Many individuals often discuss instances of hyperinflation from the past and present when advocating for bitcoin. Bitcoin's fixed supply and mathematical sophistication become particularly appealing in contrast to situations where the money supply spirals out of control and prices skyrocket every day. When discussing the advantages of bitcoin with someone who is not well-versed in cryptocurrency, references to countries like Weimar and Venezuela frequently arise.
Despite being enthusiastic about bitcoin, many individuals, including its proponents, may not fully grasp the potential impact of deflation on the cryptocurrency's value. Interestingly, since bitcoin's debut during the height of the financial crisis in 2008, many developed nations have been experiencing deflation. This is an unprecedented situation where central banks are implementing negative interest rates to stimulate growth and boost wages, while normal nominal interest rates are now a thing of the past.
Deflation is often associated with falling prices and is commonly believed to be beneficial for the economy. However, this assumption may not be entirely accurate. In order to fully understand the implications of deflation on Bitcoin and other cryptocurrency prices, it is important to delve deeper into what deflation truly means.
Deflation is not simply a decline in prices for goods; it is a more widespread drop in overall prices across the economy. As a result, wages and daily costs of goods become stagnant and keeping cash in the bank no longer generates any returns. When workers see that their salaries remain unchanged while the prices of goods decrease, they tend to delay purchases. This slowdown in demand can negatively impact the economy, leading to lower corporate profits, tax revenues, and slow or nonexistent growth. Central banks may respond by reducing interest rates to encourage lending and economic activity, eventually reaching the point where nominal rates are pushed into negative territory after hitting the zero lower bound.
Looking at it from the perspective of an investor or trader, with interest rates near zero, holding cash in a bank account generates no return on investment. To grow their wealth, individuals must invest in an asset market. However, stocks and real estate have experienced an ongoing bull market for the past decade, while commodities have remained sluggish due to weak economic conditions. This leaves investors searching for alternative options to generate yield, leading some to turn to bitcoin.
Over the past decade, Bitcoin has experienced a significant bull market, attracting individuals disillusioned by a financial system in crisis during the Great Financial Crisis. Bitcoin represents more than just a successor to gold - it brings forth a new type of internet-based currency that takes the form of a bearer asset. This digital cash is both robust against state-level attacks and uncensorable. Unlike traditional asset markets, such as stocks with fundamental earnings or real estate with rental incomes and raw material costs, Bitcoin is driven by sentiment. Its price can quickly rise or fall, making it an excellent uncorrelated asset class that is essential for any well-diversified investor portfolio.
As hyperinflation leads to the devaluation of fiat currency, causing bitcoin prices to increase in fiat terms, deflation has a different effect. In a deflationary environment, investors seeking higher returns are motivated to buy bitcoin as they are unable to obtain similar returns through traditional asset markets or bank investments. This makes bitcoin an attractive option for investors seeking yield.
Thus, considering a limited supply of Bitcoins, hyperinflation is good for its health!
