Bitcoin bulls cite a simple reason for its rally: Not enough coins

Like the price of any commodity—whether it be gold, oil or soybeans—bitcoin’s price is sensitive to fluctuations in demand. And demand for bitcoin surged after the January launch of U.S. exchange-traded funds, known as “spot" bitcoin ETFs, that directly hold units of the digital currency. Since then, investors have poured billions of dollars into these ETFs. Those inflows prompted the funds to buy bitcoin to meet the demand, bidding up the price.

But what makes bitcoin different from just about any other commodity is its tightly constrained supply, a dynamic that can lead to sharp price spikes.

The computer code underpinning bitcoin imposes a hard limit of 21 million coins. More than 90% of them have already been created. To expand supply, number-crunching computers run algorithms to “mine" new coins. But they can only crank out about 900 new bitcoins a day, a rate expected to drop next month after a periodic event called the halving. The bitcoin supply is eventually set to stop growing when the final coin is mined, around the year 2140.

“Bitcoin is one of the scarcest assets in the world and it is becoming scarcer every day," said Alex Thorn, head of research at Galaxy Digital.

There is no guarantee that bitcoin will keep rallying. Its current high prices could encourage holders to sell their coins and lock in profits. Bitcoin’s previous bull markets have been followed by devastating crashes: After its last peak in November 2021, bitcoin dropped more than 70% over the next year.

And skeptics—including government officials and Wall Street executives who have stayed on the sidelines of the rally—still dismiss bitcoin as a speculative asset with no intrinsic value.

Bitcoin was trading at $67,139.33 at 4 p.m. ET Wednesday, down from the record high of $69,208.79 that it touched the previous day, but still up 58% since the start of the year.

In economics jargon, the supply of bitcoin is highly inelastic, meaning it doesn’t respond to price moves. Commodities that have this property are prone to bursts of price volatility. Producers of natural gas, for instance, can’t pump substantially more gas in the short term to take advantage of high prices.

In the long term, though, sustained high prices for natural gas motivate drillers to discover new sources of the fuel. Similarly, when gold prices are elevated for lengthy periods, gold miners can pursue costly new mining projects, hunting for the precious metal in ever more exotic places.

Bitcoin doesn’t work that way. Rules baked into bitcoin’s code specify the rate at which miners can bring new coins into the market, a rate that is periodically cut in half. In the past, bitcoin’s price has climbed ahead of such halvings, as crypto investors anticipate tighter supplies. And the idea that bitcoin should have a fixed maximum supply comes from Satoshi Nakamoto, bitcoin’s anonymous creator, who wrote that such a design would keep bitcoin inflation-free.

“There is fundamentally no ability to bring additional supply to the market," said Steven Lubka, head of private client services at investment firm Swan Bitcoin.

This makes bitcoin sensitive to increases in demand—and the new ETFs have been gobbling up bitcoins since their launch on Jan. 11. On that day, nine new spot bitcoin ETFs made their debut for trading, while an existing fund, the Grayscale Bitcoin Trust, converted into an ETF. Close to $8 billion have flowed into the ETFs since then, on a net basis, with inflows into the nine new funds outpacing outflows from Grayscale.

As of Tuesday, 5% of the world’s total supply of bitcoin was held by ETFs or other investment funds globally, up from 4.4% on Jan. 11, when the new U.S. ETFs started trading, according to estimates from investment research firm ByteTree.

When the ETFs buy new bitcoins to meet investor demand, they generally rely on proprietary trading firms such as Cumberland, a unit of Chicago-based trading giant DRW Holdings, or New York-based Jane Street Capital. These firms run crypto trading desks that scour the digital-currency markets for big slugs of bitcoin to fill the funds’ orders.

Some analysts say it has become increasingly difficult to obtain bitcoin from big holders. Public blockchain data show that much of the world’s supply of about 19.6 million bitcoins is located in digital wallets that rarely move the coins—potentially because they belong to long-term bitcoin holders who refuse to sell, or perhaps because the owners lost their passwords, rendering their coins inaccessible.

About 80% of bitcoin’s supply hasn’t changed hands during the past six months, Swiss private bank Julius Baer analyst Manuel Villegas said in a research note last week. Coupled with the ETF inflows, and data suggesting limited inventories of bitcoin available for sale on exchanges, that “could set the stage for an intensified supply squeeze," Villegas wrote.

Others say there have been plenty of sellers willing to sell into the rally—potentially a reason why bitcoin’s momentum stalled this week after it briefly surpassed its 2021 record.

Cumberland didn’t have a problem finding bitcoin to meet the ETFs’ demand for the coins during the recent weeks of heavy ETF inflows, said Rob Strebel, head of relationship management at DRW. The firm got much of that bitcoin from big crypto investors who bought bitcoin when it was cheaper and took the opportunity to take profits, he said.

“When you see a market go parabolic, as we have with bitcoin, it’s a natural selling opportunity," Strebel said. “And especially as people remember the last bull market of 2021, they’re taking some chips off the table."

—Angus Berwick contributed to this article.

Write to Alexander Osipovich at alexo@wsj.com