Bitcoin isn’t a useful currency for many reasons. And one top reason is that it’s a deflationary cryptocurrency. Let’s look at why this is bad and how Gresham’s Law applies.
Why is Bitcoin Deflationary?
There’s a reason the Federal reserve shoots for low inflation. As the economy expands, so should the amount of dollars in the system. If deflationary currency takes hold, a single dollar would buy you more in the future.
That sounds great on the surface, but it pushes people to avoid spending today knowing they can buy more later. This can then lead to a vicious cycle of decreasing prices and wages.
In a vacuum, deflationary currency might work well. But that’s not reality. We live in a world with many competing currencies and there are many factors at play. For example, technology is a deflationary pressure. For a counter argument on why deflation is good, check out The Price of Tomorrow (affiliate link).
With history as a guide, deflation tends to be the worse of two evils.
With that in mind, Bitcoin is a deflationary cryptocurrency. There’s a finite amount of Bitcoin that will ever be available – about 21 million. But on top of this, people lose access to their Bitcoins by forgetting their private keys (access to Bitcoin wallets).
These Bitcoins don’t disappear from the system. Anyone can track them down in the public decentralized ledger, but they’re out of circulation.
I believe this is one of the big reasons why Bitcoin will fail as a currency. Although for now, the number of Bitcoin available will continue to climb thanks to Bitcoin miners.
Bitcoin and Gresham’s Law
What is Gresham’s Law? You can boil Gresham’s Law down to a simple definition… Bad currency beats out the good currency.
Here’s a short video I published a few years ago…
There are over 100 comments and I’ve responded to many questions. If you want a deeper understanding, check them out. And feel free to comment with any questions or say hello (and where you’re watching from). Because this motivates me to keep sharing my research.
A bad currency is one that’s losing value compared to competing currencies. For example, if you have silver coins and fiat U.S. dollars, you’re more likely to spend the dollars (even assuming they’re equally easy to spend).
Inflation is slowly chipping away at your dollars’ purchasing power. This makes dollars the bad currency. And silver is the good currency. It tends to keep purchasing power over the long-term.
People tend to spend money that’s losing value. They hold onto the appreciating currency. And this creates a feedback loop that pushes the good currency out of circulation. With market competition, companies go to great lengths to make it easier for you to spend your money (reduce friction).
This example of Gresham’s Law helps explain why deflationary cryptocurrencies will fail. And Bitcoin has many advantages over traditional currencies such as silver and gold. However, it can’t compete with government currencies…
The U.S. Dollar is a Cryptocurrency
The U.S. dollar reigns supreme in part due to the network effect, backed by government mandates. You have to pay your taxes in dollars. But barring those points, the U.S. dollar would still be the more useful currency.
I’ve run into many crypto fans that want to replace the U.S. dollar. However, that approach is throwing the baby out with the bath water. The current system is far from perfect, but is Bitcoin better?
I’m a big fan of Bitcoin’s decentralized control. But it comes with many downsides. Without forking, Bitcoin can’t fix transactional mistakes. And it can’t adapt and expand its use cases. As a result, developers are adding layers to make it more useful. But this adds complexity that comes with costs (fees, security issues, etc.).
Back in 2017 I sent out close to $500,000 worth of Bitcoin. This was in batches of $250-$300 to roughly 1,900 different wallets. And I can’t remember the exact transaction costs, but the total was in the thousands. And if I made a mistake in sending, I wouldn’t have been able to reverse it. Unlike the U.S. dollar, there aren’t good protections in place (FinCEN, AML, KYC, etc.).
The Fed has also announced that it’s exploring central bank digital currency (CBDC). But it’s easy to argue that the U.S. dollar is already a digital currency. Most transactions take place online and they’re backed by different layers of cryptography (most of the web is secured with encryption). But I digress…
I hope you’ve gained a better understanding of Bitcoin and Gresham’s Law. Deflationary cryptocurrencies have many barriers to overcome. And to learn more, here’s the original video I shared on Why Bitcoin Will Fail as a Currency. Feel free to comment with any questions.