Why Bitcoin cannot be called deflationary? There is a lot of debate on whether Bitcoin is deflationary and there are a large number of people who still consider it to be one.
The main reason behind it could be their inadequate knowledge about the characteristics of the coin itself.
Well, if you too are one of those who believe Bitcoin is deflationary or cannot really decide whether or not it is, do not fret because you are in the right place eventually.
Here is an article that will make you more knowledgeable.
Ideally, it is high time people stop calling Bitcoin to be a deflationary coin.
This drains off wealth slowly but surely from the average person and directs it to those who are politically well connected.
However, there are also a lot of other reasons not to consider Bitcoin as deflationary which you will come to know as you continue reading this article.
There are lots of Bitcoin critics who, in response, claim that inflation may be really frustrating for the people as well as the economy but the alternative to it, a stagnant and deflationary economy, is even worse.
However, why do they possess such a belief will need understanding a few other things first.
This includes the concept and foundation of deflation, the falling prices that the critics are concerned of and the monetary supply of the coin which typically protects against deflationary spiral.
Why Bitcoin Can’t be Called Deflationary?
Typically, Bitcoin is not a deflationary coin. The money supply of it is comparatively finite.
However, if you want to understand the relation between these two facts you will first need to know what the term deflation actually refers to.
More colloquially, the term deflation refers to the decreasing prices.
This is the result of the decline in the supply of money or the money substitutes.
This is one of the most significant aspects of its distinction between the colloquial meaning of it and its actual meaning.
Ideally, the term deflation does not signify the reduction of the prices itself but instead it refers to a financial phenomenon that results in the reduction of prices at times.
Therefore, if you consider only this specific factor, then Bitcoin should not be considered as a deflationary coin.
At this point, it is also necessary to know about the hard cap of Bitcoin supply which is 21 million coins.
This fact indicates that the supply of Bitcoin will not decrease actually.
On the contrary, the supply will keep on increasing till the block rewards are exhausted when it reaches its hard cap, a phenomenon that is not expected to happen any time before 2140.
To support this fact, there are several graphs and charts you can refer to and find the emission rate of Bitcoin.
You will see that it starts with a comparatively high inflation rate but it levels off slowly over time as it approaches towards its hard cap of 21 million coins.
Instead, the network protocol is designed to be disinflationary.
This means that it is planned to create a stable monetary base without needing to make any changes to its supply.
At this point, just like others, you may argue that the coins that are lost can create a deflation in spite of its projected continuous base because these are the coins that are functionally removed from its circulating supply.
Well, this is not a big deal and therefore should not be a concern to you. Here is why.
The number of lost coins will reduce over time because coin custody will become more and more user friendly and professional.
This will create a fine middle ground when the supply of Bitcoin expansion comes close to zero just as the supply due to the number of lost coins decreases.
Bitcoin critics also argue on another point on the basis of the constant supply of Bitcoin and the growing populace.
This, they say, will result in a deflationary pressure because the growing number of miners will be chasing a fixed supply of coins.
However, a major section of the Bitcoin community considers this to be a dubious claim.
They relate it with the actual behavior of the society with respect to growth in population which is common among different cultures.
They say that when there is a decline in the growth of the population when the society goes through a higher level of education and experiences massive urbanization.
This creates a downward continual pressure on the future of the society as the regions experiencing highest population growth rates go on with rapid industrialization.
Based on these diverse arguments, latest estimates show that there is population equilibrium experienced as of now and it is ideal to correspond with the Bitcoin emission rate approaching zero.
Perhaps, a better match could not be asked for.
Therefore, to put in simple and formal terms, Bitcoin is surely not deflationary and the supply of the coins will continue to increase so that it can account for the growing population as well as the coins that are lost.
This means that with its steady supply base, there will be no inherent pressure that may increase or decrease the price of Bitcoin.
Whatever fluctuations in price the coin may experience will be solely due to the movements in the market and the signals from its participants.
Perhaps this is the tidiest of ways to show that Bitcoin is not actually deflationary.
However, the core of the arguments put up by the critics is still left unaddressed which is the concerns regarding the decreasing prices of the coin with respect to the constant monetary base of Bitcoin as it is.
This brings to the next important section of the article.
Concerns over Falling Prices
The falling prices of Bitcoin raises quite a bit of a concern among the users, miners, and critics alike.
More importantly, it creates confusion while determining whether Bitcoin is deflationary or inflationary.
This is because when people say that Bitcoin is deflationary they actually mean that it will make the prices go down.
Generally speaking, the Bitcoin critics usually are concerned about three main aspects of the so-called deflationary aspect of the Bitcoin standard. These are:
- The ever-rising real debt burdens on the loans dominated by Bitcoin
- The outrage of the workers at the continual decrease of the nominal Bitcoin wages and
- The lack of growth due to the hoarding of the coins by the savers instead of consuming or investing which appreciates Bitcoin.
However, before addressing these particular concerns of the critics, you should understand the basics of the working process of prices.
