Bitcoin has been going through a phase of deflation. There were a specific number of bitcoins created and one million of them have been located in an account that can be seen, but not touched, on the blockchain. The coins are regarded as bitcoin’s lost tokens and some believe that there are more lost tokens out there. The lost tokens do not have private access keys because they have been either destroyed or misplaced. When tokens are lost, there are simply fewer bitcoin tokens in the world and as a result, the remaining bitcoins become more valuable. This process is called deflation and it can negatively impact a currency.
Unlike deflation, demand is desire for a product – in this case, bitcoin. Demand can be measured by a currency’s native economy. However, when it comes to bitcoin, there is no native economy and therefore, demand must be measured by the market capitalization of the cryptocurrency market.
When it comes to fiat economy, it can either grow or mitigate a currency’s supply relative to demand. In an economy run with fiat currency, this system works well. However, not so much with bitcoin. When bitcoin is removed from a hard money economy, it stays that way.
Deflation of bitcoin is inherent because it is developed around a methodical and slow production that requires a fixed quantity. As a result, no matter how many people are interested in bitcoin, not everyone can have them. The more people that enter the economy, the higher the value of bitcoin goes. Though some believe that this will create a stable plateau, others believe that bitcoin’s value will continue to fluctuate depending upon demand. As a result, bitcoin’s value is unpredictable. Due to this nature, investors tend to treat bitcoin like an investment, and not as a currency.
Deflation provides incentives for saving, known as “hoding” in the bitcoin context because it leads to assured gains when one puts the currency in their wallet. This then leads to instability and causes the currency to be a de facto investment instead of transactable money.
Things become more challenging when a currency project has a hard token cap. The future success of a cryptocurrency can lead to a deflationary cycle and there is no way to release more tokens to combat against it.
While it all sounds dour, it isn’t such a bad thing. What people should recognize that the bitcoin’s volatility is due to its structure just as much as it is due to market forces. Volatility is unlike to go away over the long term and investors may want to continue viewing bitcoin as an investment.