The Non-Inflationary Bitcoin Fallacy

There is a theory that market production of money is not inflationary because its production consumes goods equivalent in value to that of the newly produced money. This cannot be the underlying explanation for the non-inflationary production of market money because the overall impact of a simultaneously increasing quantity of money and decreasing quantity of goods would be a general increase in prices. The essence of the fallacy is the notion that because there is no seigniorage in market money production, there can be no monetary inflation. This is only coincidental because before Bitcoin there never was a money in which the cost of production is a function of the price.

The consumption of goods in the process of production is not the key to the non-inflationary production of market money. It is just another way of stating that the production is competitive, but this alone is insufficient to make the production non-inflationary. This consumption of goods in the process of production occurs within the context of demand for the product (money) itself and the available supply of "representation" goods. The profitability of all physical production continually regulates the rates of production. With physical production, the cost will tend to rise to reach the price, but the cost will not tend to fall in response to falling price as it does with Bitcoin, and production can slow down or cease.

A change in mining profitability can temporarily change the rate of Bitcoin production, but this change will be soon offset by the difficulty adjustment. As the rate of coin production tends to be stable, the increasing quantity of coin and decreasing quantity of goods as they are consumed in the production of Bitcoin will exert inflationary pressure that can only be offset by an increase in the quantity of goods. The decrease in production of Bitcoin in its issuance schedule reduces the inflationary pressure over time. The continual reduction of the inflation rate has an exponentially diminishing impact over time, contrary to the expectations of the Stock-to-Flow model.

The stability property of Bitcoin does not offset the inflationary pressure from its production. The stability property is derived from the limit on the overall utility of the coin due to the utility threshold. It does not prevent the dilution of one unit of coin as more units come into existence.

In the larger context of a new digital coin emerging in the market, this production of a new chain is regulated by demand and is therefore not inflationary. However, the production of new units of coin within an existing chain is inflationary because its rate is not determined by demand for coin. In the case of a monopoly money, the rate is driven by political interests, and in the case of Bitcoin, it is established by consensus among participants in the network.