Does Bitcoin Solve Inflation?

NOTE: This is the conclusion of a 4-part series of articles on Bitcoin and inflation. Part 3 can be found here.

For all the bad things you can say about inflation, at least it has one redeeming quality: it’s fair. Everyone’s dollars are worth the same amount. So whether you’re a billionaire or just scraping by, inflation is the same for everyone.

Except, actually, it isn’t. Inflation isn’t fair at all. Because while it may apply to everyone equally, it does not affect everyone equally. It eats away at middle- and low-income households in a way that it doesn’t for the rich. 

Why is that? And is cryptocurrency the solution?

Inflation Helps the Rich, Hurts the Poor

The average American lives paycheck to paycheck, covering yesterday’s costs with tomorrow’s income. As you’d imagine, this has all kinds of dangerous repercussions.

For example, according to Federal Reserve research in 2019, about half of Americans wouldn’t be able to afford to cover a sudden, unexpected $400 expense, whether it be a failure in their car, or their house, or a medical bill.

People who live like this–again, most people–get squeezed by inflation on both sides. First, the cost of everything in their lives goes up. That means those paychecks–which were barely covering their costs as is–now have to stretch even further. Second, they rely more on cash itself. This is crucial, but too often overlooked.

Last year, ProPublica investigated how much the super rich pay in taxes. They found that Jeff Bezos–the richest man on the planet–pays less than 1% of his wealth in taxes. Michael Bloomberg pays just over 1%, Elon Musk just over 3%, and Warren Buffett pays 0.1%. The reason why the rich get away with such low tax bills is because their wealth is tied up in assets, not cash.

Warren Buffet – the fifth richest person in the world as of this writing – receives an annual salary of just $100,000. Nearly every bit of his 120-plus-billion dollar net worth is invested in the stock of his company, Berkshire Hathaway. Bezos, Bloomberg and Elon Musk’s companies all make billions of dollars in income every year, but most of their personal wealth is also in equity and other assets: real estate, land, stock and so on. This is true of many wealthy people who aren’t necessarily billionaires. They all choose to invest heavily in assets for a few key reasons:

  1. Income is taxed more strictly than most assets. For example, Warren Buffet might have to pay 35% taxes on his $100,000 salary every year. But he only has to pay taxes on stocks–the “capital gains” tax–when he sells them. Buffett doesn’t ever sell, so his wealth has been compounding on top of itself, tax-free, for decades now.
  2. Good investments, like valuable real estate, rise in value over time.
  3. Cash constantly loses value over time due to inflation.

Even worse, b) and c) actually contribute to one another. Just look at what’s happening in America now: prices for stocks, real estate, and most other assets are going up, diminishing the purchasing power of dollars. This is motivating more people to invest in those assets, which, in turn, contributes further to that price inflation and dollar shrinkage.

So the rich don’t just reduce their inflation exposure by minimizing their cash holdings. The assets they own actually become more valuable because of inflation. And if they own businesses, even better. Inflation, after all, is simply a general rise in the price of goods and services. These are the folks running the companies selling those goods and services.

The majority of people, by contrast, receive essentially their entire net worth through weekly or biweekly paychecks. $X for Y hours worked. $X usually isn’t so much, and most of it goes to pay off expenses like rent, food, electricity, and so on. That leaves very little leftover for investing into value-accruing assets. Then, as inflation causes the rent, electricity, and other bills to go up, $X has to stretch even further, leaving even less leftover for long-term investing.

In short: not having a lot of money forces you to rely on that money even more, even as its value is constantly shrinking. It’s a vicious cycle.

This is why the cryptocurrency community focuses so much on inflation.

How Bitcoin Beats Inflation

Bitcoin was designed to be the future of money–a kind of money that would empower ordinary people, and subvert the inherent imbalances of the traditional financial system. Inflation is one of those imbalances, so Bitcoin intentionally combats runaway money printing with two primary tools: 

  • A predictable distribution mechanism. The same number of Bitcoin is printed, at equal intervals, all the time. (The only time this ever changes is during a halving event, every four years or so, when the number of BTC minted every interval is cut by 50%.)
  • A maximum supply. No more than 21 million Bitcoin can be created.

