suggestions, questions, different approaches, views, doubts are welcome.

Although many people are heading towards the common problem of expecting bitcoin's price to increase next year and its price sure to go up. But I think this is a great trap for damn manipulated sharks. I always fear that when the market grows unevenly and the alts are always marginalized compared to bitcoin. When halving occurs, it is likely that the market will be out of balance again and that bitcoin may drop unaltered at any time. I think there should be a correction between Bitcoin Dominance and Altcoins Dominance before the halving event takes place. do you think so  ?

[Murat]

   
I think every coin has the main theme to get used in the payment system, So Bitcoin should also be used for this purpose but due to lack of availability of making payment through Bitcoin, we can't do randomly in our community that's why its demand depends on the price in the market, now come to the point, When the main purpose couldn't meet then some people are making this platform very volatile, since the price volatility, people are getting interested in holding Bitcoin for making more money, when they get a high price then they want to sell, this is the major problem of this platform, If there are a lot of vendors who accept Bitcoin as a payment tool then Bitcoin could be more potential on the current context.

[mu_enrico]

Okay, it's widely known that Liquidity Preference Theory is a theory that explains why people prefer to hold cash. The problem is, Bitcoin is far from being cash so that this theory might not (all) be useful to explain the demand for Bitcoin.

Transaction motive
Bitcoin cannot be used (at the moment) for purchasing daily goods and services, because of regulation, scalability, etc.

Precautionary Motive
If you get sick, how many hospitals or doctors that accept Bitcoin? How many house or car repair services that accept Bitcoin?

Speculative motive
This one can be used to explain Bitcoin demand at the moment (to some extent). People hold Bitcoin to get quick access to trade altcoins.

[Strongkored]

1. Transactions Motive : very difficult to apply to Bitcoin, because prices are to fluctuate, and this will result in increased or decreased living costs, I don't want to be too dizzy thinking about the cost of living which is changings.

2. The Precautionary Motive : Only suitable for securing assets not for reserve funds if something happens for example sick.

3. Speculative motive : Mostly people considering Bitcoin as investment get benefits from increase Bitcoin prices.

[Kprawn]

The Speculative Demand for Money is currently pushing most of the demand, but I think you should ad income generation as another option,

because a lot of people are using Bitcoin as a method to earn an income. This is currently helping people to earn an extra income from an employer

that are not necessarily from the same country. This is also very important, because it opens up a whole new income stream for people living in

third world countries. These people use Bitcoin for remittance and that is VERY important on the demand side. 

[hugeblack]

Good Job

Lr = k(Y*X)
X = |(S-B)/B|

I agree with you that you need to find the X factor to measure change. Is this equation with correct results?
The absolute value of measuring the difference in value between two values divided by one of the two values is a measure that may lead to false results, although approaching the true value will be closer.
Try some charts to compare the willingness to pay in BTC and the price change.
Do not forget that there are some effects where I can pay now if I expect a decline in independently or bad events.

[Theb]

The wrong thing about this is when people talk about higher interest rates = people saving/investing their money is they are only talking about traditional kinds of investments here from stocks, forex, and into mutual funds. There is really no direct link that tells us that people will move their money onto something that is not stable given with a higher risk to reward ratio, some even enter the market late when Bitcoin and other cryptos already went up which in their minds is what a "favorable market condition". Other factors such as Bitcoin not known to many has a less likely chance to become one of the preferred investments by people when the time interests rates increase, they would just go like I said to traditional investments where they think their money is much safer to grow.

[webtricks]

Okay, it's widely known that Liquidity Preference Theory is a theory that explains why people prefer to hold cash. The problem is, Bitcoin is far from being cash so that this theory might not (all) be useful to explain the demand for Bitcoin.

Transaction motive
Bitcoin cannot be used (at the moment) for purchasing daily goods and services, because of regulation, scalability, etc.

Precautionary Motive
If you get sick, how many hospitals or doctors that accept Bitcoin? How many house or car repair services that accept Bitcoin?

Speculative motive
This one can be used to explain Bitcoin demand at the moment (to some extent). People hold Bitcoin to get quick access to trade altcoins.

That's true! Due to inherent limitation of scalability and limited supply of-course, Bitcoin can never be used as first preference medium of exchange in ideal society for transaction and precautionary motives. However, most of our Economics laws and rules are based on 'if' so I just tried to drive the comparison between cash and Bitcoin from one more perspective and you can say that this way too proves that Bitcoin is not a substitute to present currency system.

The Speculative Demand for Money is currently pushing most of the demand, but I think you should ad income generation as another option,
because a lot of people are using Bitcoin as a method to earn an income. This is currently helping people to earn an extra income from an employer
that are not necessarily from the same country. This is also very important, because it opens up a whole new income stream for people living in
third world countries. These people use Bitcoin for remittance and that is VERY important on the demand side. 

This could be another interesting aspect. If freelancers or some sort of out-sourcers like KPOs or BPOs start charging their fees in Bitcoin then their clients would have to convert their money into Bitcoin first before remittance. This will create another sort of demand from income generation method. However, in Liquid Preference Theory, we study demand from the expenditure point of view.