First and foremost, decrease in the prices is a natural thing to happen especially in a competitive marketplace like crypto.
This is the same principle that is applicable for any other product you can imagine. If it becomes easier to produce, the supply will increase.
And, if there is no simultaneous increase in the demand, the price will fall.
This is nothing surprising because this has been happening for thousands of years to make the industry more productive and the competitors fight for consumers.
This is because humans apply their inventiveness to fulfill the demands and needs of others some way or the other.
Now, do prices decrease always you may ask. Well, no, it doesn’t.
There are lots of incidents when the prices of products were found to increase due to rise in demand or the production process being hampered.
The point is that when you consider things on a long timescale, people put in their labor so that they can become more productive to create cheaper and easier to produce items that were once expensive and hard to get.
This is why it is said that the fall in prices is an intuitive and natural phenomenon.
However, in spite of this fact, prices of consumer goods have increased continuously over decades but the quality, on the other hand, decreased almost at the same pace.
This is mainly due to the constant need for a monetary base which is the basic unit to measure this process.
In any monetary measuring system that has a constant base, Bitcoin in this case, when there is an increase in productivity, there will be a simultaneous decrease in the prices.
However, if this monetary base is tampered with, through mining for example, then the prices will continue to rise in spite of an increased productivity.
Now, it is time to debunk the concerns of the critics.
Concern # 1:
Their first concern was the increasing burden of real debts when Bitcoin prices increase.
They fear that this will result in debtors being unable to repay their loans which will eventually make rendering loans impossible.
This, however, is a very naive thought at best because it is based on the notion that the price of Bitcoin will continue to increase forever, which is certainly not true.
At this point, it will be good to know a little bit about how Bitcoin evolved as money. It needs some time for new and superior money to evolve and take its perfect form.
During the early stages, Bitcoin absorbed its value from conventional stores of value and slowly gained it.
However, its current status is far from being considered as a global reserve because it has yet to pass its initial stage of price discovery.
In fact, it may take another decade for Bitcoin to have the same market cap and liquidity as other conventional reserve assets in spite of its greater monetary attributes.
However, Bitcoin is poised to triumph over this monetary competition, albeit slowly, and become a dependable standard for exchange value as well.
When it reaches its later stages, Bitcoin will stabilize alongside other assets and become a steadfast unit of account.
Therefore, the concern of the critics is not quite viable and it seems that they are confused with just the timeline.
Ideally, it is unwise to price debts in Bitcoin which is still in its initial stages.
Also, when the value of it slowly stabilizes in the later stages of its adoption, it will be easy to price debts in Bitcoin and their value will also be stable because by that time the coin will have grown into a reliable and mature unit of account.
Concern # 2:
The second concern of the critics was the decreasing nominal wages due to the falling consumer prices according to the Bitcoin standard which might spill over to the wages of the workers leaving them demoralized and frustrated.
In this particular case, there is also a significant problem. It is that the critics seem to have forgotten what wages actually represent.
It represents human time, and it is very much different from the technological advancements that make production much easier.
Human time is specifically irreplaceable and is also pretty scarce.
With technology being used in the production process, one particular aspect of the work may be automated but then a new role and avenue opens up for the humans from other advances.
Moreover, jobs are infinite and therefore the price of human time does not fall with constant supply as it is in the case of production of an item.
According to the Bureau of Labor Statistics or BLS, the overall money wages trend moves upward and the cost of living moves downwards with the rise in price of commodities.
It is due to the conflicting movements of retail prices of wages that results in a substantial rise in the real wages. This is in spite of the increase in labor supply.
The best example of it is seen in the technology sector.
The supply of electronics has increased which resulted in the fall in prices of the electronics goods but still the companies manage to pay high wages to their employees.
This shows that the cost of labor or wages simply, can remain stable or even go up but it is less likely to fall.
Now, for arguments sake even if you believe that the concern of the critics is quite reasonable then there will be an impact noticed in the purchasing power of the workers.
They will be unable to buy goods of better quality in larger amounts due to increase in production simply because they will have limited supply of money.
On the other hand, if you compare things with inflationary money, it will lose its value every year.
This will mean that the wealthy people will be able to make profit from the financial assets while the average person will be looking for a safe place to store and protect their savings from losing value.
Such a situation leads to a dire outcome where income inequality will be serious, prominent, and increasing.
It may also cause social unrest and populism.
Therefore, the concerns of the critics are not quite true, once again.
If they were then they would have supported Bitcoin as a worthy savings technology which would have helped the average people to guard their savings against automatic and silent dilution.
Concern # 3:
The third concern of the critics was the stagnant growth due to low or no consumption or investments which may result in a stagnant economy.
Well, if you consider the trajectory of evolution of Bitcoin you will know that this is another confusing case.
As already stated earlier, Bitcoin will slowly stabilize as compared with other traditional assets once its initial stage of price discovery comes to an end.
