Recently I started investing in bitcoins and I’ve heard a lot of talks about inflation and deflation but not many people actually know and consider what inflation and deflation are. But let’s start with inflation.

We always needed a method to trade value and probably the most practical way to take action is to link it with money. In past times it worked quite well because the money that was issued was linked to gold. So every central bank needed enough gold to pay back all the money it issued. However, previously century this changed and gold is not what is giving value to money but promises. As possible guess it’s very easy to abuse to such power and certainly the major central banks aren’t renouncing to do so. For this reason they are printing money, so in other words they’re “creating wealth” out of nothing without really having it. This technique not merely exposes us to risks of economic collapse nonetheless it results also with the de-valuation of money. Therefore, because money is worth less, whoever is selling something must raise the price of goods to reflect their real value, that is called inflation. But what’s behind the amount of money printing? Why are central banks doing so? Well the answer they would give you is that by de-valuing their currency they’re helping the exports.

In fairness, inside our global economy this is true. However, that is not the only reason. By issuing fresh money we are able to afford to cover back the debts we’d, basically we make new debts to cover the old ones. But that’s not only it, by de-valuing our currencies we have been de-facto de-valuing our debts. That’s why our countries love inflation. In inflationary environments it’s simpler to grow because debts are cheap. But what are the consequences of all this? It’s hard to store wealth. If you keep the money (you worked hard to obtain) in your bank account you’re actually losing wealth because your cash is de-valuing pretty quickly.

Because each central bank comes with an inflation target at around 2% we can well say that keeping money costs most of us at least 2% each year. This discourages savers and spur consumes. This is one way our economies are working, based on inflation and debts.

What about Bitcoin Revolution ? Well this is often the opposite of inflation and it is the biggest nightmare for our central banks, let’s see why. Basically, we’ve deflation when overall the prices of goods fall. This might be caused by an increase of value of money. To start with, it could hurt spending as consumers will be incentivised to save money because their value will increase overtime. However merchants will undoubtedly be under constant pressure. They’ll need to sell their goods quick otherwise they’ll lose money because the price they will charge because of their services will drop as time passes. But when there is something we learned in these years is that central banks and governments do not care much about consumers or merchants, what they care the most is DEBT!!. In a deflationary environment debt will become a real burden since it will only get bigger as time passes. Because our economies are based on debt you can imagine exactly what will function as consequences of deflation.

So to summarize, inflation is growth friendly but is founded on debt. Therefore the future generations can pay our debts. Deflation however makes growth harder but it means that future generations won’t have much debt to cover (in such context it might be possible to afford slow growth).

OK so how all this fits with bitcoins?

Well, bitcoins are made to be an alternative for the money and to be both a store of value and a mean for trading goods. They’re limited in number and we’ll never have a lot more than 21 million bitcoins around. Therefore they’re designed to be deflationary. We now have all seen what the consequences of deflation are. However, in a bitcoin-based future it would still be easy for businesses to thrive. The ideal solution will be to switch from the debt-based economy to a share-based economy. Actually, because contracting debts in bitcoins would be very costly business can still obtain the capital they need by issuing shares of their company. This could be an interesting alternative as it will offer you many investment opportunities and the wealth generated will be distributed more evenly among people. However, just for clarity, I must say that the main costs of borrowing capital will undoubtedly be reduced under bitcoins because the fees will be extremely low and there won’t be intermediaries between transactions (banks rip people off, both borrowers and lenders). This would buffer some of the negative sides of deflation. Nevertheless, bitcoins will face many problems unfortunately, as governments still need fiat money to cover back the huge debts that we inherited from the past generations.