Bitcoin & Inflation – Review of the Correlation Between The Two

As is known, the global economy is currently undergoing a major recession. This temporary global economic decline has evidently damaged individuals of all classes, businesses of all sizes, and countries of all kinds. While experts warned the world about a possible upcoming recession, little to no action was undertaken to prevent it. Nevertheless, 2020 and 2021 remain confusing times for most people, and the aftermath of the Covid-19 pandemic has permanently scarred the global economy.

The Current Global Economy

In one of the surveys it conducted back in August 2020, the National Association for Business Economics (NABE) targeted known economists in relation to the U.S. economy. More than 69% of the respondents believed that the U.S. economy will return to pre-pandemic levels before the year 2022. It was mainly through artificial pumps on the US Dollar and interest rate increases, that the FED successfully recovered the U.S. economy, however that did not withstand future events. The world had scarcely moved on from the pandemic when the conflict between Russia and Ukraine sparked. In turn, the oil and gas supply chain was damaged, and simultaneously the global economy faced its downhill. 

The United States was not spared the severe indirect effects of such a crisis. Essentially, the USD’s purchasing power weakened, although its value in the foreign exchange market increased. With the United States being one of the most important players in the global economy, such uncertainties inside its own borders hugely affect the flow of things globally. Additionally, the US Dollar has been the global reserve currency since 1945, making the United States’ economy crucial to the global economy.

If that is the case, the worst is yet to come. In an article written by Bill Conerly for Forbes in November 2021, the author suggests that if the FED manages to avoid a recession in 2022, the years after will be troublesome for the economy. The longer the gas and oil supply chains stay disrupted, the more profound this crisis becomes.

With inflation rates increasing, people are constantly trying to find ways to hedge their fiat. While stocks and gold usually serve that purpose, it becomes alarming that even stocks are volatile right now. In recent years, a new variable entered the equation, and that is Bitcoin.

What is Bitcoin?

Bitcoin is a peer-to-peer digital payment network that utilizes blockchain, a type of distributed ledger technology (DLT). What Bitcoin created came to be known as a cryptocurrency, a digital currency that uses cryptography to execute safe transactions. There are several factors that make Bitcoin an interesting concept, but the most important ones are those related to its properties. Bitcoin’s main properties are:

  • Decentralization – Bitcoin does not have a central authority
  • Low Inflation Rate – Bitcoin’s inflation rate lowers by 50% every four years through its halving mechanism
  • Transparency – Bitcoin uses a public ledger to store transaction history
  • Anonymity – Bitcoin transactions don’t require any personal information and can be executed only through addresses
  • Scarcity – Only 21 million Bitcoin exist

Anyone can purchase Bitcoin in several ways, with the most prominent way being centralized exchanges. The other way of purchasing Bitcoin is through peer-to-peer (P2P) transactions. For beginners, however, purchasing Bitcoin is way easier through centralized exchanges such as Binance, Kraken, Robinhood, Coinbase, or any other licensed exchange. However, acquiring Bitcoin in such manner requires providing a lot of personal information. Furthermore, most centralized exchanges require passing a Know Your Customer (KYC) test before verifying your account. This means that providing government-issued documents, such as a Passport or an ID, is a prerequisite for purchasing Bitcoin.

As for peer-to-peer transactions, all that is needed is the deposit address where the Bitcoin should be sent, and vice versa. Because Bitcoin is stored in wallets, the public key of the address is necessary, so that the blockchain knows where to direct the transaction. While these transactions are transparent and are stored in a public ledger, the addresses do not include any personal information.

How Bitcoin Came Into Existence

Officially, Bitcoin was first mentioned during the 2008 financial crisis on the Bitcoin whitepaper. This whitepaper was released by a group or individual known as Satoshi Nakamoto. To this day, the real identity of Nakamoto remains unknown. Nevertheless, Satoshi provided enough information regarding Bitcoin’s blockchain before he disappeared from the internet. Even though Bitcoin first made an appearance in 2008, the concept behind such technology goes back to 1982.

Many computer scientists were working on cryptology back then, but one of the most important books was “Advances in Cryptology,” written by David Chaum, Ronald L. Rivest, and Alan T. Sherman. After this publication, David Chaum went on to narrow his work into a paper titled “Blind Signatures for Untraceable Payments.” This gave birth to the first-ever cryptocurrency, eCash (FYI, this project has nothing to do with the current eCash cryptocurrency) in 1990. The project behind eCash failed and the company went bankrupt; however, the concept survived. After 18 years, the anonymous inventor, Satoshi Nakamoto, published the Bitcoin whitepaper which changed everything. This led to the creation of a market worth trillions of dollars.

It should be mentioned that Bitcoin was never the first-ever cryptocurrency. There were several attempts to create a functional cryptocurrency throughout the years. Some prior projects are eCash, B-Money, Bit Gold, and Hashcash. Although these projects failed, they served as the backbone of Bitcoin’s creation. Bitcoin is the first-ever cryptocurrency that successfully took over the world. The ideology behind the concept of Bitcoin is astonishing, and time only can allow the masses to become cognizant of this. 

Satoshi Nakamoto

The real identity of Satoshi Nakamoto is unknown, however, his name appears on the Bitcoin whitepaper. Nakamoto was active even after Bitcoin made its debut. He used to send emails to his colleagues and contribute to Bitcoin’s success until 2010 when he finally announced his leave. He sent an email to Gavin Andersen, a software developer, giving him total control over Bitcoin’s ecosystem and informing him that he will be moving to other things.

