Inflation in Fiat vs Pure Digital Currencies

Spiralus
8 min readJul 26, 2016

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A recent article published at Bitcoin.com stated a ROI of 18% for Dash (Digital Currency).

A recent Medium article called “A Tale of Two Networks” by Ryan Taylor @baby_giraffe about the Dash (Digital Cash) cryptocurrency brought up the topic of inflation of currency as a ‘tax’ on people.

While I agree with Ryan’s assessment, it got me thinking about the impact of inflation in a cryptocurrency versus the inflation of fiat money.

So I thought it would be good to delve into this in more details since just comparing “inflation” rates is not a good comparison.

Price Inflation versus Monetary Inflation

First, let’s take a quick look at inflation as most people see it. The central banks usually target a goal of 2% inflation.

Below is a graph of the Personal consumption expenditure inflation from the Bureau of Labor Statistics from here

Personal consumption expenditure inflation 2007–2014

or in for more recent details

However, while this is the documented inflation rate, it is very important what is included in that index. Especially since the way it is calculated has changed over the years. This is discussed at Shadow Government Stats website.

So, as noted there, the inflation rate is much higher than officially stated. Most people who buy groceries or try renting an apartment in San Francisco will probably have no problem agreeing.

These measures of inflation though are primarily ‘price inflation’, which in turn is said to occur through ‘monetary inflation’, which is the growing size of the money supply, with the idea that more money for the same amount of goods drives prices up.

A good example of this occurred during the Dot Com boom, when lowered interest rates (by the Federal Reserve) caused more people to borrow money and buy houses, which in turn drove up prices — the so called “Housing bubble” that peaked in 2007. In that case, obviously house prices rose way more than 2%. More like 10 or 20% in select areas of the USA. That all happened without huge spikes in the official inflation rate.

The overall point here is that a rapidly expanding money supply will cause price increases much more than 2% especially if you need to rent or buy a home during a housing bubble. By one measure, the actual money supply growth been charted by Michael Pollaro for the US here. From that site, you’ll see that the rate in increase in money supply quite erratic and by some measures can get as high as about 18 or 19%. This doesn’t work well to build confidence in the stability of our money system — but that’s a topic for another day.

Inflation in Pure Digital Currencies

Now let’s take a look at inflation in cryptocurrencies like Bitcoin, Ethereum or Dash (Digital Cash). I prefer to use the term Pure Digital Currency since the encryption part is irrelevant to the discussion.

Take a look at Dash’s current inflation rate — About 10% this year.

Below is a graph of inflation year over time (starting this year)

At first, it is shockingly high and would probably scare many people from putting their money into Dash — as a store of value, like people would put money in their savings account or in Gold. At first, you’d be inclined to think that the value of any Dash coins you have is effectively decreasing at a rate of 10% per year (for the first year 2016). However, this is not really true for a number of reasons, which I’ll elucidate on below.

Money Supply

First of all the 10% is the growth of the coin supply. So we shouldn’t compare this to official inflation rate (which some people might mistakenly do), but rather to the money supply as pointed out earlier — and money supply growth is usually only known and understood well by bankers and economists. Not only does the Dash coin growth slow down over time, but it is quite predictable unlike fiat money supply growth.

Below is a graph of the year over year increase in Dash coins (as show above) compared to the M2 money supply in the USA over the period 1992–2016. The M2 data is taken from the Federal Reserve Website here. They’ve been aligned so that Year 0 is 1992 for the M2 Supply and Year 0 is 2015 for Dash. The dip in M2 around year 18 corresponds to the Financial crisis of 2008.

Dash Coins & M2

The average M2 growth rate over this period is about 5.5% (note: very little M2 growth around 1992–1995). So obviously the Dash rate is quite a bit higher for the first 5 or so years. However, while M2 still can bounce around a lot, Dash is monotonically decreasing.

Now if we take the overall supply at the start of this period compared to the end, we’ll see that Dash grew by 160%, while M2 grew by 209%. As we go out longer in time, this difference will only increase, since the M2 will probably tend to still average 5.5%.

Why is Dash inflation rate so high initially

At this point, you may wonder why the rate for Dash starts so high and is it intentional. I believe it was setup that way since there is a need to compensate the early adopters more generously since they are taking the highest risks initially. If the Federal Reserve issued it’s own digital currency it wouldn’t need to do this since acceptance would be guaranteed if it was in some way tied to the US dollar.

Impact of Monetary Inflation

Since Dash is not the only currency in use, inflation in Dash doesn’t mean in turn that the overall money supply (of all currencies) grows by the same amount. In fact Dash money supply is a drop in the bucket of the overall money supply. And thus, there is no reason to believe it would drive prices up at all (and thus devalue itself accordingly). Keep in mind though, this may not be a fair comparison to fiat, since for example in the USA, the dollar is basically the only currency in use and there is no place in the world where only a digital currency is in use. So there is no need to worry that the growth in Dash coins will cause it values to fall due that growth causing rising prices.

Increased Adoption

One other thing, unique to these digital currencies though, is that their adoption is increasing over time, since they have many traits that old fiat currencies don’t have. So although their supply increases, so also does their demand. In fact, I think the increase in demand rate is far higher than any supply inflation. This helps to increase the value more than enough to compensate supply inflation. A case in point here is Bitcoin, where it’s value has been growing steadily in the last couple of years as adoption grows. This is also true for Dash where you can see it’s price over the last year below

Dash price in US Dollar over the last 12 months
Dash price in Dollars & Bitcoin over last month

Of course at some point the rate of new demand will taper off, but as that happens the inflation rate will also decrease as the mining reward tapers off too.

Interest Rates

Currently in the USA you are probably lucky to get a 0.1% interest rate on your savings in a Bank. In fact, the interest rates are so low, there is even talk of negative interest rates eventually making it to the consumer.

With crypto-currencies there are no “banks” or interest rates generally (although some exchanges allow you to loan out your currency for interest).

While there is no interest for Dash, there is also no fear of negative interest rates or of bank runs or bank “bail ins”.

Additional return on investment for Dash

A very good feature of Dash is it’s Proof of Stake through Masternodes. If you are still worried about currency supply inflation, this is the antidote. About half of the coins that are contributing to the increase of money supply are allocated from mining to Masternodes. This basically rewards people who are not spending their Dash on a daily/weekly basis. And it is only fair that their value shouldn’t be inflated away by allocating them some of the newly minted coins. The philosophy of Proof of State is a little beyond the scope of this article, so I won’t go into the plus and minuses of it versus Bitcoin or other digital currencies. Currently setting up a Masternode requires about $9,000-$10,000 investment (or 1,000 Dash to be exact), however, there are ways to participate in Masternode benefits with as few as 25 Dash.

Currently the return on investment for this method of saving is about 11% per year (as measured in Dash itself — masternodes earn an average of 0.28 Dash per day). In fiat terms you must also consider how the price of Dash itself changes.

Conclusions

While the Dash coin emission rate may seem quite high now, if you look at it over a longer term it is actually less the the M2 growth rate.

So hopefully you can see that the emission rate is not as scary as it might first seem and you may want to ask yourself,

Should I put my money in a savings account and earn 0.1% interest rate while real inflation is probably closer to 10%, or should I be prepared to take a risk and put my money into something that has recently had returns of 18%*?

*18% here was in terms of Dash itself, in US dollar terms the ROI is much higher.

If you want to find out more about how this exactly works, I’d advise you to read the Dash documentation on dash.org. And also be aware, that the returns quoted are not guaranteed as these are potential high risk investments. Thanks to the people at the Dash slack (signup here) for feedback and help writing this. Join the Dash slack group for vibrant discussions.

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