Crypto Currently

Cryptocurrencies Are in Fixed Supply and That's a Problem

Economists have long known that fixed currencies tend to fall in value.
February 5, 2018, 4:50am
Image via Shutterstock

Crypto Currently is our three-times-a-week update on digital currencies in Australia and overseas.

What's new in crypto this week? Well, not much really. The disastrous start to the year for many of the major cryptocurrencies is showing little signs of abating. Bitcoin was the hardest hit out of them all, and has broke through the $10,000 mark for the first time since November last year. And Ripple is quickly giving up all the major gains that it made during December.

But even with these steep declines in price, it’s important to remember that all the major cryptocurrencies are still up hugely from a year back, or even six months ago. Anyone who bought in early has still done extremely well. There are also claims floating about that with the decline in price, Bitcoin may be transitioning from a speculative gambling instrument to a more stable currency. As some of the more enthusiastic fans claim, cryptocurrency will eventually replace fiat government-issued money. In the future, they claim, crypto will be used just as widely as we now use credit cards.

One of the main benefits of crypto, say its proponents, is that the currency is in fixed supply. Fiat currency, on the other hand, is paper created out of thin air by central banks that manipulate its value for their own purposes.

On the surface this seems like a solid argument. But scratch a little deeper and you hit a central pillar to economic theory: the more transactions that occur using crypto, the more its value will tend to rise. I'll explain.

Imagine an economy with $100 of currency that produces only one item—apples. If this economy produces 10 apples a year (assuming they’re all the same), the price will need to be $10 each to clear the market. If output rises to 20 apples, the price will (assuming nothing else changes) then fall to $5. So if output grows and the quantity of money is fixed then prices must fall as the same amount of currency chases more and more goods and services.

This is a major problem because if prices keep falling people will stop spending and hoard their money because they think it’ll buy them more later on. Then if people stop spending, the economy will grind to a halt and people will lose jobs.

Central banks therefore have an important job to do in creating new currency to maintain stable prices. Without stable prices, the economy is likely to suffer. And as long as this rather fundamental economic principle exists, it's difficult to see how cryptocurrency will ever achieve mainstream adoption.

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