Probably one of the most revolutionary aspects of Bitcoin is its model of deflation. This means that the number of Bitcoin that is produced decreases over time and even will stop eventually once supply reaches 21,000,000. This stands in stark contrast to the inflationary model most of the world operates under.
Inflation Based Model
In this model, the money printed is intentionally increased year by year. The underlying principle is that the value of your fiat decreases therefore you are more incentivized to spend it now rather than later. This facilitates a spending economy with free-flowing cash. Inflationary economics also tend to be geared toward high leverage practices such as debts, loans, and credit. Collateralized, non-government printed, yet still approved medium of exchange fits into this paradigm as it also increases spending habits.
Deflation Based Model
In this model, less money is printed year by year. The idea is that your fiat (or Bitcoin) will be worth more later than it is now. However, one criticism this model has received is that it creates a hoarding culture so that no one will actually want to spend money that appreciates. Therefore, there a spending economy wouldn’t exist. In fact, I actually get this question a lot on reddit. Why would I spend BTC now if it’ll be worth more tomorrow?
I recently stumbled across this wonderful video by Jörg Guido Hülsmann, a professor from the Austrian School of Economics, which I believe summed up very nicely the fundamentals of deflation to answer this question. If you have an hour, I strongly suggest you listen to it. However, I’ve also included some notable highlights I thought were important below.
Some Notable Highlights
Inflation economists have long claimed that a deflation based model is impractical; or rather impossible. However, Germany had one of the highest growth rates in the 1980’s within the context of deflation. This is a fact and acts as evidence that deflation is more than just a viable alternative.
But how exactly does deflation based model work if everyone’s hoarding?
- Deflation discourages spending. However, it is impossible to completely remove the need to spend.
- Two reasons why someone would spend are as follows: a) The Basic Necessities b) Time Preference
- The Basic Necessities- It’s true that your groceries will cost less next year. However, you still need to eat in order to get through to next year. Therefore, people will spend money on the things they absolutely need or value. This extends to housing, security, etc.
- Time Preference- This is the idea that people will spend money on things now rather than later. For example, even though it’d be cheaper to go to the beach next year, I’m not going to wait until then to go with my friends or family. I want to enjoy the beach now.
In essence, deflation encourages people to take stock of what they actually need or want. This has a really interesting side effect. As people spend less, businesses will have less revenue. This will force them to either to renegotiate their business relationships to cut the costs of production which spreads throughout the economy, or shut down. This in turn causatively kills alternative labor markets, especially intermediary services.
Finally, the last noteworthy criticism to address is what economists call the “Deflationary Death Spiral.” This situation occurs when decreases in the price of products or services (which is inherent in a deflation based model) lead to lower production, which in turn leads to lower wages and demand, which leads to further decreases in price.
However, Professor Hülsmann points out that this Death Spiral only exists under specific conditions: in a high leverage economy (debt-based) and when a part of the supply is created through fractional reserve banks.
For example rather than renegotiating business relationships to cut down costs, the solution is to simply print more money which in turns further devalues the fiat currency. Or when a bank runs out of money because they gambled incorrectly by trading stocks and derivatives, they go to the Federal Reserve who then acts as a Lender of Last Resort to bail them out rather than shutting down their doors.
All this to say, currency within an economy of deflation acts as both a store of value as well as a medium of exchange i.e. currency. This is why Bitcoin is and can be used for both.
So Do I Use BTC as a Store of Value or as a Currency?
Because Bitcoin is a deflationary currency, you should expect it to only increase in value; especially because the rest of the world practices inflation. This is a reality I don’t ever expect to change, at least in the immediate future. This is why Bitcoin is a great store of value.
However, we have to keep in mind that Bitcoin is still a currency. That means it must be used in order for it to have value. If you can’t spend BTC anywhere, it’ll always and forever be just a magical internet coin.
This presents a particular dilemma for Bitcoin hodlers. Do I spend the currency to help push adoption but miss out on the opportunity cost of future gains? Or do I hodl the currency?
We must do both.
First, we must continue to promote the usage of Bitcoin as much as possible and increase its utility. Despite the fact that Bitcoin is now becoming more well established among institutional investors and supported through custodial solutions, we must continue to demonstrate the value of Bitcoin’s censorship resistance, trustlessness, and immutability by creating a market for it through stores, applications, and services. As consumers, we must view using Bitcoin as a willful and intentional act of protest against inflationary economics and financial institutions built around high leveraged intermediary services which ultimately devalue our net worth.
At the same time, we must also remind ourselves of the core principles of deflation by recognizing that the Bitcoin we have now will be worth more in the future. That way we don’t miss out on its future price appreciation.
Therefore, I leave you with two very specific ways in which you can align yourself with Bitcoin being both a store of value as well as a currency:
- First, have a plan of cashing out. Remember that deflation doesn’t mean you hodl forever, rather it suggests that you take stock of the things you truly value and spend money on those things. Be disciplined about identifying value whether it relates to big purchase items or hitting a specific price point where you cash out x% of your portfolio (which by the way is a great way to hedge against BTC’s volatility).
- Identify different ways to spend BTC on smaller purchases to continually demonstrate BTC’s utility. These are things you’d normally spend in fiat but can use Bitcoin for. But remember to buy back what you spend. That way the opportunity cost of an appreciating asset is mitigated. For example, you’re going to spend money to buy lunch anyways. Why not use Bitcoin instead and simply buy it back later to help increase adoption? Especially when this will only make your Bitcoin more valuable in the future?
When you buy Bitcoin, you are not only buying sound money. You are buying into a new mindset. Although it takes time to adapt to a new paradigm, I hope this article helps you better navigate the decision making process of using a deflationary currency like Bitcoin.