Enough of discussion around this right? Every one keeps on saying that Bitcoin is valuable because it is a deflationary asset. Influencers across the social media would make sure that they feed this idea of BTC being fixed in supply to you. However, do we really know what it means? I don’t have any economics or finance background. Therefore, I clearly didn’t understand what these influencers were talking about. So, I did what most people don’t do: DYOR. “Do your own research” to actually find these answers. And through this blogpost, I would love to help you out with the same. Why is Bitcoin Deflationary? What is deflationary after all? Well, wait no more. Let’s jump right in:
What is Deflationary:
Deflationary is derived from the word ‘deflation‘. Deflation means a prolonged decrease in prices of goods and services over a period of time. It is usually characterized by a decrease in demand and hence a non desirable event in the economy.
However, in case of Bitcoin the deflation refers to the fact the purchasing power of people increases as the time progresses. In other words, the asset that they hold is growing more in terms of intrinsic value as compared to the rate at which inflation is growing.
What is Inflation:
Well, there are no surprises for guessing this one. It is the other end of the spectrum. Inflation refers to increase in the price of goods or services (or decrease in the value of the currency that you are holding) over a period of time. My grandfather likes to talk about when he started his job back in 1968. His first paycheck was worth Rs. 175 (inclusive of all deductions).
Soon after getting married, he got first gas connection for our home. The cylinder, gas stove and regulator (with rubber pipe) costed him Rs. 25. Today, the same amount would fetch you a packet of Lay’s which might be more air and less chips.
You kind of get the idea right? Our money lost it’s value to the extent that I recently had to shell out Rs. 3500 for a similar setup in Gurugram. That’s a 100x devaluation.
But Why Does Inflation and Deflation Happen?
I will not go into economical concepts of demand pull and cost push inflation. Just putting out these words here to look smart.
We would try to understand this using a small oversimplified example.
There is a sale at Lifestyle. You buy this amazing T-Shirt at a bargain price. You are so happy because you have made a fantastic decision. The shirt was originally worth Rs. 1800 and you got it just for Rs. 900. Soon after a few days, you decide to visit a concert (pre pandemic blues much?). What better occasion to flash that amazing tee right? But at the concert, you find 6 other boys wearing the exact same T-shirt.
Do you still value that shirt @900? I think there might be a case that you don’t wear it again. Ever. Thus reducing it’s value to zero. If you are not bought in by this example, replace yourself with your significant other. It’ll all make sense.
So what do we learn? More the supply of something, lesser is it’s value (given that demand is constant).
The same has happened with INR as well. The government time and again prints more money which runs a risk of devaluing it. The latest example of such an incident is during the pandemic, when government was forced to push money into the system to kickstart economy.
Now, on the contrary, you can take the example of Gold. Since it is fixed in quantity globally, increase in demand only pushes it’s price up. As a result, gold is also a deflationary asset.
But what about Bitcoin?
You must have heard someone saying that Bitcoin is fixed in supply at 21mn. But how is that possible? The answer lies in the intricate design of BTC which we are going to discuss in the next section.
The Magic Behind:
As we know that people validate blockchain transactions to win Bitcoin as a reward or incentive to do so (if you wish to dig in deeper on how Bitcoin works, please read this). So, the only way to earn Bitcoin is:
A. If someone gives it to you, in which case they lose it.
B. If you mine the bitcoin by validating transactions.
But if everyone who is mining gets BTC for validating the transaction, isn’t new BTC entering the system constantly. This would make it a inflationary asset right?
Here’s where things get spicy.
Luckily enough, the creator(s) of BTC, Satoshi Nakamoto thought of this problem. So, the reward earned for mining Bitcoin keeps on reducing at a steady rate.
This reward has decreased as per the following rate:
- 2008-2012: 50 Bitcoins per block
- 2012-2016: 25 Bitcoins per block
- 2016-2020: 12.5 Bitcoins per block
- 2020 till data: 6.25 Bitcoins per block
As you can see, that reward for mining gets halved every 4 years. Therefore, theoretically, after the year 2140, there would be no new bitcoin rewards for validating a transaction.
At that time, the circulating supply of BTC would be equal to the max supply of Bitcoin i.e. 21 million.
While I often find myself blown away with the nuances that were taken care off by Satoshi Nakamoto, I think it is a must have when you are set to overthrow the existing global economic system.
Will BTC ever be able to do that? May be time will tell. But does it have all the tools required to do so? Hell yeah!
If you forget your secret key to Bitcoin Wallet for 20 years, it would still buy you more than what it could buy today.Tweet
So, what do you think about this piece of technology which tries to solve multiple problems with one solution?
Until Next Time. . .
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