Crypto-inflation

Posted by on Sep 30, 2014 in Technical, Thoughts | No Comments

Throughout this article I will reference Bitcoin, however the same logic applies to all cryptocurrencies available today.

Many people once touted fixed supply as one of Bitcoin’s strengths. I knew this wasn’t valid for one fundamental reason; inflation is a symptom of a healthy modern economy. Capitalist economies prosper when money exchanges hands, ie. people spend. Depressions and recessions happen when banks stop loaning money and people stop spending. Falling real value is a big motivator for people to spend their wealth or at least invest it back into the economy. The absence of inflation risks deflation rearing its head. In this situation, the real value of the currency increases and the price of goods falls in relation to this. This leads consumers to hoard money as why would you buy something now when it will be cheaper tomorrow. This arrests the flow of money in the economy, killing business, which kills wages, which kills consumer sentiment, which force people to save more money, thus making the problem worse. Vicious cycle. Deflation has been a problem in Japan for over a decade.

Right now, Bitcoin is operating like any normal currency. New supply is being introduced into circulation as mining progresses. It’s impossible to predict what will happen once mining no longer produces coins. Will people still provide the computing infrastructure and absorb costs for free? How will the crypto currency replace coins in wallets that are lost or coins owned by bitcoinaires who will take their wealth to the grave? A dwindling supply would spell death for any commodity or currency. People and industry would simply switch to alternatives. Assuming quantum computing doesn’t pull the carpet out from under public key cryptography security, I can see future headlines of the last known bitcoin being lost and the currency officially going extinct.

One solution I’ve previously considered, is that supply can be regulated by introducing a Bitcoin 2.0 which would progressively inject a second fixed amount of coins to the network. You could argue this is already happening with the emergence of alt-coins. Some are even explaining the current price drop of Bitcoin as proof of this effect in action. The only problem is this requires a central authority to approve the release of new Bitcoins, or a multitude of independent coins could result in hyperinflation. The middle ground I see is if the network can achieve consensus on which currencies are officially recognised in the crypto economy. I believe the network is at this decision point right now. It needs to move way from having Bitcoin as it’s poster child and evolve to support a basket of widely accepted cryptocurrencies. All other fledgling alt-coins can operate in a secondary underground market until they gain enough support to be voted into the primary market. Older currencies that suffer from dwindling supply can also be removed from the official lineup to maintain a healthy level of fluidity and force wealth hoarders to spend their coins.

Ironically, the key to Bitcoin’s success is not in it’s price but in it’s supply. How the cryptocurrency community solves this problem will determine if Bitcoin makes history or becomes history. Bitcoin’s stellar price performances in the past only served to promote adoption, generate interest and increase awareness. The next phase of Bitcoin’s evolution is all about usability and accessability.

Due to these reasons, don’t concern yourself with the price of Bitcoin. As a medium of exchange you shouldn’t be holding onto a Bitcoin long enough for it to matter. I actually believe that having the exchange price of Bitcoin go down to more affordable levels benefits the currency. It means all the squatting investors, high speed traders, price manipulators and wealth hoarders are releasing their coins and Bitcoin can do what it does best, be a frictionless worldwide payment network.

Contributed by Kevin Purnama