Dispelling the mith of Bitcoin deflation

Michael Castillo pointed me to this Reddit post.  Redditor imkharn does a nice job of summarizing the meaning and magnitudes of inflation and deflation in the world of Bitcoin and the world at large.

imkharn says Bitcoin deflation, if it becomes a common currency, will be very, very moderate (see his charts) so the specter of an economic depression driven by deflation is bogus.

I would like to amplify his post, just with a moderate change of terminology.

Inflation/deflation is used to mean different things at different times, sometimes by economists in good faith because of convenience, sometime by lay people out of ignorance and sometime by intentional obfuscators, be it academics, politicians, businesspeople or a combination thereof.

there are three definitions of inflation that I can think of:

1. Inflation is the rate of increase of the price of a specific good,

2. Inflation is the rate of increase of the general price level in any specific economy,

3. Inflation is the increase in the money supply, however defined.

The first and the third are very easily measured without any argument.  The second, on the other hand is controversial, since price indices are inherently arbitrary and complex.  The three are somewhat connected by the quantity theory of money.

Going to Bitcoin, by measure three it is by design and it will always be inflationary, although decreasingly so until stabilizing in about a century.  Conversely, it is deflationary by measure one, because if you look at bitcoin as a merchandise, it increasing supply should push down the price.

By measure two, it has been mostly deflationary, because an economic agent who lived his/her life with bitcoin as base currency, prices of everything else have mostly gone down, even if with swings.

The most useful definition is generally number two, even with measuring hiccups. If you live your life in US dollars, what you care about is (roughly) how well your savings will hold and how well off you are right now or will be in the future.

With that in mind, if you live in Bitcoin, which very few people do, you are probably in for a pronounced  (the shorter the more acute) deflationary era. In my post, I estimate the value of BTC under several different adoption scenarios and they all point to a value much higher than the current one.

That “deflation” is a growing pain.  Short and acute, or long and drawn out.  Increased demand and adoption overshadow the built in supply growth.  Once an equilibrium is achieved, there is no reason to expect that BTC will rise more than economic growth.  No harm should come from that.

I think a more rigorous and technical paper on this is due and I hope a professional economist with no axe to grind (is there such an animal?) gets working on this soon.  If you know of such work, please let me know about it via comments or email.


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