The classification of Bitcoin as either inflationary or deflationary remains a contentious subject. Economists and academics have mixed reactions to that proposition. Some people view Bitcoin as an inflationary currency. However, others insist Bitcoin has the characteristics of a deflationary asset. The following article distinguishes an inflationary currency from a deflationary currency to explain Bitcoin's economics.

The Essentials of Inflationary and Deflationary Currencies

Economics describes inflationary currencies as floating, meaning their value is relative to the value of other currencies. That is different from deflationary currencies, whose values are tied to material goods or based on regulations.

Inflationary currencies are also subject to a central authority, which can mint new units whenever they need. However, deflationary currencies are not subject to any rule. That means no government or institution can control their supply.

Inflationary currencies become worthless if more units are available in circulation. However, deflationary currencies have fixed or decreasing supply and steady demand.

Why Bitcoin is a Deflationary Currency

As hinted above, cryptocurrencies like Bitcoin are deflationary, while fiat currencies are inflationary. Here are the main reasons why Bitcoin is a deflationary currency.

Is Bitcoin an Inflationary or a Deflationary
Is Bitcoin an Inflationary or a Deflationary Currency Pixabay

Fixed Supply

Unlike fiat currencies that the central banks can mint at will, Bitcoin has a fixed supply of 21 million tokens only. That means only 21 million Bitcoin tokens will ever come into circulation, with over 18 million already in the market. Bitcoin's supply will halt once the miners reach the stipulated 21 million tokens. The limit would not change even if some users lose their private keys, making Bitcoin more scarce over time. That would significantly push the prices up if demand remains steady. The same applies to other cryptocurrencies, which also have upper limits on their supply.

Decreasing Rewards

The decreasing rewards for Bitcoin miners are another aspect that makes Bitcoin deflationary. The Bitcoin protocol has a process called halving, which stipulates the tips issued to miners will decrease by half every four years. That helps keep Bitcoin's supply in check, allowing the currency to retain its purchasing power over time. Bitcoin will decrease supply over time, allowing the tokens to gain value as they become increasingly scarce.

Infinite Divisibility

Bitcoin will likely gain more value in the future due to its dwindling supply. And that might seem troubling to some investors. However, proponents of Bitcoin say its infinite divisibility would address such concerns, allowing them to transact with smaller units. However, critics argue such a characteristic could be disastrous, contributing to hoarding as most people would hold back from spending Bitcoin. As Bitcoin becomes scarce, many people would likely shy away from spending their tokens, instead, accumulate extensive Bitcoin holdings to capitalize on the projected price increments,

Bitcoin's inflation rate is constantly depreciating and would hit zero when its supply reaches the stipulated 21 million tokens. Bitcoin miners will no longer receive any rewards from generating new tokens after hitting the 21 million cap. As a result, the transaction fees or trading volumes on crypto exchanges like would have to increase.

Purchasing Bitcoin might become very expensive in the future due to its deflationary attribute. That is because the demand would overshadow the supply, pushing Bitcoin prices through the roof. Bitcoin's value would still grow even if the market remains constant because there will be no more new tokens after miners have minted the stipulated 21 million Bitcoin.

Bitcoin is a deflationary currency compared to fiat currencies because its purchasing power and value increase over time. Bitcoin's price is currently highly volatile but economists expect it will stabilize in the long term.