INVESTED: In Markets, in the Future, and in Society.

Hyper-deflation by Design

What is nightmare fuel for Federal reserve chairmen? The looming specter of deflation.

When your capital buys you more in the future than it does today, it becomes profitable for individuals and businesses to hoard their money, and both investment and spending are discouraged. The demon of deflation slows the flywheel of our economic system. Without money flowing, production slows and halts, and our economic engine grinds to a halt. If deflation is so terrifying for fiat currencies, why is it the primary value statement of most crypto currencies today?  

Why do I say crypto is deflationary? First, let us remember the namesake of crypto as currency. In 2016 you would have needed to spend 100 bitcoin to buy a new car. In 2019, 10 bitcoin. In 2022, a single bitcoin is enough. Contrast this with fiat currencies: from 2016 to 2022, the price of a new mid-range sedan in Canadian dollars has gone from maybe $30,000 to $40,000. The intrinsic value of the car hasn’t changed – it’s the same product. From the perspective of spending fiat currency, the price has inflated because Canadian dollars are seen as less valuable. However, from the perspective of a resident living in cryptoland and spending bitcoin, the price has deflated. In fact, the relative cost has deflated by 10,000 percent over a five-year period. It is this hyper-deflation of real assets with respect to a crypto holder which people are eager to participate in. Most people investing in crypto today aren’t the crypto anarchists of old, looking to shake off the yoke of the federal reserve and the legacy of the 2008 bailouts and quantitative easing. Rather, messaging like “fortune favours the brave” suggests that you too could get in on that sweet, sweet deflation. 

One might argue that deflation is the wrong lens through which to view crypto; it’s an investment like any other financial asset and investments should go up. However, in contrast to other common financial assets, bitcoin is a zero-sum game. If you hold stocks, you are investing in companies which create real products and provide real value to the economy. Sure, every trade on a stock has a winner and a loser, but the value created in the real economy means that the total size of the pie is growing: non-zero-sum. Crypto is different: holding bitcoin is not directly associated with investments in any real economic activity, and the total number of bitcoins that will ever exist is fixed. The size of the pie is constant. Investment in bitcoin is zero-sum. Any dollars which you earn on your crypto holdings must come from dollars someone else is putting in.

Crypto currencies are hyper-deflationary by design because they are predicated on a perpetual promise of someone else believing more in its intrinsic value than you do; they pay you out today in the hopes that someone else will come along and pay them out tomorrow. There are two possible conclusions to this story: either we are in one of the biggest “greater fool” investment runs of all time, or humanity will collectively agree on the stable, intrinsic value of bitcoin, ether, and all the other crypto currencies. Given our inability to agree on the intrinsic value of Microsoft or RBC or Spotify, which are real companies producing real goods and services which can be observed and measured, I find it unlikely that we will be able to agree on the intrinsic value of something so esoteric as decentralized, trustless ledgers. But am I willing to be wrong and miss out?