Crypto’s hyperdeflation problem

To non-geeks, one of the most fascinating potential use cases for the blockchain is everyday consumer transactions. Largely due to the popularity of bitcoin in particular, people wonder if cryptocurrencies might replace traditional “fiat” currency — like the U.S. dollar — as a way to buy everything from food to movie tickets.

So far, we’re nowhere near that point. Bitcoin and similar crypto tokens are largely vehicles for speculative trading, not actual commerce. And it may be because they’re effectively undergoing a very rare economic problem — hyperdeflation.

Hyperinflation periods through history

The opposite issue — hyperinflation — is perhaps more readily understood and definitely more frequent through history. It’s what happens in the collapse of fiat currencies issued by governments, like Germany’s mark in the 1920s, Zimbabwe’s dollar in the 2000s, or Venezuela’s bolivar just last year.

In a hyperinflation scenario, the purchasing power of a physical currency unit falls so rapidly that massive, unwieldy amounts are needed to buy or sell goods. This basically renders the money useless.

For instance, in one famous (among economists, at least) photo from Germany’s hyperinflation, a woman burns stacks of marks instead of firewood. By that point in the hyperinflation, the thousands of marks it would’ve taken to buy firewood could generate more heat as kindling than burning the wood.

By comparison, if it were physically possible to burn a bitcoin, you certainly wouldn’t want to. Even though it’s well off its late-2017 highs, bitcoin has still had an eye-popping run over the longer haul. Over the last five years, bitcoin is up more than 5,000%, trading around $7,000 per coin this week, according to CoinDesk data.

Hyperdeflation in cryptocurrency

Problem is, those big gains effectively create a powerful incentive to hoard coins, not spend them. For instance, if the programmer who famously spent 10,000 bitcoins on two pizzas in 2010 had instead held onto the bitcoins, he’d have assets today worth $70 million.

Anecdotally, present-day bitcoin holders seem to be taking that lesson to heart. It’s difficult to separate actual commerce from speculative trades when the major crypto exchanges report volume, but most analysts agree that daily bitcoin activity is heavily weighted toward the speculators.

Ultimately, the bitcoin market has ended up with a remarkably similar practical result as one would see in a hyperinflation — money that no one actually wants to spend on stuff. Bitcoin just got there by the exact opposite means, with a relatively rapid rise in value.

There is reason for hope, though. In recent months, there has been a burgeoning movement among issuers of crypto tokens toward offering “stablecoins” like Tether, MakerDao, and Havven. Such tokens are pegged to a real-world asset like the U.S. dollar and are often structured as smart contracts in order to maintain the peg and clear regulatory hurdles.

Such crypto coins could offer not only a more reliable means of conducting actual commerce, but also lower fees and more nimble fulfillment of payments, tech writer David Z. Morris wrote in a recent post for Futurism.com.

“The crypto-economy, which thrives on speed, is throttled to a crawl at its contact-points with the old paper-money economy,” Morris wrote. “A blockchain asset that was firmly connected to that paper economy, and didn’t move with the crypto market, would drastically increase the informational efficiency of both.”

Like what you read? Give Peter A. McKay a round of applause.

From a quick cheer to a standing ovation, clap to show how much you enjoyed this story.