It sounds like you have more technical experience with cryptocurrency than I do. I think I understand the economics side a little better, though I admit I’m not an expert. I’m sure a more professional economist would have a conniption based on how I’m using some terminology and concepts.

Why is Deflation Bad for Currency?

‘Inflationary’ and ‘deflationary’ as adjectives are usually applied by economists to government fiscal policy, not to currency itself. Since cryptocurrency fiscal policy is usually set in code when it is released, and reaching consensus required to change it is rare, I think it’s kind of appropriate to label cryptocurrency with these adjectives, but I realize it’s also confusing. I’ll do a better job of explaining it, because our differing understandings of this concept are going to be a problem if I don’t.

Money, like all commodities purchased with money, responds to supply and demand. The more money available in an economy, the less that money is worth with regard to other commodities. When the value of money with regard to other commodities goes down (more dollars, less eggs) this is called inflation. When the opposite happens, (less dollars, more eggs) this is called deflation.

During most of history, money was linked to precious ore. There wasn’t a lot of academic economics going on back then, but this meant that the rate at which ore was mined and minted determined the base of a civilization’s currency supply. Argentarii, Priests, and Metalsmiths offered credit, usually some multiple of the actual amount of precious metals they had on hand. Rulers debased their printed coins with non-precious metals. But these methods of increasing supply had drawbacks, so available ore was king.

The policy of letting the availability of precious metals have a direct influence on the money supply continued until very recently. I want to be clear - granting government (I use the term loosely here because the FED, Bank of England, and most other national analogues are technically not a branch of government, but are so intertwined to make the distinction irrelevant) control of the money supply gives it another tool of power, and I’m not happy about that. But giving control of the money supply to the rate of strip mining, conquest, and trade policy is still government-involved, and in many ways worse.

I bring this up because the same economic thinkers who championed Bitcoin are the ones who think a return to the days when money was pegged to the gold standard is a good thing. They’re wrong. Even without the other problems associated with using precious metal as currency, having a money supply that does not adapt to market conditions creates forces that re-enforce hierarchical structures, and privilege the capitalist class over the working class. It gives power to bankers, and removes power from debtors.

The primary use of money is as a medium of exchange. In cases where money retains its value with regards to other commodities or increases in value over time, it can be used as a store of wealth. But money that is a good store of wealth is bad for use as a medium of exchange. “Good money” slowly loses value over time; slow enough not to cause a panic to spend it, but enough to encourage spending it rather than hoarding it. In order to save money, it must be placed in a bank with an interest rate higher than the rate of inflation. The bank then uses that money to issue debt, and it goes back into the economy.

Inflation takes some of the edge off of debt - interest rates are decreased when the inflation rate is factored in. Consider what happens when the opposite is true; not only does the total debt increase over time, but the money to pay the debt becomes more and more scarce, both increasing the value of what is owed and making it difficult to pay in a reasonable time. While inflation has an effect on real wages, raising the minimum wage and negotiating salary increases compensate for this effect. It is difficult for banks to renegotiate contractual agreements on long-term loans in the same way.

Being able to save wealth without banks might be considered a benefit of deflation, but something much worse happens. Working people generally need to spend most of the money they earn, and only a small fraction of a rich person’s income is needed for life’s necessities. When it becomes beneficial to hold on to money, the capital class can easily reduce spending, but those with less money are forced to continue to spend, leading to a pattern that collects more and more of the money supply in the hands of the rich. Because banks and the wealthy are incentivized to hold on to money, less infrastructure is built, loans are harder to get, and the amount of jobs available and total economic activity decreases. This is called a contraction, and a period of economic retraction is called a recession. When a recession becomes really bad, it’s called an economic depression.

It is no mistake that decoupling the dollar from precious metals coincided with the lessons of the great depression. People lost faith in the political order, revolutions occurred in Russia and Germany, and many turned to fascism. The tight coupling of banks and government is no mistake, as they rely on each other for stability. If we built a society based on a fiscal policy that allowed the currency of exchange to significantly deflate, it would fall into economic depression and revolution also.

Bitcoin is Bad Exchange Currency

Bitcoin, unlike precious metals, derives its value from its ability to be used as an exchange currency. I’ve explained why it’s a terrible candidate for that use. Like starving people during the gilded age, the primary people using bitcoin for exchange when it is more valuable to hold are the ones who have little choice in the matter - people with no safer way to get illicit items and victims of ransomware gangs.

I call Bitcoin deflationary because it was designed from the start to encourage deflation, but even cryptocurrency like Dogecoin, where the monetary supply is designed to increase exponentially, can increase in value if demand for it is high enough. Cryptocurrency will never replace government money so long as it doesn’t improve on its ability to avoid periods of deflation or hyperinflation. In order to do this it needs to respond to market conditions, scaling the money supply when population and economic activity changes.

As it stands, the monetary supply of bitcoin may be increasing with each minted block, but it is also tempered by the amount of bitcoin ‘burned’ - people losing their keys, or dying with no-one inheriting access to their account. This is the best scenario for Satoshi’s million, for example. It’s difficult to gauge the amount of bitcoin that can come into play even when it is in highest demand due to this ambiguity.

Since 19 of the 21 million coins have already been minted, and the rate of minting new coins is slow and predictable, the independent variable for Bitcoin’s value is not supply, but demand. Ending the minting of new coins will not cause stability in the price - its price will still fluctuate with demand. Population is projected to grow long past 2040, when Bitcoin will stop minting. Take an absurd and simple model of the world where the entire population uses bitcoin: an increase in the population means the same amount of coins for more people, resulting in deflation, a predictable economic depression, and the collapse of that society unless it adopts a better monetary system.