Recently I started investing in bitcoins and I’ve heard a lot of discusses 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 ways to trade value and probably the most practical way to do it would be to link it with money. In the past it worked quite well because the money that has been issued was linked to gold. So Bitcoin Era 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. Since you can guess it’s very an easy task to abuse to such power and certainly the major central banks are not renouncing to do so. Because of this they are printing money, so put simply they’re “creating wealth” out of nothing without really having it. This technique not merely exposes us to risks of economic collapse but it results also with the de-valuation of money. Therefore, because money will probably be worth less, whoever is selling something has to increase the price of goods to reflect their real value, this is called inflation. But what’s behind the amount of money printing? Why are central banks doing so? Well the answer they might give you is that by de-valuing their currency they are helping the exports.

In fairness, in our global economy this is true. However, that is not the only reason. By issuing fresh money we can afford to cover back the debts we’d, in other words 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 is why our countries love inflation. In inflationary environments it’s easier to grow because debts are cheap. But which are the consequences of all this? It’s hard to store wealth. If you keep the money (you worked hard to get) in your money you are actually losing wealth because your money is de-valuing pretty quickly.

Because each central bank has an inflation target at around 2% we can well say that keeping money costs all of us at least 2% each year. This discourages savers and spur consumes. This is how our economies are working, predicated on inflation and debts.

What about deflation? Well this is often the opposite of inflation in fact it is the biggest nightmare for our central banks, let’s understand why. Basically, we’ve deflation when overall the costs of goods fall. This might be caused by an increase of value of money. Firstly, it could hurt spending as consumers will be incentivised to save lots of money because their value will increase overtime. On the other hand merchants will undoubtedly be under constant pressure. They’ll need to sell their goods quick otherwise they will lose money as the price they will charge because of their services will drop as time passes. But if there is something we learned in these years is that central banks and governments usually 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 as it will only get bigger over time. Because our economies derive from debt you can imagine what will be the consequences of deflation.

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

OK so how all this fits with bitcoins?

Well, bitcoins are designed to be an alternative for money also to be both a store of value and a mean for trading goods. They are limited in number and we will never have more than 21 million bitcoins around. Therefore they are designed to be deflationary. We now have all seen what the results of deflation are. However, in a bitcoin-based future it could still be possible for businesses to thrive. The ideal solution will be to switch from the debt-based economy to a share-based economy. In fact, because contracting debts in bitcoins would be very expensive business can still obtain the capital they want by issuing shares of these company. This could be an interesting alternative as it will offer many investment opportunities and the wealth generated will undoubtedly be distributed more evenly among people. However, just for clarity, I have to say that area of the costs of borrowing capital will be reduced under bitcoins because the fees would be extremely low and there will not be intermediaries between transactions (banks rip people off, both borrowers and lenders). This might buffer a number of the negative sides of deflation. Nevertheless, bitcoins will face many problems unfortunately, as governments still need fiat money to pay back the huge debts that people inherited from days gone by generations.