Understanding Deflation
In macroeconomic terms, deflation typically refers to a decrease in the general price level accompanying a contraction in the monetary supply.
However, price declines can occur due to various factors, such as low productivity, technological advancements, or decreased demand.
Deflation | Source: Investopedia
In the context of Bitcoin, deflation relates explicitly to the cryptocurrency‘s maximum supply.
Bitcoin has a fixed limit of 21 million coins that will ever be mined.
Once this limit is reached, no new coins will be created, and block rewards will cease.
Over time, the circulating supply of Bitcoin may actually decrease as a result of lost private keys and unrecoverable coins. Many other cryptocurrencies also follow a deflationary model.
Addressing Deflation Concerns
The Bitcoin community has always been concerned about the implications of a deflationary system.
Beyond mere speculation, those who envision Bitcoin as a widely adopted medium of exchange discuss solutions such as subdividing Bitcoin into smaller units (bits).
Proponents argue that Bitcoin’s infinite divisibility can help address potential challenges associated with deflation.
Deflation Debate
Furthermore, some individuals argue that the problem lies not with the deflationary nature of cryptocurrencies but with the inflationary nature of fiat currencies.
They posit that prices will naturally decrease in a Bitcoin-based economy due to increased innovation and productivity.
They believe that a deflationary spiral would be unlikely because Bitcoin is not based on theoretical loans but on a tangible and finite money supply.