Inflation happens when the currency value falls but the prices of goods and services increase in the market. As a result, you have to spend more to buy the items you need. Inflation is also related to the supply of currency. If the government introduces more currency in circulation, it will lead to a spike in market prices.
Cryptocurrencies work differently. Though they are not part of the financial mainstream yet, their prices still affect inflation in the market. To understand how the price of Bitcoin affects inflation in the markets, you need to understand what determines the Bitcoin prices.
What Determines the Bitcoin Prices?
Unlike conventional currencies, Bitcoin is not backed by governments or issued by central banks. Hence the economic growth measurements, inflation rates, and monetary policies that affect the traditional currencies do not concern Bitcoin. The following factors influence the price of Bitcoin.
- The market’s demand for Bitcoin and the supply
- Cost of producing a Bitcoin through the mining process
- Rewards that are issued to Bitcoin miners for confirming transactions to the blockchain
- The exchanges on which Bitcoins are traded
- Number of competing crypto-assets
- Internal governance
- Regulations governing the sale of Bitcoins
Understanding the Supply and Demand Model of Bitcoin
The Bitcoin protocol for mining allows miners to create new Bitcoins at a fixed rate. When the miner’s processes block transactions, new Bitcoins are created. The rates at which Bitcoins are mined are designed to slow over time. For example, the mining rate, which stood at 6.9% in 2016, slowed down to 4.4% in 2017 and 4.0% in 2018.
The decreased rate of Bitcoin mining can be attributed to the division of the block rewards offered to miners. It can be termed as artificial inflation for the cryptocurrency system.
Once all 21 million Bitcoins are mined by 2140, the Bitcoin price would be determined by the practical uses and legality of the cryptocurrencies. If Bitcoin is legal for many transactions, the demand will increase, which will drive the prices higher.
After 21 million Bitcoins are mined, the block rewards offered to miners will not affect its price. The cost of production is an essential factor in determining the Bitcoin prices. Though a virtual currency, Bitcoin is still produced with some cost of production. The electricity consumption during the mining process is a crucial factor in the Bitcoin price.
Do Bitcoin Prices Affect Inflation?
Unlike US dollars, Bitcoin is designed to have a limited supply. Hence, central banks or governments cannot decrease their value by distributing too many of them. According to the Bitcoin blockchain protocol, only 21 million Bitcoins can be mined by miners. A lot depends on the market sentiment that floats in the cryptocurrency market.
Once the miners unlock all Bitcoins, the developers would tap out the planet’s supply of Bitcoins. As per recent data, as of February 24, 2021, 18.638 million Bitcoins have been mined. It means only 2.362 million are yet to be mined. Once all Bitcoins are mined, they will become deflationary, and no one can issue more of them.
Bitcoin and inflation have a unique relationship. Though there is no direct connection between them, the rise in inflation has led to a sharp increase in Bitcoin prices. When there is inflation, people look for investment options that will keep their purchasing power intact. Bitcoin is considered “physical gold” by investors, and its value is expected to remain intact despite global inflation.
As inflation increases and investors look towards Bitcoins as a safe investment option, Bitcoin prices are only expected to rocket in the near future.
To sum up, these are different factors that affect Bitcoin prices and how it reacts to inflation.