As inflation figures hit record highs globally, it’s no surprise that the topic is making rounds in the news and markets. Inflation occurs when the prices of services and goods rise, whereas deflation happens when prices decrease. However, maintaining a balance between these two economic conditions is critical since an economy can quickly shift from one to the other. This is why central banks monitor price levels and introduce monetary policies to control inflation or deflation.
This article will delve into the definition of inflation and deflation, explain inflationary and deflationary cryptocurrencies, and explore how Bitcoin (BTC) can serve as an effective inflation hedge.
What exactly is inflation?
Inflation refers to the increase in the general level of prices of services and goods in an economy over a certain period. In simpler terms, you can buy fewer goods and services for the same amount of money as you previously could. Inflation is usually measured using the Consumer Price Index (CPI), which tracks the price changes of a basket of services and goods commonly purchased by consumers.
Various factors, including increased money supply, rising production costs, and growing demand for goods and services, cause inflation. Inflation can be beneficial for an economy by encouraging spending and investment. However, suppose inflation rises too quickly or becomes too high. In that case, it can lead to economic instability as the value of money decreases, and the cost of services and goods becomes too expensive for consumers to afford.
What exactly is deflation?
Deflation is the inverse of inflation and refers to the gradual decline in an economy’s overall prices of services and commodities. This implies that money’s buying power rises, allowing you to purchase more products and services for the same amount of money as previously.
Deflation can be caused by decreased money supply, lower production costs, or decreased demand for goods and services. While deflation may seem beneficial to consumers, as the cost of living decreases, it can adversely affect an economy. Deflation can lead to decreased spending and investment, as consumers and businesses tend to hold onto their money, waiting for prices to drop even further. This can cause a downward economic spiral, reducing economic activity, higher unemployment rates, and decreased overall economic growth.
Inflationary and Deflationary Cryptos
The currency becomes inflationary when more tokens are introduced to a cryptocurrency network through mining, minting, or staking. The increase in token supply leads to decreased value, requiring holders to spend more tokens for purchases over time. With an unlimited supply, Dogecoin is a popular example of inflationary crypto. On the other hand, Bitcoin has a fixed supply of 21 million coins, but not all are in circulation. As mining rewards decrease the number of available coins, Bitcoin will eventually shift into a deflationary currency. The halving process slows inflation, and the last Bitcoin coin is expected to be introduced in the next century.
Contrarily, deflationary cryptocurrencies possess a diminishing supply, leading to a rise in value if the demand remains steady. Different cryptos implement various deflationary measures. For instance, Binance destroys some of its Binance Coins (BNB) quarterly, while other projects combine inflationary and deflationary mechanisms to stabilize the value. Ether (ETH), which used to be inflationary, adopted a deflationary policy in August 2021 by burning a portion of its supply as network activity increases. Ripple (XRP) locked away 55 billion tokens and released them periodically to maintain liquidity while transaction fees are burned to uphold the token’s deflationary status.
Why is Bitcoin seen as an inflation hedge?
Some believe that bitcoin can serve as an inflationary hedge due to its limited supply of 21 million coins, in contrast to the typical increase in US dollars over time. If the supply of US dollars increases, then the value of bitcoin should also rise, all other things being equal. For instance, if the market caps of Bitcoin and the US dollar were equal, doubling the supply of dollars would lead to doubling the value of a single bitcoin. However, the market is sometimes straightforward, as other variables can influence outcomes.
Future Possibilities of Bitcoin as an Inflation Hedge
As the mining of the final bitcoin from the capped 21 million supply approaches, there is much speculation surrounding its significance. While the last bitcoin may not be mined for some time, it is intriguing to consider the potential outcomes once this occurs.
Suppose the demand for bitcoin persists even after the last bitcoin is mined. In that case, it could trigger a deflationary trend in which the value of each bitcoin appreciates as scarcity persists while demand remains steady or increases. This could lead to a scenario in which bitcoin becomes increasingly valuable.