BitCoin – The Deflationary Currency

BitCoin is inherantly deflationary.  The system is designed to have a finite number of bitcoins in circulation.  The system has a distributed mechanism to ensure a steady rate of inflation of 50 bitcoins every 10 minutes.  The system cannot have inflation that is greater than this, because there is no central banker or authority who can change the rules and arbitrarily create more inflation.

The BitCoin algorithm, which is implemented on tens of thousands of computers that form the BitCoin network, is designed to increase the difficulty of the hashing algorithm’s “Proof Of Work” difficulty as the computing power of the network grows.  This means that inflation is pretty much held at a predictable steady rate.

But the demand for BitCoin, the visibility, the mass usability of the system are increasing rapidly.  Thus the value of BitCoins is increasing faster than the rate of inflation.  This makes BitCoin an inherently deflationary currency.

We are used to government currencies that are inherently inflationary.  Meaning that the price of a gallon of gas used to be $0.10 and is now $4.00.  Homes used to be $40,000 and are now $600,000.  This is partly due to the inflation of the currency base (ie. more money is printed).  So each dollar is worth less over time, making everything cost more dollars.

BitCoin appears to be different.  Because inflation is capped, and is currently much lower than the growing interest in the currency, every BitCoin is generally worth more money over time, and if the economy grows, this will continue.  Fortunately BitCoins are divisible into smaller quantities.  Meaning that over time, a loaf of bread might cost 1 bitcoin, and years later might cost 0.1 bitcoin or 0.001 bitcoin.  So get used to a deflationary world where things cost “less” bitcoins over time, not more.



About Dave

I have been into financial cryptography and alternative electronic currencies since the mid 1990s. I have attended the Financial Cryptography conference, and have invented patents in the fields of cryptography and security. I've built systems for Visa, the US Federal Reserve, NASD, and hundreds of banks around the world.

Posted on August 12, 2011, in Uncategorized. Bookmark the permalink. Leave a comment.

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