Inflation: Bitcoin vs. Fiat Currencies2 min read
The domestic purchasing power of the U.S. dollar continues to decline, as does the purchasing power of fiat currencies around the world, as inflation continues to impact economies large and small. In the U.S., the inflation rate jumped to 9.1% in June. That’s the highest level since the early ’80s when the economy suffered double-digit increases for three straight years. The inflation rate in the United Kingdom hit 9.1% a month earlier in May, also the highest level in 40 years, while other countries like Spain (10%), Estonia (20%), Argentina (61%), Turkey (74%) and Venezuela (167%) have fared even worse.
Inflation reflects the rate of increase in prices for a relevant set of goods and services over a given period of time, a year in the case of the rates listed above. Several factors contributed to the recent price spikes, from supply chain and labor shortage issues to reduced pandemic restrictions and pent-up demand to the war in Ukraine and its impact on surging energy prices. However, inflation also reflects a decline in the purchasing power of a given currency, which can occur when a government rapidly increases the amount of money in circulation, as happened across the globe during the pandemic.
To quote the IMF from 2018, “If the money supply grows too big relative to the size of an economy, the unit value of the currency diminishes; in other words, its purchasing power falls and prices rise. This relationship between the money supply and the size of the economy is called the quantity theory of money and is one of the oldest hypotheses in economics.”
National currencies are typically “fiat,” which means they are not backed by a commodity like gold. In most cases, the only backing for fiat currency is a government decree, and governments like the U.S. can essentially print and distribute money at will. Like the IMF said, printing and distributing too much money can have consequences, notably increased inflation.
Bitcoin differentiates itself from fiat money in a significant way by limiting itself to a finite amount: 21 million. So far, miners have produced 19 million bitcoin, but the mining (or production) rate is reduced by half every four years. This means only 2 million more bitcoin will ever be produced, with the final mining taking place in 2140.
A set limit of bitcoin might not completely contain inflationary factors like war and crippled supply chains, but it does eliminate the self-inflicted wounds of growing and distributing the money supply too quickly.
Still, some might argue that Bitcoin is merely a different type of fiat because it too lacks the backing of a commodity. SEC Chairman Gary Gensler killed this argument in July when he told CNBC that he, and his predecessors, see Bitcoin itself as “a commodity.” As a medium of exchange, this empowers Bitcoin to function as the equivalent of digital gold.