When such a thing happens, Bitcoin will be considered to be the global value invariable.
It will then be used for making investment judgment as well as for communicating prices.
During these later stages, Bitcoin will become the more favored digital asset for the investors and they will be motivated to invest in it for more returns in Bitcoin.
At that point of time, holding these coins simply with an anticipation that its price will rise in the future will be similar to a low rate and risk-free investment.
Therefore, such a shift will encourage people to make better and more productive investments.
However, in an inflationary situation, financial institutions and individuals with high net worth will be forced to channelize their money into more speculative ventures simply to protect their funds from the decaying effects of inflation.
Bitcoin, on the other hand, having stabilized and gained the status of a reliable storage vehicle that is immutable and cannot be diluted, will prove to be that safe and risk-free haven to store funds to protect them from inflation.
It will help the investors to make much more measured and accurate investment decisions.
Now, what about the spending part? Will people spend less when the price is falling and slow the growth rate?
Well, several research reports corroborate what the Federal Reserve concluded.
They said that deflationary prices usually do not experience depression, and history has proved the same especially during the time of the Great Depression.
This is quite intuitive and makes a lot of sense to believe that people will not stop spending all of a sudden due to the decreasing prices.
This is because they will always have needs to fulfill and therefore will always spend their money to meet them, and this is not only in the case of essential goods only but also for non-essential goods.
Once again, the technology industry seems to be the best example which, in spite of facing an intense deflationary movement in cost of goods for decades, customers keep lining up for fresh releases.
Therefore, following the basic principle of economics, people will in fact spend more when prices fall.
This is because they feel that their purchasing power has increased, which actually is a wealth effect.
That is why people love to see the prices of goods falling down.
Therefore, all the three major concerns of the critics are not very strong ones to consider Bitcoin to be a deflationary coin.
Thwarts Systemic Deflation
Finally, Bitcoin cannot be considered to be deflationary because it prevents systemic deflation.
Typically, the deflationary spirals will be much less severe under a Bitcoin standard.
This is because money, once again, is the measuring system that the participants of the market use to communicate prices.
This measuring system is distorted when money is manipulated by the central banks by increasing its supply by printing more of it and making changes in the rates of interest or even by making adjustments in the reserve ratio necessities.
When there is an inflationary money supply due to manipulation of credit price and a string of simulated market signals, it will result in mismanaged or over leveraged investments.
This will increase the risks in it eventually and also misprice it. In such a situation, people will tend to consume more than what is produced.
However, as the saying goes ‘What goes up must come down,’ these artificial stimulations of the economy will result in poor investment and a bubble that will burst at one point of time when it will create more pronounced and painful price swings.
This will also result in creating more unsustainable credit that may eventually result in another Great Depression!
The asset prices will fall resulting in the smashing of an expansive fiscal policy with equities falling drastically and real markets crashing to half its worth.
If intervention continues this may even lead to slow growth of the economy for decades with firms closing and the nation facing a serious liquidity crunch.
The credit market as well as the pricing mechanisms will also freeze and the easy money policy will exacerbate the situation with low interest rates created artificially and the highly leveraged fiat deposits crashing down.
Therefore, deflation is truly terrifying. It creates bubbles of overconfidence that bursts all of a sudden eventually bringing the markets down and gives an opportunity to the financial institutions to manipulate money and make the situation even worse.
All of these actions by the central bank, politicians, government and elected officials create disastrous consequences in the long term and put the expansive monetary policy in jeopardy.
That is not all that inflationary money can do.
It can also make recovery of money and its value very hard after the fall which will worsen the situation even further.
In order to find some immediate respite from the collapse, authorities provide short term support to the firms which, in turn, leave the long term prospects devastated.
This results in an economy where inferior firms with utter mismanagement and inferior objectives gain a foothold and continue to exist for decades affecting the economy on the whole.
Bitcoin provides a strong monetary foundation which prevents the external authorities from creating artificial credit bubbles which, in turn, saves the entire economy from the horrible consequences deflation can bring to it.
It will also smoothen out the credit cycles, though not entirely, and prevent the economy from experiencing violent swings. With the natural rates restored, it will surely become the backbone for the economy and align consumption with productivity perfectly.
Therefore, it can be said in the end that as the world comes together to a Bitcoin standard, Bitcoin will be the new monetary base.
It will smooth the progress of the economy and its signaling in a much more profound way to result in more sustainable and healthier growth overall like never before.
However, there will be a side effect of it. Prices will fall naturally but that is due to the productive nature of humans and not due to the deflationary nature of Bitcoin.
This is because it will prevent the truly horrific deflationary spirals that are typically created by simulated monetary injections.
With all this said, Bitcoin, which is poised to become the reliable monetary base of the future economy, surely cannot be called deflationary.
Most people call Bitcoin deflationary knowing the fact that the monetary supply of it is designed to be constant.
If you too possessed this wrong notion until now hopefully this article has been able to do its best to make you more informed and conversant.