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What is the link between Bitcoin and the inflation rate?

What is the link between Bitcoin and the inflation rate?

The relationship between Bitcoin and inflation is one of the main reasons for believing in the solidity of the asset and its use as an alternative to national currencies in countries with hyperinflation. Just to give you an idea, a research firm in the financial sector projected that Bitcoin will have a lower inflation rate than gold in 2021.

But what does this mean in practice for those who seek innovation in currencies and want to have Bitcoin in their portfolio? That’s what we are going to talk about today.

In this article, we will tackle the following questions:

Interested? Then get off that couch, grab some coffee and enjoy the read!

What is inflation?

In order to understand the relationship between Bitcoin and the inflation rate, we need to first define the two main terms in this scenario. Bitcoin, of course, you already know. But what about inflation, do you know what it entails?

There is a certain misunderstanding about the term. For many, it is about increasing the prices of products on the market. When rice, meat, beer, cars or cell phones go up, we have inflation, right? Well, yes, but not exactly.

The price increase in the market is not inflation itself, but the best-known symptom of how it works. In practice, inflation happens when the money supply and credit in the market are greater than the result of the production negotiated in that environment.

Imagine a farmer who has a chicken. His chicken lays 6 eggs every week. Every Saturday, a traveler passes by that farm, who buys all the eggs for 6 coins. That is: each egg is equivalent to a coin. That is the egg’s price.

However, one day, a second traveler also appears with 6 coins. In total, there are 12 coins competing for 6 eggs. The farmer then raises the price of the products to maximize his profit. The result: each egg is sold for 2 coins and each customer goes home with 3 eggs

The illustrative example shows the basic functioning of inflation. In practice, we had a 100% variation in the price of the product (eggs) because of a 100% increase in the money supply (with the second traveler).

In real life, the amount of demand is defined by the amount of currency in circulation plus the supply of credits (personal loans, credit cards, financing, and others). If there is an increase in this, there is an inflationary factor that generates an appreciation of goods for sale in the country. Typically, many countries issue new units of money as part of their macroeconomic policies. However, these actions have the side effect of increasing inflation.

 

What is the relationship between Bitcoin and inflation?

Now that we understand the concepts, it’s time to ask what is the relationship between Bitcoin and inflation. After all, how does cryptocurrency innovate in managing the value of products in the market? How is it possible that the inflation rate of crypto will go down while other currencies’ and assets’ will go up?

To understand the relationship between Bitcoin and inflation, we need to start from the fact that there are a limited number of units in the cryptocurrency: 21 million. Recently the number of Bitcoins in circulation has reached 18 million. The 21 million limits is expected to be reached by 2140.

This happens because of the way Bitcoin is produced. It is mined in a decentralized manner (meaning that anyone can mine Bitcoins if they have a computer powerful enough).

The fact, however, is that the number of Bitcoins is limited to 21 million units, divisible by up to 8 decimal places. Thus, there is no way to issue new currencies.

Without the ability to issue new Bitcoins and not even a centralized government that can approve the issuance of new currencies, the cryptocurrency is practically immune to inflationary effects, being an excellent asset for accumulating wealth.

 

What is Bitcoin’s pre-programmed inflation rate?

Mining is done by solving a problem proposed by the Bitcoin algorithm. On average, this takes 10 minutes to achieve. Each mined block currently generates 12.5 units of the cryptocurrency.

However, this value is not fixed. Every given amount of time, a halving occurs, which is when the coin reward per mined block is halved. The next halving is expected to take place in May 2020, when each block mined will be worth 6.25 Bitcoins.

In other words: Bitcoin’s current inflation rate is set at 3.74% per year, but is forecast to decrease steadily as more blocks are mined thanks to its currency limit.

Therefore, Bitcoin inflation is predictable thanks to its open-source and will tend to zero as we approach 2140 when the last currency will be produced. After that, there will be no more inflation.

 

How does Bitcoin help countries with hyperinflation?

Because of this solidity and inability to be manipulated, Bitcoin is a very powerful solution for people in countries that are going through hyperinflationary processes, as is the case in Argentina today.

The South American country reached record inflation rates in 2019. The monthly average for inflation rates is around 4% per month, which accumulated to a whopping 55% in a span of 12 months.

In practice, a product that used to cost 100 pesos a year ago, now costs around 150 pesos. This greatly erodes the purchasing power of Argentinians, who are now able to buy much less because of uncontrolled inflation.

Because of this, Bitcoin has become a viable alternative for the Argentine population. 37 cities in the country already use cryptocurrency as an alternative means of payment for public transport. Buenos Aires, the country’s capital, is constantly installing Bitcoin ATMs. In fact, Argentine traders have already registered record cryptocurrency movements in the country.

With all this in mind, Bitcoin becomes an attractive asset to protect its wealth in the long run, especially in countries with fragile economies and with the possibility of hyperinflation. Brazil, for example, is not much different from Argentina. Presently, Brazil has an inflation rate of around 2.89% per year, but it is more due to the cooling of the economy than good government practices.

Just remember that, in 2016, the inflation rate exceeded 10% per year. In the 90s, it went up to 4,000% per year, while in the 80s it reached 6,000% per year, as our history records. In other words: there is a real possibility that your wealth will devalue sharply because of poor state management. So, the relationship between Bitcoin and inflation presents itself as a good way to protect its assets.

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