The supply of bitcoin is NOT capped, but that's a good thing.

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It is true that bitcoin cannot be created at will by a government simply by printing it like paper currency. However, that does not mean that the supply of bitcoin is capped at 21 million.    

Bitcoin, the currency, can be created by any creditworthy entity by issuing a short-term IOU denominated in bitcoin, for example a demand deposit issued by a bank. This IOU is not the exact same as bitcoin, just like the money backing a debit card is not the exact same as paper dollars. But this doesn't matter.  If the IOUs are accepted like bitcoin by merchants and savers, then the IOUs have the same value as a means of exchange and store of value as bitcoin. They are bitcoin just like the money in a USD bank account is USD.  

So who can create bitcoin?  Anyone who is able to create an IOU accepted by merchants and savers as bitcoin. This may be a government or a bank or any other type of entity.  Traditionally governments use the government sponsored banking system to create these IOUs. But this financial infrastructure could develop in a different form for bitcoin or any other new currency.  

How much bitcoin can be created? This is governed by prudential controls of the marketplace. Savers and merchants ultimately make the decision as to when an IOU is equal to the cash instrument in terms of credit risk. On average globally, the total amount of short-term IOUs is about 12x the amount of the physical currency.          

So the ultimate supply of bitcoin is likely to be much higher than 21 million, but this is good for bitcoin. Unlike with fiat currencies, changes in bitcoin supply can only happen due to market forces. If consumers want bitcoin, they will seek to borrow it. Lenders will then seek to fund these loans with bitcoin denominated short-term IOUs, which create more bitcoin. This will happen so long as there is demand for the loans and supply of acceptable IOUs. This financial system will create a healthy, liquid marketplace for bitcoin as a means of exchange and savings vehicle.       

The only potential perceived downside of this financial reality is that bitcoin is not independent of supply changes caused by governments or large business entities. Any creditworthy entity can affect the supply of bitcoin at any time if merchants and savers agree to accept the IOU. But, this is the nature of currency. The bitcoin community should embrace this reality and seek to build a robust financial infrastructure on its own terms with features unique to bitcoin.  More to come on this in future posts.  

About The Currency Report:  The Currency Report promotes the adoption of a decentralized common global currency. We provide advisory services to new currency designers and investors, including our fund, the Global Currency Fund. Read the Guide to New Currency Valuation and Design, sign up for our blogs or, for accredited investors, inquire about our fund.  For more information contact Shane Hadden at shane@globalcurrencyreport.com.