Bitcoin vs. Fiat: A Tale of Two Currencies
In a world increasingly dominated by digital transactions and a fluctuating economy, Bitcoin presents an intriguing alternative to traditional fiat money systems. In medicine, we need to understand (diagnose) the problem in order to cure the patient. Inflation is the disease in the fiat money system. Let's explore why Bitcoin is the cure to inflation.
The Nature of Fiat Money
Fiat money, unlike Bitcoin or gold, isn't backed by a physical commodity. Its value is based on trust in the issuing government and its central bank. Fiat means 'by decree,' and in this case refers to the government declaring which currency will be used within its border. This system allows for a significant amount of flexibility, enabling governments to print more money when deemed necessary for economic growth, managing national debt, or responding to crises. However, this flexibility comes with a cost: inflation.
Inflation occurs when the money supply increases. Some (most?) economists will argue that inflation only occurs when there is not a corresponding increase in economic output. Regardless, what occurs is more currency is chasing the same goods. This scenario leads to each unit of currency buying less over time, as there's more money chasing the same amount of goods and services. This is reflected by Adam Smith's laws of Supply and Demand.
Bitcoin’s Deflationary Model
In stark contrast, Bitcoin operates under a completely different economic model. It has a hard cap of 21 million coins, embedded into its protocol. This scarcity is not just a feature; it's a fundamental aspect of Bitcoin's design. Every four years, Bitcoin undergoes a "halving" event where the reward for mining new blocks is halved, effectively reducing the new supply entering the market over time.
Be careful when you are hearing from people who don't understand this, or perhaps have other perverse incentives to keep you from learning about Bitcoin. For instance, here is what Jamie Dimon, JP Morgan's CEO, said last year:
Bitcoin's fixed supply is designed to counteract the inflationary policies often associated with fiat currencies. As more fiat money is printed, potentially leading to higher inflation, Bitcoin's fixed supply could, in theory, increase its value if demand remains constant or grows.
The supply cannot be 'artificially inflated,' or changed, because the network creates the supply, and recognizes the addresses where the created coins have been spent/moved. Mr. Dimon's lack of understanding of this basic principle, which Joe Kernen is trying to explain to him, really drives home my point of be careful who you trust. In Bitcoin parlance, this phrase is "Don't Trust, Verify." You can verify that the bitcoin code does not allow for any additional coins after 21 Million.
The Economic Consequences
With fiat currencies, central banks often target inflation rates (like the 2% target of the US Federal Reserve) to encourage spending over saving. This policy is based on the assumption that inflation is necessary to stimulate economic activity. However, this constant increase in money supply ultimately leads to a decrease in purchasing power over time.
Bitcoin, on the other hand, encourages saving rather than spending due to its increasing value over time. This aspect makes it an attractive option for those looking to preserve wealth in times of economic uncertainty or high inflation.
Historical Performance and Future Projections
This isn't just theory. Historical data (chart above) shows Bitcoins value has risen over time. Said another way, fiat's purchasing power has fallen. Thusly, bitcoin is behaving as a 'store of value.' It is wise to think of this as a store of value over long time frames, because the asset price can vary widely in short time frames.
There is only one thing that drives the price rise over time, and that is increased demand. Why would demand increase? The simplest answer is increased adoption. As more global citizens learn that bitcoin is the cure to the inflation in their own currency, they will demand Bitcoin. Currently, most people around the world think of the US Dollar as the stable currency. While it may be more stable than their local government coin, it is far from stable, as we Americans are experiencing inflation at home. People trade into Bitcoin and back into their local currency 24/7 and this allows for the volatility. That volatility scares a lot of people. But, again refer to the chart, the volatility is to the upside. Buy and hold for the long term, and you will win. Below is the same chart, but on a linear scale.
And if you zoom in to that flat part of the price chart on the left (2012-2016), you see the same volatility:
As long as the fiat system continues its trend of currency expansion, Bitcoin's fixed supply will keep its purchasing power on an upward trajectory. This assumes, of course, that Bitcoin's adoption and public faith in its system continue to grow. I have spent considerable time on this, and have not found a way for it to be stopped. Bitcoin is 'too big to fail' at this point. Unlike gold, which the US government confiscated from its citizens in 1933, Bitcoin held in self-custody cannot be seized.
Bitcoin has no leader to be jailed, the protocol is open-source and free to be downloaded and run by anyone with a computer. No one can influence the CEO to get a favorable deal. The only way to get some Bitcoin is to mine it with your computer(s), or buy it from someone willing to sell it to you.
As more and more people discover this truth, the demand will rise, because bitcoin has an inelastic supply. In other words, supply will not expand because more people want it. Consider elastic supply goods like gold, oil, or wheat: companies can expend capital to create more of these goods and sell into the market. Despite more people wanting Bitcoin, the supply issuance is the same and decreasing over time.
In my opinion, the price rise happens when more people demand bitcoin. The price rise catches the attention of more people. It becomes in the news/zeitgeist. As more people learn and buy, the price rise eventually becomes dramatic. This attracts more attention, and this gets more people, and so on. However, many of the individuals participating in the trade of bitcoin vs fiat currency do not have the confidence, financial stability/flexibility, and long time horizon required to really hold onto the bitcoin capture exponential purchasing power gains. Also, a lot of the people who join in late use leverage and get rekt. Leverage is RISKY. Not everyone who comes in late leaves, but instead they study and become believers (Bitcoiners). These diehard bitcoiners create the new floor price that we see between all time highs. This floor price steadily rises over time. Measuring from bitcoin floor price to floor price between the all time high (ATH) is a better gauge of societal adoption than the FOMO we see on around the all time high. I think most humans look at the peaks of the chart. Go back and look at the charts above, and focus only on the lows, and you see clear increase in purchasing power of the asset over time. Even if you went all-in at an ATH, these price points are eventually below the inter-high low on a 4 year or greater time horizon. One way to avoid the mental anguish over when to buy is to dollar-cost-average over time. Also, notice the volume bar graph at the bottom of the second chart. See how the volume increases during the dramatic price rise, and then the volume tapers off when it falls? This volume increase is during the FOMO phase, and the market is filled with tourists who don't understand the profound importance of Bitcoin. Some of those tourists, though, will stick around, and study Bitcoin, and become Bitcoiners, and they will create the next floor.
These patterns have occurred on a 4 year cycle. Most people in the space believe this is related to the halving, and that may be true. The pattern has occurred 3 times so far. My guess is that we have at least one or two more parabolic rises before enough humans with their investable assets understand Bitcoin. Maybe there are 3 more, but I doubt it takes 4. Time will tell. My advice is spend some time studying Bitcoin. Your future self will thank you. If you wait until 'everybody knows that Bitcoin is the best,' then you have missed on the exponential upside.
Conclusion
Bitcoin's design presents a direct challenge to the inflationary nature of fiat currencies. Bitcoin's model of scarcity contrasts sharply with the abundance inherent in fiat systems. This fundamental difference favors Bitcoin in terms of long-term purchasing power.
The debate between Bitcoin and fiat money isn't just about digital vs. physical currency; it's about fundamentally different economic philosophies: scarcity versus abundance in currency supply. Considering the argument that "Bitcoin is an inflation hedge," I would suggest a better phrase from Parker Lewis: Bitcoin is the solution for inflation.
Feel free to share your thoughts in the comments below. Do you see Bitcoin as the future of money, or do you think other factors will ultimately determine its fate? Let's keep the conversation going!
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