Several basic economic concepts can be applied directly to understanding bitcoin:
- Bitcoin supply is highly inelastic;
- Many commodities, such as natural gas, just as an example, find it hard to increase or decrease production in the short-term when prices move quickly;
- Economists talk about this lack of price sensitivity in the short-run as an inelastic supply;
- And, inelastic supply is typically associated with substantial price volatility.
In addition, taking an application from commodities, say the mining of copper, the marginal costs of production can be very critical to price dynamics.
In the bitcoin world, the term used is ‘difficulty’, due to the ‘mining’ of bitcoin being based on math problems. The price feedback loops involve ‘difficulty’ as a major driver of price, and price also influences ‘difficulty’. Finally, we note that transaction volume may influence price trends, and rising transaction costs are a risk indicator for bitcoin.