Bitcoin is a hyperdeflationary cryptocurrency.
What’s that, you ask? Before examining hyperdeflation, it’s helpful to examine the opposite phenomenon since most are probably more familiar with it. Hyperinflation occurs when there’s a continuing increase in the supply of money without corresponding growth in the output of goods and services. There are numerous examples from history, the most famous being that of the Weimer Republic following World War I. One US dollar was worth 4 trillion German marks at the height of inflation. There are documentaries that cover this event in more detail.
Hyperdeflation is an interesting and opposite phenomenon that can be observed in Bitcoin. The cryptocurrency’s supply was designed to grow by a smaller percentage amount each year. Supply growth will decrease from roughly 10% now down to 4% by the end of 2016. At the same time, demand for the cryptocurrency will probably grow at an increasing rate. The massive price swings we saw last year are a product of these forces, and I predict there will be more in the near future. If you haven’t read about the guy who bought $27 of Bitcoin in 2009, you’ll want to read that here. It’s hard not to wonder, “if only I’d invested X back then…”, but I guess you could’ve just as easily squandered 10,000 BTC for two pizzas.
Bitcoin Supply Mechanics
As time goes on, Bitcoin miners have to solve increasingly more difficult algorithms as the amount of unmined currency diminishes. This translates to more time, energy, and expensive hardware (see Paul Krugman’s Op-Ed about why Iceland offers optimal mining). Since the total supply is finite (never to exceed 21 million Bitcoins), the growth rate of Bitcoin’s supply will eventually asymptote toward zero. It’s worth noting that there will most likely be several million less available. There’s Satoshi’s genesis block, coins lost to hardware failures, missing/lost wallet keys, as well as coins that were simply forgotten about back in 2009-2010 when the currency was worth fractions of a cent.
Is Deflation Bad?
But isn’t deflation a bad thing? Well, it depends on who you ask. In Keynesian economics, deflation is viewed as a negative because it incentivizes individuals to save money rather than invest and create jobs. Individuals are more likely to horde a currency if its value is surging, because they expect a greater future value. This whole inflation vs deflation debate is far from settled. If you were to pose that same question to a proponent of the Austrian School, you would receive an entirely different answer.
That’s what makes the study of economics so interesting. The science is so new (when compared to something like medicine or physics), and there’s so much we still need to learn and discover. Testing require massive scale (nation states), and an economic test can take years or even decades. As Bitcoin and other cryptocurrency ecosystems mature, they could provide an even more flexible vehicle for testing economic theory and money supply.
*This shouldn’t be confused with the codename for AngularJS 1.2.11.