Critics of Bitcoin claim that while inflation is bad, the alternative is much worse, deflation. While falling prices are commonly referred to as deflation, deflation formally decreases the supply of money or monetary substitutes. Deflation is not a fall in prices per se, but a monetary phenomenon that sometimes lowers prices. In this sense, Bitcoin is not really deflationary.
There are a few things to understand about Bitcoin before responding to accusations that it is deflationary and that its core characteristics will cause problems. Some of the important features and terms that you should understand are:
- Bitcoin is not a physical currency; rather, it is a digital or virtual currency called cryptocurrency. In this way, Bitcoin is different from government-issued fiat money, such as the US dollar. It gets this name because of the way it is created, which is secured by cryptography.
- There are only a certain number of Bitcoin that can be made, which means that, even while Bitcoin’s demand may increase or decrease, Bitcoin’s supply will stay fixed. Because of this, it makes sense that the demand for Bitcoin will actually increase since Bitcoin’s fixed supply makes it a rare commodity.
- To keep the supply fixed, miners’ rewards, aka block rewards, for completing Bitcoin mining are halved every 210,000 blocks of Bitcoin mined, which averages out to approximately every four years. It is estimated that Bitcoin will max out at 21 million.
- The creation of Bitcoin is done via Bitcoin mining. This process requires computers, which must solve complex computational math problems and puzzles. A human cannot do these complex computational puzzles, and it even requires the use of high-powered computers; you cannot just use your normal everyday computer for Bitcoin mining.
Advantages and Disadvantages of Bitcoin
There are many advantages and disadvantages to Bitcoin, including:
- Bitcoin is easy. Bitcoin, just like other cryptocurrencies, has the advantage of being able to transfer funds from point A to point B without a third party, such as a bank or credit card company. Not only does this make transfers easier, but it also means avoiding the steep fees that usually come with transferring funds via a third party.
- Bitcoin is secure. Bitcoin is secured via virtual keys. There is a public key, a virtual “wallet” that allows you to receive Bitcoin and other cryptocurrencies. There is a private key, which is only known by the owner and allows you to pay out Bitcoin and other cryptocurrencies.
- Bitcoin is discrete. Because of its secure, virtual nature, Bitcoin allows for more discretion than other forms of payment. If you use currency from a bank or credit card company on transactions for goods and services, then the information for what you buy, how much you pay for it, and when is all attached to you and your identity (think: credit score), but Bitcoin transactions are not tied to you or your identity in any way, that makes it pseudonymous.
- Bitcoin’s reputation. Bitcoin and other cryptocurrencies are also thought of together with illegal activities. However, this is not always the case. Many people who use Bitcoin want their privacy protected. Bitcoin has also been highlighted to protect whistleblowers and activists, so it is not fair for its reputation to be tarnished because of the few people who use Bitcoin for illegal activities.
- Bitcoin is public. Depending on how much privacy you are looking for, Bitcoin may not be your top choice. Forensic analysis of the Bitcoin blockchain has been used in the past to find and prosecute illegal criminals. Because of this, Bitcoin may not necessarily be as private as you might expect.
- Bitcoin fees. Bitcoin mining rewards are halved every 4 years, which means that miners only get half the Bitcoin value they usually earn for the same amount of work. To offset the miners’ loss, who plays an important role, Bitcoin fees should go up.
Is Bitcoin Deflationary?
Bitcoin is unstable in nature. Because of this, some people who have invested in Bitcoin to sell it and make a large profit have just sat on their Bitcoin, waiting and waiting for the buyout they are looking for. When so many people just buy Bitcoin for speculation, it runs the risk of turning Bitcoin into a dead currency.
Hyperdeflation is when deflation occurs quickly and in an extreme measure. Hyperdeflation is characterized by a large increase in the purchasing power of a currency in a short period of time. Because of the large increase in Bitcoin’s purchasing power over a short period of time, economists are concerned that Bitcoin will go into a deflationary spiral, characterized by a decrease in demand and the following price decrease.
Due to the above reasons, there has been an increase in Bitcoin’s concern that it may become a deflationary currency. This has worried some economists, especially when combined with the fact that there is no reserve bank for Bitcoin like the Federal Reserve, which would set policies to offset deflation or inflation.
However, there have also been many arguments in support of Bitcoin not being deflationary. One common argument focuses on terminology. While many people mistake deflation for a price decrease, deflation is actually a “decrease in the supply of money or money substitutes,” which itself may cause a decrease in price. If you look at deflation in this way, then it does not make sense that Bitcoin could be considered deflationary: Bitcoin supply, while it will at some point cap off, will not decrease.
How Deflation Affects Bitcoin
Bitcoin supporters are not concerned about Bitcoin’s fixed money supply. They point to the infinite divisibility of Bitcoin as a solution. As Bitcoin gains in value, we will use smaller units, like Satoshis, to transact.
Some economists agree with this logic, arguing that a fixed monetary system could fundamentally change all of our assumptions about money. Bitcoin appears to be safe when it comes to normal deflation and inflation. Since it is not a fiat currency, it does not affect the economic market as a whole in the same way. On the flip side, some economists believe that a deflationary currency would be a disaster, leading to a spiral of Bitcoin hoarding and not spending.
However, with the current debasement issues caused by the coronavirus pandemic, it is believed that as confidence in fiat currency such as the US dollar wanes, confidence in alternative currencies such as Bitcoin will increase. Deflation could, in that way, be good for Bitcoin.
The Coming Monetary Renegotiation
There is a coming monetary renegotiation, and Bitcoin may play a big role in this monetary renegotiation. This has been shown in many different ways recently, including:
- Using Bitcoin to fight fiat inflation— or at the very least to mitigate the issues that could come with fiat currency debasement.
- Michael Saylor, the CEO of MicroStrategy, who has already invested $425 million of MicroStrategy’s funds into Bitcoin, was recently heard saying: “Bitcoin is less risky than holding gold.“
- It was said that famous investor Warren Buffett would “start panic-buying Bitcoin at $50,000“.
- Paul Tudor, a famous hedge fund manager, holds almost 2% of his assets in Bitcoin.
Bitcoin isn’t the only key player in this monetary renegotiation. Warren Buffett, who has been known for his dislike of gold, recently changed his mind about gold. Similar to how it is believed Bitcoin may become a trusted alternative to fiat currency, Warren Buffett wanted to invest in gold now because of the potential fiat currency debasement happening with the printing of so much fiat money.
There is certainly a monetary renegotiation on its way — or already in our midst, and Bitcoin is at the forefront of this renegotiation. Despite its deflationary nature being debated by different economists, Bitcoin seems only to be gaining popularity and is around to stay.