Introduction
If you are even the slightest bit aware of what Bitcoin is, then you are likely aware that Bitcoin is issued into the Bitcoin economy through the mining process.
Though lots of purists may deny this, the truth is that this has made bitcoin a de facto inflationary currency since its inception with new Bitcoin being issued into circulation by miners as their reward for solving hash blocks created by Bitcoin's cryptographic algorithm.
However, all this may be about to change.
What I set out to do in this article, was to check how Bitcoin performs from an inflation/deflation point of view.
Deflationary assets ultimately make for better investments. Unlike with fiat, cryptocurrencies are infinitely and easily divisible so there is no real threat to market liquidity from deflation alone because the same cryptocurrencies are infinitely divisible as price appreciates.
There is also the very obvious fact that any cryptocurrency in a state of deflation is likely to make a recovery from the recent crisis sooner rather than later.
Inflation And Deflation In Bitcoin
The nature of inflation in Bitcoin is an interesting one because what we have to remember is that there is only a single source of Bitcoin in the overall Bitcoin ecosystem (the miners) versus fiat which has multiple different sources for it's issuance (including central banks and also the issuance of credit by retail and business banks). This means that Bitcoin's overall inflation rate is far more vulnerable to being offset by deflationary factors than fiat which should obviously be interest to investors.
To contrast this, one of the main causes of deflation is the fact that Bitcoin ultimately gets lost (sometimes in significant quantities) and tiny pieces of it (equivalent to "loose change" in the fiat world) get left in wallets and accounts and are forgotten about. A significant percentage of bitcoins are also tied up in long-term investments and thus not actively circulating in the markets.
Factoring the two together should logically give us forecasts for the overall net rate of inflation and of course whether it is a positive or negative figure.
The Known Statistics
The first thing we have to remember are a few fundamentals regarding the issuance of new Bitcoins into the markets.
- Bitcoin has a hard market cap of 21 million coins.
There will never be any more than 21,000,000 coins without a substantial revision to the coding of Bitcoin itself.
- The current supply is in the region of 17,379,150 BTC
Around 17.3million (17,379,150) coins have already been mined and are out there in the wild. This equates to around 82% of the maximum possible supply.
Bitcoin Inflation And Liquidity Are Actively Reducing
Factoring in the issuance of new Bitcoins, https://www.bitcoinblockhalf.com/ is currently quoting Bitcoin's inflation rate as 3.86% per annum averaging-out due to the impact of miners upon the ecosystem. However, the problem with this figure is that it is a gross figure and does not take into consideration the problem of lost coins and coins which are actively being taken out of circulation due to investing and so forth.
Thus, the gross inflation figure does not factor in the counter-effect of deflation through contraction of the circulating supply and so we need to somehow come up with a net figure for what Bitcoin's current rate of inflation is which is what I ultimately set out to do in this article.
Lost Coins
The first thing I did was to look for estimates of how many bitcoins have been lost and taken out of circulation as a total percentage of the supply.
The main search result was an article from Fortune.com which quotes between 2.78 and 3.79 million bitcoins being lost forever as of 2017.
"According to new research from Chainalysis, a digital forensics firm that studies the bitcoin blockchain, 3.79 million bitcoins are already gone for good based on a high estimate—and 2.78 million based on a low one. Those numbers imply 17% to 23% of existing bitcoins, which are today worth around $8,500 each, are lost."
(Source: http://fortune.com/2017/11/25/lost-bitcoins/)
The same fortune article quotes figures in the region of 8.6 million Bitcoins are also "out of circulation" through the fact of people simply holding onto them without necessarily losing them or losing access to them on a permanent basis. Sometimes people even forget about them and never bring them to market. Moreover, the estimate is that around 50% of these (4.3million coins) will never actually be bought to market.
The Math
So lets do some math and work backwards.
If we take the figures of Chainanalysis's estimate for "out of circulation" coins which includes long-term "Hodlers" and Strategic Investors and work off Chainanalysis' assumption that 50% of these are not going to be brought to market and take this number as a percentage of Bitcoin's overall supply then these figures combine into an aggregate figure of 4.3 million Bitcoins representing 20.4% of the max possible supply.
We can add into this the figures for "permanently lost" coins which amounts to between 2.78 - 3.79 million bitcoins. We'll take the median figure here which amounts to 3.28 million bitcoins representing an additional 15.6% of the max possible supply.
The combination of these two statistics represent over 35% of the total current circulating supply.
We thus arrive at a rather conservative net figure of 35% of the current reported supply of Bitcoin effectively being absent from circulation.
Now, bear in mind, Bitcoin has only been around for roughly 9 years. So what we'll do is take that 35% figure and average it out over a decade.
This figure over 10 years translates to a net deflationary burden of 3.50% per annum.
Taking the current inflation rate of Bitcoin (which is reported by https://www.bitcoinblockhalf.com/) then the current Bitcoin inflation rate per annum is reported as being 3.85%.
Therefore we can subtract the deflationary factor from the inflation report figure and give us a net inflation score for Bitcoin.
3.85 - 3.50 = 0.35Thus, as of 2018 we are currently experiencing roughly 0.35% per annum net inflation.
Now the interesting part to this story comes because www.bitcoinblockhalf.com report that Bitcoin's gross inflation rate will reduce to 1.80% per annum.
Assuming that the median rate of deflation per year is going to remain stable then the math works out the following figures:
1.80 - 3.50 = -1.70Giving Bitcoin a net inflation score of minus 1.70 percent.
The projected date for this to occur (assuming everything remains stable on the Bitcoin network) is on the next Block Halving which is forecast to occur on May 27, 2020.
Conclusion
Now think about this... this means that for the first time in it's decade-long history, Bitcoin will become a deflationary currency.
I must also stress that throughout this article I have deliberately used a conservative set of figures. The actual fact of what happens out in the markets is likely to be far more radical.
My conclusion here is obvious. Deflationary currencies are no-brainer buy-n-holds from an investors point of view. If Bitcoin is set to become one, then we should be buying it now while it's cheap. Moreover, if Bitcoin will drive the crypto market recovery as it has done in the past, then the run up to 2020 will be critical.