Bitcoin is a Deflationary Currency: What does it Mean?

In this article, you will learn the only real substantial difference between US banknotes and Bitcoin that matters.

Bitcoin vs US Banknotes

There’s a term that’s lightly floating around the cryptocurrency discussion like fresh snow. Gingerly peppered into one article, and then another, floating whimsically into one ear, or eye, and back out the other. And the truth is I think this term needs to fall on all of our heads like a bag of bleeding hammers.

That term is “deflationary currency” and it’s going to change your life.

When you think of the word grape, what do you imagine? That synthetic lollipop flavor, or an actual grape? When I hear “grape flavored”, I think “purple flavored”. Ah, yes. The flavor of purple.

Why Am I Saying This?

Because humans are conditioned to forget the past over the course of a single generation and be reprogrammed to associate words and ideas to other words and ideas.

If you hand a child real fresh-pressed grape juice, it will taste foreign to him or her. It’s healthier, but unknown. All they know of grape is purple.

Now, take money for instance. Specifically, the US banknote. I could use just about any national currency today as an example, but I like picking on this one.

Money. In your mind, it means a positive value. When we have it, we don’t think of it as a debt, we think of it as a plus 1. If you have $10 US dollars, you can add something to your life. Like put a sandwich in your face or buy a bottle of beer.

Isn’t that nice.

But value — the goods and services you can buy with that 10 bucks — changes over time. And usually that change means buy less with the same 10 dollars.

Isn’t That Strange?

No, it isn’t. Why? Because humans have accepted inflationary currency as the norm in as little as a single full generation (maybe a few years more, but you get the idea). And that’s terrible.

As I’ve written before; “Yesterday a five dollar US note could buy you a meal, today it struggles to buy you a head of lettuce. It’s still $5 USD on paper, but its value is a moving target. According to the US Inflation Calculator, $20 in 1913 would pass for $494.86 at the time of writing this (August 2017)”.

What Happened?

Over time, your money went from being tied to gold (deflationary, finite) and became an IOU from the Federal Reserve Bank (inflationary, ever-expanding). We were bamboozled. I wrote a little about that here.

If I were to use a blockchain metaphor to explain Keynesian economics I’d say it’s like we give someone the right to edit the global financial ledger as they see fit. But it is more complicated than that — I’ll get to it in a moment.

Bitcoin as a Deflationary Currency

The value of Bitcoin will only increase until it plateaus and the last Bitcoin is mined (issued). It might jerk up and down but it’s the oldest cryptocurrency and we’re seeing it stabilize today, right before our very eyes.

Why Will the Value of Bitcoin Increase?

The value of Bitcoin will increase over time because there are only going to be a finite number of them. This is why we call it “digital gold”.

Like gold, Bitcoin is a finite (albeit digital) resource. Each is tracked uniquely in Bitcoin’s immutable blockchain to ensure no one “cooks the books”, like they did in the years that led up to the financial crisis. In other words, no “derivatives”, no IOUs, no meddling, no issuing new Bitcoins beyond a predefined number, and no inflation.

When the last Bitcoin is issued, there will be 21 million of them in circulation. Actually, there will be less — some people have lost their passphrases and their Bitcoin is lost forever. A finite number and scarcity: all the magical attributes of an investment that will steadily increase in value for the foreseeable future.

Opposing Theories

This is where it gets complicated. All of this inflation vs deflation talk arises from two schools of thought; Austrian Economics vs Keynesian Economics.

 

Austrian Economics Keynesian Economics
Deflation is good!
Free markets
Gold standard, finite resource
Savings
Investment
Let inefficient corporations fail
Oldest continuous school of financial thought
Deflation is bad!
Government control
FIAT currency
Debt
Consumption
Bail out inefficient companies

In all of US history, our best times were those under the Austrian school of economic thought. They were a time of prosperity. Until the Great Depression.

Why do We Use the Keynesian Economic System Now?

You see, neither system seems to be a perfect match for society. Banks keep moving around the furniture, and the government can’t keep up. Bottlenecks and a lack of transparency, all over the place.

Austrian economic thought was challenged during the Great Depression, so we threw the baby out with the bathwater and later introduced Keynesian economics. (Penned in the 1930s by John Maynard Keynes).

As you’ll read here, you will learn that Keynesian economics aren’t working very well, either.

“Keynes rejected the idea that the economy would return to a natural state of equilibrium”. Keynesian thinking dictates that a deflationary currency will drive prices so low that everyone will be poor and businesses won’t invest in innovation.

And in many ways, both sides were right on many points.

The economy needs tending to 24/7, in real-time, at a level of transparency that a body of people (banks, or the government) simply can’t (be trusted to) manage alone.

Until 2009, when Bitcoin came along.

Could blockchain technology change global economics for the better?

Bitcoin and a Third School of Economic Thought

It’s only a matter of time before the entire economy is run on a series of smart contracts. The future may not be Bitcoin, but it sure is likely it’s going to be saved by blockchain technology.

Russ Roberts, professor of economics at George Mason University, explains that a fixed supply of money is certainly different. However, the rate of deflation posed by Bitcoin will occur at such a controlled rate that markets will have time to adjust.

“Elaborate controls to make sure that currency is not produced in greater numbers is not something any other currency, like the dollar or the euro, has.”

“That is considered very destructive in today’s economies, mostly because when it occurs, it is unexpected,” says Roberts. But he thinks that won’t apply in an economy where deflation is expected. “In a Bitcoin world, everyone would anticipate that, and they know what they got paid would buy more than it would now.”

Is It Too Late to Invest in Bitcoin?

For those wondering if it’s too late to invest into Bitcoin, the short answer is no. Yeah, it might be worth $5,500 USD as I write this article today –but look at it as a sliding scale. A percentage point on a return, not an expense.

The value of Bitcoin will likely continue to rise. Everyone has heard the guy at the water cooler say “I almost invested in Bitcoin when it was $5, $100, or even $1,000”. If Bitcoin reaches $500,000, that’s still two more zeroes than you started with if you jump in today. And if things keep going the way they are, it likely will reach $500k say forward-thinkers John McAfee and Jeremy Liew.

In Conclusion

Both Austrian and Keynesian schools of economic thought have run their course. Today, inflation is firmly cemented into our lives. Both systems have run the globe into the ground.

But if we HODL on and start exploring a third popular economic system, perhaps we can do away with inflation once again and stabilize the global economy by choosing to use a hybrid economic system based on a deflationary currency and creating a more transparent, autonomous economic system.

 

What do you think? Can smart contracts on a blockchain save the world? Let us know in the comments.

 

Related

2 Comments

  • Deepak Parmar
    Posted October 28, 2017 7:06 am 0Likes

    Great article!

  • viktor
    Posted March 16, 2018 11:09 pm 0Likes

    Very nicely put together!
    16.03.2018 -0:18 am

Leave a comment

This site uses Akismet to reduce spam. Learn how your comment data is processed.