Is Crypto Inflationary or Deflationary?

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Crypto is booming right now. Largely because of the purchase of more than a billion USD in Bitcoin by Tesla CEO Elon Musk. He is making the Winklevoss brothers rich who famously bought 200 mln wordth of BTC when it was below $4000 per BTC or less. But crypto is confusing to many because contrary to ordinary USD BTC seems to be in deflation, one of the main reasons to own it.

Inflation and deflation are words often used and its necessary to define them a bit more precisely to be able to answer the question above. In theory inflation is the situation in which more money is trying to buy the same amount of product, leading to higher prices, and deflation is when there is less money for the same amount of product, leading to lower prices. So lets look at a situation when a couple of people have to share a finite amount of money and buy a finite amount of product.

10 People each having 10 Euro to buy 10 breads => Price of bread is 10 Euro!

10 People each having 100 Euro to buy 10 breads => Price of bread is 100 Euro!

From the above you can see that the value of the Euro is not fixed, it really depends on the amount of bread that is available, as well as how much Euro are made available. We often ignore this in real life, maybe coins being so tangible make it harder to believe they can vary in value. The Euro is just a means of exchange, and it even has next to zero intrinsic value. The above also shows you that banks that can create money can mess things up.

Where does bread come from?

planting(using diesel)->tending(using diesel)->harvesting(using diesel)->logistics(using diesel)->milling (using electricity)->baking (using fossil fuel)->bread

Now the above picture is not complete because we have to make money to spend it, and of course we also spend money to produce, so the bread in the example does not fall out of the heavens. This complicates things because it immediately shows the strange nature of our current economy, in the sense that we can always buy something nobody can make : fossil fuels. Let’s close the loop and say the people in the example are all bakers baking 1 bread. This way the cycle is closed..

The baker bakes one bread, sells it for 10 Euro, then goes out to buy bread for himself for 10 Euro. Next day the cycle repeats.

Our imaginary baker will earn the money to buy bread each day by baking bread. Now this can’t work. Because to bake bread the baker needs to pay for the flour and energy and labour He will earn less than 10 Euro baking one bread! If he pays the energy company how does that money ever return to the economy? The energy company is not spending any money in society except perhaps wages of its workers. We know the energy company has to pay for the gas and oil or coal it uses (in the fossil economy). So who ends up with a large part of the money? The oil and gas companies! Do they spend it? No! What’s going on??

The economic system until discovery of fossil fuels

We need a complete picture of a working ‘economy’ first in order to talk about what currencies do in such a system. The above image shows the situation as it was until we discovered fossil energy (and nuclear energy). The sun and the weather combined with a rather constant number of people. The economy consisted of those that ensured people could survive, those that supported that effort and those that did other things but where not essential (ignoring governing structures such as kings and religions).

Money the qunatity of which remains relatively constant, like the labour pool

In that era gold could be money, because the amount of gold was about as constant as the amount of labour. Prices would not fluctuate too much except when nature or war struck the population. Governments and banks tried to print money and this always resulted in a crisis as the glue of cooperation was being destroyed. I consider one of the primary functions of money that it makes people cooperate. Still in that era many people where happy and poor, they took care of themselves owned their homes and did not need an economy at all.

In the Weimar Republic control over the money supply was abused resulting in worthless currency and loss of control over society, “hyperinflaction”

So in those times inflation and deflation where absolutely real, but could only happen if the currency used was so called ‘fiat’, easy to make with no significant intrinsic value. The way things could go wrong with gold and silver was that a lot of it was suddenly discovered or a government taxed to much so the economic web desintegrated.

Oil entered the mix and economists like you to believe ‘its just a commodity’. It is not. It has become the engine of everything.

Fast forward to today, around 1900 oil was discovered in Iran and Saudi Arabia, also in the US, the internal combustion engine was invented and industrialization happened with many significant inventions. The role of banks changed, not even because paper money was accepted but because oil or its derivatives was beginning to be used in every activity. This was an active process. The oil and gas people wanted to sell oil and gas. The banks liked the cashflow. Slowely they realized the enormous difference in the way the ‘economy’ could work with fossil fuels. Modern ‘free market capitalism’ was invented and sold to the masses as the best way to achieve wealth for all.

If everyone spends money on a product, but the producer does not spend that money back, you get deflation.

But the first oil economy picture was incomplete, and so I made the implied money flow explicit in the above image. As you can see money flows to the oil supplier. And it stays there. The oil supplier has way more income than it needs. If it “spends” it on say a car, the car maker will use oil to make another car. So the money ends up back with the oil producer!

In an oil based economy money is constantly removed from circulation, there is constant “deflationary pressure”. Banks –have– to manage this somehow.

This oil based money system has no room for gold or silver, clearly all gold and silver will end up with the oil producers! So Nixon went off the gold standard, which was an enormous victory for the banks, but also for the people because now every drop of oil could be used to improve lives, most of which sucked (not even looking at Europe or elsewhere) at the time.

Nixon gave banks the power to strategically use their ability to distribute fuel (by lending currency) in the economy to consolidate and increase their grip on all cashflow. They had in their arsenal ‘economic thinking’, the Federal Reserve Bank, no gold standard, fractional banking. The deal was “a bank gets a small cut of any business” but banks soon decided they wanted to have it all, and the unrelenting oil supply (and Wallstreet’s ability to defend control over it for instance by stealing the money back from Saudi Arabia) meant banks could conquer our planet. Imagine, people with no other usefull occupation than keeping track of a currency without any intrinsic value maximize the oil supply to the world in order to control more of it.

