By Cristhian Rodriguez Diaz

The EU has recently released a new regulation vis-à-vis crypto assets known as MiCa, (1) constituting the world’s most comprehensive legislation concerning that novel type of financial instruments. This legal framework is expected to foster and promote the crypto industry across the union, leading to a new boom of both the underlying blockchain technology and the prices of crypto assets such as Bitcoin. In this scenario, a question arises, what are the fundamentals of crypto assets’ value?

Many factors may be named to explain the value of crypto assets, from the decentralised to the secure nature of the blockchain technology that supports them; yet, in this article, attention is paid to a less popular concept that is immersed into their code: the scarcity.

Scarcity is a notion that has played a major role in economics, from Malthus to Robbins. Access, distribution, price, and incentive to produce any good are determined to a certain extend by its scarcity or abundance. (2) In a similar way, the scarcity or abundance of money affects its intrinsic value and purchasing power.

This paper explores the concept of scarcity and its evolution on the digital realm, in order to ascertain its function and importance vis-a-vis cryptocurrencies and digital assets based on blockchain technology. 

  1. Scarcity: an economic concept

The concept of scarcity is built on the premise that resources are limited, while the needs and wants of the always growing human society are unlimited. (3) As a result, humans are compelled to decide how to use those limited resources among different alternatives. (4) From investing public funds in the health system or in national security (money), to using a plot of land to erect a new school or a new police station (space), examples can be found everywhere.

A scarce good may be defined as one that can be used in different ways; however, every option excludes the others. (5) How to distribute those scarce resources is a question at the core of economics science, and the market seems to be the most common answer to address that issue. (6) Indeed, in a free-market dynamic, the price becomes the instrument to determine how scarce a good is and who can get access to it, while the interaction between offer and demand in turn determines the price. Then, if the demand for a good increases faster than its supply, the good becomes scarce, and the price rises. In contrast, if the demand for a good decreases, the good becomes abundant, and the price shrinks. In addition, the price can be seen as a signal to produce more or less of something. (7) In the end, only those able to pay the price can get the good or service, solving the problem of distribution.

Although this is a very simplified explanation of the concept of scarcity, it is sufficient to understand its practical application to cryptocurrencies based on blockchain technology.

  1. Digital scarcity: From resources scarcity to programmed scarcity

In the digital realm, the concept of scarcity has been evolving during the last decades. First, it was used to refer to the limited access to some resources necessary for the manufacturing and the functioning of hardware, such as bandwidth or radio spectrum for communication devices. (8)

Later, the mass adoption of the internet led to a substantial generation of digital content including music, images, video, text, and so on. The novel way of producing, copying, and distributing information condensed into bits, was more accessible, faster and cheaper than ever before, bringing about a serious threat for some business-models based on limited access to information, such as the music, literature or film industries. (9) Then, in an attempt to protect their business activity, some players of the creative industry developed Digital Rights Management (DRM) technologies to restrict the unauthorized access and reproduction of their copyright protected content. Examples include the infamous case of Sony BMG’s rootkit in 2005. (10)  

As a result, the meaning of the term digital scarcity switched from limited IT resources to a programmed limitation to the access to digital information, which has been controversial and difficult to reach in practice since digital information is not inherently scarce. (11)

  1. Digital scarcity on a Blockchain: Unlimited FIAT money vs Limited Bitcoin

The 3rd of January of 2009, the bitcoin’s genesis block was mined, including a hidden message: ‘The Times 03/Jan/2009 Chancellor on brink of second bailout for banks’ (12) This message refers to a news published in a British daily announcing the allocation of public funds to rescue banks after the financial crisis of 2008. It also has a more profound meaning relating to the revolutionary spirit of bitcoin and the aim to create an alternative to the traditional financial system and its flaws. Then, a final transformation was experienced by the term ‘digital scarcity’.

One of the features of modern financial systems is the inflationary spiral they create. The causes of inflation are multiple, complex and their analysis falls out of the scope of this paper. Yet, the relation between the creation of money and inflation is undeniable. (13) Indeed, as it was explained before, if the supply of money increases, people are able to buy more goods; demand then increases and prices rise as well. To be precise, money loses its purchasing power. This is inflation in a nutshell.

In modern economies, money is printed by central banks at will. Since the abolition of the gold pattern in the 70’s and the adoption of FIAT money, its creation is even more uncontrolled. (14) This situation is exacerbated by commercial banks, which are also allowed to create money. In fact, thanks to fractional reserve systems, commercial banks are permitted to lend out way more money than the money they receive via deposits. (15) In practice, every time a commercial bank issues a loan, it creates new money known as ‘broad money’, money created out of nothing that only exists in the system of the bank. Yet money that must be paid back with interest to the bank. (16)

The uncontrolled for-profit creation of money by commercial banks around the world may be deemed as one of the primary causes of recent global financial crisis, including the occurred in 2008 and the current post-pandemic crunch.

To avoid the inflationary consequences of the traditional financial system, a new concept of digital scarcity was embedded into bitcoin’s code: a limitation of the total supply. (17) In this sense, chapter 6 of the bitcoin white paper describes the process through which new coins are created. In practice, new tokens are released as part of the incentive miners receive for supporting the network. However, the number of new bitcoins that are generated is reduced to the half on a regular basis. Above all, a limit of 21 million bitcoins to be released was set in its code. Then, once the total supply of bitcoins has been distributed, miners will receive only transaction fees as their incentive and bitcoin will be ‘completely inflation free’. (18)

Digital scarcity as a programmed limit of the total amount of bitcoin or any other cryptocurrency, is then a safeguard of value and a deflationary mechanism, (19) as long as the demand remains higher than the supply. (20) This mechanism has been shown to be efficient as the value of bitcoin has steadily risen since its creation, playing a significant role in its adoption too.

It is important to note that in the blockchain context, digital scarcity does not depend on restricting access to the digital information registered on the blockchain (which in fact is public), it instead depends on a verifiable and immutable entry in a distributed ledger. (21)

This notion of digital scarcity has been widely applied in multiple DLT-based projects, leading to applications that push the concept even to the limits of uniqueness. That is the case of Non-Fungible Tokens (NFT), (22) an admirable development beyond the bounds of this article.

  1. Conclusion

As we have seen, digital scarcity, defined as a programmed limitation of the total supply of a cryptoasset, plays a fundamental role in maintaining and increasing the intrinsic value of the asset. It was conceived as an instrument to avoid the inflationary process that FIAT money experiences due to its out-of-control creation. It also has been a crucial incentive for the adoption of cryptocurrencies all over the world.

In brief, digital scarcity constitutes an efficient safeguard of value for those crypto assets that implement it into its code.

ABOUT THE AUTHOR

Cristhian Rodriguez Diaz is a lawyer who graduated from the Universidad Externado de Colombia. He holds specializations in Commercial Law and Corporate Law from the Universidad del Rosario and also obtained  an LL.M. in International Technology Law from the Vrije Universiteit Amsterdam. Additionally, Cristhian is co-founder and Chief Legal Officer (CLO) of Ebam SAS, a Colombian blockchain FinTech company.

Featured Image Credit: Jonathan Borba (Unsplash)