Tokenomics can be complicated, but the outcome is simple: investors can have confidence that the coins they hold now won’t shrink in value as they hold them long-term.

Just as important as these rules that prevent inflation is the fact that they can’t easily be changed.

As we mentioned earlier in this series, central banks have the power to influence economic conditions by speeding up or slowing down the creation of new money. Usually they’re doing more speeding than slowing, and sometimes that has positive effects. For example, Federal Reserve actions taken at the onset of the COVID-19 pandemic helped the U.S. economy bounce back from a potential recession at light speed. However, money printing has caused all kinds of problems in the past–not just inflation but outright recessions and, arguably, depressions. Some people don’t like that such a small group of people at a central bank can make rules that have such a significant impact on the rest of us.

The rules that govern Bitcoin, by contrast, can’t be changed without majority support from the community. No central bank or committee can adjust the mining reward, or the max supply. Instead of one powerful institution making the decisions for everyone, it’s everyone who gets to decide, collectively.

Majority vote has its downsides, to be sure. Imagine, for example, a simple rule change that would help Bitcoin recover from a major drop in price. If the community can’t reach a consensus in time to implement such a change, the value of Bitcoin will suffer. Many people would point to the debate over Bitcoin’s 1 megabyte block size limit as an example of this.

Still, majority rule ensures that no one can make irrational or selfish decisions which disproportionately benefit one group over another. That kind of equity isn’t true of any government money in the world.

Maybe, one day, Bitcoin users will choose to drastically change the rules of the network. Maybe they’ll adjust the halving cycle, or raise or outright eliminate the max supply. If they do, though, it’ll be a community effort. The system does not eliminate inflation, it eliminates the kind of centralized control that can cause harmful inflation.

Are Bitcoin Tokenomics Better than Fiat Economics?

Some investors believe that Bitcoin is superior to fiat money.

In some ways it’s an attractive argument. Certain countries, by mismanaging inflation, have caused widespread hardship. A few countries have hyper-inflated their currencies out of existence. Bitcoin hasn’t experienced–indeed, cannot experience–such outcomes.

But the majority of government currencies actually operate quite soundly. The U.S. dollar, despite its issues, has remained trusted throughout the world for far longer than Bitcoin has been around. And central banks, for all their bad decisions, have implemented some very effective policies in the past.

(graphic by Visual Capitalist)

Ultimately, it isn’t that Bitcoin is objectively better or worse than fiat currencies. Rather, it is an alternative. It’s superior in some ways–like eliminating the worst consequences of inflation–and inferior in others–like being inflexible to changes in macroeconomic conditions.

It’s actually kind of remarkable, in the end, that Bitcoin works as well as it does. The entire system was conceived of by just one person (or group of people), only a decade and a half ago. Yet in certain respects it beats all the other monetary systems we have. And, in every conceivable way, it’s healthier and sturdier today than it’s ever been.

NOTE: This is the conclusion of a 3 part series of articles on Bitcoin and inflation. Part 2 can be found here.

Shep
Shep
Serial entrepreneur, jack of all trades, started first online business in 1997. Survived the dot com crash and operated for 24 years. Ditched our physical office in 2007 and ran virtual for 14 years after that. Sold during COVID lockdown (and highpoint for our business). I'm a husband, father, gardner, meditator and investor. Love the water, energy-work, trees, bonsai and bitcoin!

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Rule of investing thumb via @EconguyRosie “Over the past five decades, only when the 10-year T-note yield plunged 135 basis points (on average) did the S&P 500 manage to make a bottom.”

In 2011 when Gox was hacked & BTC market-dumped to a penny, that was the entire ecosys.

In 2012 when pirateat40 blew up, that swung the market 50% in a few days. 1/

When liquidity is flowing, anyone with a narrative in an unregulated offshore gray zone can sell a token idea.

But when liquidity dries up, most of the things that aren’t serving a real purpose get killed, and often will not reach higher highs in the next cycle.

in the past when #bitcoin tagged the weekly MA 100 headed down , it has gone on to tag the MA 150 and MA 200 not long after, thus our limit orders at $28k and $21k.

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