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Bitcoin and Inflation 101

In this article, we will be looking at the inflation of both fiat currencies and Bitcoin (BTC). We will also take a brief look at what causes inflation, high inflation issues, hyperinflation and how the inflation rate of BTC compares to other currencies.

What is inflation?

All UN-recognised countries use some form of fiat currency as their legal tender. The only country which currently uses a cryptocurrency as recognised legal tender is El Salvador. However, the small South American country also uses the US dollar as legal tender. Fiat currencies are traditional currencies which we use on a daily basis, such as the US dollar or Japanese Yen. Traditionally these currencies are inflationary, resulting in their purchasing power decreasing over time*.

*Purchasing power is the ability to pay for goods and services and practically refers to ‘how much you can actually buy with your money’.

An example of purchasing power decreasing over time is the GBP. If you had a wage of £500.00 GBP per month in the year 1971, that is relative to £7,225.00 per month in today’s monetary value. Therefore, your wage would have needed to increase by over 1,400% within this time period for your purchasing power to remain constant.

This major decrease in currency value over time is due to inflation. Inflation is often set by a country’s central bank. For example in the USA, the Federal Reserve sets the inflation rate. Most central banks attempt to have a yearly inflation rate of somewhere between 2 – 5%. For example the Bank of England tries to implement a 2% inflation rate.

What affects inflation?

There are numerous factors which influence a country’s inflation rate, some of which are shown below:

  • Taxation levels
  • Interest rate changes
  • Monetary supply changes

These factors are themselves also influenced by external factors. For example, the taxation levels of a country are directly affected by the political ideology of the ruling party. Left-wing parties tend to have increased taxation in order to fund increased government spending. The increased tax decreases disposable income, which in-turn can counter a country’s inflation.

Countries make changes to their economic policies in an attempt to maintain inflation at a steady rate. Traditionally the macroeconomic policies which are implemented, aim to `save` during periods of positive economic growth. This then allows for `spending` during economic downturn periods (such as 2008-2009) in an attempt to counteract the negative economic effects seen.

However, with a small number of politicians directly affecting these decisions, if not managed properly, it can spell disaster for a country and its citizens.

High inflation issues

When the monetary policy is mismanaged by a country’s central bank and politicians, it can lead to high inflation, sometimes even hyper-inflation. A high inflation rate is typically bad news for a country’s citizens. High inflation rates decrease a citizen’s purchasing power at an increased rate. High inflation rates have numerous negative effects for citizens such as:

  • Money saved rapidly decreases in value
  • Cost of living goes up
    • Everyday items become more expensive
      • Bread, milk, eggs, etc.
  • Decreased disposable income
  • Increased unemployment
    • Due to increased costs for employers and citizens having less disposable income.

On the whole, it is widely considered that high inflation is detrimental for a country and its citizens. Most countries manage to resolve high inflation, often through bailouts from the IMF. When receiving bailouts, countries are required to agree to economic reforms in order to ensure long term economic sustainability.

Hyperinflation

If the economic rot through high inflation is not ended, it can cause hyperinflation. This is when a currency decreases in value so rapidly that it becomes worthless. For example in Zimbabwe, the country had an estimated yearly inflation rate of 89,700,000,000,000,000,000,000% (2008)! During periods of hyperinflation, countries often see the following:

  • citizens life savings eroded completely
  • mass unemployment
  • extreme poverty / poverty increase
  • Increased crime rate
  • Some form of political uprising / extreme ideology formation
  • Increased death rate
  • Mass emigration

Bank of Zimbabwe, one hundred trillion dollars note 2008

Worryingly there are numerous examples of hyperinflation, as shown in the table below (all countries shown below had / have an inflation rate of over 1,000%)…

CountryContinentTime Period 
AustriaEurope1922
Weimar Republic (Germany)Europe1922 – 1923
GreeceEurope1943 – 1946
HunguaryEurope1919 – 1924
PolandEurope1923
PolandEurope1989 – 1990
YugoslaviaEurope1989 – 1994
Soviet UnionEurope / Asia1921 – 1922
MalayaAsia1942 – 1945
North KoreaAsia2010
PhilippinesAsia1944
ChinaAsia1947 – 1949
PeruSouth America1990
BoliviaSouth America1985 – 1987
BrazilSouth America1985 – 1994
VenezuelaSouth America2016 – ongoing
ZimbabweAfrica2007 – 2008
Countries which have suffered with hyperinflation since 1900

How is this relevant now?

