Inflation In Bitcoin & Tezos

There’s a popular narrative that Bitcoin is deflationary and thus superior to any proof-of-stake based cryptocurrency since they are all inflationary. “Superior” meaning its value will increase over time due to increased scarcity.

This is not true, Bitcoin features inflation just like Tezos and most other cryptocurrencies to secure the network. In order to designate who gets to create the next block, Bitcoin miners solve a complex cryptographic puzzle (work), and the first one who finds the answer can create the next block. Proof-of-work simply references the amount of electricity that was used to find the answer to the puzzle.

The current reward for finding the answer and creating a new block is 6.25 BTC, which means that the supply is increased by 6.25 BTC every ten minutes and the miners have to sell this block reward in order to recoup their costs, suppressing the price. With a Bitcoin supply of 18.6M BTC, this results in inflation at about 1.8% per year, which will continue at this rate at least until 2024. At a price of $50,000 per BTC, the inflation denominated in USD is roughly $16,000,000,000 per year.

What’s worse is that a significant share of this inflation goes toward electricity costs, the main fuel for proof-of-work algorithms. Digiconomist estimates that Bitcoin miners use $3,900,000,000 worth of electricity annually, or 37 megatons of CO2 – comparable to the carbon footprint of New Zealand. 

Proof-of-stake cryptocurrencies, like Tezos, also have inflation. This is also used to secure the network, by creating a block reward that is given to validators. The big difference is that a validator is chosen randomly based on the amount of stake, funds designated to secure the network. A validator can use a very power-efficient computer, like a Raspberry Pi 4, which means that even with around 400 active bakers (validators), the electricity usage is negligible compared to Bitcoin.

Funds used for staking can’t be used for anything else, but as long as they are used for staking it basically works like getting interest. From a purist viewpoint, you avoid dilution by staking, but as long as XTZ (the native token on Tezos) will keep its value against comparable crypto and fiat the net result is similar to interest.

The current inflation rate for Tezos is 4.87%, and with around 77.5% of the available supply used for staking the rewards hover at around 6%. Just like with Bitcoin the staking rewards are fixed per block, so the rewards expressed as a percentage will reduce over time.

It was with the third reward era (after eight years, each era is about four years) that Bitcoins inflation rate became less than that of Tezos. At first, Bitcoin had something that resembled hyperinflation, used as a distribution mechanism. Tezos had a well-diversified genesis allocation based on an open crowdsale instead. After this initial period, both blockchains have relatively flat inflation curves that will stay that way for many years.

To sum up, after getting up to speed, Bitcoin and Tezos have inflation profiles not too different from each other. But Bitcoins inflation is mainly used to cover costs and electricity for miners, while Tezos rewards goes towards its holders. Tezos is not only green, it’s the token holders who help secure the network and are rewarded for doing so.