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If bitcoin were a real currency, hyperinflation would be here. The recent cryptocurrency convulsions would easily meet the definition. Bitcoin’s loss of purchasing power since its peak on October 6 would be equivalent to an annual inflation rate of 900 percent. This sudden drop in value from $125,000 per bitcoin to around $82,500 last Friday demonstrates the fatal flaw that prevents crypto from being a real currency.
The supply of a specific crypto-token is limited by design. Central banks, the producers of current currency, operate under no such constraints. Theoretically, they can print as much money as they want, but if they do, they destroy the value of the currency they issue. The problem for advocates of “crypto-currency” is that they see the world with one eye closed.
The value of any currency never depends on a rigid control of the money supply. The most basic economics text will tell you that all value depends on the balance of supply and demand. To ignore the demand for money is to achieve disaster, because the demand for money is not stable.
The first issuers of paper currency understood the importance of the demand for money. In 10th-century China, paper currency was introduced with a simultaneous legal requirement that taxes to the government be paid in paper. This immediately created a demand for paper currency along with its supply, which gave it value. As long as the supply and demand for paper currency were balanced, value was maintained. When the demand for the new paper currency fell below what the government chose to supply, inflation and hyperinflation were the inevitable result.
Cryptocurrencies lack the government-imposed requirement for money represented by tax payments. Even the crypto-friendly Swiss canton of Zug does not accept crypto directly for tax purposes. The canton has tax obligations denominated in Swiss francs and accepts Swiss francs and only Swiss francs for settlement. Zug will help people who want to sell crypto buy Swiss francs to settle their tax obligations, through a partnership with the private company Bitcoin Swiss (to which the individual taxpayer must pay a 1% conversion fee on their tax liability). And, of course, someone who wants to settle their tax bill by converting crypto to Swiss francs today will have to find a lot more crypto to sell than they would have been the case a few weeks ago; the Swiss franc liability is fixed, the amount of crypto to be converted is not.
This lack of automatic demand for cryptocurrencies is a problem, but not the fatal flaw that prevents cryptocurrencies from acting as currency. The flaw is that the supply of bitcoins can only increase, not decrease.
As the pandemic receded, the demand for real money (liquidity) fell in many countries. Central banks noticed this and reduced the money supply. While it is debatable whether they were quick enough to reduce the supply, they did reduce it. The money supply in the US fell by 13.6% from peak to trough. The European Central Bank reduced the money supply in the Eurozone by 12.8% and the Bank of England withdrew more than 15% of the sterling money supply. This response to a marked decline in money demand prevented a more serious episode of inflation.
Conversely, the supply of cryptocurrencies cannot decrease. It is true that cryptocurrencies can be lost, for example by carelessly forgetting how to access a wallet. But random accidents do not allow for the required flexibility of the supply of cryptocurrencies. Last week's plunge into cryptocurrency hyperinflation was due to the fact that demand for cryptocurrencies fell - and the supply could not fall at all.
There is a parallel to cryptocurrencies after the 14th century bubonic plague in Europe. The population fell. Fewer people meant fewer transactions, requiring less currency. As the demand for money fell, the supply of currency did not respond, remaining (broadly) stable. The result was rapid inflation.
Falling demand for money could become a more frequent occurrence in the future. Roughly half of the world's GDP is generated in economies with declining populations. Demand for money should grow more slowly, with occasional negative growth. Central banks can react to this. Cryptocurrencies cannot.
Central banks only generate hyperinflation through extraordinary policy incompetence (Germany in 1923) or a deliberate political decision (the Soviet Union from 1917 onwards). At that point, fiat currency ceases to be a currency. The inability of cryptocurrency supply to respond to falling demand means that the risks of hyperinflation in cryptocurrencies are built into the design. This disqualifies cryptocurrencies from any claim to be a currency./ FinancialTimes
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