With oil supply as a factor inflation and deflation now had more levers and the risk for it was higher. Also because there was no anchor for the value of a Dollar you could have inflation without real problems or with (for instance if the oil supply stopped). The Dollar became a floating currency. Rules had changed:

One barrel of oil 100 USD => Makes 50 sneakers =>2 USD per boot

One barrel of oil 200 USD => Makes 50 sneakers => 4 USD per sneaker

Now if wages follow the above change, so you suddenly make 400 a week instead of 200 before, the above price change has no effect. So it is inflation of the currency, but there is no real downside. Banks however don’t like it. They want constant prices because changing prices make people reconsider deals. Houses bought with a mortgage suddenly become easy to pay off. Inflation would hand a lot of power to the people, especially the essential ones.

(For banks) Prices need to remain constant to avoid renegotiations and loss of control through their applied debt load

But a stark difference with the old economic system is that NOBODY can make oil or gas. Also EVERYBODY consumes oil and gas. Getting oil out of the ground is not “making oil”. Oil is being destroyed at a constant rate and it can NOT be recovered except in hypothetical synthesis processes that no normal participant in the economy has on hand. NOBODY can make what EVERYBODY needs. And banks made it so you can only get your hands on it if you borrow their money.

Soo to sum things up : Inflation and deflation can not happen in the current money system because banks guard price changes by –and this is the key– making sure the amount of currency in circulation tracks the amount of oil available for production (or the amount of products).

Banks manage this by both influencing the expectations of people and by printing money or becoming more strict lenders. It is very easy for the banks to say “We think the economy will shrink” and then just stop lending, causing the economy to shrink!

Now there are two factors that are a problem to the above management (and resulting ownership) of our economy : Renewables and Crypto. They are not related but they both mess with the system. First Crypto :

Adding crypto to the economic system has different effects on different parts of the economy

If you add cryto currencies to this system you are increasing the money supply but not increasing the oil supply. You are also reducing the control of banks over prices because the crypto never leaves circulation while fiat money is constantly created and destroyed (payment for debt). The litmus test of this truth is that oil companies do not accept crypto. If anything oil companies are cashing in fiat from people that buy energy to mine crypto coins. If they would accept crypto coins they would be mining themselves!

So crypto can circulate besides fiat (fossil energy buying) currency but it is hard for products to be sold in crypto because they are not produced using crypto (their fossil input directly or indirectly). There is a group of products and services that is not created using fossil energy, like organic food, solar energy, wind energy, and some jobs (but most require the provider to live in a home and eat so indirectly still require fossil buying currencies). So crypto can only circulate in parts of the economy that do not require fossil energy.

One scenario though is that oil companies unite and create their own cryto coin, which you could think would become dominant immediately, but no, because fossil energy is not everywhere (even though we are made to think that). Prices and supply vary wildly. It is important that local banks manage local prices. This is an argument against a shared currency (the Euro/Dollar) even though you can take measures to make them work better.

Three tier economy

The above picture shows the ‘Three tier economy’ as I may call it. In it fiat currencies like the USD and EUR function for fossil driven activities and the people that perform them. For the fiat currencies inflation and deflation will remain at the whim of banks.

Then there can be controlled crypto that can be used to by specific assets or goods or services, probably not oil unless it is an oil industry coin (say AramcoCoin). Because confusion makes people think banks will try to avoid this at all cost. The more bank fiat is used the more control they retain. Oil companies are placated to agree.

Then the third tier consists of groups, communities, perhaps cities, provinces and even countries that decide they will use their own crypto coin instead of fiat. This is imaginable in small african countries on the largest scale. The condition is that the currency circulates amongst the members and never ends up at a bank or a fossil energy supplier. It can end up (and be created) by a renewable energy supplier, as that supplier delivers the energy to make products and allow services to be rendered.

A ‘climate coin’ could be sold by energy producers (or handed out by the government as basic income) so that people can buy energy to make products and render services. This coin would not see inflation or deflation if the quantity is manage vis a vis the energy production capacity.

So if your city owns a huge solar power plant it can pay people with electricity tokens and these can circulate to make people do all kinds of usefull things for each other. But they can also be used to pay for products like purified water (if that process is 100% electric). Farmers can use such coin to buy fertilizer made with electricity, or use the currency to power their farm equipment. In essence it functions just like the fossil economy with fiat, the only difference is that the amount of energy is finite (in the beginnning). The good thing about that is that there will be no inflation or deflation as long as energy production keeps pace with its consumption. This requires planning, but you can basically “size the battery to the device” so to say.

The answer to the question “Is Crypto Inflationary of Deflationary” can thus only be answered if we know what rules the crypto will follow. As long as crypto can function at the margin of a fiat system it will lead to inflation, because you can buy a thing with more types of money. The value of the USD will drop because there’s also Bitcoin and Ethereum and Tron to buy stuff. But it is not likely sellers will except these crypto currencies if they can not buy the energy they need to produce the products! As a result the value of these coins can inflate while the USD value deflates after a period in which producers who accept cryto learn this truth.

If a group of people decides to only accept a specific crypto coin as payment for their services, that coin can experience serious deflation. Just like you see with Bitcoin, if people think they need it its value explodes. If you want a PHP developer you need to pay in PHPcoin. Suddenly anyone owning PHPcoin is a rich man! Again this only works if the PHP developers can pay for their own way in PHPcoin. This is imaginable because they could sell their coin for practically any other currency. In essence what happens is that all the worlds PHP developers take the world that needs them hostage through demanding use of their coin. This could happen to many professions, it is happening (somewhat) with Dentacoin, a currency to pay for dental care.

For most coins that have no system that requires them their value remains free floating, based on mythology. There are more factors at play but belief in a coin, its marketing hype and its use are all important factors. The desire to own them however seems to remain speculative (I accept Tron because I think it will become more valuable). Only when you connect a coin to a real world activity or asset (like energy) can you expect it to develop a stabile value.