Bitcoin Inflation: How Perception of Deflation Works with Cryptocurrency
Deflation is roughly defined as the relative decline that takes place with the price of goods and services, specifically, when the inflation rate reaches a negative value. While inflation steadily decreases the value of a currency over time, deflation increases it, this is due to having a fixed supply, which creates a system of scarcity for the money.
When it comes to deflation, it can either refer to the general decline that happens in goods and services, but it is something that can also apply to the increased purchasing power that can go towards a currency, for example, the US Dollar.
Throughout history, the notion of deflation taking place within a modern financial system has been increasingly polarizing. On the other hand, the concepts such as the Friedman Rule, while not actively promoting a policy of consistent deflation, argues that limited deflation is something that can mitigate agaisnt inflation, helping to maintain the competitiveness of a currency as a store of value over time.
On the other hand, there are a number of economists that argue that deflation is a dangerous situation to befall a currency, this is because it increases the value of debt, and during times of recession, can prove to be an accelerant, creating a downwards deflationary spiral.
Assessing the status of debt through deflation occurs through a distorted type of prism, however. With the current financial system that we have, inflation is an inherent feature in government-issued currencies that increasingly devalue over time, and are created in a parallel dynamic to debt itself. In the weighing and measuring of macroeconomics of such systems is incredible complex, and to many people, this is regarded as relatively impossible and ridiculous.
One of the instances used, for example, was the last time that significant levels of deflation occurred within the United States, this being the great depression, exacerbated by the collapse of several major banks, causing a run on coinciding banks. The cause of deflation in this instance was due to the decrease in the money supply which generated scarcity. This was a relatively short-lived period and has profoundly affected the perception of deflation over time as it's correlated with an extremely adverse event.
It's over time, however, that the adjustment to inflation has created a phenomenon where debt has become rampant, and even economists are beginning to require a re-think in the underlying concept of deflation. In times of deflation, the issuance of debt decreases, simply because its underlying value increases. Interestingly enough, the stable or increased value of the currency over time with deflation may mitigate against the limitations of reduced debt financing.
It's a difficult concept to get a firm grasp of, this is because loans are everywhere, as too is credit financing, as they've . become staples of the financial system in its current form, but the intrigue is there, and cryptocurrencies have arrived at an opportune time.
Cryptocurrencies & Value
The term value in the world of finance takes on many forms and can get particularly murky when it comes to its precise use in regards to money, especially with its correlation to storing value versus a medium of exchange. Well known, established and otherwise popular cryptocurrencies provide a unique example of the challenges that the definition of value faces.
It would be advantageous to use them as an example. And with the issues of Scalability put to one side for right now, it is difficult for those that disparage cryptocurrencies to talk about its usefulness as a store of value. But while Bitcoin may not be the ‘electronic cash' that it was set out to be right now, it definitely represents one of the most stable and potentially lucrative stores of value in history.
There are only a few general ways that people are able to store value. These consist either of keeping fiat money in a bank account, invest it, or purchase precious metals or gems that have proven to be continuously stable stores of value throughout history. Inflation demonstrates that storing fiat currency of any kind in a bank account or under your proverbial mattress is a poor value storage model, even if you have millions of dollars earning you interest on their own, the return you receive when compared to the devaluation currency experiences makes them mediocre.
Buy precious metals such as Gold, Silver or Palladium provide a great alternative way to store value, but often this is highly inconvenient for the average investor, and usually requires some level of storage with a third party. Bitcoin on the other hand is different. It is convenient, you completely control your funds, and it is deflationary with a fixed supply.
Not only is Bitcoin a deflationary digital asset, all because it has it has a fixed supply, but its issuance (mining reward) decreases by half of every 210,000 blocks, and this happens roughly every four years. One of the endemic problems that the creator of Bitcoin, Satoshi Nakamoto saw were those of inflation that government-backed currencies created, he then intended to develop an alternative form of storage akin to precious metals, but in a more modern, digitalized format.
With macroeconomics being far more complicated than first glances make it seem, it seems like a highly unlikely thing at this point for the Federal Reserve to be overcome with a motive to change to monetary policy to one with deflation in mind.
As a result of this, Bitcoin represents, not only some novel technology sub-genre in its consensus mechanisms and blockchain architecture but as a broader experiment for transferring deflationary long-term value storage to the digital realm rather than the physical (precious metals and gems)
The ability that other cryptocurrencies have to program their issuance rates at predefined values also presents an important experiement with value and money supply. Aspects such as inflation and deflation rates can be set at a pretty solid number, with little negotiating room in changing them or changing it as with central banking inflation rates. This allows people to always know what that set value is at any particular time, and to know in advance what to expect, building systems and making financial decisions based on a concrete value.
Value Storage & Value Exchange
The dynamic of Bitcoin as a store of value begs the question of if it can function as a medium of exchange at the same time. Other currencies used for a medium of exchange have an underlying requirement to be stable, this is simply because interacting parties don't want to deal with the risk of any price fluctuations involved in a transaction.
Due to Bitcoin being in a state of consistently high volatility at this point, it's not exactly the gold standard for transactions, due to this volatility, making it a weaker candidate for those looking for an asset to use in frequent everyday purchases. In contrast, the US Dollar is an excellent alternative, but the long term cost is devaluation over time and poor storage value. The question becomes whether or not a currency is capable of functioning effectively as both a store of value and medium of exchange.
The underlying complexities of central banking financial systems and carefully tailoring inflation rates to aggregate various economic metrics in a realistic manner only allows for the dollar to function as one or the other, instead of both. And even if the Dollar's long term value were to undergo some improved level / phase of stability vs inflation, and still performed as a medium of exchange, how sustainable would this model be long term?
This is where Bitcoin has an essential advantage that fiat currencies do not have when it comes to this, the technology of decentralization.
Bitcoin, unlike its older, more reputable counterparts, may not be a great medium of value exchange for small purchases for the time being, but the Lightning Networks stands to prove to the contrary. This network allows for the facilitation of micropayments between parties with no intermediaries that would make the concept far more difficult than it would have to be, opening up the further possibility of technology overcoming this final financial hurdle.
Predicting what will happen if the Lightning Network becomes ubiquitous throughout the Bitcoin network is impossible, but it will answer some important questions.
Overall, whether or not a currency can function as a medium of exchange and a long-term, storage system for value. This remains a feature that has, for a long time, eluded national currencies and has been further stifled by the increasing complexities of tying a currency to both the government's institutions and banks.
Bitcoin and cryptocurrencies, unlike other stores of value, operate and exist outside of both of these, so in one day soon, they can offer a long-term solution to a problem that has proven unreachable by generations of economists for a long period of time.