TL;DR: Fiat currencies and cryptocurrencies serve different purposes, and it is not inherently bad that fiat currencies are inflationary. Fiat currencies typically have low levels of inflation to, among other things, encourage investment and consumption and to discourage hoarding. So far, most cryptocurrencies have behaved more like deflationary currencies because their extremely limited supply relative to the population of cryptocurrency users drives up their prices.Yes, it's really unfortunate that the cash is only worth 46k now when it would have been worth $400k+ at the time of its burial. However, people are piling on like crazy saying how terrible it is that inflationary currency destroyed the value of that cash without stopping to think about why inflationary currencies are useful in the first place, then letting this anger spill over into "banks and government bad, De-Fi good" style comments with no substance.I am writing this post to try to explain the purpose of inflationary currencies as compared to deflationary currencies, and why they would serve fundamentally different purposes. Please note that I am not an economist, and this is not a field in which I work.Below is information excerpted from the Wikipedia article on the indicated topics. Italics, bolding, and ellipses are my own for emphasis and clarity. I did by best not to cherry-pick, but instead to focus this discussion on the issues:Fiat CurrenciesParaphrased: Fiat currencies typically do not have intrinsic or use value. They have value only because a government maintains its value, or because parties engaging in exchange agree on its value. The US Dollar, and basically every national currency, are examples of a fiat currency. With respect to inflation:The adoption of fiat currency by many countries, from the 18th century onwards, made much larger variations in the supply of money possible. Since then, huge increases in the supply of paper money have occurred in a number of countries, producing hyperinflations – episodes of extreme inflation rates much greater than those observed during earlier periods of commodity money. The hyperinflation in the Weimar Republic of Germany is a notable example.Economists generally believe that high rates of inflation and hyperinflation are caused by an excessive growth of the money supply... However, money supply growth does not always cause nominal increases of price. Money supply growth may instead result in stable prices at a time in which they would otherwise be decreasing.InflationContrary to the conventional wisdom of this subreddit, inflation has positive and negative effects on economies. This sub has done well pointing out some negative effects of inflation, and I wanted to balance that out by showing the upsides that are typically not included in those discussions.Inflation affects economies in various positive and negative ways. The negative effects of inflation include an increase in the opportunity cost of holding money, uncertainty over future inflation which may discourage investment and savings, and if inflation were rapid enough, shortages of goods as consumers begin hoarding out of concern that prices will increase in the future. Positive effects include reducing unemployment due to nominal wage rigidity, allowing the central bank greater freedom in carrying out monetary policy, encouraging loans and investment instead of money hoarding, and avoiding the inefficiencies associated with deflation.Today, most economists favour a low and steady rate of inflation. Low (as opposed to zero or negative) inflation reduces the severity of economic recessions by enabling the labor market to adjust more quickly in a downturn, and reduces the risk that a liquidity trap prevents monetary policy from stabilising the economy. The task of keeping the rate of inflation low and stable is usually given to monetary authorities. Generally, these monetary authorities are the central banks that control monetary policy through the setting of interest rates, through open market operations, and through the setting of banking reserve requirements.DeflationFor added context, here are some key concepts of deflation (the opposite of inflation):In economics, deflation is a decrease in the general price level of goods and services.[1] Deflation occurs when the inflation rate falls below 0% (a negative inflation rate). Inflation reduces the value of currency over time, but sudden deflation increases it....Deflation is also related to risk aversion, where investors and buyers will start hoarding money because its value is now increasing over time. This can produce a liquidity trap [people prefer holding cash rather than non-liquid forms of money] or it may lead to shortages that entice investments yielding more jobs and commodity production...Deflation is the natural condition of economies when the supply of money is fixed, or does not grow as quickly as population and the economy. When this happens, the available amount of hard currency per person falls, in effect making money more scarce, and consequently, the purchasing power of each unit of currency increases. Deflation also occurs when improvements in production efficiency lower the overall price of goods. Competition in the marketplace often prompts those producers to apply at least some portion of these cost savings into reducing the asking price for their goods. When this happens, consumers pay less for those goods, and consequently, deflation has occurred, since purchasing power has increased.ConclusionsFiat currencies serve specific purposes. They tend to be inflationary to disincentive hoarding and to incentivize investment and consumption. Therefore, stating that because the USD is inflationary should not be interpreted as a conclusion that the government is intentionally trying to make you poor over 75 years. The government is trying to incentivize us to USE our USD so that it has value by serving its purpose: facilitating the exchange of goods and services.The most significant barrier to the adoption of cryptocurrencies like Bitcoin, (just an example, please ignore fees and outdated technology), is that the supply of the currency is deflationary (supply has a hard limit, coins leave the market as people buy them, lose wallet keys, hard drives, or for whatever other reason no longer have their coins). Why would you ever want to be the next Bitcoin pizza guy?We have been witnessing the problem with constrained cryptocurrency supply for years now - most people would rather hoard cryptocurrencies than spend them on anything because it provides more value to you as an asset for investment than as a medium of exchange. Further, the entire mantra of this subreddit is to 'hodl' until one can cash out in their home nation's fiat currencies. That is literally just another way of saying that we want to hoard cryptocurrency for as long as it is likely to increase in value. I know I will get replies like "but I just bought a Tesla with BTC" or whatever. That's great, and good on you for helping crypto achieve its goals! The problem is that there are not enough of us doing that to stabilize the prices of cryptocurrency. Who knows if and when that will happen.Bitcoin, Reddit Moons, and many other cryptocurrencies have a fixed supply of currency. Correct me if I am wrong, but it is impossible to create new Bitcoins. Therefore, as long as the population of Bitcoin users increases, Bitcoin is guaranteed to be deflationary.We are also seeing deflationary indications from Etherium because its supply is growing slowly relative to the increase in its use, which fits the definition of scarce money described in the deflation article. There is no reason to think that ANY OTHER cryptocurrency with usage increases greater than than its supply will experience anything other than deflationary patterns like the others in the short and medium term.Thank you for reading, and I hope that you find this informative.
Submitted April 25, 2021 at 08:33AM
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