A fundamental economic flaw in Bitcoin

This news was published around a decade back. What would you do if Toyota makes a similar announcement today?

I guess, if you are planning to buy a Toyota car then you would rather wait and buy it only after the prices drop. This could actually be detrimental to Toyota’s current period sales.

When the price of a product is expected to go down, people postpone their decision to buy the product. This explains why a deflationary scenario can be disastrous for the economy when measured by standard parameters like GDP which is based on consumption.

On the other hand, a moderate level of inflation is actually healthy for the economy as it drives consumption.

But where is this inflation coming from? It is not some natural phenomenon, in fact, it's a man-made (central bank made) phenomenon. Central banks systematically control the supply of money such that a moderate level of inflation is maintained. There are multiple benefits to this, the major one being — inflation discourages people from just holding the currency as a store of value and instead force them to either consume it or invest it in productive avenues.

However, if we were to think purely in barter terms, we have been living in a deflationary scenario for a very long time. Almost every product and service has become efficient over the years. Research shows that an average American in 1959 had to work for around 100 hours to buy a washing machine. Today, it's just around 20 hours. There are 2 reasons for this: (A) The average American has become more productive. (B) The washing machine manufacturing companies have become more efficient.

Despite this improvement in productivity and efficiency, the price (measured in dollars) of washing machines has only gone up — thanks to the inflation that is created by central banks (the one who creates the dollar).

Now, let's take the case of bitcoins.

Imagine a world that has abolished all central bank currencies and bitcoin is the only medium of exchange.

As per the bitcoin algorithm, only 21 million bitcoins can be mined. Of which, around 19 million has already been mined, and within the next few years the remaining 2 million is expected to get mined too. And then the supply of bitcoin stops.

As the world continues to become more efficient and productive, products and services will get cheaper in bitcoin currency terms. There is no way to artificially create inflation in bitcoins as they cannot be printed or mined beyond a particular level.

This is where bitcoin as a currency might fail. A world with bitcoin as the the primary currency will always be in a deflationary scenario. In such a world, bitcoin could do a good job as a store of value, but will it really become a good medium of exchange? Will it really drive consumption? or just lead to hoarding?

The Blockchain and Distributed Ledger Technology (DLT) innovation have definitely shown us that we can imagine a world without banks and other intermediaries. But is Bitcoin really the best use of this innovation?