Inflation has been a hot topic recently. This is mainly due to US inflation rates rising to their highest levels seen since the 2008 financial crash. The US inflation rate currently looks set to hit around 5% this year. This high inflation rate is largely due to the COVID19 pandemic. It is expected that the US will push down the current high inflation rate gradually. However, those within the cryptocurrency industry were fast to point out that the number one cryptocurrency has not seen its inflation rate increase during the pandemic. Rather, its inflation rate has decreased since March 2020.

Bitcoins inflation rate

Contrary to common belief, Bitcoin is not deflationary. A currency is deflationary when the inflation rate falls below 0%. For example, during 2015 the Swedish Riksbank (Sweden’s central bank) lowered interest rates to -0.5%. This meant that during 2015 the Swedish Krona was a deflationary currency.

Currently Bitcoin has an annual inflation rate of 1.8%. Bitcoin currently has a lower inflation rate than numerous fiat currencies, some of which are listed below:

  • Russian Ruble (6%)
  • US Dollar (5%)
  • British Pound Sterling (2.1%)
  • Euro (2%)

How does the Bitcoin inflation rate work?

The misconception of BTC currently being deflationary stems from BTC’s inflation rate decreasing over time. In the chart below, you can see the inflation rate decrease over time with BTC.

Bitcoin inflation rate changes over time

BTC has a fixed maximum supply of 21,000,000 coins. In the chart below, you can see the increasing circulating supply of BTC over time.

Circulating supply over time – BTC

As shown in the chart above, BTC started with zero coins. Bitcoins instead needed to be mined. If you provided computing power, you would be rewarded with BTC. Initially, BTC saw hyperinflation (which was expected). This hyperinflation gradually turned into high inflation, with BTC now seeing a low inflation rate. The primary reason for the BTC inflation rate decrease is due to the BTC halvings.

During a BTC halving event, the block reward for mining BTC is cut by 50%. This subsequently decreases selling pressure, reaffirms Bitcoin’s scarcity and reduces the inflation rate. In the table below are the BTC halving events and the subsequent inflation rate changes. Also included is the 2024 and 2028 halving dates with the estimated BTC inflation rate changes based on previous trends.

Date of halvingBlock size after halvingDaily circulating supply increaseInflation rate week before halvingInflation rate week after halving
28/11/1225360030%10.2%
09/07/1612.518008.91%4.41%
11/05/206.259004%1.5%
20243.125450est = 1.2%est = 0.5%
20281.5625275est = 0.4%est = 0.15%

Why does this matter?

The primary reason why the BTC inflation rate matters, is because unless numerous countries deploy a negative inflation rate (something which looks unlikely in the near future), BTC will soon be one of the lowest inflationary currencies across the globe. Holding a strong asset will allow for people across the globe to store their monetary value without inflationary fear. Additionally, the currencies which BTC is measured against such as the USD, are starting to see an inflation gap to BTC. This could allow for BTC to become an effective store of value, providing that demand remains constant or increases. The store of value point is clear on the chart below.

BTC/USD – BTC/TRY

On the right hand side is the BTC/TRY chart (Turkish lira). The Turkish lira has seen a high inflation rate in recent years, with the TRY expected to hit an inflation rate of 13.6% in 2021. If you had invested in BTC at the start of 2021 with the TRY, at time of writing you would be up around 14%.

On the left hand side is the BTC/USD chart (US dollar). The USD looks set to see around a 5% inflation rate this year. However, if you had invested in BTC at the 2021 opening price, you would currently be down 2.6%.

The charts show that the inflation rates of these individual fiat currencies is clearly affecting how well BTC acts as a store of value. Therefore, as the BTC inflation rate will continue to fall, BTC will become an increasingly effective store of value for people across the globe.

Once mining rewards reach zero, in the next century. There will be no more Bitcoin entering the market. Instead, over time, it is more likely for Bitcoin’s supply to decrease due to unfortunate events such as loss of private keys, although we can also assume such events will become less and less likely as people get used to living with Bitcoin.

Conclusion

In conclusion, BTC offers an alternative to previous stores of value. Historically, people would buy a house, invest in a stock index or potentially invest in gold. However, now we can place BTC on that list. Demand for the Bitcoin is expected to continue expanding over the coming years, while the low inflation rate and limited supply of BTC, could see BTC test new heights.

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