How to understand inflation?

Definition

Inflation is the process in which currencies such as the dollar or euro lose value over time, causing commodity prices to rise. Bitcoin (and some other cryptocurrencies) are designed to have a predictable low inflation rate.

One of the attributes of cryptocurrencies (especially Bitcoin) that are extremely attractive to investors is that cryptocurrencies are more resistant to inflation than fiat currencies such as the U.S. dollar.

But what is inflation? Inflation is the process in which currency depreciates over time, causing the prices of consumer goods to rise. Because most economists believe that a certain level of inflation is good for the economy. For example, for decades, the U.S. government has printed more money than consumers actually need. This is why cola, which sold for tens of cents half a century ago, today costs a few dollars.

On the other hand, Bitcoin generally appreciates much faster than the dollar devalues-from almost worthless in 2010 to more than $20,000 in late 2020. (Since this is a turbulent market, Bitcoin has also experienced sharp fluctuations and declines, but has generally increased over time.) This makes Bitcoin an increasingly popular hedge against fiat currency inflation.

The main way Bitcoin can withstand inflation is that its supply is limited and well-known, and the generation of new bitcoins will gradually decrease in a predictable manner over time. (There will always be only 21 million bitcoins, and the number of bitcoins mined will be halved every four years.)

Why is inflation important to cryptocurrencies?

High inflation rates in fiat currencies may cause individuals to invest more in digital currencies, as the dollars or euros they place in their savings accounts actually lose value over time. Certain other cryptocurrencies such as Bitcoin and Ethereum provide investors with another option. The economic principles of the Bitcoin market are complex, but digital currencies have some features designed to help it fight inflation.

Governments cannot manipulate Bitcoin by adjusting reward rates or printing more currency to achieve policy goals.

Like gold and other scarce value carriers, the traditional view around Bitcoin is that Bitcoin should rise in value during periods of uncertainty. (However, this is not always the case. For example, at the beginning of the COVID-19 pandemic, it followed the stock market\'s sharp decline.) This is an easier way to store and transfer value than gold and can simply be sent over the Internet.

One of the keys to scarcity is the ability to build a reserve of value against inflation. There will never be more than 21 million bitcoins. So far, people have mined approximately 19 million bitcoins. About every ten minutes, miners process a new \"block\" and add 6.25 bitcoins to the network. (In 2024, the reward for mining will drop to 3.125 bitcoins, and will drop by half again every four years until all bitcoins are mined.) This mechanism designed in the Bitcoin protocol is called halving.)

Bitcoin has unique predictability over time and as new supply dwindles. This is different from gold, and no new bitcoins will ever be \"mined\" after that.

Will cryptocurrencies experience inflation?

Yes, technically speaking, even mining Bitcoin experiences inflation (and so does gold). But since the number of new bitcoins automatically decreases by 50% every four years, Bitcoin\'s inflation rate will also decrease.

In fact, as long as Bitcoin\'s purchasing power continues to increase relative to the fiat currency we often compare, Bitcoin\'s annual inflation rate of just a few percent is not a major factor for investors to consider.

But not all cryptocurrencies are designed like Bitcoin. For example, a category of digital currencies called stablecoins is becoming increasingly popular, many of which are pegged to fiat currencies such as the U.S. dollar and could be a useful, low-volatility money-saving tool. However, if you peg a stablecoin to fiat currency, your investment will be affected by inflation and may gradually depreciate as its reserve currency devalues. (Some stablecoins offer rewards, which may change the value equation, especially if non-cryptocurrency reward rates hover near zero.)