Bitcoin 105 (101 part 5): inflation and the number of bitcoins

Wednesday 29 June 2016

There will only ever be 21 million bitcoins. This makes bitcoin very different from normal currencies like the dollar, euro and pound.

One of the things that sets bitcoin apart from regular money is its limited supply. The number of bitcoins in existence increases every day, as miners receive their rewards, but the amount they receive decreases over time. Eventually, no new bitcoins will be created, and miners will be rewarded only through the small fees that are required for each transaction.

Although this point will not occur for many years, it means the total supply of bitcoins will never be more than 21 million. This is an integral part of bitcoin, and the nature of the blockchain means it can never be changed.

Dollar balloon

Regular currencies are inflationary: they are worth less over time

Fiat currencies and bitcoin

Regular fiat currencies such as US dollars, pounds Sterling, Euros and Chinese Yuan are all created at will by central banks - hence the term ‘fiat’, from the Latin ‘let it be so’. This means it is possible for central banks to increase the money supply whenever they want, Quantitative Easing being one notable example.

Central banks’ ability to create new money has several implications. One is that the steady increase in the amount of money in existence has the overall effect of making it worth less. Inflation means a dollar today will be worth less than a dollar next year, in terms of the goods and services it can purchase.

Because bitcoin has no central control, it works on a different basis. Its supply is limited by the rules miners follow in maintaining the network. Instead of being an inflationary currency in the long term, it is a deflationary one. (At best the number of bitcoins in circulation will stay the same. Realistically, it will decrease slightly as coins are lost when account-holders die without passing on their private keys, and so on.) All things being equal, its value will increase, rather than decrease over time, like fiat currencies.

‘Digital gold’

This makes bitcoin more like a commodity such as gold, than dollars or euros. Some people even characterise bitcoin as as 'digital gold'. Although the value of bitcoin and gold fluctuate in the short term, due to speculation on the markets, the limited supply of both means they are both deflationary assets.

This deflationary property is attractive to some people, who dislike the idea that regular money can be created at will and devalued in the process.

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