Well, one would doubt that Nakamoto left without a reason. Understanding that the concept of Bitcoin threatens the current global financial system, people have reason to believe that Nakamoto was scared to continue his involvement with Bitcoin. Because Bitcoin undermined the very concept of the centralized nature of banking and money, governments might have been amongst the first ones to actively work towards bringing Nakamoto and his innovation down. Fun fact, the 31st of October marked the 14th anniversary of Bitcoin’s whitepaper.

How Does Bitcoin Work?

Bitcoin’s mechanism is simple. To begin with, Bitcoin uses blockchain technology. The name “blockchain” is self-explanatory since it means precisely a chain of blocks. To be succinct, a blockchain uses timestamps to make it impossible for people to tamper with the data. Data is stored in the networks as blocks of 2,000 transactions. Each block, then, is chained with one another depending on which came first. In this way, a chain with unique, irreversible blocks of 2,000 transactions is gained, hence the name blockchain.

What makes this method indisputably effective is the speed of transactions, the data’s level of safety, the low fees, and the low space it requires to run. Each Bitcoin block has a maximum size of 1 Megabyte. This is extremely low when it comes to storing data from 2,000 transactions.

As for its decentralization, Bitcoin uses the classic Proof-of-Work (PoW) mechanism to validate transactions. The PoW mechanism uses computing power from validators (also known as miners) from all around the world to keep the network secure. At least 51% of these validators need to confirm each transaction before the transaction goes through. This keeps the network decentralized and safe at the same time. Thus, Bitcoin’s PoW mechanism is similar to a centralized model of a server; the only difference is that the server is scattered throughout the globe in a decentralized manner. This makes it virtually impossible for anyone to attack the Bitcoin network.

Bitcoin Halving

The supercomputers that make up the Bitcoin network get rewards in BTC for each block they create. This process is known as “mining” and is a way to acquire BTC without buying it directly. Today, people are creating Bitcoin farms all across the world so that they maximize their profits. What makes Bitcoin unique is the halving mechanism that Nakamoto implemented. Every four years, Bitcoin’s mining rewards are halved, making BTC more scarce. At this time, validators split 6.25 BTC every time they create a block. However, after the next Bitcoin halving in 2024, they will get only 3.125 BTC per block. This makes Bitcoin’s inflation rate decrease over time. More importantly, it makes Bitcoin’s inflation rate stable and predictable.

The current global situation has shown that we need to explore alternatives to traditional currencies. With ever-growing inflation rates and interest rates, the financial welfare of billions of people is being put at risk.

What is Inflation?

According to the Cambridge dictionary, inflation is “a general, continuous increase in prices.” These past months, the term inflation has been circulating across all mediums. The current inflation rates are dangerously high globally. The United States reached an annual inflation rate of 8.2% in September 2022. Inflation is also part of the reason that Fiat currencies are rapidly losing their purchasing power. There are three main types of inflation: cost-push, demand-pull, and built-in inflation. Such a classification is based on the causes of a particular period of high inflation. While a regulated inflation rate is common, a high inflation rate,  akin to the current one, is not. The latter is extremely dangerous to economies and makes it hard for individuals to afford necessary commodities such as food, fuel, electricity, transportation, and health care.

Bitcoin & Inflation

As previously mentioned, Bitcoin has a low and predictable inflation rate. Unlike the US Dollar, nobody has the authority to change the amount of Bitcoin entering market circulation. With this being the case, the inflation rate of Bitcoin will remain stable and halve every four years. However, inflation is way more complex than this. Even if we control the production of money or Bitcoin, there are other variables one should take into consideration. As such, while Bitcoin introduced the world with a new concept of money, it remains unknown whether it can fully substitute fiat, at least for now.

As per inflation, Bitcoin is holding up quite well. Regardless, it is still one of the most volatile investments in the global market. For those who truly believe in Bitcoin and the concept of a decentralized, global currency, then volatility is the smallest problem. I hold the view that one should not look at Bitcoin as an investment, but rather as an ideology. Bitcoin is the first successful attempt towards decentralizing the financial system, a system full of flaws that are proving severe for the world economy.

One insightful video regarding the correlation between Bitcoin & Inflation is that of Lex Fridman. This video is an interview with Michael Saylor, co-founder of MicroStrategy. Here, they discuss about the current armed conflicts, economic sanctions, market crashes, and Bitcoin.

Frequently Asked Questions (FAQ)

Is Bitcoin Inflationary or Deflationary?

Bitcoin is currently inflationary. However, Bitcoin’s inflation rate is really low and it gets lower every four years through Bitcoin halving. By the year 2100, Bitcoin will become deflationary because Bitcoin production will stop. For reference, only 21 million BTC will ever exist.

What is the Bitcoin Inflation Rate?

The current Bitcoin inflation rate is 1.8% and it is decreasing with time. Every four years, the Bitcoin production rate undergoes halving. This reflects in the inflation rate as well. Per context, the current inflation rate of the US Dollar is 8.26% and that of the Euro is 10.7%.

Is Bitcoin an Inflation Hedge?

Depends. For the foreseeable future, Bitcoin is the best inflation hedge. Until today, Bitcoin has proven itself to be inflation-proof in the long term. Nevertheless, this cryptocurrency is still young, and henceforth very volatile. This volatility is one of the main reasons why investors refrain from going into the cryptocurrency market and continue to adhere and abide by traditional markets, including stocks and gold.