Bitcoin Inflation Convergence

A few months ago bitcoins "inflation" rate was effectively halved from 8% to 4%. This happens through a process called the halving, where the supply of new bitcoins is reduced every 210,000 blocks (or approximately every four years). We have seen demand for the currency growing faster than this creation rate which theoretically leads to bitcoins price increase. Since the last halving we have seen the price of bitcoin go up around 80% to date.

National price inflation rates, the ones people used to talk about in the 80's and 90's are rising reported at around 2% in the USA. What happens when bitcoins reducing inflation rate and increasing headline inflation rates converge? Could there be a relationship between interest rates, national inflation and bitcoins increasing value. Could this changing environment put cash "behind the curve" in a whole new way?

Though these are not calculated in quite the same way for bitcoin, at its next halving it's inflation rate (1.73%) will match the 2% target or ceiling that many countries now use. At this point, we could assume that the bitcoin price should be theoretically stable against the dollar if all other factors stayed the same and volatility is put aside. This halving is due to happen in 2020 with another in 2024 and again until eventually, the rate becomes zero. At this point, we could expect the bitcoin price go up, all things equal again, by the same rate as the national inflation of that year. If countries hold a 2% inflation rate this means the older bitcoin gets the more upward pressure there is on its price and the more attractive it is a store of value as compared with cash. In other words, bitcoin users automatically earn interest on all their bitcoin accounts.

You can see in this situation why more and more people would prefer to be involved in the bitcoin economy and want to move all their finances into this space. The math that once had the effect on average of slightly dampening bitcoins price growth will start to provide an increasing boost. There comes a point where if you are a large investor and have cash you will want to move it all over to bitcoin. Further to this, the curve can become moon like when it gets to a point where it will be worthwhile for a company, able to take out a fiat loan at a low rate, to hold bitcoin with that money rather than pay down debt. Because you can deduct the inflation rate from the interest and then add the expected gains from holding the asset,

It all does sound extremely bullish but there are a few details to be aware of. The premise relies on bitcoin holding together, proving itself as a hard currency, not being replaced and most probably also sorting out transaction volume. Also comparing the money supply side calculations of inflation used for bitcoin with the purchasing power calculations like "core PCE" of fiat currencies like the USD is not an exact match. Bitcoin price can move up and down a lot where the supply is constant. Conversely, fiat values are relatively consistent even when the supply (money printing) is increased a lot. Though this may balance out in the longer term for fiat, there is a level of control here. The PCE number does not show the whole picture in fiat and this is not yet available in bitcoin. We need a new measure for bitcoins inflation and deflation and value growth something to match the current PCE and CPI numbers.

A key to the situation is the level of integration in the economy and digitisation. Where the cost of goods in bitcoin can be updated in real time, the cost of goods in your store with stickers on them are not changed as easily. The inflation convergence concept is strengthened when bitcoin prices for goods become more sticky. Without this bitcoin doesn't counter inflation as directly. online goods purchased with bitcoin simply have prices to mirror those of goods in fiat on a day to day basis. The fiat inflation is masked in the volatility of the bitcoin price. Often high bitcoin prices lead to higher levels of bitcoin spending and stores often sell their bitcoin straight away leading the bitcoin price to fall. Many of the technical advantages of the international cryptocurrency are lost. If bitcoin is not economically integrated price movement simply interpreted as "a bubble" and that inhibits real uptake and removes any sticky prices altogether.

Everything of course is comparative.  In Venezuela, for example, quoting a bitcoin price is better than using your own currency, where in the USA digitally converting to USD prices is favoured. The inflation rate is also much higher there, so run away inflation could be a major to bitcoin utility and price increase. Which comes first is hard to tell. With bitcoins current adoption level, new tools could be developed to measure bitcoin inflation in the same way countries do. This would help. With fiat inflation increasing some people may start wanting to use bitcoin as a checking account and not just as savings. It is a slow process in different pockets of the world but it is proving to be sustained. It could be exponential.  

Mathematically bitcoin is transitioning into deflationary bitcoin environment, and that means the value of bitcoin should continue to go up should it prove to be a truly hard currency. The only way for Janet Yellen to get behind the bitcoin curve is to put interest rates up fast and try to induce some fiat deflation... And that I think is unlikely.