Understanding Currency Debasement, Inflation, and Bitcoin’s Limited Supply

As you probably know, bronze, silver, and gold have been used as currency throughout most of human history, usually in the form of coins. What you might not know is that the amount of bronze, silver and gold in those coins was gradually reduced over time. Take the denarius, for example. The standard Roman silver coin was initially created with almost pure silver, weighting around 4.5 grams. Julius Caesar reduced the silver amount to around 4 grams, and Nero further reduced it to 3.7 grams per coin. The coin continued to shrink in size and purity, until reaching only 0.2 grams of silver in the third century.

The practice of decreasing the value of a currency is called debasement. Why would a government want to do that? Usually is to create financial gains for the government itself, at the expense of the purchasing power of people who own that currency. For example, by halving the amount of silver on each coin the Roman government would be able to create twice as many coins as before for a given amount of silver. If such a government had debts, it would now be able to pay twice as much of that debt. When the increased number of coins hit the market, however, prices would tend to rise, and owners of that currency would now be able to purchase fewer goods. The general increase in price levels across an economy is called inflation. Increasing money supply (which is connected with currency debasement) will almost always create inflationary pressure because there will be more money around chasing the same amount of goods, so merchants will gradually increase the price of those goods. This was true in the time of Julius Caesar, and it remains true today.

Crypto Currencies with Limited Supply

Bitcoin and similar crypto currencies have several benefits (e.g., digital, decentralized) but perhaps the most important one is their limited supply, which is programmed into the system. The maximum number of bitcoins that will ever circulate, for example, is 21 million. Today around 80% of that supply is already in circulation, and the remaining 20% will be mined over the coming years at a predetermined rate.

The result of this limited supply is that the currency should not lose its value over time. Once the 21 million bitcoins are in circulation no one will be able to create even a single new one.

Bitcoin’s original and main goal is to create a decentralized digital currency that can be used it for everyday transactions like buying a cup of coffee. Given its limited supply, however, it might also become one of the best assets to store value.

Obviously crypto currencies are still very new and a kind of financial experiment. No one knows if they will succeed, and even if they succeed, no one knows yet how much 1 bitcoin should be worth.

Should they succeed, however, their limited supply will certainly contribute enormously to keep their value over time.

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