Why were Bitcoin and other cryptocurrencies designed with a fixed maximum supply? As the pseudonymous Satoshi Nakamoto put it in his famous paper establishing the protocol for Bitcoin, with a predetermined number of coins in circulation, the system is designed to be “completely inflation free”.
Central banks tend to encourage a certain level of monetary inflation as a way to keep people spending their cash rather than hoarding it.
“Without the fear of inflation, holders of currency tend to hoard rather than spend it,” CME Group economists Bluford Putnam and Erik Norland wrote in Bloomberg in 2018. “This is why most major central banks, such as the Federal Reserve, European Central Bank, and the Bank of Japan, for example, have set modest inflation targets of 2 per cent, as suggested back in the 1960s by Professor Milton Friedman. The inflation target creates a dis-incentive to hoard the currency, since hoarding a currency depresses economic growth and creates financial instability.”
But proponents of blockchain-based currencies often view such strategies, as well as other conventional monetary policies, as undesirable meddling that leaves cryptocurrency holders with less control over their assets. So Bitcoin and other cryptocurrencies – including Ripple, Bitcoin Cash, EOS and Litecoin – were established with fixed supplies to create a kind of “digital gold”. In fact, among crypto fans, there also tends to be support for a return to a fiat-based gold standard.
“Those in favour of fixed supplies, as seen in Bitcoin, say that this creates digital scarcity,” Cointelegraph noted in this guide to crypto values. “Lower supply can mean higher demand, thereby increasing prices. They also say that this sets crypto aside from the global financial system, in which central banks can effectively print more money through a strategy known as quantitative easing, which can lead to inflation and mean the dollar in your pocket isn’t worth as much as it used to be.”
By being inherently deflationary rather than inflationary, fixed-supply cryptocurrencies could in theory encourage people to spend more wisely and avoid debt, because they know every coin not spent today will likely be worth more tomorrow. On the other hand, while out-of-control inflation is a risk under conventional monetary policies, the potential danger with fixed-supply currency is a “deflationary death spiral”.
For example, low levels of spending and investment after the 1929 US stock market crash, when the gold standard was still in effect, eventually drove prices, and then wages, downward as well in a deflationary spiral that started in 1931.
Crypto deflation today wouldn’t lead to another Great Depression, because most goods, services and wages today are still paid in fiat currencies. However, there’s another potential downside to finite supply: an increased disincentive for miners. In his paper, Nakamoto noted that transaction fees could continue to provide miners with an incentive after the last Bitcoin is mined, expected sometime around 2140 when a total of 21 million coins will have been mined.
“Critics say that a reliance on miner fees instead of a block reward will make mining very unaffordable, which will lead to a contraction of miners, a centralisation of the network, and possibly a complete collapse of the network,” Bitcoin.com reported. “There are several different ways that Bitcoin mining can remain profitable after the block reward goes away... The most likely combination of factors that will keep miners afloat in the future is evolving mining technology and the steady increase in Bitcoin’s purchasing power.”
Ironically, the CME Group’s Putnam and Norland see a possible future where central banks themselves might adopt blockchain technology as a way to exert more data-informed and finer control over the economy.
“Blockchain technology has the potential to allow policy makers to issue their own cryptocurrencies that will give them real time information on inflation, nominal and real GDP,” they wrote. “This could allow them to create the amount of money and credit necessary to keep the economy growing at a smooth pace more easily than they do today. Switching off the gold standard vastly reduced economic volatility and improved per capita economic growth. Moving to blockchain-enhanced fiat currencies could further reduce economic volatility and, ironically, enable further leveraging of the already highly indebted global economy as people find ways to use capital more efficiently.”
That outcome, however, is probably not what Nakamoto had in mind when he established a hard limit for Bitcoin.